Regional Economic Integration (REI)

Regional economic integration

'Regional economic integration is the agreement between countries in a geographic region to reduce, and ultimately remove, tariff and non-tariff barriers to the free flow of goods, services, and factors of production between each other' (Hill, 2015).

Monetary Union

In addition to the characteristics of the single market, a monetary union means that member states share a common currency. In the EU, currently 19 of its 28 member states share the Euro as a common currency. While there are benefits from elimination of costs and risks associated with exchange rate fluctuations and trade transparency, a monetary union requires a level of harmonization of monetary and fiscal policy, for example, the EU established the European Central Bank to preside over these policies.

The Case against NAFTA

• Jobs will be moved from the US and Canada into Mexico - But new jobs can be created in the US and Canada as a result of the higher demand from the Mexicans. • NAFTA will not have a great impact on the US and Canada, as Mexico was only 5% of the size of the US economy • Environmental Impact

Other examples of regional economic integration

- Association of South-East Asia Nations (ASEAN); Members: Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam - North American Free Trade Agreement (NAFTA) Members: US, Canada and Mexico

1) Market size and economies of scale

As integration increases market size, firms can increase their sales and production, realizing economies of scales. Many industries, such as steel and automobiles, require large-scale production in order to obtain economies of scale in production. Therefore, certain industries may simply not be economically viable in smaller, trade-protected countries. However, the formation of a trading bloc enlarges the market so that large-scale production is justified. The lower per-unit costs resulting from scale economies may then be obtained. These lower production costs resulting from greater production for an enlarged market are called internal economies of scale. In a single market, external economies of scale may also be present. Because a single market allows factors of production to flow freely across borders, the firm may now have access to cheaper capital, more highly skilled labour, or superior technology. These factors will lower costs and/or improve the quality of the firm's goods or services.

3) National Autonomy

Countries may lose their economic independence. This becomes a real problem in the case of an Economic Union, where countries have to adopt a common currency as well as a common monetary and fiscal policy. One policy cannot satisfy the needs of different member countries (as their economic factors such as inflation, unemployment, and growth vary).

3) Higher productivity and economic growth

Firms will be able to produce more output from the same amount of input, as they will be able to locate their production facilities in areas of high productivity (resulting in either a higher volume of production or in lower production costs).

Full Economic Integrations

Full economic integration would require harmonization of the member countries tax rates, and a common monetary and fiscal policy. Clearly, the formation of an economic union requires nations to surrender a large measure of their national sovereignty. There are no true economic unions in the world today, but the EU aims to establish itself as a complete one in the future.

The example of NAFTA (North American Free Trade Agreement)

In 1992, the US, Canada and Mexico agreed to enter a free trade agreement. The agreement became law in January, 1994. NAFTA agreement included: • Elimination of tariffs on 99% of the goods traded between the members. • Remove most barriers on services • Protect intellectual property rights • Remove most restrictions on FDI • Application of national environmental standards • They also established two commissions which monitor the standards and the legislation re health, safety, min wage and child labour.

Common/Single market

In addition to the characteristics of customs union, factors of production (capital, labour and technology) are also allowed to move freely among member countries (hence, restrictions on immigration are eliminated). Establishing a common/single market demands a significant degree of harmony and cooperation on fiscal, monetary, and employment policies. The EU can be considered as an example of a common market.

Customs Union:

In addition to the characteristics that the free trade area includes, the customs union establishes a common trade policy with respect to non-members. Typically, this takes the form of a common external tariff, where imports from non-members are subject to the same tariff when sold to any member country. Tariff revenues are then shared among members according to an agreed formula. A higher level of integration is needed since am element of budgetary control and planning is necessary between member states in order to share the customs fees collected. The examples of customs union include the early stage of the European Community and currently between the EU and Turkey.

2) Increased competition and consumer welfare.

Integration increases competition and therefore may result in a lower degree of monopoly in the production of certain goods and services. This is because a larger market will tend to increase the number of competing firms. The high levels of competition drive prices at lower levels => consumers pay lower prices => this leads to an increased level of consumer welfare.

Results of academic studies on NAFTA:

On average, the results of academic studies indicate that NAFTA's overall impact has been small but positive. The results of studies undertaken for the initial 3-4 years indicated that the effects of NAFTA were not very significant. It is also found that trade between NAFTA member countries grew by 250% between 1993 and 2005. There is also evidence that the three member countries have become increasingly interconnected. All three countries enjoyed considerable productivity gain over this period. In particular, Mexico saw an increase of 50% in productivity and it was suggested that joining NAFTA has been one of the important contributors. The impact on jobs was said to be positive but relatively small. There are various figures which, while subject to debate, are indicative of this effect. For example, some suggest that although NAFTA created around 31,000 jobs in the US, around 28,000 jobs were lost due to imports from Mexico. Others suggest that the US lost 110,000 jobs annually between 1994 and 2000 and this was a result of its participation in NAFTA; however, this was only a small fraction when compared with the annual increase of more than 2 million jobs in the US during the same period. Studies also suggest that Mexico benefitted from a more stable political and business environment as a result of NAFTA.

