Lecture 5 Regional Economic Integration

1. Lecture 5Regional Economic Integration

2. Regional Economic Integration Agreements among countries in a geographic region to reduce, and ultimately remove • Tariff and • Non-tariff barriers (NTBs) to the free flow of goods, services and factors of production among each other.

3. Economic Union NAFTA Free Trade Area EU 1992 Levels of Economic Integration Level ofIntegration Political Union Common Market Customs Union

4. Dimensions of economic integration Outputs Inputs Policy Free trade between member states Common external tariff Free movement of factors of production Harmoni- zation of economic policy Centralization of economic and monetary policy Free trade area Customs union Common market Economic Union YES NO NO NO NO YES YES NO NO NO YES YES YES YES NO YES YES YES YES YES

5. Economic Case for Regional Integration • Stimulates economic growth in countries • Countries specialize in those goods and services efficiently produced. • Gains from trade a la Smith and Ricardo • Additional gains from free trade beyond international agreements such as GATT and WTO.

6. Beet sugar England Germany Cane Sugar Cuba Trade Diversion: The Viner Paradox* • 30% tariff on all • sugar imports • German beet sugar • is 15% more expensive • to produce than Cuban • cane sugar • Efficiency in the pattern of • trade is maintained – Cuban sugar dominates Before Customs Union * Named for Jacob Viner, Professor of Economics, Harvard U, 1933

7. Beet sugar Cane Sugar After Customs Union Trade Diversion: Viner Paradox • The customs union • makes German sugar • artificially cheaper than • Cuban sugar • The pattern of trade is • less efficient than before • ‘RING-FENCING’ England Germany Cuba

8. Political Case for Economic Integration • Internal: Economic interdependence creates incentives for political cooperation and reduces potential for violent confrontation • External: Together, the countries have the economic clout to enhance trade with other countries or trading blocs

9. Impediments to Regional Integration • Groups within countries may be hurt • Factor movements, particularly labor migration • Potential loss of sovereignty and control over domestic issues • Environment, workplace safety • E.g., Mexican trucks on US roads • Debate – the Viner paradox lives on • Is integration trade creation? • Is integration trade diversion?

10. Impediments to Regional Integration • Impediments increase with the level of integration being proposed • Free Trade Area • Customs Union • Common Market • Economic Union

11. Free Trade Area 1 2 • Desired impacts – • increased trade flows • Likely impact – • increased FDI • Opponents • import sensitive industries (goods/services imports) • non-factor-specialized industries (job export) • Supporters? Trade FDI

12. Customs Union • Desired impact – • increased trade flows with union members • Likely impact – • increased FDI within union • Viner trade diversion effects • Opponents – same as with the FTA, though less vehement, fewer in number • Supporters?

13. Common Market • Desired impact – • increased productive and allocative efficiency • factor mobility • avoiding ‘races to the bottom’ in taxes and regulations • Likely impact – • Viner trade diversion effects • Erection of alternative barriers to limit factor mobility • Opponents? Supporters?

14. Economic Union • Loss of independent policy control • Fiscal transfers from one region to another to offset the effects of divergent shocks • Similar monetary and fiscal priorities • Similar levels of economic development, so that fiscal transfers are not excessive • Difficult to divorce from monetary union • Difficult to divorce from political union

15. Economic and Monetary Union in Europe

16. Regional economic integration in Europe • Europe has two trade blocks • European Union • Seen as the emerging power with 25 members • The EU-15 = Germany, France, Italy, Spain, Belgium, The Netherlands, Luxembourg, The UK, Ireland, Denmark, Sweden, Finland, Austria, Greece, Portugal • May 2004 entrants – 10 new entrants • European Free Trade Association • Norway, Iceland, Switzerland, Liechtenstein

17. Enlargement of the European Union • Collapse of communism led to pressures for enlargement • By the end of the 1990’s 13 countries had applied to become EU members • May 2004, 10 new members • Addition of 75 million citizens to the EU • Creation of a single continental economy with a GDP close to 11 trillion Euros

18. Enlargement of the European Union • To qualify for EU membership applicants must: • Economic requirements • Privatize state assets • Deregulate markets • Restructure industries (remove state subsidies) • Tame inflation • Political requirements • Enshrine complex EU laws into their own systems • Establish stable democratic governments • Respect human rights

19. 10,933.5 (31.2%) 12.7% 21.9% 10,500.2 (30.0%) 19.3%+ 18.7%+ 4,300.9 (12.3%) 8.3% 6.4% The EU - A relative view, 2003 GDP (World Share) Share of World Exports* Imports* The US The EU 15 Japan *Merchandise trade only. + Excludes intra-EU trade..

