Economic Integration Theory - UdG Integration Theory… · Economic Integration Theory and Practice. Definition of economic integration ... share of the resulting benefit

4. Economic 4. Economic Integration Integration Theory and Theory and PracticePractice

Definition of economic integrationDefinition of economic integration

� The combination of several national economies into a larger territorial unit.

� It implies the elimination of economic boarders between countries.

� Economic borders: any obstacle which limits the mobility of goods services and factors of production between countries.

Definition of economic integrationDefinition of economic integration

• Jan Tinbergen: all processes of economic integration include two aspects:– Negative integration: the elimination of obstacles. – Positive integration: harmonization, coordination of

existing instruments.

Number of regional trade agreements, 1948-2002

Source: WTO (2003)

Levels of economic integrationLevels of economic integration

• There are several levels of economic

integration:

– A. Free trade area

– B. Customs union

– C. Common or single market

– D. Economic and monetary union

Types of Regional Trade AgreementsTypes of Regional Trade AgreementsThe EU

FECHA PAIS FECHA AMPLIACIONES FECHA AMPLIACIONES

Alemania Dinamarca 2004 Hungría

Francia Irlanda 2004 Polonia

Italia Reino Unido 2004 República Checa

Bélgica 1981 Grecia 2004 Eslovenia

Holanda España 2004 Estonia

Luxemburgo Portugal 2004 Chipre

Austria - Turquía

Suecia 2004 Malta

Finlandia 2007 Rumanía

2007 Bulgaria

2004 Letonia

2004 Lituania

2004 Eslovaquia

1958

1973

1986

1995

FECHA PAÍS FECHA PAÍS FECHA PAÍS FECHA PAÍS

Reino Unido Austria Austria Noruega

Austria Noruega Noruega Suiza

Dinamarca Portugal Suecia IslandiaNoruega Suecia Suiza Liechtenstein

Portugal Suiza Islandia

Suecia Islandia FinlandiaSuiza Finlandia Liechtenstein

Islandia Liechtenstein

FinlandiaLiechtenstein

19731986

1960

1995

EFTA

EUROPEAN ECONOMIC AREA (EEA)

FECHAS PAÍSESUE-15EFTA (menos Suiza) Noruega Islandia Liechtenstein

1994

Types of Regional Trade AgreementsTypes of Regional Trade Agreements

ACUERDOS FECHAS PAÍSESUSACanadáMéjicoArgentinaBoliviaBrasilChileColombiaEcuadorMéjicoParaguayPerúUruguayVenezuelaArgentinaBrasilParaguayUruguay

NAFTA 1994

ALADI 1980

MERCOSUR 1991

ACUERDOS FECHAS PAÍSESBoliviaPerúEcuadorVenezuelaCosta RicaEl SalvadorGuatemalaHondurasNicaraguaAntigua/BarbudaBahamasBarbadosDominicaGranadaGuayanaJamaicaMontserratSanta LucíaSan Cristobal/NievesSan Vicente y GranadinasTrinidad y Tobago

PACTO ANDINO

1969

MERCADO COMÚN

CENTRO-AMERICANO

1960

COMUNIDAD DEL CARIBE

1973

Types of Regional Trade AgreementsTypes of Regional Trade Agreements

Theory: Preliminaries

• Demand curve shows how much consumers would buy of a particular good at any particular price.

• It is based on optimisation exercise:

– Would one more be worth price?

• Market demand is aggregated over all consumers’ demand curves.

– Horizontal sum.

price

mu’

p*

quantityc*c’

mu”

c”

Marginal

utility curve is

the demand

curve for one

consumer

9


• Supply curve shows how much

firms would offer to the market

at a given price.

• Based on optimisation:

– Can increase production as

long as price you can sell at

is equal or above mc.

• Market supply is aggregated

over all firms.

– Horizontal sum.

price

mc”

p*

quantity

Marginal

cost

q*q’

mc’

q”10

A firm’s supply curve is its marginal cost curve.


• Since demand curve based

on marginal utility, it can

be used to show how

consumers’ well-being

(welfare) is affected by

changes in the price.

• On the right we have the

market demand for a

product.

• Gap between marginal

utility of a unit and price

paid shows ‘surplus’ from

being able to buy c* at p*.

price

p*

quantity

Demand

curve

c*

Triangle is sum of

all gaps between

marginal utility

and price paid

(summed over

total consumption)

11

= MU


• If the price falls:

– Consumers obviously better off.

– Consumer surplus change quantifies this

intuition.

