ECONOMIC INTEGRATION

INDEX

CERTIFICATE

INTRODUCTION Before 1947 countries were free to impose any tariffs on their imports. However, when one country increased its tariffs, this action often triggered retaliatory actions by its trading partners. The end result of protectionism was lowered efficiency, less and no increase in employment. Thus in the post-war era efforts were made to reduce tariff barriers, that is, to liberalize international trade. Integration between countries is an important feature of trade liberalization. International integration may be either political or economic. Political integration involves pooling of countries sovereignty to some degree. Economic integration involves links between the economics of a group of countries. These are often called regional economic groups. In practice, economic integration tends to produce some degree of political integration, though not necessarily full political union. The benefits of free trade and stable exchange rates are available only if the countries are welling to give up some measure of independence and autonomy. This has resulted in increased economic integration around the world with agreements among countries to establish links through movement of goods, services, capital and labor across the borders. However, according to some writers the regional trading blocs of the new economic world order may divide the world into a handful of protectionist super-states that, although liberalizing trade among members, may raise barriers to external trade. Economic Integration is the unification of economic policies between different states through the partial or full abolition of tariff and non-tariff restrictions on trade taking place among them prior to their integration. This is meant in turn to lead to lower prices for distributors and consumers with the goal of increasing the combined economic productivity of the states. Economic Integration is process in which two or more states in a broadly defined geographic area reduce a range of trade barriers to advance or protect a set of economic goals. The level of integration involved in an economic regionalist project can very enormously from loose association to a sophisticated, deeply integrated, transnational zed economic space. It is in its political dimension that economic integration differs from the broader idea of regionalism in genera. Although economic decision go directly to the intrinsically political question of resource allocation, an economic region can be deployed as a technocratic tool by the participating government advance a clearly defined and limited economic agenda without requiring more than minimal political alignment or erosion of formal state sovereignty. The unifying factor in the different forms of economic regionalism is thus the desire by the participating states to use a wider, transnationalized sense of space to advance national economic interests.

MEANING OF ECONOMIC INTEGRATION The term Economic Integration has been interpreted in different ways. Tinbergen defines economic integration as the creation of most desirable structure of international economy, removing artificial hindrances to the optimum operation and introducing deliberately all desirable elements of coordination or unification. Negative integration relates to those aspects of economic integration which involve the removal of discrimination and restriction on the movement of goods among the member countries. On the other hand, positive integration involves the modification of existing institutions and policy instruments and adoption of new ones in order to remove market distortions within the economic region. In short, economic integration aims at removal of discrimination among the nations to bring about free movement of goods and factors of productions. Economic integration, therefore, refers to a process whereby two or more countries combine into a larger economic group by removing discriminations existing a long frontiers. Economic integration can thus be viewed as a spectrum. At one extreme we can envision a truly global economy in which all countries share a common currency and agree to a free flow of goods, services, and factors of production. At the other extreme there would be a number of closed economies, each independent and self-sufficient. The various integrative agreements in effect today lie along the middle of this spectrum.

DEFINITION OF ECONOMIC INTEGRATION An economic arrangement between different regions marked by the reduction or elimination of trade barriers and the coordination of monetary and fiscal policies. The aim of economic integration is to reduce costs for both consumers and producers, as well as to increase trade between the countries taking part in the agreement. Economic integration can thus be viewed as a spectrum. At one extreme we can envision a truly global economy in which all countries share a common currency and agree to a free flow of goods, services, and factors of production. At the other extreme there would be a number of closed economies, each independent and self-sufficient. The various integrative agreements in effect today lie along the middle of this spectrum.

