chapter regional economic integration mcgraw-hill/irwin global business today, 5e © 2008 the...

chapter

Regional Economic Integration

McGraw-Hill/IrwinGlobal Business Today, 5e

© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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Chapter 8: Regional Economic Integration

INTRODUCTION

Regional economic integration refers to agreements between countries in a geographic region to reduce tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other.

While regional trade agreements are designed to promote free trade, there is some concern that the world is moving toward a situation in which a number of regional trade blocks compete against each other.

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LEVELS OF ECONOMIC INTEGRATION There are five levels of economic integration.

• In a free trade area all barriers to the trade of goods and services among member countries are removed, but members determine their own trade policies with regard to nonmembers• Examples of free trade areas include the European Free Trade Association (between Norway, Iceland, Liechtenstein, and Switzerland), and the North American Free Trade Agreement (between the U.S., Canada, and Mexico)

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The different levels of economic integration are shown in Figure 8.1.

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• The customs union is one step further along the road to full economic and political integration, and eliminates trade barriers between member countries and adopts a common external trade policy

• The Andean Pact (between Bolivia, Columbia, Ecuador and Peru) is an example of a customs union

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• The common market has no barriers to trade between member countries, a common external trade policy, and the free movement of the factors of production

• MERCOSUR (between Brazil, Argentina, Paraguay, and Uruguay) is aiming for common market status

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• An economic union involves the free flow of products and factors of production between members, the adoption of a common external trade policy, and in addition, a common currency, harmonization of the member countries’ tax rates, and a common monetary and fiscal policy

• The European Union (EU) is an economic union, although an imperfect one since not all members of the EU have adopted the euro, and differences in tax rates across countries still remain

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• In a political union, independent states are combined into a single union

• The EU is headed toward at least partial political union, and the United States is an example of even closer political union

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Classroom Performance System

In a _______, all barriers to the free flow of goods and services between member countries are removed, and a common policy toward nonmembers is established.

a) Free trade area

b) Customs union

c) Common market

d) Economic union

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The European Union is an example of a(n)

a) Free trade area

b) Customs union

c) Common market

d) Economic union

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THE CASE FOR REGIONAL INTEGRATION

The Economic Case for Integration

• Regional economic integration is an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO

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The Political Case for Integration

The political case for integration has two main points: • by linking countries together, making them more dependent on

each other, and forming a structure where they regularly have to interact, the likelihood of violent conflict and war will decrease

• by linking countries together, they have greater clout and are politically much stronger in dealing with other nations

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Impediments to Integration

There are two main impediments to integration:

• while a nation as a whole may benefit from a regional free trade agreement, certain groups may lose

• concerns over the loss of national sovereignty

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THE CASE AGAINST REGIONAL INTEGRATION

• Regional economic integration only makes sense when the amount of trade it creates exceeds the amount it diverts• Trade creation occurs when low cost producers within the free trade area replace high cost domestic producers• Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers

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REGIONAL ECONOMIC INTEGRATION IN EUROPE Evolution of the European Union

The EU is the result of: • the devastation of two world wars on Western Europe and the desire for a lasting peace• the desire by the European nations to hold their own on the world’s political and economic stage

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The evolution of the European Union is shown in Map 8.1.

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• The forerunner of the EU was the European Coal and Steel Community, which had the goal of removing barriers to trade in coal, iron, steel, and scrap metal formed in 1951

• The European Economic Community was formed in 1957 at the Treaty of Rome with the goal of becoming a common market

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Political Structure of the European Union

The five main institutions of the EU are:• the European Council (resolves major policy issues and sets policy directions)• the European Commission (responsible for implementing aspects of EU law and monitoring member states to ensure they are complying with EU laws)• the Council of the European Parliament (the ultimate controlling authority within the EU)• the European Parliament (debates legislation proposed by the commission and forwarded to it by the council)• the Court of Justice (the supreme appeals court for EU law)

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The Single European Act

• The Single European Act, adopted by the EU member nations in 1987, committed the EC countries to work toward establishment of a single market by December 31, 1992

The Stimulus for the Single European Act • The Single European Act was born out of frustration among EC members that the community was not living up to its promise

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The Objectives of the Act

• frontier controls to remove all frontier controls between EC countries• mutual recognition of standards to apply the principle of “mutual recognition,” which is that a standard developed in one EC country should be accepted in another, provided it meets basic requirements in such matters as health and safety• public procurement to open procurement to non-national suppliers