• Consumer surplus rise, 2 parts:

– Pay less for units consumed at old price;

measure of this = area A.

• A = Price drop times old consumption.

– Gain surplus on the new units consumed

(those from c* to c’); measure of this =

area B.

• B = sum of all new gaps between

marginal utility and price

price

p*

quantity

Demand

curve

c*

p’

c’

A B

12


• Since supply curve based

on marginal cost, it can be

used to show how

producers’ well-being

(welfare) is affected by

changes in the price.

• On the right have the

market supply of the

product.

• Gap between marginal cost

of a unit and price received

shows ‘surplus’ from being

able to sell q* at p*.

price

p*

quantityq*

Triangle is sum of

all gaps between

price received and

marginal cost

(summed over

total production)

13

S=MC


• If the price rises:

– producers obviously better off.

– Producer surplus change quantifies this

intuition.

• producer surplus rise, 2 parts:

– Get more for units sold at old price;

measure of this = area A.

• A = Price rise times old production.

– Gain surplus on the new units sold

(those from q* to q’). Measure of this =

area B.

• B= sum of all new gaps between

marginal cost and price.

price

p*

quantity

Supply

curve

p’A B

q’q*

14

Price

Supply

P*

P”

P’

Z’ C’Quantity

Z” C”

Demand

A B C D

World price: P’

Domestic price: P*

Price with tariff: P’’

Effect of tariff

On trade:

Reduces imports

On welfare

Consumer surplus:

-A-B-C-D

Producer surplus: +A

Tariff revenue: +C

Dead weight losses: +B+D (why?)

Benefits from the creation of a Benefits from the creation of a free trade areafree trade area

Benefits of a customs unionBenefits of a customs union

• Effects of a customs union: static and dynamic.

• A. Static effects, 2 groups:– A.1. Trade creation

• Production effect• Consumption effect (also known as trade expansion)

– A.2. Trade diversion• B. Dynamic effects

Static effects. Trade creationStatic effects. Trade creation

• Replace domestic production by cheaper imports from another member of the customs union:

– Production effect: reduce inefficient local production and minimize the inefficient use of resources

– Consumption effect: increase demand since price has fallen

Static effects. Trade diversion. Static effects. Trade diversion.

• Replace imports from cheaper 3rd countries by more expensive imports from members of the customs union.

• The customs union has a positive welfare effect if trade creation > trade diversion. This will tend to happen when:– The more inclusive the customs union (fewer 3rd

countries). – The higher the initial tariff eliminated by the creation of

the customs union (PF-P G in the following figure) – The smaller the difference between the price which

emerges from the customs union and the price which could be had from importing from the most efficient producer who by definition is a 3rd country.

Static effects. Example, France & Germany Static effects. Example, France & Germany form a customs union leaving the US outsideform a customs union leaving the US outside

P

Quantity

PUS

PG

PF

0a

Supply

Demand

A B C D E F

g

k

r u

l

h i

m n

jSw

l m

The US is the most efficient producer (Pus)

Before the CU:

France imports ru from the US applying a tariff which leads to PF. T = ruhi

CU: Germany faces no tariffs but the US does: France imports kn from Germ.

Loss of tariff revenue and reduction of producer surplus: ruhi + PFrkPG (in favour of consumers) Trade creation:•Consumption effect: umn•Production effect: rkl

Trade deviation: lmhi (what you don’t import from the US multiplied by PA-PUS)

Net welfare effect: rkl+umn-lmhi

Customs union and tradeCustoms union and trade

0%

20%

40%

60%

80%

100%

1958

1959

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

EEC-6 Other 6 Europe Rest of W orld

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

1958

1959

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

$ billion (current prices) EEC

Total imp orts

Note: Left panel shows share of EEC6’s import from the three regions. Other Euro-6 are the 6 countries that joined the EU by the mid 1980s, UK, Ireland, Denmark, Spain, Portugal and Greece. Source: Table 5, External Trade and Balance of Payments, Statistical Yearbook, Recapitulation, 1958-1991,

Dynamic effects of a customs unionDynamic effects of a customs union

• More difficult to measure• Increases productivity and thus potential

growth rates due to:– More specialization with the CU.– Greater competition with the CU. – Capacity to explore economies of scale

and thus compete with 3rd countries.

Benefits of a common marketBenefits of a common market

• Free movement of K and L:– More efficient allocation of resources– Convergenece of wages and capital incomes within the

CM. – But:

• K moves easier than L (transport and cultural costs).

Capital movements in the Common Market

• M&A activity is high in EU.

