4. Economic
Integration
Theory and
Practice
Definition of economic integration
The combination of several national economies into
a larger territorial unit.
It implies the elimination of economic boarders
between countries.
Economic borders: any obstacle which limits the
mobility of goods services and factors of
production between countries.
Definition of economic integration
• Jan Tinbergen: all processes of economic
integration include two aspects:
– Negative integration: the elimination of obstacles.
– Positive integration: harmonization, coordination of
existing instruments.
Number of regional trade agreements, 1948-2002
Source: WTO (2003)
Levels of economic integration
• There are several levels of economic
integration:
– A. Free trade area
– B. Customs union
– C. Common or single market
– D. Economic and monetary union
Types of Regional Trade Agreements
The EU
FECHA
PAIS
FECHA AMPLIACIONES
FECHA
Dinamarca
2004
Hungría
Irlanda
2004
Polonia
Reino Unido
2004
República Checa
Grecia
2004
Eslovenia
España
2004
Estonia
Portugal
2004
Chipre
Austria
-
Turquía
Suecia
2004
Malta
Finlandia
2007
Rumanía
2007
Bulgaria
2004
Letonia
2004
Lituania
2004
Eslovaquia
Alemania
Francia
1958
1973
Italia
Bélgica
Holanda
1981
1986
Luxemburgo
1995
AMPLIACIONES
Types of Regional Trade Agreements
EFTA
FECHA
1960
PAÍS
FECHA
PAÍS
FECHA
PAÍS
Reino Unido
Austria
Austria
Austria
Noruega
Noruega
Dinamarca
Portugal
Suecia
Noruega
Suecia
Portugal
1973
FECHA
PAÍS
Noruega
1995
1986 Suiza
Suiza
Islandia
Liechtenstein
Suiza
Islandia
Suecia
Islandia
Finlandia
Suiza
Finlandia
Liechtenstein
Islandia
Liechtenstein
EUROPEAN ECONOMIC AREA (EEA)
Finlandia
Liechtenstein
FECHAS
PAÍSES
1994
UE-15
EFTA (menos Suiza)
Noruega
Islandia
Liechtenstein
Types of Regional Trade Agreements
ACUERDOS
ACUERDOS FECHAS
NAFTA
ALADI
MERCOSUR
1994
1980
1991
PAÍSES
USA
Canadá
Méjico
Argentina
Bolivia
Brasil
Chile
Colombia
Ecuador
Méjico
Paraguay
Perú
Uruguay
Venezuela
Argentina
Brasil
Paraguay
Uruguay
PACTO
ANDINO
FECHAS
1969
MERCADO
COMÚN
CENTRO-
1960
AMERICANO
COMUNIDAD
DEL CARIBE
1973
PAÍSES
Bolivia
Perú
Ecuador
Venezuela
Costa Rica
El Salvador
Guatemala
Honduras
Nicaragua
Antigua/Barbuda
Bahamas
Barbados
Dominica
Granada
Guayana
Jamaica
Montserrat
Santa Lucía
San Cristobal/Nieves
San Vicente y Granadinas
Trinidad y Tobago
Theory: Preliminaries
• Demand curve shows how
much consumers would buy
price
of a particular good at any
particular price.
• It is based on optimisation
exercise:
mu’
– Would one more be worth
p*
price?
• Market demand is
mu”
aggregated over all
consumers’ demand curves.
– Horizontal sum.
9
c’ c* c”
Marginal
utility curve is
the demand
curve for one
consumer
quantity
Theory: Preliminaries
• Supply curve shows how much
firms would offer to the market
at a given price.
• Based on optimisation:
– Can increase production as
long as price you can sell at
is equal or above mc.
• Market supply is aggregated
over all firms.
– Horizontal sum.
price
Marginal
cost
mc”
A firm’s supply
curve is its
marginal cost
curve.
p*
mc’
q’ q* q”
10
quantity
Theory: Preliminaries
price
• Since demand curve based
on marginal utility, it can
be used to show how
consumers’ well-being
(welfare) is affected by
changes in the price.
• On the right we have the
market demand for a
product.
• Gap between marginal
utility of a unit and price
paid shows ‘surplus’ from
being able to buy c* at p*.
Triangle is sum of
all gaps between
marginal utility
and price paid
(summed over
total consumption)
p*
= MU
Demand
curve
c*
11
quantity
Theory: Preliminaries
•
•
If the price falls:
– Consumers obviously better off.
– Consumer surplus change quantifies this
intuition.
Consumer surplus rise, 2 parts:
– Pay less for units consumed at old price;
measure of this = area A.
