Regional Economic Integration and Cooperative Agreements

• US (50 states in continental US) + Alaska and Hawaii

• Common Currency

• Perfect Labor and Capital Mobility

• As compared to WTO agreements, faster progress is at regional level where countries close together already engaged in a significant amount of trade

• Post World War II-1940’s-countries came together for economic cooperation-Regional economic integration and commodity arrangements

• Economic integration-Political and economical agreement among countries

• Might reduce tariffs for members countries while keeping tariffs for non-member countries

• Lowest level of cooperation is usually trade and highest level-beyond trade

• Commodity Agreements: Result in cooperation among producers of commodities such as oil-producing countries or between producers and consumers of commodities such as coffee and tin.

Regional Economic Integration and Cooperative Agreements

• Regional Trading groups have an import influence on MNE’s strategies

• Define size or regional market and rules to operate• Companies need to adjust organizational structure and operating

strategy to take advantage of regional trade groups• Companies in initial stages of expansion• E.g.: EU and Ford• 107 RTA’s-all RTA’s are registered with the WTO and majority are

bilateral• 17-including EU involve 3 or more countries• NAFTA and EU have high level of integration

Regional Economic Integration• Geographic proximity is an important reason for economic

integration• Distance for goods to travel is short• Consumer tastes are similar and distribution channels can

easily be established• Neighboring countries have common history and interests

and may be more willing to coordinate their policies• Countries-not neighbors-form agreements-if their political

ideologies are similar• E.g.: Cuba- communist, political and economic

philosophy-member for COMECON(the Council for Mutual Economic Assistance) (Vietnam, Bulgaria, Soviet Union, Hungary, Poland, Romania, Mongolia, Cuba, etc)

Regional Economic Integration-4 types

• Free trade areas: economic blocs in which all barriers to trade, i.e., tariff and nontariff barriers, are abolished amongst member nations, but each member determines its own external trade barriers beyond the bloc. Can explore other forms of cooperation, such as reduction on NTB or trade in services and investment but focus on clearly on tariffs.

• Customs unions: economic blocs in which all barriers to trade, i.e., tariff and nontariff barriers, are abolished amongst member nations, and common external barriers are levied against non-member countries. E.g.: NAFTA and EU

A more extensive type of regional trade agreement :• Common market: An economic bloc which also permits the free

flow of capital and labor. It is free to work in any country in the common market without restriction. E.g.: MERCOSUR, EU

• Complete Economic Integration: Adopt common economic policies. E.g.: EU-Common currency complete with a Common Central Bank. High degree of Political integration among member countries

Effects of Integration

• Affects member countries in social, culture, political and economic ways

• E.g.: Prior to NAFTA, Canada has small but successful film industry

• Reduction of entry barrier-US

• Quebec-requires all foreign films including US films to bear a Canadian government issue classification sticker before being sold or distributed in Canada

• MNEs are more concerned with economic effects

• Reduction of tariffs products static effects and dynamic effects.

8-6

The Effects of Economic IntegrationStatic effects: • Static effects may develop when either of two conditions occurs: Trade Creation: • Production shifts to more efficient producers for reasons of comparative

advantage, allowing consumers access to more goods at a lower price than would have been possible without integration

• Companies protected in their domestic markets face real problem when barriers are eliminated and they attempt to compete with more efficient producers

Trade Diversion: • Trade shifts to countries in the group at the expense of trade with countries

not in the group, even though the nonmember companies might be more efficient in the absence of trade barriers.

Dynamic effects: • They occur when trade barriers come down and size of the market

increases. Because of larger size of the market, companies can increase their production, which will result in lower cost per unit, a phenomenon called Economies of Scale.

