C04 Economic Integration

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Economic Integration

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After completing this chapter, the student should be

able to:

Identify the stages of economic integration. Discuss the static and dynamic effects of a

regional trading arrangement. Assess the nature and operation of the EU. Discuss the advantages and disadvantages of

the NAFTA.

Identify the reforms that the transitioneconomies have implemented to improve their standard of living.



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Regional Integration vs Multilateralismo regional trade blocs could be a complement to

multilateralism by setting a precedent whichother nations will follow

o can lead to deeper integrationo however regional agreements are also

discriminatory in that some nations aretreated differently than others

o decreases incentives for nations to pursuemultilateral agreements

o trade bloc members may not gain additionaleconomies of scale through multilateralism



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Types of Regional Agreementso free-trade area ± agreement to remove trade

barriers among membersexample: NAFTA

o

customs union ± agreement to remove tradebarriers among members and impose uniformtrade restrictions against non-members

example: Benelux

o common market ± agreement that permits (1)free trade among members; (2) commonexternal trade restrictions; and (3) freemovement of factors of production

example: EU



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Types of Regional Agreements (cont.)

o economic union ± common market agreementwith :1) common national, taxation, fiscal, and social

policies among members

2) transfers of sovereignty to a supranationalauthority

example: Belgium and Luxembourg 1920s

o monetary union ± economic union withadditional characteristic of common monetarypolicy and common currency

example: United States



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Static Effects of Trade Arrangements

With Tariff:(before customs union)

red triangle = consumer

surplusgreen triangle =producer surplus

black rectangle = tariff

revenuea + b = deadweight loss



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Static Effects of Trade Arrangements

With Customs Union:

agreement with Germanywill lower the price to SG

trade-creation effect:welfare losses now partof consumer surplus

a = production effectb = consumption effect

trade-diversion effect:area c

lost benefits from lower cost suppliers



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Dynamic Effects of Trade Arrangements

o economies of scale ± access to a larger market allows producers to become moreefficient through greater specialization, better

equipment, and usage of by-productso greater competition ± increased number of

producers makes collusion less likely andforces firms to become more efficient

o stimulus of investment ± because of increased rate of return and ability to spreadR&D costs trade makes greater levels of investment more likely



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European Union

Treaty of Rome ± 1957 ± established EuropeanCommunity ± precursor to EU

1) 1957: Belgium, France, Italy, Luxembourg,

Netherlands &West Germany2) 1973: United Kingdom, Ireland & Denmark3) 1981: Greece4) 1987: Spain & Portugal

5) 1995: Austria, Finland & Sweden6) 2004: Cyprus, Czech Republic, Estonia,

Hungary, Latvia, Lithuania, Malta, Poland,Slovakia & Slovenia

7) 2007: Bulgaria & Romania



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European Union: 1960 - 1985o EU members removed tariffs in 1968 leading

to fivefold increase in tradeo EU adopted common external tariffs in 1970

making it a customs uniono trade creation: machinery, transportation

equipment, chemicals & raw materialso trade diversion: agricultural commodities and

raw materialso trade creation exceeded trade diversiono EU saw increases in economies of scale,

competition & investmento 1985 EU eliminated nontariff barriers resulting

in creation of European common market



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European Union & Maastricht

o 1991 Maastricht Treaty established monetaryunion and euro as common currency by 2002

o convergence criteria:

1) inflation 1.5% above average inflation of three countries with lowest inflation

