International Business

Sixteenth Edition, Global Edition

Chapter 7
Economic Integration
and Cooperation
 Learning Objectives (1 of 2)
7-1 Define the three major types of international
economic integration
7-2 Explain what the World Trade Organization is
and how it is working to reduce trade barriers
on a global basis
7-3 Summarize the major benefits of regional
economic integration

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 Learning Objectives (2 of 2)
7-4 Compare and contrast different regional
trading groups
7-5 Describe the forces that affect the prices of
commodities and their impact on commodity
agreements

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 What is Economic Integratio
Objective 7-1
• Economic Integration Definition
• Major ways to approach agreements
– Global integration
– Bilateral integration
– Regional integration

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Regional Trade Agreements
• Trade agreements between two or more countries that reduce trade
barriers for countries involved
• Reduction of trade barriers in them are discriminatory
• Amount of trade between countries is reduced, but countries not
part of agreement lose some trade

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Types of Agreements
• One side is an agreement that has limited reduction in trade
barriers between the countries
• Other end is an agreement that causes countries to act as if the
group was one distinct country in every economic respect

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Levels of Integration
1. Tariffs abolished on a limited number of commodities
– Preferential trade agreement
– Illegal under rules of WTO
 WTO requires trade barriers to be lifted on “substantially all”
of trade between countries
– Waivers can be granted
 1962 US-Canadian Agreement on Trade in Automobiles and
Parts

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Levels of Integration
2. Free-trade area - FTA
– Countries agree to eliminate tariffs and other non-tariff barriers
between them
– Again must cover “substantially all” trade
 May just cover non-agricultural products
 May cover all merchandise trade
 May cover all trade in goods/services, foreign direct/portfolio
investment

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Levels of Integration
2. Free Trade Area -FTA (cont.)
– Country maintains own separate national tariff schedule
– Trade deflation may occur – diversion of exports to a country with in a
FTA that has lower tariffs on a good
– Can lead to establishment of “screwdriver plants”
 Plants designed to provide minor assembly work produced in “foreign country” but
within FTA

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Levels of Integration
2. FTA (cont.)
– Rules of origin
 Duty free treatment requires certain percent of value added
performed in a member country
– Phased in over time
 May take many years to establish
 Signed agreement does not mean instant free trade like
between states

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Levels of Integration
3. Customs union
– Agreement between countries to maintain a free trade area
and a common external tariff
– Common external tariff – each country replace national tariff
schedule with common tariff schedule applicable to all member
countries
 US exporting to EU faces one tariff schedule

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Levels of Integration
3. Customs Union (cont.)
– Takes time for nation schedules to harmonize with common
external tariff
– Not all free trade areas include trade in agricultural products,
services and financial flows
– Level of economic integration is usually “deeper” than that
implied by FTA

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Levels of Integration
4. Common Market
– Capital and labor are free to move within member countries
– More efficient allocation of capital
– More efficient allocation of human capital
– Large wage differentials may induce large amount of migration
– noticeable effect on national wage rates
– Problems with common regulations

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Levels of Integration
5. Economic Union
– Maintain
 FTA
 Common external tariff
 Free mobility of capital and labor
 Some degree of unification in government policies and
monetary policies
– Requires common currency
 Common Central Bank

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Levels of Integration
5. Economic Union
– Each national government must align national policies with
other member countries
 Tax rates
 Antitrust law
 Labor regulations
 Environmental regulations, etc.

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Trade Effects of Integration
• Trade Creation (TC)
– Increase in trade between two countries from mutual elimination
of tariffs
– If Mexico and US eliminate tariffs to each other, US will import
more from Mexico and vice versa
• Losses to other countries as trade shifts from them to member
countries

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Trade Effects of Integration
• Trade Diversion (TD)
– Export losses to other countries
– US will import from Mexico instead of from other countries
– The larger the tariff before the agreement, the larger the loss to
other countries
• Change in world trade depends on larger effect: trade creation or
diversion

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Economic Effects - Example

Before NAFTA
US Exporter Other Exporter
Import Price to $24,000 $21,600
Mexico 20% Tariff 20% Tariff
After NAFTA
Import Price to $20,000 $21,600
Mexico 0% Tariff 20% Tariff