• A = Price drop times old consumption.
– Gain surplus on the new units consumed
(those from c* to c’); measure of this =
area B.
• B = sum of all new gaps between
marginal utility and price
price
p*
p’
A
B
Demand
curve
c* c’
12
quantity
Theory: Preliminaries
• Since supply curve based
on marginal cost, it can be
used to show how
producers’ well-being
(welfare) is affected by
changes in the price.
• On the right have the
market supply of the
product.
• Gap between marginal cost
of a unit and price received
shows ‘surplus’ from being
able to sell q* at p*.
price
Triangle is sum of
all gaps between
price received and
marginal cost
(summed over
total production)
S=MC
p*
q*
13
quantity
Theory: Preliminaries
•
•
If the price rises:
– producers obviously better off.
– Producer surplus change quantifies this
intuition.
producer surplus rise, 2 parts:
– Get more for units sold at old price;
measure of this = area A.
• A = Price rise times old production.
– Gain surplus on the new units sold
(those from q* to q’). Measure of this =
area B.
• B= sum of all new gaps between
marginal cost and price.
price
Supply
curve
p’
A
B
p*
q*
14
q’
quantity
Benefits from the creation of a
free trade area
World price: P’
Price
Supply
Domestic price: P*
Price with tariff: P’’
Effect of tariff
On trade:
P*
P”
Reduces imports
On welfare
P’
A
B
C
D
Consumer surplus:
Demand
-A-B-C-D
Producer surplus: +A
Tariff revenue: +C
Dead weight losses: +B+D
(why?)
Z’ Z”
C”
C’
Quantity
Benefits of a customs union
• Effects of a customs union: static and
dynamic.
• A. Static effects, 2 groups:
– A.1. Trade creation
• Production effect
• Consumption effect (also known as trade
expansion)
– A.2. Trade diversion
• B. Dynamic effects
Static effects. Trade creation
• Replace domestic production by cheaper imports
from another member of the customs union:
– Production effect: reduce inefficient local
production and minimize the inefficient use of
resources
– Consumption effect: increase demand since price
has fallen
Static effects. Trade diversion.
• Replace imports from cheaper 3rd countries by more
expensive imports from members of the customs union.
• The customs union has a positive welfare effect if trade
creation > trade diversion. This will tend to happen when:
– The more inclusive the customs union (fewer 3rd
countries).
– The higher the initial tariff eliminated by the creation of
the customs union (PF-P G in the following figure)
– The smaller the difference between the price which
emerges from the customs union and the price which could
be had from importing from the most efficient producer
who by definition is a 3rd country.
Static effects. Example, France & Germany
form a customs union leaving the US outside
The US is the most efficient producer
(Pus)
P
Before the CU:
Demand
France imports ru from the US applying
a tariff which leads to PF. T = ruhi
Supply
CU: Germany faces no tariffs but the
US does: France imports kn from Germ.
PF
k
PG
PUS
0a
g
A B
r
u
ll
m
h
i
C D
Loss of tariff revenue and reduction of
producer surplus: ruhi + PFrkPG (in
favour of consumers)
n
Trade creation:
j
E F
Sw
Quantity
•Consumption effect: umn
•Production effect: rkl
Trade deviation: lmhi (what you don’t
import from the US multiplied by PAPUS)
Net welfare effect: rkl+umn-lmhi
Customs union and trade
EEC-6
Other 6 Europe
Rest of W orld
$100
100%
$ billion (current prices)
$90
80%
60%
40%
$80
EEC
$70
T otal imp ort s
$60
$50
$40
$30
$20
20%
$10
0%
$0
1970
1969
1968
1967
1966
1965
1964
1963
1962
1961
1960
1959
1958
1970
1969
1968
1967
1966
1965
1964
1963
1962
1961
1960
1959
1958
Note: Left panel shows share of EEC6’s import from the three regions. Other Euro-6 are the 6 countries that
joined the EU by the mid 1980s, UK, Ireland, Denmark, Spain, Portugal and Greece.
Source: Table 5, External Trade and Balance of Payments, Statistical Yearbook, Recapitulation, 1958-1991,
Dynamic effects of a customs union
• More difficult to measure
• Increases productivity and thus potential
growth rates due to:
– More specialization with the CU.
– Greater competition with the CU.
– Capacity to explore economies of scale
and thus compete with 3rd countries.
Benefits of a common market
• Free movement of K and L:
– More efficient allocation of resources
– Convergenece of wages and capital incomes within the
CM.
– But:
• K moves easier than L (transport and cultural
costs).
Capital movements in the Common Market
• M&A activity is high in EU.
