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Chapter 08 - Regional Economic Integration

Regional Economic Integration

Chapter Outline
OPENING CASE: The European Energy Market INTRODUCTION LEVELS OF ECONOMIC INTEGRATION THE CASE FOR REGIONAL INTEGRATION The Economic Case for Integration The Political Case for Integration Impediments to Integration THE CASE AGAINST REGIONAL INTEGRATION REGIONAL ECONOMIC INTEGRATION IN EUROPE Evolution of the European Union Political Structure of the European Union Management Focus: The European Commission and Media Industry Mergers The Single European Act Country Focus: Creating a Single European Market in Financial Services The Establishment of the Euro Enlargement of the European Union REGIONAL ECONOMIC INTEGRATION IN THE AMERICAS The North American Free Trade Agreement The Andean Community MERCOSUR Central American Common Market, CAFTA and CARICOM Free Trade Area of the Americas REGIONAL ECONOMIC INTEGRATION ELSEWHERE Association of Southeast Asian Nations Asia Pacific Economic Cooperation Regional Trade Blocs in Africa


Chapter 08 - Regional Economic Integration


Learning Objectives
1. Be able to explain the different levels of regional economic integration. 2. Understand the economic and political arguments for regional economic integration. 3. Understand the economic and political arguments against regional economic integration. 4. Be familiar with the history, current scope, and future prospects of the world's most important regional economic agreements. 5. Understand the implications for business that are inherent in regional economic integration agreements.

Chapter Summary
In this chapter, the topic of regional economic integration is explored. The levels of regional economic integration discussed (from least integrate to most integrated) include: a free trade area, a customs union, a common market, an economic union, and a full political union. The arguments for and against regional economic integration are provided. Many students will remember some of these arguments from the debate of the ratification of the North American Free Trade Agreement (NAFTA). The chapter also provides information about the major trade blocks of the world, including the European Union, NAFTA, the Andean Group, MERCOSUR, and several other Latin American and Asian trade alliances. In addition, the implications for business of these trade agreements and others are fully discussed.


Chapter 08 - Regional Economic Integration

Opening Case: The European Energy Market

Summary The opening case examines efforts by the European Union to liberalize its energy market. The goal is to replace the regions individual markets, with a single continent-wide market for electricity and gas. It is expected that when the process is complete, competition among energy producers will intensify, bringing down prices for consumers, and forcing producers to become more efficient. While the first phase of the process went into effect in 2007, the process has not been easy. Many politicians oppose the notion of foreign companies taking over their countrys national energy company. Discussion of the case can revolve around the following questions: Suggested Discussion Questions QUESTION 1: Why is the European Union promoting free trade in energy across national borders? What does it hope to gain? How is this approach superior to the current method? ANSWER 1: Currently, many national markets in the European Union are dominated by a single company, often one that had been state-owned. As a result, competition within the markets is low, resulting in high prices and inefficiencies. In France for example, Electricitie de France has an 87 percent market share. By creating a single continent-wide market for companies, the European Union hopes to inject competition into markets, force companies to increase efficiencies, and lower prices for consumers. QUESTION 2: In 2006, Spanish politicians effectively blocked the acquisition of Spains largest utility, Endesa by German company E.ON. Why were the Spanish politicians so opposed to the acquisition? What does this tell you about the drawbacks of regional economic integration? ANSWER 2: Students may recognize the actions by the Spanish politicians as being an effort to maintain autonomy in the midst of a process designed to further integrate the economies of the European Union. One of the main impediments to regional economic integration is its implied loss of sovereignty for individual nations. The European Union is attempting to eliminate a decadesold system where individual countries handled their own energy needs in favor of a broader approach where companies serve the entire region. However, the process means that the companies within the region that are more competitive like Germanys E.ON will eventually takeover less competitive companies like Spains Endesa. Despite the efforts of the Spanish politicians, most students will recognize the inevitable demise of the less efficient Endesa. Indeed, while the politicians were successful at blocking the companys acquisition by E.ON, Endesa was later acquired by Italys Enel.


Chapter 08 - Regional Economic Integration

Teaching Tip: The process of creating a single continent-wide energy market in the European Union continues to be a significant challenge. To extend this case, consider { ex=1346558400&en=5a7500ead1928eb9&ei=5088&partner=rssnyt&emc=rss}and {{C5773E9B-6BAE-4363-9602-C0C2F88BA45F}.

