Download Economic Integration

Chapter 17
Economic
Integration
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
17-2
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.
17-3
4 Types of Integration




Free Trade Areas (FTAs)
Customs Unions (CUs)
Common Markets
Economic and/or Monetary Union
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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
17-5
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)
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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)
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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.
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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.
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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.
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Trade Creation and Trade
Diversion: An Example
Production
Costs
Price with
50% Tariff
Sudan
$1.00
$1.50
Kenya
$1.20
$1.80
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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.
17-12
Trade Creation and Trade
Diversion: An Example
Production
Costs
Price with
50% Tariff
Price with
FTA
Sudan
$1.00
$1.50
$1.50
Kenya
$1.20
$1.80
$1.20
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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.
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Trade Creation and Trade
Diversion: An Example
P
PS rises as a
result of initial
protection.
S
$1.50
Tariff price
$1.00
Free trade price
D
160
200
Q
17-15
Trade Creation and Trade
Diversion: An Example
P
CS falls as a result
of the initial protection.
S
$1.50
Tariff price
$1.00
Free trade price
D
160
200
Q
17-16
Trade Creation and Trade
Diversion: An Example
P
Revenue rises as a result
of the initial protection.
S
$1.50
Tariff price
$1.00
Free trade price
D
160
200
Q
17-17
Trade Creation and Trade
Diversion: An Example
P
Welfare declines
overall by the DWL
triangles.
S
$1.50
Tariff price
$1.00
Free trade price
D
160
200
Q
17-18
Trade Creation and Trade
Diversion: An Example
P
With FTA, CS rises.
S
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
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Trade Creation and Trade
Diversion: An Example
P
With FTA, PS falls.
S
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
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Trade Creation and Trade
Diversion: An Example
P
With FTA, revenue falls.
S
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
17-21
Trade Creation and Trade
Diversion: An Example
P
Lost revenue transferred back
S
to domestic consumers
Lost revenue not transferred
back to domestic consumers
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
17-22
Trade Creation and Trade
Diversion: An Example
P
Overall, we must compare
the gain in welfare (trade creation)
with the lost revenue (trade diversion).
S
trade creation
trade diversion
Tariff price
$1.50
FTA price
Free trade price
$1.20
$1.00
D
160
200
Q
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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).
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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.
17-25
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).
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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
17-27
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 1992.
 It wasn’t 1992, but it eventually
happened.
17-28
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.
17-29
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
17-30
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.
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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.
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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.
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Worries Over NAFTA
 There have also been concerns about
• environmental degradation, and
• Mexico’s lower labor standards.
17-34
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.
17-35
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)
17-36