Regional Economic Integration

Regional Economic Integration means agreements between groups of countries in a geographic region to reduce and ultimately remove tariff and non-tariff barriers for the free flow of goods, services and factors of production between each other. GATT and WTO are the biggest association of more than 140 member countries, which strive to reduce the barriers. However, more than regional, WTO has a global perspective. By entering into regional agreements, groups of countries aim to reduce trade barriers more rapidly than can be achieved under WTO. While there have been decreases in the global barriers to trade and investment, the greatest progress had been made on a regional basis. There are many examples in the current popular push on the European Union (EU) and the effects the EU have on a particular business or industry that illustrates this point.

Perhaps the best example of the benefits of economic integration and political union is the USA. Before the current constitution was written, the thirteen colonies had erected significant barriers to trade between each other and had separate currencies. Seeing that this was not working well, and wanting a better system for their citizens, the founding fathers agreed to combine their separate states into a United States. Whether the EU, with its significant cultural and language differences in neighboring countries, can achieve similar benefits remains to be seen. Nevertheless, major gains have already been made.

The notion of regional economic integration is becoming increasingly important as countries strive to work together better and become more productive. While integration takes place at a much broader level under the WTO, it is within local regions — with fewer countries — that have the ability to make much greater steps. Integration creates both winners and losers, however. An important challenge facing many firms and governments is what should be done to minimize the costs of transition to freer markets regionally as well as internationally.

Levels of Regional Economic Integration

Regional Economic Integration Levels

  1. Free Trade Area:  All barriers to trade among members are removed, but each member can determine its own trade policies with non-members. Theoretically free trade are
  2. Customs Union:  All barriers to trade among members are removed and a common external trade policy is adopted.
  3. Common Market:  All barriers to trade among members are removed, a common external trade policy is adopted, and factors of production allow mobility between countries.
  4. Economic Union:  All barriers to trade among members are removed, a common external trade policy is adopted, factors of production allow mobility between countries, a common currency is established, tax rates are harmonized, and a common monetary and fiscal policy is established.
  5. Political Union:  Separate nations are essentially combined to form a single nation. The establishment of the European Parliament suggests that Europe is moving towards political union. Giving up this last bit of sovereignty, however, is a big step psychologically and philosophically.

The Arguments for Regional Economic Integration

The economic case for integration has been largely presented in the previous chapters. Free trade and movement of goods, services, capital, and factors of production allow for the most efficient use of resources. That is positive sum game, as all countries can benefit.

Regional economic integration is an attempt to go beyond the limitations of WTO. While it is hard for 100 countries to agree on something, (e.g. the United Nations) it is much more likely that only a few countries with close proximity and common interests will be able to agree to even fewer restrictions on the flows between their countries.

The political case for integration has two main points: (1) by linking countries together, making them more dependent on each other, and forming a structure where they regularly have to interact, the likelihood of violent conflict and war will decrease. (2) By linking countries together, they have greater influence and are politically much stronger in dealing with other nations.

In the case of the EU, both a desire to decrease the likelihood of another world war and an interest in being strong enough to stand up to the US and USSR were factors in its creation.

There are two main impediments(obstacles) to integration:

(1) there are always painful adjustments, and groups that are likely to be directly hurt by integration will lobby hard to prevent losses,

(2) concerns about loss of sovereignty and control over domestic interests.

For example, Canada has always been concerned about being dominated by its southern neighbor, and Britain is very hesitant to give much control to European bureaucrats. The case on NAFTA and the US Textile Industry shows that although the effects of NAFTA have hurt employment in the US textile industry, the overall effect has actually been positive. The reason: clothing prices have fallen, exports have increased, and sales to apparel factories have surged. Those factors more than compensate for the loss of jobs.

The Arguments Against Regional Economic Integration

Many groups within a country do not accept the case for integration, especially those that are likely to be hurt or those that feel that sovereignty and individual discretion will be reduced. Thus, it is not surprising that most attempts to achieve integration have progressed slowly and with hesitation.

Whether regional integration is in the economic interests of the participants depends upon the extent of trade creation as opposed to trade diversion.

  • Trade creation occurs when low cost producers within the free trade area replace high cost domestic producers.
  • Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers.

A regional free trade agreement will only make the world better off if the amount of trade it creates exceeds the amount it diverts.

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