4 ECONOMIC INTEGRATION

TU-91.2043 International Economics

by

Hannele Wallenius

Aalto University School of ScienceDepartment of Industrial Engineering and

Management

4 ECONOMIC INTEGRATION

International Economics

Hannele Wallenius

6 Economic Integration - 6.1 Institutions Of International Finance 2


4.1 Institutions of International Finance: World Bank and International Monetary Fund

4.2 Customs Unions and FreeTrade Areas


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The Founding Fathers of World Bank and IMF John Maynard Keynes

and Harry Dexter White

White was the chief international economist at the U.S. Treasury

In 1944, he drafted the American plan for the IMF that competed with the British Treasury blueprint drafted by Keynes


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THE WORLD BANK

Founded in 1944 by 44 countries (now 188 member countries) to finance the reconstruction of the war-ravaged economies of Western Europe

After Western Europe recovered and achieved economic self-sufficiency, the bank turned its attention to assisting developing countries

Dr. Jim Yong Kim is the 12th president of the World Bank Group


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The World Bank is a development Bank which provides loans, policy advice, technical assistance and knowledge sharing services to low and middle income countries to reduce poverty

See also: http://www.worldbank.org


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THE INTERNATIONAL MONETARY FUND (IMF) Was established in Bretton Woods,

USA, in 1944 and started operating in 1946 (first only 29 member countries, now 188)

Christine LagardeManaging Director, IMF


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TO DAY:

“The IMF promotes international monetary cooperation and exchange rate stability, facilitates the balanced growth of international trade, and provides resources to help members in balance of payments difficulties or to assist with poverty reduction.”


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“Through its economic surveillance, the IMF keeps track of the economic health of its member countries, alerting them to risks on the horizon and providing policy advice. It also lends to countries in difficulty, and provides technical assistance and training to help countries improve economic management.”

For more: http://www.imf.org/


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CritiqueStructural Adjustment Programs (SAPs)



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Critique… Structural Adjustment Programs (SAPs) are a set of

economic policies that are implemented by International Monetary Fund (IMF) and World Bank (WB) in developing countries

They constitute the “conditionality” of loans provided by IMF and WB, leaving heavily indebted developing countries with virtually no choice but to implement them

The principle goal of SAPs is to address balance of payment problems and implement fiscal discipline. They also call for significant cuts in public services, trade liberalization, broadening the tax base, reducing marginal tax rates and minimal state regulation on economic activity

SAPs are traditionally based on a set of economic principles called “Washington Consensus,” a name that alludes to the city that both IMF and WB are headquartered in.



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6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 11


4.1 Institutions of International Finance: World Bank and International Monetary Fund

4.2 Customs Unions and FreeTrade Areas


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International Trade Liberalization: Global Approach

General Agreement on Tariffs and Trade, GATT (founded 1947, lasted until 1994, when it was replaced by the World Trade Organization in 1995)

GATT’s objectives were: To establish the rules of conduct of international

commerce

To provide a forum for multilateral talks aimed at lowering trade protection around the world; aims to reduce tariffs worldwide: First, Second, Third and Fourth Round 1947 - 1956, Dillion, Kennedy, Tokyo, Uruguay Rounds 1986 – 1994, Doha…


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World Trade Organization (WTO) WTO established during the Uruguay round

and started 1.1.1995

160 members June, 2014) (some 25 more countries applying membership) accounting for more than 97% of world trade

The agreements have three main objectives: to help trade flow as freely as possible to achieve further liberalization gradually

through negotiations to set up an impartial system of settling

disputes


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WTO

Doha Round 2001 - talks have stalled over issues, such as

agriculture, industrial tariffs and non-tariff barriers, and services

significant differences are between developed nations led by EU, USA, and Japan and the major developing countries led mainly by India, Brazil, China, South Korea, and South Africa

See for more http://www.wto.org

Roberto Azevêdo Director-General of the WTO


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Trade without Discrimination

Most-favored-nation (MFN): treating other people equally Under the WTO agreements, countries

cannot normally discriminate between their trading partners

Grant someone a special favor (such as a lower customs duty rate for one of their products) and you have to do the same for all other WTO members

Exception: free trade agreements, such as EU and NAFTA



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International Trade Liberalization: Global Approach continued

OECD (Organization for Economic Co-operation and Development)

established by 20 countries in 1960

now 34 full members from the “developed”, industrialized countries* sharing the principles of the market economy,

pluralist democracy and respect for human rights

promoting policies to improve the economic and social well-being of people around the world

* Accession talks with, Russia and enhanced engagement offered to Brazil, China, India, Indonesia and South Africa.

A forum in which

governments share

experiences and seek

solutions to common

problems: what drives

economic, social and

environmental change.


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International Trade Liberalization: Regional Approach

Free trade among small number of nations; while maintaining some barriers with rest of the world

These are called preferential trading arrangements


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Stages of Economic Integration


No Internal Common Factor and Common Common

Trade Barriers External Tariff Asset Mobility Currency Economic

Policy

Free Trade Are X

Customs Union X X

Single Market X X X

Monetary Union X X X X

Economic Union X X X X X


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EU Trade Agreements


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Examples of Regional Trade Agreements (RTAs):

The number of RTAs from around 70 in 1990 to over 300 today.

