9. Regional Economic Integration – Fundamentals of International Business

CHAPTER 9

Regional Economic Integration

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

  • Define different forms of economic integration and their effects on international business
  • Examine the costs and benefits of integration
  • Explore different regional trading groups and their impact on the world and regional economy
  • Explain the rationale for international commodity agreements

BREXIT SPELLS DOOM FOR WINE, HAM AND CHEESE

Port wine from Portugal, feta cheese from Greece and Parma ham from Italy are in danger of losing their identity. Reason? — BREXIT: Britain’s decision to exit from the EU.

Port wine and its distinctive flavor comes from ripe black supersweet grapes ripened in the scorching late summer Sun of Northern Portugal. Winemaking has for centuries been a way of life for people in this part of the world and helps to sustain the local economy. Britain is the port wine’s second-largest export market, but its decision to leave the EU may spell trouble for wine makers.

The names of products like French Champagne, Greek feta cheese and Italy’s Parma ham have been saved from large scale industrial production by lower-cost copycats as a consequence of the EU’s name-protection Geographical Identification laws. This has been a bone of contention with authorities in the US who have long fought against these EU laws, equating them as tariff barriers which create monopoly. Geographical Identification rules fall under trademark law in the US, feta and parmesan, for example, are considered generic names.

This argument may now find favour with British authorities who are looking out for closer business ties with Washington. The EU seeks to protect local economies and cultures against misuse of names or imitations of these laws which are an important aspect of intellectual property issues.

Britain’s exit from the EU is throwing almost EUR 50 million (USD 58 million) worth of annual business of port wine export into doubt as it has chosen to remain silent on whether it will abide by the EU’s name protection rules after its formal exit from the EU in 2019. This implies that Britain may choose to drink port wine from rival producers such as South Africa and Australia, as it casts around for post-Brexit trade deals.

Meanwhile in the picturesque Douro Valley with its unique grape varieties such as Touriga nacional, Tinta roriz and Barroca, Port - the queen of wines has an uncertain future.

References: Port wine? Feta? Brexit may spell trouble for famed EU names, https://primenewsnow.com/, last accessed on 30 September 2018.

INTRODUCTION

Economic integration is the process of removal of economic barriers between two or more nations and the establishment of cooperation and coordination between them. It is a part of the ongoing process of globalization which is concerned with the growing economic interdependence of countries. Thus, economic integration may be viewed as a spectrum of understanding between nations. At one end of the spectrum, lies a truly global economy in which all countries share a common currency and agree to a free flow of goods, services, and factors of production. At the other extreme, are a number of closed economies, where each is independent and self-sufficient. In actual fact, most agreements on regional economic integration are actually found somewhere in the middle of this spectrum.

 

Economic integration is the process of removal of trade barriers between two or more nations and the establishment of cooperation and coordination between them.

Market integration is the extent to which one or more separated markets combine to form a single market. Integration leads to increased cross-border flows of goods, services, capital, and labor. The process of regional economic integration is pushed by the efforts of institutional and policy coordination of both the government and private market players. This is further encouraged by advancements in technology, global institutional growth and advances in transportation and communications.

The key to market integration is the elimination of barriers to trade and investment in the form of tariffs, quotas, import licensing, limits on the amount of foreign ownership in a particular firm or industry, and the differential treatment of foreign and domestic investors.

This chapter begins with an explanation of different levels of economic integration. It then takes you through some important regional agreements and explores their effects on the regional and world economic system. It also outlines the implications of integration for international business managers.

Figure 9.1 Layers of Economic Integration

LEVELS OF ECONOMIC INTEGRATION

There are five levels of economic integration as illustrated in Figure 9.1 and 9.2.

Free Trade Area (FTA)

A free trade area is the loosest form of economic integration between nations. It is an agreement in which member nations remove all trade restrictions among themselves, but may continue to have any number of such restrictions vis-à-vis their other trading partners. No discriminatory taxes, quotas, tariffs or other trade barriers are allowed between member countries, but they can be used between non-members.

 

A free trade area is an agreement in which member nations remove all trade restrictions among themselves, but continue to have any number of such restrictions vis-à-vis their other trading partners.

The North American Free Trade Agreement (NAFTA) and the Latin American Free Trade Area (LAFTA) now replaced by the Latin American Association of Integration (ALADI) are examples of this form of cooperation. The US similarly has free trade agreements with Israel, Jordan, Chile and Singapore, and is negotiating with countries of the Central American Common Market (CACM).

Customs Union

This is the next step in the process of regional economic integration. A customs union is characterized by the removal of barriers between member countries and the establishment of a common trade policy with respect to non-member countries. This typically takes the form of a common external tariff, where exports from non-members are subject to the same tariff when sold to any member country. Tariff revenues are shared among members according to a predetermined formula. The South African Customs Union is the oldest example of this form of integration. Other examples are the CACM and the Caribbean Community and Common Market (CARICOM).

