Gbm unit-07 (regional economic integration)

07/06/10 1

By :

Prof. Amit Kumar

07/06/10 2

“A student pursuing management education from IILM-

Graduate School of Management, for example may find

himself or herself placed in a firm located in a totally

different country. Knowledge about international

business keeps the youngster mentally prepared to

accept assignment in an alien environment. Forewarning

is definitely forearming, for the fresh management

graduate”.

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Importance of this course

Global Business Management

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Course: International Business Management

1. Globalization

2. Global Trade & Theory

3. Global Technological Environment

4. Global Economic Environment

5. Global Political-Legal Environment

6. Foreign Direct Investments

7. Regional Economic Integration

8. Strategy and Structure of International Business

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Global Business Management

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International Business Management Regional Economic Integration

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Contents

• Opening Case : NAFTA The Mexican Story• Levels of Integration• Impact of Integration• Presentation on : Major Regional Trading Groups

• EU• NAFTA• SAARC• ASEAN• APEC• Mercosur• WTO• GCC• ECOWAS

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Major Regional Trading Groups

Major Regional Trading Groups • EU- European Union

• NAFTA- North American Free Trade Agreement

• SAARC- South Asian Association for Regional Cooperation

• ASEAN- Association of Southeast Asian Nations

• APEC- Asia-Pacific Economic Cooperation

• Mercosur - RTA among Argentina, Brazil, Paraguay & Uruguay

• WTO- World Trade Organization

• GCC- Gulf Cooperation Council

• ECOWAS- Economic Community of West African States

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NAFTA: The Mexican Story

‘ Located in the middle America-surrounded by the US, the Gulf of Mexico, the Caribbean Sea, Belize, Guatemala, and the North Pacific Ocean- Mexico has an area of 19,64,375 sq km and a population of more than 100 million. The country is the largest nation in Latin America, followed by Brazil and Argentina.

Like Brazil, Mexico is a newly industrialized country with abundant resources and vast economic potential. It has a large manufacturing base, fertile and productive agricultural land , and an enormous potential export market to its immediate north in the US. Despite this, Mexico like Brazil, suffered from high population growth, widespread poverty, excessive income inequalities, severe unemployment and a massive foreign debt-burden’.

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‘ But this changed in 1994 when Mexico signed the North America Free Trade Agreement (NAFTA). Ten years into the huge trading block, Mexico has gained immensely. FDI poured into the economy, factories sprang up, export surged, and thousands of jobs have been created. Delphi alone created jobs for 70,000 Mexicans. Being in league with big partners- US and Canada- Mexico has gained enormously. Buoyed by its success from NAFTA, Mexico signed trade agreements with 30 other countries. Millions of Mexicans are a proof of benefits of forming trading blocks’.

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Delphi is an automotive parts company headquartered in Troy, Michigan, USA. Delphi is one of the world's largest automotive parts manufacturers and has approximately 146,600 employees (18,900 in the United States).

With offices worldwide, the company operates 150 wholly owned manufacturing sites, 44 joint ventures, 53 customer centers and sales offices, and 33 technical centers in 38 countries.

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Introduction

‘Integration between countries’ focus on arrangements between nations.

The Great Depression plunged the world into a period of isolation, trade protectionism, and economic chaos. In the mid to late-1940s, countries realized that greater cooperation was needed to help them emerge from the wreckage of World War II. The spirit of cooperation was designed to promote economic growth and stability.

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Integration means Regional Trading Block

‘ In the 1950s and 1960s regional integration gained significant momentum. Integration, also called regional trading block, involves the organizing of individual countries into groups that eventually abolish trade restrictions with member countries and also may engage in other activities that promote their citizens welfare.’

When we say integration, it means economic integration between nations, bordering sometimes on political integration too.

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‘ Any type of arrangement in which countries agree to coordinate their trade, fiscal, and/or monetary policies is referred to as economic integration. Obviously, there are many different degrees of integration ‘.

Level of Integration

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Preferential Trading AgreementReduced tariffs or special quotas allowing

Preferential access to markets

Free Trade AreaFormal tariff-free trading area between countries

Customs UnionFree trade area plus a common external tariff

Common MarketCustoms union plus the free movement of goods,

Services, people and capital

Economic UnionCommon market plus full economic policy harmonization

Political UnionGroup of nations with shared sovereignty or complete

Unification of nations

LOOSE ECONOMIC INTEGRATION

FORMAL ECONOMIC INTEGRATION

POLITICAL INTEGRATION

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Level of IntegrationPreferential Trading Agreement

• Preferential Trading Agreement is the loosest form of economic integration. Under this, a group of countries have a formal agreement to allow each other’s goods and services to be traded on preferential terms.

