ECONOMIC INTEGRATION

Economics a Course CompanionP267-273

Oxford, 2007

Source: http://www.people.hofstra.edu/geotrans/eng/ch5en/conc5en/img/economicintegration.gif

Date Accessed: 11th November 2009

What is Economic Integration?

• Economic integration describes a process whereby countries coordinate and link their economic policies.

• As the degree of economic integration increases, the trade barriers between countries decrease and their fiscal and monetary policies are more closely harmonized.

http://www.geographyalltheway.com/ib_geography/ib_globalization/imagesetc/globalization.jpg.Accessed: 10th November 2009

http://www.tcnj.edu/~yang23/globalization.jpg. Accessed: 10th November 2009

Source:http://www.ircc.iitb.ac.in/~webadm/update/archives/December03/images/globalization.jpg Accessed: 10th November 2009

http://www.cartoonweb.com/images/globalization/globalization5.gif. Accessed: 10th November 2009

http://globalizationeffects.files.wordpress.com/2009/05/globalization2.jpg. Accessed: 10th November 2009

http://www.communicationagents.com/steve_bosserman/Displacement%20and%20Globalization/Globalization%20and%20Displacement.jpg. Accessed: 10th Nov 09

http://images.google.co.ve/images?gbv=2&hl=es&q=globalization&sa=N&start=20&ndsp=20

What is Globalization?

What is Globalization?

Globalization may be defined as the increased

integration of national economies into global, rather than national markets, prompted by liberalized capital flows, liberalized trade flows, significant advances in information technology, and marked decreases in the costs of international transport.

When did globalization start?

• From the 1980s to the present day, there has been significant and rapid globalization of the world economy.

What is the role of MNCs in globalization?

• Multinational Corporations (MNCs) have played a significant role in the process of globalization.

• They are defined as companies that produce in more than one country.

• MNCs are creating global factories, where production takes place in a number of countries, taking advantage of the cost differences in those countries.

What is the role of MNCs in globalization?

• A product may have component parts made in several countries and the final construction may take place in another country.

• This is know as integrated international production.

• Eg: A Toyota car may be designed in Japan, the leather upholstery may be produced in Argentina, the engine may be constructed in Mexico, the car assembled in Brazil and then it may be transported to the US for sale.

MNCs & Foreign Direct Investment (FDI)

• MNCs are associated with foreign direct investment (FDI)

• FDI is the long term overseas investment by MNCs.

• The contribution of MNCs to the process of globalization and global economic growth cannot be over-estimated.

TRADING BLOCS

• A trading bloc is defined as a group of countries that join together in some form of agreement in order to increase trade between themselves and/or to gain economic benefits from cooperation on some level.

• This coming together is economic integration.• The Hungarian Economist Bela Balassa,

identified six stages of economic integration.

Six Stages of Economic Integration

1. Preferential Trading Areas2. Free Trade Areas3. Customs Union4. Common Markets5. Economic & Monetary Union6. Complete Economic Integration

1. Preferential Trading Areas (PTA)

• A PTA is a trading bloc that gives preferential access to certain products from certain countries.

• This is usually achieved by reducing, but not eliminating tariffs. • An example of a PTA is one between the EU and the ACP (Africa,

The Caribbean & the Pacific) countries. • This is an agreement between the EU and 71 countries in the

ACP.• Many of these countries were former colonies of EU members.• It enables the EU to guarantee regular supply of raw materials

and the ACP countries gain tariff preferences and access to special funds that are used to achieve price stability in agricultural and mining markets.

2. Free Trade Areas

• A free trade area is an agreement made between countries, where the countries agree to trade freely between themselves, but are able to trade with countries outside of the FTA in whatever way they wish.

In this diagram , countries A, B & C have signed a free trade agreement and are now trading freely among themselves. However, under the agreement, each country may trade with any other country in any way it sees fit. Thus country A has political grievances with country D and so has placed a complete embargo on foreign trade. Country B protects its economy from country D, by placing tariffs on a number of imports. Country C has good relationships with country D and trades freely with it.

2. Free Trade AreasNAFTA

• An example of an FTA would be the North American Free Trade Agreement, which comprises the US, Canada and Mexico.

