Economic Integration

Introduction
• Basically there are two approaches to international
trade liberalization and economic integration: the
international approach and the regional approach.
• The international approach involves international
conferences under WTO. The purpose of these
international conferences is to reduce barriers to
international trade and investment.
• The regional approach involves agreements among a
small number of nations whose purpose is to establish
free trade among themselves while maintaining
barriers to trade with the rest of the world
 Economic Integration
• A process whereby countries cooperate with one
another to reduce or eliminate barriers to the
international flow of products, people or capital.
• Regional Economic Integration:
Agreement between countries in a geographic region
to reduce and ultimately remove tariff and non tariff
barrier to the free flow of good, services and factors of
production among each other.
• By entering into regional agreements groups of
countries aim to reduce trade barriers more rapidly
than can be achieved under the auspices of the WTO
 Levels Of Regional Economic
Integration:

1.Free Trade Area

2. Customs Union
3.Common Market
4. Economic Union
5. Political Union
•
Preferential Trade Area:
• Preferential trade agreements provide lower
barriers on trade among participating nations
than on trade with nonmember nations.
That is, lower tariffs on imports of each
other.
• This is the loosest form of economic
integration.
• A good example is the Commonwealth
Preference System , which was established in
1932 among 48 Common wealth countries of
the British empire.
 Free Trade Area(FTA)
• An agreement between two or more countries to
remove all trade barriers between themselves.
• A free trade area occurs when a group of
countries agree to eliminate tariffs between
themselves, but maintain their own external tariff
on imports from the rest of the world.
• Examples of FTA are: The ASEAN Free Trade
Agreement(AFTA) and the North American Free
Trade Areas(NAFTA).
Examples of
FTA
 Customs Union
• An agreement between two or more countries to
remove tariffs between themselves and set a common
external tariff on imports from non-member countries
• Each country determines its own barriers and
maintains its own external tariffs on imports against
non-members.
• A customs union has common policies on product
regulations and movement of factors of productions in
goods, services, capital and labor amongst members
• Unlike FTA, members of a customs union have common
policies on external tariffs against non-members,
• An example of a customs union is the established
customs union between the European Union and
Turkey, which came into effect in 1996.
Customs Union EXAMPLE
 Common Market:

• An agreement between two or more countries

to remove all barriers to trade and allow free
mobility of capital and labor across member
countries.
• Harmonize trade policies by having common
external tariffs against non-members.
• Example is the European Union (EU)
previously known as European Economic
Community(EEC)
 Economic Union
• An agreement between two or more countries to
remove barriers to trade, allow free flow of labor and
capital and coordinate economic policies.
• Sets trade policies through common external tariffs on
non-members.
• Integration is more intense in an economic union
compared to a common market, as member countries
are required to harmonize their tax, monetary, and
fiscal policies and to create a common currency
• Example is the European Union(EU) where economic
and monetary integration has created a single market
with a common euro currency
 Political Union:
• An agreement between two or more countries to
coordinate their economic monetary and political
systems.
• Required to accept a common stance on economic and
political policies against non-members.
• Example is US 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
 The European Union in
brief
• The European Union (EU) is an economic and
political union.
• It is a unique economic and political partnership
between 28 European countries.
• It has delivered half a century of peace, stability,
and prosperity, helped raise living standards,
launched a single European currency, and is
progressively building a single Europe-wide
market in which people, goods, services, and
capital move among Member States as freely as
within one country
 Why the European Union
The EU’s mission in the 21st century is to:
• maintain and build on the peace established
between its member states;
• bring European countries together in practical
cooperation;
• ensure that European citizens can live in
security;
• promote economic and social solidarity;
• preserve European identity and diversity in a
globalized world;
• promulgate the values that Europeans share.
 GOVERNAN
CE
The European Union has seven institutions:
1. the European Parliament,
2. the Council of the European Union,
3. the European Commission,
4. the European Council,
5. the European Central Bank,
6. the Court of Justice of the European Union
7. European Court of Auditors
 The EU
symbols
• The European anthem
• The European flag
• Europe Day, 9 May
• The motto: United in diversity
Founders: France, Belgium, Luxembourg, Italy,
Nether lands, Germany
Balance of Payments and
Foreign Exchange
rate
 Balance of
Trade
• Balance of Trade is simply the difference between the
value of exports and value of imports. Thus,
the Balance of Trade denotes the differences of
imports and exports of a merchandise of a country
during the course of year. It indicates the value of
exports and imports of the country in question.
• The balance of trade can be a "favorable" surplus
(exports exceed imports) or an "unfavorable" deficit
(imports exceed exports). The official balance of trade
is separated into the balance of merchandise trade for
tangible goods and the balance of services....
• It deals with exports and imports of visible items only.
• It takes into account only merchandise exports
& imports only.
 Types of
BOT
• Surplus/favorable (exports exceed imports)

