Economic Integration Ch. 17. Economic Integration occurs when two or more countries come together...

Economic Integration

Ch. 17


• occurs when two or more countries come together for purposes of trade and/or economic coordination

• may indicate a movement away from multilateralism

4 Types of Integration

• Free Trade Areas (FTAs)

• Customs Unions (CUs)

• Common Markets

• Economic and/or Monetary Union

Free Trade Areas

• members remove tariffs and other trade barriers on each other

• each member maintains its own tariff structure for non-members

• possible problem: transshipment

Free Trade Areas: Examples

• NAFTA (Canada, Mexico, U.S.)• ASEAN (Brunei, Indonesia, Malaysia,

Philippines, Singapore, Thailand)• ANZCERT (Australia and New Zealand)• EFTA (Iceland, Liechtenstein, Norway,

Switzerland)• CEFTA (Czech Rep., Hungary, Poland,

Slovak Rep.)

Customs Unions

• Tariffs between members are eliminated (just like a FTA), but also:– members agree to a common set of external

tariffs and other trade barriers– members speak with one voice in external trade

negotiations (that is, there would be just one representative from the CU at the WTO)

Customs Unions: Examples

• UDEAC (Cameroon, CAR, Chad, Congo, Equatorial Guinea and Gabon)

• Andean Pact (Bolivia, Colombia, Ecuador and Venezuela)

• MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay)

Common Markets• Tariffs between members are eliminated, a

common external tariff is established (all of the features of CUs) plus free movement of labor and capital

• Examples:– ECOWAS (16 West African nations)– AMU (Algeria, Libya, Mauritania, Morocco,

and Tunisia)

Economic and/or Monetary Union

• Similar to a common market:– tariffs between members are eliminated– a common external tariff is established– factors can move freely between member

countries

• But economic policy is coordinated by a supranational institution in the economic and/or monetary union

Monetary Union: An Example

• The European Union has moved towards monetary union:– The Euro exists as a currency, and member

country currencies have been phased out– There’s only one exchange rate; there’s one

central bank

Economic and/or Monetary Union

• Economic union is generally a bit more involved: it includes – monetary union and monetary policy

coordination– fiscal policy coordination

• No current examples, but isn’t that what the United States is?


• As a country moves from a FTA to a CU to a common market to an economic union– benefits may accrue– sovereignty is increasingly lost

• Will the U.S. ever move into an economic union with Canada and Mexico? Not likely!

Welfare Effects of Integration: Static Issues

• Jacob Viner argued that integration leads to two welfare effects:– trade creation: increases a country’s welfare– trade diversion: decreases a country’s welfare

• Whether economic integration is welfare-enhancing depends on which effect is larger

Trade Creation and Trade Diversion: An Example

• Suppose we have three countries: Uganda, Sudan, and Kenya

• Initially, Uganda imports textiles and applies a 50% tariff to textiles from both Sudan and Kenya

• Suppose that Sudan is able to produce a unit of textiles for $1, whereas it costs Kenyan producers $1.20 per unit


ProductionCosts

Price with50% Tariff

Sudan $1.00 $1.50

Kenya $1.20 $1.80


• Prior to integration, Uganda imports 40 units from the most efficient supplier, Sudan

• Suppose now that Uganda enters into a free trade agreement with Kenya, but not Sudan

• That is, Sudanese textile imports are dutiable, but Kenya textiles can enter duty-free


ProductionCosts

Price with50% Tariff

Price withFTA

Sudan $1.00 $1.50 $1.50

Kenya $1.20 $1.80 $1.20


• Notice that Uganda will now import from Kenya, although Sudan is the more efficient producer

• Uganda loses tariff revenue, but reverses some of the deadweight loss caused by the protectionism

• What is the overall effect?


D

P

Q

S

Tariff price$1.50

160 200

Free trade price$1.00

PS rises as a result of initialprotection


D

P

Q

S

Tariff price$1.50

160 200


CS falls as a resultof the initial protection


D

P

Q

S

Tariff price$1.50

160 200


Revenue rises as a resultof the initial protection


D

P

Q

S

Tariff price$1.50

160 200


Welfare declinesoverall by the DWLtriangles


D

P

Q

S

Tariff price$1.50

160 200

Free trade price$1.00FTA price$1.20

With FTA, CS rises


D

P

Q

S

Tariff price$1.50

160 200


With FTA, PS falls


D

P

Q

S

Tariff price$1.50

160 200


With FTA, revenue falls


D

P

Q

S

Tariff price$1.50

160 200


Lost revenue transferred back to domestic consumers


D

P

Q

S

Tariff price$1.50

160 200


Lost revenue not transferred back to domestic consumers


D

P

Q

S

Tariff price$1.50

160 200


Overall, we must compare the gain in welfare (trade creation) with the lost revenue (trade diversion)

Trade Creation and Trade Diversion

• When is it likely that trade diversion outweighs trade creation?– When the excluded countries are much more

efficient than the included countries– When there are only a few members of the FTA

(consider a global FTA: there would be no trade diversion because no country would be excluded)

Dynamic Welfare Effects

• In the long run, integration may increase a country’s welfare because:– increased competition (lower prices and higher

quality) may occur– larger markets may allow economies of scale to

be realized– lower costs resulting from standardization and

reduction in technical barriers

The European Community: A Brief History

• 1952: France, Italy, West Germany, and Benelux countries form European Coal and Steel Community

• 1957: ECSC expanded to all products; name changed to European Economic Community (EEC)


• Other countries joined over the years:– 1973: Denmark, Ireland, U.K.– 1981: Greece– 1986: Portugal and Spain– 1995: Austria, Finland, Sweden


