REGIONAL ECONOMIC INTEGRATION By regional economic integration we mean egreements among countries in a geographic region to reduce, and ultimately

remove, tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other. LEVELS of ECONOMIC INTEGRATION In a free trade area, all barriers to the trade of goods and services among member countries are removed. In the theoretically ideal free trade area, no discriminatory tariffs, quotas, subsidies, or administrative impediments are allowed to distort trade between members. The most enduring free trade area in the world is the European Free Trade Association (EFTA). Established in January 1960, EFTA currently joins 4 countries-Norway, Iceland, Liechtenstein, and Switzerland-down from 7 in 1995 (3 EFTA members Austria, Finland, and Sweden, joined,the EU on January 1, 1996). EFTA was founded by those Western European countries that initially decided not to be part of the European Company (the forerunner of the EU). Its original members included Austria, Great Britain, Denmark, Finland, and Sweden, all of which are now members of the EU. The emphasis of EFTA has been on free trade in industrial goods. Agriculture was left out of the arrangement, each member being allowed to determine its own level of support. Members are also free to determine the level of protection applied to goods coming from outside EFTA. Other free trade areas include the North American Free Trade Agreement. Levels of Economic Integration:

Political Union

Economic Union

Common Market

Custom Union

Free Trade Area X

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. Establishment of a common external trade policy necessitates significant administrative machinery to oversee trade relation with nonmembers. Most countries that enter into a custom union desire even greater economic integration down the road. Othe customs unions around the world include the current version of the Andean Community between Bolivia, Colombia, Ecuador, Peru and Venezuela. The next level of economic integration, a common market, has no barriers to trade between member countries, includes a common external trade policy, and allows factors of production to move freely between members. Labor, and capital are free to move because there are no restriction on immigration, emogration, or cross-border flows of capital between member countries. Establishing a common market demands a significant degree of harmony and cooperation has proven very difficult. For years, the European Union functioned as a common market, although it has now moved beyond this stage. MERCOSUR, the South American grouping of Argentina, Brazil, Uruguay, Paraguay, and (as of 2006) Venezuela, hopes to eventually establish itself as a common market. 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 member countries and the adoption of a common external policy, but it also requires a common currency, harmonization of members tax rates, and a common monetary and fiscal policy. Such a high degree of integration demands a coordinating bureaucracy and the sacrifice of significant amounts of national sovereignty to that bureaucracy. The EU is an economic union, although an imperfect one since not all members of the EU have adopted its currency, the euro, differences in taxe rates and regulations across countries still remain, and some markets, such as the market for energy, are still not fully deregulated. The moved toward economic union raises the issue of how to make a coordinating bureaucracy accountable to the citizens of member nations. The answer is through political union in which a central political apparatus coordinates the economic, social, and foreign policy of the member states. The EU is on the road toward at least partial political union. The European Parliament, which is playing an ever more important role in the EU, has been directly elected by citizens of the EU countries since the late 1970s. in addition, the Council of Ministers (the controlling, decision-making body of the EU) is composed of government ministers from each EU member. The US provides an example of even closer political union; in the US, independent states are effectively combined into a single nation. Ultimately, the EU may moved toward a similar federal structure. THE CASE FOR REGIONAL INTEGRATION The case for regional integration is both economic and political. Typically not many groups within a country accept the case for integration, which explains why most attempts to achieve regional economic integration have been contentious and halting.