• Deficit/unfavorable (imports exceed exports).

• Equilibrium((imports equal exports).

Factors that can affect the balance of
trade
 a) cost of production
b) availability of raw materials
c) Exchange rate
d)Prices of goods manufactured at home
c)Exchange rate movements;
 Multilateral, bilateral and unilateral taxes or
restrictions on trade;
 Non-tariff barriers such as environmental,
health or safety standards;
 Balance of Payment
• Balance of Payment is a system of recording all
the economic transactions of a country, with the
rest of the world over a period, say one year.
• The balance of a payment is a systematic record
of all its monetary transections with other
countries of the world in a given period of time.
i.e 1 year
• when we say “a country’s balance of payments”
we are referring to the transactions of its citizens
and government.
Factors affecting balance of payments

A current account deficit could be caused by

factors such as.
• High rate of consumer spending on imports
(during economic boom)
• Decline in international competitiveness
making countries exports less competitive
• Overvalued exchange rates which makes
exports relatively more expensive
Components of
BOP
 1. Current Account Balance
BOP on current account is a statement of actual
receipts and payments in short period.
• It includes the value of export and imports of
both visible and invisible goods. There can be
either surplus or deficit in current account.
• The current account includes:- export &
import of services, interests, profits, dividends
and unilateral receipts/payments from/to
abroad.
 2. Capital Account Balance
It is difference between the receipts and
payments on account of capital account. It refers
to all financial transactions.
• Capital account of BOP records all those
transactions, between the residents of a
country and the rest of the world, which cause
a change in the assets or liabilities of the
residents of the country or its government. It
is related to claims and liabilities of financial
nature.
 3. Official Reserve Account
• The official reserve account, a subdivision of the
capital account, is the foreign currency and
securities held by the government, usually by its
central bank, and is used to balance the
payments from year to year.
• The official reserves increases when there is a
trade surplus and decreases when there is a
deficit. Sometimes the central bank will use it to
attempt to change the exchange rate to what the
government perceives as more favorable.
• records the transactions of the central bank when
it buys/sells foreign currencies.
 Disequilibrium of
BOP
Disequilibrium occurs when there is either surplus
or a deficit in the balance of payments.
• A Surplus in the BOP occurs when Total
Receipts exceeds Total Payments. Thus, BOP=
CREDIT>DEBIT
• A Deficit in the BOP occurs when Total Payments
exceeds Total Receipts. Thus, BOP= CREDIT<DEBIT
Deficit increases the demand for foreign exchange.
Causes of deficit in the Balance of Payments
• Fall In Export Demand
• Growth Of Population
• Change in foreign Exchange Rate
• Huge International Borrowings
• Developmental Expenditures
• Demonstration Effect
 Correcting
Disequilibrium
• Monetary Policy- Restricting credit by
increasing bank rates which raises exports &
reduces imports.
• Devaluation – Value of currency is reduced to
make exports cheaper & imports dearer.
• Exchange Control – RBI controlling the flow
of foreign currency.
• Fiscal policy – Controlling the export
promotion. Import duties(taxes) & quotas.
 BOP vs. BOT
• BOP • BOT
1. It is a broad term. 1. It is a narrow term.
2. It includes only visible items.
2. It includes all transactions
related to visible, invisible and
capital transfers.
3. It can be favourable or
3. It is always balances itself.
unfavourable.
4. BOP = Current Account + Capital 4. BOT = Net Earning on
Account + or - Balancing item Export - Net payment for imports.
( Errors and omissions) 5. Following are main factors
5. Following are main factors which affect BOT
which affect BOP a) cost of production
a) Conditions of foreign lenders. b) availability of raw materials
b) Economic policy c) Exchange rate
of Govt. d) Prices of goods manufactured at
home
c) all the factors of BOT
 Foreign
Exchange
• Foreign exchange is the mechanism by which the
currency of one country gets converted into the
currency of another country.
• The conversion of currencies is done by banks
who deal in foreign exchange.
• The rate at which one currency is converted into
another currency is the rate of exchange between
the currencies concerned.
• The banks operating at a financial center and
dealing in foreign exchange constitute the foreign
exchange market.
Types of Exchange Rates?
Spot Rate