• Companies can produce more cheaply which is good

Major Trading Groups

• 2 ways to look at Trading Groups-by location and by type

• By Location: Europe, Asia, North America, Africa

• By type-free trade area, customs union, common market, economic integration

• Offers location specific advantages to foreign investors due to increased size

Major Trading Groups

1. Free Trade Area: European Free Trade Association (EFTA), North American Free Trade Agreement (NAFTA), Association of South East Asian Nations(ASEAN)

2. Customs Union: MERCOSUR

3. Common market: Caribbean Community and Common market, Central American Common Market, Andean Group

4. Economic integration—European Union

North American Free Trade Agreement (NAFTA)

• United States, Mexico and Canada-formed in 1994• Initially had Automotive Products Trade Agreement, effective in 1965• Qualified duty-free trade in specified automotive products• 1980- US and Canada discussed free trade development in specific

industries such as steel and textiles• 1987, negotiations were on boarder terms of trade• 1st Jan 1989 negotiations resulted in Canada-US free Trade Agreement

(FTA)-eliminated barrier on bilateral trade• 1st Feb 1991, Mexico approached US to establish FTA, which included

Canada too. • 1st Jan 1994, North American Free Trade Agreement was made

effective

Why Nafta?• US-Canada and US-Mexico trade is more significant• NAFTA is a powerful trading bloc with a combined population

and total GNP less than 25 member EU

• Tremendous size of US economy in comparison to those of Mexico and Canada

• Canada has a much richer economy than that of Mexico, even through its population is 1/3rd of that of Mexico

• Even though NAFTA is FTA instead of customs union or common market, its cooperation extends far beyond reduction of tariff and non-tariff barriers, including provisions for services, investments and intellectual properties

• In addition, the agreement establishes a new dispute resolution process.

Comparative NAFTA Data(1999 data)

Population

(Millions)

GNP (Billions in USD)

GNP per Capita

(USD)

Canada 30,287 594,976 19640

Mexico 94,349 348,627 3700

United States

267, 636 7,783,092 29080

392,272 8,726,695 22,247

• Rationale: • US-Canadian trade is the

largest bilateral trade in the world

• US is Mexico’s and Canada’s largest trading partner

NAFTA-Static and Dynamic Effects• Static Effect: • Canadian and US consumers benefit from lower cost of agriculture from

Mexico which is a Static Effect of economic liberalization• US producers also benefit form the large and growing Mexican market,

which has a huge appetite for US products-a dynamic effect• Dynamic Effect: • NAFTA is a good example of trade diversion Many US and Canadian companies have established manufacturing

facilities in Asia due to labor advantage These companies now go to Mexico rather than Asian countries E.g.: IBM –makes computer parts in Mexico-earlier made in Singapore IBM thus boosted Mexico’s exports to US from USD 350 million to

USD 2 billion Gap Inc and Liz Claiborne are increasingly buying garments from

Mexican contracts than their ASIAN counterparts RC Willey, the US furniture retailers, also imports furniture from Mexico

as well as from China rather than importing everything from China because of the reduction of tariff barriers and close proximity to Mexico

Coverage of NAFTA• Market Access: Rules of origin, tariff and non-tariff• Trade Rules: safeguards, subsidies antidumping duties, health and

safety standards• Services-provides for the same safeguards for trade in services that

exist for trade in goods (consulting, engineering, etc)• Investments-Establishes investment rules governing minority interests,

portfolio investments, real property and majority owned or controlled investments from NAFTA countries + extends to investment by any company in NAFTA, regardless of country of origin.

• Intellectual property: All countries will provide adequate and effective protection and enforcement of intellectual property right.

• Dispute Settlement: Common process to be followed against an offending party

• Mexico made significant strides in tariff reduction after joining GATT in 1986.

• Due to NAFTA-reduced tariffs on originating goods traded between Mexico and Canada –immediately or in phase manner

Rules of Origin and Regional Value Concept

• NAFTA is FTA and not custom union-each country has its own tariff to the rest of the world.