20. NAFTA

21. North American Free Trade Agreement - NAFTA • Became law: January 1,1994 • Over 15 year period: • tariffs reduced (99% of goods traded) • NTBs reduced • investment opportunities increased • Protects intellectual property • Applies national environmental standards • Establishment of commission to police violations

22. NAFTA • Removal of most barriers on cross border flow of services • Special treatment for many industries • E.g., removal of restrictions on FDI except in certain sectors • Mexican railway and energy • US airline and radio communications • Canadian culture

23. Enlarged and productive regional base Labor-intensive industries move to Mexico Mexico gets investment and employment Increased Mexican income to buy US/Canada goods Demand for goods increases jobs Consumers get lower prices Loss of jobs – 110K per year by some estimates Mexican firms have to compete against efficient US/Canada firms Mexican firms become more efficient Environmental degradation Loss of national sovereignty PROS NAFTA CONS

24. NAFTA Results • Recent surveys indicate that NAFTA’s overall impact has been small but positive • From 1993 to 2004, trade between NAFTA partners grew by 250 percent • Canada’s trade with NAFTA partners increased from 70% to more than 80% of all Canadian foreign trade • Mexico’s trade with NAFTA partners increased from 66% to 80% of all Mexican foreign trade

25. NAFTA Results • All countries experienced strong productivity growth • More than 2 million jobs a year were created in the US during the same time period • The most significant impact of NAFTA has been political • NAFTA helped create the background for increased political stability in Mexico

26. Andean PACT

27. ANCOM: Andean Pact • Bolivia, Colombia, Ecuador, Peru, Venezuela • Cartagana Agreement, 1969. One of oldest still in existence • Population: 97 mm (14% of hemisphere) • GNP: $122.6 billion • Changed from FTA to customs union in 1992

28. Mercosur • 1985 agreement between Argentina, Brazil. • 4 nations acceded via the 1991 Treaty of Asunción • Argentina, Brazil, Paraguay, Uruguay • Bolivia, Chile, Colombia, Ecuador, Peru are associate members • 1995: Agreed to move toward a full customs union • Trade quadrupled between 1990-1998 • Has significant trade diversion issues • Revival in 2003 by Brazil’s president to be modeled after EU with common currency and elected parliament • Venezuela became a full member 2006

29. Other Hemisphere Associations • Central American Common Market • CARICOM • Free Trade Area of the Americas

31. ASEAN

32. Association of Southeast Asian Nations • Created in 1967 • 400 million citizens • Economic, political and social cooperation • Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam.

33. APEC

34. Asia-Pacific Economic Cooperation (APEC) • Established in 1989 in response to the growing Asia-Pacific economic interdependence • Begun as an informal dialogue group, APEC has become the primary regional vehicle for open trade and economic cooperation • Its goal is to advance Asia-Pacific economic dynamism and sense of community. • APEC 2000 GDP is US$17,921 billion • APEC's 2000 share of global trade is 46.76%

35. 21 APEC Members Korea Malaysia Mexico New Zealand Papua New Guinea Peru The Philippines Russia Singapore Rep Taiwan Thailand The US Vietnam Australia Brunei Canada Chile PR China HK China Indonesia Japan

36. The World of Trade Blocs NAFTA EU China APEC Japan Africa The Andean Pact ASEAN Mercosur

37. Implications for Managers • Advantages • Protected markets, now open • Lower costs doing business in single market • Concerns • Differences in culture and competitive practices make realizing economies of scale difficult • More price competition • Outside firms shut out of market • Government intervention • E.g., EU intervention in mergers and acquisitions

38. Takeaways • The growth of regional trade blocs is based on both economics and politics • Economic considerations (wealth creation) are fueling expansion • Economies of scale, specialization • Political considerations are creating barriers • Wealth diversion: Upheavals, dislocation • Concerns over sovereignty