Regional Integration, Firms’ Location and Convergence: An Application to the Euro-Mediterranean Area

FEM33-01 | November 2009

Title

« Regional Integration, Firms’ Location and Convergence: An Application to the Euro-Mediterranean Area »

By

Nicolas Péridy (Université de Nantes, Laboratoire d’Economie de Nantes, France)

Contributeurs

Corinne Bagoulla (Université de Nantes, Laboratoire d’Economie de Nantes, France), Ahmed Ghoneim (Cairo University, Faculty of Economics and Political Science, Egypt)

Note :

This document has been produced with the financial assistance of the European Union within the context of the FEMISE program. The contents of this document are the sole responsibility of the authors and can under no circumstances be regarded as reflecting the position of the European Union.

Summary :

1. Stylized fact about regional integration, firms’ location and convergence

a) Regional integration and trade patterns

– The Barcelona agreement is often questioned about its effects on trade and convergence. The factors which explain this modest performance can be found in the lack of deep integration, long transitional periods, the high propensity to agricultural protectionism in the EU as well as the modest levels of the funds provided by the EU to MENA countries.

– Although it is too early to assess the effects of the Union for the Mediterranean (UMed agreement), the UMed main contribution relies in the new institutional setup designed to govern this initiative. It includes a co-presidency, a joint permanent committee as well as a secretariat. On the other hand, the main pitfall of the UMed is the dilution of the Barcelona process, notably through the large number of countries involved compared with the Euromed agreement, but also through the addition of vagueness and complexity in the decisions.

– The analysis of trade patterns since the implementation of the Barcelona agreement reveals that there has not been much change in the export and import structure of MENA countries. In particular, trade diversification and the geographical orientation of trade have not changed a lot.

– Both MENA countries and EU experience similar trends and levels of the contribution of manufacturing to their economies in terms of percentage of exports, employment, and GDP. However, the indicators revealed that MENA countries differ significantly from EU countries in terms of the products and sectors in which both sets of countries are specialized in, with MENA specialized in low technology products and EU specialized in high technology products.

 

b) Industrial structure and location

– MENA countries exhibit a significant share of industrial value added in GDP (from 27% for Turkey up to 36% for Egypt). This is more than in EU countries. However, high technology industry only account for 1/3 of industrial production in MENA countries, against 50% in EU countries.

– The calculation of concentration indexes show that MENA countries’ industries are more concentred (especially Tunisia, Morocco, Jordan and Egypt) than in the EU (except Ireland, Greece and Finland). Moreover, this concentration process has been reinforced in the past 2 decades in MENA countries, contrary to the EU. A breakdown by industry shows that concentration is particularly significant in low-technology industries, especially pottery, plastic, footwear, leather, textile and tobacco.

– The estimation of a model of economic geography shows that firms’ location in the euro-mediterranean area depends on:

* Labour costs. Hence, the low labor costs observed in MENA countries explain to a large extend the concentration of labour-intensive industries in these countries.

* Supply access. The higher the supply access, which measures the proximity to inputs, the higher the concentration process.

* Market access. The better market access (due to a large country size), the more firms are incited to locate in these markets. In MENA countries, the small size of their markets reduces concentration. Firms tends to concentrates in the EU because a a more favourable market access

* The quality of infrastructure and on business environment is also a key variable for explaining firms’ location in the euro-mediterranean area.

* The level of technology also matters. The lower the technology level, the higher the concentration process.

* Finally, openness as well as regional integration generally promotes concentration, as it makes easier market access.

To sum up, the high concentration level observed in MENA countries can be explained by their low labour costs, their low-technology industrial specialisation, their efforts in openness and regional integration, infrastructure and business environment as well as the proximity to inputs (supply access). However, their detrimental market access leads to a reduction in firm’s concentration in Mediterranean countries.

c) Evolution of GDP par capita

– Looking at per capita GDP growth as a first insight about convergence, it is striking to observe that over the period 1960-2007, the per capita GDP growth in MENA countries (MENA) is slightly above that recorded for the EU (EU-6 and EU-15), whatever the GDP indicator used. However, this result masks significant differences across countries. As a matter of fact, countries like Tunisia, Morocco as well as Egypt show per capita GDP growth rates well above that of the EU. On the other hand, Algeria shows growth rates well below the EU average, whereas for Turkey and Syria, it is similar to that of the EU.

– Considering changes over time, it is worth mentioning that the EU per capita GDP rate of growth is declining over time whatever the indicator considered. Regarding MENA countries on the other hand, this rate of growth declines first before recovering in the last period. This means that in the first period (from 1960 to 1994), the MENA rates of growth are generally lower than those recorded for the EU before becoming above that of the EU from 1995 onward.