THE ECONOMIC CASE FOR INTEGRATION The economic case for regional integration is straightforward. A case can be made for government intervention in international trade and FDI. Because many government has accepted part of all the case for intervention, unrestricted free trade and FDI have proved to be only an ideal. Although international institution such as the WTO have been moving the world toward a free trade regime, success has been less than total. In a world in many nation and many political ideologies, it is very difficult to get all countries to agree to a common set of rules. 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 WTO. Coordination and policy harmonizations problems are largely a function of the number of countries that seek agreement. The greater the number of countries involved, the more perspectives that must be reconciled, and the harder it will be to reach agreement. Thus, attempts at regional economic integration are motivated by a desire to exploit the gains from free trade and investment. THE POLITICAL CASE FOR INTEGRATION The political case for regional economic integration also has loomed large in several attempts to establish free trade areas, customs unions, and the like. Linking neighboring economies and making them increasingly dependent on each other creates incentives for political cooperation between the neighboring states and reduces the potential for violent conflict. Europe had suffered two devastating wars in the first half of the 20th century, both arising out of the unbridled ambitions of nation-states. Those who have sought a united Europe have always had a desire to make another war in Europe unthinkable. Many Europeans also believed that after World War II, the European nation-states were no longer large enough to hold their own in world markets and politics. The need for a united Europe to deal with the US and the politically alien Soviet Union loomed large in the minds of many of the ECs founders. A long standing joke in Europe is that the European Commision should erect a statue to Joseph Stalin, for without the aggressive policies of the former dictator of the old Soviet Union, the countries of Western Europe may have lacked the incentive to cooperate and from the EC. IMPEDIMENTS TO INTEGRATION Despite the strong economic and political arguments in support, integration has never been easy to achieve or sustain for two main reasons. First, although economic integration aids the majority, it has its costs. While a nation as a whole may benefit significantly from a regional free trade agreement, certain groups may lose. Moving to a free trade regime involves painful adjustment. For example, due to the 1994 establishment of NAFTA, some Canadian and U.S. workers in such industries as textiles, which employ low-cost, low-skilled labor, lost their jobs as Canadian and U.S. firms moved production to Mexico. The promise of significant net benefits to the Canadian and U.S. economies as a whole is little

comfort to those who lose as a result of NAFTA. Such groups have been at the forefront of opposition to NAFTA and will continue to oppose any widening of the agreement. Second impedement to intergratiion arises form concerns over national sovereignty. For example, Mexicos concerns about mantaining control of its oil interests resulted in an agreement with canada and the United States to exempt the Mexican oil industry from any liberalization of foreign investment regulations achieved under NAFTA. Concerns about national sovereignty arise because close economic integration demands that countries give up some degree of control over such key issues as monetary policy, fiscal policy, and trade policy. This has been a major stumbling block in the EU. To achieve full economic union, the EU introdeced a common currency, the euro, contolled by a central EU bank. Although most member states have signed on, great Britain remains an important holdout.

THE CASE AGAINTS REGIONAL INTEGRATION Although the tide has been running strongly in favor of regional free trade egreement in recent years, some economists have expressed concern that the benefits of regional integration have been oversold, while the costs have often been ignored. They point out that the benefits of regional integration are determined by 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. It may also occur when lower cost external producers within the free trade area replace higher cost external producers. Trade diversion occurs when higher cost suppliers replace lower cost external suppliers within the free trade area. A regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amount it diverts. REGIONAL ECONOMIC INTEGRATION IN EUROPE Europe has two trade blocs-the European Union and the European Free Trade Association. EVOLUTION OF THE EUROPEAN UNION 1. The EU, is the product of two political factors: The devatation of Western Europe during two world wars and the desire for a lasting peace The european nations desire to hold their own on the worlds political and economic stage 2. 1951 - European Coal and Steel Community. 3. 1957- Treaty of Rome establishes the European Community 4. 1994 - Treaty of Maastricht changes name to the European Union In addition, many Europeans were aware of the potential economic benefits of closer economic integration of the countries.

POLITICAL STRUCTURE OF THE EUROPEAN UNION The European Commision is responsible for proposing EU legislation, implementing it, and monitoring compliance with EU laws by member states. The Council of the European Union represents the interest of member states. It is clearly the ultimate controlling authority within the EU since draft legislation from the commision can become EU law only if the council agrees. The council is composed of one representative from the government of each member state. The membership, however, varies depending on the topic being discussed. When agricultural issues are being discussed, the agriculture ministers from each state attend council meetings, when transportation is being discussed, transportation ministers attend, and so on. The European Parliament, which now has 732 members, is directly elected by the populations of the member states. The parliament, which meets in Strasbourg, France, is primarily a consultative rather than legislative body. It can proposed amendments to that legislation, which the commision and ultimately the council are not obliged to take up but often will. The European Parliament now has the right to vote on the appointment of commisioners as well as to veto some laws. THE SINGLE EUROPEAN ACT Two revolutions occurred in Europe in the late 1980s. The first was the collapse of comunism in Eastern Europe. The second revolution was much quieter, but its impact on Europe and the world may have been just as profound as the first. It was the adoption of the Single European Act by the member nations of the European Community in 1987.