2) long term interest rates 2.0% aboveaverage of same three countries

3) exchange rate within target bands of monetary union for 2 years

4) budget deficit 3.0% of GDP5) government debt 60.0% of GDP



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EU Agricultural Policy - Variable Levies

o no restriction on agriculture traded internallyo EU policy based in part on variable levieso adjusted to maintain

desired price levelso more restrictive than

an import quota inthat foreign

producers cannot cutprices and absorbtariff cost to maintainexport sales



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EU Agricultural Policy - Subsidieso export subsidies also used to maintain higher

prices of EU - common policyo EU producers

sell for low pricebut receivehigher price

o EU purchases

any surpluso surplus then

sold on worldmarket for lower

price



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Government Procurement Policieso government purchases previously limited primarily

to domestic producerso 1992 EU required bidding process from EU firms

o

benefits: governmentspurchase fromlower costproducers

increasedcompetition

remaining firmsproduce witheconomies of scale



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European Monetary Union A common currency also implied the need for asingle European Central Bank responsible for allmonetary and exchange rate policies of the EMU.

o

advantages: eliminated exchange rate risk reduced currency conversion costs insulation from monetary disturbance &

speculation

o disadvantages: loss of individual monetary authority transition to common currency could lead to

speculative attacks



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Optimum Currency Areaso definition ± region in which it is economically

preferable to have a single official currencyo success of common currency area:

similar business cycles similar economic structures single monetary policy affecting all members in

same manner absence of legal or cultural barriers that would limit

labor mobility wage flexibility stabilizing transfer system

o EU concerns based on rigid wages and limitedlabor mobility tied to cultural factors



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North American Free Trade Agreement

o free trade area for U.S., Canada & Mexico butnot a customs union

o issues:

U.S. & Canada represented developedeconomies while Mexico was a developingeconomy

Mexico¶s authoritarian political system substantial difference in standard of living

between Mexico and Canada & U.S.

o decision: integrate Mexico to stimulatedevelopment or allow problems in that nationto continue to spill over borders



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Benefits to Mexicoo substantial benefits for Mexico because it

integrated with much larger economies

o increase in production of goods in which it has

comparative advantageo gains at the expense of other low-wage

nations

o increases in agricultural goods and labor

intensive goodso agriculture represents small portion of GDP

but supports roughly 25% of the population



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Benefits & Concerns for Canadao Benefits:

maintain status in international trade

free trade preference in U.S. market

equal access to Mexico¶s market inclusion in future free trade area with

Central & South America

economies of scale associated with

increased output levelso Possible Cost: closer integration with U.S. as

potential threat to Canada¶s social welfaresystem



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Economies of Scale from NAFTAo access to additional markets increases demand

o Canadianproducers cansell moreautos

o increasedconsumer surplus due to

lower priceo no worse for

producerssince costs

have dropped



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Benefits & Costs to the U.S.o Benefits:

expanded trade increased competition and lower prices

enhanced economies of scale decrease in illegal immigration improved political stability in Mexico

o Costs: U.S. industries competing with imports impact on unskilled workers domestically potential for environmental consequences limited benefits due to relative size of these

economies



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Labor Cost Compared to Productivityo Would NAFTA cause many U.S. companies to

relocate to Mexico due to lower wages?o Productivity is a major factor in determining cost

per unit of output.

o Based on higher productivity, U.S. workers can

still receive higher wages.



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NAFTA as Optimum Currency Area?

o measures of economic integration: Canada &Mexico are the U.S. largest trading partners

o Canada & U.S.: advanced industrial

economies with similar per capita incomes,inflation rates and interest rates

o Mexico: lower average per capita income,higher inflation rate, higher interest rates, and

volatile exchange rateo Mexico adopting U.S. dollar:

pro: price & interest rate stability

con: loss of independent monetary policy



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Free Trade Area of the Americaso 1994 proposal calling for agreement among

34 nations in North and South Americao potential to become largest trading bloc in the

world with 850 million consumers and $14trillion in combined income

o progressive Latin American trade policies: reduced governmental management conventional macroeconomic policies to promote

growth and stability failure of import substitution model

o challenges:o other free trade agreementso

subsidies on agricultural goods



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Transition Economieso nations making the transition from centrally

planned to market economy

o countries

opting for greater political &economicfreedom

have seenimprovedperformanceand income

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C04 Economic Integration