EconomicIntegration

(Chapter8)

EconomicIntegration

Processofreducingoreliminatingtradebarriers
betweencountries

FourStagesofEconomicIntegration
1.

FreeTradeAreas (FTA)

Agreementtoremovetradebarriersamong
members
Eachmembermaintainsindependenttrade
policyagainstnonmembercountries
(e.g.,NAFTA)

Transshipment probleminFTA

2.CustomsUnion

FTA + common external trade policy against nonmember nations

(e.g.) Benelux (Belgium, the Netherlands, and
Luxembourg) formed in 1948
No trans-shipment problem

3.CommonMarket

Removal of trade barriers among members

Common external trade policy against nonmember nations
Free movement of factors of production within the
bloc
(e.g.) EC 1992

4.EconomicUnion

Common market + political union

Common social, taxation, and fiscal policies are
conducted by a supernational authority
Common currency
(e.g.) Belgium and Luxembourg since 1920's
EU 2002?

EffectsofEconomicIntegration

Staticeffects
Tradecreationvs.tradediversioneffect
Dynamiceffects
Economiesofscale
Greatercompetition
Investmentstimulus

TradeCreationvs.TradeDiversion

(e.g.)U.S.andMexico
formsatradingbloc
BeforetheNAFTA,the
U.S.imports22unitsof
thisgoodfromJapan,
thelowcostproducer.
Aspecifictariffof$2
perunitisimposedto
theJapaneseproduct.
(Noimportsfrom
Mexico)

UndertheNAFTA,only
tariffagainstMexican
goodsiseliminated.
Asaresult,theU.S.
nowimports34units
fromMexico
Area(a+b) =trade
creation(why?)

10

Tradediversion=area
c.
Fromtheefficiency
pointoftheworld
economy,inefficiency
occursbecause
productionisshifted
fromJapantoMexico,
alessefficientproducer
U.S.andtheworldwill
gainfromtheNAFTA
onlyif
(a+b)>c

11

DynamicEffects
1.

EconomiesofScale
Marketenlargementallowsfirmstoachieve
____________attributabletogreater
specializationofworkersandmachinery

12

DynamicEffects
2.

Increased_______________
Asmarketsbroadenandbecomemoreopen,the
potentialforsuccessfulcollusionisdiminished
andincreased__________forcesfirmstobe
moreefficient

13

DynamicEffects
3.

Stimulationof____________
Tosurviveinexpandedandmorecompetitive
markets,firmsmustundertakeinvestmentsin
newequipment,technologies,andproductline.
Investmentmayalsoincreaseasnonmember
countriestrytoestablishsubsidiaryoperations
insidethebloc

14

EuropeanUnion(EU)
Treatyof_________(1957) establishedEuropean
Community precursortoEU
1) 1957:Belgium,France,Italy,Luxembourg,Netherlands&
WestGermany
2) 1973:UnitedKingdom,Ireland&Denmark
3) 1981:Greece
4) 1987:Spain&Portugal
5) 1995:Austria,Finland&Sweden
6) 2004:Cyprus,CzechRepublic,Estonia,Hungary,Latvia,
Lithuania,Malta,Poland,Slovakia&Slovenia
7) 2007:Bulgaria&Romania

EuropeanUnion:1960 1985
o EUmembersremovedtariffsin1968leadingtofivefoldincrease
intrade
o EUadoptedcommonexternaltariffsin1970makingitacustoms
union
o tradecreation:machinery,transportationequipment,chemicals
&rawmaterials
o tradediversion:agriculturalcommoditiesandrawmaterials
o tradecreationexceededtradediversion
o EUsawincreasesineconomiesofscale,competition&
investment
o 1985EUeliminatednontariffbarriersresultingincreationof
Europeancommonmarket

EuropeanUnion&Maastricht
o 1991MaastrichtTreatyestablishedmonetaryunionand
euroascommoncurrencyby2002
o convergencecriteria:
1) inflation1.5%aboveaverageinflationofthree
countrieswithlowestinflation
2) longterminterestrates2.0%aboveaverageofsame
threecountries
3) exchangeratewithintargetbandsofmonetaryunion
for2years
4) budgetdeficit3.0%ofGDP
5) governmentdebt60.0%ofGDP

EU____________Policy VariableLevies
o
o

norestrictiononagriculturetradedinternally
EUpolicybasedinpartonvariablelevies

adjustedtomaintain
desiredpricelevels
morerestrictivethanan
importquotainthat
foreignproducerscannot
cutpricesandabsorbtariff
costtomaintainexport
sales