– Again, there are some differences across countries. Tunisia, Turkey and Jordan follow this general declining-recovering trend, whereas Morocco, Egypt and Syria show a declining trend over the whole period. As a result, these differentiated trends modify the ranking of the countries in terms of GDP growth over time. As a matter of fact, taking the most recent period (1995-2007), the best performance is recorded for Tunisia and Turkey (increasing trend), still followed by Egypt despite its declining trend. These three countries are above the EU average. On the other hand, Morocco moves from above to EU-average (declining trend), Syria moves from above to below EU-average. Algeria and Jordan generally remain below the EU-average.

– A final interesting set of statistics relates to the comparison of per capita growth rates with the four cohesion EU members (Greece, Spain, Portugal as well as Ireland). Over the whole period, it is obvious that these four countries perform better that MENA. In fact, Tunisia only approaches these growth rate levels. However, the evolution over time changes this picture to some extent. As a matter of fact, the growth gap between MENA and cohesion countries is very significant in the first period. However, this gap is narrowing in the second and last periods. In 1995-2007, the per capita GDP growth in MENA countries becomes greater than that of Portugal and approaches that of Spain (this is particularly true for Tunisia, Morocco, Egypt and Turkey). The gap is only increasing with Ireland, which takes advantage of the growth waves in the financial economy.

 

2. Analysis of convergence indicators

a) The calculation of s-convergence does not establish that the MENA countries have converged toward EU per capita income levels, except in recent years for specific countries, such as Tunisia, Turkey as well as Egypt and Morocco to a lesser extent. These results contrast with cohesion countries, especially Ireland, Spain and Portugal which show a rapid convergence process to the EU-6 per capita GDP levels. There is also evidence for divergence within the Euro-Mediterranean as a whole, despite a stable value of s in recent years. Finally, there is no evidence of convergence across MENA countries.

b) However, the absence of s-convergence does not mean an absence of convergence process. This is why the g-convergence indicator, based on the country ranking of per capita GDP, can be used together with the s-convergence to infer about b-convergence (Boyle and McCarthy, 1999). In this respect, the g-convergence analysis is generally supporting convergence between MENA countries and the EU. Another difference is that the g-convergence also supports a slight convergence across Mediterranean countries, whereas s was constant. In spite of these differences, the relative performance of the countries is unchanged whatever the convergence indicator used. As a matter of fact, the best performance in terms of convergence is that of Tunisia, followed by Turkey and Egypt. Morocco and Syria are in a intermediate position, whereas Algeria and Jordan are diverging whatever the convergence indicator used.

c) The calculation of b-convergence supports the previous results, showing some evidence of convergence between MENA countries and EU per capita GDP levels, whatever the way GDP is measured and whatever the estimator chosen. This result is also valid whatever the EU reference countries used (EU-6 or EU-15)

d) More detailed results a country level indicate that b-the convergence hypothesis is clearly accepted (at 1% level) for Tunisia, Turkey, Egypt and Morocco. It is barely accepted for Syria (10% level) and clearly rejected for Algeria and Jordan. These results correlates those previously found with the other convergence indicators. In addition, the hypothesis of convergence within the MENA region is also accepted in all cases. Finally, the convergence hypothesis is also supported for the whole euro-mediterranean area.

e) The calculation of convergence for Human Development Index (HDI) levels complements the results previously found with GDP per capita only. In this regard, it can be argued that i) the convergence process between the Mediterranean countries and the EU is well established for the HDI; ii) Tunisia, Turkey and Egypt remain the countries which show the greatest convergence rates; iii) the euro-mediterranean area is also converging as well as HDI within the MENA area.

 

3. The determinants of convergence

a) The initial income level is a first determinant of growth and convergence in MENA countries. In this regard, these countries are globally converging to the EU level over the whole period, conditionally to the other independent variables included in the model. This result correlate those found with the non conditional b-convergence calculated the previous section.

b) Some other variables are also very significant. These are first education and R&D, which both significantly contribute to growth in MENA countries. Second, transport and communication also play a determinant role for explaining convergence. As a matter of fact, roads, telephone lines and even internet show all a positive and significant sign whatever the estimator.

c) Trade, specialization and economic geography also matter. Indeed, inter-industry specialisation tends to reduce growth in MENA countries, essentially because MENA countries are specialized in low value added products. For the same reason, the agglomeration of economic activities is detrimental to convergence. In regard, it is also interesting to observe that the variable related to the share of primary exports has a negative impact on convergence. Openess and FDI are a necessary but not sufficient condition for convergence.

d) The Barcelona agreement has no direct impact on real convergence of MENA countries toward EU income revels. However, the EIB loans positively contribute to the convergence process of MENA countries.

e) Amongst the remaining determinants, the share of government consumption in GDP has an expected negative impact on convergence. This can be explained by the fact that public consumption is financed by distortionary taxes which reduce the growth rate (Sala-i-Martin, 2004). However, the share of public sector investment in GDP has a positive impact on convergence. This result supports the role of public investment in MENA countries, especially concerning transport, infrastructure and technology.

