15.1 Economic integration

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Economic integration:

-economic co-operation between countries and co-ordination of their economic policies leading to increased economic links between then

-occurs because of the numerous benefits that may be derived by the co-operating countries

-many degrees of integration

Preferential trade agreements (PTA):

1. preferential trade agreement

an agreement between two or more countries to lower trade barriers between each other on particular products

trade barriers may remain the same for other products and on imports from non-member countries

sometimes involves co-operation between members on other issues such as labour standards, environmental issues or intellectual property

free trade areas

custom unions

common markets

may be bilateral or regional

2. bilateral, regional and multilateral (WTO) trade agreements:

-main objective to promote trade liberalisation

-free trade by reducing or eliminating trade barriers between members

bilateral trade agreement:

an agreement between two countries

multilateral trade agreement:

an agreement between many countries

regional trade agreement:

agreements between a group of countries that are within a geographical region

Comparing and contrasting trading blocs:

Trading bloc:

-a group of countries that have agreed to reduce tariff and other barriers to trade for the purpose of encouraging free or freer trade and co-operation between them

1. free trade area:

-countries that agree to gradually eliminate barriers between themselves and is the most common type of trading bloc

-problem: 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 that have higher external trade barriers

-arises because each country has its own individual barriers toward non-members

-creates difficulties for those countries with higher barriers because they may end up importing more of the good than they would like

FTAs make complicated ‘rules of origin’ for imports, designed to prevent goods from entering countries with lower external barriers

2. customs union:

-a group of countries that fulfils the requirements of a free trade area (elimination of trade barriers between members)

-adopts a common policy towards all non-member countries

-each country in a customs union is no longer free to determine its own trade policy towards non-member countries, but must adopt the policy agreed upon by the customs union

-member countries of the customs union act as a group in all trade negotiations and agreements with non-members

-customs union therefore involves a higher degree of economic integration than a free trade area

-have the advantage over FTAs in that they avoid having to create complicated ‘rules of origin’ for imports, since they all have the same external barriers, usually a common external tariff

-must co-ordinate their policies toward non-members

-gives rise to the possibility of disagreements, as they may not all agree on what are appropriate levels of tariff and other barriers for non-members

3. Common market:

-an even higher degree of economic integration

-which countries that have formed a customs union proceed further to eliminate any remaining barriers to trade between them

-continue to have a common external policy (as in a customs union)

-agree to eliminate all restrictions on movements of any factors of production within the common market

-free to cross all borders and move, travel and find employment freely within all member countries

-offers major advantages to its members compared to FTAs and customs union.

-members enjoy free trade and all its advantages (lower prices, greater consumer choice, etc,)

-workers are free to move and work in any member country without restrictions, and capital can also flow from country to country without restrictions

-better use of factors of production

-encourages unemployed workers to seek work in the country facing labour shortages

-if the profitability of investing is greater in one country than in another, capital gravitates to the more profitable country, making better use of capital resources

-factor mobility across countries improves the allocation of resource

-development of a common market requires even greater policy co-ordination among members than in a customs union, and 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

-can be difficult to accomplish, and need a long time for all countries to make the necessary policy changes to achieve co-ordination

-far fewer common markets in the world than free trade areas and customs unions

Advantages to trading blocs:

1. Increased competition:

-low or no barriers, imports increase, forcing domestic producers to compete with lower cost producers from other countries

-trade barriers, on the other hand, protect inefficient domestic producers

-increased competition offers major advantages in terms of production by more efficient producers, lower prices for consumers and improved allocation of resources

2. Expansion into larger markets:

-arising from the ability of firms to sell beyond their national boundaries, increasing their exports and leading to greater economic growth

3. Lower prices for consumers and greater consumer choice

-enlarged markets often give rise to increased investment by firms that want to take advantage of the larger market size

-investment may be internal; firms originating from a country within the trading bloc, or external, originating from a country outside the bloc

-major incentive for outsider firms to invest within the bloc is that they escape the tariff or other protection imposed by the trading bloc on imports from outside

-an incentive faced by countries forming trading blocs is to attract investments by multinational corporations

4. Better use of FOP: improved resources allocation:

-if a trading bloc develops into a common market, which involves free movement of factors of production,

-results in better use of these within the bloc

-unemployed workers in one country may seek a job elsewhere where there are more employment opportunities

-capital can also move freely in search of greater profits

4. Improved efficiency in production and grater economic growth:

-elimination of trade barriers, leading to a better utilisation of resources and improved efficiency in production, allow for more rapid economic growth

5. Political advantages:

-likely to result in a reduced likelihood of hostilities between countries whose economies become more interdependent through increased trade, investment, labour and financial flows

