EUROPEAN COMMISSION
DIRECTORATE GENERAL
ECONOMIC AND FINANCIAL AFFAIRS
RISING INTERNATIONAL ECONOMIC INTEGRATION
Opportunities and Challenges
September 2005
1. Introduction
Public perceptions of how rising international economic integration affects the EU economy
are often beset by anxieties concerning job losses and downward pressures on wages and
working conditions, with potential detrimental impact on economic well-being. Fears appear
to be running strong, in particular in the EU countries where wages are highest, that increased
import competition from low wage countries puts too much pressure on local producers and
workers; import penetration of products from countries endowed with cheap labour may
render domestic industries uncompetitive, enforce the closing of factories or parts of them at
home and induce the re-location of plants and operations abroad. Clearly, such perceptions of
the impact of “globalisation” fuel widespread anxieties that this process will be associated
with rising employment and earnings insecurity, or may even lead to a mass-exodus of wellpaid jobs in high-wage countries and induce a “race to the bottom” which is deemed as
inescapable by many.
These concerns are not new, of course, given the rapid pace of international economic
integration in recent decades as reflected in the steadfastly growing volumes of world trade
and foreign direct investment. However, more recently, a number of factors appear to have
heightened public apprehensions about the negative impact of the increasingly open character
of the EU economy.

The pace of international economic integration has accelerated in the second half of
the 1990s and new key economic players, such as China and India, have emerged at
the world trading scene. The new international trading partners are endowed with a
large labour force and, when compared with other episodes of emerging developing
countries, with relatively high technical capacities. Moreover, a lower wage than
elsewhere constitutes an even more attractive competitiveness factor when it comes
with a well educated labour force; indeed, many of the new actors in the world trade
system fare relatively well in that respect or are catching-up quite rapidly.

Production activities in both manufacturing and services have become increasingly
fragmented and international sourcing according to the principle of relative
comparative advantage has been continuously growing. The advance in information
and communication technologies has led to a fundamental change in the tradability of
service sector jobs. Many jobs previously considered as being located in sheltered
sectors of the economy are now suddenly exposed to international competition and
risk being off-shored. Indeed, while manufacturing outsourcing mainly impacted bluecollar jobs, services outsourcing is likely to affect white-collar workers; furthermore,
since services outsourcing is structurally easier in terms of resources, space and
equipment requirements, it may proceed more quickly.

Migration (labour mobility in the case of the recently acceded Member states) may
constitute another mechanism whereby previously non-tradable economic activities
become exposed to intensified competition as domestic workers find themselves in
more contestable positions in activities such as construction, hotels and restaurants,
and social and personal services.

Last, but not least, the proposals for further liberalisation of trade and investment
flows in the context of on-going WTO negotiations and the Doha Development
Agenda also appear to carry with them intensified competitive pressures for workers,
farmers and firms in high-wage countries.
-1-
In a nutshell, the combination of technological advance and policy liberalisation is allowing
economic activity to become increasingly specialised and dispersed across countries and
continents. The boundary of what can and cannot be traded is being steadily eroded, and the
global economy is encompassing an ever-greater number of tradable goods and services. Set
against a background of sluggish economic growth and persistently high unemployment in
much of the EU, these developments have led to a sometimes highly charged debate about
European competitiveness and the allegedly negative impact of rising economic integration
on jobs and wages.
The widespread popular ambivalence towards globalisation stands in stark contrast to the
sanguine view shared by most economists that trade and investment liberalisation are an
important source of rising living standards for the overall population. The broad consensus
view, backed up by solid economic theorizing and robust empirical evidence, holds that the
most important long-run impact of international trade and investment on labour markets has
been to raise average real wages without undermining the aggregate employment base, thus
providing substantial payoffs to the representative household.1 Indeed, the historical record
strongly suggests that increased international integration has never let to a net reduction of
employment over more than short periods of time, if at all.
Notwithstanding the overall benefits from deeper international economic integration, both
economic theory and empirical evidence demonstrate that in this process the welfare of some
people may be reduced even as aggregate productivity and income improve. There is no
shortage of individual case studies and anecdotic evidence indicating significant labour
market adjustment costs arising from intensified international competition for certain groups
of the workforce, as reflected in higher job displacement rates and the social hardship
associated with ensuing long spells of inactivity and unemployment and/or large wage losses
once re-employed.
