MBA Global Economy

Economic Integration

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 Economic growth
◦ Larger market creates economies of scale, encourages
specialization, attracts foreign investment
 Non-economic objectives
◦ Helps manage immigration flows, or enhances regional
security, for example
 Solidifies domestic economic reforms
◦ East European nations have looked to association with the
EU as a way of locking in economic reforms

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 Considered the second approach to trade
liberalization
 A small group of nations, typically on a
regional basis, form an arrangement
◦ Lower barriers while trading with member nations
◦ Preferential treatment for group members

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 Regional trading arrangements
◦ Trade barriers reduced only for a small group of
partner nations
 Multilateral liberalization (WTO)
◦ Trade liberalization extended to all WTO members,
on a nondiscriminatory basis
 Regional trading blocs can complement
multilateral trading system
 Regional trading blocs can also be
protectionistic and antagonistic
 Trans-regional FTAs

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 Discriminatory; a departure from the principle
of normal trading relations, a cornerstone of
the WTO system
 Can act as stumbling blocks to
multilateralism
 Factors suggesting members’ non-interest in
worldwide liberalization:
◦ May not realize additional economies of scale from
global trade liberalization
◦ May want to invest time and energy in establishing
strong regional linkages

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 Ways that foster global market opening:
◦ Can achieve deeper economic integration among
members than multilateral accords
◦ Establishment of a regional free-trade area sets in
place a self-reinforcing process
 Attractive for nonmembers to join and receive trade
preferences
◦ Encourages partial adjustment of workers out of
import-competing industries and into exporting
industries based on comparative advantages

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 Free-trade area
 Customs union
 Common market
◦ Example: European Union (EU)
 Economic union
◦ Would include the dimension of a monetary union
◦ Common currency

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 Allows economies of large-scale production
 Fosters specialization and learning-by-doing
 Attracts foreign investment
 Fosters a variety of noneconomic objectives
◦ Managing immigration flows
◦ Promoting regional security
 Enhances and solidifies domestic economic
reforms
 Smaller nations may seek safe-haven trading
arrangements with larger nations

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 Static effects of economic integration
◦ On productive efficiency and consumer welfare
 Dynamic effects of economic integration
◦ Relates to member nations’ long-run rates of
growth

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 Static welfare effects of a customs union (Figure
8.1)
 Movement toward freer trade under a
customs union affects world welfare in two
opposing ways:
◦ A welfare-increasing trade-creation effect
 Consumption effect
 Production effect
◦ A welfare-reducing trade-diversion effect
 Generally implies a welfare loss

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 Dynamic gains
◦ Stem from the creation of larger markets by the
movement to freer trade under customs unions
◦ Include:
 Economies of scale, greater competition, and a
stimulus of investment
◦ Noticeable result: Market enlargement
◦ Broader markets may promote greater competition
among producers
◦ Can accelerate pace of technical advance and boost
level of productivity

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 European Community; created by the Treaty
of Rome in 1957
◦ Initially consisted of six nations
◦ Other countries joined the union between 1973 to
2004; total membership increased to 25 countries
◦ Opportunity to promote stability and further
integration of the continent by peaceful means
◦ Expansion will produce both winners and losers

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 Studies conducted on the overall impact of
the EU on its members’ welfare (1960s and
1970s)
◦ Study conclusion on static welfare benefits:
 Trade creation: Pronounced in machinery,
transportation equipment, chemicals, and fuels
 Trade diversion: Apparent in agricultural commodities
and raw materials
 Trade creation exceeds trade diversion
by a wide margin
◦ Dynamic benefits: Additional competition,
investment, and economies of scale

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 Continued

 1985: EU became a common market,

resulting in:
◦ Elimination of remaining nontariff trade barriers to
intra-EU transactions by 1992
◦ Process of replacing central banks with a European
Central Bank
◦ Replacing national currencies with a single Euro

 The Maastricht Treaty (signed in 1991)

 European Monetary Union (EMU) (2002) emerged with a
single currency, known as the euro

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 Continued

 Convergence: European nations aligned

economic and monetary policies
◦ Convergence criteria mandated by the Maastricht
Treaty:
 Price stability
 Low long-term interest rates
 Stable exchange rates
 Sound public finances
◦ Important motivation for the EMU:
 Momentum it provides for political union

