Final Exam Study Notes - Chapter 8-Regional Economics Integration

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12 Oct 2010
MGT491 FINAL EXAM NOTES ± Chapter 8: Regional Economic Integration
x Regional economic integration ± agreements among countries in a geographic region to reduce and ultimately
remove tariff and nontariff barriers to the free flow of goods, services, and factors of production between countries.
x Proliferation of regional trade blocs that promote regional economic integration is high in past 2 decades
x Consistent with predictions of international trade theory and the theory of comparative advantage, agreements
designed to promote freer trade within regions are believed to produce gains from trade for all member countries
x GATT and WTO seek to reduce trade barriers
x By entering into regional agreements groups of countries aim to reduce trade barriers more rapidly than can be
achieved under the WTO
x EU is the most successful regional economic integration
o Single currency
o 450 million consumers in the regional market
o 25 countries
x Similar moves elsewhere in the world ± NAFTA, one in south America (MERCOSUR), also in central America,
southeast Asia, and parts of Africa
x Move toward regional economic integration is generally seen as a good thing but some worry that it will lead to a
world in which regional trade blocs compete against each other ± free trade would exist within each bloc but each
will protect its market from outside competition with high tariffs
Levels of Economic Integration
x From least integrated to most integrated:
o Free trade area
o Customs union
o Common market
o Economic union
o Full political union
x Free trade area ± all barriers to the trade of goods and services among member countries are removed, no
discriminatory tariffs, quotas, subsidies or administrative impediments are allowed to distort trade between
members, each country is allowed to determine its own trade policies with regard to non-members, most popular
form of regional economic integration (90% of regional agreements are of this type)
o Most enduring free trade area in the world = European Free Trade Association (EFTA)
Norway, Iceland, Liechtenstein, Switzerland
Emphasis is on free trade in industrial goods, agriculture left out of the agreement
Members free to determine the level of protection applied to goods coming from outside EFTA
x Customs union ± one step further along the road to full economic and political integration ± eliminates trade
barriers between member countries and adopts a common external trade policy, establishment of a common
external trade policy necessitates significant administration to oversee trade relations with non-members, most
countries that enter into a customs union desire even greater economic integration down the road
o EU began as a customs union but now moved beyond this stage
o Current customs unions incl. Andean Community (Bolivia, Colombia, Ecuador, Peru, Venezuela) ± free
trade between member countries, imposes a common tariff of 5-20% on goods imported from outside
x Common market ± no barriers to trade between member countries, common external trade policy, allows factors of
production to move freely between members
o Labour and capital are free to move because no restrictions on immigration, emigration, or cross-
border flows of capital between member countries
o Demands significant degree of harmony and cooperation on fiscal, monetary and employment policies
o Achieving this degree of cooperation has proven very difficult ± EU functioned as a common market for
many years but now moved beyond this stage
x Economic union ± even closer economic integration and cooperation than a common market
o Free flow of products and factors of production between member countries and the adoption of a
common external trade policy, also requires a common currency, harmonization of tax rates, and a
common monetary and fiscal policy
o High degree of integration demands a coordinating bureaucracy and the sacrifice of significant
amounts of national sovereignty to that bureaucracy
o The EU is an economic union, although an imperfect one since not all members have adopted the
same currency, and there are still differences in tax rates and regulations
x The move toward economic union raises the issue of how to make a coordinating bureaucracy accountable to the
citizens of member nations ± answer: through a political union
x Political union ± the central political apparatus coordinates the economic, social, and foreign policy of the member
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o The EU is on the road toward at least partial political union ± European Parliament has been directly
elected by the citizens of EU countries, Council of Ministers is composed of government ministers from
each EU member
o US provides an example of even closer political union ± independent states are effectively combined
into a single nation ± ultimately the EU may move toward a similar federal structure
The Case for Regional Integration
x Both economic and political
x Typically not many groups within a country accept the case for integration, which is why most attempts to achieve
regional economic integration have been contentious and halting
The Economic Case for Integration
x Economic theories of international trade:
o Predict that unrestricted free trade will allow countries to specialize in the production of goods and
services that they can produce most efficiently, result is greater world production than would be
possible with trade restrictions
o Opening a country to free trade stimulates economic growth, which creates dynamic gains from trade
o FDI can transfer technological, marketing and managerial know-how to host nations, which is likely to
stimulate economic growth
x Economic theories suggest that free trade and investment is a positive-sum game, in which all participating
countries stand to gain
x Theoretical ideal ± absence of barriers to the free flow of goods and services and factors of production among
x Because many governments have accepted part or all of the case for intervention, unrestricted free trade and FDI
are only an ideal and not reality
x International institutions such as WTO have been moving the world toward a free trade regime, success is less