THE OBJECTIVE OF THE ACT The purpose of the Single European Act was to have one market in place by December 31, 1992. The act proposed the following changes: Removed all frontier controls between EC countries, thereby abolishing delays and reducing the resources required for complying with trade bureaucracy Apply the principle of mutual recognition to product standards. A standard developed in one EC country should be accepted in another, provided it meets basic requirements in such matters as health and safety Open public procurement to nonnational suppliers, reducing costs directly by allowing lower cost suppliers into national economies and indirectly by forcing national suppliers to compete. Lift barriers to competition in the retail banking and insurance businesses, which should drive down the costs of financial services, including borrowing, throughout the EC Remove all restrictions on foreign exchange transactions between member countries by the end of 1992

Abolish restriction on cabotage-the right of foreign truckers to pick up and deliver goods within another member states borders-by the end of 1992. Estimates suggested this would reduce the cost of haulage within the EC by 10 to 15 percent

IMPACT The act provided the impetus for restructuring substantial section of European industry. Many firms have shifted from national to pan-European production and distribution system in an attempt to realize scale economies and better compete in a single market. The results have included faster economic growth than would otherwise have been the case. THE ESTABLISHMENT OF THE EURO Establishment of the euro has rightly been described as an amazing political feat withfew historical precedents. Establishing the euro required participating national governments not only to give up their own currencies but also to give up control over monetary policy. Government do not routinely sacrifice national sovereignty for the greater good, indicating the importance that the Europeans attach to the Euro. By adopting the euro,the EU has creted the second largest currency zone in the world after that of the U.S. dollar. Some believe that ultimately the euro could come to rival the dollar as the most important currency in the world. BENEFITS OF THE EURO Europeans decided to establish a single currency in the EU for a number of reasons. First, they believe that businesses and individuals will realize significant saving from handling one currency, rather than many. These savings come from lower foreign exchange and hedging costs. Second, and perhaps more impotantly, the adoption of a common currency will make it easier to compare prices across Europe. This should increase competition because it will be much easier for consumers to shop around. Third, faced with lower prices, European producers will be forced to look for ways to reduce their production costs to maintain their profit margins. The introduction of a common currency, by increasing competition, should ultimately produce long-run gains in the economic efficiency of European companies. Fourth, the introduction of a common currency should give a strong boost to the development of a highly liquid pan-European capital market. The development of such a capital market sjould lower the cost of capital and lead to an increase in both the level of investment and the efficiency with which invetment funds are allocated. This could be especially helpful to smaller companies that have historically had difficulty borrowing money from domestic banks. Finally, the development of a pan-European, euro-denominated capital market will increase the range of investment options open to both individuals and institutions.

THE ENLARGEMENT OF THE EUROPEAN UNION

One major issue facing the EU over the past few years has been that of enlargement o Has become a possibility since the collapse of communism at the end of the 1980s o By the end of the 1990s 13 countries had applied to become EU members In December 2002 the EU formally agreed to accept the applications of 10 countries, which resulted in: o The EU expanding to include 25 states o The addition of 75 million citizens to the EU o Created a single continental economy with a GDP close to 11 trillion Euros To qualify for EU membership applicants must: o Privatize state assets o Deregulate markets o Restructure industries o Tame inflation o Enshrine complex EU laws into their own systems o Establish stable democratic governments o Respect human rights

REGIONAL ECONOMIC INTEGRATION IN THE AMERICAS The most significant attempt is the North American Free Trade Agreement. In addition to NAFTA, several other trade blocs are in the offing in the Americas, the most significant of which appear to be the Andean Community and MERCOSUR. Also, nefotiation are under way to establish a hemispherewide Free Trade Area of the Americas (FTAA), altough currently they seem to be stalled. THE NORTH AMERICAN FREE TRADE AGREEMENT

