Chapter 6 Economic Integration PDF

EEB21003 INTERNATIONAL ECONOMICS & TRADE CHAPTER 6 ECONOMIC INTEGRATION Study Outline: ECONOMIC INTEGRATION ⚫ 6.1 Preferential Trade Areas ⚫ 6.2 Custom Unions  INTRODUCTION Economic integration is an arrangement among nations that typically includes the reductio...

EEB21003 INTERNATIONAL ECONOMICS & TRADE CHAPTER 6 ECONOMIC INTEGRATION Study Outline: ECONOMIC INTEGRATION ⚫ 6.1 Preferential Trade Areas ⚫ 6.2 Custom Unions  INTRODUCTION Economic integration is an arrangement among nations that typically includes the reduction or elimination of trade barriers and the coordination of monetary and fiscal policies. Economic integration aims to reduce costs for both consumers and producers and to increase trade between the countries involved in the agreement Economic integration is sometimes referred to as regional integration as it often occurs among neighboring nations.  INTRODUCTION When regional economies agree on integration, trade barriers fall and economic and political coordination increases. Specialists in this area define seven stages of economic integration: 1.Preferential Trading Area, 2.Free Trade Area, 3.Customs Union, 4.Common Market, 5.Economic Union, 6.Economic And Monetary Union, 7.Complete Economic Integration. The final stage represents a total harmonization of fiscal policy and a complete monetary union. Economic integration, or regional integration, is an agreement among nations to reduce or eliminate trade barriers and agree on fiscal policies. The European Union, for example, represents a complete economic integration. Strict nationalists may oppose economic integration due to concerns over a loss of sovereignty. LEVELS OF ECONOMIC INTEGRATION  PREFERENTIAL TRADING AREA The Treaty establishing the Preferential Trade Area for Eastern and Southern Africa was signed in December 1981, as a first step towards higher forms of regional economic cooperation and integration to bring about sustainable growth and development of Member States. Membership and location: The PTA Treaty was signed on 21 September 1982 following ratification by more than seven signatory states as provided for in Article 50.  PREFERENTIAL TRADING AREA One of the most important elements of trade policy in the world is the rapid growth of various forms of Free Trade Agreements (FTAs), more generally referred to as PTAs or Regional Trade Agreements (RTAs). They have been in existence for many centuries in various forms, such as the Hanseatic League among northern German principalities and parts of Scandinavia in the 13th to 17th centuries and various trade agreements among Italian republics during the Renaissance. The first major FTA after World War II was the European Coal and Steel Community (ECSC), which eventually became the European Community and now the European Union. The first major agreement involving the United States was the North American Free Trade Agreement (NAFTA) with Canada and Mexico in 1994, which succeeded the Canada-US FTA. PTAs really began to grow in number and scope after NAFTA and as of January 2018 there were 455 such agreements in place involving nearly all countries in the WTO (Chart). PREFERENTIAL TRADE AGREEMENT What is the meaning of a preferential trade agreement? Preferential trade agreements: (FTAs) remove barriers to trade between members and offer preferential access to markets on a reciprocal basis. This is the term used in the WTO for trade preferences, such as lower or zero tariffs, which a member may offer to a trade partner unilaterally In addition to trade in goods, FTAs usually cover trade in services and investment provisions as well as remove both tariff and non-tariff barriers to trade. The Regional Comprehensive Economic Partnership (RCEP) is a proposed PTA involving China, India, Japan, S Korea, Australia, New Zealand, and the 10 ASEAN countries. Are preferential trade agreements good or bad? Preferential trade agreements (PTAs) trigger investment through their commitment to a liberal market economy. Increasingly however, PTAs go far beyond liberalizing trade and investment flows. Especially controversial features included in most modern PTAs are environmental and labor standards  PREFERENTIAL TRADE AGREEMENT How do preferential trade agreements help in reducing trade barriers? 1. Preferential Trade Areas. The preferential trading agreement requires the lowest level of commitment to reducing trade barriers, though member countries do not eliminate the barriers among themselves. Also, preferential trade areas do not share common external trade barriers. Does the WTO allow preferential trade agreements? RTAs, defined in the WTO as reciprocal preferential trade agreements between two or more partners, have allowed countries to negotiate rules and commitments that go beyond what was possible multilaterally. In turn, some of these rules have paved the way for agreement in the WTO. REAL-WORLD EXAMPLE :PREFERENTIAL TRADE AGREEMENT A preferential trade agreement (PTA) is perhaps the weakest form of economic integration. In a PTA, countries would offer tariff reductions, though perhaps not eliminations, to a set of partner countries in some product categories. Higher tariffs, perhaps nondiscriminatory tariffs, would remain in all other product categories. This type of trade agreement is not allowed among World Trade Organization (WTO) members, who are obligated to grant most-favored nation (MFN) status to all other WTO members. Under the MFN rule, countries agree not to discriminate against other WTO member countries. Thus, if a country’s low tariff on bicycle imports, for example, is 5 percent, then it must charge 5 percent on imports from all other WTO members. Discrimination or preferential treatment for some countries is not allowed. The country is free to charge a higher tariff on imports from non-WTO members, however. In 1998, the United States proposed legislation to eliminate tariffs on imports from the nations in sub-Saharan Africa. This action represents a unilateral preferential trade agreement since tariffs would be reduced in one direction but not the other. (Note that a PTA is also used more generally to describe all types of economic integration since they all incorporate some degree of “preferred” treatment.) FREE