Obviously, reaping the potential gains from globalisation will necessarily entail adjustment
towards further specialisation, innovation and diversification into new areas of relative
comparative advantage, inducing shifts in the sectoral and occupational composition of
employment. Thus, the trend increase in international economic integration may well be a
cause for increased “turbulence” in labour markets; and, almost inevitably, the re-allocation of
resources generates short-run frictions, in particular in the labour market as it can be hard for
people to acquire additional skills and/or to move between jobs, sectors, occupations and
regions. From this perspective, finding an adequate response to globalisation should best be
seen as being part of the broader policy challenge for dynamic economies to successfully cope
with structural economic change.
Against this background, Section 2 of this note sketches recent trends in international
economic integration, focusing mainly on trade in goods and services and foreign direct
investment flows; this also encompasses phenomena such as growing trade in intermediate
inputs and business services and the re-location of production activities abroad. Section 3
reviews the available evidence of the impact on jobs and wages, a focal point of the current
debate. Section 4 simply concludes with some policy implications.
1
Estimates of the resulting income gains from deeper economic integration are typically quite substantial. For example, analysis
prepared in the context of the forthcoming EU Annual Economic Review suggests a potential gain in living standards of about € 2500
annually, in 2004 prices, for every EU citizen over the next few decades. In a June 5, 2005 Op-ed in the Washington Post, Hufbauer
and Grieco (2005) of the Institute for International Economics estimate that after a half-century of shrinking distances and commercial
liberalisation, the average US household enjoys an income gain of about $10,000 per year. The payoff comes through the same routes
as other economic gains: lower prices at the check-out counter, more product choices, and fatter pay-checks. They argue that the
payoff could be even bigger: Future policy liberalization could produce an added $5,000 per household each year. Much of the benefit
would come from sectors that were essentially left out during earlier rounds of liberalisation: services, agriculture, transportation, and
trade with developing countries.
-2-
2. Recent trends in international economic integration
Both mirroring and amplifying the effects of foreign direct investment and trade driven
integration, global financial integration has developed dynamics of its own. Based on a
process of progressive financial market liberalisation and advances in technology since the
80ies, economic performance of countries across the world is increasingly supported by – and
depending on – international capital flows – notably in the form of consortial bank loans as
well as the equity, bond and derivatives based portfolio investments of the international
institutional players. Obviously, the introduction of the euro in 1999 was a major change in
the international financial system as well. EMU both built on previous trade and financial
integration in the common market and reinforced it. On the external side, the new currency
has quickly established itself as the second currency in all major segments of international
financial markets.
Graph 1 depicts the development of financial integration. Cross border holdings of assets
began to increase steadily from the mid-1970s on, with the accumulation of foreign assets
accelerating sharply in the 1990s. The most remarkable feature in foreign direct investment in
recent years was the acceleration in mergers and acquisitions activity from the mid-1990s on.
It drove global FDI inflows to a peak of 1.4 trillion USD in 2000. This was followed by a
sharp slump of FDI flows: In 2003, global inflows amounted to 560 bn USD, of which 367 bn
(two thirds) flew to developed countries. Excluding Luxembourg, China was in 2003 the
biggest recipient of FDI, followed by France and the USA. Still, FDI flows are the largest
capital flows to developing countries, where they represented 10% of gross fixed capital
formation in 2003 (7 % in developed economies). In a global perspective, FDI flows rose
from 5% of world GDP in 1985 to over 15% by the late 1990s.
World trade has grown at an
annual average rate of around 8
½ % over the period 1992-2003.
250
While overall EU15 trade has
Industrial Countries
been running at considerably
200
Emerging Market Countries
lower rates, this relatively poor
150
performance essentially reflects
a lack of buoyancy in intra100
EU15 trade flows rather than
problems at the extra-EU level,
50
where growth rates are close to
those of the world average.