• Monetary union was a goal as early as 1969– agreement to fix exchange rates and have a

common monetary policy was reached

– however, global economic disruptions in the 1970s prevented this

• The Exchange Rate Mechanism (ERM) was revived in 1978– ERs are kept within a narrow band of each other

EC 92

• During the 1980s, there were still various and sundry barriers to trade between member countries

• 1985: Single European Act (commonly called EC 92): elimination of all barriers to the flow of goods, services, people, and capital by 1992

• It wasn’t 1992, but it eventually happened

EC 92: Expected Impacts

• Predictions:– EU’s GDP 3.2% to 5.7% higher than it would

have been without EC 92– Consumer prices 4.5% to 7.7% lower than

without EC 92– 1.3 to 2.3 million additional jobs under EC 92

• Mainly these gains were supposed to result from dynamic gains from integration

Maastricht Treaty• 1989: The Delors Report on monetary union was

received - this became the framework for the Maastricht treaty

• Maastricht has been approved by 11 out of 15 EU countries

• According to the treaty, monetary union was to be achieved in 3 phases: convergence, European System of Central Banks, and Monetary Union

Maastricht: Convergence Phase• Launched in 1990• To have monetary union, wide differences in

inflation rates, economic growth, and budget deficits would need to be eliminated by 1999

• Most countries would not have met the original (and strict) requirements, but the requirements were broadened

• Only Greece failed to make the cut

Maastricht: European System of Central Banks (ESCB)

• Began in 1994

• The ESCB controls the exchange rate mechanism

• Each EU country continues to make monetary policy for itself

Maastricht: Monetary Union

• 1999 – accounts can be stated in terms of euros, but

member countries’ currencies remain legal tender

– each members’ exchange rate is fixed in terms of euros

– Monetary policy is made by the ESCB; each member no longer controls its own money supply

Maastricht: Monetary Union

• 2002– In January, euro notes and coins were issued by

the ECB– In July, national currencies were withdrawn

“Europhiles”

• Currently, Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain are members of the EMU

• “Euroland” has 290 citizens (more than the U.S) and has a GDP that approaches that of the U.S.

“Euroskeptics”

• Denmark, Sweden and the U.K. are deeply concerned about the loss of sovereignty that EMU implies

• These countries may yet choose to join the EMU

• Greece is trying hard to qualify now

NAFTA

• On January 1, 1994 the North American Free Trade Agreement came into being

• It allows for a dismantling of trade barriers between Canada, Mexico, and the U.S.

• It creates the largest market in the world: 360 million people and GDP of more than $6 trillion

NAFTA

• Fall of the Berlin Wall

• New “WAR” Economic War (prior 9/11)

• Mexican Harvard Economist trained President

• Texas President (Bush Sr.)

• NSA

NAFTA: Some Provisions

• Many tariffs were eliminated immediately; others will be phased out over 5, 10, or 15 years

• Services (esp. banking) will be traded freely by 2007

• All U.S. environmental standards will remain in force

NAFTA: Alleged Benefits to U.S.

• Increased ability to export products

• Wider consumer choice

• Increased competitiveness leading to dynamic gains

• Job growth

• Lower consumer prices

NAFTA: Alleged Problems for the U.S.

• Job loss: the “giant sucking sound”

• Unfair competition for U.S. firms

• Environmental decline in Mexico

• Exploitation of Mexican workers

• Increased illegal immigration

• Increased flow of illegal drugs

• Loss of sovereignty

NAFTA: 10 Years Later

• Has NAFTA helped or harmed the U.S.?• The answer is unclear:

– There were nearly 17 million more jobs in the U.S. in 2004, but was this due to NAFTA or in spite of NAFTA?

– Clearly there has been job loss in certain industries (textiles, transportation equipment), but there has been job gains in other sectors (e.g., electronics and electrical equipment)


– Clearly certain geographic areas have been hurt (e.g., El Paso and other border cities, North Carolina); other areas have blossomed (non-border parts of Texas)

– Presently the U.S. imports more than it exports from Mexico, but this has a lot to do with the peso crisis and the sluggish Mexican economy


– Giant sucking sound? Hasn’t happened: perhaps some U.S. industries have moved south to use lower-cost labor, but they are faced with

• lower Mexican labor productivity

• a crumbling and inadequate infrastructure

• a shortage of qualified managers

• an unreliable legal system

– In fact, some U.S.-owned companies have returned home from Mexico (Cummins Engine, GM, Quality Coils)!


• Although estimates of employment effects vary, a fairly respected estimate is that as of 2004 the U.S. enjoyed a net gain of 100,000 jobs as a direct result of NAFTA

• Remember, though, that the U.S. economy employs 140 million workers. A gain of 100,000 jobs amounts to an increase of only 0.7%!

NAFTA: An Attempt to Cut Through the Rhetoric

• Most economists predicted that the effect of NAFTA on the U.S. would be modest at best

• Whether you think NAFTA has been a help or a hindrance to the U.S., it is hard to argue that it is either incredibly horrible or incredibly wonderful

A Comparison of NAFTA Countries (1994)

Country Population(in millions)

GDP (billionsof $)

Canada 30 570

Mexico 92 251

U.S. 265 7254

A Comparison of NAFTA Countries (1994)

Country Population(% of U.S.)

GDP (% ofU.S.)

Canada 11.3% 7.9%

Mexico 34.7% 3.5%

NAFTA: The Future

• There is still opposition to NAFTA in each country, and NAFTA could disintegrate (unlikely in the near future)

• Other countries may be added (Chile and Central America and less likely now Brazil)

Economic Integration Ch. 17. Economic Integration occurs when two or more countries come together...

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