Chapter Outline with Lecture Notes, Video Notes, and Teaching Tips
INTRODUCTION A) One notable trend in the global economy in recent years has been the accelerated movement toward regional economic integration. Regional economic integration refers to agreements between countries in a geographic region to reduce tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other. B) Despite the rapid spread of regional trade agreements designed to promote free trade, there are those who fear that the world is moving toward a situation in which a number of regional trade blocks compete against each other. In this scenario of the future, free trade will exist within each bloc, but each bloc will protect its market from outside competition with high tariffs. LEVELS OF ECONOMIC INTEGRATION A) Several levels of economic integration are possible in theory (see Figure 8.1 in the textbook). From least integrated to most integrated, they are a free trade area, a customs union, a common market, an economic union, and, finally, a full political union. B) In a free trade area all barriers to the trade of goods and services among member countries are removed. In a theoretically ideal free trade area, no discriminatory tariffs, quotas, subsidies, or administrative impediments are allowed to distort trade between member nations. Each country, however, is allowed to determine its own trade policies with regard to nonmembers. C) The most enduring free trade area in the world is the European Free Trade Association (EFTA). EFTA currently joins four countries-Norway, Iceland, Liechtenstein, and Switzerland. Other free trade areas include the North American Free Trade Agreement (NAFTA). Teaching Tip: To find out more about EFTA, and its current issues, go to {}. D) The customs union is one step further along the road to full economic and political integration. A customs union eliminates trade barriers between member countries and adopts a common external trade policy.


Chapter 08 - Regional Economic Integration

E) Customs unions around the world include the current version of the Andean Pact (between Bolivia, Columbia, Ecuador, and Peru). F) Like a customs union, the common market has no barriers to trade between member countries and a common external trade policy. Unlike in a customs union, in a common market, factors of production also are allowed to move freely between members. Thus, labor and capital are free to move, as there are no restrictions on immigration, emigration, or cross-border flows of capital between markets. G) Currently, MERCOSUR, the South America grouping that includes Brazil, Argentina, Paraguay, Venezuela, and Uruguay, is aiming to eventually establish itself as a common market. H) An economic union entails even closer economic integration and cooperation than a common market. Like the common market, an economic union involves the free flow of products and factors of production between members and the adoption of a common external trade policy. Unlike a common market, a full economic union also requires a common currency, harmonization of the member countries tax rates, and a common monetary and fiscal policy. I) The European Union (EU) is an economic union, although an imperfect one since not all members of the EU have adopted the euro, the currency of the EU, and differences in tax rates across countries still remain. J) In a political union, independent states are combined into a single union. The EU is on the road to at least partial political union. The United States provides an example of even closer political union. THE CASE FOR REGIONAL INTEGRATION A) The case for regional integration is both economic and political. The Economic Case for Integration B) Regional economic integration can be seen as an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the World Trade Organization. The Political Case for Integration C) 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, and 2) by linking countries together, they have greater clout and are politically much stronger in dealing with other nations


Chapter 08 - Regional Economic Integration

Impediments to Integration D) There are two main impediments to integration. First, although economic integration benefits the majority, it has costs. Although a nation as a whole may benefit significantly from a regional free trade agreement, certain groups may lose. A second impediment to integration arises from concerns over national sovereignty. THE CASE AGAINST REGIONAL INTEGRATION A) Although the tide has been running strongly in favor of regional free trade agreements in recent years, some economists have expressed concern that the benefits of regional integration have been oversold, while the costs have often been ignored. B) 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. REGIONAL ECONOMIC INTEGRATION IN EUROPE A) There are two trade blocks in Europe: the European Union (EU) and the European Free Trade Association. Of the two, the EU is by far the more significant, not just in terms of membership, but also in terms of economic and political influence in the world economy. Evolution of the European Union B) The European Union (EU) is the product of two political factors: first, the devastation of two world wars on Western Europe and the desire for a lasting peace, and second, the European nations desire to hold their own on the worlds political and economic stage. Teaching Tip: The EU maintains an excellent web site at {}. Students can click on a number of subjects to see the EUs position and role in the area. The site also contains a broad array of information about the historical role and current activities of the EU in the global economy. C) The forerunner of the EU was the European Coal and Steel Community, which had the goal of removing barriers to trade in coal, iron, steel, and scrap metal formed in 1951. The European Community was formed in 1957 at the Treaty of Rome. While the original goal was for a common market, progress was generally very slow. Over the years the EU expanded in spurts, as well as moved towards ever-greater integration. Today, the EU has 27 members, a population of almost 500 million, and a GDP of 11 trillion. Map 8.1 in the text shows the current membership of the EU. Most recently, Turkey has expressed a desire to join the EU. However, at this time, there appears to be considerable resistance to the idea among many EU countries.