0
Consequently, at the extraEU15 level, which is the area of
focus for the present analysis,
Source: The EU Economy: Annual Review 2005; forthcoming
the EU15 countries have been
largely holding their own. The acceleration of international economic integration in the
second half of the 1990s is also clearly visible in the EU’s rising trade and foreign direct
investment (FDI) linkages (see Graphs 1 and 2). FDI activity became buoyant in the late
1990s, though numbers were inflated by the simultaneous equity price bubble. Despite some
normalisation in FDI flows after 2000, cross-border investment has remained on a
substantially higher level than in past decades. Alike trade flows, FDI has been particularly
strong among industrialised countries and less so with the developing world.
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
Graph 1: Stock of foreign assets as percentage of GDP
-3-
Graph 2: Trade openness, EU-15
Graph 3: Foreign direct investment, EU-15
4
16
Services
3.5
Goods
12
3
10
2.5
% of GDP
% of GDP
14
8
6
Average value of inward
and outward FDI
2
1.5
4
1
2
0.5
0
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Source: commission services
Source: Commission services
Perhaps the most striking development over the last decade is the rapidly growing role of
China in world trade. In 2003, Chinese exports accounted for 6.2% of world exports, up by
almost 4 percentage points when compared to 1992; however, as imports rose almost in
parallel, China absorbed 5.6% of world imports as well. In consequence, China’s trade
surplus increased only moderately from 1% of GDP in 1992 to 1.6% in 2003. India’s share in
world exports and imports of about 1% each is still relatively small; moreover India ran a
trade deficit with the rest of the world in 2003, amounting to 2.2% of its GDP, which was
even somewhat wider than 10 years ago.
Graph 4: World export market shares for different countries/country groupings
18
% Sh are o f W o rld Exp o rts
% Sh are o f W o rld Exp o rts
EU15
16
Americas
(excl. US)
10,4
South East Asia
14
8, 4
12
6, 4
EU Neighbours
US
10
China
4, 4
Japan
EU10
8
2, 4
India
6
1992
1994
1996
1998
2000
2002
0, 4
1992
1994
1996
1998
2000
2002
Source: The EU Economy: Annual Review 2005, forthcoming
From a bird’s eye perspective, Europe has embraced the process of rising trade integration,
well defending its position on world markets. In fact, the share of extra EU-15 exports in
world exports rose from 15% in 1992 to 15.9% in 2003, while the corresponding import share
fell by 0.8 percentage points to 15.8%. In consequence, over this period, EU-15 trade has
-4-
remained in broad balance with the rest of the world, with its position somewhat improving
over time. The external trade deficit of the 10 new Member States, however, expanded from
2.8% of their GDP in 1992 to 6.6% in 2003. US imports accounted for 17.7% of world
imports in 2003, up by 2.6 percentage points compared to 1992; over the same the period, the
US export share in world exports fell from 12.6% to 10.2%, resulting in a significant
widening of the trade deficit. The Japanese trade surplus shrank by 0.8 percentage points to
2.1% of GDP, and Japan’s world market shares in both exports and imports are now
somewhat smaller than ten years ago.
Changes to the EU15’s overall market positions (graph 5) indicate large and rising deficits
with Asia compensated by surpluses with most of the rest of the world. All 3 areas of Asia
have opened up significant trade gaps with the EU, with the Chinese trade deficit of nearly
½% of GDP at similar levels to that of Japan, with which we have had a persistently large
deficit since the early 1990’s. In addition, the EU’s small surplus with the rest of south east
Asia in the 1992-1997 period has now been replaced with a deficit of about 0.3% of GDP.
These negative developments at the bilateral level are to a large extent being offset at the
aggregate level by the buoyancy of the US market where the EU has seen a sharp turnaround
in its trading position. The new Member States as well as the EU neighbours / Americas
group of countries also provide the EU with small but relatively stable trading surpluses.
However, upon closer inspection
there is some evidence that the
EU may be less than ideally
% of GDP
positioned to fully realise the
potential gains from deeper
US
Americas
EU
international
economic
EU10
(Excl US)
Neighbours
integration.
