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LESSON 3.3. Economic Integration and Cooperation

Economic integration is a term used to describe the political and monetary

agreements among nations and world regions in which preference is given to
member countries. There are three major ways to approach such agreements:
• Global integration—Countries from all over the world decide to cooperate
through the World Trade Organization (WTO)
• Bilateral integration—Two countries decide to cooperate more closely
together, usually in the form of tariff reductions
• Regional integration—A group of countries located in the same geographic
proximity decide to cooperate, as with the European Union

The World Trade Organization—Global Integration

Governments often actively cooperate with each other to remove trade barriers.
The following discussion focuses on the World Trade Organization (WTO), the
successor to the General Agreement on Tariffs and Trade (GATT) and the major
multilateral forum through which governments can come to agreements and settle
trade disputes.

Gatt: Predecessor to the WTO

In 1947, 23 countries formed GATT under the auspices of the United Nations to
abolish quotas and reduce tariffs. By the time the WTO replaced GATT in 1995,
125 nations had become members. Many believe that GATT’s contribution to trade
liberalization enabled the expansion of world trade in the second half of the
twentieth century.

Trade Without Discrimination

The fundamental principle of GATT was that each member nation must
open its markets equally to every other member nation. This principle of
“trade without discrimination” was embodied in GATT’s most-favored-nation
(MFN) clause—once a country and its trading partners had agreed to
reduce a tariff, that tariff cut was automatically extended to every other
member country, irrespective of whether the country was a signatory to the
agreement.

What Does the WTO Do?

The WTO adopted the principles and trade agreements reached under the
auspices of GATT but expanded its mission to include trade in services,
investment, intellectual property, sanitary measures, plant health, agriculture, and
textiles, as well as technical barriers to trade. Its 159 members collectively account
for more than 97 percent of world trade and include the BRIC countries (Brazil,
India, China, and Russia, which was finally admitted to membership in 2012). The
entire membership makes significant decisions by consensus. However, there are
provisions for a majority vote in the event of a non-decision by member countries.
Agreements then must be ratified by the governments of the member nations.

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Most Favored Nation

The WTO continued the MFN clause of GATT, which implies that member
countries should trade without discrimination, basically giving foreign
products “national treatment.” Although the WTO restricts this privilege to
official members, some exceptions are allowed, as follows:
1. Developing countries’ manufactured products have been give
preferential treatment over those from industrial countries.
2. Concessions granted to members within a regional trading alliance,
such as the EU, have not been extended to countries outside the
alliance. (Recall from our opening case, for instance, that although
EU members can export and import cars from other EU nations
without limitations, Japanese carmakers must comply with strict
import tariffs.
3. Countries can raise barriers against member countries who they feel
are trading unfairly. Exceptions are made in times of war or
international tension.

Dispute Settlement
One function of the WTO that is garnering growing attention is the
organization’s dispute settlement mechanism, in which countries may bring
charges of unfair trade practices to a WTO panel, and accused countries
may appeal.

Doha Round
Perhaps the most complex issues the WTO currently faces, however, are
those it is trying to address through the Doha Round, also called the Doha
Ministerial Declaration, which commenced in Doha, Qatar, in 2001 with a
focus on giving a boost to developing countries on the world scene

The Rise of Bilateral Agreements

Bilateral agreements can be between two individual countries or may involve one
country dealing with a group of other countries. Even though bilateral trade is
much simpler than trying to forge a deal in the WTO, neither deal was easy. And it
is always difficult to measure the impact in the short run, especially during a time
when the global economy is struggling

Regional Economic Integration

Regional trade agreements are reciprocal pacts between two or more partners that
lie somewhat between bilateral and global integration agreements. According to
the World Trade Organization, 354 RTAs were in force as of mid-January 2013.
Some of the best known RTAs are the European Union, the European Free Trade
Association (EFTA), the North American Free Trade Agreement (NAFTA), the

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Southern Common Market (MERCOSUR), the ASEAN (Association of Southeast

Asian Nations) Free Trade Area (AFTA), and the Common Market of Eastern and
Southern Africa (COMESA).