The European Union (EU) – a customs union, a single market and now with a single currency

The European Free Trade Area (EFTA)

The North American Free Trade Agreement (NAFTA) – created in 1994

Mercosur - a customs union between Brazil, Argentina, Uruguay, Paraguay, and Venezuela

Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA)

Common Market of Eastern and Southern Africa (COMESA)

South Asian Free Trade Area (SAFTA) created in January 2006 and containing countries such as India and Pakistan

In addition, United States has free trade agreements in force with 20 countries


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Mega-regionalism:

Trans-Pacific Partnership (TPP) and the Trans-Atlantic Trade and Investment Partnership (TTIP)

The United States is negotiating a regional FTA, the Trans-Pacific Partnership, with Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam

USA and EU launched negotiations on the Transatlantic Trade and Investment Partnership in June 2013



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The Road to EU in a Nut Shell EEC formed in 1957 as CU among six

countries: France, West Germany, Italy, Netherlands, Belgium and Luxemburg (signed the Treaties of Rome)*

*Already in 1951, the same six countries formed the European Coal and Steel Community, which begins to unite European countries

The signing of the Treaties of Rome


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Will preferential arrangements foster free trade?

Some concerns among economists that regional trade agreements may make it more difficult, rather than easier, to achieve the ultimate objective of global free trade

The regional approach to trade liberalization could lead to the formation of large "trade blocs" which trade freely among members but choke off trade with the rest of the world


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Will preferential arrangements foster free trade! continued

For this reason some economists have argued that the multilateral approach (MFN)1 to trade liberalization, represented by the trade liberalization agreements in successive WTO rounds, is more likely to achieve global free trade than the regional or preferential approach

1Most Favored Nations


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Will preferential arrangements foster free trade? continued

Preferential trade arrangements are often supported because they represent a movement in the direction of free trade

If free trade is economically the most efficient policy, it would seem to follow that any movement towards free trade should be beneficial in terms of economic efficiency

It turns out that this conclusion can be wrong!


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Will preferential arrangements foster free trade? continued

Even if free trade is most efficient, it is not true that a step in that direction necessarily raises economic efficiency

Whether a preferential trade arrangement raises a country's welfare and economic efficiency depends on the extent to which the arrangement causes trade diversion versus trade creation


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Trade Creation and Trade Diversion: Regional Integration and Welfare

The overall welfare effects of economic integration are ambiguous and require case-by-case judgment

Reason: integration is both a policy of protection and a move toward free trade


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The effect of the protectionist element of integration is called trade diversion

and

the effect of the trade liberalization element is called trade creation

The free-trade area's overall effect on welfare is determined by comparing the trade-creation and trade-diversion effects


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If trade creation dominates, the formation of a free-trade area will enhance welfare...

Sdom

Ddom

SNM + t

SM

SNM

SM + t

QX

PX

e

C

H

G

J

P0

P1

Q0 Q2Q1Q3

Figure 1

ba dc

PD

2.Trade increases from Q0 - Q1 to Q2 - Q3, if a free trade area is formed with country M, causing a welfare gain c + d.

3.Trade diversion, however, causes an efficiency loss e (lost tariff revenue).

1.Let’s assume that a country has originally imposed a tariff t on all imports of X. Imports then being Q0 – Q1.


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Figure 1: Welfare Effects of Economic Integration: Formation of a Free-Trade Area in Good X. SM denotes the supply of good X by member countries and SNM the supply by nonmember countries

Formation of a free-trade area causes a move from point C to point H in consumption. Trade increases as imports rise from Q0 - Q1 to Q2 - Q3, causing a welfare gain c + d

Trade also is diverted from nonmember countries toward member countries, causing an efficiency loss represented by the area of rectangle e


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The net gain for the domestic country depends which is larger (c + d) or e!

Note that if member countries are the low-cost producers of the traded good, there will be no trade diversion effect and integration will unambiguously increase welfare

Note also that if tariff is low enough to make the tariff-inclusive price of nonmember imports lower than the price of member imports, the free-trade area will have no trade-creating or trade-diverting effects since no trade with member countries will occur


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Why would a country create a

FTA with a country A if it could improve its

welfare more by forming one with

country B?


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Why would a country create a FTA...1. To answer that we need to go beyond

calculation of static gains and losses (i.e. trade creation and trade diversion) to dynamic gains: there may be economies of scale in

production in various goodso market size expands for the

manufacturers in these two countries…

why not include country B as well?maybe the economies of scale have

already been fully exploited...


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Why would a country create a FTA … continued

2. Preferential trading arrangements are some times formed for political (noneconomic) reasons

for instance, EU was formed because the European political leaders wanted to integrate their economies so completely that temptations to go on war would be diminished substantially


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Economists obtain estimates of the overall impact of integration by calculating the effects corresponding to areas a, b, c, d, and e (in our figure) for each major good traded

In the case of EU, most analysts agree that trade creation outweighs trade diversion; estimates suggest the EU's trade-creating effect has been about four times that of its trade-diverting impact

How efficient is EU in terms of trade creation?


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Arguments Against Regionalism

Bhagwati views the formation of regional trade arrangements (RTAs) as undermining the WTO

Regionalism is harmful because it encourages trade diversion

Arguments Against and For of Regional Trade Agreements


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Arguments Favoring Regionalism

Paul Krugman argues that trade diversion from FTAs is low because trading blocs are “natural” trading areas

Due to proximity and similarity of cultures and standards of living, regional trade agreements stimulate trade that would have occurred even in the absence of an agreement


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In-Class Exercise 3

Draw a mind map of economic integration



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ECONOMIC AND MONETARY UNION

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4 ECONOMIC INTEGRATION