10 May 2000 • Economic Integration, Specialisation and the Location of Industries. A Survey of the Theoretical Literature • Yvonne Wolfmayr-Schnitzer

European integration and global competition can be expected to have important consequences on the industrial specialisation of individual EU countries as well as the location of industrial activities within Europe. Generally, from a policy point of view, for given endowment and/or technological differences across countries, greater specialisation and a higher degree of division of labour will enhance efficiency and competitiveness and therefore be beneficial. On the other hand, specialisation in narrow product groups may increase the exposure to fluctuations of demand for individual countries. Another policy concern has been the possibility that locations and countries with optimal market access may benefit earlier and at a greater rate from economic integration, strengthening the imbalance between a rich core and a poor periphery. The article gives a survey of the most important predictions of economic theory on these issues which can be summarised as follows:

For given endowment and/or productivity differences across EU countries, intensified integration and global competition are predicted to increase specialisation according to comparative advantage. The higher income countries are predicted to specialise in capital-, technology-, skill- and research-intensive industries. If endowments and productivities converge – as is a natural prediction for a single market with perfect factor mobility – and industries are characterised by constant returns to scale, specialisation is forecast to decrease.

High income countries will concentrate on industries with high levels of product and process innovation, driven by forces on the demand side (new products and greater variety are demanded) and the supply side (innovation rents and the capacity to make use of technological opportunities). In industries where product differentiation is important, countries specialise in products in the upper quality segment. Countries with similar incomes, factor endowments and technologies engage in intra-industry trade.

Economic geography models focus on the forces of agglomeration and dispersion. Economies of scale are as essential to these models as are transportation costs. Their main focus is on regions or locations, not countries, on the share of production, not trade, and finally, on differences in market size and demand structures. Economic geography highlights the possibility that locations and countries with optimal market access may benefit first and more strongly from economic integration. In the presence of transportation costs, industries for which increasing returns to scale are important locate near the largest market. These are likely to produce technologically advanced, innovative, new products which involve a high share of fixed costs due, e.g., to R&D investments. Through agglomeration economies, the geographic concentration of economic activity can then become a self-reinforcing process. The periphery specialises in low wage industries and mature products, in industries with less product differentiation and limited spillovers. Eventually this process of agglomeration is forecast to reverse, however, if factor prices rise faster in the centre, if diseconomies of agglomeration emerge and if economic integration reaches a sufficiently low level to make a given cost difference between the core and the periphery more decisive.