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 New constitutional treaty finalized in 2004
that contained changes to the EU’s original
governing constitution
◦ Constitution’s future questionable following
rejection by French and Dutch voters in separate
referenda in 2005
◦ Experts predict that EU may face a period of
stagnation

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 Substantial elements of this policy:
◦ Support of prices received by farmers for their
produce
 Through schemes involving deficiency payments,
output controls, and direct income payments
◦ Supported EU farm prices through a system of
variable levies
◦ Exports of any surplus quantities of EU produce
have been assured through the adoption of export
subsidies

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 Continued

 Operation of a system of variable levies and

export subsidies
 Variable levy
◦ More restrictive than a fixed tariff
◦ Discourages foreign producers from absorbing part
of the tariff and cutting prices to maintain export
sales
 Export subsidy
◦ Ensures that any surplus agricultural output will be
sold overseas
◦ Government support for agriculture [Table 8.1]

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 Used by EU nations to support national and
regional firms and industries for several
reasons:
◦ National security
◦ Compensation for local communities near
environmentally damaging public industries
◦ Support for emerging high-tech industries
◦ Politics

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 Continued
 Sources for savings:
◦ Static trade effect: Purchases from the cheapest
foreign suppliers
◦ Competition effect: Domestic suppliers decreased
prices to compete with foreign competitors
◦ Restructuring effect: Restructuring of industries
over the long run; surviving companies achieve
economies of scale
◦ Opening up of government procurement

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 EU members have advanced to higher levels
of economic unification
 Regulatory differences remain, creating
barriers to trade and investment stifling
economic growth
◦ Examples:
 Kellogg Co.
 Caterpillar Inc.
 Ikea Group

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 European Monetary Union (EMU)
◦ Lowers the costs of goods and services
◦ Facilitate a comparison of prices within the EU
◦ Promotes more uniform prices

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 When Italy adopted the euro as its currency:
◦ Gave up option of changing its exchange rate to
improve competitiveness of its exporters
◦ Lira converted to euro at too high a rate, resulting
in uncompetitiveness?
◦ Effects of euro strengthening against the dollar:
 Italian firms lost competitiveness in U.S. markets
 Realization of the downside of joining the euro club

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 A region that has a single official currency
◦ Advantages and disadvantages (Table 8.2)
◦ Various reactions to economic shocks:
 Mobility of labor
 Flexibility of prices and wages
 Automatic mechanism for transferring fiscal resources to
the affected country
◦ To improve success chances, countries should have:
 Similar business cycles
 Similar economic structures
 Affect all the participating countries in the same manner

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 Advantages of forming a EMU:
◦ Improves economic efficiency
◦ Facilitates genuine comparison of prices
◦ Elimination of exchange-rate risk
◦ Stimulates competition
◦ Facilitates broadening and deepening of financial
markets
 Disadvantage of the EMU:
◦ Loss in use of monetary policy and exchange rate
as a tool in adjusting to economic disturbances

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 Difficulty in determining interest rates due to
wide difference in economic growth rates
among EMU countries
 Avoidance of excessive budget deficits
 Structural reform in European countries

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 Came into effect in 1994:
◦ Aim: Help Mexico develop as part of an integrated
North America
◦ Main goal: Provide each member nation better
access to the others’ markets, technology, labor,
and expertise
◦ Main concerns: Canada and the U.S. had little to
gain from trade liberalization with Mexico
◦ Likely gains and losses (Table 8.3)

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 Mexico
◦ Gains higher in comparison to U.S. and Canada
◦ Increases in production of goods and services for
which Mexico has a comparative advantage
◦ Rising investment has helped:
 Increase wage incomes and employment, national
output, and foreign exchange earnings
 Facilitated the transfer of technology
 Benefits to Canada of Abolishing U.S. Trade
Restrictions

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 Benefits of the U.S. economy overall:
◦ Expanding trade opportunities
◦ Reducing prices
◦ Increasing competition
◦ Enhancing the ability of U.S. firms to attain
economies of large-scale production
 Economic gains for the U.S. estimated to be
modest, because of size of U.S. economy

