Economic Integration Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin Chapter 17

17-2 Learning Objectives  Differentiate among the four basic levels of economic integration.  Identify the static and dynamic effects of economic integration.  Analyze the real-world impact of economic integration on countries in the EU and NAFTA.  Summarize current economic integration efforts in the world.

17-3 Economic Integration  Economic integration occurs when two or more countries come together for purposes of trade and/or economic coordination.  Greater integration may yield additional benefits, but it may also involve giving up increasing sovereignty.

Types of Integration  Free Trade Areas (FTAs)  Customs Unions (CUs)  Common Markets  Economic and/or Monetary Union

17-5 Free Trade Areas  Members remove tariffs and other trade barriers on each other.  Each member maintains its own tariff structure for non-members.  Possible problem: transshipment  Example: NAFTA

17-6 Customs Unions  Tariffs between members are eliminated (just like a FTA), but also: members agree to a common set of external tariffs and other trade barriers, and members speak with one voice in external trade negotiations.  Example: Southern African Customs Union (SACU)

17-7 Common Markets  Tariffs between members are eliminated, a common external tariff is established (all of the features of CUs) plus free movement of labor and capital.  Example: European Community (1957 – 1993)

17-8 Economic and/or Monetary Union  Similar to a common market: Tariffs between members are eliminated. A common external tariff is established. Factors can move freely between member countries.  But economic policy is coordinated by a supranational institution in the economic and/or monetary union.

17-9 Welfare Effects of Integration: Static Issues  Jacob Viner argued that integration leads to two welfare effects: trade creation: increases a country’s welfare trade diversion: decreases a country’s welfare  Whether economic integration is welfare-enhancing depends on which effect is larger.

17-10 Trade Creation and Trade Diversion: An Example  Suppose we have three countries: Uganda, Sudan, and Kenya.  Initially, Uganda imports textiles and applies a 50% tariff to textiles from both Sudan and Kenya.  Suppose that Sudan is able to produce a unit of textiles for $1, whereas it costs Kenyan producers $1.20 per unit.

Trade Creation and Trade Diversion: An Example 17-11

17-12 Trade Creation and Trade Diversion: An Example  Prior to integration, Uganda imports from the most efficient supplier, Sudan.  Suppose now that Uganda enters into a free trade agreement with Kenya, but not Sudan.  That is, Sudanese textile imports are dutiable, but Kenya textiles can enter duty-free.

Trade Creation and Trade Diversion: An Example 17-13

17-14 Trade Creation and Trade Diversion: An Example  Notice that Uganda will now import from Kenya, although Sudan is the more efficient producer.  Uganda loses tariff revenue, but reverses some of the deadweight loss caused by the protectionism.

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 PS rises as a result of initial protection

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 CS falls as a result of the initial protection

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 Revenue rises as a result of the initial protection

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 Welfare declines overall by the DWL triangles

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 FTA price $1.20 With FTA, CS rises

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 FTA price $1.20 With FTA, PS falls

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 FTA price $1.20 With FTA, revenue falls

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 FTA price $1.20 Lost revenue transferred back to domestic consumers Lost revenue not transferred back to domestic consumers 17-22

Trade Creation and Trade Diversion: An Example D P Q S Tariff price $ Free trade price$1.00 FTA price $1.20 Overall, we must compare the gain in welfare (trade creation) with the lost revenue (trade diversion). trade creation trade diversion 17-23

17-24 Trade Creation and Trade Diversion  When is it likely that trade diversion outweighs trade creation? When the excluded countries are much more efficient than the included countries. When there are only a few members of the FTA (consider a global FTA: there would be no trade diversion because no country would be excluded).

17-25 Dynamic Welfare Effects  In the long run, integration may increase a country’s welfare because: increased competition may occur, leading to lower prices, larger markets may allow economies of scale to be realized, more investment may be attracted, and increased factor mobility may lead to greater efficiency.

17-26 The European Community: A Brief History  1951: France, Italy, West Germany, and Benelux countries form European Coal and Steel Community.  1958: ECSC expanded to all products; name changed to European Economic Community (EEC).

17-27 The European Community: A Brief History  Other countries joined over the years: 1973: Denmark, Ireland, U.K. 1981: Greece 1986: Portugal and Spain 1995: Austria, Finland, Sweden Recent additions: Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia, Slovenia

17-28 EC 92  During the 1980s, there were still various and sundry barriers to trade between member countries.  1985: Single European Act (commonly called EC 92): elimination of all barriers to the flow of goods, services, people, and capital by  It wasn’t 1992, but it eventually happened.

17-29 Further Integration: Monetary Union  1999 Accounts could be stated in terms of euros, but member countries’ currencies remained legal tender. Each members’ exchange rate was fixed in terms of euros. Monetary policy was made by the ESCB; each member no longer controlled its own money supply.

17-30 Further Integration: Monetary Union  2002 In January, euro notes and coins were issued by the ECB. In July, national currencies were withdrawn.  Members: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Monaco, Netherlands, Portugal, San Marino, Slovenia, Spain, and the Vatican

17-31 NAFTA  On January 1, 1994 the North American Free Trade Agreement came into being.  It allows for a dismantling of trade barriers between Canada, Mexico, and the U.S.  It created a market comparable in size to the EU and EFTA combined.

17-32 NAFTA: Some Provisions  Many tariffs were eliminated immediately; others will be phased out over 5, 10, or 15 years.  Restrictions on trade in services (esp. banking) phased out.  All U.S. environmental standards will remain in force.

17-33 Worries Over NAFTA  GDP Most studies estimate a sizeable increase in Mexican GDP, with more modest (but positive) effects on Canadian and U.S. GDP.  Employment There were some dire forecasts of job loss, but U.S. employment has risen.  Wages NAFTA has shifted low-skill employment to Mexico. U.S. wages have continued to grow.

17-34 Worries Over NAFTA  There have also been concerns about environmental degradation, and Mexico’s lower labor standards.

17-35 Recent Discussions of NAFTA  In the 2008 presidential campaign, both Hillary Clinton and Barack Obama called for revisions to NAFTA.  However, it appears the Obama administration plans to move forward with new free trade agreements.

17-36 Other Major Economic Integration Efforts  MERCOSUR  U.S.-Central America Free Trade Agreement – Dominican Republic (CAFTA-DR)  Free Trade Area for the Americas (FTAA)  Chilean trade agreements  Asia-Pacific Economic Cooperation (APEC)