Chapter 08 - Regional Economic Integration

Video Note: The iGlobe Turkey Torn between Tradition and Modernization explores Turkeys efforts to be a part of the global economy and its desire to become a member of the EU. Political Structure of the European Union D) The four main institutions of the EU are the European Commission (responsible for implementing aspects of EU law and monitoring member states to ensure they are complying with EU laws), the Council of the European Union, (the ultimate controlling authority within the EU), the European Parliament, (debates legislation proposed by the commission and forwarded to it by the council), and the Court of Justice, (the supreme appeals court for EU law). E) The Treaty of Lisbon, signed in 2007, will give, if ratified by all member states, more power to the European Parliament which will effectively become the co-equal legislator for almost all European laws. Lecture Note: To learn more about the Lisbon Agreement, consider { chan=search}and {}. Management Focus: The European Commission and Media Industry Mergers Summary This feature explores the efforts of the European Commission to influence the strategies of media companies as they joined forces in Europe. The European Commission, concerned that proposed joint ventures and mergers between companies would negatively affect competition within the industry, demanded that some companies alter their plans to work together, and in some cases, abandon relationships all together. Discussion of the feature can begin with the following questions.


Chapter 08 - Regional Economic Integration

Suggested Discussion Questions 1. Why did Timer Warner and EMI agree to drop their proposed joint venture? How did the European Commission convince AOL and Time Warner to change their strategy? Discussion Points: Time Warner and EMI, bowing to pressure from the European Commission, agreed to drop their joint venture plans after the European Commission raised concerns about the size of a jointly owned company, which would have been three times that of the next largest competitor. According to the European Commission, the joint venture would have too much market power. The European Commissions goal was to preserve a competitive market for consumers. A similar situation existed with the Time Warner - AOL deal, which if approved would dominate the emerging market for downloading music over the Internet. The companies involved had little choice in the matter, if they wanted to operate in the European market, they had to follow the rules. 2. In your opinion, were the actions of the European Commission reasonable? Why or why not? Do you feel that the governing bodies of one nation should have the power to restrict the actions of foreign companies? Discussion Points: Students will probably be divided on this issue. Some will argue that the European Commission had no right to become involved in the business decisions of the companies, especially the ones from the United States. Others however, will probably note that one of the roles of the European Commission is to preserve a fair market system that protects consumers. In this particular case, that meant that the deals had to be blocked. Teaching Tip: To learn more about the companies in this feature, go to {}, {}, and {}. The Single European Act F) The Single European Act, adopted by the EU member nations in 1987, committed the EC countries to work toward establishment of a single market by December 31, 1992. The Stimulus for the Single European Act G) The Single European Act was born out of frustration among EC members that the community was not living up to its promise. In the early 1980s, many of the ECs prominent businesses people mounted an energetic campaign to end the ECs economic divisions. The result was the Single European Act, which was independently ratified by the parliaments of each member country and became EC law in 1987.


Chapter 08 - Regional Economic Integration

The Objectives of the Act H) The purpose of the Single European Act was to have a single market in place by December 31, 1992. The changes the act proposed included the following: (i) the removal of all frontier controls between EC countries, (ii) mutual recognition of standards to apply the principle of mutual recognition, which is that a standard developed in one EC country should be accepted in another, provided it meets basic requirements in such matters as health and safety, (iii) open public procurement to non-national suppliers, (iv) financial services to lift barriers to competition in the retail banking and insurance businesses, (v) the removal of all restrictions on foreign exchange transactions between members by the end of 1992, (vi) the abolishment of all restrictions on cabotage (the right of foreign truckers to pick up and deliver goods within another members borders), by the end of 1992. Impact I) The Single European Act has had a significant impact on the EU economy. The act provided the impetus for the restructuring of substantial sections of European industry allowing for faster economic growth than would otherwise have been the case. Country Focus: Creating a Single European Market in Financial Services Summary This feature explores the European Unions progress towards creating a single financial market. The quest, started in 1999, was to have been completed by 2005, however, progress has been slowed by various factors related to the tradition of each member country operating autonomously. By 2007, significant progress had been made. Some 41 measures designed to create a single market were in place, and others were in the pipeline. The current issue facing the EU revolves around the enforcement of the rules that have been established as law. Some experts believe that it will be at least another decade before the benefits of the new rules become apparent. Discussion of this feature can begin with the following questions. Suggested Discussion Questions 1. What are the benefits of creating a single financial market in the European Union for companies? Does it make sense for consumers? Discussion Points: A single financial market involving a common currency eliminates numerous challenges for companies and consumers. Not only are transactions and the associated paperwork greatly simplified, a single currency system also facilitates price comparisons across borders which should force companies to become more competitive. In addition, a single financial system would encourage competition in the financial services sector and increase liquidity in capital markets.


