Economic Integration
Ch. 17
Economic Integration
• occurs when two or more countries come
together for purposes of trade and/or
economic coordination
• may indicate a movement away from
multilateralism
4 Types of Integration
•
•
•
•
Free Trade Areas (FTAs)
Customs Unions (CUs)
Common Markets
Economic and/or Monetary Union
Free Trade Areas
• members remove tariffs and other trade
barriers on each other
• each member maintains its own tariff
structure for non-members
• possible problem: transshipment
Free Trade Areas: Examples
• NAFTA (Canada, Mexico, U.S.)
• ASEAN (Brunei, Indonesia, Malaysia,
Philippines, Singapore, Thailand)
• ANZCERT (Australia and New Zealand)
• EFTA (Iceland, Liechtenstein, Norway,
Switzerland)
• CEFTA (Czech Rep., Hungary, Poland,
Slovak Rep.)
Customs Unions
• Tariffs between members are eliminated
(just like a FTA), but also:
– members agree to a common set of external
tariffs and other trade barriers
– members speak with one voice in external trade
negotiations (that is, there would be just one
representative from the CU at the WTO)
Customs Unions: Examples
• UDEAC (Cameroon, CAR, Chad, Congo,
Equatorial Guinea and Gabon)
• Andean Pact (Bolivia, Colombia, Ecuador
and Venezuela)
• MERCOSUR (Argentina, Brazil, Paraguay,
and Uruguay)
Common Markets
• Tariffs between members are eliminated, a
common external tariff is established (all of
the features of CUs) plus free movement of
labor and capital
• Examples:
– ECOWAS (16 West African nations)
– AMU (Algeria, Libya, Mauritania, Morocco,
and Tunisia)
Economic and/or Monetary
Union
• Similar to a common market:
– tariffs between members are eliminated
– a common external tariff is established
– factors can move freely between member
countries
• But economic policy is coordinated by a
supranational institution in the economic
and/or monetary union
Monetary Union: An Example
• The European Union has moved towards
monetary union:
– The Euro exists as a currency, and member
country currencies have been phased out
– There’s only one exchange rate; there’s one
central bank
Economic and/or Monetary
Union
• Economic union is generally a bit more
involved: it includes
– monetary union and monetary policy
coordination
– fiscal policy coordination
• No current examples, but isn’t that what the
United States is?
Economic Integration
• As a country moves from a FTA to a CU to
a common market to an economic union
– benefits may accrue
– sovereignty is increasingly lost
• Will the U.S. ever move into an economic
union with Canada and Mexico? Not
likely!
Welfare Effects of Integration:
Static Issues
• Jacob Viner argued that integration leads to
two welfare effects:
– trade creation: increases a country’s welfare
– trade diversion: decreases a country’s welfare
• Whether economic integration is welfareenhancing depends on which effect is larger
Trade Creation and Trade
Diversion: An Example
• Suppose we have three countries: Uganda,
Sudan, and Kenya
• Initially, Uganda imports textiles and
applies a 50% tariff to textiles from both
Sudan and Kenya
• Suppose that Sudan is able to produce a unit
of textiles for $1, whereas it costs Kenyan
producers $1.20 per unit
Trade Creation and Trade
Diversion: An Example
Production
Costs
Price with
50% Tariff
Sudan
$1.00
$1.50
Kenya
$1.20
$1.80
Trade Creation and Trade
Diversion: An Example
• Prior to integration, Uganda imports 40
units from the most efficient supplier, Sudan
• Suppose now that Uganda enters into a free
trade agreement with Kenya, but not Sudan
• That is, Sudanese textile imports are
dutiable, but Kenya textiles can enter dutyfree
Trade Creation and Trade
Diversion: An Example
Production
Costs
Price with
50% Tariff
Price with
FTA
Sudan
$1.00
$1.50
$1.50
Kenya
$1.20
$1.80
$1.20
Trade Creation and Trade
Diversion: An Example
• Notice that Uganda will now import from
Kenya, although Sudan is the more efficient
producer
• Uganda loses tariff revenue, but reverses
some of the deadweight loss caused by the
protectionism
• What is the overall effect?
