International Business Chapter 9

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 United States and Canada will benefit from the access to a large and increasingly prosperous market and from the lower prices for consumers who buy goods produced in Mexico. In addition, U.S. and Canadian firms with production sites in Mexico will be more competitive on world markets

The Economic Case for Integration

Regional economic integration can be seen as 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 World Trade Organization.

Regional economic integration

Regional economic integration is on the rise in the Americas. The North American Free Trade Agreement (NAFTA) is the most significant attempt. Other efforts include the Andean group and MERCOSUR. In addition, there are plans to establish a hemisphere wide Free Trade Area of the Americas (FTAA.)

Several levels of economic integration

Several levels of economic integration are possible in theory. From least integrated to most integrated, they are a free trade area, a customs union, a common market, an economic union, and, finally, a full political union.

The Results so far (NAFTA)

Studies of NAFTA's impact to date suggest that its initial effects were at best muted, and both advocates and detractors may have been guilty of exaggeration. The most significant impact of NAFTA may not have been economic, but rather political. The agreement has helped to create the background for increased political stability in Mexico.

The Andean Pact

The Andean Pact, originally formed in 1969, was based on the EU model, but was far less successful in achieving its stated goals. By the mid-1980s, the Andean Pact had more or less failed. However, in the late 1980s, Latin American governments began to adopt free market economic policies, and in 1990, the Andean Pact was relaunched. The renamed Andean Community now operates as a customs union, and in 2003, it signed an agreement with MERCOSUR to restart negotiations towards the creation of a free trade area between the two trading blocs.

The Asia-Pacific Economic Cooperation (APEC)

The Asia-Pacific Economic Cooperation (APEC) currently has 21 members including such economic powerhouses as 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.

The Maastricht Treaty

The Maastricht Treaty, signed in 1991, committed the EU to adopt a single currency, the euro, by January 1, 1999. The euro is now used by 19 of the 28 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.

Impact

The Single European Act has had a significant impact on the EU economy. The 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.

Costs of the Euro

The drawback of a single currency is that national authorities lose control over monetary policy. Thus, it is crucial to ensure that the EU's monetary policy is well managed. The Maastricht treaty called for the establishment of an independent European Central Bank (ECB), similar in some respects to the U.S. Federal Reserve, with a clear mandate to manage monetary policy so as to ensure price stability. The ECB is based in Frankfurt. Like the U.S. Federal Reserve, the ECB is meant to be independent from political pressure - although critics question this. Among other things the ECB sets interest rates and determines monetary policy across the euro-zone. The implied loss of national sovereignty to the ECB underlies the decision by Britain, Denmark and Sweden to stay out of the euro-zone for the time being.

the North American Free Trade Agreement

The United States, Canada, and Mexico established the North American Free Trade Agreement (NAFTA) in 1994. -The free trade agreement between the United States, Canada, and Mexico contains the following actions: • abolishes by 2004, tariffs on 99 percent of the goods traded between Mexico, Canada, and the United States, • removes 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 with the power to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored.

An economic union

-An economic union entails even closer economic integration and cooperation than a common market. Like the common market, an economic union involves the free flow of products and factors of production between members and the adoption of a common external trade policy. Unlike a common market, a full economic union also requires 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, the currency of the EU, and differences in tax rates across countries still remain.

European Free Trade Association (EFTA)

The most enduring free trade area in the world is the European Free Trade Association (EFTA). EFTA currently joins four countries-Norway, Iceland, Liechtenstein, and Switzerland. Other free trade areas include the North American Free Trade Agreement (NAFTA).

The Political Case for Integration

The political case for integration has two main points: 1) 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, and 2) by linking countries together, they have greater clout and are politically much stronger in dealing with other nations

Opportunities

-Creation of a single market offers significant opportunities because markets that were formerly protected from foreign competition are opened. -The greatest implication for MNEs is that the free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes, makes it possible for them to realize potentially enormous cost economies by centralizing production in those locations where the mix of factor costs and skills is optimal. By specialization and the shipping of goods between locations, a much more efficient web of operations can be created. -On the other hand, even after the removal of barriers to trade and investment, enduring differences between nations in culture and competitive practices often limit the ability of companies to realize cost economies by centralizing production in key locations and producing a standardized product for a single multi-country market.

