INTERNATIONAL

UNIT 4 SECTION 6 REGIONAL ECONOMIC INTEGRATION

BUSINESS Unit 4, section 6: Regional economic integration

You are welcome to the last Section of Unit 4. The formation and
development of regional blocs has become an increasingly significant
feature of the international business environment. Such blocs are formed by
group of countries aiming to increase the benefits from trade by eliminating
or reducing barrier to the free flow of goods and services across their
national borders. The rationale for regional blocs arose from experience in
the 1930s; at that time world trade decreased by about a third, as more and
more countries restricted imports and raised tariffs and barriers to trade, in
their attempts to overcome the unemployment caused by economic
depression. These measures led to a downward spiral of relation and
increasing protectionism, which further depressed world economic activity.

After world war two, countries were anxious not to repeat this experience;
the prevailing view was that co-operation between countries was needed
both to stimulate world trade and to achieve longer-term economic growth
and stability.

By the end of this Section, you should be able to;

 explain regional economic integration
 outline and explain the levels of economic union.
 explain any two regional economic agreements

Read on

Regional Economic Integration Explained

Regional Economic Integration (REI) is the establishment of transnational
rules and regulations that enhance economic trade and cooperation between
countries. It is the means by which countries define the extent to which they
liberalise international trade geographically. REI is the formation of regional
blocs by eliminating or reducing barriers to free movement of goods,
services, capital and labour across borders. At one extreme, economic
integration would result in one worldwide, free trade market in which all
nations have a common currency and can export anything they want to any
other nation. At the other extreme, there would be a total lack of economic
integration, in which nations are self-sufficient and do not need to trade with
anyone.

Countries promote regional economic integration in order to;

 open new markets for firms of member countries
 lower prices for consumers in member countries
 stimulate trade and investment among member countries
 promote foreign policy of nations
 lower cost structure for member countries
 attract foreign direct investment from non-member countries

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The integration has enabled the countries to enjoy free trade within the
union. Unions such as the European Union has been successful but an
attempt to integrate the economies of West African states, known as
Economic Community of West African States (ECOWAS) was met with
little success. Notwithstanding, efforts are underway to revamp the union

Levels of Economic Integration.

There are five levels of integration. The levels differ in form, function and
degree of restriction, and include free trade, custom union, common market,
economic union, and political union.

 A free trade area is an economic integration arrangement in which

barriers to trade (such as tariffs, quotas, and other nontariff barriers)
among member countries are removed. One of the best known free trade
arrangements is the European Free Trade Association (EFTA) and North
American Free Trade Area (NAFTA). Each member country is free to
establish its own trade policies with or against other non-members. For
example, Ghana and Ivory Coast that are members of ECOWAS can
move goods and services amongst them but Libya will face Ghana or
Ivory Coast’s country specific restrictions if it has to trade with both or
another. This exposes member states to (one form of) trade diversion or
trade deflection.

Trade diversion occurs when the members of an economic integration

group decrease their trade with non-member countries in favour of trade
with each other. One common reason is that the removal of trade
barriers between member countries makes it less expensive to buy from
companies within the group, and continuing trade barriers with non-
member countries makes it more difficult for the latter to compete. Thus,
trade diversion can lead to the loss of production and exports from more
efficient non-member countries to less-efficient member countries that
are protected by tariffs or other barriers.

To overcome this problem, most trade agreements specify rules of origin

– conditions under which a product is classified as a member product or
a non-member product. Contrary, Trade creation occurs when the
members of an economic integration group begin focusing their efforts on
those goods and services for which they have a comparative advantage and
start trading more extensively with each other.

 A customs union is a form of economic integration in which all tariffs

between member countries are eliminated and a common trade policy
toward nonmember countries is established. It is much more restrictive.
Unlike a free trade area, members of a custom union operate as a bloc in
trade negotiation and not as individual nations. An example of a custom
union is the Mercusor Accord made up of Argentina, Brazil, Paraguay
and Uruguay

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 A common market is a form of economic integration characterized by:

(a) no barriers to trade among member nations; (b) a common external
trade policy; and (c) mobility of factors of production among member
countries. Member countries join this bloc to promote the growth of
their economies. There are no restrictions on immigration, emigration
and cross-border investment.

 An economic union is a deeper form of economic integration

characterized by the free movement of goods, services and factors of
production between member countries, and full integration of economic
policies. An economic union also: (a) unifies monetary and fiscal policy
among the member nations; (b) has a common currency (or a
permanently fixed exchange rate between currencies); and (c) employs
the same tax rates and structures for all members. Members give up a
large measure of national sovereignty and use a common currency. The
European Union is an example.

 A political union goes beyond full economic integration and results in a

situation in which all economic policies are unified and there is a single
government. It is a complete economic and political integration of two
or more countries into one country.