TYPES OR FORMS OF ECONOMIC INTEGRATIONThere are five important types of economic integration. They are:1. Preferential Trading Agreement2. Free Trade Area3. Customs Union4. Common Market5. Economic Union The above types of economic integration start at the lowest degree of economic integration, that is, preferential trading club, and go through progressively higher stages to the most complete degree of economic integration, that is, economic union. A brief analysis of the above forms of economic integration is undertaken below:1. Preferential Trading Agreement : A preferential trading agreement is the loosest form of economic integration. Under it a group of countries have a formal agreement to allow each others goods to be traded on preferential terms. These countries usually reduce their respective duties on imports of all goods from each other. However, the member countries retain their original tariffs against the outside world. A good example of preferential trading agreement is the commonwealth preference system. In 1932, great Britain and its commonwealth associates established a system of trade known as the commonwealth preference system.

2. Free Trade Area : It is usually a permanent arrangement a group of countries. It allows for tariff-free trade among the member countries. There is complete removal of tariffs goods traded between the members of the free trade area. The member countries are free to levy their own tariffs on imports of goods from other countries outside the free trade area. Each member country thus retains autonomy over trade with other countries. An important problem faced by the countries under the free trade area is that goods from outside the area may enter a high-duty member country through a low-duty member country, and thus avoid the high import duty. This practice will distort the patterns of trade between the member countries and will, in effect, circumvent the external tariff sovereignty of the member countries with higher tariffs.3. Customs Union : A customs union is a free-trade area plus an agreement to establish common barriers to trade with the rest of the world. Since they have a common tariff against the outside world, the members need neither customs controls on goods moving among themselves nor rules of origin. Agreement is needed on the level of the common external tariff and on the administration of the tariff revenues. A good example of customs union is the European community which was formed by the treaty of Rome in 1957. The European community originally included six countries: Belgium, France, West Germany, Italy, Luxembourg and the Netherlands.

4. Common Market : Common Market is a customs union that also has free movement of all factors of production among the common market countries. The common market countries abolish all trade restrictions on their mutual trade and also establish a common external tariff, as a customs union. The existence of a common market implies that the internal market comprising all the member countries, is common to all firms trading within it. The removal of all internal barriers, both tariff and non-tariff, allows all firms access to the entire internal market. Trade in goods may be obstructed by non-tariff barriers such as differences in product standers or testing procedures, customs formalities, transport restrictions and so on. Non-tariff barriers are often much more of an obstructions to trade than tariff barriers because they are less visible and more difficult to overcome. Removal of such barriers will facilitate trade in goods. The central American Market is working towards becoming a common market. However, it is yet to achieve this goal. The EU has achieved this to some extent. The goal of EU was to create a true common market. 5. Economic Union : An economic union is the most complete form of economic integration between countries. It involves a common market and also the harmonization of economic policies, in particular monetary union and coordination of fiscal policies. Monetary union implies there is a fixed exchange rate system between the member countries, a common or single currency, and central control over interest rates and other instruments of monetary policy. Coordination of fiscal policy implies harmonization of tax rates and taxes, and some degree of control over government budgets and budget deficits. There may also be coordination of other economic policies such as regional, industrial and agricultural policies. The member countries in the economic union function as a single economy. An economic union is the ultimate form of economic integration. The European Union provide the best example.Thus, the degree of economic integration ranges from preferential trade arrangements to free trade areas, customs unions, common markets and economic unions.