• This requires that the tariffs are reduced between the countries so that special quotas allow preferential access for their products.

A good example is the ‘Lome’ Agreement among the African, Caribbean, and Pacific (ACP) group of

countries and European Union.

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Level of IntegrationPreferential Trading Agreement

• Lome Agreement mainly covers agricultural products, which are the main exports of the ACP countries.

‘ It is said that Preferential Trading Agreement is merely a trading agreement between countries

rather than integration. Often, these are agreements between developing and developed countries and are designed primarily to support

the latter countries’ economic development’.

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Level of IntegrationFree Trade Area

• A free trade area is usually a permanent arrangement between neighbor countries. It involves complete removal of tariffs on goods traded among the members of the free trade area. The arrangement does not, in general, apply to agriculture, fishing and services.

• Member countries are free to levy their own external tariff on goods from outside the free trade area.

• Each member thus retains autonomy over trade with external countries and there is little need for formal institutions and policies other then to maintain the internal tariff-free area.

NAFTA is the best example. Others include EFTA and AFTA (Asian Free Trade Area).

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Level of IntegrationCustoms Union• Members of a customs union remove barriers to trade in goods

and services among themselves.• In addition, the customs union establishes a common trade policy

with respect to non-members. Typically, this takes the form of a common external tariff, whereby imports from non-members are subject to the same tariff when sold to any member country.

• Tariff revenues are then shared among members according to a prescribed formula.

EU, a customs union, was established among the original six members by the late 1960s. This has since been extended to

each of the new EU member states.

The EU agreed to form a customs union with Turkey in 1995. Another example is Mercosur in South America.

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Level of IntegrationCommon Market

• Like the Custom Union, a common market has no barriers to trade among members and has a common external trade policy.

• In addition, the common market removes restrictions on the movement of factors of production (labor, capital and technology) across borders. Thus, restrictions on immigration, emigration and cross-border investments are abolished.

The best example of common market is the EU, which achieved this status in the 1990s as a result of a 35-

year struggle to end barriers to free movement of labor, capital and technology.

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Level of IntegrationCommon Market

The European Union was established as a common

market by the Treaty of Rome in 1957, although it took

a long time for the transition to take place.

Today, EU citizens have a common passport, can work in any EU member country and can

invest throughout the union without restriction.

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Level of IntegrationEconomic Union

• It represents integration of economies of two or more countries.

• In addition to eliminating internal trade barriers, adopting common external trade policies and abolishing restrictions on the mobility of the factors of production among member (i.e. common market), an economic union requires its member to coordinate their economic policies (monetary policies, fiscal polices, taxation, and social welfare programmes) so as to blend their economies into a single entity.

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• Formation of one economic union requires nations to surrender a large measure of their national sovereignty.

• Needless to say formation of economic union is extremely difficult since member countries strong desire to retain the power of nation-state, and attempts to undermine the authority of the state will encounter opposition.

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The Belgium-Luxembourg Economic Union, founded in1922, is the best existing example of this form of

economic integration.

• The economic union of these two European neighbors has been facilitated by the tight bonds between their two currencies.

• The two nations coordinate their monetary policies and maintain a fixed exchange rate of one Luxembourg franc to one Belgium franc, and Belgium franc is commonly used to conduct business in Luxembourg.

• However, a much larger economic union is yet to emerge.

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Level of IntegrationMonetary Union as a part of Economic Union

Monetary union establishes a common currency among a group of countries. This involves the formation of a central monetary authority which will determine monetary policy for the entire group.

The Maastricht treaty signed by EU members in 1991 proposed the implementation of a single European currency (the Euro) by 1999. The degree of monetary union that will arise remains uncertain in 1998.

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Level of IntegrationMonetary Union as a part of Economic Union

Perhaps the best example of an economic and monetary union is the United States.

Each US state has its own government which sets policies and laws for its own residents. However, each state cedes control, to some extent, over foreign policy, agricultural policy, welfare policy, and monetary policy to the federal government.

Goods, services, labor and capital can all move freely, without restrictions among the US states and the Nations sets a common external trade policy.

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Level of IntegrationPolitical Union

• While some degree of political integration often accompanies economic integration, political union implies more formal political links between countries.