Previously, the formation of regional blocs involved countries that were

geographically neighbours but new developments have emerged
whereby agreements are reached among countries located on distant
lands. Example is the economic partnership agreement (EPA).

It is not necessary for a country to pursue economic integration by

starting with a free trade area and then working up to a common market
or economic union. For example, the United Kingdom was a member of
a free trade area before deciding to leave it and enter the EU.

Historical Backgrounds of Some Leading Economic

Agreements/Blocs.
The European Union (EU)
The EU is the world’s most integrated economic bloc and has taken the
following steps to becoming a full-fledged economic union:
 Market access - Tariffs and most nontariff barriers have been eliminated
for trade in products and services, and rules of origin favour
manufacturing using parts and other inputs produced in the EU.
 Common market - Barriers to the cross-national movement of production
factors—labour, capital, and technology—have been removed. An
Italian worker now has the right to get a job in Ireland, and a French
company can invest freely in Spain.

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 Trade rules - The member countries have largely eliminated customs

procedures and regulations, which streamline transportation and
logistics within Europe.
 Standards harmonization - The EU is harmonizing technical standards,
regulations, and enforcement procedures that relate to products, services,
and commercial activities.

In the long run, the EU is seeking to adopt common fiscal, monetary,

taxation, and social welfare policies. The 2002 introduction of the euro
eliminated exchange rate risk and forced member countries to improve their
fiscal and monetary policies. Since 2004, 12 new states have joined the EU,
and the recent addition of Bulgaria and Romania brought the number of
member countries to 28. Most new members are important, low-cost
manufacturing sites for EU firms.

There are six major institutions that manage the EU: the European Council,
composed of the heads of all member states; the council of the EU, the
major policy decision-making body of the EU (decisions are conducted by
the relevant ministers from each country); the European Commission, the
executive branch of the EU, handles a great deal of the technical work
associated with preparing decisions and regulations; the European
Parliament, the watchdog on EU expenditures in addition to evaluating other
decisions of the Council and; the Court of Justice, the official interpreter of
EU law; the Court of Auditors, responsible for ensuring that revenues and
expenditures are implemented lawfully in accordance to the budget. The EU
is a powerful economic union. Empirical studies show that the community
has created much more trade than it has diverted from the rest of the world.
In addition to the European Union, several other trading blocs are notable:

European Free Trade Association (EFTA)

This was established in 1960 by Austria, Britain, Denmark, Norway,
Portugal, Sweden, and Switzerland. It is the second largest free trade area in
Europe. Most of these countries left the EFTA to join the EU. Current
EFTA members are Iceland, Liechtenstein, Norway, and Switzerland. EFTA
promotes free trade and strengthens economic relations with other European
countries and the world - i.e., the European Economic Area arrangement
allows for free movement of people, products, services, and capital
throughout the combined area of the EFTA and the EU.

North American Free Trade Agreement (NAFTA)

This bloc was formed in 1994 by Canada, the U.S., and Mexico. It is the
most significant economic bloc in the Americas. NAFTA passage was
facilitated by the maquiladora program - Since the 1960s U.S. firms locate
manufacturing facilities just south of the U.S. border and access low-cost
labour without having to pay significant tariffs.

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NAFTA: Increased market access between Canada, Mexico, and the U.S.;
Eliminated tariffs and most nontariff barriers for products/services traded in
the bloc; Initiated bidding for government contracts by member country
firms; Established trade rules and uniform customs procedures and
regulations; Prohibited standards/technical regulations to be used as trade
barriers; Instituted rules for investment and intellectual property rights;
Provided a forum for dispute settlement regarding investment, unfair
pricing, labour issues, and the environment.

Trade among the members has more than tripled and now exceeds one
trillion dollars per year. In the early 1980s, Mexico’s tariffs averaged 100
percent and gradually disappeared under NAFTA. From 1994 to 2008, U.S.
exports to Mexico grew from about $40 billion to more than $150 billion;
U.S. exports to Canada more than doubled, to over $260 billion; Canada's
exports to Mexico and the U.S. more than doubled; Mexican exports to the
U.S. grew from $50 billion to over $215 billion per year; Access to Canada
and the U.S. helped launch numerous Mexican firms in industries such as
electronics, automobiles, textiles, medical products, and services; Annual
foreign investment in Mexico rose from $4 billion in 1993 to nearly $20
billion by 2008 as U.S. and Canadian firms invested in their southern
neighbour; Mexico’s per capita income rose to about $11,000 in 2007,
making Mexico the wealthiest per capita income country in Latin America;
Member countries now trade more with each other than with former trading
partners outside the NAFTA zone. Both Canada and Mexico now have
some 80 percent of their trade with, and 60 percent of their FDI stocks in,
the United States. By increasing Mexico’s attractiveness as a manufacturing
location, firms like Gap Inc. and Liz Claiborne moved their factories from
Asia to Mexico during the 1990s. IBM shifted much of its production of
computer parts from Singapore to Mexico. NAFTA resulted in North
American labour market restructuring

Compared to the EU or NAFTA, the remaining blocs are less stable and
have been less successful - located in Latin America, Asia, the Middle East,
and Africa.