Examining
the
geographical direction of EU
India
trade and FDI flows suggests that
the EU is generally quite inward
South East Asia
looking and may be missing
(Excl China)
China
opportunities in newly emerging
Japan
B92-97
B98-03
markets. With the bulk of trade
and FDI for the EU being intraSource: The EU Economy: Annual Review 2005, forthcoming
EU15, the most dynamic part of
the intra-EU flows is nevertheless the one between the new Member States and the EU15,
reflecting inter alia the benefits from recent enlargement. Extra-EU flows have grown too,
but adjusting for the rapid growth in these markets, it appears that the EU may not have
grasped all opportunities here, especially with regard to the fastest growing areas, like China.
Obviously, trade and FDI with these fast developing countries are not only motivated by low
costs, but also by access to skills and markets.
Graph 5: Extra-EU-15 Trade Balances
0,6
0,4
0,2
0
-0,2
-0,4
-0,6
-5-
Graph 6: Shifts in the Geographical Focus of EU15 Trade
35
% Share of Extra EU15 exports
% Share of Extra EU15 exports
EU
Neighbours
30
10,4
25
20
8,4
US
15
10
EU10
12,4
Americas (excl
USA)
6,4
South East Asia
China
4,4
Japan
5
2,4
0
1992
1994
1996
1998
2000
2002
India
0,4
1992
1994
1996
1998
2000
2002
Source: The EU Economy: Annual Review 2005, forthcoming
Table 1: EU-15 FDI outflows – Geographic destination
1997
1998
1999
2000
2001
2002
Bn
Ecus/euros
Bn
Ecus/euros
Bn
Ecus/euros
Bn
Ecus/euros
Bn
Ecus/euros
Bn
Ecus/euros
109,8
218,8
307,1
403,0
257,8
130,6
USA
49,0
128,7
191,4
182,1
141,9
45,1
New Member States
6,0
9,8
12,1
19,9
16,3
16,1
China
1,8
0,4
2,2
2,2
3,1
2,6
India
0,6
0,8
0,8
0,9
1,0
0,7
EU-15 outflows
of which
Source : Eurostat
With regard to the issue of company relocation and outsourcing specifically, taking into
account the problems of identifying the phenomenon, the available evidence on FDI and trade
offers an anything but dramatic picture. As argued above, developed countries continue to be
the main recipients of EU FDI outflows, with the US the major destination. In comparison, in
2002 12.4% of all EU foreign direct investment went to the new Member States, and only 2%
was directed to China and 0.5% to India.
However, there is growing evidence for rising fragmentation and vertical integration of
production processes; accordingly, trade in intermediate goods accounts for an increasingly
large proportion of total trade. Intermediate goods trade represents around 30 per cent of
world trade in manufactures. While the outsourcing of intermediate inputs appears to have
-6-
contributed to increased productivity, the available evidence also suggests that it was
associated with a quite substantial drop in the relative demand for less-skilled workers.
The current skill-content of
EU trade raises additional
concerns in that respect.
Although the EU’s trade
balance in high-tech sectors is
improving, a good deal of the
EU’s
positive
trade
performance is due to
intermediate skills sectors.
Indeed, an investigation of
indices
of
revealed
comparative advantage shows
that the EU economy is
specialised in sectors with
intermediate labour skills,
Source: See EU Sectoral Competitiveness Indicators: op. cit.,
whereas other high-income
footnote 1, Graph VI.9
regions are more specialised
in products requiring high to
high-intermediate skills. This illustrates that the EU is lagging behind in technology and
human capital intensive production.
Graph 7: EU-15 trade by labour skills categories
(Net exports divided by exports plus imports)
0.4
0.3
0.2
High
High-intermediate
0.1
Low-intermediate
Low
0
-0.1
-0.2
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
Another indicator pointing to potential shortcomings in the structure of EU exports is the
relatively low share of high-technology, in particular when compared to the US. While hightechnology now accounts for a considerably higher share of EU manufacturing exports than
10 years ago, the gap to the US has not diminished. Remarkably, although of course still
much smaller in absolute levels, the
Graph 8: Share of high-technology in manufacturing exports
share
of
high-technology
in
manufacturing exports in China is
comparable to that of the EU.
In those areas where most of the
growth in world exports is realized
(semiconductors, passenger cars,
telecommunications,
computers,
computer parts and pharmaceuticals),
the EU has managed to keep its
position, but could not make
improvements
either.
Clearly
impressive is the speed with which
China has advanced in these areas
(the only exception for the moment
being
passenger
cars
and
pharmaceuticals).
