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RegionalEconomicIntegration

References Griffin and Pustay, Chapter 10; Rutledge, Chapters 2 & 4

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Fundamentalissues

» Driversofregionaleconomicintegration

» Stagesofregionaleconomicintegration

» Casestudy:EuropeanEconomicIntegration

» CostsandBenefitsofEconomicandMonetaryUnion

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Drivers of Regional Integration

» Politicaldrivers

» ThemotivationsforregionalintegrationinbothEuropeandEastAsiawereinitiallypoliticalinnature.

» InEurope,economicinterdependencewasthoughttobethemosteffectivemeanstopromotepoliticalcooperationintheregionfollowingtheatrocitiesofWorldWarII.

» Integrationtendstobedrivenbypoliciesandinstitutionsinthiscase,forexampleinEU.

» Market‐drivendrivers

» Thedriversofregionalintegrationarehighlevelsofintra‐regionaltradeandFDIcarriedoutbymultinationalcorporations(MNCs)andthedevelopmentofcross‐borderproductionnetworks.

» Forexample,regionalintegrationinEastAsiahastakenthisform.

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Stages of Regional Economic Integration

Deg

ree

of e

conom

ic inte

grat

ion

Low

High

1. Free Trade AreaMembersremovetariffsandotherbarrierstointernationaltradeamongthemselves;however,eachmembermayestablishitsowntradepolicieswithnon‐membercountries.

2. Customs Union Freetradearea+membersalsoadoptcommonexternaltradepoliciestowardsnon‐membercountries.

3. Common MarketCustomsunion+membersalsoeliminatebarriersthatrestrictmovementoffactorsofproductionamongthemselves.

4. Economic UnionCommonmarket+membersmorefullyintegratetheireconomiesbycoordinatingtheireconomicpolicies(thisinvariablyincludesmonetaryunion– e.g.the€ euro)

5. Political Union Byencompassingbothpoliticalandeconomicintegration,theunioneffectivelytransformsitselfintoonecountry.

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Stage 1: a Free Trade Area

» AFreeTradeAreaencouragestradeamongitsmembersbyremovingtradebarriers,suchas:

» Tariffsandquotasongoodsandservices

» Cancreate‘tradedeflection’problem

» NAFTA:

» TheNorthAmericanFreeTradeAgreementisanexampleofsuchaFreeTradeArea

» NAFTAreducestariffsandtradebarriersbetweentheeconomiesofCanada,theUSAandMexico

1. Free Trade Area

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Stage 2: a Customs Union

ACustomsUnioncombinestheeliminationofinternaltradebarriersamongitsmembersaswellas:

“theadoptionofcommonexternaltradepoliciestowardnon‐members”

» Becauseoftheuniformtreatmentofproductsfromnon‐membercountries,acustomsunionavoidsthe‘tradedeflection’problem.

» Afirmfromanonmembercountrypaysthesametariffrateonexportstoanymemberofthecustomsunion.

» Example:thesixGCCstateshave‘agreed’toacommontariffof5%onallimportedgoodsandservicesfromnon‐membercountries

2. Customs Union

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Stage 3: a Common Market

Membersofacommonmarketremoveinternaltradebarriersamongthemselves.

» Aswellasadoptingacustomsunion,membersofacommonmarketalsoremovebarriersthatrestrictthemovementoffactorsofproduction– labour,capital,andtechnology– amongitsmembers.

Inotherwords:withinacommonmarkettherearenorestrictionsonthemovementoflabour,capitalandtechnologybetweenallmembereconomies.

3. Common Market

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Stages 4 and 5: Economic and Political Union

`

» Aneconomicunionrepresentsfullintegrationoftheeconomies.

» Inadditiontothecustomsunionandthecommonmarket,aneconomicunionrequiresitsmemberstocoordinatetheireconomicpolicies(monetarypolicy,fiscalpolicy,taxation,andsocialwelfareprograms)inordertoblendtheireconomiesintoasingleentity.

» Example:TheEuropeanMonetaryUnion

» Apoliticalunionisthecompletepoliticalaswellaseconomicintegrationoftwoormorecountries,therebyeffectivelymakingthemintoasingularcountry.

» ThereunificationofEastandWestGermanyforinstance

4. Economic Union

5. Political Union

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Theoretical Underpinnings

» ‘TradeCreationEffect’

» Regionalintegrationexpandsmarketsandpromotescompetitionbyeliminatingbarrierstotradeamongmembercountries

» Thiscontributestomoreefficientallocationofresourcesandgreaterproductivitywithinmembercountries;thishasa‘tradecreationeffect’becauseagreaternetvolumeofgoodsandservicesareproduced

» ‘InvestmentCreationEffect’

» Toforeigncompanies,thesingle,unifiedmarketthatregionalintegrationcreatesisalsoanattractiveinvestmentmarket

» Thelargertheintegratedmarket,thegreaterthescalemeritsandthereforetheattractionoflocatingthere

» Example:in1984theEUreceivedonlyonethirdofthedirectinvestmentthattheUSdid,butby1989itreceivedasimilarlevel

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Benefits of Regional Economic Integration

TherearebenefitsfrombeingamemberoftheCommonMarket:

» Biggerdomesticmarket‐ Lowertariffsbetweenmembersofaregionaleconomicblocopensupthemarketsofallmembercountriestoallmembercountryfirms.