 

A customs union is characterized by the removal of barriers between member countries and the establishment of a common trade policy with respect to non-member countries.

Figure 9.2 Stages in Regional Economic Integration

Common Market

The next stage in economic integration is the common market. At this stage, there are no barriers to trade among members and a common external trade policy between members and non members. In addition to this, there is free mobility of the factors of production including labor, capital and technology among member countries. Thus, restrictions on immigration, emigration and cross-border investments are abolished. Free mobility of the factors of production leads to capital, labor and technology being employed in their most productive uses contributing to economic growth. Members of a common market need to cooperate in terms of fiscal and monetary policies. Furthermore, while a common market is beneficial for its members in the aggregate, it is not clearly proved that it is beneficial for individual members as well. The Southern Common Market Treaty (MERCOSUR) is an example of this form of cooperation.

 

A common market has no barriers to trade among members and a common external trade policy along with free mobility of the factors of production.

Economic Union

An economic union is a common market which has unified fiscal and monetary policies. This requires harmonization of monetary, fiscal and government policies among member countries and the adoption of a common currency. The formation of an economic union implies giving up a significant portion of national sovereignty to a supranational authority in community-wide institutions such as the European Parliament. This leads to member countries becoming the states of a larger ‘economic community’ which has the same features as a country. For example, the ratification of the Maastricht Treaty by 12 member countries led to the creation of the European Union with effect from 1 January 1994. This treaty jointly with the treaty of Amsterdam laid the foundation for the Economic and Monetary Union (EMU) with the euro as the common currency.

 

An economic union is a common market which has unified fiscal and monetary policies and a common currency.

Political Union

This is the final stage of integration which requires participating nations to become unified in both an economic and political sense. It involves the establishment of a common parliament and other political institutions.

 

The political union is the final stage of integration which requires the establishment of a common parliament and other political institutions.

The features of each level of economic integration have been further discussed in Table 9.1.

 

Table 9.1 Levels of Economic Integration Levels

EFFECTS OF INTEGRATION

There are four major effects of regional economic integration.

Trade Creation and Trade Diversion

The most prominent economic benefits of integration given by economist Jacob Viner are trade creation and trade diversion.

Bird’s-eye View

Regional economic integration is a process of economic co-operation and co-ordination which proceeds in five stages to combine a geographical region into a common economic area. There are a number of closed independent and self-sufficient economies at one end of the spectrum of integration. The other extreme is an integrated global unit with a free flow of goods, services and factors of production with a common currency and common institutions of governance.

Trade creation is the benefit of increased exports to members of a customs union due to the elimination of tariff barriers. Viner explained this with the example of the US and Spain. Both countries were wheat producers and exporters and subject to a common tariff rate in the world economy, but the cost of production was lower in the US than in Spain. However, when Spain joined the EU as a member, its products were no longer subject to the common external tariff which non-members had to pay. Exports of wheat to EU countries from Spain now cost less than they would from the US which was subject to the external tariff. This resulted in increased exports from Spain to other EU countries. This benefit of increased exports to Spain as a result of its EU membership is termed trade creation.

 

The major benefits of regional economic integration include trade creation and trade diversion, increased competition, reduced prices, and higher factor productivity.

As a result of EU membership, trade between the EU and Spain increased, while trade between the EU and the US declined. Thus, when the source of trading competitiveness shifts in this manner from one country to another, it is known as trade diversion.

Trade creation brings with it the benefits of free trade in the form of lower prices. For consumers of EU member nations, the cost of wheat from Spain declined as it was a member nation and its products were subject to a lower tariff rate. Trade diversion, on the other hand, has the negative impact of shifting the competitive advantage away from the once low-cost producer (US) to the high-cost producer (Spain). Hence, while economic integration benefits both the producer and consumers of member nations, it has a negative impact on other global producers and their exports. Economic integration is, therefore, beneficial for members but not for non-members.

Reduced Import Prices

We saw in an earlier chapter that imposing a tariff increases the price of goods as the seller increases his price to cover the tariff. This, in turn, leads to a fall in demand. If the tariff is imposed by a bloc of countries, the fall in price may lead to a substantial fall in demand forcing the producer to reduce the price to boost demand. The possibility of reduced prices is the result of increased market power of the blocof nations relative to that of a single country. This may result in an improved trade position for the importing bloc of countries but would be disadvantageous for the exporting country.

