Economic Integration

IB Economics SL

Globalization

The increased integration of national economies into global, rather than national markets, promoted by liberalized capital flows, liberalized trade flows, significant advances in IT and decreased cost of int. transport.

As globalization continues, countries are joining together to form trade blocs to lower or eliminate trade barriers and to try to accede to the WTO.

MNCs have played a significant role in the process of globalization

MNCs account for 25% of the world output

51 of the world’s largest economies are MNCs and not countries

There are approximately 63000 MNCs

In 1997, MNCs controlled $12 trillion of foreign assets, employed 30 million people , earned $ 9.5 trillion in revenues

this is more than the annual GDP of the US or EU

MNCs

MNCs are associated with foreign direct investments (FDI)

FDI is long term overseas investment by MNCs

Ex: A Toyota may be designed in Japan, the leather is made in Argentina, the engine is made in Mexico, the car may assembled in Brazil and then it will be transported to the US for sale.

Why? low cost of labour and ultimately, profitability

Trading Blocs

A trade bloc is an agreement between nations to create a “free trade area” of varying integration that is formed through international agreements (i.e. treaties) and/or with intergovernmental organization help to reduce of eliminate different forms of protections.

The Hungerian economist Bela Balassa identified six stages of Economic integration

from the least extensive (the Preferential Trade Area) to the most extensive (complete economic integration).

Preferential Trade Area (PTA)

a trading bloc giving preferential treatment for certain products from certain countries. (i.e. EU and ACP countries, India and Afghanistan).

This is usually carried out by reducing and not eliminating, tariffs.

Free Trade Area (FTA)

a trading bloc comprised of countries that have agreed to eliminate tariffs, quotas and preferences on most (if not all) gov. between them (i.e. North American Free Trade Area (NAFTA) between Canada, the US and Mexico). 

However, the countries can have different external tariffs to non-members.

Country A

Country B

Country C

Country D

Free Trade Area

Free trade

Imposes tariffs

Embargo

Custom Union (CU)

an FTA with a common external tariff (i.e. MERCOSUR in much of South America, CARICOM in the Caribbean).

CU

FTA

Country A

Country B

Country c

Country D

Common external barriers

Common Market (CM)

a CU with common policies on product regulations , free movement of goods, services, capital and labor(specifically capital and labor)

(i.e. the European Union)

Economic and Monetary Union

(EMU) a CM with a single market and common

currency (i.e. 16 countries of the Eurozone, West African EMU and the West African CFA franc).

Complete economic integration

An economic integration, at which point the individual countries involved would have no control over the fiscal policy, full monetary policy and complete harmonization.

This is the aim of Eurozone

Evaluation of trading blocs

In economic terms: Being a member of a trading bloc is similar to

free trade Potential for a larger export market More efficient Increased competition More choice Lower prices Greater political stability

Disadvantages

Increased trade among members

Enact discriminatory policies against non-members

HL ONLY

Obstacles to economic integration

Two reasons against economic integration1. It takes away a countries political sovereignty

This reduces the power domestic government in the country. Ex: EU

2. It takes away the economic sovereignty If it reaches the custom union, the economic

decisions will be made by the central body. Ex: EU, bailout of Portugal and Spain

Trade Creation

the advantage of a country joining (at least) a customs union as specialization according to comparative advantage from high-cost producers to low-cost producers occurs.

Graph Analysis:

In this example, we address what happens to Slovenia when it joins the European Union.  Before joining, Slovenia faced an EU tariff on beef (P-EU+Tariff).  When Slovenia joined the EU, the tariff was eliminated, leading to a gain in the world efficiency lost before with the tariff (the orange triangle) and a gain in the consumer surplus also previously lost (green triangle).  If there were any g/s the Slovenes placed on the EU, those would also we eliminated.  A full-fledged analysis would include the full pre- and post-tariff situation with new labels.

trade diversion

the disadvantage of a country joining (at least) a customs union since the country may have to put tariffs on g/s from countries they previously traded with to adhere to the new agreement (low-cost to high-cost).

Graph Analysis:

In this example, we address what would happen if Albania entered at least a customs union with the European Union.  We assume Albania had an agreement with India by which they could purchase shirts at a price of P-India.  If Albania signs an agreement with the EU, they'll have to assume the EU's tariff on the Indian shirts (P - EU+T) which is a price higher than the EU price for shirts.  In this instance, Albania ceases to trade with India and, instead, purchases EU shirts beyond domestic production.  Therefore, the red trapezoid represents the loss of world efficiency (the left triangle and rectangle) and the loss of consumer surplus (the right triangle) enjoyed before the agreement.  A full-fledged analysis would include the full pre- and post-tariff situation with new labels