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• financial services to lift barriers to competition in the retail banking and insurance businesses • exchange controls to remove all restrictions on foreign exchange transactions between members by the end of 1992• freight transport to abolish restrictions on sabotage, the right of foreign truckers to pick up and deliver goods within another member’s borders, by the end of 1992• supply-side effects should lower the costs of doing business in the EC, but the single-market program is also expected to have more complicated supply-side effects

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Impact

• The Single European Act provided the impetus for the restructuring of substantial sections of European industry allowing for faster economic growth than would otherwise have been the case

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The Establishment of the Euro

• The Treaty of Maastricht, signed in 1991, committed the EU to adopt a single currency, the euro, by January 1, 1999• The euro is used by 12 of the 25 member states• By adopting the euro, the EU has created the second largest currency zone in the world after that of the U.S. dollar • For now, three EU countries, Britain, Denmark and Sweden, are opting out of the euro-zone• Euro notes and coins were issued on January 1st, 2002 (in the interim, national currencies circulated, and were worth a defined amount of euros)

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Benefits of Euro

• Businesses and individuals should realize significant savings from having to handle one currency, rather than many

• The adoption of a common currency will make it easier to compare prices across Europe

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• Faced with lower prices European producers will be forced to look for ways to reduce their production costs in order to maintain their profit margins

• The introduction of a common currency should give a strong boost to the development of highly liquid pan-European capital market

• The development of a pan-European euro denominated capital market will increase the range of investment options open both to individuals and institutions

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Costs of Euro

• A drawback of a single currency is that national authorities lose control over the monetary policy

• The Maastricht treaty called for the establishment of an independent European central bank (ECB) with a clear mandate to manage monetary policy so as to ensure price stability

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• The ECB sets interest rates and determines monetary policy across the euro-zone

• Another drawback of the Euro is that the EU is not an optimal currency area (an area where similarities in the underlying structure if economic activities make it feasible to adopt a single currency and use a single exchange rate as an instrument of macro-economic policy)

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The Early Experience

• Since its establishment January 1, 1999, the euro has had a volatile trading history with the U.S. dollar

• Initially, the euro fell in value relative to the dollar, but strengthened to a five year high of $1.33 in March 2005

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Enlargement of the European Union

• Many countries, particularly from Eastern Europe, have applied for membership in the EU

• Ten countries joined on May 1, 2004 expanding the EU to 25 states, with population of 450 million people, and a single continental economy with a GDP of €11 trillion

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The ultimate decision making body of the European Union is the

a) Council of the European Union

b) European Parliament

c) Court of Justice

d) European Commission

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REGIONAL ECONOMIC INTEGRATION IN THE AMERICAS

Regional economic integration is on the rise in the Americas.

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Regional economic integration in the Americas is shown in Map 8.2.

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The North American Free Trade Agreement (NAFTA)

NAFTA’s Contents

• The free trade agreement between the United States, Canada, and Mexico became law January 1, 1994

• NAFTA abolished tariffs on 99 percent of the goods traded between Mexico, Canada, and the United States, removed most barriers on the cross-border flow of services, protects intellectual property rights, removes most restrictions on FDI between the three member countries, allows each country to apply its own environmental standards, provided such standards have a scientific base, establishes two commissions to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored

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The Case for NAFTA

Proponents of NAFTA have argued that it will provide economic gains to all countries: • Mexico will benefit from increased jobs as low cost production moves south, and will attain more rapid economic growth as a result• The U.S. and Canada will benefit from the access to a large and increasingly prosperous market and from the lower prices for consumers from goods produced in Mexico• In addition, U.S. and Canadian firms with production sites in Mexico will be more competitive on world markets

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The Case against NAFTA

Opponents of NAFTA argued:• that jobs would be lost and wage levels would decline in the U.S. and Canada• Mexican workers would emigrate north• pollution would increase due to Mexico's more lax standards• Mexico would lose its sovereignty

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NAFTA: The Results so Far

• Studies of NAFTA’s early impact suggest that both advocates and detractors may have been guilty of exaggeration

• The agreement has helped to create the background for increased political stability in Mexico

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Enlargement

• Several other Latin American countries have indicated their desire to eventually join NAFTA

• Currently both Canada and the U.S. are adopting a wait and see attitude with regard to most countries

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Studies show that after its first decade,

a) There was a small net gain of jobs in the U.S.

