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Chapter 8

Economic Integration

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Learning ObjectivesTo review types of economic integration among countriesTo examine the costs and benefits of integrative arrangementsTo understand the structure of the European Union and its implications for firms within and outside EuropeTo explore the emergence of other integration agreements, especially in the Americas and AsiaTo suggest corporate response to advancing economic integration

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IntroductionEconomic integration is best viewed as a spectrum with the various integrative agreements in effect today lying in the middle of this spectrumThe level of integration defines the nature and degree of economic links among countries

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Levels of Economic Integration

Trading bloc: preferential economic arrangement among a group of countries

Trading blocs may take various forms:

Free trade areaCustoms unionCommon marketEconomic union

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The Free Trade Area and the Customs Union

The free trade area is the least restrictive and loosest form of economic integration among countriesIn a free trade area, all barriers to trade among member countries are removed

Members of a customs union dismantle barriers to trade in goods and services among themselvesA customs union establishes a common trade policy with respect to nonmembers

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The Common Market and the Economic Union

A common market has no barriers to trade among members and has a common external trade policyFactors of production are mobile among membersMembers of a common market must be prepared to cooperate closely in monetary, fiscal, and employment policies

The creation of a true economic union requires integration of economic policies in addition to the free movement of goods, services, and factors of productionUnder this union, members would harmonize monetary policies, taxation, and government spending and a common currency would be used by all members

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Arguments Surrounding Economic Integration

A number of arguments surround economic integrationThese arguments center on:

Trade creation and diversionThe effects of integration on import prices, competition, economies of scale, and factor productivityThe benefits of regionalism versus nationalism

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Trade Creation and Trade DiversionWhereas trade creation is positive in moving toward freer trade, and therefore lower prices for consumers within the EU, the impact of trade diversion is negative

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Reduced Import PricesWhen a small country imposes a tariff on imports, the price of the goods will typically rise, which will in turn result in lower demand for the imported goodsWhen a bloc of countries imposes the tariff, the fall in demand for the imported goods will be substantial

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Increased Competition and Economies of Scale

Integration increases market size and may result in a lower degree of monopoly in the production of certain goods and services

Certain industries may not be economically viable in smaller, trade protected countries

Internal economies of scaleExternal economies of scale

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Higher Factor Productivity and Regionalism Versus

NationalismWhen factors of production are freely mobile, the wealth of the common market countries, in aggregate, will likely increaseFactor mobility will not benefit each country in the common market

The biggest impediment to economic integration remains the reluctance of nations to surrender a measure of their autonomy

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European IntegrationEconomic integration in Europe from 1948 to the mid 1980s:

Organization for European Economic Cooperation (OEEC)Treaty of RomeEuropean Free Trade Association (EFTA)Common agricultural policy (CAP)

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European Integration

The European Union since the mid 1980s:

1992 White PaperEuropean Union (EU)

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Organization of the EUThe executive body of the EU is the European Commission, headquartered in BrusselsThe Council of Ministers has the final power to decided EU actionsThe future expansion of the EU will cause changes in the decision making processes

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Implications of the Integrated European

MarketPerhaps the most important implication for Europe is the economic growth that is expected to resultSeveral specific sources of increased growth have been identified:

Gains from eliminating transaction costsAchievement of economies of scaleMore intense competitionCheaper transaction costs and reduced currency risks

Many U.S. firms fear a unified Europe

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North American Economic Integration

Although the EU is undoubtedly the most successful and well-known integrative effort, integration efforts in North America has gained momentum and attentionNorth American integration has an interest in purely economic issues and there are no constituencies for political integration

U.S.-Canada Free Trade AgreementNorth American Free Trade Agreement (NAFTA)

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Other Economic Alliances

The world’s developing countries have perhaps the most to gain from successful integrative efforts

Import substitution

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Integration in Latin America

Before the signing of the U.S.-Canada Free Trade Agreement, all of the major trading bloc activity in the Americas had taken place in Latin AmericaOne of the longest lived integration efforts among developing countries was the Latin America Free Trade Association (LAFTA), formed in 1961

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Integration in Asia and Integration in Africa and the

Middle EastThe development in Asia has been different from that in Europe and the AmericasAsian interest in regional integration is increasing for pragmatic reasons

Africa’s economic groupings range from currency unions among European nations and their former colonies to customs unions among neighboring statesCountries in the Arab world have made some progress in economic integration

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Economic Integration and the International

ManagerRegional economic integration creates opportunities and challenges for the international managerEconomic integration may have an impact on a company’s entry modeDecisions regarding integrating markets must be assessed from four different perspectives

Effects of changeStrategic planningReorganizationLobbying

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Cartels and Commodity Price Agreements

An important characteristic that distinguishes developing countries from industrialized countries is the nature of their export earningsThis distinction is important for several reasonsA cartel is an association of producers of a particular goodCommodity price agreements involve both buyers and sellers in an agreement to manage the price of a certain commodity