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Subject COMMERCE

Paper No and 11: INTERNATIONAL BUSINESS

Title
Module No and 31 : REGIONAL ECONOMIC INTEGRATION: STRUCTURE AND
Title FUNCTIONING-I
Module Tag COM_P11_M31

COMMERCE PAPER No. 11: INTERNATIONAL BUSINESS

MODULE No. 31: Regional Economic Integration: Structure
And functioning – I
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TABLE OF CONTENTS
1. Learning Outcomes
2. Introduction
2.1 Regional economic integration (REI): An overview
2.2 World Trade Organization
3. Levels of economic integration
3.1 Levels of integration: Basic classification
3.2 Distribution of REIs notified to WTO
4. Benefits and costs
4.1 Benefits associated with REIs
4.2 Costs associated with REIs
5. Summary

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MODULE No. 31: Regional Economic Integration: Structure
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1. Learning Outcomes

After studying this module, you shall be able to

 Understand the rationale for regional economic groups.

 Know about the levels of economic integration.
 Understand the perceived benefits and costs associated with regional economic
integration.

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2. Introduction

2.1 Regional Economic Integration (REI): An Overview

During the last half century there has been a proliferation in regional economic integration among
the various countries around the globe. Such regional economic integration (also known as
regional trade agreements1) refers to an agreement among economies (or nations) to reduce, and
ultimately remove, tariff and non-tariff barriers to liberalize flow of goods, services, and factors
of production. These regional economic integrations are designed to promote free trade and
generate gains from trade for all member economies. However, each member economy can have
its own trade policies with respect to non-member economies.

COUNRTY X

REST OF
THE
REGIONAL
COUNTRY Z TRADE COUNTRY R WORLD
AGREEMENT (NON
MEMBER)

COUNTRY Y

Fig 1.1 Regional economic bloc

Regional economic integration can be either bilateral or multilateral. Bilateral trade

agreements are between two nations at a time. They are easy to negotiate and even
provide both the nations favored trading status.

X Y

Fig 1.2 Bilateral trade agreements

1
Trade focuses on economic exchange of goods, services and factors of production between two or more
integrated countries.
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Multilateral trade agreements are negotiate among many

nations at a given time forming a bloc. They are complicated to
negotiate but very powerful once all parties sign the agreement.

Y
X Z

A C
B

Fig 1.3 Multilateral trade agreements

The major regional economic integrations which have been negotiated in the last few decadesare
European Union (EU),North American Free Trade Agreement (NAFTA), Mercosur, Association
of Southeast Asian Nations (ASEAN), South Asian Free Trade Area (SAFTA) and many others.
Even more than 100 bilateral regional economic integrations have been negotiated and formed
including US – Colombia, Panama – Peru ,China – Costa Rica ,New Zealand – Malaysia
,Australia - Malaysia, South Korea – United States, European Union – South Korea, European
Union – Latin America, European Union - Singapore, India-Japan, etc.

1.2 World Trade Organization (WTO)

WTO is an international organization formed to regulate, support and liberalize international

trade. WTO was officially founded on January, 1 1995. WTO is the successor to Global
Agreement on Tariffs and Trade (GATT) which was created in 1947. WTO acts as a forum for
trade negotiations among its member countries2, it regulates and administers trade agreements,
handles trade disputes, etc. WTO aims to enforce member countries to abide by the agreement
signed by the participating countries. Since the creation of WTO large number of agreements
have been created, some are still in force (and notified) but few have discontinued. Large
numbers of discontinued agreements have been superseded by restructured agreement. The
numbers have quadrupled since 1990, rising to around 260 in force (and notified) to WTO by late
2012 (WTO database).

2
Any country (or nation) who wants to conduct its trade policies may join the WTO, but must agree on the
terms. Membership means a balance of right and obligations. Currently, more than 150 countries are
member of WTO.
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MODULE No. 31: Regional Economic Integration: Structure
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3. Levels of economic integration

3.1 LEVEL of economic integration: Basic classification

Economic integrations are progressing from low level integration to higher levels of integrations
with the growth of trade and investment. There are FIVE levels of economic integration starting
from lower lever of preferential trade agreement to deeper level of political union.

3.1.1 Preferential Trade Agreement (Free Trade Agreement)

 Simplest and most common arrangement of economic integration.

 Member countries agree to gradually reduce (and even eliminate) barriers to trade in
products and services within the bloc.
 However, in case of preferential trade agreement member nations agree to reduce or
eliminate tariff barrier on selected goods whereas in case of free trade agreement member
nations agree to reduce or remove tariff barriers on all goods.
 Each member country maintains an independent trade policy for non-member countries
outside the bloc.
 Examples of FTA are North American Free Trade Agreement (NAFTA).

3.1.2 Custom Union

 Similar to Free Trade Agreement except that the member countries of a given bloc also
have common trade policies towards non-member nation implying common tariff (non-
tariff) barriers on trade with non-member nations.
 Example MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay), Andean Community.
 More difficult to negotiate as compared to Free Trade Agreement.

3.1.3 Common Market

 Similar to custom union but in addition to it, common market also allows free movement
of labor and capital within the bloc.
 No restriction on emigration, immigration and cross boarder flow of capital among
member countries.
 Requires substantial cooperation from member countries on labor, economic and
employment policies.

3.1.4 Economic Union

 It’s a deeper level of integration.

 Along with the advantages of earlier stages of integration member economies also agree
to have a common monetary and fiscal policy including identical tax rates, fixed
exchange rates, and free convertibility of currencies and free movement of capital.

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 European Union (EU)3 is an example of economic

union. EU members have eliminated cross border controls, have a monetary policy with a
single currency (euro).