b) Exports from the U.S. failed to grow

c) NAFTA’s overall impact has been significant

d) The U.S., Canada, and Mexico all experienced a decrease in productivity

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The Andean Community

• The Andean Pact, originally formed in 1969, was based on the EU model• By the mid-1980s, the Andean Pact had more or less failed• In the late 1980s, Latin American governments began to adopt free market economic policies• In 1990, the Andean Pact was re-launched, and now operates as a customs union• In 2003, it signed an agreement with MERCOSUR to restart negotiations towards the creation of a free trade area

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MERCOSUR

• MERCOSUR originated in 1988 as a free trade pact between Brazil and Argentina• In 1990, it was expanded to include Paraguay and Uruguay• MERCOSUR has been making progress on reducing trade barriers between member states• Given some fairly high tariffs for goods from other countries, it appears that in some industries, MERCOSUR is diverting trade rather than creating trade, and local firms are investing in industries that are not competitive on a worldwide basis

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Central American Common Market and CARICOM

There are two other trade pacts in the Americas:

• the Central American Trade Market• CARICOM

Neither has made much progress yet.

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Free Trade of the Americas

• Talks began in April 1998 to establish a FTAA (Free Trade of The Americas) by 2005• If the FTAA is established, it will have major implications for cross-border trade and investment flows within the hemisphere• The FTAA would create a free trade area of nearly 800 million people

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REGIONAL ECONOMIC INTEGRATION ELSEWHERE

Association of Southeast Asian Nations

• Formed in 1967, ASEAN currently includes Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, and, most recently, Vietnam, Myanmar, Laos, and Cambodia• The basic objectives of ASEAN are to foster freer trade between member countries and to achieve some cooperation in their industrial policies• In 2003, an ASEAN Free trade Area (AFTA) between the six original members of ASEAN came into full effect with a goal of reducing import tariffs among the older members to zero by 2010, and for newer members by 2015

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Asian Pacific Economic Cooperation (APEC)

• APEC currently has 21 members including the United States, Japan, and China

• The stated aim of APEC is to increase multilateral cooperation in view of the economic rise of the Pacific nations and the growing interdependence within the region

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Regional Trade Blocs in Africa

• There are nine trade blocs on the African continent, however progress toward the establishment of meaningful trade blocs has been slow

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IMPLICATIONS FOR MANAGERS

Opportunities • Markets that were formerly protected from foreign competition are opened • The free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes, makes it possible for firms to realize potentially enormous cost economies by centralizing production in those locations where the mix of factor costs and skills is optimal

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Threats

• The business environment becomes competitive

• For non-EU and/or non-North American firms, challenges arise from the likely long-term improvements in the competitive position of many European and North American companies

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• There is a risk of being shut out of the single market by the creation of a “trade fortress”

• Firms may be limited in their ability to pursue the strategy of their choice in the EU as the EU continues to increase its role in competition policy and intervene and impose conditions on companies proposing mergers and acquisitions

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CRITICAL THINKING AND DISCUSSION QUESTIONS

1. NAFTA has produced significant net benefits for the Canadian, Mexican, and U.S. economy. Discuss.

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2. What are the economic and political arguments for regional economic integration? Given these arguments, why don’t we see more substantial examples of integration in the world economy?

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3. What effect is creation of a single market and a single currency within the EU likely to have on competition within the EU? Why?

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4. Do you think it is correct for the European Commission to restrict mergers between American companies that do business in Europe? (For example, the European Commission vetoed the proposed merger between WorldCom and Sprint, both U.S. companies, and it carefully reviewed the merger between AOL and TimeWarner, again both U.S. companies.)

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5. How should a U.S. business firm that currently only exports to ASEAN countries respond to the creation of a single market in this regional grouping?

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6. How should a firm that has self-sufficient production facilities to in several ASEAN countries respond to the creation of a single market? What are the constraints on its ability to respond in a manner that minimizes production costs?

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7. After a promising start, in the last few years, MERCOSUR, the major Latin American trade agreement, has faltered and made little progress since 2000. What problems are hurting MERCOSUR? What can be done to solve these problems?

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8. Would the establishment of a Free Trade Area of the Americas (FTAA) in 2005 be good for the two most advanced economies of the hemisphere, the United States and Canada? How might the establishment of the FTAA impact the strategy of North American firms?

chapter regional economic integration mcgraw-hill/irwin global business today, 5e © 2008 the...

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