• Products entering into Canada must have commercial or customs invoice that identity's the ultimate origin

• Otherwise-third country would ship the products to the NAFTA country and from there to other 2 countries-duty free

• Goods and services must originate in North America to get access to lower tariffs

• Local Content: • At least 50% of the net cost of most products must come from NAFTA

region• Exceptions are 55% for footwear, 62.5% for passenger automobiles and light

trucks and engines and transitions for such vehicles and 60% for other vehicles and automotive parts

• E.g.: Ford cars assembled in Mexico could use parts from Canada, US and Mexico and labor & other factors from Mexico. For the car to enter Canada and US, according to NAFTA, at least 62.5% of its value must come from North America,

Special Provisions of NAFTA• FTA are for reducing tariffs• Two sides agreements were later included in NAFTA due to strong objectives:

Labor unions and environmentalists• Opponents were worried about potential loss of jobs in Canada and US to Mexico as a

result of Mexico's cheap wages, poor working conditions and lax environmental enforcement

• Companies may move from US and Canada to Mexico• Labor Lobby: Included labor standards and Environmental Lobby: Upgrade of

environment standards in Mexico and strengthening of compliance• NAFTA commission, cabinet-level body-meets once a year-to implement the agreements

and side agreements and supervise the implementation progress• Side agreement 1: Improving working conditions and living standards, promoting

compliance with effective enforcement of labor laws, promoting the Agreement’s principles through cooperation and coordination and promoting publication and exchange of information to enhance mutual understanding of the Parties Law

• Environmental Side agreement 2: Includes promotion of sustainable development, cooperation on the conservation, protection and enhancement of the environment and effective enforcement of an compliance with domestic laws.

• Transparency and public participation in the development and improvement of environmental laws and policies

• NAFTA Secretariat administer the NAFTA dispute resolution process• Solve the matter without Secretariat as with secretariat the roles are same as that of

WTO

Merchandise trade between US and Canada and between US and Mexico

1993Amount

% of Total

1994Amount

1995Amount

1996Amount

1997Amount

1998Amount

% of Total

% Growth1993-1998

Canada

Exports to US

101.2 22.2 114.8 127.6 135.2 152.1 156.8 23.4 54.9

Imports to US

113.3 19.2 131.1 147.1 158.7 170.1 175.8 19.2 55.2

Mexico

Exports to US

41.5 9.1 50.7 46.2 56.8 71.1 78.4 11.7 88.9

Imports to US

40.4 6.9 50.1 62.8 75.1 86.7 95.5 10.4 136.4

Total World

Exports to

456.8 502.4 575.8 612.1 679.7 670.2 46.7

Imports to

589.4 668.6 749.6 803.3 876.4 917.2 55.6

Impact of NAFTA on Trade, Investment and Jobs

• Reducing trade barrier in Mexico would result in an increase in exports to Mexico, resulting in creation of jobs in US and Canada

• Increased exports to Mexico from both US and Canada• Investments increase• Decentralization of Canada and US as they move to Mexico to take

advantage of cheaper cost• Observations from the Table shown in previous slide:

1. US exports to Canada and imports from Canada have not changed

2. US exports to Mexico and imports from Mexico have changed

3. Mexico replaced Japan as second largest market for US exports and being 3rd most important supplier to US after Canada, Japan

4. US exports rose faster to Canada and Mexico as compared to rest of world. Same phenomenon was observed for imports

5. Mexico currency crisis in 1994, exports dropped but gain regained to larger extend

Hourly compensation costs for Production workers in Manufacturing, in USD

Country Wage

Germany 28.28

Japan 19.37

United States 18.24

Canada 16.55

Mexico 1.75

Hong Kong 5.42

Korea 7.22

Singapore 8.24

Taiwan 5.89

Impact of NAFTA on Trade, Investment and Jobs…contd…

• NAFTA members have become much more significant trading partners with each other

• Overall trade with NAFTA members has increased faster than trade with rest of the world

• Exports to NAFTA members have increased, but imports have increased faster.

• The investment and employment pictures are far more complicated. • Investment Picture:• Mexico-IBM• Foreign investment into Mexico has risen from USD 4 billion per year

in 1993 to USD 10 billion per year in 1988• Mexico-12th important location for US FDI as Brazil is more important

but Germany and Japan are investing in Mexico• US FDI Contribution: Mexico: 2.6% Vs Canada 10.6%

Impact of NAFTA on Trade, Investment and Jobs

• The impact of NAFTA on employment has been difficult to measure• More jobs have been created than lost to NAFTA, but difficult to measure• USD 1 billion US exports= 14,000 US jobs• 1993-1998: Total exports of US to Mexico and Canada=USD 92.5

Billion=1.3 Million job• Imports are also significant• Wage difference between Mexico• Even Mexico had tough time -when NAFTA required Mexico to strip the

companies on Mexican border of their duty-free status, foreign companies started looking elsewhere

• Sanyo, Canon and French battery producer -Saft left Mexico and relocated to China, Vietnam and Guatemala, where labor was cheap.