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 Affected segments of the U.S. economy
◦ Industries that rely on trade barriers to limit
imports of low-priced goods (citrus-growing and
sugar)
◦ Affects unskilled workers; jobs vulnerable to
competition from low-paid workers abroad
◦ Mexico’s environmental regulations criticized as
being less stringent compared to U.S.
◦ GDP, employment, and labor productivity (Table 8.4)

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 Making NAFTA more agreeable
◦ Regarding environment and labor:
 Establishing an agency to investigate abuses
◦ Fines or trade sanctions levied or imposed on
countries that fail to enforce:
 Environmental laws
 Minimum-wage standards
 Child-labor laws
 Worker-safety rules
 Effects of NAFTA on the U.S. economy (Table 8.5)

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 Other U.S Trade Agreements
◦ Many of the U.S. trade agreements are with
other Western Hemisphere countries
◦ This is largely because of the failure of the Free
Trade Area of the Americas (FTAA)
◦ In late 1994, 34 governments agreed to pursue
and FTA for the entire hemisphere
◦ Progress has been quite slow largely because
many South American governments are
concerned about protectionism and agricultural
subsidies in the U.S.

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Table 10.2(a) U.S. Regional Trade Agreements

Country Status of Agreement Date of Implementation

Israel Implemented 1985
Canada Implemented 1989, 1994
Mexico Implemented 1994
Jordan Implemented 2001
Chile Implemented 2003
Singapore Implemented 2003
Australia Implemented 2004
Bahrain Implemented 2004
Morocco Implemented 2004
Central American FTA Implemented 2005

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Table 10.2(b) U.S. Regional Trade Agreements

Country Status of Agreement Date of Implementation

Oman Pending Implementation
Peru Pending Congressional Approval
Panama Pending Congressional Approval
Korea Pending Congressional Approval
Colombia Pending Congressional Approval
Malaysia Under Negotiation
Thailand Under Negotiation
South Africa Under Negotiation
United Arab Emirates Under Negotiation

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 The U.S. is using FTAs to enhance economic
development in selected countries that wish to
pursue a more export-oriented strategy
 The U.S. helps countries develop and gains
access to potentially fast growing markets
 Since trade barriers are usually much higher in
developing countries than in developed
countries, the developing countries are the
ones who are sacrificing protection
 The use of RTAs allows the U.S. to move at a
faster pace than with the MTN process

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 Trade liberalization is a contentious matter
 Outside the EU, until the 1980s most trade
liberalization had been through MTNs
 Since then RTAs have become more
common
 The benefits and costs of RTAs are difficult
to calculate
 This has lead to some reservations about
the spread of RTAs
 Others believe the benefits outweigh the
costs

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 Theoretically, MTNs are nondiscriminatory
as there is only trade creation and no trade
diversion
 An RTA is inherently discriminatory as
member countries are treated differently
than nonmember countries
 As RTAs spread, world trade becomes more
complicated
 The world trading system could revert back
to a system where each country has
different tariffs for each product for specific
countries

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 The increased amount of trade diversion
potentially reduces world welfare
 As countries spend more time on RTAs, they
will spend less time on WTO matters
 This makes obtaining multilateral
agreements more difficult
 However, RTAs are legal under WTO rules
and trade creation generally exceeds trade
diversion
 Their popularity may be because
governments prefer them

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 In some cases, governments want to pursue
deeper levels of integration than is possible
with multinational agreements
 The adjustment costs for domestic
industries may be lower with RTAs than with
MTNs
 Some economists see RTAs as substitutes
for MTNs
 Some see them as compliments
 There is little or no support for abandoning
the process

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 U.S. is a member since 1989
◦ Vision (1993): Elimination of barriers to trade and
investment by the year 2020
◦ Pace of implementation would take into account the
differing levels of economic development among
APEC economies
◦ Status: Remains to be seen whether the APEC goal
of economic integration will be achieved

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 Involves nations making the transition from a
centrally planned economy to a market
economy
◦ Gross national income per capita for the transition
economies as of 2004
◦ Major features of these economic systems:
 Market economy: Commercial decisions of
independent buyers and sellers govern both domestic
and international trade
 Nonmarket economy: State planning and control
govern foreign and sometimes domestic trade

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