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Since the mid-1950s, the term economic in­tegration has become part of the vocabulary of economists. Economic integration is a proc­ess of eliminating restrictions on international trade, payments, and factor mobility. Eco­nomic integration thus results in the uniting of two or more national economies in a re­gional trading arrangement. Before proceed­ing, let us distinguish the types of regional trading arrangements.

A free-trade area is an association of trad­ing nations whose members agree to remove all tariff and nontariff barriers among themselves. Each member, however, maintains its own set of trade restrictions against outsiders. An ex­ample of this stage of integration is the North American Free Trade Agreement (NAFTA), consisting of Canada, Mexico, and the United States.

Like a free-trade association, a customs union is an agreement among two or more trading partners to remove all tariff and non-tariff trade barriers among themselves. In ad­dition, however, each member nation imposes identical trade restrictions against nonparticipants. The effect of the common external trade policy is to permit free trade within the customs union, whereas all trade restrictions imposed against outsiders are equalized. A well-known example is Benelux (Belgium, the Netherlands, and Luxembourg), formed in 1948.

A common market is a group of trad­ing nations that permits (1) the free movement of goods and services among member nations, (2) the initiation of common external trade re­strictions against nonmembers, and (3) the free movement of factors of production across national borders within the economic bloc. The common market thus represents a more com­plete stage of integration than a free-trade area or a customs union. The European Union (EU)1 achieved the status of a common market in 1992 (in 1999, several members of the EU formed a monetary union).

Beyond these stages, economic integration could evolve to the stage of economic union, which national, social, taxation, and fiscal policies are harmonized and administered by a supranational institution. Belgium and Luxembourg formed an economic union during1920s. The task of creating an economic union is much more ambitious than achieving the other forms of integration. This is because a free- trade area, customs union, or соmmon market results primarily from the abolition of existing trade barriers, but an economic union requires an agreement to transfer economic sovereignty to a supranational authority. The ultimate degree of economic union would be the unification of national monetary policies and the acceptance of a common currency administered by a supranational monetary authority. The economic union would thus include the dimension of a monetary union.

The United States serves as an example of г monetary union. Fifty states are linked together in a complete monetary union with a common currency, implying completely fixed exchange rates among the 50 states. Also, the Federal Re-serve serves as the single central bank for the na­tion; it issues currency and conducts the nation's monetary policy. Trade is free among the states, and both labor and capital move freely in pur­suit of maximum returns. The federal govern­ment conducts the nation's fiscal policy and deals in matters concerning retirement and health programs, national defense, international affairs and the like. Other programs, such as police protection and education, are conducted by state and local governments so that states can keep their identity within the union.



Answer the questions

1. What are the types of regional trading arrangements?

2. What is a free trade area? Give examples.

3. What is a Customs union? Give examples.

4. What is a common Market?

5. What is a monetary union?

6. What is an economic union?


Regional trading arrangements are pursued for a variety of reasons. A motivation of virtually every regional trading arrangement has been the prospect of enhanced economic growth. An expanded regional marker can allow economies of large-scale production, foster specialization and learning by doing, and attract foreign investment. Regional initiatives can also foster a variety of noneconomic objectives, such as managing immigration flows and promoting regional security. Moreover, regionalism may enhance and solidify domestic economic re­forms. East European nations, for example, have viewed their regional initiatives with the European Union as a means of locking in their domestic policy shifts toward privatization and marker oriented reform.

Smaller nations may seek safe-haven trad­ing arrangements with larger nations when future access to the larger nations markets ap­pears uncertain. This was an apparent moti­vation for the formation of NAFTA. In North America, Mexico was motivated to join NAFTA partially by fear of changes in U.S. trade policy toward a more managed or strategic trade orientation. Canada's pursuit of a free-trade agree­ment was significantly motivated by a desire to discipline the use of countervailing duties and antidumping duties by the United States,

As new regional trading arrangements are formed or existing ones are expanded or deep­ened, the opportunity cost of remaining outside an arrangement increases. Nonmember ex­porters could realize costly decreases in market share if their sales are diverted to companies of the member nations. This prospect may be sufficient to tip the political balance in favor of becoming a member of a regional trading arrangement, as exporting interests of a non-member nation outweigh its import-competing interests. The negotiations between the United States and Mexico to form a free-trade area appeared to have strongly influenced Canada's decision to join NAFTA, and thus not get left behind in the movement toward free trade in North America.




