4.4 economic integration

Large initial outlay to change currency (Disadvantages of a monetary union)

It costs time and funds to set up a new currency in a country. All firms need to produce new price lists and convert to the new currency. When the euro was introduced, many people complained that prices were rounded up. However, it is not clear from the evidence that the introduction of the euro added to existing uncertainty about inflation or whether it directly caused inflationary pressure.

Preferential trade agreements

Preferential trade agreements (PTAs) reduce or remove trade barriers, such as tariffs, for specific goods or services between participating countries. This is considered to be the first stage of economic integration.

Tariff escalation

Tariff escalation is a scenario where tariffs get higher as the product becomes more processed. Finished goods would have higher tariffs than semi-finished goods, which would in turn have higher tariffs than raw materials.

Exchange Rate Mechanism (ERM)

The ERM is a system for controlling the fluctuation of the value of a currency. The ERM is also a tool for evaluating possible applicants to the Eurozone.

foreign direct investments (FDIs)

The long-term investment by multinational corporations in a foreign country; involves either setting up factories and expanding their operations in the new country, or the purchase of at least a 10% share of a foreign company.

Trade creation

Trade creation occurs when trade moves from a high-cost producer to a lower-cost producer. By joining a trade agreement, a country which may not previously have been able to trade with the lower-cost producer can now trade with it as a benefit of the agreement.

fair trade

Trade that promotes equity in international trade by offering fair payment to producers in the developing world, as well as improving environmental and social standards.

Greater political stability and cooperation (Advantages of trading blocs)

When countries bond together through trade agreements, they share a mutual interest in the growth and prosperity of the whole bloc. In that sense, the improvement of one country promotes the improvement of its partners. There is a common goal that drives actions and policies towards helping each other.

Stronger bargaining power in multilateral negotiations (Advantages of trading blocs)

When countries integrate through trade agreements, they become stronger together.

Greater employment opportunities and labour mobility (Advantages of trading blocs)

Within trade blocs such as a common market, factors of production are free to move around without restrictions or barriers. That includes labour. So, in practical terms, workers could work and live in any country within the common market. This free movement allows nations to become more efficient because workers and companies have many more options to find the best fit for their skills and preferences. If one country has higher rates of unemployment, such as Greece (16% in Feb of 2020), workers can migrate to other countries in the EU, where there might be more opportunities for employment.

The main goal of the World Trade Organization (WTO)

to improve and broaden international trade by setting rules and practices to achieve greater balance and transparency in trade negotiations among countries.

In order to be part of the Eurozone, countries have to meet certain conditions

-(Convergence criteria) -related to levels of budget deficits, national debt, interest rates, exchange rates and inflation. In addition, countries would have to forgo their own ability to control national monetary policies. The ECB is responsible for the monetary policy decisions for all members, including the money supply and interest rates.

Reduction of uncertainties (Advantages of forming a monetary union)

-A common currency also eliminates the uncertainties that come with multiple currencies fluctuating in value in relation to other currencies -A major reason for the currency stability is the European Exchange Rate Mechanism (ERM), which has been updated to ERM II. The ERM II is part of the system responsible for adjusting European currencies and integrating EU members into the Eurozone.

Access to markets and the benefits of economies of scale (Advantages of trading blocs)

-A country that joins an economic bloc would have access to the markets of the whole bloc. This would increase the number of consumers for its domestic companies. This increase in demand could push national companies to increase exports and could promote economic growth. By producing more, those companies would have to hire more workers and invest in all sorts of productive capital. -If the market is big enough, firms may also be able to take advantage of economies of scale, which is one of the most significant benefits of a trading bloc. Economies of scale decrease the average cost of production. -Gaining access to new markets and new production opportunities will allow firms to benefit from economies of scale. This is when a firm can lower average total costs in the long run with expansion. With at least one factor of production fixed in the short run (a firm's market can only be so big if limited to one country), at some point it may start to experience diminishing marginal returns.

Monetary union

-A monetary union (also called a currency union) is created when countries form a trading bloc in which there is free trade, a common external policy, free movement of factors of production and a shared currency.

multilateral trade agreement

-A preferential trade agreement (PTA) related to the reduction or removal of tariffs for specific goods or services among more than two participating countries. -Often, trade agreements are put in place with the aim of eventually forming stronger relationships, and becoming a free trade area, as the world moves closer to freer trade under the rules of the World Trade Organization (WTO).

Bilateral trade agreement

-A preferential trade agreement (PTA) related to the reduction or removal of trade barriers for specific goods or services between the participating countries. -in which two countries agree to engage in freer trade. The term 'freer trade' means that the countries agree to reduce or even remove tariffs for certain products, but not for all products and services.