3.1.5 Political Union

 It represents the most advanced level of integration with a common government and
single constitution.
 The sovereignty and democratic rights of the member economies are significantly
reduced.

integartion
LEVELS OF INTEGRATION of political
and
CM+
common economic
monetary affairs
CU+free
movement and fiscal
of factors of
FTA+ production
common
trade policy
no trade political union
barriers on economic union
all goods
no trade (EU)
barriers on common
some goods custom union market (CM)
free trade (CU)

preferential
agreement
trade agreement
LEVELS OF INTEGRATION

Fig 2.1 Levels of integration

Apart from the above said regional economic integrations, there are some other popular forms of
regional economic integrations that can be notified by WTO. One of them is Partial Scope
Agreement (PSA) which is preferential trade agreements notified to WTO. Another, Economic
Integration Agreements which cover trade in services unlike FTAs which cover trade in goods.

3
Though not a perfect economic union as the member economies do not have identical tax rates and
regulation.
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3.2 Distribution of Regional Economic Integrations notified to WTO (and in force) BY

TYPE OF AGREEMENTS

The member nation cannot if to WTO by entering into following types of RTAs
o A Free Trade Agreement (FTA), under the provisions of GATT for trade in
goods;
o A Customs Union (CU), under the provisions of GATT for trade in goods;
o An Economic Integration Agreement (EIA), under the provisions of GATS for
trade in services;
o A "Partial Scope" Agreement (PS). "Partial Scope" which covers only certain
products.

Table 1: The existing distribution of types of RTAs notified to WTO (and in force)

TYPE COVERAGE NUMBER

Partial Scope Agreement GOODS 14
Partial Scope Agreement & Economic Integration
GOODS & SERVICES 1
Agreement
Free Trade Agreement GOODS 110
Free Trade Agreement & Economic Integration Agreement GOODS & SERVICES 109
Custom Union GOODS 17

Custom Union & Economic Integration Agreement GOODS & SERVICES 8

Economic Integration Agreement SERVICES 1

TOTAL 260

*RTA in force and notified to WTO as on sept, 2013.

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MODULE No. 31: Regional Economic Integration: Structure
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4. Benefits and costs associated with regional economic integration.

4.1 BENEFITS ASSOCIATED WITH REGIONAL ECONOMIC INTEGRATION.

Regional economic integration promotes better flow of goods and services among member
nations. Hence, the positive impact of regional economic integrations can be seen but the
magnitude of advantages may differ for each member of the bloc. Some of the common benefits
can be seen as follows:

4.1.1 Trade creation

Regional economic integration brings about policies and measures to reduce trade barriers. Such
an environment helps to boost trade among the member nations. Reduction in tariff encourages
member economies to expand the market size, look for more competitive products, reduction in
trade cost, and reduction in the cost of factors of production. Hence, trade creation takes place
between members.

4.1.2 Larger market size

Regional economic integration provides a larger market as compared to the domestic market in
isolation since the consumer can easily look for product and services offered by all members who
belong to a bloc. The larger market so created would lead to high degree of specialization of
product offered leading to industrial development.

4.1.3 Enhance political cooperation

Economic integration links economies which makes them more dependent upon each other,
providing incentive for political cooperation among member nations. Integration is a vital tool for
addressing the issues of political instability and conflicts. Moreover, by grouping, member
nations can enjoy political strength in the world.

4.1.4 Generating Employment prospects

Economic integration leads to trade liberation, market expansion, and better cooperation among
member nations which creates employment prospects. People are free to migrate from one nation
to another for better job opportunities and/or better pay. Industries may shift their production
processes to nations that provide cheaper inputs like low wage workers, cheap raw materials, less
cost of establishment, cheaper equipment and tools.

4.1.5 Supports economic growth

Economic integration promotes better production and consumption which leads to rise in real
income generated. Nevertheless, member nations try to harmonize key policies such as trade,
fiscal and monetary policies that encourages flow of both trade and investment.

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4.2 Costs associated with economic integration

Economies entering into regional economic integration suffer various limitations along with the
benefits.

4.2.1 Destruction of indigenous (domestic) industries

Some producers may manage to cope up with the competition rising due to economic integration
whereas others, which lack international standards, may lose the market. Even some industries
may need to make painful adjustmentsto sustain in the market like lower profits, retrenchment of
labor, bearing high cost of production, etc.

4.2.2 Concerns over national sovereignty

In the wave of economic integration member nations need to harmonize key policies like
monetary, fiscal and trade policies for deeper integration and in the process need to give up
considerable control over key policies.

4.2.3 Risk of unemployment

As member countries may have different wage structures, there may be movement of worker at
low cost or/and better skill which may hamper the employment level in the domestic country.

5. Summary
 Regional economic integrations have been quadrupled since 1990, rising to around 260
integrations in force and notified by late 2012 (WTO database).
 With the emergence of large number of regional economic integration the entire world
can be seen as a global market for trade and investment as economic integrations are
facilitating the economies to reduce and even remove tariff and non-tariff barriers.
 Moreover, some integration can be seen at a deeper stage of integration like European
Union (EU) whereas others are still at the initial stage of integration.
 Large number of integrations is gaining popularity and strength in their respective regions
like ASEAN, NAFTA, etc.
 Member economies are enjoying benefits in the form of trade creation, employment
generation, larger market size, strengthening political cooperation, boosting economic
growth.
 Economic integration even has its cost for the member nations. It brings concern over
national sovereignty and may even discourage growth of domestic industry. Even it may
lead to unemployment if industries move the work of production to economies of cheaper
labor.
 Hence, such integrations have both cost and benefits for the participating economies.

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MODULE No. 31: Regional Economic Integration: Structure
And functioning – I