ARGUMENTS SURROUNDING ECONOMIC INTEGRATIONThe important arguments surrounding economic integration are discussed in this section.1. Trade Creation and Trade Diversion : Jacob Viner, by his pioneering study of the customs union, had brought out the economic costs and benefits of economic integration. He argued that customs union gives rise to two opposing tendencies. On the one hand, a customs union tends to increasing competition among the member countries and this represents a movement towards free trade. On the other hand, a customs union tends to provide relatively more protection against trade and competition from the rest of the world and this represents a movement towards greater protection. Thus, according to Viners an economic integration combines elements of freer trade with elements of greater protection, and may either improve or worsen resource allocation and welfare, depending upon the respective strengths of trade creation and trade diversion.(a) Production Effects : The formation of a customs unions causes some products that were formerly produced domestically to be imported from other member country due to the elimination of tariffs. In this case, the shift in production is from a higher-cost domestic producer to a lower-cost producer of a member country. This results in trade creation. Thus, trade creation increase welfare by reducing costs or, alternatively by increasing world income.(b) Consumption Effects : Formation of customs union leads to increase it consumption. This can be observed from the above examples of credit creation and credit diversion. In both the cases, after the formation of customs union the price of X in country A falls. Unless As demand for X is perfectly inelastic, As consumption of X will increase. This is bound to expand trade and improve welfare. 2. Increased Competition : Economic integration is likely to result in increased competition. As trade barriers are eliminated the market expands and the number of potential competitors increases. Oligopolistic and monopolistic market structures become exposed to outside competition. Inefficient firms must either become efficient or close down. The increased level of competition is also likely to stimulate the development and utilization of new technology. This creates a stimulus conducive to managerial efficiency and technological improvements. This creates an environment for faster economic growth. All these efforts will lead to reduction in the costs of production and thus benefit the consumers. 3. Economies of Scale : Formation of customs union leads to expansion of the size of the market, increase in competition and greater degree of specialization. Firms will be able to exploit internal and external economies. The firms will be able to utilize fully their plant capacity and reach their optimum size.4. Technical Change : Increased competition and expansion of the market encourage research and development, innovation and technical change. Economic integration will be conductive to technological improvement since large scale economies can be reaped. This tends to promote faster technical change and economic growth.5. Investment : The formation of customs union may stimulate investment. The increase in competition and technical change leads to additional investment, which is necessary to take advantage of the newly created opportunities. At the same time, some important-competing industries may be hit by the increase in competition coming from more efficient producer located in other union countries. This may result in some disinvestment. This disinvestment must be subtracted from the positive investment activity to determine the net effect on investment. Some countries of the customs union may experience increase in investment from the rest of the world. The foreign firms already operating in the union may expand their activities to take advantage of the newly created opportunities. Apart from this, some foreign firms that in the past used to export to the union country may decide to invest by building plants in the union countries. According to some writers, the massive US investment in Europe after 1955 was due to the formation of European Economic Community.

6. Economic Growth : Increased competition, technical changes, economies of scale and increased investment may lead to increase in income and employment among the member countries of the union. This may lead to higher economic growth which could be sustained with continuing changes in business expectations, higher investment and new production technique in the union countries.7. Better Utilisation of Resources : In a common market, the free movement of labor and capital is likely to result in better utilisation of the economic resources of the entire community.INVESTOPEDIA EXPLAINS 'ECONOMIC INTEGRATION' There are varying levels of economic integration, including preferential trade agreements (PTA), free trade areas (FTA), customs unions, common markets and economic and monetary unions. The more integrated the economies become, the fewer trade barriers exist and the more economic and political coordination there is between the member countries. By integrating the economies of more than one country, the short-term benefits from the use of tariffs and other trade barriers is diminished. At the same time, the more integrated the economies become, the less power the governments of the member nations have to make adjustments that would benefit themselves. In periods of economic growth, being integrated can lead to greater long-term economic benefits; however, in periods of poor growth being integrated can actually make things worse.

Stages of Economic IntegrationThere are several stages in the process of economic integration, from a very loose association of countries in apreferential trade area, tocompleteeconomic integration, where the economies of member countries are completely integrated.A regional trading bloc is a group of countries within a geographical region that protect themselves from imports from non-members in other geographical regions, and who look to trade more with each other. Regional trading blocs increasingly shape the pattern of world trade - a phenomenon often referred to asregionalism.Stages of Integration