Trading bloc

-A trading bloc is an agreement between nations to form a region in which trade and cooperation take place more freely. One key objective is to increase economic efficiency by increasing competition between producers in the region. -A trading bloc is a closer level of economic integration than the PTAs

Notifications of regional trade agreements (RTAs)

-All members of the World Trade Organization (WTO) must notify the WTO of any RTAs which they participate in. This includes the addition of new countries to already existing trade agreements, such as when Croatia entered the European Union customs union in 2013.

Common market

-An area of economic integration that allows nations to trade freely with each other, set a common external policy and allow free movement of factors of production between member states. -The physical, technical and fiscal barriers between countries need to be removed as much as possible for a common market to work properly. First, people need to be able to move freely across borders between countries. -Second, standards should be synchronised between countries to allow capital and labour to move freely across borders. Production regulations should also be standardised so that goods can be sold anywhere within the common market, and companies applying for patents should not have to do so in all the countries within this type of trading bloc.

The World Bank

-An international organisation focused on fighting world poverty by providing developmental assistance to poorer nations.

The International Monetary Fund (IMF)

-An international organisation that aims to promote global economic growth and financial stability, encourage international trade and reduce poverty.

Political difficulties (Disadvantages of a monetary union)

-Any kind of joint decision-making is likely to be difficult when there are many different nations involved. In the case of the Eurozone, there are 19 very different countries, with vastly differing economies, trying to jointly manage a currency. Managing the currency is unproblematic if the economic experience of the countries does not vary too much. However, if some countries need to loosen monetary policies while others do not, or vice versa, there will be disagreements. In addition, some countries within the Eurozone, such as Germany and France, have more bargaining power than others. -Governments also differ in ideology, depending on the political parties in charge at any given moment. -Finally, there is a big distance between the decision-making process at the top of the organisation and ordinary voters in each member nation. Polling indicates that some people feel decisions are being made that they did not vote for. This is also a problem for the European Union and the running of the EU parliament.

Loss of control over monetary policy (Disadvantages of a monetary union)

-Decisions that would usually be made by the national central bank are made by the central bank of the monetary union. In the case of the euro, the European Central Bank (ECB) sets monetary policy for all countries in agreement with the national central banks. It is a major task to set a base rate that is appropriate for all countries. -The financial difficulties Greece has faced have led many to question whether it would be safe for countries to give up control of their monetary policy and move towards greater integration.

The difficulties of engaging in multilateral trade negotiations (Disadvantages of trading blocs)

-Due to the differences among countries, it may be difficult to find common ground when attempting to close trade deals. Think of how widely political, social, cultural, historical and economic characteristics might vary between countries in a trading bloc. -On the one hand, those differences may be a key driver to move the trade deal forward. Consider the relationship between Mexico and the US. They are quite different, but they are complementary partners. The US imports vegetables and fruit from Mexico, and Mexico imports meat, oilseeds and grains from the US. -On the other hand, those differences can be an obstacle to closing the deal. -The gains from joining a trade bloc can be very different for each of its members. Those differences can be a source of disputes, especially as there are also likely to be various stakeholders within each country, who would be impacted in different ways based on the outcomes of trade deals. -Trade blocs can also be a threat to global trade liberalisation. Different trade blocs may try to defend the best interest of their members, while at the same time imposing barriers on non-member countries. Disputes between major trading blocs could also potentially undermine the efforts of the WTO.

There are four types of trading blocs

-Free trade areas -Customs unions -Common markets -Monetary unions

Free trade areas/agreements

-Free trade areas (FTAs) are formed by a trading bloc of countries signing trade agreements to remove most or all barriers to trade with the other countries involved in the agreement. Countries are free to set their own external policy towards non-member countries. This is the most common type of trading bloc.

Advantages of trading blocs

-Greater access to markets and the potential benefit from economies of scale -Greater employment opportunities with labour mobility -Stronger bargaining power in multilateral negotiations -Greater political stability and cooperation

Stronger relations between countries (Advantages of forming a monetary union)

-Having to jointly negotiate issues regularly, and in a formal parliamentary way, will force countries to build closer ties with each other. Even though the political atmosphere may sometimes be difficult, countries taking part in open discussion will always be a good thing for stability, both politically and economically.

Restrictions on the use of fiscal policy (Disadvantages of a monetary union)

-In 1992, when the Maastricht Treaty was signed, countries agreed to limit government deficits to 3% of GDP and public debt levels to 60%. The Stability and Growth Pact (SGP), put together a year later, set out the rules for national fiscal policy for both Eurozone and non-Eurozone EU member states. Countries face a fine of 0.2% of GDP if they fail to abide by the rules, or 0.5% of GDP if they break the rules repeatedly. Countries also stand to lose out on other opportunities, such as the European Regional Development Fund. -If a country in the Eurozone enters a recession, it cannot implement independent monetary policies, as the ECB determines monetary policy. Eurozone countries can still enact their expansionary fiscal policies, but if the country is already in debt, it is unlikely that the criteria of the Stability and Growth Pact (SGP) will be met.

