Regional Economic Integration. References Griffin and Pustay, Chapter 10; Rutledge, Chapters 2 & 4

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1 Regional Economic Integration References Griffin and Pustay, Chapter 10; Rutledge, Chapters 2 & 4 Fundamental issues» Drivers of regional economic integration» Stages of regional economic integration» Case study: European Economic Integration» Costs and Benefits of Economic and Monetary Union Regional Economic Integration, MBA 2 page 1

2 Drivers of Regional Integration» Political drivers» The motivations for regional integration in both Europe and East Asia were initially political in nature.» In Europe, economic interdependence was thought to be the most effective means to promote political cooperation in the region following the atrocities of World War II.» Integration tends to be driven by policies and institutions in this case, for example in EU.» Market driven drivers» The drivers of regional integration are high levels of intra regional trade and FDI carried out by multinational corporations (MNCs) and the development of crossborder production networks.» For example, regional integration in East Asia has taken this form. Regional Economic Integration, MBA 3 Stages of Regional Economic Integration High 5. Political Union By encompassing both political and economic integration, = the union effectively transforms itself into one country. Degree of economic integration 4. Economic Union 3. Common Market 2. Customs Union = Common market + members more fully integrate their economies by coordinating their economic policies (this invariably includes monetary union e.g. the euro) Customs union + members also eliminate barriers that = restrict movement of factors of production among themselves. Free trade area + members also adopt common external = trade policies towards non member countries. Low 1. Free Trade Area Members remove tariffs and other barriers to international = trade among themselves; however, each member may establish its own trade policies with non member countries. Regional Economic Integration, MBA 4 page 2

3 Stage 1: a Free Trade Area 1. Free Trade Area» A Free Trade Area encourages trade among its members by removing trade barriers, such as:» Tariffs and quotas on goods and services» Can create trade deflection problem» NAFTA:» The North American Free Trade Agreement is an example of such a Free Trade Area» NAFTA reduces tariffs and trade barriers between the economies of Canada, the USA and Mexico Regional Economic Integration, MBA 5 Stage 2: a Customs Union 2. Customs Union A Customs Union combines the elimination of internal trade barriers among its members as well as: the adoption of common external trade policies toward non members» Because of the uniform treatment of products from non member countries, a customs union avoids the trade deflection problem.» A firm from a nonmember country pays the same tariff rate on exports to any member of the customs union.» Example: the six GCC states have agreed to a common tariff of 5% on all imported goods and services from non member countries Regional Economic Integration, MBA 6 page 3

4 Stage 3: a Common Market 3. Common Market Members of a common market remove internal trade barriers among themselves.» As well as adopting a customs union, members of a common market also remove barriers that restrict the movement of factors of production labour, capital, and technology among its members. In other words: within a common market there are no restrictions on the movement of labour, capital and technology between all member economies. Regional Economic Integration, MBA 7 Stages 4 and 5: Economic and Political Union ` 4. Economic Union» An economic union represents full integration of the economies.» In addition to the customs union and the common market, an economic union requires its members to coordinate their economic policies (monetary policy, fiscal policy, taxation, and social welfare programs) in order to blend their economies into a single entity.» Example: The European Monetary Union 5. Political Union» A political union is the complete political as well as economic integration of two or more countries, thereby effectively making them into a singular country.» The reunification of East and West Germany for instance Regional Economic Integration, MBA 8 page 4

5 Theoretical Underpinnings» Trade Creation Effect» Regional integration expands markets and promotes competition by eliminating barriers to trade among member countries» This contributes to more efficient allocation of resources and greater productivity within member countries; this has a trade creation effect because a greater net volume of goods and services are produced» Investment Creation Effect» To foreign companies, the single, unified market that regional integration creates is also an attractive investment market» The larger the integrated market, the greater the scale merits and therefore the attraction of locating there» Example: in 1984 the EU received only one third of the direct investment that the US did, but by 1989 it received a similar level Regional Economic Integration, MBA 9 Benefits of Regional Economic Integration There are benefits from being a member of the Common Market:» Bigger domestic market Lower tariffs between members of a regional economic bloc opens up the markets of all member countries to all member country firms.» Economies of scale in production Firms can operate economies of scale and lower their average production and distribution costs as they expand their customer base within the trading bloc.» Greater competitiveness The lower cost structure can then help firms to compete internationally outside the trading bloc.» Increased investment A regional economic bloc may attract increased FDI from non member countries as firms seek to access the enlarged market from within.» Greater bargaining power being part of a larger market gives members greater clout in international talks than as an single state Regional Economic Integration, MBA 10 page 5

6 Costs of Regional Economic Integration It is the case however that certain entities or specific industries could be made worse off as a result of deeper regional integration.» For instance:» Increased Competition Elimination of trade barriers within the trade bloc exposes a firm s home market to competition from firms located in other member countries, thus threatening less efficient firms.» Firms which operate in a small domestic national market may be at a greater disadvantage compared to those that already operate in a large national market.» Location effects businesses may concentrate their activities in a core at the expense of the periphery leading to greater income inequality within the regional economic bloc.» Loss of Sovereignty loss of national power over regulations and policy Regional Economic Integration, MBA 11 Case Study: European Economic Integration KEY Existing EU members Prospective EU members Regional Economic Integration, MBA 12 page 6

7 The European Union Common Market Beginning in the 1950s several European states called for closer integration, over five decades the EU came into existence» Most important regional trading bloc» 27 member countries» 491 million population» Combined GDP of $14.4 trillion» Governing Institutions of the EU» The Council of the European Union Located in Brussels, Belgium» The European Commission in Brussels» The European Parliament in Strasbourg, France» The European Court of Justice in Luxembourg European Union flag Regional Economic Integration, MBA 13 Case Study: The European Monetary Union Monetary Union involves the permanent fixing of exchange rates between two or more independent countries.» It can be considered the penultimate stage of economic integration, as full economic union.» Once in monetary union, all member states will share a single currency, and have the same interest rates and monetary policy It is often said that any decision to form a monetary union is:» As much a political one as it is an economic one. Regional Economic Integration, MBA 14 page 7

8 Case Study: The European Monetary Union» The Maastricht Treaty rests on three pillars designed to further Europe s economic and political integration» The most important aspect of the Maastricht Treaty was the establishment of the Monetary Union (MU).» Initially 11 EU members (later increasing to 17) agreed to form a MU and share a common currency.» The creation of a single currency called the euro, launched in 1999 becomes an important global reserve currency to rival the US dollar.» European Central Bank responsible for controlling the Eurozone s money supply, interest rates, and inflation (located in Frankfurt, Germany). Regional Economic Integration, MBA 15 Convergence Criteria for EMU 1. Inflation rates: No more than 1.5 % higher than the average of the three best performing member state 2. Government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% 3. Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the fiscal year. 4. Exchange rate: Applicant countries should have joined the exchange rate mechanism for two consecutive years and should not have devalued its currency during the period. 5. Long term interest rates: The nominal long term interest rate must not be more than 2 percentage points higher than in the three lowest inflation member states. Regional Economic Integration, MBA 16 page 8

9 Costs and Benefits of Monetary Union Costs include:» Loss of independent national monetary policy (interest rate setting).» Loss of complete control over national economic policy (inflation)» Loss of sovereign control over government budgets and finance. Benefits include:» Reduction of transaction costs (currency conversion costs) on trade and investment between members.» Price transparency and convergence. among member markets» Capital market growth reduced exchange rate risk and increased transparency of asset prices. Regional Economic Integration, MBA 17 page 9