Transcript Global Business Today, 5e

chapter
8
Regional Economic
Integration
McGraw-Hill/Irwin
Global Business Today, 5e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Chapter 8: Regional
Economic Integration
INTRODUCTION
Regional economic integration refers to agreements between
countries in a geographic region to reduce tariff and nontariff
barriers to the free flow of goods, services, and factors of
production between each other.
While regional trade agreements are designed to promote free
trade, there is some concern that the world is moving toward a
situation in which a number of regional trade blocks compete
against each other.
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LEVELS OF ECONOMIC INTEGRATION
There are five levels of economic integration.
• In a free trade area all barriers to the trade of goods and
services among member countries are removed, but members
determine their own trade policies with regard to nonmembers
• Examples of free trade areas include the European Free Trade
Association (between Norway, Iceland, Liechtenstein, and
Switzerland), and the North American Free Trade Agreement
(between the U.S., Canada, and Mexico)
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The different levels of economic integration are shown in Figure
8.1.
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• The customs union is one step further along the road to full
economic and political integration, and eliminates trade barriers
between member countries and adopts a common external trade
policy
• The Andean Pact (between Bolivia, Columbia, Ecuador and
Peru) is an example of a customs union
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• The common market has no barriers to trade between member
countries, a common external trade policy, and the free
movement of the factors of production
• MERCOSUR (between Brazil, Argentina, Paraguay, and
Uruguay) is aiming for common market status
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• An economic union involves the free flow of products and
factors of production between members, the adoption of a
common external trade policy, and in addition, a common
currency, harmonization of the member countries’ tax rates, and a
common monetary and fiscal policy
• The European Union (EU) is an economic union, although an
imperfect one since not all members of the EU have adopted the
euro, and differences in tax rates across countries still remain
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• In a political union, independent states are combined into a
single union
• The EU is headed toward at least partial political union, and the
United States is an example of even closer political union
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Classroom Performance System
In a _______, all barriers to the free flow of goods and services
between member countries are removed, and a common policy
toward nonmembers is established.
a) Free trade area
b) Customs union
c) Common market
d) Economic union
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Classroom Performance System
The European Union is an example of a(n)
a) Free trade area
b) Customs union
c) Common market
d) Economic union
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THE CASE FOR REGIONAL INTEGRATION
The Economic Case for Integration
• Regional economic integration is an attempt to achieve
additional gains from the free flow of trade and investment
between countries beyond those attainable under international
agreements such as the WTO
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The Political Case for Integration
The political case for integration has two main points:
• by linking countries together, making them more dependent on
each other, and forming a structure where they regularly have to
interact, the likelihood of violent conflict and war will decrease
• by linking countries together, they have greater clout and are
politically much stronger in dealing with other nations
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Impediments to Integration
There are two main impediments to integration:
• while a nation as a whole may benefit from a regional free trade
agreement, certain groups may lose
• concerns over the loss of national sovereignty
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THE CASE AGAINST REGIONAL INTEGRATION
• Regional economic integration only makes sense when the
amount of trade it creates exceeds the amount it diverts
• Trade creation occurs when low cost producers within the free
trade area replace high cost domestic producers
• Trade diversion occurs when higher cost suppliers within the
free trade area replace lower cost external suppliers
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REGIONAL ECONOMIC INTEGRATION IN EUROPE
Evolution of the European Union
The EU is the result of:
• the devastation of two world wars on Western Europe and the
desire for a lasting peace
• the desire by the European nations to hold their own on the
world’s political and economic stage
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The evolution of the European Union is shown in Map 8.1.