than total ± difficult to get all countries to agree to a common set of rules
x Regional economic integration can be seen as an attempt to get additional gains from the free flow of trade and
investment between countries beyond those attainable under international agreements such as the WTO ± easier
to establish a free trade and investment regime among a limited number of adjacent countries than among the
whole world
x Coordination and policy problems are largely a function of the number of countries that seek agreement -the larger
the number of countries involved, the more perspectives must be reconciled and the agreement is harder to reach
x Attempts at regional economic integration are motivated by a desire to exploit the gains from free trade and
The Political Case for Integration
x Linking neighbouring economies and making them increasingly dependent on each other creates incentives for
political cooperation between the neighbouring states and reduces the potential for violent conflict, also by
grouping their economies the countries can enhance their political weight in the world
Impediments to Integration
x Despite the strong economic and political arguments in support, integration has never been easy to achieve or
sustain because:
o Although economic integration aids the majority, it has costs
While a nation as a whole may benefit significantly from a regional free trade agreement,
certain groups may lose
Moving to a free trade regime involves painful adjustments
Ex. low-cost low-skilled labour loses their jobs when production is moved
Groups that will be disadvantaged are at the forefront of opposition to these integrations
o Concerns over national sovereignty
Close economic integration demands that countries give up some degree of control over key
issues such as monetary policy, fiscal policy, trade policy ± major stumbliQJEORFNIRUWKH(8V
x EU implemented a common currency in order to achieve full economic union, and
although most member states have switched over Britain has not agreed
The Case Against Regional Integration
x Some economists have expressed concern that the benefits of regional integration have been oversold, while the
costs are often ignored
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o They say that the benefits of regional integration are determined by the extent of trade creation as
opposed to trade diversion
x Trade creation ± occurs when low-cost producers within the free trade area replace high-cost domestic producers.
It may also occur when lower cost external producers within the free trade area replace higher cost external
x Trade diversion ± occurs when higher cost suppliers replace lower cost external suppliers within the free trade
x Regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amount it
x In theory, WTO rules should ensure that a free trade agreement does not result in trade diversion
x The only way to guard against the possibility of diversion effects being greater than creation effects is to increase
the scope of the WTO so that it covers nontariff barriers to trade as well as tariff barriers. However there is no sign
that this is likely to happen anytime soon so there is still a risk that the regional economic integration of an area
might end in trade diversion
Regional Economic Integration in Europe
x Europe has 2 trade blocs ± the European Union and the European Free Trade Association
o EU is by far more significant in number of members as well as economic and political influence in the
world economy
o EU is an emerging superpower on the same scale as the US and Japan
Evolution of the European Union
x EU is the product of 2 political factors ± the devastation of western Europe during two world wars and the desire for
x Also many Europeans knew of the potential benefits of closer economic integration of the countries
x Originally formed as the European Coal and Steel Community, objective was to remove barriers to intragroup
shipments of coal, iron, steel and scrap metal
x The Treaty of Rome established the European Community
o Provided for the creation of a common market
o Elimination of internal trade barriers and creation of a common external tariff
o Required member states to abolish obstacles to the free movement of factors of production among the
o Committed the EC to establish common policies in agriculture and transportation
x The Maastricht Treaty changed it from EC to the European Union
Political Structure of the European Union
x Economic policies of the EU are formulated and implemented by a complex and still evolving political structure
x 4 main institutions in this structure are the European Commission, the Council of the European Union, the
European Parliament, and the Court of Justice
x European Commission ± responsible for proposing EU legislation, implementing it and monitoring compliance with
EU laws by member states, run by a group of commissioners appointed by each member country, entire
commission must be approved by the European Parliament before it can begin work
o Monopoly in proposing European Union legislation ± makes a proposal, goes to Council of the EU,
then European Parliament, council cannot legislate without a commission proposal in front of it
o Commission is also responsible for implementing aspects of EU law, although in practice much of this
must be delegated to member states
o Also responsible for monitoring member states to make sure they are complying with EU laws, in this
policing role the commission will ask a member state to comply with any EU laws that are being
o Competition commissioner ± ensure that no enterprise uses its market power to drive out competitors
and monopolize markets (anti-competition laws)
o Influence over business decisions in terms of mergers and acquisitions
x Council of the European Union ± represents the interests of member states, the ultimate controlling authority within
the EU since draft legislation from the commission can become law only if this council agrees
o Membership varies depending on which topic is being discussed ± ex. when agricultural issues are
being discussed, the agriculture ministers from each member state are sent
o Used to need unanimous consent on a decision, since the Single European Act was passed they only
need majority vote for some things but still unanimity for others
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