Chapter 08 - Regional Economic Integration

2. What are the impediments to creating a single financial market in the European Union? What does the potential for this type of market mean for countries like Great Britain that have not joined the euro-zone? Discussion Points: Creating a single financial market is not easy. Countries which have a long history of operating autonomously have to work together for common economic goals, a common regulatory framework must be developed, and cultural and linguistic barriers must be overcome. Countries that choose not participate in the system will retain control over their monetary policy, but may also lose investments or sales as companies seek to simplify their financing alternatives. Teaching Tip: The European Union has a web page devoted to the euro {}. Students can explore the site and click on the pages to see pictures of the coins and notes, the advantages of participating in the euro zone, and frequently asked questions about the euro. The Establishment of the Euro J) The Maastricht Treaty, signed in 1991, committed the EU to adopt a single currency, the euro, by January 1, 1999. The euro is now used by 15 of the 27 member states. By adopting the euro, the EU has created the second largest currency zone in the world after that of the U.S. dollar. For now, three EU countries, Britain, Denmark, and Sweden, are opting out of the euro-zone. Teaching Tip: The European Central Bank maintains a web site with current information on the euro. The site is available at {}. K) Euro notes and coins were not actually issued until January 1st, 2002. In the interim, national currencies circulated in each of the 12 countries. However, in each participating state the national currency stood for a defined amount of euros. Benefits of Euro L) There are a number of reasons why the Europeans decided to establish a single currency in the EU. First, they believe that business and individuals will realize significant savings from having to handle one currency, rather than many. Second, and perhaps most importantly, the adoption of a common currency will make it easier to compare prices across Europe. Third, faced with lower prices European producers will be forced to look for ways to reduce their production costs in order to maintain their profit margins. Fourth, the introduction of a common currency should give a strong boost to the development of a highly liquid pan-European capital market. Finally, the development of a pan-European euro denominated capital market will increase the range of investment options open both to individuals and institutions.


Chapter 08 - Regional Economic Integration

Costs of Euro M) The drawback of a single currency is that national authorities lose control over monetary policy. Thus, it is crucial to ensure that the EUs monetary policy is well managed. The Maastricht treaty called for the establishment of an independent European Central Bank (ECB), similar in some respects to the U.S. Federal Reserve, with a clear mandate to manage monetary policy so as to ensure price stability. The ECB is based in Frankfurt. Like the U.S. Federal Reserve, the ECB is meant to be independent from political pressure although critics question this. Among other things the ECB sets interest rates and determines monetary policy across the euro-zone. The implied loss of national sovereignty to the ECB underlies the decision by Britain, Denmark and Sweden to stay out of the euro-zone for the time being. O) Another drawback of the euro is that the EU is not what the economists would call an optimal currency area. An optimal currency area is an area where similarities in the underlying structure of economic activities make it feasible to adopt a single currency and use a single exchange rate as an instrument of macro-economic policy. Many of the European economies in the euro-zone, however, are very dissimilar. The Early Experience P) Since its establishment January 1, 1999, the euro has had a volatile trading history with the U.S. dollar. Initially, the currency fell in value relative to the dollar, but strengthened to an all time high of 1=$1.54 in March 2008. Enlargement of the European Union Q) A number of countries, , particularly from Eastern Europe, have applied for membership in the EU. In December of 2002, the EU formally agreed to accept the applications of 10 countries that joined on May 1, 2004. Their inclusion expanded the EU to 25 states, creating an EU population of 450 million people, and a single continental economy with a GDP of 11 trillion. In 2007, the EU welcomed its newest members, Bulgaria and Romania. REGIONAL ECONOMIC INTEGRATION IN THE AMERICAS A) Regional economic integration is on the rise in the Americas. The North American Free Trade Agreement (NAFTA) is the most significant attempt. Other efforts include the Andean group and MERCOSUR. In addition, there are plans to establish a hemisphere wide Free Trade Area of the Americas (FTAA.) The North American Free Trade Agreement (NAFTA) B) The United States, Canada, and Mexico established the North American Free Trade Agreement (NAFTA) in 1994. NAFTAs Contents


Chapter 08 - Regional Economic Integration

C) The free trade agreement between the United States, Canada, and Mexico contains the following actions: abolishes by 2004, tariffs on 99 percent of the goods traded between Mexico, Canada, and the United States, removes most barriers on the cross-border flow of services, protects intellectual property rights, removes most restrictions on FDI between the three member countries, allows each country to apply its own environmental standards, provided such standards have a scientific base, establishes two commissions with the power to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored.

Teaching Tip: For more information on NAFTA, go to {}. The Case for NAFTA D) Proponents of NAFTA have argued that it will provide economic gains to all countries: Mexico will benefit from increased jobs as low cost production moves south, and will attain more rapid economic growth as a result. The United States and Canada will benefit from the access to a large and increasingly prosperous market and from the lower prices for consumers who buy goods produced in Mexico. In addition, U.S. and Canadian firms with production sites in Mexico will be more competitive on world markets The Case against NAFTA E) Opponents of NAFTA argued that jobs would be lost and wage levels would decline in the United States and Canada, Mexican workers would emigrate north, pollution would increase due to Mexico's more lax standards, and Mexico would lose its sovereignty. NAFTA: The Results so Far F) Studies of NAFTAs impact to date suggest that its initial effects were at best muted, and both advocates and detractors may have been guilty of exaggeration. The most significant impact of NAFTA may not have been economic, but rather political. The agreement has helped to create the background for increased political stability in Mexico. Enlargement