-7-
Graph 9: World export market share in Telecommunications and Computers
Te le com m unications
30
Com pute rs
% Share of W orld Export Markets
30
% Share of W orld Export Markets
South East Asia
South East Asia
South East Asia
25
20
25
EU15
20
US
15
15
Japan
US
Japan
10
10
EU15
China
5
5
China
0
1992
1994
1996
1998
2000
0
2002
1992
1994
1996
1998
2000
2002
Source: ECFIN, Annual Review 2005 forthcoming
Trade integration has also quickly proceeded in services and international outsourcing of
business services has been growing. However, insourcing – i.e. exports of business services –
has also increased substantially in recent years. In fact, countries such as the US and UK are
net exporters in business services, and for several other EU countries the balance of trade in
business services is broadly in equilibrium. Looking ahead, however, some authors see a large
potential for eventual off-shoring of ICT-intensive using occupations; among the reasons
mentioned for the job outflow are overpricing of scarce skills at home and a strong emerging
skill basis abroad, while low-cost communication and global cost competition facilitate and
enforce, respectively, the most
efficient allocation of resources.
Graph 10: Net immigration flows in the EU, in thousands
1400
1200
1000
800
600
400
200
0
-200
-400
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Source: New Cronos, EUROSTAT
Although there is still little
evidence that the EU is losing
R&D jobs on a large scale,
available indicators show that,
relative to the USA and Japan,
the EU has become a less
attractive place for location of
R&D. Attracting foreign talent
is likely to become an ever
more important challenge, in
particular for migration policy.
Net immigration flows into the
EU rose again in the second half
of the 1990s. In general, the EU appears to be significantly less successful than the US in
efficiently absorbing migrants into its labour markets, having to cope with a larger share of
low-skilled immigrants.
-8-
3. The impact of deeper economic integration on jobs and wages
Similar to the introduction of new technologies, international trade even with low-wage
countries has never led to a net reduction of employment over more than a short period of
time, if at all. At the aggregate level, there is no evidence that countries with a higher
(increase in the) degree of openness to trade, suffer from a higher (increase in the) rate of
unemployment.
Graph 11: Unemployment and openness, industrial countries
Graph 12: Change in unemployment and change in
openness, industrial countries
EL
10
ES
FR
IT
8
FI
DE
BE
CA
6
US
JP
4
Rate of unemployment (avg 2001-05 relative to
early 1980s)
Rate of unemployment (avg 2001-05)
12
AU
PT
UKNZ
SE
DK
AT
NO
CH
IE
NL
IS
2
0
0
20
40
60
80
Openness (trade in g+s relative to GDP, avg 2001-05)
Source: Commission services.
-10
100
6
EL
4
FI DE
JP
2NO
ISFR
IT
NZ
0
-2
-4
-6
AU
PT
DK
US
CHSE
ES
AT
CA
BE
UK
NL
-8
IE
-10
0
10
20
30
Change in openness (trade in g+s relative to GDP, avg 2001-05 to
early 1980s)
40
Source: Commission services.
However, trade integration is likely to have had a negative impact on the decline of
manufacturing jobs. Manufacturing sectors, in which the import-penetration ratio increased,
seem to have recorded a stronger decline in employment than those where import competition
has been weaker. Graph 13 illustrates this relationship for the period 1980-2000 based on
aggregated industrial data for 8 EU Member States, showing that employment shrinkage has
been much stronger in the textile industry, where import-penetration doubled from 25 to about
50%, than in food industries where the 2000 import-penetration index was comparatively
small. Indeed, the index was smaller in the food industry in 2000 than it had been in textiles
20 years ago and increased by less than in textiles over the 2 decades analysed. The overall
picture does not change if different periods are looked at (1990-2000 and 1995-2000).
The relationship between industrial employment and foreign trade is less clear cut when the
export-import ratio is considered. A large part of the EU’s foreign trade takes place in the
form of intra-industry trade. This is evidenced by a strong correlation between changes in
import penetration and the export share of production across sectors. Sectors exposed to
strong import competition are also those that export a large share of their production. No
relationship between changes in the export-import ratio and relative employment across
sectors is visible in Graph 14.