Preferential Trade AreaPreferential Trade Areas (PTAs) exist when countries within a geographical region agree to reduce or eliminate tariff barriers on selected goods imported from other members of the area. This is often the first small step towards the creation of a trading bloc.Agreements may be made between two countries (bi-lateral), or several countries (multi-lateral).Free Trade AreaFree Trade Areas (FTAs) are created when two or more countries in a region agree to reduce or eliminate barriers to trade on all goods coming from other members. The North atlantic free Trade Agreement (NAFTA) is an example of such a free trade area, and includes the USA, Canada, and Mexico.Customs UnionA customs union involves the removal of tariff barriers between members, plus the acceptance of a common (unified) external tariff against non-members. This means that members may negotiate as a single bloc with 3rdparties, such as with other trading blocs, or with the WTO.Common MarketAcommon marketis the first significant step towards full economic integration, and occurs when member countries trade freely in all economic resources not just tangible goods. This means that all barriers to trade in goods, services, capital, and labour are removed. In addition, as well as removing tariffs, non-tariff barriers are also reduced and eliminated. For a common market to be successful there must also be a significant level of harmonisation of micro-economic policies, and common rules regarding monopoly power and other anti-competitive practices. There may also be common policies affecting key industries, such as the Common Agriculture Policy. (CAP) and Common Fisheries Policy (CFP) of the European Single Market (ESM).Economic UnionEconomic Union is a term applied to a trading bloc that has both a common market between members, and a common trade policy towards non-members, but where members are free to pursue independent macro-economic policies.Monetary UnionMonetary union is the first major step towards macro-economic integration, and enables economies to converge even more closely. Monetary union involves scrapping individual currencies, and adopting a single, shared currency, such as the Euro for the Euro-16 countries, and the East Caribbean Dollar for 11 islands in the East Caribbean. This means that there is a common exchange rate, a common monitory policy, including interest rates and the regulation of thequantity of money and a single central bank, such as the European Central Bank or the East Caribbean Central Bank.

Fiscal UnionA fiscal union is an agreement to harmonise tax rates, to establish common levels of public sector spending and borrowing, and jointly agree national budget deficits or surpluses. The majority of EU states agreed a fiscal compact in early 2012, which is a less binding version of a full fiscal union.Economic and Monetary UnionEconomic and Monetary Union (EMU)is a key stage towards compete integration, and involves a single economic market, a common trade policy, a single currency and a common monetary policy.Obstacles to economic integration Obstacles standing as barriers for the development of economic integration include the desire for preservation of the control of tax revenues and licensing by local powers, sometimes requiring decades to pass under the control of supranational bodies. The experience of 1990-2009 has shown radical change in this pattern, as the world has observed the economic success of the European Union. So now no state disputes the benefits of economic integration: the only question is when and how it happens, what exact benefits it may bring to a state, and what kind of negative effects may take place. Theory of Economic IntegrationThe theory of economic integration is the branch of economics concerned with analysing the effects of different forms of integration on the economies of member states and the rest of the world. Its relevance for Europe is the progress made since the foundation of the European Community and European Free Trade Area in 1958 and 1960 in dismantling trade barriers, adopting a common external tariff (in the case of the EC), establishing a single market and, more recently, creating a common currency. The basic theory of customs union, first expounded by Viner in 1950 and later extended by Meade and Lipsey, provides the theoretical foundation on which the theory of integration rests. While Viner's work was important in showing that customs unions and free trade areas are not always welfare-enhancing and may even lower global economic welfare, in its simple form the theory was incomplete. It focused mainly on the short-run effects of regional integration and failed to provide a convincing rationale for why countries enter into such arrangements. Subsequently, Viner's analysis was modified and added to by relaxing some of the more limiting assumptions on which it rested, preparing the way for a deeper understanding of the integration process. In particular, our understanding of how integration affects countries was strengthened by the incorporation of economies of scale and terms of trade effects, which Viner had largely ignored.Beginning in the 1980s, important advances were made by extending the analysis to incorporate the effects of increasing returns and imperfect competition. An important role in this respect was played by the emergence of the new trade theories. The launching of the Single Market programme in 1987 led to greater attention being given to the effects of deep integration on markets in which intra-industry trade was the predominant form of competition. On top of the normal gains from lower prices and improved resource allocation, potentially much greater gains could be reaped from intra-industry specialisation. At the same time, integration theory became much more interested in the effects of integration on economic growth. The application of endogenous growth theories to integration theory appeared to show that much the largest gain from integration results from a permanent increase in the regional growth rate. More recently, integration theory has become concerned about the location effects of integration, reflecting the growing interest of trade theorists in the importance of geography. New models of trade, incorporating the effects of factor mobility, external economies of scale and product competition, have established the importance of location in the analysis of the effects of integration. In short, integration theory has come a long way from where it started out fifty years or more ago, leaving us with a much more comprehensive picture of how it impacts on countries both inside and outside the region.