Trade Creation and Trade
Diversion: An Example
P
PS rises as a
result of initial
protection
S
$1.50
Tariff price
$1.00
Free trade price
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
CS falls as a result
of the initial protection
S
$1.50
Tariff price
$1.00
Free trade price
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
Revenue rises as a result
of the initial protection
S
$1.50
Tariff price
$1.00
Free trade price
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
Welfare declines
overall by the DWL
triangles
S
$1.50
Tariff price
$1.00
Free trade price
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
With FTA, CS rises
S
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
With FTA, PS falls
S
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
With FTA, revenue falls
S
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
Lost revenue transferred back
S
to domestic consumers
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
Lost revenue not transferred
back to domestic consumers S
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
Trade Creation and Trade
Diversion: An Example
P
Overall, we must compare
the gain in welfare (trade creation)
with the lost revenue (trade diversion)
S
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
Trade Creation and Trade
Diversion
• When is it likely that trade diversion
outweighs trade creation?
– When the excluded countries are much more
efficient than the included countries
– When there are only a few members of the FTA
(consider a global FTA: there would be no trade
diversion because no country would be
excluded)
Dynamic Welfare Effects
• In the long run, integration may increase a
country’s welfare because:
– increased competition (lower prices and higher
quality) may occur
– larger markets may allow economies of scale to
be realized
– lower costs resulting from standardization and
reduction in technical barriers
The European Community: A
Brief History
• 1952: France, Italy, West Germany, and
Benelux countries form European Coal and
Steel Community
• 1957: ECSC expanded to all products; name
changed to European Economic Community
(EEC)
The European Community: A
Brief History
• Other countries joined over the years:
–
–
–
–
1973: Denmark, Ireland, U.K.
1981: Greece
1986: Portugal and Spain
1995: Austria, Finland, Sweden
The European Community: A
Brief History
• Monetary union was a goal as early as 1969
– agreement to fix exchange rates and have a
common monetary policy was reached
– however, global economic disruptions in the
1970s prevented this
• The Exchange Rate Mechanism (ERM) was
revived in 1978
– ERs are kept within a narrow band of each
other
EC 92
• During the 1980s, there were still various
and sundry barriers to trade between
member countries
• 1985: Single European Act (commonly
called EC 92): elimination of all barriers to
the flow of goods, services, people, and
capital by 1992
• It wasn’t 1992, but it eventually happened
EC 92: Expected Impacts
• Predictions:
– EU’s GDP 3.2% to 5.7% higher than it would
have been without EC 92
– Consumer prices 4.5% to 7.7% lower than
without EC 92
– 1.3 to 2.3 million additional jobs under EC 92
• Mainly these gains were supposed to result
from dynamic gains from integration
Maastricht Treaty
• 1989: The Delors Report on monetary union
was received - this became the framework
for the Maastricht treaty
• Maastricht has been approved by 11 out of
15 EU countries
• According to the treaty, monetary union was
to be achieved in 3 phases: convergence,
European System of Central Banks, and
Monetary Union
Maastricht: Convergence Phase
• Launched in 1990
• To have monetary union, wide differences
in inflation rates, economic growth, and
budget deficits would need to be eliminated
by 1999
• Most countries would not have met the
original (and strict) requirements, but the
requirements were broadened
• Only Greece failed to make the cut
Maastricht: European System of
Central Banks (ESCB)
• Began in 1994
• The ESCB controls the exchange rate
mechanism
• Each EU country continues to make
monetary policy for itself
Maastricht: Monetary Union
• 1999
– accounts can be stated in terms of euros, but
member countries’ currencies remain legal
tender
– each members’ exchange rate is fixed in terms
of euros
– Monetary policy is made by the ESCB; each
member no longer controls its own money
supply
Maastricht: Monetary Union
• 2002
– In January, euro notes and coins were issued by
the ECB
– In July, national currencies were withdrawn
“Europhiles”
• Currently, Austria, Belgium, Finland,
France, Germany, Ireland, Italy,
Luxembourg, Netherlands, Portugal, and
Spain are members of the EMU
• “Euroland” has 290 citizens (more than the
U.S) and has a GDP that approaches that of
the U.S.