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• The forerunner of the EU was the European Coal and Steel
Community, which had the goal of removing barriers to trade in
coal, iron, steel, and scrap metal formed in 1951
• The European Economic Community was formed in 1957 at the
Treaty of Rome with the goal of becoming a common market
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Political Structure of the European Union
The five main institutions of the EU are:
• the European Council (resolves major policy issues and sets policy
directions)
• the European Commission (responsible for implementing aspects of EU law
and monitoring member states to ensure they are complying with EU laws)
• the Council of the European Parliament (the ultimate controlling authority
within the EU)
• the European Parliament (debates legislation proposed by the commission
and forwarded to it by the council)
• the Court of Justice (the supreme appeals court for EU law)
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The Single European Act
• The Single European Act, adopted by the EU member nations in
1987, committed the EC countries to work toward establishment
of a single market by December 31, 1992
The Stimulus for the Single European Act
• The Single European Act was born out of frustration among EC
members that the community was not living up to its promise
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The Objectives of the Act
• frontier controls to remove all frontier controls between EC
countries
• mutual recognition of standards to apply the principle of
“mutual recognition,” which is that a standard developed in one
EC country should be accepted in another, provided it meets basic
requirements in such matters as health and safety
• public procurement to open procurement to non-national
suppliers
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• financial services to lift barriers to competition in the retail
banking and insurance businesses
• exchange controls to remove all restrictions on foreign
exchange transactions between members by the end of 1992
• freight transport to abolish restrictions on sabotage, the right of
foreign truckers to pick up and deliver goods within another
member’s borders, by the end of 1992
• supply-side effects should lower the costs of doing business in
the EC, but the single-market program is also expected to have
more complicated supply-side effects
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Impact
• The Single European Act provided the impetus for the
restructuring of substantial sections of European industry
allowing for faster economic growth than would otherwise have
been the case
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The Establishment of the Euro
• The Treaty of Maastricht, signed in 1991, committed the EU to adopt a single
currency, the euro, by January 1, 1999
• The euro is used by 12 of the 25 member states
• By adopting the euro, the EU has created the second largest currency zone in
the world after that of the U.S. dollar
• For now, three EU countries, Britain, Denmark and Sweden, are opting out of
the euro-zone
• Euro notes and coins were issued on January 1st, 2002 (in the interim,
national currencies circulated, and were worth a defined amount of euros)
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Benefits of Euro
• Businesses and individuals should realize significant savings
from having to handle one currency, rather than many
• The adoption of a common currency will make it easier to
compare prices across Europe
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• Faced with lower prices European producers will be forced to
look for ways to reduce their production costs in order to
maintain their profit margins
• The introduction of a common currency should give a strong
boost to the development of highly liquid pan-European capital
market
• The development of a pan-European euro denominated capital
market will increase the range of investment options open both to
individuals and institutions
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Costs of Euro
• A drawback of a single currency is that national authorities lose
control over the monetary policy
• The Maastricht treaty called for the establishment of an
independent European central bank (ECB) with a clear mandate
to manage monetary policy so as to ensure price stability
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• The ECB sets interest rates and determines monetary policy
across the euro-zone
• Another drawback of the Euro is that the EU is not an optimal
currency area (an area where similarities in the underlying
structure if economic activities make it feasible to adopt a single
currency and use a single exchange rate as an instrument of
macro-economic policy)
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The Early Experience
• Since its establishment January 1, 1999, the euro has had a
volatile trading history with the U.S. dollar
• Initially, the euro fell in value relative to the dollar, but
strengthened to a five year high of $1.33 in March 2005
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Enlargement of the European Union
• Many countries, particularly from Eastern Europe, have applied
for membership in the EU
• Ten countries joined on May 1, 2004 expanding the EU to 25
states, with population of 450 million people, and a single
continental economy with a GDP of €11 trillion
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Classroom Performance System
The ultimate decision making body of the European Union is the
a) Council of the European Union
b) European Parliament
c) Court of Justice
d) European Commission
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REGIONAL ECONOMIC INTEGRATION IN THE
AMERICAS
Regional economic integration is on the rise in the Americas.
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Regional economic integration in the Americas is shown in Map 8.2.
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The North American Free Trade Agreement (NAFTA)
NAFTA’s Contents
• The free trade agreement between the United States, Canada, and Mexico
became law January 1, 1994
• NAFTA abolished tariffs on 99 percent of the goods traded between Mexico,
Canada, and the United States, removed most barriers on the cross-border flow
of services, protects intellectual property rights, removes most restrictions on
FDI between the three member countries, allows each country to apply its own
environmental standards, provided such standards have a scientific base,
establishes two commissions to impose fines and remove trade privileges when
environmental standards or legislation involving health and safety, minimum
wages, or child labor are ignored
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The Case for NAFTA
Proponents of NAFTA have argued that it will provide economic gains to all
countries:
• Mexico will benefit from increased jobs as low cost production moves south,
and will attain more rapid economic growth as a result
• The U.S. and Canada will benefit from the access to a large and increasingly
prosperous market and from the lower prices for consumers from goods
produced in Mexico
• In addition, U.S. and Canadian firms with production sites in Mexico will be
more competitive on world markets
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The Case against NAFTA
Opponents of NAFTA argued:
• that jobs would be lost and wage levels would decline in the
U.S. and Canada
• Mexican workers would emigrate north
• pollution would increase due to Mexico's more lax standards
• Mexico would lose its sovereignty
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NAFTA: The Results so Far
• Studies of NAFTA’s early impact suggest that both advocates
and detractors may have been guilty of exaggeration
• The agreement has helped to create the background for
increased political stability in Mexico
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Enlargement
• Several other Latin American countries have indicated their
desire to eventually join NAFTA
• Currently both Canada and the U.S. are adopting a wait and see
attitude with regard to most countries
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Classroom Performance System
Studies show that after its first decade,
a) There was a small net gain of jobs in the U.S.