Loss of sovereignty (Disadvantages of trading blocs)

-In highly integrated trading blocs such as monetary unions, countries lose their ability to control their own monetary policies. In a monetary union, countries forgo their autonomy to control interest rates and their own currencies -Individual countries within the Eurozone lose not only the ability to adjust their economy through monetary policies, but also the ability to manipulate the value of their own currency. A country may also lose a sense of identity by forgoing its national currency, with all the history and culture that it represents.

Prior to the formation of the Eurozone, the countries who wanted to participate had to abide by 'convergence criteria' in managing their economies. These included:

-Keeping inflation at no more than 1.5% above the average of the three lowest rates among EU members -Maintaining exchange rate stability within the Exchange Rate Mechanism (ERM) bands for two years prior to joining -Ensuring that the government budget deficit was no greater than 3% of GDP and that the national debt was no more than 60% of GDP -Maintaining interest rates no more than 2% above the average rate of the three EU member countries with the lowest rates

Disadvantages of trading blocs

-Loss of sovereignty -The difficulties of engaging in multilateral trade negotiations

Power imbalances (What affects the influence of the WTO?)

-MDCs usually send large groups of trade specialists and negotiators to work on trade agreements, while LDCs struggle to send any representatives to the rounds of negotiation. -This has led to claims that many trade agreements favour MDCs and that the LDCs' representatives have not even been consulted. -Trade blocs such as the EU have significant power when negotiating trade deals. The sheer size of its combined economy (USD 18.2 trillion in 2019, according to the IMF) may tilt the balance in any negotiation it has with individual countries.

Trade disagreements (What affects the influence of the WTO?)

-Many of the issues related to trade disagreements are linked to agricultural subsidies in the developed world and tariff escalation in developing countries. -On the one hand, more developed countries (MDCs), in general, have higher levels of support for agriculture than less developed countries (LDCs). -On the other hand, historically there has been a drastic decline in the level of agricultural export subsidies among the MDC member nations of the WTO. Also, in general MDCs have a lower level of tariffs for all goods in comparison to LDCs. -Tariff escalation is a practice used by developed nations when importing raw materials and semi-processed goods from developing countries. The tariffs become higher the more processed the product is. So raw materials have lower tariffs than semi-processed goods, which in turn have lower tariffs than processed goods. -This scenario creates a situation where the developing countries end up being stuck producing raw materials and semi-processed goods, which usually generate lower levels of revenue. This situation discourages LDCs from improving their industries and receiving higher revenues for their exports.

New technology (Factors that contribute to globalisation)

-New technology is making international trade and communication much easier. The internet allows information to be shared and firms to operate on a global scale even if they are relatively small. -Another significant technological improvement that is important for international trade is the size of container ships. Bigger ships can carry more cargo and reduce the cost of transportation. This can help a firm to achieve economies of scale. There has been a dramatic increase in the size of those ships.

The WTO is guided by the following set of principles

-Non-discrimination: this principle is applied to higher and lower income countries, but not to trading blocs -Openness of trade: this should be achieved by lowering all trade barriers among nations -Predictability and transparency: all stakeholders should trust that negotiations are not led arbitrarily -Promotion of fair competition: this principle attempts to assess the fairness of trade transactions and guide responses -Privileging less developed countries: this is aimed at improving equity between more developed countries (MDC) and less developed countries (LDC) -Protecting the environment: initiatives should have the environment at heart including public health, animal health and plant health

Custom unions pros and cons

-On the one hand, members of a customs union may enjoy greater efficiency, an increased variety of goods and services, and possibly lower prices and higher employment within the economies of the customs union. -On the other hand, all members of a customs union must apply the same trade barriers to non-member nations. This might 'divert' trade from more efficient countries which are not part of the customs union but which could produce goods cheaper and more efficiently.

A more competitive business environment (Advantages of forming a monetary union)

-One of the main purposes of closer ties between countries - whether in the form of a preferential trade agreement, a free trade area, a customs union or a monetary union - is to develop a more competitive business environment. Some inefficient firms may struggle to cope with the new environment, but many others will thrive, providing an opportunity for them and the wider economy to achieve economic efficiency and growth. -A monetary union provides closer economic ties, which will enable firms to develop trading and investment opportunities as well as achieving greater economies of scale by being able to access a much larger market. -There will be lower transaction costs as firms do not have to pay commission every time currencies are converted and they do not have to reprint their catalogues to convert prices for every country they operate in. -In addition, there will be greater price transparency as everybody is familiar with the same currency. Price comparisons can easily be made and firms will be encouraged to compete more directly with each other, leading to a more efficient production process.

