Economic Integration

1. Economic Integration • Definition: economic cooperation between countries and co-ordination of their economic policies, leading to increased economic links between them. It occurs because of numerous benefits that may be derived by the co-operating countries. • There are different degrees of integration, depending on the type of agreement made between the co-operating countries, and the degree to which barriers between them are removed.

2. Preferential trade agreements (PTA) • Definition: an agreement between two or more countries to lower trade barriers between each other on particular products. Trade barriers may remain on the rest of the products, and on imports from non-member countries. • PTAs sometimes involve cooperation between members on labour standards, environmental issues or intellectual property. • They include free trade areas (FTAs), customs unions or common markets and they may be bilateral or regional.

3. Bilateral, regional and multilateral (WTO) trade agreements • Bilateral trade agreement: between two countries. • Multilateral trade agreement: many countries. • Regional trade agreement: involves a group of countries that are within a geographical region. • Their main objective is to promote trade liberalisation, ie, free(r) trade by reducing or eliminating trade barriers between members. • WTO trade agreements are multilateral: they include WTO member countries around the world and they require member countries to reduce trade barriers at the same time.

4. A fundamental principle of the WOT is non-discrimination, ie, a country cannot discriminate between any WTO members (it cannot impose higher barriers on imports from one country and lower ones on imports from another country). • However, WTO makes an exception for bilateral and regional trade agreements, even though all PTAs involve discrimination against non-member countries.

5. Trading blocs • Free trade area (FTA). A group of countries that agree to gradually eliminate trade barriers between themselves. Each country keeps the right to apply protectionist policies when trading with non-member countries. The trade of some products might still be protected. Examples: NAFTA=CA, MX, US; ASEAN One problem is that a country may be imported into the FTA by the country that has the lowest external trade barriers and then sold to countries within the FTA with higher external barriers. To avoid this: rules of origin.

6. Customs union. Same conditions as FTA plus adoption of common policy towards non-member countries. Also, in negotiations with other countries the member countries act as a group. Higher degree of economic integration than a FTA. • Example: CEFTA (Central European Free Trade Agreement), SACU (South African Customs Union). • Advantage: same common external barriers, so no need to create rules of origin for imports. • Disadvantage: Possibility of disagreements, as members must coordinate their policies towards non-members.

7. In a common market, countries that have formed a customs union decide to eliminate any remaining barriers to trade between them. In addition, they agree to eliminate all restrictions on movements of factors of production (labour and capital) within the common market. Example: European Economic Community, precursor of the EU. • Advantages: • Free trade, which implies lower prices, greater consumer choice, etc • Workers are free to move and capital can also flow without restrictions. This results in a better use of factors of produciton and improves the allocation of resources.

8. Disadvantages: • Requires even greater policy coordination among members. • Requires the willingness of member governments to give up some of their policy making authority to an organisation with powers over all the member governments. • A long time is needed for all countries to make the necessary policy changes to achieve coordination.

9. Economic and monetary union. Economic union involves the unification of the monetary and fiscal systems of the members, with a unified system of economic policy making. Countries maintain political identity. • Monetary union is achieved by adopting a common currency. Ex: eurozone countries. • Eurozone countries still have separate fiscal systems and only a partially unified policy-making system.

10. Pros and cons of trading blocs Benefits: • Increased competition. • Expansion into larger markets. • Economies of scale. • Lower prices for consumers and greater consumer choice. • Increased investment: internal by firms from a member country or external by outsider firms, which escape the tariff imposed by the trading bloc on imports from outside.

11. Better use of factors of production, especially if a trading bloc develops into a common market. • Improved production efficiency and greater economic growth. • Political advantages: Reduced likelihood of hostilities between countries becoming increasingly interdependent and political cooperation resulting from economic integration.

12. Disadvantages: • Many economists think that trading blocs are inferior to the WTO’s multilateral approach of reducing trade barriers towards all countries. Trading blocs involve an increasing amount of discrimination, which violates the WTO’s non-discrimination principle. • May create obstacles for global free trade. Some economists believe that conflicts between trading blocs might arise, difficulting the process of global integration. Trade barriers on non-members may result in limiting trade on a global scale, which would worsen the allocation of resources, lower global output and a weakened role for the WTO. • Unequal distribution of gains from trading blocs, as not all members obtain the same benefit.

13. Monetary union: the EMU • Involves a greater degree of integration than a common market and occurs when the member countries of a common market adopt a common currency and a common central bank responsible for monetary policy. • EMU: • Created in 1999 by 11 European countries: A, BE, FI, FR, G, IR, IT, L, NL, PT, SP. • 2001: GR; 2007: Slovenia; 2008: CY, MT

14. 1 January 1999: ‘birth’ of the euro. The currencies of the member countries are locked together through fixed and unchangeable exchange rates. • 1 January 2002: euros and national currencies co-exist • 1 January 2003: national currencies are abandoned. • Convergence requirements: • Limiting inflation rate • Limiting budget deficit (T-G) to 3% of GDP • Limiting gov. debt to 60% of GDP • The ECB assumed the responsibility for monetary policy for all members.

15. Advantages • Eliminates exch rate risk and uncertainty → benefits for importers, exporters and investors → encourages trade and investment across boundaries. • Eliminates transaction costs, which encourages trade. • Encourages price transparency → easier for econ decision makers to see price differences quickly → promotes competition and efficiency.

16. Low inflation rates, which gives rise to low interest rates → more investment, increased output. • Promotes higher level of inward investment (from outsiders towards the member countries), due to absence of currency risk.

17. Disadvantages • Loss of exch rates as a mechanism of adjustment. Currency depreciation/devaluation cannot be used to solve trade deficit problems or loss of competitiveness (due to higher inflation rate). • Loss of monetary policy as an instrument of economic policy. Monetary policy carried out by ECB to achieve price stability for the region as a whole. Individual countries unable to carry out their own monetary policy. • Fiscal policy constrained by convergence criteria (on public debt and government deficit). This limits gov’s ability to borrow according to domestic needs and priorities.

18. Monetary policy by the ECB will have different impacts on each member, since they will differ in theoir UE, inflation levels and where they are in the business cycle.