Free Trade of The Americas

-In April 1998, 34 heads of state traveled to Santiago, Chile for the second summit of the Americas where they formally inaugurated talks to establish a FTAA (Free Trade of The Americas) by 2005. While an agreement was not reached, the continuing talks have addressed a wide range of economic, political, and environmental issues related to cross-border trade and investment. -At the moment, there are two major stumbling blocks preventing an agreement. First, the United States wants the southern countries to agree to tougher enforcement of intellectual property rights and lower manufacturing tariffs. Second, Brazil and Argentina want the United States to reduce agricultural subsidies, and eliminate tariffs on agricultural imports. -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 over 850 million people who accounted for $16 trillion in GDP in 2007.

Threats

-Just as the emergence of single markets in the EU and North America creates opportunities for business, it also presents a number of threats. For one thing, the business environment within both groups will become more competitive. A further threat to non-EU and/or non-North American firms arises from the likely long-term improvements in the competitive position of many European and North American companies. -Another threat to firms outside of trading blocks is the threat of being shut out of the single market by the creation of a "trade fortress." Finally, firms may be limited in their ability to pursue the strategy of their choice in the EU as the EU increases its willingness and ability to intervene and impose conditions on companies proposing mergers and acquisitions.

the common market

-Like a customs union, the common market has no barriers to trade between member countries and a common external trade policy. Unlike in a customs union, in a common market, factors of production also are allowed to move freely between members. Thus, labor and capital are free to move, as there are no restrictions on immigration, emigration, or cross-border flows of capital between markets. -Currently, MERCOSUR, the South America grouping that includes Brazil, Argentina, Paraguay, Venezuela, and Uruguay, is aiming to eventually establish itself as a common market.

Regional economic integration

-One notable trend in the global economy in recent years has been the accelerated movement toward regional economic integration. 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 -Despite the rapid spread of regional trade agreements designed to promote free trade, there are those who fear that the world is moving toward a situation in which a number of regional trade blocks compete against each other. In this scenario of the future, free trade will exist within each bloc, but each bloc will protect its market from outside competition with high tariffs.

Early beginnings

-Since its establishment January 1, 1999, the euro has had a volatile trading history with the U.S. dollar. Initially, the currency fell in value relative to the dollar, but strengthened to an all time high of €1=$1.54 in March 2008.

Evolution of the European Union

-The European Union (EU) is the product of two political factors: first, the devastation of two world wars on Western Europe and the desire for a lasting peace, and second, the European nations' desire to hold their own on the world's political and economic stage. -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 Community was formed in 1957 at the Treaty of Rome. While the original goal was for a common market, progress was generally very slow. Over the years the EU expanded in spurts, as well as moved towards ever-greater integration. Today, the EU has 28 members, a population of almost 500 million, and a GDP of €11 trillion.

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 Single European Act was born out of frustration among EC members that the community was not living up to its promise. In the early 1980s, many of the EC's prominent businesses people mounted an energetic campaign to end the EC's economic divisions. The result was the Single European Act, which was independently ratified by the parliaments of each member country and became EC law in 1987.

The customs union

-The customs union is one step further along the road to full economic and political integration. A customs union eliminates trade barriers between member countries and adopts a common external trade policy. -Customs unions around the world include the current version of the Andean Pact (between Bolivia, Columbia, Ecuador, and Peru).

Political Structure of the European Union

-The four main institutions of the EU are 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 Union, (the ultimate controlling authority within the EU), the European Parliament, (debates legislation proposed by the commission and forwarded to it by the council), and the Court of Justice, (the supreme appeals court for EU law). -The Treaty of Lisbon, ratified in 2009 gives all member states more power to the European Parliament, which will effectively become the co-equal legislator for almost all European laws.

Central American Common Market and CARICOM

-There are two other trade pacts in the Americas: the Central American Common Market (between Costa Rica, El Salvador, Guatemala, Honduras, the Dominican Republic, and Nicaragua) and CARICOM (includes the English speaking countries of the Caribbean), although neither has made much progress as yet.

Enlargement of the EU

A number of countries, , particularly from Eastern Europe, have applied for membership in the EU. In December of 2002, the EU formally agreed to accept the applications of 10 countries that joined on May 1, 2004. Their inclusion expanded the EU to 25 states, creating an EU population of 450 million people, and a single continental economy with a GDP of €11 trillion. In 2007, the EU welcomed its newest members, Bulgaria and Romania.

Case Against Regional Integration

Although the tide has been running strongly in favor of regional free trade agreements in recent years, some economists have expressed concern that the benefits of regional integration have been oversold, while the costs have often been ignored.