Chapter 08 - Regional Economic Integration

G) One issue now confronting NAFTA is that of enlargement. Following approval of NAFTA by the U.S. Congress a number of other Latin American countries indicated their desire to eventually join NAFTA. Currently the governments of both Canada and the United States are adopting a wait and see attitude with regard to most countries. The Andean Community H) The Andean Pact, originally formed in 1969, was based on the EU model, but was far less successful in achieving its stated goals. By the mid-1980s, the Andean Pact had more or less failed. However, in the late 1980s, Latin American governments began to adopt free market economic policies, and in 1990, the Andean Pact was relaunched. The renamed Andean Community now operates as a customs union, and in 2003, it signed an agreement with MERCOSUR to restart negotiations towards the creation of a free trade area between the two trading blocs. Teaching Tip: To see new developments with the Andean Community go to {} MERCOSUR I) MERCOSUR originated in 1988 as a free trade pact between Brazil and Argentina. In 1990 it was expanded to include Paraguay and Uruguay. In 2005, Venezuela joined the bloc. MERCOSUR made some progress on reducing trade barriers between member states, however, given some fairly high tariffs for goods from other countries, it would appear that in some industries MERCOSUR is trade diverting rather than trade creating, and local firms are investing in industries that are not competitive on a worldwide basis. As of 2008, critics of the bloc suggested that the customs union was becoming more imperfect over time. Teaching Tip: For more information on MERCOSUR go to {}. Lecture Note: Information of the EUs relations with MERCOSUR can be found at {}. Central American Common Market and CARICOM J) There are two other trade pacts in the Americas: the Central American Common Market (between Costa Rica, El Salvador, Guatemala, Honduras, the Dominican Republic, and Nicaragua) and CARICOM (includes the English-speaking countries of the Caribbean), although neither has made much progress as yet. K) In 2005, an agreement was reached between the United States and the members of the Central American Common Market. The agreement, known as the Central American Free Trade Agreement (CAFTA), is designed to lower trade barriers between the United States and the six countries on most goods and services.


Chapter 08 - Regional Economic Integration

L) In 2006, six members of CARICOM established the Caribbean Single Market and Economy (CSME) with the goal of lowering trade barriers, and harmonizing macro-economic and monetary policy between member states. Free Trade of the Americas M) In April 1998, 34 heads of state traveled to Santiago, Chile for the second summit of the Americas where they formally inaugurated talks to establish a FTAA (Free Trade of The Americas) by 2005. While an agreement was not reached, the continuing talks have addressed a wide range of economic, political, and environmental issues related to cross-border trade and investment. N) At the moment, there are two major stumbling blocks preventing an agreement. First, the United States wants the southern countries to agree to tougher enforcement of intellectual property rights and lower manufacturing tariffs. Second, Brazil and Argentina want the United States to reduce agricultural subsidies, and eliminate tariffs on agricultural imports. O) If the FTAA is established, it will have major implications for cross-border trade and investment flows within the hemisphere. The FTAA would create a free trade area of over 850 million people who accounted for $16 trillion in GDP in 2007. Teaching Tip: Additional information on the Free Trade of the Americas can be found at {}. REGIONAL ECONOMIC INTEGRATION ELSEWHERE A) There have been numerous attempts at regional economic integration throughout Asia and Africa. Few efforts however, have made much progress. Association of Southeast Asian Nations B) Formed in 1967, the Association of Southeast Asian Nations (ASEAN) currently includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam (see Map 8.3 in the text). The basic objectives of ASEAN are to foster freer trade between member countries and to achieve some cooperation in their industrial policies. C) In 2003, an ASEAN Free trade Area (AFTA) between the six original members of ASEAN came into effect. Vietnam, Laos, and Myanmar joined later, and Cambodia is expected to be a member by 2010. The goal of AFTA is to reduce import tariffs among the six original members by 2010, and for the newer members by 2015.