• much M&A is mergers within member state.

– about 55% ‘domestic.’

– Remaining 45% split between:

• one is non-EU firm (24%),

• one firm was located in another EU nation (15%),

• counterparty’s nationality was not identified (6%).

23

Capital movements in the Common Market

• Distribution of M&A

quite varied:

– Big 3’s share M&As

much lower than share

of the EU GDP. It, Fr,

D (Ger) 36% of the

M&As, 59% GDP.

– UK share is important

(31.6%).

– Small members have

disproportionate share

of M&A (compared to

GDP).

M&A activity by nation, 1991-2002

B, 2.8%

DK, 2.6%

EL, 1.1%

E, 5.0%

F, 13.5%

IRL, 1.7%

I, 6.2%

L, 0.5%NL, 6.5%

A, 2.1%

P, 1.2%

FIN, 3.9%

S, 5.3%

UK, 31.4%

D, 16.3%

24

Competition rules in the Single MarketCompetition rules in the Single Market

• For creating an effective single market two elements are necessary:

– As we have stated, the removal of national barriers to the trade of goods, the provision of services and the

mobility of factors of production.

– The application of an effective competition policy to ensure that firms do not exercise monopoly power or

abuse their market power to the detriment of

consumers and the efficient allocation of resources in

general.


• The basic competition law of the EU is contained in Articles 81 to 89 of the TEU and in particular:

– Articles 81 to 86 deal with the infringement of the competition rules by agreement between enterprises

– Articles 87 to 89 deal with state aids.


• Article 81 deals with collusion between firms and refers to agreements (explicit collusion) and

concerted practices (implicit collusion).

– It specifically prohibits price fixing and market sharing; limit or control of production, markets,

technical development or investment; discrimination,

collective boycotts and tie in clauses (when you

purchase one good or service, you are compelled to

buy another unrelated good or service).

– This list is not exhaustive and in general any collusive practices are prohibited.


– They apply to both vertical agreements (between producers and retailers) and horizontal ones (between

producers or between retailers).

– The rules apply to all firms operating in the common market.

– There are exemptions of course: The agreements must contribute to the improvement of the production or

distribution of goods or to the promotion of technical

or economic progress, while allowing consumers a fair

share of the resulting benefit.

Competition rules in the Single MarketCompetition rules in the Single Market• Article 82 is an anti-monopoly instrument.

– It prohibits any abuse by one or more undertakings of a

dominant position within the common market or in a substantial

part of it … insofar as it may affect trade between member

states.

– The emphasis is not on the acquiring a dominant position (which

implies market concentration) but on its abuse, primarily in

trade between member states.

– Again cooperation agreements between firms which are

considered beneficial for the consumers by improving

production, distribution or technical progress are exempted.


• One major drawback of article 82 as an instrument of

merger control is that it can be activated only after a

merger has taken place (remember abuse of monopoly

power is prohibited) and so pre-emptive action by the

Commission is not possible under this article.

• This power was agreed upon in 1989 in the form or two

regulations (4064/89 and 1310/97). Under these

regulations the Commission can preemptively block

mergers with a community dimension:


• There is a Community dimension where:

– the combined aggregate worldwide turnover of all the companies

is more than 5 000 million, and;

– the aggregate Community-wide turnover of each of at least two

of the companies is more than 250 million, unless each of the

companies achieves more than two-thirds of its aggregate

Community-wide turnover within one and the same Member

State.

• Large companies incorporated outside the EU but generating at least

€100 million of their annual business in the Community are also

subject to these rules if a merger between them threatens to distort

competition in the EU market.

• Proposed mergers must be notified to the Commission.


• State aids: one of the duties of the Commission is to ensure that in the single market no member state provides its own firms with a competitiveadvantage over the firms of other member states.

– In this vein, article 87 prohibits direct subsidies, tax exemptions, preferential interest rates, loans on especially favorable termsindemnities against losses

– Some state aids may be authorized if the distortions in competition are considered to be offset by advantage to the Union, for example, state aid for companies engaged in high tech. research, or directed to less developed regions. Aid which does not affect trade between member states does not come under this law.

– Public procurement: Countries tend to favor domestic firms in the awarding of government contracts, particularly military contracts and such purchases represent on average 15% of GDP. This is similar to a state subsidy. For this reason the public procurement market is gradually being opened up to intra-community competition – when contracts are of some minimum threshold of expenditure

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Economic Integration Theory - UdG Integration Theory… · Economic Integration Theory and Practice. Definition of economic integration ... share of the resulting benefit