Olofsdotter K Overheads

8/2/2019 Olofsdotter K Overheads

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ECONOMIC INTEGRATION THEORY

1. Types of economic integration

2. Effects of economic integration

- Gains from trade

- Static effects

- Dynamic effects

3. Effects on outside countries

4. Empirics - European Integration



1. Economic integration

The process of removing trade impediments between two or more countries. Requires

certain elements of cooperation and coordination

Global integration (GI)

Negotiations within GATT / WTO ⇒ large reductions in tariffs

Uruguay-round:

- non-tariff barriers

- trade in services

- intellectual property rights

- environment

Regional integration (RI)

Number of regional integration agreements grown rapidly since 1980s

Regional integration a step towards or an obstacle to global integration?

“ a building bloc or a stumbling bloc”



Principles of World Trade governed by the World trade Organization (WTO):

Article I:

Most-Favored-Nation (MFN) principle: a principle of non-discrimination. Rules out any

preferential treatment among nations

If a country gives preferential tariff-access to any other country that concession must be extended

(immediately) to all other countries

Exceptions

Article XXIV:

Preferential Trading Areas (PTAs) allowed if

1) trade barriers removed on substantially all trade and

2) the agreement does not “on the whole” result in more restrictive trade barriers to

outsiders than those that existed before



Levels of Integration:

1) Free Trade Area (FTA)

Trade barriers eliminated against the members and each country has its own trade barriers against

outside countries. EFTA, EU/EFTA, NAFTA

2) Customs Union (CU)

Free trade within the union and common external trade barriers

EU

3) Common market

Free factor mobility ⇒ factor price-equalization

4) Economic Union

Fixed exchange rates and coordination of fiscal and monetary policies

5) Political Union

A sovereign parliament

Germany





b) Regional Integration

I. Static effects

Viner (1950) “The Customs Union Issue”

Trade creating viz. Trade-diverting effects

Trade creation: free-trade effect

imports from a lower-cost producer in another country instead of domestic production

Trade diversion: protectionistic effect

imports from a higher-cost producer within the CU instead of importing from thelowest-cost producer in the international market



No CU, tariff rate = 200% CU with Germany, tariff rate =

200%Sweden Germany Thailand Sweden Germany Thailand

Cost of

Production

2.00 1.50 1.00 2.00 1.50 1.00

Tariff in

Sweden

- 3.00 2.00 - - 2.00

Price in

Sweden

2.00 4.50 3.00 2.00 1.50 3.00

⇒ Trade-creating customs union

imports from a lower-cost producer in another country instead of domestic production



No CU, tariff rate = 90% CU with Germany, tariff rate =

90%Sweden Germany Thailand Sweden Germany Thailand

Cost of

Production

2.00 1.50 1.00 2.00 1.50 1.00

Tariff in

Sweden

- 1.35 0.90 - - 0.90

Price in

Sweden

2.00 2.85 1.90 2.00 1.50 1.90

⇒ Trade-diverting customs union

imports from a higher-cost producer within the CU instead of importing from thelowest-cost producer in the international market (no tariff revenue)



Trade creation:

1) members produce similar goods

2) demand and supply should be as flexible as possible

Trade-diversion:

1) smaller the larger the CU

2) the larger the differences in production costs between members.

3) initially low level of trade relative to production

4) high proportion of pre-union trade with future partners

Countries that are currently competitive but potentially complementary should form a CU!

Importance of the level of economic development:

Welfare-enhancing CU where the trade-creating effect dominates is more likely if the integrating countries

are richer, produce similar (industrial) goods and have a large volume of trade before the CU is formed.

Typically involves intra-industry trade.



II. Dynamic Effects

i) Increased efficiency and economic growth by:

- increased competition

- exploitation of scale economies

the importance of market size

integration⇒ lower production costs and lower prices

ii) Polarization

Concentration of production to certain regions ⇒ need for redistributing policies (EU)

Could attract industries from outside countries



3. Effects on Outside Countries /Trade Policy Aspects

- Terms-of-trade effect: outside countries may face lower demand for their products

- The Common External Tariff (CET) under a CU?

(GATT article XXIV states that PTAs allowed if:

1) trade barriers removed on substantially all trade and

2) agreement must not “on the whole” result in more restrictive trade barriers to outsiders than

those that existed before (weighted average of the trade barriers applied by the individual

members before the CU))

Risk of trade blocs (Europe, the US and South-East Asia). A few strong trade blocsprobably the most trade-diverting outcome

Globalization viz. Regionalisation?



4. The European Union: Gains and Losses

Trade creation and trade diversion:

- Trade creation: Manufacturing ⎯ competitive production

Exports as a share of total exports increased from 35% in 1960 to 60%

IIT around 60%.

- Trade diversion: Agriculture, textiles due to heavy protection

The Single Market

- administrative costs/bureaucracy and transport costs (boarder crossing simplification)

- mutual recognition of health and safety standards

- public procurement

- services- labor mobility

- fiscal harmonization etc



Gains

- one-time effects 2-4 %

- potential long-run effects from e.g. increased competition and agglomeration

effects

Losses

- risk of higher protection⇒

Fortress Europe

Small open country: risk of external trade barriers rise when adapting to the CET of

the union

Other arguments:

-

compensation for increased competition from other member countries- protect certain industries in order to obtain monopoly power

- voting rules tend to favor protectionistic countries

- the economic development in the early 1990s



Macro-economic effects from the Monetary Union

⇒may increases integration and stability by

- elimination of transaction costs

- elimination of exchange risks

- reduced investment risk

- lower interest rates

- lower inflation

- more efficient taxation etc



Other Arrangements:

South – South:

- common market not big enough, small industry sector, low competition and inefficient production

behind a high CET

- a more industrialized partner tend to reap most of the gains through trade diversion⇒ polarization

and unequal distribution

South – North:

- often a colonial pattern, e.g. between the EU and former colonies or bilateral agreements with

East-European countries, the US and countries in South-America and the Caribbean

- increased specialization based on differences in endowment ⇒ risk of large trade-diverting effects

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Olofsdotter K Overheads