Geography matters
It’s logical that most trade groups contain countries in the same area of the world.
Neighboring nations tend to ally for several reasons:
• The distances that goods need to travel are short.
• Consumers’ tastes are likely to be similar, and distribution channels can
easily be established. From the standpoint of tariff reduction, the two main
types of agreements are free trade agreements and customs unions.
• Free Trade Agreement (FTA) The goal of an FTA is to abolish all tariffs
between member countries. It usually begins modestly by eliminating them
on goods that already have low tariffs, and there is usually an
implementation period during which all tariffs are eliminated on all products
included in the agreement. Moreover, each member country maintains its
own external tariffs against non-FTA countries. About 90 percent of the
RTAs identified by the WTO are free trade agreements.
• Customs Union In addition to eliminating internal tariffs, member countries
levy a common external tariff on goods being imported from nonmembers
in order to establish a customs union. For example, when the EU was
organized in 1957, it began to remove internal tariffs among member states,
but in 1967 it eliminated the remaining internal tariffs and established a
common external tariff, meaning that goods shipped into one member
country from abroad are free from tariffs in the rest of the member countries.
The Effects of Integration
Regional economic integration can affect member countries in social, cultural,
political, and economic ways. Initially, however, our focus is on its economic
rationale. The imposition of tariff and nontariff barriers disrupts the free flow of
goods, affecting resource allocation.

Static and Dynamic Effects

Regional economic integration reduces or eliminates those barriers for
member countries, producing both static and dynamic effects.
• Static effects are the shifting of resources from inefficient to efficient
companies as trade barriers fall.
• Dynamic effects are the overall growth in the market and the impact
on a company caused by expanding production and by its ability to
achieve greater economies of scale.

Figure 3.3.1. shows how RTAs result in static and dynamic effects on trade
and investment flows.

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Figure 3.3.1. Impact of Free Trade Agreements

Source: International Business: Environments and Operations by Daniels, Radebaugh, & Sullivan
(2019)

When economic integration reduces or eliminates trade barriers, the effects on the
nations involved may be either static or dynamic. Static effects apply primarily to
trade barriers themselves—for member countries they go down, and for
nonmembers they go up. Dynamic effects, on the other hand, apply to economic
changes affecting the newly structured market—not only does the market expand,
but so do local companies, which take advantage of the larger market.

From the standpoint of tariff reduction, the two main types of agreements are free
trade agreements and customs unions.
• Free Trade Agreement (FTA) The goal of an FTA is to abolish all tariffs
between member countries. It usually begins modestly by eliminating
them on goods that already have low tariffs, and there is usually an
implementation period during which all tariffs are eliminated on all
products included in the agreement. Moreover, each member country
maintains its own external tariffs against non-FTA countries. About 90
percent of the RTAs identified by the WTO are free trade agreements.
• Customs Union In addition to eliminating internal tariffs, member
countries levy a common external tariff on goods being imported from
nonmembers in order to establish a customs union. For example, when
the EU was organized in 1957, it began to remove internal tariffs among
member states, but in 1967 it eliminated the remaining internal tariffs
and established a common external tariff, meaning that goods shipped

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into one member country from abroad are free from tariffs in the rest of
the member countries.
• Economies of Scale. Dynamic effects of integration occur when
trade barriers come down and markets grow.
• Increased Competition Another important effect of an RTA is
greater efficiency due to increased competition. Many MNEs in
Europe have attempted to grow through mergers and acquisitions to
achieve the size necessary to compete in the larger market.

Major Regional Trading Groups

The two ways to look at different regional trading groups are by location (such as
the European Union) and by type (such as an FTA, customs union or common
market). Major trading groups exist in every region of the world, and it is impossible
to cover every group in every region, so we’ll discuss a few of the major ones and
examine the type of RTA they are.

The European Union

The largest and most comprehensive regional economic group is the European
Union (EU). It began by gradually abolishing internal tariffs but eventually
established an external tariff while integrating in other ways such as facilitating the
free movement of workers, establishing a common agricultural policy, and
agreeing on a value-added tax system. The formation of the European Parliament
and the establishment of a common currency, the euro, make the EU the most
ambitious of all the regional trade groups

Map 3.3.1. European Trade and Economic Integration

Source: International Business: Environments and Operations by Daniels, Radebaugh, & Sullivan
(2019)

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Although the 27-member EU is easily the dominant trading bloc in Europe, it’s not
the only one. Founded in 1960, the four-member European Free Trade Association
(EFTA) also maintains joint free trade agreements with several other countries.
The European Economic Area (EEA) includes three members of the EFTA and all
members of the EU. The Central European Free Trade Agreement (CEFTA) was
originally formed to integrate Western practices into the economies of former
Soviet bloc nations, two of whom have already been admitted into the EU.