• NAFTA was formally established in January 1994.

• However, it was not until January 2003, that a final tariff reduction between Canada and Mexico, achieved the ultimate goal of tariff free trade in the region (99%)

2. Free Trade AreasOther examples of FTAs

European Free Trade Association• Iceland, Norway, Switzerland and

Liechtenstein)

South Asia Free Trade Agreement• India, Pakistan, Nepal, Sri Lanka, Bangladesh,

Bhutan and the Maldives.

3. Customs Unions

• A Customs Union is an agreement made between countries, where the countries agree to trade freely among themselves, and also they agree to adopt common external barriers against any country attempting to import into the customs union.

Countries A, B & C have joined in a Customs Union and are traded freely with each other. If country D wishes to export goods to the customs union, the goods will be treated in the same way, no matter which country the goods enter. If the customs union has agreed to place tariffs on the products of country D, then those tariffs will be imposed, no matter what point of entry to the customs union.

3. Customs Unions

• All common markets and economic and monetary unions are also customs unions.

• Therefore the EU has a customs union.• Other examples: The Switzerland-Liechtenstein Customs Union.East Africa Community, comprising Kenya,

Uganda, & Tanzania.Mercosur, comprising Brazil, Argentina, Urugay

and Paraguay.

4. Common Markets

• A common market is an extension of a customs union.

• It is different to a customs union because there are common policies on product regulation, free movement of goods, services, capital and labour.

• The best known example of a Common Market is the EU.

Common MarketsExample: CARICOM

• The Caricom a single market and economy (CMSE)

• Current members are Barbados, Belize, Guyana, Jamacia, Suriname, Trindad & Tobago, Antigua & Barbuda, Dominica, Grenada, St Kitts & Nevis, St Lucia & St Vincent and the Grenadines.

• Montserrat is also expected to join.

5. Economic & Monetary Union

• Economic & monetary union is a common market with a common currency.

• The best example of economic and monetary union is the Eurozone, which includes the member countries of the EU that have adopted the EU as their currency.

• Note: Some countries in the EU have not adopted the Euro (Eg: Britain) and therefore are not part of Eurozone statistics.

6. Complete Economic Integration

• This would be the final stage of economic integration at which point the individual countries involved would have no control of economic policy.

• There would be full monetary union and complete harmonization of fiscal policy.

An Evaluation of Trading Blocs

• The advantages and disadvantages of trading blocs clearly depends to a large extent on the degree of integration.

• In purely economic terms, the benefits of being a member of a trading bloc are similar to those of free trade.

• These include greater market size with the potential for a larger export market, increased competition leading to greater efficiency, more choice and lower prices for consumers.

• The consequences may not be even, as some domestic producers are likely to gain from the larger market while others may find themselves unable to compete.

An Evaluation of Trading Blocs

• There may be further stimulus for investment due to the larger market size, and foreign investment might be attracted from the outside the bloc as a way of getting a foot in the door of a larger market.

• There is also an argument that along with the economic gains, a trading bloc will foster greater political stability and cooperation.

• It is also possible that trade negotiations may be easier in world made up of a number of large trading blocs, rather than among sovereign states.

An Evaluation of Trading Blocs

Discriminatory Policies Against non-members• By their very nature, trading blocs favour

increased trade among members, but enact discriminatory policies against non-members.

• This can be damaging to the achievements of the multilateral trading negotiations of the WTO.

OBSTACLES TO ECONOMIC INTEGRATION

The two most common reasons stated againsteconomic integration are:• Economic integration takes away a country’s

political sovereignty. • Economic integration takes away economic

sovereignty

OBSTACLES TO ECONOMIC INTEGRATION

Loss of Political Sovereignty • If integration reaches the stages of a customs

unions, then political decisions start to be made by a central body and this reduces the power of the domestic government of the country.

• This may not be popular with domestic politicians and also with those members of the population who are especially patriotic.

• An example is the European Parliament making decisions for EU countries.

OBSTACLES TO ECONOMIC INTEGRATION

Loss of Economic Sovereignty • Again if integration reaches the stages of a

customs union, then economic decisions also start to be made by a central body.