EUAgriculturalPolicy Subsidies
o

exportsubsidiesalsousedtomaintainhigherpricesofEU
commonpolicy

EUproducerssell
forlowpricebut
receivehigherprice
EUpurchasesany
surplus
surplusthensoldon
worldmarketfor
lowerprice

o
o

Government_____________Policies

governmentpurchasespreviouslylimitedprimarilytodomestic
producers
1992EUrequiredbiddingprocessfromEUfirms

benefits:

governments
purchasefromlower
costproducers
increasedcompetition
remainingfirms
producewith
economiesofscale

EuropeanMonetaryUnion
Acommoncurrencyalsoimpliedtheneedforasingle
EuropeanCentralBankresponsibleforallmonetaryand
exchangeratepoliciesoftheEMU.
o advantages:
eliminatedexchangerate_______
reducedcurrency____________costs
insulationfrommonetarydisturbance&speculation
o disadvantages:
lossofindividual___________authority
transitiontocommoncurrencycouldleadtospeculative
attacks

OptimumCurrencyAreas
o definition regioninwhichitiseconomicallypreferableto
haveasingleofficialcurrency
o successofcommoncurrencyarea:

similarbusinesscycles
similareconomicstructures
singlemonetarypolicyaffectingallmembersinsamemanner
absenceoflegalorculturalbarriersthatwouldlimitlabormobility
wageflexibility
stabilizingtransfersystem

o EUconcernsbasedonrigidwagesandlimitedlabor
mobilitytiedtoculturalfactors

NorthAmericanFreeTradeAgreement
(NAFTA)
o freetradeareaforU.S.,Canada&Mexico(notacustoms
union)
o issues:
U.S.&Canadarepresenteddevelopedeconomieswhile
Mexicowasadevelopingeconomy
Mexicosauthoritarianpoliticalsystem
substantialdifferenceinstandardoflivingbetween
MexicoandCanada&U.S.
o decision:integrateMexicotostimulatedevelopmentor
allowproblemsinthatnationtocontinuetospillover
borders

BenefitstoMexico
o substantialbenefitsforMexicobecauseitintegratedwith
muchlargereconomies
o increaseinproductionofgoodsinwhichithascomparative
advantage
o gainsattheexpenseofotherlowwagenations
o increasesinagriculturalgoodsandlaborintensivegoods
o agriculturerepresentssmallportionofGDPbutsupports
roughly25%ofthepopulation

Benefits&ConcernsforCanada
o Benefits:

maintainstatusininternationaltrade

freetradepreferenceinU.S.market

equalaccesstoMexicosmarket

inclusioninfuturefreetradeareawithCentral&South
America

economiesofscaleassociatedwithincreasedoutput
levels

o PossibleCost:closerintegrationwithU.S.aspotential
threattoCanadassocialwelfaresystem

EconomiesofScalefromNAFTA
o

accesstoadditionalmarketsincreasesdemand

Canadian
producerscansell
moreautos
increased
consumersurplus
duetolower
price
noworsefor
producerssince
costshave
dropped

Benefits&CoststotheU.S.
o Benefits:
expandedtrade
increasedcompetitionandlowerprices
enhancedeconomiesofscale
decreaseinillegalimmigration
improvedpoliticalstabilityinMexico
o Costs:
U.S.industriescompetingwithimports
impactonunskilledworkersdomestically
potentialforenvironmentalconsequences
limitedbenefitsduetorelativesizeoftheseeconomies

LaborCostComparedtoProductivity
o
o

WouldNAFTAcausemanyU.S.companiestorelocateto
Mexicoduetolowerwages?
Productivityisamajorfactorindeterminingcostperunitof
output.

Basedonhigherproductivity,U.S.workerscanstillreceive
higherwages.

NAFTAasOptimumCurrencyArea?
o measuresofeconomicintegration:Canada&Mexicoare
theU.S.largesttradingpartners
o Canada&U.S.:advancedindustrialeconomieswithsimilar
percapitaincomes,inflationratesandinterestrates
o Mexico:loweraveragepercapitaincome,higherinflation
rate,higherinterestrates,andvolatileexchangerate
o MexicoadoptingU.S.dollar:
pro:price&interestratestability
con:lossofindependentmonetarypolicy

FreeTradeAreaoftheAmericas
o 1994proposalcallingforagreementamong34nationsin
NorthandSouthAmerica
o potentialtobecomelargesttradingblocintheworldwith
850millionconsumersand$14trillionincombinedincome
o progressiveLatinAmericantradepolicies:

reducedgovernmentalmanagement
conventionalmacroeconomicpoliciestopromotegrowthand
stability
failureofimportsubstitutionmodel

o challenges:
o
o

otherfreetradeagreements
subsidiesonagriculturalgoods

TransitionEconomies
o nationsmakingthetransitionfromcentrallyplannedto
marketeconomy
o countriesopting
forgreater
political&
economic
freedomhave
seenimproved
performance
andincome