The North American Free Trade Agreement (NAFTA )

Various forms of mutual economic cooperation have historically existed between
the United States and Canada, such as the Canada-U.S. Free Trade Agreement
of 1989, which eliminated all tariffs on bilateral trade by 1998. In February 1991,
Mexico approached the United States to establish a free trade agreement. Canada
was included in the formal negotiations and the resulting North American Free
Trade Agreement (NAFTA) became effective on January 1, 1994.

Regional Economic Integration in The Americas

If you look at Maps 7.2 and 7.3, you’ll see six major regional economic groups in
the Americas, divided into Central American and South American. Central America
(excluding Mexico) has the Caribbean Community (CARICOM), the Central
American Common Market (CACM), and the Central American Free Trade
Agreement (CAFTA-DR)—which includes the members of CACM but also
Honduras and the Dominican Republic, along with the United States. The two
major groups in South America are the Andean Community (CAN) and the
Southern Common Market (MERCOSUR). The Andean Community is a customs
union, whereas MERCOSUR is set up to be a common market.

Map 3.3.2. Economic Integration in Central America and the Caribbean

Source: International Business: Environments and Operations by Daniels, Radebaugh, & Sullivan
(2019)

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Throughout Central America and the Caribbean, the focus on economic integration
has shifted from the concept of the free trade agreement (whose goal is the
abolition of trade barriers among members) to that of the common market (which
calls for internal factor mobility as well as the abolition of internal trade barriers).
The proposed structure of the Caribbean Community and Common Market
(CARICOM) is modeled on that of the EU.

Map 7.3 Latin American Economic Integration

Source: International Business: Environments and Operations by Daniels, Radebaugh, & Sullivan
(2019)

There are only two key RTAs in South America: the Andean Group and
MERCOSUR. The Latin American Integration Association, which was established
in 1980, has failed to establish a free trade agreement or a dispute resolution
mechanism.

Regional Economic Integration In Asia

There are several RTAs in Asia as recognized by the WTO and a few significant
trade initiatives in process. Of the officially approved RTAs, the most important is
the Association of Southeast Asian Nations/ASEAN Free Trade Area. As is the

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case in Latin America, regional integration in Asia has not been as successful as
in Europe or North America because most of the countries in the region have relied
on U.S. and EU markets for as much as 20 to 30 percent of their exports—not as
extensive as in Latin America but still significant. In addition, China and Japan,
which are not members of ASEAN/AFTA, are significant players in the region in
terms of trade and investment.

Map 3.3.3. The Association of Southeast Asian Nations

Source: International Business: Environments and Operations by Daniels, Radebaugh, & Sullivan
(2019)

Although the total population of ASEAN countries (as of 2013) is larger than that
of either the EU or NAFTA, per capita GDP is considerably lower. Economic growth
rates among ASEAN members, however, are among the highest in the world.

Regional Economic Integration in Africa

Africa is truly the new frontier. Between 2001–2010, six of the fastest growing
economies in the world were in Africa. Real GDP growth has been strong, and FDI
has risen significantly. In addition, Africa has the fastest-expanding labor force in
the world with more than 500 million people of working age (15–64), and is
expected to surpass China and India in working-age population by 2040.

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Map 7.5 Regional Integration in Africa

Source: International Business: Environments and Operations by Daniels, Radebaugh, & Sullivan
(2019)

Although African nations have joined to form several groups for the purpose of
economic integration, the total amount of trade among members remains relatively
small. African nations tend to rely heavily on trading relationships with countries
elsewhere in the world—notably with industrialized nations.

Other Forms of International Cooperation

Up to now, this chapter has focused on treaties between nations designed to
reduce trade and investment barriers and increase trade and investment among
member nations. We have moved from the global—the WTO—to the bilateral and
the regional. However, there are other forms of cooperation worth mentioning that
could have an influence on MNE strategies.

