05 May 2011

Is the EU internal market suffering from an integration deficit?

Consuelo Pacchioli

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As an alternative to measuring the extent of market integration, ‘home-bias’ indicates the degree to which economic agents ‘over-prefer’ to transact with domestic agents rather than agents from other EU countries. Such an exclusive preference is measured against a benchmark of (ideal) market integration and is called ‘home-bias’.

This CEPS Working Document by former CEPS Researcher Consuelo Pacchioli addresses the estimation of a ‘normal trade’ gravity equation to establish the possible existence of home-bias effects in the US market and the EU internal market, which are the two most integrated regions in the world. Estimations based on pooled OLS cross-section analysis, with the novelty of the inclusion of time dummies in order to obtain unique indexes and panel data-fixed effects, both reject the hypothesis of no internal barrier to trade. This shows a tendency to ‘over-trade’ within borders both in the US and the EU. Taking the finding for the US market as a benchmark, a direct comparison with the EU internal market is considered: the estimated results show that an average EU country still trades more within its borders than with other member states – about three to four times as much as a random US state does. A number of explanations are offered for this relatively low level of EU internal market integration.