Chapter 08 - Regional Economic Integration

Asian Pacific Economic Cooperation (APEC) D) The Asia-Pacific Economic Cooperation (APEC) currently has 21 members including such economic powerhouses as the United States, Japan, and China. The stated aim of APEC is to increase multilateral cooperation in view of the economic rise of the Pacific nations and the growing interdependence within the region. Teaching Tip: For more information on APEC, go to {}. Regional Trade Blocs in Africa E) There are nine trade blocs on the African continent, however progress toward the establishment of meaningful trade blocs has been slow. FOCUS ON MANAGERIAL IMPLICATIONS A) The most significant developments in regional economic integration are occurring in the EU and NAFTA. These developments have the most profound and immediate implications for business practice. Opportunities B) Creation of a single market offers significant opportunities because markets that were formerly protected from foreign competition are opened. C) The greatest implication for MNEs is that the free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes, makes it possible for them to realize potentially enormous cost economies by centralizing production in those locations where the mix of factor costs and skills is optimal. By specialization and the shipping of goods between locations, a much more efficient web of operations can be created. D) On the other hand, even after the removal of barriers to trade and investment, enduring differences between nations in culture and competitive practices often limit the ability of companies to realize cost economies by centralizing production in key locations and producing a standardized product for a single multi-country market. Threats F) Just as the emergence of single markets in the EU and North America creates opportunities for business, it also presents a number of threats. For one thing, the business environment within both groups will become more competitive. A further threat to non-EU and/or non-North American firms arises from the likely long-term improvements in the competitive position of many European and North American companies.


Chapter 08 - Regional Economic Integration

G) Another threat to firms outside of trading blocks is the threat of being shut out of the single market by the creation of a trade fortress. Finally, firms may be limited in their ability to pursue the strategy of their choice in the EU as the EU increases its willingness and ability to intervene and impose conditions on companies proposing mergers and acquisitions.

Critical Thinking and Discussion Questions

1. NAFTA has produced significant net benefits for the Canadian, Mexican, and U.S. economy. Discuss. Answer: Proponents of NAFTA argue that the agreement should be viewed as an opportunity to create an enlarged and a more productive base for the United States, Canada, and Mexico. As lowincome jobs move from Canada and the United States to Mexico, the Mexican economy should be strengthened giving Mexican consumers the ability to purchase higher-cost American products. The net effect of the lower income jobs moving to Mexico and Mexico increasing its imports of higher quality American goods should be positive for the American economy. In addition, the international competitiveness of U.S. and Canadian firms that move production to Mexico to take advantage of lower labor costs will be enhanced, enabling them to better compete with Asian and European rivals. 2. What are the economic and political arguments for regional economic integration? Given these arguments, why dont we see more substantial examples of integration in the world economy? Answer: The economic case for regional integration is straightforward. As noted in Chapter 5, unrestricted free trade allows countries to specialize in the production of goods and services that they can produce most efficiently. If this happens as the result of economic integration within a geographic region, the net effect is greater prosperity for the nations of the region. From a more philosophical perspective, regional economic integration can be seen as an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the World Trade Organization. The political case for integration is also compelling. Linking neighboring economies and making them increasingly dependent on each other creates incentives for political cooperation between neighboring states. The potential for violent conflict between the states is also reduced. In addition, by grouping their economies together, the countries can enhance their political weight in the world. Despite the strong economic and political arguments for integration, it has never been easy to achieve on a meaningful level. There are two main reasons for this. First, although economic integration benefits the majority, it has its costs. While a set of nations as a whole may benefit significantly from a regional free trade agreement, certain groups may lose. The second impediment to integration arises from concerns over national sovereignty.


Chapter 08 - Regional Economic Integration

3. What effect is creation of a single market and a single currency within the EU likely to have on competition within the EU? Why? Answer: If the EU is successful in establishing a single market and currency, member countries can expect significant gains from the free flow of trade and investment. This will result from the ability of the countries within the EU to specialize in the production of the product that they manufacture the most efficiently, and the freedom to trade those products with other EU countries without being encumbered by tariffs and other trade barriers. In terms of competition, the competition between European firms will increase. Some of the most inefficient firms may go out of business because they will no longer be protected from other European companies by high tariffs, quotas, or administrative trade barriers. Companies from those countries that have not adopted the euro may find that their costs are higher as they deal with currency exchanges. 4. Do you think it is correct for the European Commission to restrict mergers between American companies that do business in Europe? (For example, the European Commission vetoed the proposed merger between WorldCom and Sprint, both U.S. companies, and it carefully reviewed the merger between AOL and TimeWarner, again both U.S. companies.) Answer: This question deals with the delicate issue of just how far a country can extend the reach of its law, and should set the stage for a good debate. While some students will argue that the European Commission is overstepping its boundaries by restricting mergers between American companies doing business in Europe, other students will recognize that the U.S. might act in a similar fashion if American firms were being threatened by foreign companies seeking to merge and operate in the U.S. market. 5. How should a U.S. firm that currently only exports to ASEAN countries respond to the creation of a single market in this regional grouping? Answer: A U.S. firm that is currently only exporting to ASEAN markets should seriously consider opening a facility somewhere within the region, as the economics of a common market suggest that outsiders can be at a disadvantage relative to insiders. The opening of borders within a common market has the potential to increase the size of the market for the firm. Of course it is possible, after careful consideration, that exporting may still be the most appropriate means of serving the market in some situations.


