Different models for regional integration: Lessons from total factor productivity in Europe

As the countries of Europe have successfully managed to move the region's integration forward step by step, the European experience offers three possible models for regional integration with different depths: a free trade arrangement, a single market, and a common currency area. In this paper, we examine the effect of these three different models of regional integration on total factor productivity (TFP) to assess the long-run growth implication of each model. Our findings suggest that joining a regional grouping changes the way participating economies grow, no matter which model of regional integration is used: domestically powered growth becomes less important, and regionally powered growth becomes the new source of growth. As existing theory identifies knowledge creation and its spillovers as key drivers of economic growth, regionally powered growth is expected to become relatively more important with a higher level of intra-regional dependence on research and development (R&D) spillovers. Of the three models for regional integration, the free trade arrangement is found to be the most effective in promoting intra-regional dependence on R&D spillovers. We find that largely negative windfall effects on TFP are associated with the other two models.