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News : EU Economy Last Updated: Aug 20, 2010 - 8:15:08 AM

Invisible wall endures for trade 20 years after German reunification; Convergence can take at least 33 years
By Michael Hennigan, Founder and Editor of Finfacts
Aug 20, 2010 - 2:06:52 AM

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The 20th anniversary of German reunification will be celebrated this October and while its said that a person would need to know where to look to find a trace of the old border between East and West, an invisible wall endures for trade. Convergence can take at least 33 years and that has implications for trade in the internal market of the European Union. 

CESifo (Ifo Institute for Economic Research - - Ifo Institut für Wirtschaftsforschung and the Center for Economic Studies at the University of Munich) researchers Volker Nitsch and Nikolaus Wolf show in a paper recently released in English that the wall between East and West is still alive and well - - at least, as regards its impact on trade. And this is not the only “deactivated” political border where its effects on trade are still felt.

The authors ask if the EU has largely erased borders for travel, labour, study and intra-EU migration, why should an invisible, but nonetheless effectively, a domestic barrier to trade still persist in Germany?

They say they found little evidence that political integration is rapidly followed by economic integration. Instead, they estimate that the impact of the former East-West border on trade declines very slowly but steadily.

The paper says a large body of empirical literature has established that national borders reduce trade by about 50% or more. However, there is no consensus regarding why this should be so. Three kinds of explanations are put forth: the “political barriers” approach, the “fundamentals” approach, and the “artefact” approach.

The political barriers approach states that borders continue to affect trade mainly because of the existence of non-tariff barriers that diminish trade even after the removal of tariff barriers, or even after the establishment of a currency union. In other words, the establishment of a free-trade area or a currency union removes only some political barriers, but anything short of political unification will still leave plenty to hinder trade. For example, trade across the US-Canadian border or the Franco-German border may still be affected by differences in taxation or dissimilar legal frameworks.

The fundamental approach, in turn, asserts that border effects stem from some source of heterogeneity between regions that exists independently of the political border and often predates it. Usually, culture, language, social and business networks, as well as geography, can play a role in this: a mountain range can pose a significant barrier to trade, while a river or sea can ease it.

The artefact approach claims that border effects are at least to some extent a statistical artefact that arises from the difficulties of separating the impact of border-related trade barriers from the impact of geographical distance and from the non-directional multilateral barriers to trade.

The authors say the particular pattern of change over time strongly suggests that border effects are neither statistical artefacts nor mainly driven by administrative or “red tape” barriers, but instead arise from more fundamental factors. After all, over the period of the data used in the research, 1995-2004, no administrative barriers to trade continued to exist along the former Iron Curtain in addition to barriers along Germany's federal state borders. The authors estimate that it will take from 33 to as many as 40 years to remove completely the impact of the old political border on trade.

In sum, borders indeed matter and it is hard to change them, because they are related to underlying economic fundamentals. South Korea, watch out. An eventual political union with your prickly northern neighbour might turn out to be the easy bit after all.

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