Economic Integration Ch 17 Economic Integration

Economic Integration Ch. 17

Economic Integration • occurs when two or more countries come together for purposes of trade and/or economic coordination • may indicate a movement away from multilateralism

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

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

Free Trade Areas: Examples • NAFTA (Canada, Mexico, U. S. ) • ASEAN (Brunei, Indonesia, Malaysia, Philippines, Singapore, Thailand) • ANZCERT (Australia and New Zealand) • EFTA (Iceland, Liechtenstein, Norway, Switzerland) • CEFTA (Czech Rep. , Hungary, Poland, Slovak Rep. )

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 – members speak with one voice in external trade negotiations (that is, there would be just one representative from the CU at the WTO)

Customs Unions: Examples • UDEAC (Cameroon, CAR, Chad, Congo, Equatorial Guinea and Gabon) • Andean Pact (Bolivia, Colombia, Ecuador and Venezuela) • MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay)

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 • Examples: – ECOWAS (16 West African nations) – AMU (Algeria, Libya, Mauritania, Morocco, and Tunisia)

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

Monetary Union: An Example • The European Union has moved towards monetary union: – The Euro exists as a currency, and member country currencies have been phased out – There’s only one exchange rate; there’s one central bank

Economic and/or Monetary Union • Economic union is generally a bit more involved: it includes – monetary union and monetary policy coordination – fiscal policy coordination • No current examples, but isn’t that what the United States is?

Economic Integration • As a country moves from a FTA to a CU to a common market to an economic union – benefits may accrue – sovereignty is increasingly lost • Will the U. S. ever move into an economic union with Canada and Mexico? Not likely!

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 welfareenhancing depends on which effect is larger

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

Trade Creation and Trade Diversion: An Example • Prior to integration, Uganda imports 40 units 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 dutyfree

Trade Creation and Trade Diversion: An Example

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 • What is the overall effect?

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 160 200 D Q

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 160 200 D Q

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 160 200 D Q

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 160 200 D Q

Trade Creation and Trade Diversion: An Example P With FTA, CS rises S Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q

Trade Creation and Trade Diversion: An Example P With FTA, PS falls S Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q

Trade Creation and Trade Diversion: An Example P With FTA, revenue falls S Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q

Trade Creation and Trade Diversion: An Example P Lost revenue transferred back S to domestic consumers Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q

Trade Creation and Trade Diversion: An Example P Lost revenue not transferred back to domestic consumers S Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q

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 Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q

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)

Dynamic Welfare Effects • In the long run, integration may increase a country’s welfare because: – increased competition (lower prices and higher quality) may occur – larger markets may allow economies of scale to be realized – lower costs resulting from standardization and reduction in technical barriers

The European Community: A Brief History • 1952: France, Italy, West Germany, and Benelux countries form European Coal and Steel Community • 1957: ECSC expanded to all products; name changed to European Economic Community (EEC)

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

The European Community: A Brief History • Monetary union was a goal as early as 1969 – agreement to fix exchange rates and have a common monetary policy was reached – however, global economic disruptions in the 1970 s prevented this • The Exchange Rate Mechanism (ERM) was revived in 1978 – ERs are kept within a narrow band of each other

EC 92 • During the 1980 s, 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

EC 92: Expected Impacts • Predictions: – EU’s GDP 3. 2% to 5. 7% higher than it would have been without EC 92 – Consumer prices 4. 5% to 7. 7% lower than without EC 92 – 1. 3 to 2. 3 million additional jobs under EC 92 • Mainly these gains were supposed to result from dynamic gains from integration

Maastricht Treaty • 1989: The Delors Report on monetary union was received - this became the framework for the Maastricht treaty • Maastricht has been approved by 11 out of 15 EU countries • According to the treaty, monetary union was to be achieved in 3 phases: convergence, European System of Central Banks, and Monetary Union