Chapter 08 - Regional Economic Integration

6. How should a firm that has self-sufficient production facilities to in several ASEAN countries respond to the creation of a single market? What are the constraints on its ability to respond in a manner that minimizes production costs? Answer: The creation of the single market means that it may no longer be efficient to operate separate production facilities in each country. Instead, the facilities should either be linked so that each specializes in the production of only certain items, or several sites should be closed down and production consolidated into the most efficient locations. Existing differences between countries as well as the need to be located near important customers may limit a firms ability to fully consolidate or relocate production facilities for production cost reasons. Minimizing production costs are only one of many objectives of firms, as location of production near R&D facilities can be critical for new product development and future economic success. Thus what is most important in location decisions is long run economic success, not just cost minimization. 7. After a promising start, in the last few years, MERCOSUR, the major Latin American trade agreement, has faltered and made little progress since 2000. What problems are hurting MERCOSUR? What can be done to solve these problems? Answer: MERCOSUR originated in 1988 as a free trade pact between Brazil and Argentina. The pact was expanded in 1990 to include Paraguay and Uruguay with goal of becoming a full free trade area by 1994, and a common market sometime later. While initially considered a success, critics began to question whether the trade diversion effects of MERCOSUR outweighed it trade creation effects. Then, in 1998 member states slipped into a recession and in 1999, Brazils financial crisis led to a significant devaluation of its currency creating further turmoil. Finally, in 2001, Argentina, beset by economic stresses, asked that the customs union be temporarily suspended, effectively ending MERCOSURs quest to become a fully functioning customs union. However, in 2003, Brazils new president announced his support for a revitalized and expanded MERCOSUR that would be modeled after the EU. Teaching Tip: Students can check the current status of the agreement online {}. 8. Would the establishment of a Free Trade Area of the Americas (FTAA) be good for the two most advanced economies of the hemisphere, the United States and Canada? How might the establishment of the FTAA impact the strategy of North American firms? Answer: In 1994, a Free Trade of the Americas (FTAA) was proposed. If the agreement comes about, it would effectively create a free trade area of nearly 850 million people responsible for more than $16 trillion in GDP in 2007. Most students will probably recognize that if an agreement is reached, it will change the strategy of North American firms in that they could treat the entire area as a single market. The United States, while initially a strong advocate of the agreement, has lessened its support for the FTAA recently. The question of whether the agreement is good for the United States and Canada will likely produce a lively debate among students.


Chapter 08 - Regional Economic Integration

9. Reread the Management Focus case on the European Commission and Media Industry Mergers, then answer the following questions: a) Given that both AOL and Time Warner were U.S. based companies, do you think the European Commission had a right to review and regulate their planned merger? b) Were the concessions extracted by the European Commission from AOL and Time Warner reasonable? Whose interests was the Commission trying to protect? c) What precedent do the actions of the European Commission in this case set? What are the implications for managers of foreign enterprises with substantial operations in Europe? Answer: a) This question is likely to generate lively debate among students. Some may argue that the European Commission had no right to extend its reach to influence the strategies of American companies. Other students however, may point out that given that the merger would directly affect European consumers, the European Commission was acting within its bounds. Some students may argue that had the European Commission not become involved, it would actually be reneging on its duties. b) Most students will probably agree that the goal of the European Commission was to protect European consumers. Students will probably suggest that request that Time Warner and EMI drop their proposed joint venture, and the request to allow rival companies access to online music on the same terms as AOL were reasonable in that they preserved competition within the industry. However, students may wonder whether the European Commission went too far when it asked AOL to sever its ties with Bertelsmann. c) Most students will agree that the European Commission clearly demonstrated that it is willing and able to force companies to follow policies it believes are best for European consumers. Students may suggest that companies will have to think beyond what a particular strategy means to their organization, and consider it from the perspective the industry as a whole, and from the perspective of the consumer.

Closing Case: NAFTA and the U.S. Textile Industry

Summary The closing case explores the effect of NAFTA on the U.S. textile industry. Prior to the signing of the NAFTA agreement, many concerns were raised regarding the potential for a significant loss of jobs in the American textile industry. Indeed, between 1994 and 2004, employment in U.S. textile mills fell from about 473,000 to 239,000, and employment in apparel fell from 858,000 to just 296,000. However, at the same time, U.S. consumers enjoyed lower clothing prices and U.S. fabric and yarn makers saw a boost in their exports to Mexico. Discussion of the case can revolve around the following questions.