• Governments and citizens in any given country may be reluctant to give up rights to make decisions about economic matters.

• An example of this would be the European Central Bank, making decisions relating to interest rates.

OBSTACLES TO ECONOMIC INTEGRATION

Loss of Economic Sovereignty • Integration into a common market may `force` a country

to change its economic policies.• If there are greater tax benefits in one country and

factors of production are free to move from one to another, then the government in the country with higher taxes may have to lower them in order to discourage such movement.

• The greater the level of economic integration the move member countries will lose control over political and economic affairs.

TRADE CREATION

• Trade creation occurs when the entry of a country into a customs union leads to the production of a good or service transferring from a high cost producer to a low-cost producer.

• This is advantage of greater economic integration.

Example of Trade Creation

• When the UK joined the EU in 1973, it had a comparative advantage over France, (an EU member) in the production of lawnmowers.

• However, as a non-member of the EU, the EU has placed a tariff on UK lawnmowers.

TRADE CREATION EXAMPLE

With the tariff on UK lawnmowers in place, the French would produce 0Q2 lawnmowers themselves and would import Q2Q3 lawnmowers from the UK. On entering the EU, the tariff on UK lawnmowers is removed and UK can now make full use of its comparative advantage. With the tariff gone, French production falls to 0Q 1 and imports rise to Q1Q4. There are Q3Q4 more lawnmowers brought and thus trade has been created. In addition, the extra demand means that there is an increase in consumer surplus, shown by the shaded triangle.

P (UK) + T

P (UK)

Example of Trade Creation (continued)UK-France Lawnmower Market

• There is a movement from high-cost to low-cost producers, since the Q1Q2 lawnmowers, which were being made by relatively inefficient French producers are now being made by more efficient UK producers.

• Although the French lawnmower producers may have lost out, there has been a world welfare gain, because fewer resources are being used to produce these lawnmowers.

Example of Trade Creation (continued)UK-France Lawnmower Market

Two Way Process• It should be remembered that this ought to be

a two-way process.• It is highly likely that, with free trade, there

will also be French products that UK will now buy more of because the French have a comparative advantage. Eg: Wine

TRADE DIVERSIONExample-UK-Thailand Trade

Hypothetical Example• When the UK joined the EU in 1973, it had been

producing textiles itself and importing textiles from Thailand, which has a comparative advantage in producing textiles.

• The UK did not place a tariff on textiles from Thailand.

• However, once the UK joined the EU it had to place a tariff on Thai textiles, because the EU already had one in place.

TRADE DIVERSION EXAMPLE

Before its entry into the EU, the UK would produce 0Q1 metres of textiles domestically and would import Q1Q4 metres of textiles from Thailand. On entering the EU, the UK is forced to impose the same tariff on Thai textiles as the other EU countries. With the tariff in place, Thai textiles become more expensive than textiles produced in the EU. Because of this, the UK will now produce 0Q2 metres of textiles itself and will import Q2Q3 metres of textiles from the EU.There will be an overall fall in the quantity demanded of textiles of Q3Q4 metres and so a loss of consumer surplus shown by the shaded triangle.

P (Thai) + T

P (EU)

P (Thai)

TRADE DIVERSIONUK-Thailand-EU Trade Example

• There is a movement from low-cost to high-cost producers, since Q1Q2 metres of textiles that were being produced by relatively efficient Thai producers are now be produced by less efficient UK producers.

• Although the UK producers may have gained, there has been a world welfare loss because more resources are being used to produce these textiles.

TRADE DIVERSIONUK-Thailand-EU Trade Example

• To make matters worse the production of Q2Q3 of textiles has transferred from relatively efficient Thai producers to relatively inefficient EU producers, so the trade diversion is even greater, as is the loss of world welfare.

• This represents a misallocation of the world’s resources and represents a disadvantage of economic integration.

EXAM QUESTIONS

Short Response Questions

1. Using a diagram, explain the difference between a free trade area and a customs union. (10 marks)

Essay Questions

1a. What do economists mean when the refer to trading blocs? (10 marks)

1b. Evaluate the likely effects of membership in a trading bloc. (15 marks)