Increased Competition and Economies of Scale

Economic integration increases market size, and helps to reduce the monopoly power of large producers. This is because a larger market increases the number of competing firms, leading to greater efficiency and lower prices for consumers. Industries such as steel and automobiles, which require large-scale production in order to be viable, benefit from the creation of a large trading bloc and, thus, a market. The creation of a large market then results in lower production costs called internal economies of scale. In a common market, there may be external economies of scale as well resulting from the free flow of factors of production such as capital, skilled labor, and superior technology.

Higher Factor Productivity

Free movement of the factors of production in a common market makes them look for areas of higher productivity. This has a two-fold effect:

  1. The movement of people leads to the movement of ideas, skills, and values embodied in them, fostering greater cross-cultural understanding.
  2. Free movement of the factors of production in a common market does not necessarily benefit all members equally as the much needed resources of a country may move to another area of higher productivity. A poorer country may lose talented workers to better opportunities in other countries. For example, multinationals such as Koninklijke Philips Electronics N.V. and Goodyear Corporation have shifted their MERCOSUR production from Argentina to Brazil to take advantage of lower costs and incentives provided by the Brazilian government.

Despite the arguements in favour of regional economic integration, an objective analysis reveals that the real benefits of regional integration depend on the amount of trade creation as against trade diversion. A regional free trade agreement benefits the world economy only if the amount of trade it creates exceeds the amount of trade it diverts.

REGIONAL TRADING AGREEMENTS—A GLOBAL OVERVIEW

There are a number of regional trading agreements that are in force across the world today. Some of the important ones have been discussed here.

European Union (EU)

The European Union (EU) is a political and economic union of 28 member states, located primarily in Europe. It was established on 1 January 1995, as a result of the signing of the Treaty on European Union, also known as the Maastricht Treaty. The treaty was signed in February 1992 and enforced in November 1993. The first EU members comprized 15 countries: Belgium, the Netherlands, Luxembourg, France, Germany, Italy, Denmark, Ireland, the United Kingdom, Greece, Spain, Portugal, Finland, Sweden, and Austria. These EC member states constitute the core as well as the deepest level of European economic integration. The outer tier of trade and economic liberalization around the European Community is composed of countries in Central and Eastern Europe, as well as Mediterranean countries (for example, Slovenia, Malta, and Turkey), with which the European community has reciprocal trade agreements. In 2017, the EU had a population of 511 million, contributing to a GDP of USD 17.5 trillion.1

Stages in the Formation of the European Union

Coal and Steel Treaty: The Coal and Steel Treaty signed in 1952 by six members with the objective of the formation of a common market in coal, steel and iron ore. In this way, none of them could make weapons of war on their own to turn against the other, as in the past. The six were Germany, France, Italy, the Netherlands, Belgium and Luxembourg—the founding members of the European Union.

Treaty of Rome (1957): The Treaty of Rome created the European Economic Community (EEC), or ‘common market’. The idea was for people, goods and services to move freely across Europe.

European Community (1967): The European Coal and Steel Community (ECSC) and EEC, as well as the European Atomic Energy Community (EURATOM) were merged to form the European Community (EC).

Maastricht Treaty (1992): The Treaty on European Union was signed in Maastricht. It was a major EU milestone, setting clear rules for the future single currency as well as for foreign and security policy and closer cooperation in justice and home affairs. Under the treaty, the name ‘European Union’ officially replaced the name ‘European Community’ on 1 January 1993. This led to the establishment of the single market and its four freedoms, making the free movement of goods, services, people, and money a reality.

Schengen Agreement (1995): The Schengen Agreement was signed between seven countries—Belgium, Germany, Spain, France, Luxembourg, the Netherlands, and Portugal. It meant that people could travel on a single passport across any of these countries. The Schengen Agreement presently covers 26 countries.

Euro—The Common Currency: On 1 January 1999, the euro was introduced in 11 countries (joined by Greece in 2001) for commercial and financial transactions only. It is currently used as a common currency in 19 out of the 28 member states of the union.

EU Characteristics

Single market: The EU is a single market which functions through a standardized system of laws which apply in all member states, guaranteeing the freedom of movement of people, goods, services, and capital.

Common policy framework: It maintains a common trade policy, agricultural and fisheries policies, and a regional development policy. It has developed a role in foreign policy, representing its members in the World Trade Organization (WTO), at G8 summits, and at the UN.

Common currency: 19 member states have adopted the euro as its common currency. Latvia is the most recent member and the Council of the EU has approved Lithuania’s membership from January 2015.2

Common Passport: Every citizen in each of its member states is eligible to obtain a common European passport for travel between member states.

