Economic Integration
 Definition: economic cooperation between countries and
co-ordination of their economic policies, leading to
increased economic links between them. It occurs
because of numerous benefits that may be derived by the
co-operating countries.
 There are different degrees of integration, depending on
the type of agreement made between the co-operating
countries, and the degree to which barriers between
them are removed.
Preferential trade agreements (PTA)
 Definition: an agreement between two or more countries
to lower trade barriers between each other on particular
products. Trade barriers may remain on the rest of the
products, and on imports from non-member countries.
 PTAs sometimes involve cooperation between members
on labour standards, environmental issues or intellectual
property.
 They may be bilateral or regional.
Bilateral, regional and multilateral (WTO)
trade agreements
 Bilateral trade agreement: between two countries.
 Multilateral trade agreement: many countries.
 Regional trade agreement: involves a group of countries
that are within a geographical region.
 WTO trade agreements are multilateral: they include
WTO member countries around the world and they
require member countries to reduce trade barriers at the
same time.
 A fundamental principle of the WTO is non-
discrimination, ie, a country cannot discriminate between
any WTO members (it cannot impose higher barriers on
imports from one country and lower ones on imports
from another country).
 However, WTO makes an exception for bilateral and
regional trade agreements, even though all PTAs involve
discrimination against non-member countries.
 Trading bloc: a group of countries that join together in
some form of agreement in order to increase trade
between themselves and or to gain economic benefits
from cooperation on some level.
 Different levels of economic integration:
1.
2.
3.
4.
5.
Free trade area
Customs union
Common market
Monetary union
Complete economic integration
Trading blocs
1. Free trade area (FTA). A group of countries that agree
to gradually eliminate trade barriers between
themselves. Each country keeps the right to apply
protectionist policies when trading with non-member
countries. The trade of some products might still be
protected.
Examples: NAFTA=CA, MX, US; ASEAN
One problem is that a product may be imported into the FTA
by the country that has the lowest external trade barriers
and then sold to countries within the FTA with higher
external barriers. To avoid this: rules of origin.
2. Customs union. Same conditions as FTA plus adoption
of common policy towards non-member countries. Also,
in negotiations with other countries the member
countries act as a group. Higher degree of economic
integration than a FTA.
 Example: CEFTA (Central European Free Trade
Agreement), SACU (South African Customs Union).
 Advantage: same common external barriers, so no need
to create rules of origin for imports.
 Disadvantage: Possibility of disagreements, as members
must coordinate their policies towards non-members.
3. In a common market, countries that have formed a
customs union decide to eliminate any remaining
barriers to trade between them. In addition, they agree
to eliminate all restrictions on movements of factors of
production (labour and capital) within the common
market.
Example: European Economic Community, precursor of the
EU.
 Advantages:
Free trade, which implies lower prices, greater consumer
choice, etc
2. Workers are free to move and capital can also flow
without restrictions. This results in a better use of factors
of produciton and improves the allocation of resources.
1.

Disadvantages:
Requires even greater policy coordination among
members.
2. Requires the willingness of member governments to give
up some of their policy making authority to an
organisation with powers over all the member
governments.
3. A long time is needed for all countries to make the
necessary policy changes to achieve coordination.
1.
 Economic and monetary union. Economic union involves
the unification of the monetary and fiscal systems of the
members, with a unified system of economic policy
making. Countries maintain political identity.
 Monetary union is achieved by adopting a common
currency. Ex: eurozone countries.
 Eurozone countries still have separate fiscal systems and
only a partially unified policy-making system.
Pros and cons of trading blocs
Benefits:
1. Increased competition.
2. Expansion into larger markets.
3. Economies of scale.
4. Lower prices for consumers and greater consumer
choice.
5. Increased investment: internal by firms from a member
country or external by outsider firms, which escape the
tariff imposed by the trading bloc on imports from
outside.
6. Better use of factors of production, especially if a
trading bloc develops into a common market.
7. Improved production efficiency and greater economic
growth.
8. Political advantages: Reduced likelihood of hostilities
between countries becoming increasingly
interdependent and political cooperation resulting from
economic integration.
Disadvantages:
1.
2.
3.
Many economists think that trading blocs are inferior to the
WTO’s multilateral approach of reducing trade barriers
towards all countries. Trading blocs involve an increasing
amount of discrimination, which violates the WTO’s nondiscrimination principle.
May create obstacles for global free trade. Some economists
believe that conflicts between trading blocs might arise,
difficulting the process of global integration. Trade barriers
on non-members may result in limiting trade on a global
scale, which would worsen the allocation of resources, lower
global output and a weakened role for the WTO.
Unequal distribution of gains from trading blocs, as not all
members obtain the same benefit.
Monetary union: the EMU
 Involves a greater degree of integration than a common
market and occurs when the member countries of a
common market adopt a common currency and a
common central bank responsible for monetary policy.
 EMU:
 Created in 1999 by 11 European countries: A, BE, FI, FR, G,
IR, IT, L, NL, PT, SP.
 2001: GR; 2007: Slovenia; 2008: CY, MT
 1 January 1999: ‘birth’ of the euro. The currencies of the
member countries are locked together through fixed and
unchangeable exchange rates.
 1 January 2002: euros and national currencies co-exist
 1 January 2003: national currencies are abandoned.
 Convergence requirements:
 Limiting inflation rate
 Limiting budget deficit (T-G) to 3% of GDP
 Limiting gov. debt to 60% of GDP
 The ECB assumed the responsibility for monetary policy
for all members.
Advantages
1. Eliminates exch rate risk and uncertainty → benefits
for importers, exporters and investors →
encourages trade and investment across
boundaries.
2. Eliminates transaction costs, which encourages
trade.
3. Encourages price transparency → easier for econ
decision makers to see price differences quickly →
promotes competition and efficiency.
4. Low inflation rates, which gives rise to low interest rates →
more investment, increased output.
5. Promotes higher level of inward investment (from outsiders
towards the member countries), due to absence of currency
risk.
Disadvantages
1.
2.
3.
Loss of exch rates as a mechanism of adjustment. Currency
depreciation/devaluation cannot be used to solve trade
deficit problems or loss of competitiveness (due to higher
inflation rate).
Loss of monetary policy as an instrument of economic policy.
Monetary policy carried out by ECB to achieve price stability
for the region as a whole. Individual countries unable to
carry out their own monetary policy.
Fiscal policy constrained by convergence criteria (on public
debt and government deficit). This limits gov’s ability to
borrow according to domestic needs and priorities.
4. Monetary policy by the ECB will have different impacts
on each member, since they will differ in their UE,
inflation levels and where they are in the business
cycle.