The Aims and Mechanics of Economic IntegrationAims and ObjectivesEconomic integration schemes share the common aim and objective of expanding net benefits available for international distribution through fiscal compensation and net distribution mechanisms. Peter Robson notes:A primary economic objective of integration is to raise the real output and income of the participants and their rates of growth by increasing specialization and competition by facilitating desirable structural (linkages) changes. This objective may be pursued with reference to trade in products only, as in a free trade area or a customs union, or it may extend to factor mobilitythe free movement of labour, capital and enterprises as in a common market, or an economic unionThe expected rise in output and income are essentially due to a combination of several factors. First,specializationbased oncomparative advantagein production tends to enlarge the output of products that can be shared by participating states. Second,economies of scaleassociated with increased production tends to lead to the obtaining of more output from a given quantity of inputs and a given state of industrial technology. Third, this induced widening of economic activity frequently contributes to an increase in outputs arising from theaugmented availabilityof factor inputs and improvements in industrial technology. And fourth, enhanced intraregional competition could causestructuraland technological changes that would reduce the power of local monopolies and lead to a moreefficient allocation of resources as well as to an expansion of output availability.In addition, joint action facilitates bargaining with countries outside the area of coordinated action.There are economic as well as political reasons why nations pursue economic integration. The economic rationale for the increase of trade between member states of economic unions that it is meant to lead to higher productivity. This is one of the reasons for the global scale development of economic integration, a phenomenon now realized in continentaleconomic blockssuch asASEAN,NAFTA,SACN, theEuropean Union, and theEurasian Economic Community and proposed for intercontinental economic blocks, such as theComprehensive Economic Partnership for East Asiaand theTransatlantic Free Trade Area.Comparative advantagerefers to the ability of a person or a country to produce a particular good or service at a lowermarginalandopportunity costover another. Comparative advantage was first described byDavid Ricardowho explained it in his 1817 bookOn the Principles of Political Economy and Taxationin an example involving England and Portugal.[3]In Portugal it is possible to produce bothwineandclothwith less labor than it would take to produce the same quantities in England. However the relative costs of producing those two goods are different in the two countries. In England it is very hard to produce wine, and only moderately difficult to produce cloth. In Portugal both are easy to produce. Therefore while it is cheaper to produce cloth in Portugal than England, it is cheaper still for Portugal to produce excess wine, and trade that for English cloth. Conversely England benefits from this trade because its cost for producing cloth has not changed but it can now get wine at a lower price, closer to the cost of cloth. The conclusion drawn is that each country can gain by specializing in the good where it has comparative advantage, and trading that good for the other.Economies of scalerefers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producers average cost per unit to fall as the scale of output is increased. Economies of scale is a long run concept and refers to reductions in unit cost as the size of a facility and the usage levels of other inputs increase. Economies of scale is also a justification for economic integration, since some economies of scale may require a larger market than is possible within a particular country for example, it would not be efficient forLiechtensteinto have its own car maker, if they would only sell to their local market. A lone car maker may be profitable, however, if they export cars to global markets in addition to selling to the local market.Besides these economic reasons, the primary reasons why economic integration has been pursued in practice are largely political. TheZollvereinor German Customs Union of 1867 paved the way forGerman (partial) unificationunder Prussian leadership in 1871."Imperial free trade"was (unsuccessfully) proposed in the late 19th century to strengthen the loosening ties within British Empire. TheEconopean Economic Communitywas created to integrate France and Germany's economies to the point that they would find it impossible to go to war with each other.