The disadvantages of monetary unions may be summarised as

-Political difficulties -Loss of control over monetary policy -Restrictions on the use of fiscal policy -Large initial outlay to change currency

The advantages of monetary unions may be summarised as

-Price stability -Reduction of uncertainties -More competitive business environment -Stronger relations between countries -Stronger position in global trade

The rise of free-market economics (Factors that contribute to globalisation)

-Since the 1980s, the benefits of the free market have been increasingly recognised and have become the dominant view. The incentives provided by the price mechanism will enhance economic growth as individuals are encouraged to work harder and resources are used in the most efficient way. -However, critics would argue that the basis of the free market is greed, which encourages exploitation, and not all problems can be resolved by the price mechanism. Where markets fail on a global level, such as environmental issues or the dominance of large MNCs in world trade, the principle that the free market provides the same benefits for all may not be accurate.3

The International Monetary Fund (IMF) and the World Bank (Factors that contribute to globalisation)

-The IMF and the World Bank actively promote globalisation, and they are an important influence on the economic direction that world economies take, particularly in the developing world. -On the one hand they provide financial assistance and advice to countries, but on the other, in order to receive that assistance, countries are often forced to liberalise their markets.

Reduced trade barriers, increased trade and competition (Factors that contribute to globalisation)

-The WTO is responsible for promoting world trade by encouraging reductions in trade barriers, although it has been accused of being dominated by the rich, industrialised countries. -Critics would argue that it is fair trade and not free trade that many developing countries need. Removing trade barriers increases imports to a country. Usually, those imports would be higher quality and have lower prices in comparison to domestic production. -On the one hand, if the industries within a country are not ready to compete with those foreign products, there is a possibility of those domestic companies shutting down. -On the other hand, if domestic industries are able to compete, the imported products would push companies to improve their production efficiency and move the industry forward. This healthy level of competition would benefit consumers by providing them with higher-quality and more varied products at lower prices.

Factors that contribute to globalisation

-The rise of free-market economics -Reduced trade barriers, increased trade and competition -Multinational corporations (MNCs) -New technology -The International Monetary Fund (IMF) and the World Bank

Multinational corporations (MNCs) (Factors that contribute to globalisation)

-There has been significant growth of multinational corporations. MNCs are companies that have production facilities in more than one country. Investment by MNCs around the world has enabled them to exploit the cheapest resources and produce on a large scale to reduce average costs. The jobs created have provided a boost to the domestic economy and the resulting trade has further enhanced the dynamic benefits of these organisations. -However, critics would argue that MNCs are powerful enough to exploit the country where production is happening, profits are repatriated, the jobs created are low-paid, and there is little respect for the environment.

Price stability (Advantages of forming a monetary union)

-This is a key benefit that is gained from the process of joining together in a single currency, and the need for economic consistency amongst the member countries once the currency has been launched.

What affects the influence of the WTO?

-Trade disagreements -Power imbalances

Trade diversion

-Trade diversion occurs when, by joining a trade agreement, a country moves its trade from a low-cost producer to a high-cost producer. This may be the result of protectionist barriers against the low-cost producer that are included in the agreement.

RTA

-When trade agreements are made between countries that are geographically close to each other we call them regional trade agreements (RTAs). RTAs include PTAs as well as other agreements with higher levels of integration. -RTAs are becoming ever more significant and complex in world trade today. There were less than thirty trade agreements in force in 1990. By 2019 there were more than 300 in force. Negotiations for trade agreements today go beyond tariffs and may also include intellectual property rights, human rights, environmental policies and more. This new complexity helps countries to redefine the rules of economic cooperation. The direct benefits include improvements in social welfare, increased international cooperation, foreign direct investments (FDIs) and economic growth.

According to the WTO website, the functions of the organisation are:

-administering and monitoring the application of WTO trade agreements -acting as a forum for trade negotiations -settling trade disputes -monitoring national trade policies -providing technical assistance and training for developing countries -cooperating with other international organisations

World Trade Organization (WTO)

A global international organisation focused on improving free trade by providing a medium for trade negotiations and acting as a moderator for trade disputes.

monetary agreements

A treaty signed by two or more countries with the intention of regulating and coordinating currencies and financial interactions.

Customs unions

An area of economic integration created via an agreement between nations to both trade freely among each other and set a common external policy towards non-member countries.

Embargo

An embargo is a restriction on trade imposed by a foreign country. It could be set on a product or even as a ban on an entire nation.

A stronger position in global trade (Advantages of forming a monetary union)

As a single currency area, the Eurozone is the world's third biggest economy, with almost 12 trillion USD worth of nominal GDP in 2019. This represents a sizeable contribution to the global economy and is a huge potential market for firms from other countries to operate in.

For the World Trade Organization (WTO), PTAs are considered to be

For the World Trade Organization (WTO), PTAs are considered to be unilateral or non-reciprocal preferential schemes. That means that one country provides preferential tariff reductions for another country without receiving the same treatment in return.