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The United Nations

The first form of cooperation worth exploring is the United Nations, which
was established in 1945 in response to the devastation of World War II to
promote international peace and security and to help solve global problems
in such diverse areas as economic development, antiterrorism, and
humanitarian actions.

Nongovernmental Organizations (NGOs)

Nongovernmental, nonprofit voluntary organizations are all lumped under
the category of NGOs: private institutions that are independent of any
government. Some NGOs operate only within the confines of a specific
country, whereas others are international in scope.

Commodity Agreements

Commodities refer to raw materials or primary products that enter into trade, such
as metals or agricultural products. Primary commodity exports—such as crude
petroleum, natural gas, copper, tobacco, coffee, cocoa, tea, and sugar—are still
important to developing countries. Out of 151 developing countries, 100, two-thirds
of the total, derive more than 50 percent of their export value from commodities.46

Commodities and The World Economy

Both long-term trends and short-term fluctuations in commodity prices have
important consequences for the world economy. On the demand side, commodity
markets play an important role in industrial countries, transmitting business cycle
disturbances to the rest of the economy and affecting the growth rate of prices. On
the supply side, as noted above, primary products account for a significant portion
of the GDP and exports of many commodity- producing countries.

Consumers and Producers

For many years, countries tried to band together as producer alliances or joint
producer/consumer alliances to try to stabilize commodity prices.

The Organization of The Petroleum Exporting Countries (OPEC)

The Organization of the Petroleum Exporting Countries (OPEC) is an example of
a producer cartel that relies on quotas to influence prices. It is a group of 12 oil-
producing countries that have significant control over supply and band together to
control output and price. Its members include Algeria, Angola, Ecuador, Iran, Iraq,
Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and
Venezuela. Indonesia suspended its membership in January 2009, and several of
the largest oil exporting countries, including the Russia, Norway, Canada, the U.S.,
and Mexico, are not members of OPEC.

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Activity 3.3.

 Read Chapter 7. Economic Integration and Cooperation on pages 301 - 338

of International Business: Environments and Operations by Daniels,
Radebaugh, & Sullivan.

 Philippines and the WTO. Explore World Trade Organization website

https://www.wto.org/english/thewto_e/countries_e/philippines_e.htm

Study Questions

1. How do the different approaches to economic integration influence trade

agreement, a customs union, or a common market?

2. What are the characteristics of different regional trading groups?

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References

Philippines and the WTO. Retrieved on 12 August 2020 from

https://www.wto.org/english/thewto_e/countries_e/philippines_e.htm

Cavusgil, S.T., Knight, G. & John Riesenberger, J. (2018). International Business

The New Realities (4th Ed.)

Daniels, J. D., Radebaugh, L. H., & Sullivan, D. P. (2019). International business:

Environments and operations. PEARSON.

Luthans, F. and Doh, J. P. (2015). International management: Culture, society and

behavior. McGraw-Hill

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ONLINE READING MATERIALS

 Read Chapter 7. Economic Integration and Cooperation on pages 301 - 338

of International Business: Environments and Operations by Daniels,
Radebaugh, & Sullivan.

 Philippines and the WTO. Retrieved on 12 August 2020 from

https://www.wto.org/english/thewto_e/countries_e/philippines_e.htm

MODULE REFERENCES

Philippines and the WTO. Retrieved on 12 August 2020 from

https://www.wto.org/english/thewto_e/countries_e/philippines_e.htm

Amadeo, K. (2020 August 2). Trade protectionism methods with examples, pros,
and cons: Why protectionism feels so good but is so wrong. The Balance.
Retrieved 12 August 2020 from https://tinyurl.com/y5t7k8du

Cavusgil, S.T., Knight, G. & John Riesenberger, J. (2018). International business:

The new realities. Pearson

Daniels, J. D., Radebaugh, L. H., & Sullivan, D. P. (2019). International business:

Environments and operations. PEARSON.

Dawson, C. (2017). International trade. Larson & Keller.

Luthans, F. and Doh, J. P. (2015). International management: Culture, society and

behavior. McGraw-Hill

Sweeney, P. D. and McFarlin, D. B. (2015). International management: Strategic

Opportunities and Cultural Challenges. Taylor & Francis Group

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