Case #3

Economic Integration

Mariella Barreto
 Economic Integration

For a variety of reasons it often makes sense for nations to coordinate their economic
policies. Any type of arrangement in which countries agree to coordinate their trade,
fiscal, and/or monetary policies is referred to as economic integration. There are about
five levels of economic integration:

1. Free Trade Area

The first level of formal economic integration is the establishment of free trade
agreement (FTA). A free trade area (FTA) occurs when two or more countries agree to
eliminate tariffs as well as import quotas between themselves, but each member country
determines and maintain their own external tariff on imports from the rest of the world
(against non-members). These agreements can be limited to a few sectors or can
encompass all aspects of international trade.  The general goal is to develop economies
of scale and comparative advantages, which promotes economic efficiency.

However, in order for an FTA to function properly, member countries must establish
"rules of origin" for all third-party goods entering the free trade area.  Goods produced
within the free trade area (and subject to the agreement) may cross borders tariff-free, but
rules of origin requirements must be met to prove that the good was in fact produced in
the exporting country. These rules are designed to prevent goods from being imported
into the FTA member country with the lowest tariff and then transshipped to the country
with higher tariffs.

Example: The North American Free Trade Agreement (NAFTA). When the NAFTA is
fully implemented, tariffs of automobile imports between the US and Mexico will be
zero. However, Mexico may continue to set a different tariff than the US on auto imports
from non-NAFTA countries.

2. Customs Union
A customs union (CU) occurs when two or more countries agree to eliminate tariffs
between themselves and set a common external tariff on imports from the rest of the
world (non-member countries). As a result, the members must agree to establish a
common customs legislation.

With a customs union, all member countries must be able to agree on tariff rates across
many different import industries. A custom union has common policies on product
regulations and movement of factors of productions in goods, services, capital and labor
among members.
Custom unions are particularly useful to level the competitiveness playing field and
address the problem of re-exports (using preferential tariffs in one country to enter
another country).

Example: Andean Pact is a customs union compromising the South American countries
of Bolivia, Colombia, Ecuador and Peru.

3. Common Market
A common market represents a major step towards significant economic integration. In
addition to containing the provisions of a customs union, a common market (CM)
removes all barriers to the mobility of people, capital and other resources within the area
in question, as well as eliminating non tariff barriers to trade, such as the regulatory
treatment of product standards. The theoretically ideal common market has no barriers to
trade between member countries and a common external trade policy.

A common market establishes free trade in goods and services, sets common external
tariffs among members and also allows for the free mobility of capital and labor across
countries.

The principal advantage of establishing a common market is the expected gains in

economic efficiency.  With unfettered mobility, labor and capital can more easily respond
to economic signals within the common market, resulting in a more efficient allocation of
resources.

Example: The European Union (EU) previously known as European Economic

Community (EEC). The European Union was established as a common market by the
Treaty of Rome in 1957, although it took a long time for the transition to take place.
Today, EU citizens have a common passport, can work in any EU member country and
can invest throughout the union without restriction.

4. Economic Union
Economic Union is the deepest form of economic integration. An Economic Union
involves the free flow of products and factors of production between member-countries
and the adoption of a common external trade policy. A full economic union also requires
a common currency, harmonization of the member-countries tax rates and a common
monetary and fiscal policy

An economic union typically will maintain free trade in goods and services, set common
external tariffs among members, allow the free mobility of capital and labor, and will also
relegate some fiscal spending responsibilities to a supra-national agency. Supranational
institutions would be required to regulate commerce within the union to ensure uniform
application of the rules.  These laws would still be administered at the national level, but
countries would abdicate individual control in this area. The European Union's Common
Agriculture Policy (CAP) is an example of a type of fiscal coordination indicative of an
economic union.

Example: The European Union (EU) where economic and monetary integration has
created a single market with a common Euro currency.

5.Political Union
An agreement between two or more countries to coordinate their economic monetary and
political systems. It is required to accept a common stance on economic and political
policies against non-members.

Political Union represents the potentially most advanced form of integration with a
common government and were the sovereignty of member country is significantly
reduced.

Example: United States of America. Where each US state has its own government that
sets policies and laws. But each state grant control to the federal government over
foreign policies, agricultural policies, welfare policies and monetary policies. Goods,
services, labor and capital can all move freely without any restrictions among the US
states and the government sets a common external trade policy.

Sources used:

 International Trade Theory and Policy by Steven M. Suranovic

 The International Trade System by Alice Landau