Disadvantages to trading blocs:

1. Trading blocs may not be the best way to achieve trade liberalisation:

-while the establishment of trading blocs with free trade between members may be an improvement over trade protection, trading blocs are inferior to the WTO’s multilateral approach of reducing trade barriers towards all countries

-involve an increasing amount of discrimination, violating the WTO’s non- discrimination principle

2. Trading blocs may create obstacles to the achievement of tree trade on a global scale:

-the break-up of the world trading system into many blocs can create trade conflicts between different blocs that may slow down the process of global trade liberalisation

-trading blocs may enjoy free trade and all its benefits within the bloc, but trade barriers on non-members may result in limiting rather than increasing trade on a global scale

-would lead to a worse global allocation of resources, lower global output, a weakened role for the WTO, and a risk of breaking up the global economy into many regional trading blocs

3. Unequal distribution of gains and possible losses:

-countries forming a trading bloc are unlikely to gain equally from the operation of the trading bloc

-creates the potential for conflicts between the members and makes it difficult to reach agreements

-possible for some countries to gain while others become worse off in some respects

-same applies to gains and losses within the member countries, as some stakeholders are likely to gain while others lose

Monetary union:

-occurs when the member countries of a common market adopt a common currency and a common central bank responsible for monetary policy

-formed by a number of the countries of the EU

-formation of a single currency, can be partly thought of as a system of ‘fixed’ exchange rates among the participating currencies, but one in which there is no possibility of changing the value of one currency in relation to another (no possibility of revaluing or devaluing)

Possible advantages of the monetary union:

1. Single currency eliminates exchange rate risk and uncertainty:

-exchange rate fluctuations create risks and uncertainties for traders and investors, who do not know what the future exchange rates will be

-single currency eliminates the risks and uncertainties, with benefits for importers and exporters, consumers and investors, thereby encouraging trade and investments across boundaries

-contributes to achieving a more efficient allocation of resources

2. Single currency eliminates transaction costs:

-transaction costs: when there is a conversion of currency to another, banks charge a fee for the conversion

-single currency eliminates these transaction costs, resulting in significant savings that have the effect of encouraging trade, investments and international financial flows of all kinds

3. Single currency encourages price transparency:

-price transparency: ability of consumers and firms to compare prices in all the countries that have adopted a common currency without having to make exchange rate calculations and conversions

-easier for all economic decision-makers to see price differences quickly and accurately across countries, and has the effect of promoting competition and efficiency

4. Single currency promotes a higher level of inward investment:

-inward investment: investments from outsiders towards the member countries with a common currency

-can be expected to rise because of the absence of currency risk within an expanded market resulting in greater economic growth

5. Low rates of inflation give rise to low interest rates, more investment and increased output:

- single currency under the control of a single central bank committed to maintaining price stability results in low rates of inflation, leading to several benefits

-low rates of interest, higher levels of investment and higher levels of output

Disadvantages of the monetary union:

1. Single currency involves loss of exchange rates as a mechanism for adjustment :

-if a member country has a trade deficit with another member country it no longer has its own national currency that could depreciate to correct the imbalance

-if a member country has a higher rate

of inflation and its goods become less competitive abroad, the problem cannot be solved by currency depreciation or devaluation

2. Single currency involves loss of monetary policy as an instrument of economic policy:

-each individual country, whatever its particular circumstances (higher or lower inflation, unemployment, etc., than the average of the euro zone countries), is unable to carry out its own monetary policy to influence the rate of interest

-hence the level of economic activity within its boundaries

3. Fiscal policy is constrained by the convergence requirements:

-each member country retains the ability to carry out its own fiscal policy, there are restrictions imposed by the convergence requirements

-limits the government’s ability to borrow according to domestic needs and priorities

-in a recession, a government cannot pursue an independent expansionary monetary policy, it would need to pursue expansionary fiscal policy

-if its deficit or debt is already approaching the limits, it cannot do this without violating the rules

4. Monetary policy pursues by the single central bank impacts differently on each member country depending on its own particular circumstances

-the single monetary policy pursued by the single central bank is unlikely to suit every country’s needs and may be inappropriate

-if some countries face unemployment and others face inflation, an expansionary monetary policy would suit the needs of the first group but would make the inflation worse in the second group

Optimum currency areas (OCA) and the European Monetary Union (EMU):

OCA:

-an area in which all members have fixed exchange rates with each other but flexible exchange rates with outsiders

More successful when:

1. there is greater mobility of capital and labour resources

2. there is close co-operation or co-ordination of fiscal policies or there is an OCA-wide fiscal authority determining fiscal policy

3. there is greater synchronisation of the phases of the business cycle among members