El Mercado Comun del Sur (MERCOSUR)

MERCOSUR or (the Southern Common Market) has become the strongest
economic bloc in South America, since its formation in 1991. MERCOSUR
established the free movement of products and services, a common external
tariff and trade policy, and coordinated monetary and fiscal policies. Priority
- construction of reliable infrastructure—roads, electricity grids, and gas
pipelines. MERCOSUR eventually aimed to become an economic union.
Trade tripled among member countries during its first six years.
MERCOSUR may be integrated with NAFTA and the Dominican Republic-
Central American Free Trade Agreement (DR-CAFTA) as part of the
proposed Free Trade Area of the Americas (FTAA). If implemented, this
integration would bring free trade to the entire western hemisphere.

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Caribbean Community and Common Market (CARICOM)

CARICOM was established in 1973 to lower trade barriers and institute a
common external tariff. It is composed of roughly 25 member and associate
member states around the Caribbean Sea. In recent years, the bloc has made
more progress toward establishing the Caribbean Single Market, a common
market that allows for a greater degree of free movement for products,
services, capital, and labour, and gives citizens of all CARICOM countries
the right to establish businesses throughout the region.

Comunidad Andina de Naciones (CAN)

Established in 1969, this bloc was long called the Andean Pact, the CAN
includes Bolivia, Colombia, Ecuador, Peru, and Venezuela. CAN is
expected to merge with MERCOSUR to form a new economic bloc that
encompasses all of South America. Geography (Andes mountain range) has
hindered intra-bloc trading - reaching only 5 percent of bloc members’ total
trade.

Association of Southeast Asian Nations (ASEAN)

One of the few examples of economic integration in Asia, ASEAN was
created with the goal of maintaining political stability and promoting
regional economic and social development in 1967. ASEAN created a free
trade area in which many tariffs were reduced to less than 5 percent.
Economic diversity has slowed further regional integration. Example - Oil-
rich Brunei has a per capita income of over $50,000, while Vietnam's is less
than $3,000. The mass movement of workers from poor to prosperous
countries that would likely result with further ASEAN integration reduces
the likelihood that this bloc will become a common market or an economic
union. ASEAN aims to incorporate powerhouses like Japan and China,
whose membership would accelerate the development of extensive trade
relationships. Note that Singapore’s exports as a percent of its GDP exceed
100 percent. The reason is that Singapore is an entrepôt nation, an import-
export platform for Asia, trading far more goods than it manufactures.

Asia Pacific Economic Cooperation (APEC)

APEC aims for greater free trade and economic integration of the Pacific
Rim countries. It incorporates 21 nations on both sides of the Pacific,
including Australia, Canada, Chile, China, Japan, Mexico, Russia, and the
U.S. Its members account for 85 percent of total regional trade, as well as
one-third of the world’s population and over half its GDP. APEC aspires to
remove trade and investment barriers by 2020. Members have varying
national economic priorities, and the composition of less affluent Asian
countries alongside strong international traders like Australia, Japan, and the
U.S. makes it difficult to achieve agreement on a range of issues.

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Australia and New Zealand Closer Economic Relations

Agreement (CER)
Australia and New Zealand reached a free trade agreement that removed 80
percent of tariffs and quotas between the two nations, but was relatively
complex and bureaucratic, in 1966. In 1983, CER sought to accelerate free
trade, leading to further economic integration of the two nations. The CER
gained importance when Australia and New Zealand lost their privileged
status in the British market as Britain joined the EU. Many believe the CER
has been one of the world's most successful economic blocs. In 2009,
members concluded important negotiations on creating a free trade
agreement with the ASEAN countries.

Management Implications of Regional Integration

Strategies for regional economic integration management include;
 internationalisation by firms inside the economic bloc
 rationalisation of operations - rationalization is the process of
restructuring and consolidating company operations following regional
integration to reduce redundancy and costs and increase the efficiency of
operations.
 mergers and acquisitions
 regional products and marketing strategy
 internationalisation by firms from outside the bloc

We discussed economic integration as involving agreements among countries

to establish links through the movement of goods, services, and factors of
production across borders. The levels of integration are vital to know which
blocs to join. Benefits from regional economic integration include trade
creation, economies of scale, improved terms of trade etc. The most successful
example of economic integration is the European Union, as it succeeded in
eliminating most barriers to the free flow of market offerings. Other alliances
and/or blocs exist in Africa and Asia
Now assess your understanding of this Section by answering the following
self-assessment questions. Good luck!

Activity 4.6
 How does trade creation differ from trade diversion? Compare and contrast
the two.
 How does the EU function? Identify and describe its organisation and
operation.

Did you score all? That’s great! Keep it up.

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