Forward Rate

Buying & Selling Rate

Floating Exchange Rate

Fixed Exchange
Rate
 Spot Rate
• Spot rate of exchange is the rate at which foreign
exchange is made available on the spot. It is also
known as cable rate or telegraphic transfer rate
because at this rate cable or telegraphic sale and
purchase of foreign exchange can be arranged
immediately. Spot rate is the day-to-day rate of
exchange.
• The spot rate is quoted differently for buyers and
sellers.
• For example, $ 1 = Rs 15.50 for buyers and $ 1 =
Rs
15.30 for the seller. This difference is due to the
transport charges, insurance charges, dealer's
commission, etc. These costs are to be born by the
buyers
 Forward Rate:
• Forward rate of exchange is the rate at which
the future contract for foreign currency is
made. The forward exchange rate is settled
now but the actual sale and purchase of
foreign exchange occurs in future. The forward
rate is quoted at a premium or discount over
the spot rate.
 Fixed Rate:
• Fixed or pegged exchange rate refers to the system in
which the rate of exchange of a currency is fixed or
pegged in terms of gold or another currency.
• A fixed exchange rate is one, whose value is fixed
against the value of another currency (or currencies)
and is maintained by the government. The value may
be set at a precise value or within a given margin. If
market forces are pushing down the value of the
currency, the government will step in and seek to
increase its price, either by buying the currency or
raising the rate of interest.
 Flexible/floating Rate
• Flexible or floating exchange rate refers to the system in
which the rate of exchange is determined by the forces of
demand and supply in the foreign exchange market. It is
free to fluctuate according to the changes in the demand
and supply of foreign currency.
• A floating exchange rate is one which is determined by
market forces. If demand for the currency rises or the
supply decreases, the value of the currency will rise. Such a
rise is referred to as an appreciation. In contrast,
depreciation is a fall in the value of a floating exchange
rate. It can be caused by a fall in demand for the currency
or a rise in its supply
 Factors Influencing Exchange
Rate
• Impact of Inflation & Deflation
• Trends in the balance of trade
• Government Budget
• Changes in Interest rate
• Economic Growth
• Speculation
• Creditor vs Debtor Nations
• Stock Market Operations
• Demand & Supply for Foreign Exchange
Appreciation & Depreciation of Currency
• Appreciation- An increase in the value of the
domestic currency with respect to the
foreign currency.
• Importers gain from Appreciation of Domestic
currency & loose when it depreciates.
• Depreciation- A decrease in the value of the
domestic currency with respect to the
foreign currency.
• Exporters loose from appreciation and gain
from depreciation
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