TRADE. Tariffs (a tax imposed on imported goods) between member countries are significantly reduced, and some are abolished altogether. Each member country keeps its own tariffs regarding third countries, including its economic policy. The general goal of free trade agreements is to develop economies of scale and comparative advantages, promoting economic efficiency. A challenge concerns resolving disputes as free trade agreements tend to offer limited arrangements and dispute resolution mechanisms. Therefore, they are prone to the respective influence and leverage of the involved nations, which can lead to different outcomes depending on their economic size. A large and complex economy having a free trade agreement with smaller economies is better positioned to negotiate advantageous clauses. What is the difference between preferential trade area and free trade area? In most cases, FTAs eliminate tariffs and duties imposed on imports and exports. Preferential Trade Agreements (Preference Programs) are unilateral trade preferences programs including reduced or eliminated tariffs on imports from designated developing countries.  CUSTOM UNION A customs union is an agreement between two or more neighboring countries to remove trade barriers, reduce or abolish customs duty, and eliminate quotas. Such unions were defined by the General Agreement on Tariffs and Trade (GATT) and are the third stage of economic integration. Unlike in free trade agreements, a common external tariff is imposed on non- members of the union. When countries outside the union trade with countries in the customs union, they need to make a single payment (duty fee) for the goods that have crossed the border. Once inside the union, they can trade freely with no added tariffs. Sets common external tariffs among member countries, implying that the same tariffs are applied to third countries; a common trade regime is achieved. Custom unions are particularly useful to level the competitive playing field and address the problem of re-exports (using preferential tariffs in one country to enter another country). Movements of capital and labor remain restricted.  CUSTOM UNION Custom Union eliminates trade barriers between member countries and adopts a common external trade policy. Most countries that enter a customs union desire further integration in the future Examples include the Andean Pact (between Bolivia, Columbia, Ecuador, Venezuela, and Peru)  PURPOSE OF CUSTOM UNION The purpose of a customs union is to make it easier for member countries to trade freely with each other. The union reduces the administrative and financial burden of barrier trading and fosters economic cooperation among nations. However, member countries are not given the freedom to form their own trade deals. The countries in the customs union usually restructure their domestic economy and economic policies in order to maximize their gain from membership in the union. The European Union is the largest customs union in the world in terms of the economic output of its members. A customs union generates trade creation and diversion that helps with economic integration. Below are the advantages and disadvantages of customs unions.  ADVANTAGE OF CUSTOM UNION. Customs unions offer the following benefits: 1. Increase in trade flows and economic integration The main effect of a free-trade agreement is that it increases trade between member countries. It helps improve the allocation of scarce resources that satisfy the wants and needs of consumers and boosts foreign direct investment (FDI). Customs unions lead to better economic integration and political cooperation between nations and the creation of a common market, monetary union, and fiscal union. 2. Trade creation and trade diversion The effectiveness of a customs union is measured in terms of trade creation and trade diversion. Trade creation occurs when the more efficient members of the union sell to less efficient members, leading to a better allocation of resources. Trade diversion occurs when efficient non-member countries sell fewer goods to member countries because of external tariffs. It gives less efficient countries in the union the opportunity to capitalize on their position and sell more goods within the union. If the gains from trade creation exceed the losses from trade diversion, that leads to increased economic welfare among member countries.  ADVANTAGE OF CUSTOM UNION. Customs unions offer the following benefits: 3. Reduces trade deflection One of the main reasons a customs union is favored over a free trade agreement is because the former solves the problem of trade deflection. This occurs when a non-member country sells its goods to a low-tariff FTA (free trade agreement) country, which then resells to a high-tariff FTA country, leading to trade distortions. The presence of a common external tariff in customs unions helps avoid problems that arise from tariff differentials. DISADVANTAGE OF CUSTOM UNION. Along with the advantages, customs unions also come with a few drawbacks: 1. Loss of economic sovereignty Members of a customs union are required to negotiate with non-member countries and organizations such as the WTO. This is necessary to maintain a customs union; however, it also means that individual member countries are not free to negotiate their own deals. If a country wants to protect an infant industry in its market, it is unable to do so by imposing tariffs or other protective barriers due to the liberal trading policies. Similarly, if a country wants to liberalize its trade outside the union, it is unable to do this due to the common external tariff. DISADVANTAGE OF CUSTOM UNION. Along with the advantages, customs unions also come with a few drawbacks: 2. Distribution of tariff revenues Some countries in the union do not receive a fair share of tariff revenues. This is common among countries like the UK that trade relatively more with countries outside the union. Around 20%-25% of the tariff revenue is retained by the member who collects the revenue. It is estimated that the cost of collecting this revenue exceeds the actual revenue collected. 