 

4. policy implications

a) Given the primary role of human capital and education for explaining convergence in MENA countries, these countries should pursue their efforts in this field. In this regard, it is worth mentioning that some MENA countries have made significant efforts in the past decades. As a matter of fact, the secondary enrolment rate, which was below 50% in most MENA countries before 1990, has reached in 2005 more than 75 % in Turkey (76%), Tunisia (83%), Egypt (86%), Jordan (88%) and Algeria (83%). Significant progress has also been made in Syria and Morocco, although this rate is still below 70% in these countries. This progress must be pursued in the coming years in order to reach the 100% rates of developed countries.

b) Similarly, given the importance of R&D for explaining growth, MENA countries should go on investing in this field. Some countries have already done significant progress in recent years, especially Tunisia, Turkey and Morocco. In these countries, the R&D expenditures approach 1% of GDP. This is close to the levels reached in Southern EU countries, but still far from those in France and Germany (greater than 2%) as well as Sweden and Finland (more than 3.5%). However, Algeria, Egypt, Jordan and Syria exhibit rates which are lower than 0.35%. These countries should make considerable efforts in the coming years to improve their research capacity as a means of catching up the GDP per capita gap with the EU.

c) MENA countries should also continue to invest in transport and communication. For instance, Turkey, Tunisia, Jordan and Morocco have significantly improved their roads and developed highways and other transport infrastructure. These countries (including also Egypt) have also considerably improved the telephone access, with more than 100 telephone lines per 1000 inhabitants. The internet access is also progressing. As a matter of fact, in 2005, Morocco enjoyed 24 internet users for 100 people, Jordan 23, Tunisia 17.  However, these countries still remain far from EU levels (generally greater than 50 users per 100 people). As a result, investments in this area must be a priority. This remark applies particularly to Algeria, Egypt and Syria which generally show a wider gap with EU levels. In this regard, the econometric results showed that public investment play a significant role in the convergence process. This means that governments must give priority to public investments in the areas above mentioned (R&D, education, transport and communication), even if public investment must be complemented by private investment.

d) MENA countries should also continue to open their economies even if openness and FDI are not sufficient conditions for growth. In addition, these countries must change their specialization process toward more high-tech (value-added) products more similar to international demand. As a matter of fact, these countries still face a detrimental specialization process which is growth-reducing simply because of the nature of the goods involved. In addition, the geographical concentration and agglomeration process is also detrimental to growth for the same reasons. A move toward higher value added industries specialization and concentration process would change this detrimental relationship by promoting growth. Again, the development of education and R&D and more generally human capital may be helpful for the change in this specialization process.

e) Finally, we have seen that also the Barcelona agreement has not made it possible to directly stimulate convergence. However, the EIB loans have significantly contributed to convergence. As a result, the EIB loans must be encouraged and developed, especially for projects in line with human capital, transports and infrastructure. The contents of the Barcelona program should also be reconsidered in the light of the Union for the Mediterranean so as to include more growth-creating projects.

f) As a final point, some countries still face detrimental demographic and migration indicators. The case of Jordan is particularly significant. Indeed, the population in this country has increased much more than in the other MENA countries, i.e. from 3 to 6 million inhabitants since 1990. This is due to both higher natural increase and also the inflow of foreign population after the two Gulf wars (especially from Iraq).  As a consequence, this country must mechanically enjoy a much higher GDP growth rate for the same GDP per capita growth. Although economic theory does not directly relate population growth to standards of living, Jordan is likely to be negatively affected by population growth, partly due to the inflow of migrants. Syria and Egypt also face a high growth rates (more than 2% each year) though it is not due to migration. Still, these countries should also accelerate their efforts to control the population growth.

g) This research is a first step for understanding the growth and convergence process in MENA countries. Despite considerable efforts to build up a comprehensive database over almost 50 years, this research is still limited by the lack of data for some variables and by the use of sometimes rough proxies. It also failed to adequately show the precise impact of particular variables, such as corruption, colonization, cohesion funds… Future research can be conducted to focus of the role of specific variables.