An optimal currency area

Another drawback of the euro is that the EU is not what the economists would call an optimal currency area. An optimal currency area is an area where similarities in the underlying structure of economic activities make it feasible to adopt a single currency and use a single exchange rate as an instrument of macro-economic policy. Many of the European economies in the euro-zone, however, are very dissimilar.

the Association of Southeast Asian Nations (ASEAN)

Formed in 1967, the Association of Southeast Asian Nations (ASEAN) currently includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. The basic objectives of ASEAN are to foster freer trade between member countries and to achieve some cooperation in their industrial policies.

ASEAN Free trade Area (AFTA)

In 2003, an ASEAN Free trade Area (AFTA) between the six original members of ASEAN came into effect. Vietnam, Laos, and Myanmar joined later, and Cambodia is expected to be a member by 2010. The goal of AFTA is to reduce import tariffs among the six original members by 2010, and for the newer members by 2015.

Central American Free Trade Agreement (CAFTA)

In 2005, an agreement was reached between the United States and the members of the Central American Common Market. The agreement, known as the Central American Free Trade Agreement (CAFTA), is designed to lower trade barriers between the United States and the six countries on most goods and services.

Caribbean Single Market and Economy (CSME)

In 2006, six members of CARICOM established the Caribbean Single Market and Economy (CSME) with the goal of lowering trade barriers, and harmonizing macro-economic and monetary policy between member states.

Free trade

In a free trade area all barriers to the trade of goods and services among member countries are removed. In a theoretically ideal free trade area, no discriminatory tariffs, quotas, subsidies, or administrative impediments are allowed to distort trade between member nations. Each country, however, is allowed to determine its own trade policies with regard to nonmembers.

Political union

In a political union, independent states are combined into a single union. The EU is on the road to at least partial political union. The United States provides an example of even closer political union

MERCOSUR

MERCOSUR originated in 1988 as a free trade pact between Brazil and Argentina. In 1990 it was expanded to include Paraguay and Uruguay. In 2005, Venezuela joined the bloc. MERCOSUR made some progress on reducing trade barriers between member states, however, given some fairly high tariffs for goods from other countries, it would appear that in some industries MERCOSUR is trade diverting rather than trade creating, and local firms are investing in industries that are not competitive on a worldwide basis. As of 2008, critics of the bloc suggested that the customs union was becoming more imperfect over time.

Enlargement (NAFTA)

One issue now confronting NAFTA is that of enlargement. Following approval of NAFTA by the U.S. Congress a number of other Latin American countries indicated their desire to eventually join NAFTA. Currently the governments of both Canada and the United States are adopting a wait and see attitude with regard to most countries.

The Case Against NAFTA

Opponents of NAFTA argued that jobs would be lost and wage levels would decline in the United States and Canada, Mexican workers would emigrate north, pollution would increase due to Mexico's more lax standards, and Mexico would lose its sovereignty.

The purpose of the Single European Act

The purpose of the Single European Act was to have a single market in place by December 31, 1992. The changes the act proposed included the following: (i) the removal of all frontier controls between EC countries, (ii) 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, (iii) open public procurement to non-national suppliers, (iv) financial services to lift barriers to competition in the retail banking and insurance businesses, (v) the removal of all restrictions on foreign exchange transactions between members by the end of 1992, (vi) the abolishment of all restrictions on cabotage (the right of foreign truckers to pick up and deliver goods within another member's borders), by the end of 1992.

Benefit of he Euro

There are a number of reasons why the Europeans decided to establish a single currency in the EU. First, they believe that business and individuals will realize significant savings from having to handle one currency, rather than many. Second, and perhaps most importantly, the adoption of a common currency will make it easier to compare prices across Europe. Third, 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. Fourth, the introduction of a common currency should give a strong boost to the development of a highly liquid pan-European capital market. Finally, the development of a panEuropean euro denominated capital market will increase the range of investment options open both to individuals and institutions.

Impediments to Integration

There are two main impediments to integration. First, although economic integration benefits the majority, it has costs. Although a nation as a whole may benefit significantly from a regional free trade agreement, certain groups may lose. A second impediment to integration arises from concerns over national sovereignty.

REGIONAL ECONOMIC INTEGRATION IN EUROPE

There are two trade blocks in Europe: the European Union (EU) and the European Free Trade Association. Of the two, the EU is by far the more significant, not just in terms of membership, but also in terms of economic and political influence in the world economy.

Trade creation

Trade creation occurs when low cost producers within the free trade area replace high cost domestic producers.

Trade diversion

Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers.

regional integration

Whether regional integration is in the economic interests of the participants depends upon the extent of trade creation as opposed to trade diversion. 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. A regional free trade agreement will only make the world better off if the amount of trade it creates exceeds the amount it diverts.