What are the possible welfare implications of regional trading arrangements? We can delineate the theoretical benefits and costs of such devices from two perspectives. First are the sta­tic effects of economic integration on produc­tive efficiency and consumer welfare. Second are the dynamic effects of economic integra­tion, which relate to member nations’ long-run rates of growth. Because a small change in the growth rate can lead to a substantial cumula­tive effect on national output, the dynamic ef­fects of trade-policy changes can yield substan­tially larger magnitudes than those based on static models. Combined, these static and dy­namic effects determine the overall welfare gains or losses associated with the formation of a regional trading arrangement.

Discuss the following problems:

1. Regional trading arrangements: pros & cons.

2. The role of larger nations in economic life of smaller ones.

3. Overall welfare gains of a regional trading arrangement.




In the years immediately after World War II, the countries of Western Europe suffered balance - of - payments disturbances in response to reconstruction efforts. To deal with these problems, they initiated an elaborate network of tariff and exchange restrictions, quantitative controls, and state trading. In the 1950s, Western Europe be­gan to dismantle its trade barriers in response to successful tariff negotiations under the auspices of GATT. Trade-liberalization efforts within Western Europe were also aided by the estab­lishment of the Organization of Economic Co­operation and Development and the European Payments Union. Convertibility for most Euro­pean currencies had been developed by 1958, and most quantitative restrictions on trade with­in Western Europe had been eliminated.

It was against this background of trade liberalization that the European Union, then known as the European Community, was cre­ated by the Treaty of Rome in 1957. The EU ini­tially consisted of six nations: Belgium, France, Italy, Luxembourg, the Netherlands, and West Germany. By 1973, the United Kingdom, Ire­land, and Denmark had joined the trade bloc. Greece became the tenth member in 1981, and the entry of Spain and Portugal in 1987 raised the membership to 12 nations. In 1995, Austria, Finland, and Sweden were admitted into the EU. Table 9.1 gives, an economic profile of the union's members.

The primary objective of the EU has been to create an economic union in which trade and other transactions take place freely among member nations. According to the 1957 Treaty of Rome, member nations have agreed in prin­ciple to the following provisions:

1. Abolition of tariffs, quotas, and other trade restrictions among member nations.

2. Imposition of a uniform external tariff on commodities coming from nonmember nations.

3. Free movement within the community of capital, labor, and enterprise.

4. Establishment of a common transport policy, a common agricultural policy, and a common policy toward competition and business conduct.

5. Coordination and synchronization of member-nation monetary and fiscal policies.

According to EU's timetable, member na­tions were to establish a free trade zone over a twelve-year period. This was accomplished in 1968, by which time all trade restrictions on manufactured goods had been eliminated. From 1958 to 1968, liberalization of trade within the community was accompanied by a nearly fivefold increase in the value of in­dustrial trade - higher than that of world trade in general. By 1970, the EU had become a full-fledged customs union with a common external tariff system.

Several studies have been conducted on the overall impact of the EU on its members' wel­fare during the 1960s and 1970s. In terms of static welfare benefits, one study concluded that trade creation was pronounced in machin­ery, transportation equipment, chemicals, and fuels, whereas trade diversion was apparent in agricultural commodities and raw materials. The broad conclusion can be drawn that trade creation in the manufactured-goods sector dur­ing the 1960s and 1970s was significant: 10 percent to 30 percent of total EU imports of manufactured goods. Moreover, trade creation exceeded trade diversion by a wide margin, es­timated at 2 percent to 15 percent. In addition, it is widely presumed that the EU enjoyed dy­namic benefits from integration. In the agri­cultural sector, however, trade-diversion effects were predominant, as trade was deflected from low-cost outsiders (Australia) to higher-cost suppliers within the EU (United Kingdom).



Discuss the following issues:

1. Objective reasons led to formation European Union.

2. Five main objectives faced before the E.U.

3. Benefits of European Union.

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