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Economic Effects - Example
• Mexico purchased cars from other countries at lower price before
NAFTA
• After NAFTA, shifted purchases to US
• US is less efficient producer – cost of production higher
• Trade is diverted from more efficient producers to less efficient
producers
– Yields losses in world output

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Price of Cars – Trade Agreement

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Economic Impacts
• To receive exception for free trade area or customs union
– Must show level of protection would not be higher on average for
an area than before agreement
– Trade creation would be larger than trade diversion
• Losses still exist in countries outside agreement

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Economic Impacts
• Number of free trade areas and customs unions rising quickly
• New agreements increase world welfare but increase trade
diversion
• May create problems for companies doing business in many
different markets

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NAFTA
• North American Free Trade Agreement
– Sets up free trade area between US, Canada, and Mexico
– Straight forward trade agreement
– Economic effect relatively small
– Signed in 1989

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 NAFTA History
• 1989 free trade agreement signed by Canada and US
– Tariff reductions phased in over 10 years
– Covered trade in goods and services, investment
– Eliminated national preference on most government contracts
– Freed US and Canada from last restrictions

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NAFTA History
• 1992 - Canada, US and Mexico agreed to broaden free trade area
• Tariff reduction phased in over 15 year period
• Covers all merchandise trade, services, investment, and intellectual
property rights
• Trade disputes adjudicated by 5-member panel
• Agreement for each country to enforce its own labor and
environmental laws

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NAFTA Effects
• Gives Canada unrestricted access to larger market
• Long run appeal to US and Canada
– Mexico economy growing much faster than US or Canada
– Mexican tariffs were much higher before trade agreement

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NAFTA Effects
• Benefits for Mexico
– Access to world’s two largest markets
– Help advance export-led growth
– Attract investment capital country needed
– Make Mexico’s economic reform process since 1980’s
permanent

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NAFTA Future
• Chile has signed free trade agreement with Mexico and Canada
• Adding Chile to NAFTA being debated
• US committed to free trade within Western Hemisphere by 2005

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 GATT: Predecessor to WTO
Objective 7-2
• GATT
– General Agreement on Tariffs and Trade
• Trade without Discrimination
– Fundamental principle

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 The WTO
Objective 7-2
• WTO
– World Trade Organization
– Purpose
• WTO and “most favored nation clause”
• WTO and Dispute Settlement

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 The Impact of Trade Agreement
Objective 7-3
Figure 7.1 Impact of Free Trade Agreements

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 The European Union (EU)
Objective 7-4
• The goals of the EU
• Why the EU?
• Governing bodies of the EU

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 Other Aspects of the EU
Objective 7-4
• Antitrust Investigations
• Monetary Union
• Schengen Area
• Expansion
• Bilateral Agreements
• Transatlantic Trade and Investment Partnership

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 The European Union Countrie
Objective 7-4
Map 7.1 European Trade and Economic Integration

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 Economic Integration in Caribbe
Objective 7-4 Central America
Map 7.2 Economic Integration in Central America and the Caribbean

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 CARICOM
Objective 7-4
Map 7.2 Economic Integration in Central America and the Caribbean

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 Economic Integration in Latin Amer
Objective 7-4
Map 7.3 Latin American Economic Integration

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 Economic Integration: MERCO
Pacific Alliance and CAN
Objective 7-4
• What is Mercosur?
• What is the Pacific Alliance?
• What is CAN?

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 Asia’s Economic Integration Agree

Objective 7-4

• ASEAN Free Trade Area

• Asia Pacific Economic Cooperation (APEC)
• Trans-Pacific Partnership (TPP)

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 ASEAN Free Trade Area
Objective 7-4
Map 7.4 The Association of Southeast Asian Nations

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 Africa Regional Integration
Objective 7-4
Map 7.5 Regional Integration in Africa

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 Commodity Agreements
Objective 7-5

• What are commodities?

• Purpose of Commodities Agreements
• OPEC
– Organization of the Petroleum Exporting
Countries

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