Chapter 08 - Regional Economic Integration

QUESTION 1: Why did many textile jobs apparently migrate out of the United States in the years after the establishment of NAFTA? ANSWER 1: Between 1994 and 2004, despite strong and growing demand by American consumers, U.S. apparel production fell by 40 percent and textile production fell by 20 percent. The cuts in production led to significant job losses, with employment in textile mills falling from 478,000 to 239,000, and apparel employment dropping from 858,000 to just 296,000. Most students will recognize that the NAFTA agreement meant that U.S. producers could take advantage of Mexicos low cost labor and inputs. Wages in Mexico are between $10 and $20 per day as compared to the $10 to $12 per hour in the United States. QUESTION 2: Who gained from the process of readjustment in the textile industry after NAFTA? Who lost? ANSWER 2: Most students will recognize that U.S. consumers, U.S. producers, and Mexican workers were the primary beneficiaries of the readjustment in the textile industry. Thanks to NAFTA and the cheaper labor available in Mexico, American consumers have watched prices on clothing fall. Designer jeans, for example, fell from about $55 in 1994 to about $48 today. For consumers, this means more money to spend on other items. However, while many consumers may be happy about the shift in apparel production from the United States to Mexico, some consumers may have been one of the unlucky individuals who also saw their job move to Mexico. QUESTION 3: With hindsight, do you think it is better to protect vulnerable industries such as textiles, or let them adjust to the painful winds of change that follow entering into free trade agreements? What would the benefits of costs of protection be? What would the costs be? ANSWER 3: Most students will probably agree that protecting an industry is simply a recipe for prolonging the inevitable pain of readjustment. Students taking this perspective are likely to point out that the need to protect an industry implies that the industry is less efficient, and unable to compete in the global market. In the long run, by forcing the adjustment, greater efficiency and competition will be introduced, and prices will fall. However, those students who have been directly affected by such a readjustment process may have a different perspective. Teaching Tip: To extend this case, consider {} and { 8153.pdf}.


Chapter 08 - Regional Economic Integration

Continuous Case Concept

Chinas automakers are poised to take on the world. Like their Japanese counterparts, Chinas Dongfeng Motor, Chery Automobile, Geely, and others want to capture significant market share in both Europe and North America. One issue that may hold them back however is the strict regulatory controls present in these markets. Ask students to consider the implications and challenges of operating in a market that is made up of several smaller markets like the European Union, yet has a single set of safety or environmental regulations. Next, consider the benefits for companies like Geely and Chery Automobile of operating in the European Union or NAFTA countries instead of individual markets. How does a single market environment affect issues such as product pricing, or the location of manufacturing? Auto unions in Mexico recently developed a two-tier hiring and pay system that brings wages levels close to those in China. How might these wage concessions affect decisions to manufacture automobiles in North America? Finally, while most of the worlds major players in the auto industry already have a presence in both North America and the European Union, consider what a common set of external trade policies means to companies like Dongfeng Motor that want to enter these markets. How does it affect the cost and choice of entry mode? What does it mean in terms of risk?

This Continuous Case Concept works well after students have been introduced to the notion of economic integration, and understand the advantages and disadvantages of membership in a trade bloc. The feature also works well as an extension of the Closing Case.

globalEDGE Exercises
Use the globalEDGE Resource Desk {} to complete the following exercises.


Chapter 08 - Regional Economic Integration

Exercise 1
The enlargement of European Union into Eastern Europe has brought together countries with different levels of economic development. Choose two long-term EU member countries and two newer members. Compare and contrast the macroeconomic situation in these countries by analyzing each countrys primary economic indicators, available from Eurostatistics Data for short-term economic analysis, a statistical book, published by Eurostat. Prepare a short report describing the similarities and differences between the two groups of countries. Answer: The Eurostat website can be access by using the search term Eurostat at Once on the Eurostat website, click on Euroindicators and select Publications and then Statistical Books. On this page, choose Eurostatistics Data for short-term economic analysis. There, download the electronic version of the report and then scroll to Chapter 2 where the primary economic indicators for each country are reported in data and charts.. Search Phrase: Eurostat Resource Name: EUROPE: Eurostat Website: globalEDGE Category: Research: Statistical Data Sources

Exercise 2
The establishment of the Free Trade Area of the Americas could be a threat as well as an opportunity for your company. Identify the countries participating in the negotiations for the FTAA. Are there any countries in the Americas not participating in the negotiations? What are the main issues covered in the negotiation process? Answer: The Free Trade Area of the Americas website can be accessed by searching the term FTAA at This resource is found under the globalEDGE category Topics in IB: Regional Trade Agreements. List of countries is found under the Links to FTAA Countries at the bottom of the left menu. The main negotiation issues are listed directly on the home page. Search Phrase: FTAA Resource Name: AMERICAS: Free Trade Area of the Americas (FTAA) Website: globalEDGE Category: IB Topics: Regional Trade Agreements


Chapter 08 - Regional Economic Integration

Additional Readings and Sources of Information

What You Dont Know About Nafta EU Dangles Membership to Woo Serbia EU Euphoria Fades for Accession Countries European Integration: Whats the Rush? A Punching Bag Named NAFTA NAFTA: To Mexicos, Two Outcomes chan=search Two Cheers for Free Trade