-9-
Graph 13: Change in employment and import-penetration
by manufacturing sector, EU-8, 1980-2000
Coke, petroleum
Wood
Pulp, paper
NEC
Non-metallic
Food minerals
-0.5
Chemicals
Transport eq
Machinery and eq
nec
-1
Electrical eq
Metals
-1.5
-2
Rubber, plastics
0
Rubber, plastics
Change in employment (relative to total
economy), % pts
Change in employment (relative to total
economy), % pts
0
Graph 14: Change in employment and export-import ratio
by manufacturing sector, EU-8, 1980-2000
Textiles
-2.5
Coke, petroleum
Wood
Non-metallic
minerals
Chemicals
-0.5
Transport eq
Machinery and eq
nec Electrical eq
-1
Pulp, paper
NEC
Food
Metals
-1.5
-2
Textiles
-2.5
0
5
10
15
20
25
30
Change in import penetration, % pts
35
40
Note: 2000 figures are averages 1999-2001, eq stands for equipment,
-40
-30
-20
-10
0
Change in export/import ratio, % pts
10
20
Note: 2000 figures are averages 1999-2001, eq stands for equipment,
nec for not elsewhere classified.
Source: OECD STAN, Commission services.
nec for not elsewhere classified.
Source: OECD STAN, Commission services.
Analysis of data from household surveys in the OECD Employment Outlook (2005) suggests
that in the US and 14 EU countries manufacturing workers face a higher risk of displacement
than employees in services. Among manufacturing industries, displacement rates also tend to
be higher in the industries where international exposure is intense. If one assumes that these
differences reflect the extra job displacement by international competition, it follows that
international trade and investment account for somewhere between zero and 20% of all
permanent layoffs in these countries.2 While this is certainly a non-negligible number, it
appears to be safe to conclude that international competition is far from being the dominant
cause of job displacement and the trend decline in the share of manufacturing employment.
Furthermore, data from the European Monitoring Centre of Change demonstrates that the
impact of company relocation on job losses has been very small, in particular when compared
to total employment or total restructuring.
Table 2: Displacement rates by industry, average in per cent of total employment
14 EU countries
1994-2001
USA
1979-99
Manufacturing
3.7
4.6
- High international competition
3.7
5.9
- Medium international competition
4.4
6.2
- Low international competition
3.5
4.3
Services (and utilities for USA)
3.2
1.7
Total employment
2.8
2.2
Source: OECD Employment Outlook (2005) on the basis of the ECHP for the EU-15 countries excl. SE; and Kletzer (20001) for the
USA.
2
Clearly, such a calculation can only provide an imprecise estimate.
- 10 -
Some authors have linked the observed degree of wage moderation in developed countries to
the emergence of China, India and Russia as trade partners, endowed with a huge labour
force. Moreover, some high-profile cases and anecdotic evidence suggest that the mere threat
of relocation and off-shoring could weaken the bargaining stance of workers and unions over
wages and working conditions. However, it is anything but evident that at the aggregate level
movements in the wage share can be directly linked to an increase in international
competition. Graphs 15 and 16 clearly demonstrate that there is no systematic relationship
between the change in openness and the wage share in a cross-country perspective, neither for
the total economy’s wage share nor for the wage share in manufacturing. The same
observation holds if the length of the period is reduced from two decades to one decade
(1992-2002). In general, thus, domestic labour market conditions continue to be the main
driver of movements in aggregate real wage growth around the productivity trend over the
medium to long-term.
Graph 15: Change in openness and wage share,
1980-2002
Graph 16: Change in openness and wage share in
manufacturing 1980-2002
30
20
IE
BE
15
20
change in openenss
change in openenss
25
BE
15
AT
ES
10
DK
5
FI
IT
FR
CA
SE
NL
DE
AU
0
JP
PT
US
EL UK
IS
AT
10
ES
SE
NL
DK
5
AU
FR
PT
DE
FI
IT
US
UK
0
JP
NO
NO
-5
-5
-25
-20
-15
-10
-5
0
5
10
-25
change in wage share
Source: Commission services.
-20
-15
-10
-5
0
5
10
15
change in wage share
Source: Commission services.