Maastricht: Convergence Phase • Launched in 1990 • To have monetary union, wide differences in inflation rates, economic growth, and budget deficits would need to be eliminated by 1999 • Most countries would not have met the original (and strict) requirements, but the requirements were broadened • Only Greece failed to make the cut

Maastricht: European System of Central Banks (ESCB) • Began in 1994 • The ESCB controls the exchange rate mechanism • Each EU country continues to make monetary policy for itself

Maastricht: Monetary Union • 1999 – accounts can be stated in terms of euros, but member countries’ currencies remain legal tender – each members’ exchange rate is fixed in terms of euros – Monetary policy is made by the ESCB; each member no longer controls its own money supply

Maastricht: Monetary Union • 2002 – In January, euro notes and coins were issued by the ECB – In July, national currencies were withdrawn

“Europhiles” • Currently, Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain are members of the EMU • “Euroland” has 290 citizens (more than the U. S) and has a GDP that approaches that of the U. S.

“Euroskeptics” • Denmark, Sweden and the U. K. are deeply concerned about the loss of sovereignty that EMU implies • These countries may yet choose to join the EMU • Greece is trying hard to qualify now

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 creates the largest market in the world: 360 million people and GDP of more than $6 trillion

NAFTA • Fall of the Berlin Wall • New “WAR” Economic War (prior 9/11) • Mexican Harvard Economist trained President • Texas President (Bush Sr. ) • NSA

NAFTA: Some Provisions • Many tariffs were eliminated immediately; others will be phased out over 5, 10, or 15 years • Services (esp. banking) will be traded freely by 2007 • All U. S. environmental standards will remain in force

NAFTA: Alleged Benefits to U. S. • Increased ability to export products • Wider consumer choice • Increased competitiveness leading to dynamic gains • Job growth • Lower consumer prices

NAFTA: Alleged Problems for the U. S. • • Job loss: the “giant sucking sound” Unfair competition for U. S. firms Environmental decline in Mexico Exploitation of Mexican workers Increased illegal immigration Increased flow of illegal drugs Loss of sovereignty

NAFTA: 10 Years Later • Has NAFTA helped or harmed the U. S. ? • The answer is unclear: – There were nearly 17 million more jobs in the U. S. in 2004, but was this due to NAFTA or in spite of NAFTA? – Clearly there has been job loss in certain industries (textiles, transportation equipment), but there has been job gains in other sectors (e. g. , electronics and electrical equipment)

NAFTA: 10 Years Later – Clearly certain geographic areas have been hurt (e. g. , El Paso and other border cities, North Carolina); other areas have blossomed (nonborder parts of Texas) – Presently the U. S. imports more than it exports from Mexico, but this has a lot to do with the peso crisis and the sluggish Mexican economy

NAFTA: 5 Years Later – Giant sucking sound? Hasn’t happened: perhaps some U. S. industries have moved south to use lower-cost labor, but they are faced with • • lower Mexican labor productivity a crumbling and inadequate infrastructure a shortage of qualified managers an unreliable legal system – In fact, some U. S. -owned companies have returned home from Mexico (Cummins Engine, GM, Quality Coils)!

NAFTA: 10 Years Later • Although estimates of employment effects vary, a fairly respected estimate is that as of 2004 the U. S. enjoyed a net gain of 100, 000 jobs as a direct result of NAFTA • Remember, though, that the U. S. economy employs 140 million workers. A gain of 100, 000 jobs amounts to an increase of only 0. 7%!

NAFTA: An Attempt to Cut Through the Rhetoric • Most economists predicted that the effect of NAFTA on the U. S. would be modest at best • Whether you think NAFTA has been a help or a hindrance to the U. S. , it is hard to argue that it is either incredibly horrible or incredibly wonderful

A Comparison of NAFTA Countries (1994)

A Comparison of NAFTA Countries (1994)

NAFTA: The Future • There is still opposition to NAFTA in each country, and NAFTA could disintegrate (unlikely in the near future) • Other countries may be added (Chile and Central America and less likely now Brazil)