Chapter 9: Regional Economic Integration

What is regional economic integration?

Agreements between countries in a geographic region to reduce tariffs and non-tariff barriers to the free flow of goods, services, and factors of production between each other.

Do regional trade agreements promote free trade?

In theory, yes, but the world may be moving toward a situation in which a number of regional trade blocks compete against each other

What are the 5 levels of regional economic integration?

1. Free-trade area

2. Custom union

3. Common market

4. Economic union

5. Political union

What is free-trade area?

Eliminates all barriers to the trade of services and goods among member countries

Example of a free-trade area?

1. EFTA: European Free Trade Association (Norway, Iceland, Liechtenstein, and Switzerland)

2. NAFTA: North American Free Trade Agreement (U.S., Canada, and Mexico)

What is customs union?

1. Eliminates trade barriers between member countries

AND

2. Adopts a common external trade policy

Example of a customs union?

Andean community (Bolivia, Columbia, Ecuador, and Peru)

What is common market?

1. Has NO BARRIERS TO TRADE between member countries

2. Common external trade policy

3. Free movement of factors of production

Example of a common market?

MERCOSUR (Brazil, Argentina, Paraguay, and Uruguay)

What is economic union?

1. Has the free flow of products and factors of production between members

2. Common external trade policy

3. Common currency

4. Harmonized tax rate

5. Common monetary & fiscal policy

Example of economic union?

European Union (EU)

What is political union?

Involves a central political apparatus that coordinates the economic, social, and foreign policy of member states.

Example of a political union?

1.The EU is headed toward at least partial political union

2. The U.S. is an example of even closer political union

Why should countries integrate their economies / What are the benefits of integration?

>>Benefits:

1. Increases dependence

2. Free trade benefits

3. Cooperation against threats

>>Explaination:

1. ALL countries gain from free trade and investment

- Regional economic integration is an attempt to exploit the gains from free trade & investment

2. Linking countries together, making them more dependent on each other:

- This creates incentives for political cooperation

- Reduced the likelihood of violent conflict

- Gives countries greater political power when dealing with other nations

What are the costs of integration / What limits efforts at integration?

>>Costs/Limitations:

1. Loss of independence

2. Some parties loose

3. Trade creation Vs. Trade diversion

>>Explanation:

1. Economic integration can be difficult because

- While a nation as a whole may benefit from a regional free trade agreement, certain groups may lose

- It implies a loss of national sovereignty

2. Regional economic integration is only beneficial IF the [amount of trade it creates is > the amount it diverts]

- Leading to either trade creation or trade diversion

What is trade creation?

Occurs when LOW COST PRODUCERS in the free trade area replace the HIGH COST DOMESTIC PRODUCERS

What is trade diversion?

Occurs when HIGHER COST SUPPLIERS within the free trade area replace LOWER COST EXTERNAL SUPPLIERS

What is optimal currency area and its implications?

- It is the "Common" exchange rate (EU is NOT an optimal currency area)

- Similarities in the underlying structure of economic activity make it feasible to adopt a single currency and use a single exchange rate as an instrument of macroeconomic policy.