Evidence is more robust that trade and vertical integration caused a shift in relative demand
for unskilled labour, in particular in manufacturing. While the outsourcing of intermediate
inputs has contributed to increased productivity, the available evidence also suggests a quite
significant drop in relative demand for unskilled workers. This development has contributed
to increasing wage inequality in the USA, estimated to account for as much as one third of the
overall increase in wage inequality. The case is less obvious in the EU Member States. Wage
inequality has increased little, while unemployment among the low-skilled has picked up.
Obviously, the feasibility to reap the benefits from deeper economic integration depends
largely on the capability to reallocate employment. The adjustment process with its shift in
the sectoral and occupational composition of employment cannot be expected to run without
friction. Thus, ensuring a smooth reallocation of labour will help to minimise the hardship for
the workers affected by job displacement and the off-shoring of production. In fact, the
magnitude of net benefits from economic integration strongly depends on costs of adjustment,
which are largely determined by the time displaced workers spend in unemployment and/or
inactivity, and any lower income once they are reemployed.
Box 1 below, which is based on calculations published by the consultancy firm McKinsey,
illustrates that reemployment of labour is indeed a crucial parameter. Whereas the USA
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benefits considerably by relocation of services, Germany and France are estimated to benefit
much less from foreign investment, basically due to the less successful reintegration of
displaced workers into the labour market.
Box 1: An estimate of the distribution of gains from the outsourcing of services
A comparison of the gains from service off-shoring in the USA and Germany undertaken by the international consultancy
firm McKinsey forcefully demonstrates that rigid labour markets mean that the benefits from globalisation are not fully
reaped. The table below gives an intriguing illustration of how the benefit from relocating a service job from the USA,
Germany or France is distributed among the source and the host country. According to the calculations, the US economy
captures 1.1 USD for each USD of corporate spending in India whereas France would capture 85 cent and Germany just 80
cent for each euro invested in India, North Africa or Central and Eastern European countries.

The authors of the study calculate that the host country captures 33% of the corporate spending, benefiting from local
wages etc.

Under perfect competition, the company would be forced to fully pass-through its cost savings to lower prices,
implying that it is the consumer who benefits most from the investment abroad. This amounts to 50-53% in the USA
and 36% in Germany and France. The cost saving for the European countries is lower because differences in
language and culture are considered to raise the transaction costs involved. Moreover, it is argued that infrastructure
and labour costs are higher in the case of the CEECs, reducing the magnitude of cost savings.

The direct benefits accruing for the source countries in the form of additional exports and repatriated earnings are
also higher in the USA than in Germany and France because the US is more specialised in exporting IT goods and
European firms have negligible ownership in Central and Eastern European business service companies.

A further benefit for the source economy accrues in the form of redeployed labour. The authors quote estimates for
the USA according to which the workers set free through off-shoring move to another job and this reallocation of
jobs adds value of 57 cent for every US dollar invested in Indian services. Because of higher unemployment and
more rigid labour markets, the authors estimate that benefits from reemployment are considerably lower in Germany
and France than in the USA.
Table : The distribution of income generated by 1 USD/euro spent on a service job in a
low wage country in per cent
India/North
Africa, CEEC
(host)
Wages paid to local workers, profits
of local agents, local taxes
Corporate savings
Additional exports to source
countries and repatriated earnings
Sum of direct benefits
Redeployed labour
Sum of total benefits
Source country of investment
USA
DE
FR
50-53
36
36
7-9
67
57
114-119
3
39
34
73
5
41
44
85
33
33
33
Source: McKinsey Global Institute (June 2005), “The emerging global labor market”.
In fact, there appear to be significant obstacles to the reallocation process in Europe, locking
resources into inefficient use. This is particularly troublesome for labour, with displaced
workers experiencing undue difficulties finding new employment. Indeed, displaced workers
in the EU suffer from a lower probability of finding a new job compared to those in the USA.
In the USA, on the other hand, displaced workers have to accept larger shortfalls in earnings
when getting re-employed. Furthermore, search efforts among displaced workers in EU
Member States appear to be stronger geared towards jobs in the same industry than in the
USA. Occupational and regional labour mobility is low and has hardly increased over the last
years in the EU-15 Member States. However, estimates based on the European Community
Household Panel indicate that training increases the probability to find a new job, especially
for those who have received training prior to being laid off.