3. Complexity of setting the tariff rate A common problem faced by customs unions is the complexity of setting the applicable tariff rate. The process is very costly and time-consuming. Member countries often find it hard to forgo the trade of certain goods or services because another country in the union is producing it more efficiently. The problem is usually faced by developing countries and is a major issue that the UK is dealing with during Brexit. SUMMARY CUSTOM UNION. The establishment of customs unions is beneficial to economies in the long term. It helps small economies tap industries that may not have been accessible with domestic trade only. They can achieve large external economies of scale within the union from transport and infrastructure. Faced with competition from other economies, domestic markets will be more inclined to increase efficiency. Customs unions help foster growth and unite economies with liberal trade policies. COMMON MARKET. Services and capital are free to move within member countries, expanding scale economies and comparative advantages. However, each national market has its own regulations, such as product standards. ECONOMIC UNION (SINGLE MARKET). All tariffs are removed for trade between member countries, creating a uniform market. There are also free movements of labor, enabling workers in a member country to move and work in another member country. Monetary and fiscal policies between member countries are harmonized, which implies a level of political integration. A further step concerns a monetary union where a common currency is used, such as the European Union (Euro). POLITICAL UNION. Represents the potentially most advanced form of integration with a common government and where the sovereignty of a member country is significantly reduced. Only found within nation-states, such as federations where a central government and regions (provinces, states, etc.) have a level of autonomy over well-defined matters such as education. THE ECONOMIC AND MONETARY UNION (EMU) represents a major step in the integration of EU economies. Launched in 1992, EMU involves the coordination of economic and fiscal policies, a common monetary policy, and a common currency, the euro. EMU, the European Monetary Union, is an alliance of the 19 European states that belong to the European Union and have introduced a common currency with the euro. Members of the EMU: Economic and Monetary Union. COMPLETE ECONOMIC INTEGRATION is the final stage of economic integration. After complete economic integration, the integrated units have no or negligible control of economic policy, including full monetary union and complete or near-complete fiscal policy harmonisation. Complete economic integration is most common within countries, rather than within supranational institutions. An example of this are the original thirteen colonies of the United States of America, which can be viewed as a series of highly integrated quasi- autonomous nation states. In this example it is true that complete economic integration results in a federalist system of governance as it requires political union to function as, in effect, a single economy.  ADVANTAGES OF ECONOMIC INTEGRATION The advantages of economic integration fall into three categories: trade creation, employment opportunities, and consensus and cooperation. More specifically, economic integration typically leads to a reduction in the cost of trade, improved availability of goods and services and a wider selection of them, and gains in efficiency that lead to greater purchasing power. Employment opportunities tend to improve because trade liberalization leads to market expansion, technology sharing, and cross-border investment. Political cooperation among countries also can improve because of stronger economic ties, which provide an incentive to resolve conflicts peacefully and lead to greater stability.  THE COSTS OF ECONOMIC INTEGRATION Despite the benefits, economic integration has costs. These fall into three categories: Diversion of trade. That is, trade can be diverted from nonmembers to members, even if it is economically detrimental for the member state. Erosion of national sovereignty. Members of economic unions typically are required to adhere to rules on trade, monetary policy, and fiscal policies established by an unelected external policymaking body. Employment shifts and reductions. Economic integration can cause companies to move their production operations to areas within the economic union that have cheaper labor prices. Conversely, employees may move to areas with better wages and employment opportunities.  THE COSTS OF ECONOMIC INTEGRATION Because economists and policymakers believe economic integration leads to significant benefits, many institutions attempt to measure the degree of economic integration across countries and regions. The methodology for measuring economic integration typically involves multiple economic indicators including trade in goods and services, cross-border capital flows, labor migration, and others. Assessing economic integration also includes measures of institutional conformity, such as membership in trade unions and the strength of institutions that protect consumer and investor rights. REAL-WORLD EXAMPLE OF ECONOMIC INTEGRATION The European Union (EU) was created in 1993 and included 27 member states in 2022. Since 1999, 19 of those nations have adopted the euro as a shared currency. According to data from The World Bank, the EU accounted for roughly 18% of the world's gross domestic product in 2020. The United Kingdom voted in 2016 to leave the EU. In January 2020 British lawmakers and the European Parliament voted to accept the United Kingdom's withdrawal. The UK officially split from the EU on January 1, 2021. As the level of economic integration increases, so does the complexity of its regulations. This involves a set of numerous regulations, enforcement, and arbitration mechanisms to ensure that importers and exporters comply. The complexity comes at a cost that may undermine the competitiveness of the areas under economic integration since it allows for less flexibility for national policies and a loss of autonomy. The devolution of economic integration could occur if the complexity and restrictions it creates, including the loss of sovereignty, are no longer judged to be acceptable by its members. Welcome Queries…