Political and social benefits from regional integration

Political Benefits. A strong incentive to form an integrated economic group is to create cooperation between the neighbouring states. When neighbouring economies are increasingly dependent on each other, there are incentives for political cooperation, thereby reducing the possibility for a violent conflict or war. Social benefits: • employment opportunities • cultural integration • democratic society

Types of regional economic integration

Preferential and Free trade area Customs Union: Common/Single market Monetary Union Full Economic Integrations Political Integration

Political Integration

Some researchers also put forward political union as a natural continuation of economic union. A political union goes beyond full economic integration, in which all economic policies are unified, and there is a single government. This represents total economic integration, and it occurs only when countries give up the national powers to leadership under a single government. A good example is the US, which combined independent states into a political union.

NAFTA employment conclusions

The above discussion suggests that the net employment effect of NAFTA depends on the extent to which the establishment of NAFTA generates jobs for all three member countries overall as opposed to job losses for individual country members. Note that the objective of regional integration is to encourage factor mobility within the integrated areas so that favorable conditions are created for firms operating within the area and hence outsider firms are discriminated. In this way, the benefits of lowering barriers to crossborder trade and investments may help insider firms to gain international competitiveness. So the central question is NOT how many jobs will be moved from one member to another member, but rather what is the overall increase in employment for a member country as a result of increased overall competitiveness of its local firm in the world economy.

The economic consequences of regional integration

The positive effects 1) Market size and economies of scale 2) Increased competition and consumer welfare. 3) Higher productivity and economic growth 4) Trade creation Political and social benefits from regional integration Negative impacts 1) Trade diversion 2) Competition 3) National Autonomy

4) Trade creation

Trade creation occurs when high-cost domestic producers are replaced by low-cost producers within the free trade area. Example: Before joining the European Community, the wine imported from Spain had to be subject to the common external tariff. After it joined the European Community in 1986, the elimination of the tariff (as a result of its membership) enabled the wine producers from Spain to export more wine than before (as the lower final price made them more competitive).

1) Trade diversion

Trade diversion occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area. The formation of an economic integration group is not always beneficial to international trade. The creation of these integration groups is beneficial only if trade creation exceeds trade diversion. Otherwise the regional economic integration impedes international trade.

2) Competition

We also need to examine whether the level of competition will remain high in the long run. Large MNEs can use their market power to either buy out small firms or to drive them out of business. In that case, the level of competition will be lower (because of the limited number of firms) and the impact on prices and consumer welfare can be negative.

Preferential and Free trade area

is the least restrictive and loosest form of economic integration among countries. In a free trade area, all barriers to trade among member countries are removed. Therefore, goods and services are freely traded among member countries in much the same way that they flow freely between two regions of one country. In the case of a free trade area each country continues to set its own policies in relation to non-members. In other words, each member is free to set its own tariffs, quotas, or other restrictions on trade with countries outside the free trade area. A good example of free trade area is that of NAFTA (North American Free Trade Agreement).

The case for NAFTA

• Created a larger market (e.g., - the combined population is 457m in 2010, close to that of the EU (around 502m); the GDP per capita in PPP price is $38,527, 27% higher than that of the EU $30,455 according to IMF estimation for 2010.) • US and Canadian firms moved production to Mexico • Higher level of employment in Mexico • Inward FDI in Mexico: The direct effect is that as US and Canadian firms relocate to Mexico and export their product to consumers in the US and Canada. Therefore, consumers in these two countries benefit from the lower prices of the products made in Mexico. Another effect is that following this relocation, the international competitiveness of US and Canadian firms would be enhanced, enabling them to better compete with Asian and European rivals. The indirect effect is that joining NAFTA has helped Mexico to achieve a greater degree of openness which has helped to increase the rate of economic growth in this country. As a result, there has been a significant increase in FDI from companies based in the other Triad blocks (EU and ASEAN). For example, GM has four plants in Mexico, and has invested some $5 billion here since 2006. General Motors will invest $540 million to build fuel-efficient engines (mostly for cars produced in Mexico.) at its plant in central Mexico. • Increased income of the Mexicans will allow them to import goods from the US and Canada

The rationale for Regional Economic Integration (REI) Referring to Balassa's Six Degrees model:

• Principle of Comparative Advantage (CA) (David Ricardo 1817) The principle of CA shows that trade barriers can be used to influence the competitiveness of products on the international market. Hence, lowering trade barriers generates opportunities for efficient firms and costs for inefficient firms. This has important implications for firms operating within and outside of the integrated economic area. The underlying principle of regional economic integration is the belief that REI promotes free trade within the integrated area and hence generates considerable benefits for member states of the integrated area and the insider firms. • A global movement towards free trade and globalisation Although all governments intervene in trade and FDI, for example, in order to deal with structural adjustment issues, protect strategically important industries, reduce negative environmental externalities, the global movement towards free trade and globalisation warrants increased efforts on lowering trade barriers and barriers to FDI. • Role of World Trade Organisation (WTO) WTO as well as other international institutions has been aiming to introduce a free trade regime to the world; however, there has been limited success. As there are many countries with diverse ideologies and social and economic conditions, it is argued that the process of getting a common set of rules to be applied to all countries is particularly difficult (Hill, 2015). • The difficulties arising from multilateral negotiations Against this background, it is argued that "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" (Hill, 2015)