• Immigration-Illegal immigration to US and Canada

NAFTA Expansion

• Expand into Central and South America-bilateral trade arrangements-hubs and Spokes arrangements with US as hub and others as spokes

• Canada and Mexico have entered into FTA with Chile, perceived to be next country to join NAFTA

• MEXICO+EU FTA

Implications of NAFTA on Corporate strategy

• Companies would look at NAFTA as one big regional market allowing companies to rationalize production, financing, especially seen in automotive products and electronics, especially computer

• Each country in NAFTA ships more automotive parts in specialized production to other two countries that any other manufactured goods

• Employment in auto industry has increased in US since NAFTA

• Auto manufacturing has moved from all over the world to Mexcico-500,000 Mexican make parts and assemble vehicle for all world's major producers-62.5% regional content has forced European and Asia automakers' to bring in parts supplier and set up assembly operation in Mexico

• Canadian Entrepreneur established a metal–stamping plant in Puebla, Mexico, to supply Volkswagen, the German auto manufacturer

• VW plant assembles revitalized Beetle supplied to US market

• Daimler-Chrysler is producing 45,000 cars and 200,000 trucks in Mexico

• Chrysler-produces new model: Pt Cruiser, in Toluca, Mexico for export to Canada, US and Europe-single plant to supply to entire world

• Some US companies are leaving US and Canada and moving to Mexico: E.g.: GE-Apparel and furniture industry

Implications of NAFTA on Corporate strategy

• Low end manufacturing moving to South, more Sophisticated manufacturing and services are increasing in US

• 35000 jobs were lost in South east, but 65,000 high tech jobs were also created

• Sophisticated US companies would run Canadian and Mexican companies out of business

• Looking at Mexico as one single consumer market• Initial excitement was low wage and now as incomes rise

demand for foreign products rise. • Canadian and US trade deficits falls-market becomes

balance

8-25

Commodity Agreements• Producers of primary commodities have also come together in an

attempt to stabilize commodity prices and supply• Crude petroleum, natural gas, copper, tobacco, coffee, cocoa, tea

and sugat-25% of world merchandise trade and especially for developing country

• Commodity agreement: It is a form of economic cooperation designed to stabilize the price and supply of primary commodities through the use of buffer stocks and/or quota systems

• 2 types • Producers’ alliances: exclusive membership agreements between or

amongst producing countries (a cartel)- Organization of Oil Exporting Countries (OPEC): a producer cartel whose members include Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela

• International commodity control agreements (ICCAs): Agreements between or amongst producing and consuming countries - International Cocoa Organization (ICO) - International Sugar Organization (ISO)

• Buffer Stock: A commodity agreement by which reserve stocks of the goods are bought and sold to regulate the price.

• Quota System: Producing countries divide total output by sales to stabilize the prices

• Cooperation to prevent sharp fluctuations• Effective when a single country has a large share of world production

so that it is able to control supply easily• E.g.: Wool-Controlled by Australia• Diamonds-Debeers Company in South Africa• Type of commodity also influences a commodity’s agreement

effectiveness-substitute

OPEC• Producer cartel• OPEC is large category of energy commodities, which includes coal

and natural gas• OPEC is more than Middle East• Members: Algeria, Iran, Iraq, Kuwait, Saudi Arabia, UAE, Venezuela,

Indonesia, Libya, Nigeria, Qatar• Saudi Arabia has maximum control• OPEC oil minister gather together to determine the quota for each

country based on estimates of supply and demand• OPEC with large population need large oil revenues• Exceed export quota to generate more revenues• 1990..why did Iraq invade Kuwait?• OPEC member countries produce 40% of world’s crude oil and 14%

of natural gas revenues