b) Exports from the U.S. failed to grow
c) NAFTA’s overall impact has been significant
d) The U.S., Canada, and Mexico all experienced a decrease in
productivity
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The Andean Community
• The Andean Pact, originally formed in 1969, was based on the
EU model
• By the mid-1980s, the Andean Pact had more or less failed
• In the late 1980s, Latin American governments began to adopt
free market economic policies
• In 1990, the Andean Pact was re-launched, and now operates as
a customs union
• In 2003, it signed an agreement with MERCOSUR to restart
negotiations towards the creation of a free trade area
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MERCOSUR
• MERCOSUR originated in 1988 as a free trade pact between
Brazil and Argentina
• In 1990, it was expanded to include Paraguay and Uruguay
• MERCOSUR has been making progress on reducing trade
barriers between member states
• Given some fairly high tariffs for goods from other countries, it
appears that in some industries, MERCOSUR is diverting trade
rather than creating trade, and local firms are investing in
industries that are not competitive on a worldwide basis
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Central American Common Market and CARICOM
There are two other trade pacts in the Americas:
• the Central American Trade Market
• CARICOM
Neither has made much progress yet.
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Free Trade of the Americas
• Talks began in April 1998 to establish a FTAA (Free Trade of
The Americas) by 2005
• If the FTAA is established, it will have major implications for
cross-border trade and investment flows within the hemisphere
• The FTAA would create a free trade area of nearly 800 million
people
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REGIONAL ECONOMIC INTEGRATION ELSEWHERE
Association of Southeast Asian Nations
• Formed in 1967, ASEAN currently includes Brunei, Indonesia, Malaysia, the
Philippines, Singapore, Thailand, and, most recently, Vietnam, Myanmar,
Laos, and Cambodia
• The basic objectives of ASEAN are to foster freer trade between member
countries and to achieve some cooperation in their industrial policies
• In 2003, an ASEAN Free trade Area (AFTA) between the six original
members of ASEAN came into full effect with a goal of reducing import tariffs
among the older members to zero by 2010, and for newer members by 2015
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Asian Pacific Economic Cooperation (APEC)
• APEC currently has 21 members including the United States,
Japan, and China
• The stated aim of APEC is to increase multilateral cooperation
in view of the economic rise of the Pacific nations and the
growing interdependence within the region
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Regional Trade Blocs in Africa
• There are nine trade blocs on the African continent, however
progress toward the establishment of meaningful trade blocs has
been slow
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IMPLICATIONS FOR MANAGERS
Opportunities
• Markets that were formerly protected from foreign competition
are opened
• The free movement of goods across borders, the harmonization
of product standards, and the simplification of tax regimes, makes
it possible for firms to realize potentially enormous cost
economies by centralizing production in those locations where
the mix of factor costs and skills is optimal
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Threats
• The business environment becomes competitive
• For non-EU and/or non-North American firms, challenges arise
from the likely long-term improvements in the competitive
position of many European and North American companies
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• There is a risk of being shut out of the single market by the
creation of a “trade fortress”
• Firms may be limited in their ability to pursue the strategy of
their choice in the EU as the EU continues to increase its role in
competition policy and intervene and impose conditions on
companies proposing mergers and acquisitions
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CRITICAL THINKING AND DISCUSSION QUESTIONS
1. NAFTA has produced significant net benefits for the Canadian,
Mexican, and U.S. economy. Discuss.
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CRITICAL THINKING AND DISCUSSION QUESTIONS
2. What are the economic and political arguments for regional
economic integration? Given these arguments, why don’t we see
more substantial examples of integration in the world economy?
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CRITICAL THINKING AND DISCUSSION QUESTIONS
3. What effect is creation of a single market and a single currency
within the EU likely to have on competition within the EU?
Why?
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CRITICAL THINKING AND DISCUSSION QUESTIONS
4. Do you think it is correct for the European Commission to
restrict mergers between American companies that do business in
Europe? (For example, the European Commission vetoed the
proposed merger between WorldCom and Sprint, both U.S.
companies, and it carefully reviewed the merger between AOL
and TimeWarner, again both U.S. companies.)
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CRITICAL THINKING AND DISCUSSION QUESTIONS
5. How should a U.S. business firm that currently only exports to
ASEAN countries respond to the creation of a single market in
this regional grouping?
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CRITICAL THINKING AND DISCUSSION QUESTIONS
6. How should a firm that has self-sufficient production facilities
to in several ASEAN countries respond to the creation of a single
market? What are the constraints on its ability to respond in a
manner that minimizes production costs?
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CRITICAL THINKING AND DISCUSSION QUESTIONS
7. After a promising start, in the last few years, MERCOSUR,
the major Latin American trade agreement, has faltered and made
little progress since 2000. What problems are hurting
MERCOSUR? What can be done to solve these problems?
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CRITICAL THINKING AND DISCUSSION QUESTIONS
8. Would the establishment of a Free Trade Area of the Americas
(FTAA) in 2005 be good for the two most advanced economies of
the hemisphere, the United States and Canada? How might the
establishment of the FTAA impact the strategy of North
American firms?
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