• much M&A is mergers within member state.
– about 55% ‘domestic.’
– Remaining 45% split between:
• one is non-EU firm (24%),
• one firm was located in another EU nation (15%),
• counterparty’s nationality was not identified (6%).
23
Capital movements in the Common Market
• Distribution of M&A
quite varied:
– Big 3’s share M&As
much lower than share
of the EU GDP. It, Fr,
D (Ger) 36% of the
M&As, 59% GDP.
– UK share is important
(31.6%).
– Small members have
disproportionate share
of M&A (compared to
GDP).
M&A activity by nation, 1991-2002
B, 2.8%
UK, 31.4%
DK, 2.6%
EL, 1.1%
S, 5.3%
IRL, 1.7%
NL, 6.5%
L, 0.5%
I, 6.2%
A, 2.1%
P, 1.2%
F, 13.5%
E, 5.0%
D, 16.3%
FIN, 3.9%
24
Competition rules in the Single Market
• For creating an effective single market two
elements are necessary:
– As we have stated, the removal of national barriers to
the trade of goods, the provision of services and the
mobility of factors of production.
– The application of an effective competition policy to
ensure that firms do not exercise monopoly power or
abuse their market power to the detriment of
consumers and the efficient allocation of resources in
general.
Competition rules in the Single Market
• The basic competition law of the EU is contained
in Articles 81 to 89 of the TEU and in particular:
– Articles 81 to 86 deal with the infringement of the
competition rules by agreement between enterprises
– Articles 87 to 89 deal with state aids.
Competition rules in the Single Market
• Article 81 deals with collusion between firms and
refers to agreements (explicit collusion) and
concerted practices (implicit collusion).
– It specifically prohibits price fixing and market
sharing; limit or control of production, markets,
technical development or investment; discrimination,
collective boycotts and tie in clauses (when you
purchase one good or service, you are compelled to
buy another unrelated good or service).
– This list is not exhaustive and in general any collusive
practices are prohibited.
Competition rules in the Single Market
– They apply to both vertical agreements (between
producers and retailers) and horizontal ones (between
producers or between retailers).
– The rules apply to all firms operating in the common
market.
– There are exemptions of course: The agreements must
contribute to the improvement of the production or
distribution of goods or to the promotion of technical
or economic progress, while allowing consumers a fair
share of the resulting benefit.
Competition rules in the Single Market
• Article 82 is an anti-monopoly instrument.
– It prohibits any abuse by one or more undertakings of a
dominant position within the common market or in a substantial
part of it … insofar as it may affect trade between member
states.
– The emphasis is not on the acquiring a dominant position (which
implies market concentration) but on its abuse, primarily in
trade between member states.
– Again cooperation agreements between firms which are
considered beneficial for the consumers by improving
production, distribution or technical progress are exempted.
Competition rules in the Single Market
• One major drawback of article 82 as an instrument of
merger control is that it can be activated only after a
merger has taken place (remember abuse of monopoly
power is prohibited) and so pre-emptive action by the
Commission is not possible under this article.
• This power was agreed upon in 1989 in the form or two
regulations (4064/89 and 1310/97). Under these
regulations the Commission can preemptively block
mergers with a community dimension:
Competition rules in the Single Market
•
•
•
There is a Community dimension where:
– the combined aggregate worldwide turnover of all the companies
is more than 5 000 million, and;
– the aggregate Community-wide turnover of each of at least two
of the companies is more than 250 million, unless each of the
companies achieves more than two-thirds of its aggregate
Community-wide turnover within one and the same Member
State.
Large companies incorporated outside the EU but generating at least
€100 million of their annual business in the Community are also
subject to these rules if a merger between them threatens to distort
competition in the EU market.
Proposed mergers must be notified to the Commission.
Competition rules in the Single Market
•
State aids: one of the duties of the Commission is to ensure that in the single
market no member state provides its own firms with a competitive
advantage over the firms of other member states.
– In this vein, article 87 prohibits direct subsidies, tax exemptions,
preferential interest rates, loans on especially favorable terms
indemnities against losses
– Some state aids may be authorized if the distortions in competition are
considered to be offset by advantage to the Union, for example, state aid
for companies engaged in high tech. research, or directed to less
developed regions. Aid which does not affect trade between member
states does not come under this law.
– Public procurement: Countries tend to favor domestic firms in the
awarding of government contracts, particularly military contracts and
such purchases represent on average 15% of GDP. This is similar to a
state subsidy. For this reason the public procurement market is
gradually being opened up to intra-community competition – when
contracts are of some minimum threshold of expenditure