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Table 3: Labour market prospects of displaced workers
EU 1994-2001
High
compt.
mftg.
Total
mftg.
Share re-employed two years later
52
Share with no earnings loss or
earnings more
Share with earnings losses greater
than 30%
USA 1979-99
Services
High
compt.
mftg.
Total
mftg.
Services
and
utilities
57
57
63
65
69
44
46
50
36
35
41
5
7
8
25
25
21
Notes: Columns relate to manufacturing with high international competition, total manufacturing and services (and utilities for USA)
Sources: OECD Employment Outlook (2005) for EU-15 (excl SE) on the basis of ECHP data and Kletzer (2001, “Job Loss from
Imports: Measuring the Loss”, Institute for International Economics, Washington, DC) for USA on the basis of bi-annual Displaced
Worker Surveys.
4. Conclusions
The European economy is inextricably linked to the world economy. Happily, upon closer
inspection many of the allegedly negative implications of rising international trade and
investment for jobs, wages and living standards are belied by the evidence. Deeper
international economic integration offers huge opportunities for European firms in rapidly
growing large markets, to exploit efficiency advantages, and to source strategic assets
globally in order to stay competitive. However, policy makers may be well advised not to
dismiss widespread public concerns all too easily. In order to realise the potential gains from
this process, production structures will have to shift considerably towards further
specialisation and diversification into new areas of relative comparative advantage.
Throwing sand into the wheels of deeper international economic integration in order to reduce
adjustment costs, as contemplated by some observers, is not an attractive option. Clearly,
when faced on the one hand with dispersed gains from economic integration that materialise
in the medium to long-term, and on the other hand with the concentrated and localised shortterm adjustment needs, it is challenging for policy makers to withstand protectionist
tendencies. However, in addition to reducing economic efficiency, income and employment
opportunities in the long run, protectionist solutions weaken the governments bargaining
stance against trade barriers in other countries, thereby undermining job creation in those
sectors that would benefit from economic integration. Moreover, the experience with
“defensive” policies which try to shield established firms/industries from new sources of
competition and/or which have tried to protect people within specific jobs has largely been
negative.
The initiative to foster European financial integration and the impact of the euro on financial
integration in the EU has to be seen in the context of globalisation, advances in technology
and regulatory reform. Concrete evidence that the introduction of the euro has made a specific
contribution to integration can be found in more homogeneous markets, a wave of
consolidation among intermediaries and exchanges and the emergence of new and innovative
products and techniques since 1999. This creation of broader, deeper and more efficient
financial markets has clearly the potential to foster European growth by attracting
international funds – if pursued regulatory and structural reforms support the necessary
rentable investment opportunities in this increasingly competitive global environment.
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As with respect to other drivers of structural change such as technological progress, the
response to globalisation cannot be to bring the process to a halt, but rather to develop a
policy design that is conducive to the full realisation of the opportunities offered by deeper
international economic integration, while minimising unavoidable adjustment costs.
Obviously, well-functioning labour markets that enable workers to move smoothly from
declining to expanding activities have a key role to play in the adjustment process; in practice,
this may often mean ensuring a better balance between income support for job losers,
adequate job-finding assistance, training, and proper re-employment incentives. Moreover,
structural funds could be used to assist structural adjustment and ease transition costs.
Meeting the broader challenge from globalisation requires policy responses that extend far
beyond labour-market and social safety-net policies. The EU must enhance its ability to create
new activities and jobs in order to take the “high road” in the emerging new international
division of labour. Producing only goods and services reflecting traditional comparative
advantage will not be sustainable in the long-run. However, creating new high value-added
activities with deeply rooted comparative advantage requires a dynamic framework where
innovation and R&D, fostered by excellent education systems, can spur productivity and job
growth. Clearly, without such a dynamic approach, no new jobs will be created to replace the
jobs lost, and public support for economic openness is likely to erode. A stable
macroeconomic environment, efficient and integrated financial markets, an open and dynamic
internal market, flexible labour markets and a well trained and highly skilled workforce
appear to be essential elements of such a strategy.
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