» Economiesofscaleinproduction‐ Firmscanoperateeconomiesofscaleandlowertheiraverageproductionanddistributioncostsastheyexpandtheircustomerbasewithinthetradingbloc.

» Greatercompetitiveness‐ Thelowercoststructurecanthenhelpfirmstocompeteinternationallyoutsidethetradingbloc.

» Increasedinvestment‐ AregionaleconomicblocmayattractincreasedFDIfromnon‐membercountriesasfirmsseektoaccesstheenlargedmarketfromwithin.

» Greaterbargainingpower– beingpartofalargermarketgivesmembersgreatercloutininternationaltalksthanasansinglestate

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Costs of Regional Economic Integration

Itisthecasehoweverthatcertainentitiesorspecificindustriescouldbemadeworseoffasaresultofdeeperregionalintegration.

» Forinstance:

» IncreasedCompetition–Eliminationoftradebarrierswithinthetradeblocexposesafirm’shomemarkettocompetitionfromfirmslocatedinothermembercountries,thusthreateninglessefficientfirms.

» Firmswhichoperateinasmalldomesticnationalmarketmaybeatagreaterdisadvantagecomparedtothosethatalreadyoperateinalargenationalmarket.

» Locationeffects– businessesmayconcentratetheiractivitiesina‘core’attheexpenseofthe‘periphery’leadingtogreaterincomeinequalitywithintheregionaleconomicbloc.

» LossofSovereignty– lossofnationalpoweroverregulationsandpolicy

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Case Study: European Economic Integration

KEY

Existing EUmembers

ProspectiveEUmembers

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The European Union Common Market

Beginninginthe1950sseveralEuropeanstatescalledforcloserintegration,overfivedecadestheEUcameintoexistence

» Mostimportantregionaltradingbloc

» 27membercountries

» 491millionpopulation

» CombinedGDPof$14.4trillion

» GoverningInstitutionsoftheEU

» TheCounciloftheEuropeanUnion– LocatedinBrussels,Belgium

» TheEuropeanCommission– inBrussels

» TheEuropeanParliament– inStrasbourg,France

» TheEuropeanCourtofJustice– inLuxembourg

European Union flag

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Case Study: The European Monetary Union

MonetaryUnion– involvesthepermanentfixingofexchangeratesbetweentwoormoreindependentcountries.

» Itcanbeconsideredthepenultimatestageofeconomicintegration,asfulleconomicunion.

» Onceinmonetaryunion,allmemberstateswillshareasinglecurrency,andhavethesameinterestratesandmonetarypolicy

Itisoftensaidthatanydecisiontoformamonetaryunionis:

» “Asmuchapoliticaloneasitisaneconomicone.”

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Case Study: The European Monetary Union

» TheMaastrichtTreatyrestsonthree“pillars”designedtofurtherEurope’seconomicandpoliticalintegration

» ThemostimportantaspectoftheMaastrichtTreatywastheestablishmentoftheMonetaryUnion(MU).

» Initially11EUmembers(laterincreasingto17)agreedtoformaMUandshareacommoncurrency.

» Thecreationofasinglecurrencycalledtheeuro,launchedin1999becomesanimportantglobalreservecurrencytorivaltheUSdollar.

» EuropeanCentralBank‐ responsibleforcontrollingtheEurozone’smoneysupply,interestrates,andinflation(locatedinFrankfurt,Germany).

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Convergence Criteria for EMU

1. Inflationrates: Nomorethan1.5%higherthantheaverageofthethreebestperformingmemberstate

2. Governmentdeficit:Theratiooftheannual governmentdeficit to grossdomesticproduct (GDP)mustnotexceed3%

3. Governmentdebt:Theratioofgross governmentdebt toGDPmustnotexceed60%attheendofthefiscalyear.

4. Exchangerate: Applicantcountriesshouldhavejoinedthe exchange‐ratemechanism fortwoconsecutiveyearsandshouldnothavedevalueditscurrencyduringtheperiod.

5. Long‐terminterestrates: Thenominallong‐terminterestratemustnotbemorethan2percentagepointshigherthaninthethreelowestinflationmemberstates.

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Costs and Benefits of Monetary Union

Costsinclude:

» Lossofindependentnationalmonetarypolicy(interestratesetting).

» Lossofcompletecontrolovernationaleconomicpolicy(inflation)

» Lossofsovereigncontrolovergovernmentbudgetsandfinance.

Benefitsinclude:

» Reductionoftransactioncosts(currencyconversioncosts)ontradeandinvestmentbetweenmembers.

» Pricetransparencyandconvergence.amongmembermarkets

» Capitalmarketgrowth– reducedexchangerateriskandincreasedtransparencyofassetprices.