“Euroskeptics”
• Denmark, Sweden and the U.K. are deeply
concerned about the loss of sovereignty that
EMU implies
• These countries may yet choose to join the
EMU
• Greece is trying hard to qualify now
NAFTA
• On January 1, 1994 the North American
Free Trade Agreement came into being
• It allows for a dismantling of trade barriers
between Canada, Mexico, and the U.S.
• It creates the largest market in the world:
360 million people and GDP of more than
$6 trillion
NAFTA
• Fall of the Berlin Wall
• New “WAR” Economic War (prior 9/11)
• Mexican Harvard Economist trained
President
• Texas President (Bush Sr.)
• NSA
NAFTA: Some Provisions
• Many tariffs were eliminated immediately;
others will be phased out over 5, 10, or 15
years
• Services (esp. banking) will be traded freely
by 2007
• All U.S. environmental standards will
remain in force
NAFTA: Alleged Benefits to U.S.
• Increased ability to export products
• Wider consumer choice
• Increased competitiveness leading to
dynamic gains
• Job growth
• Lower consumer prices
NAFTA: Alleged Problems for
the U.S.
•
•
•
•
•
•
•
Job loss: the “giant sucking sound”
Unfair competition for U.S. firms
Environmental decline in Mexico
Exploitation of Mexican workers
Increased illegal immigration
Increased flow of illegal drugs
Loss of sovereignty
NAFTA: 10 Years Later
• Has NAFTA helped or harmed the U.S.?
• The answer is unclear:
– There were nearly 17 million more jobs in the
U.S. in 2004, but was this due to NAFTA or in
spite of NAFTA?
– Clearly there has been job loss in certain
industries (textiles, transportation equipment),
but there has been job gains in other sectors
(e.g., electronics and electrical equipment)
NAFTA: 10 Years Later
– Clearly certain geographic areas have been hurt
(e.g., El Paso and other border cities, North
Carolina); other areas have blossomed (nonborder parts of Texas)
– Presently the U.S. imports more than it exports
from Mexico, but this has a lot to do with the
peso crisis and the sluggish Mexican economy
NAFTA: 5 Years Later
– Giant sucking sound? Hasn’t happened:
perhaps some U.S. industries have moved south
to use lower-cost labor, but they are faced with
•
•
•
•
lower Mexican labor productivity
a crumbling and inadequate infrastructure
a shortage of qualified managers
an unreliable legal system
– In fact, some U.S.-owned companies have
returned home from Mexico (Cummins Engine,
GM, Quality Coils)!
NAFTA: 10 Years Later
• Although estimates of employment effects
vary, a fairly respected estimate is that as of
2004 the U.S. enjoyed a net gain of 100,000
jobs as a direct result of NAFTA
• Remember, though, that the U.S. economy
employs 140 million workers. A gain of
100,000 jobs amounts to an increase of only
0.7%!
NAFTA: An Attempt to Cut
Through the Rhetoric
• Most economists predicted that the effect of
NAFTA on the U.S. would be modest at
best
• Whether you think NAFTA has been a help
or a hindrance to the U.S., it is hard to argue
that it is either incredibly horrible or
incredibly wonderful
A Comparison of NAFTA
Countries (1994)
Country
Population GDP (billions
(in millions)
of $)
Canada
30
570
Mexico
92
251
U.S.
265
7254
A Comparison of NAFTA
Countries (1994)
Country
Population
(% of U.S.)
GDP (% of
U.S.)
Canada
11.3%
7.9%
Mexico
34.7%
3.5%
NAFTA: The Future
• There is still opposition to NAFTA in each
country, and NAFTA could disintegrate
(unlikely in the near future)
• Other countries may be added (Chile and
Central America and less likely now Brazil)