The North American Free Trade Agreement (NAFTA) was ratified by the governments of the United States, Canada, and Mexico in 1993; it became law January 1, 1994 The contents of NAFTA includes the following o Over 10 year period: tariffs reduced (99% of goods traded) o Removal of most barriers on cross border flow of services o Removal of restrictions on FDI except in certain sectors Mexican railway and energy US airline and radio communications Canadian culture NAFTA contents continued: o Protection of intellectual property rights o Applies national environmental standards o Establishment of commission to police violations

NAFTA RESULT

Recent surveys indicate that NAFTAs overall impact has been small but positive o From 1993 to 2004, trade between NAFTAs partners grew by 250 percent

Canadas trade with NAFTA partners increased from 70% to more than 80% of all Canadian foreign trade o Mexicos trade with NAFTA partners increased from 66% to 80% of all Mexican foreign trade All countries experienced strong productivity growth The United States has lost 110,000 jobs per year due to NAFTA o Many economists dispute this figure because more than 2 million jobs a year were created in the US during the same time period The most significant impact of NAFTA has not been economic, but political o NAFTA helped create the background for increased political stability in Mexico

THE ANDEAN COMMUNITY

Bolivia, Chile, Ecuador, Colombia, and Peru signed an agreement in 1969 to create the Andean Pact The Andean Pact was largely based on the EU model, but was far less successful at achieving its stated goals By the mid-1980s, the Andean Pact had all but collapsed and had failed to achieve any of its stated objectives Nearly failed. Rejuvenated in 1990 in the Galapagos Declaration o Five current members include Bolivia, Ecuador, Peru, Colombia, and Venezuela o Objectives included the establishment of a free trade area by 1992, a customs union by 1994, and common market by 1995 Operates as a customs union currently

MERCOSUR

Originated in 1988 as a free trade pact between Brazil and Argentina The pact expanded in March 1990 to include Paraguay and Uruguay These countries have: o A combined population of 200 million o An average annual growth rate of 3.5% for GDP MERCOSUR countries have significant trade diversion issues

CENTRAL AMERICAN COMMON MARKET, CAFTA, AND CARICOM

Central American Common Market o 1960s: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua. o Collapsed in 1969 CARICOM o 1973: English-speaking Caribbean countries o 1991: Failed for third time to establish common external tariff CAFTA o The aim is to lower trade barriers between the US and the 6 countries for most goods and services

FREE TRADE AREA OF THE AMERICANS Free Trade Area of the Americas o Talks scheduled for January 2005 did not occur o Two stumbling blocks include intellectual property rights and reductions in agriculture subsidies REGIONAL ECONOMIC INTEGRATION ELSEWHERE Numerous attempts at regional economic intreration have been tried throughout Asia and Africa. However, few exist in anything other than name. perhaps the most significant is the Association of Southeast Asian Nation (ASEAN). In addition, the Asia Pasific Economic Cooperation (APEC) forum has recently emerged as the seed of a potential free trade region. ASEAN Association of Southeast Asian Nations

Created in 1967 Objective to achieve free trade between member countries and achieve cooperation in their industrial Brunei, Indonesia, Laos, Malaysia, the Philippines, Myanmar, Singapore, Thailand, and Vietnam Progress limited by Asian financial crisis of the 90s

APEC Asia Pacific Economic Cooperation

Founded in 1990 to promote open trade and practical economic cooperation o Promote a sense of community o 21 members o 57% of worlds GNP o 46% of global trade Despite slow progress, if successful, could become the worlds largest free trade area

REGIONAL TRADE BLOCS IN AFRICA

African countries have been experimenting with regional trade blocs for half a century; there are now 9 trade blocs on the continent Progress toward the establishment of meaningful trade blocs has been slow In 2001 Kenya, Uganda, and Tanzania committed themselves to relaunching the East African Community trade bloc 24 years after it collapsed o The intent is to establish a customs union, regional court, legislative assembly, and a political federation

IMPLICATIONS FOR MANAGERS

Opportunities: Creation of single markets o Protected markets, now open o Lower costs doing business in single market Threats: o Differences in culture and competitive practices make realizing economies of scale difficult o More price competition o Outside firms shut out of market o EU intervention in mergers and acquisitions