• A limited form of political union may exist where two or more countries share common decision making bodies and have common policies.

• In its fullest sense, it involves the unification of previously separate nations .

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The world’s best example of political union occurred when

13 separate colonies operating under the ‘Article of

confederation’ grew into a new country- the USA.

• India as a country, emerge after unification of numerous kingdoms.

• The unification of East & West Germany in 1990 is another example of total political union.

• Indeed, the formation of Soviet Union itself brought political union among its various republics, though integration was less universally popular.

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The Union of Soviet Socialist Republics (USSR) was a constitutionally socialist state that existed in Eurasia from 1922 to 1991.

Emerging from the Russian Empire after the Russian Revolution of 1917 and the Russian Civil War of 1918–1921, the USSR was a union of several Soviet republics.

On December 21, 1991, eleven of the former socialist republics declared in Alma-Ata (with the twelfth republic – Georgia – attending as an observer) that with the formation of the Commonwealth of Independent States the Union of Soviet Socialist Republics ceases to exist.

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Impact of Integration

Impact of Integration

Prices &Competition

DynamicEffect

Trade Creation& Diversion

Economics ofScale

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Impact of IntegrationTrade Creation & Trade Diversion

The entry of Spain into the European Union provides an interesting example of trade creation and diversion. In 1986, Spain formally entered the EU as a member. Prior to membership, Spain- like all non members such as US, Canada and Japan- traded with the EU and suffered from the common external tariff imposed by the EU.

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Imports of agricultural products from Spain or US had the same tariff applied to their products, for example 20%. During this period, the US was a lower-cost producer of wheat compared to Spain. US exports to EU members may have cost $3.00 per bushel, plus a 20% tariff of $.60, for a total of $3.60 per bushel. If Spain at the same time produced wheat at $3.20 per bushel, plus a 20% tariff of $.64 for total cost to EU customers of $3.84 per bushel, Spain’s wheat was more expensive and therefore less competitive.

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But when Spain joined the EU as a member, its products were no longer subject to the common external tariffs; Spain had become a member of the ‘Club’ and therefore enjoyed its benefits. Spain was the low-cost producer of wheat at $3.20 per bushel, compared to the price of $3.60 per bushel from the US. Trade flows changed as a result.

The increased export of wheat and other products by Spain to the EU as a result of its

membership is termed trade creation.

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The elimination of tariff literally created more trade between Spain and EU. At the same time, because the US is still outside the EU, its products suffer the higher price as a

result of the tariff application. US exports to the EU fell.

When the source of trading competitiveness

is shifted in this manner from one country to

another, it is termed trade diversion.

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Impact of IntegrationPrices & Competition

• When trade barriers come down, consumers can buy goods more cheaply. Trade creation increases the availability of goods enabling the consumers to pick and choose.

• By removing barriers between national markets, trading blocks create competition. Longer the trading areas and higher the level of integration, the more competition will be created.

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Impact of IntegrationPrices & Competition

Competitions benefits consumers in the form of lower

prices, wider choice and better value for the money. In

addition, competition stimulates innovation, not only

in the products themselves but also in the channels of

distribution, methods of payment and so on.

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Impact of IntegrationDynamic Effects

• The term dynamic effects describes the continuous pressure for change that is a feature of an integrated competitive environment.

• In general, the dynamic effect of integration is that it brings about a more efficient allocation of resources throughout the trading block, promoting the growth of some businesses and decline the others, development of new product & technology.

This process is creating a large-scale restructuring of

industries and firms in the EU, with the relocation of

industry and many cross-border mergers & alliances.

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Impact of IntegrationEconomies of Scale

• Many industries, such as steel and automobiles, require large-scale production in order to obtain economies of scale in manufacturing.

• Obviously, industries of this type and others may not be economically viable in smaller, trade-protected countries. However, the formation of a trading block enlarges the market so that large-scale production is justified. These lower production costs resulting from greater production for an enlarged market is called internal economies of scale.

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Impact of IntegrationEconomies of Scale

In a common market, external economies of scale

may also be present. Because a common market

allows factors of production to flow freely across

borders, the firm may now have access to cheaper

capital, more skilled labor, or superior technology.

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Major Regional Trading Groups

Trading Groups

EU

Mercosur

SAARC

ASEAN

APEC

NAFTA

Commodity Agreements

WTO

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Gbm unit-07 (regional economic integration)

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