Hybrid organization: The EU is a hybrid organization characterized by intergovernmental and supranational features. It is a unique entity with characteristics that distinguish it from any other existing organization or body. It is neither a federation of states like the US nor an organization for cooperation between governments like the UN and nor is it a state intended to replace existing states. It is a body of states which have voluntarily agreed to set up common institutions to which they delegate some of their sovereignty so that decisions on specific matters of joint interest can be taken democratically in the interest of Europe. This pooling of sovereignty has led to the EU acquiring a character over and above its member nation states which can be termed supranational.

Institutions of the EU

The EU functions through the following institutions:

The European Parliament: It represents the EU’s citizens and is directly elected by the people of the member states every five years. The Parliament is one of the EU’s main law-making institutions, along with the Council. It meets in Strasbourg, France and is primarily a consultative body. It debates and passes European laws with the Council; scrutinizes other EU institutions, particularly the Commission, to make sure that they are working democratically; and debates and adopts the EU’s budget with the help of the Council.

The Council of the European Union: It consists of the governments of the member states defines the general political direction and priorities of the European Union. It consists of the heads of state or government of the member states, together with its president and the president of the Commission. It meets every six months at Brussels in Belgium and most of its decision making is based on consensus. The number of votes that a country gets in the council depends on its size; England, for instance, has 29 votes compared to Denmark which is much smaller and, therefore, gets only 7 votes.

The European Commission: It is the executive body that is responsible for proposing new laws to the Parliament and the Council, managing the EU’s budget and allocating funding, enforcing EU law (together with the Court of Justice), and representing the EU internationally, for example, by negotiatingagreements between the EU and other countries. The Commission acts as a policeman and is also responsible for ensuring compliance with EU laws, most of which are delegated to member states for implementation.

European Court of Justice: The European Court of Justice represented by one judge from each of its member countries attempts to interpret EU law to ensure its uniform application in all EU countries. It is also the forum for the settlement of legal disputes between EU governments and EU institutions. Individuals, companies, or organizations can also bring cases before the Court, if they feel that their rights have been infringed on by an EU institution.

European Central Bank: The European Central Bank (ECB) is one of the key EU institutions. The Bank has a pivotal role as it works with the central banks in all 28 EU countries which together are known as the European System of Central Banks (ESCB). It also ensures close cooperation between central banks in the euro area—the 16 EU countries that have adopted the euro—known as the eurozone. The cooperation between this smaller, tighter group of banks is referred to as the eurosystem.

The ECB’s main functions include:

  • Keeping inflation under check, especially in countries that use the euro.
  • Ensuring stability in the financial system by making sure that financial markets and institutions are properly supervized by national authorities, and that payment systems function smoothly.
  • Setting key interest rates for the eurozone and controlling the money supply.
  • Managing the eurozone’s foreign-currency reserves and buying or selling currencies when necessary to keep exchange rates in balance.
  • Authorizing central banks in eurozone countries to issue euro banknotes.
  • Monitoring price trends and assessing the risk they pose to price stability.

Euro

The euro is the common European currency. It was initially adopted by 11 EU member countries on 1 January 1999 and is presently adopted by 19 member nations. However, important EU members such as the United Kingdom, Denmark and Sweden have still not adopted euro. It was initially introduced in 1999 as a virtual currency and used only for accounting purposes till 2002, when it came into circulation as notes and coins.

To be able to join the euro area, the EU member states are required to fulfil a ‘convergence criteria’. This consists of a set of economic and legal conditions, agreed in the Maastricht Treaty of 1992, also known as ‘Maastricht criteria’. The preconditions for joining the EU included a high degree of price stability, a sound fiscal situation, stable exchange rates and converged long term interest rates. It also meant having to give up control over national monetary policy in the interest of the Union. All participating nations have a fixed exchange rate parity against the Euro and by implication against each other. The Euro is managed by the European Central Bank, but taxes are levied at national levels by different EU countries. Each country also decides upon its own budget and national governments have devised common rules on public finances, to be able to coordinate their activities for stability, growth and employment.

Benefits of the Monetary Union

Savings in transaction Costs: The use of a common currency has led to huge savings in transaction costs and the elimination of exchange rate uncertainty. It was said that people travelling across Europe came back with half the original amount they started out with, on account of conversion costs before the introduction of the common currency. Having a common currency has benefited all participants of the EU—individuals, companies, and governments.

Reduced exchange rate uncertainty: The common currency reduced exchange rate uncertainty of dealing with many currencies and helped companies save on costs of hedging against foreign exchange risks. The common currency makes it easier to compare prices across Europe, with added benefits of channelizing resources towards more competitive firms and giving more choice to the consumer.

Macroeconomic discipline: The euro also imposes strong macroeconomic discipline on participating governments to ensure overall stability in the Union. For instance, Greece had to impose austerity measures on its domestic economy to be able to get international funding for its huge domestic debt and save its economy from bankruptcy.

Creation of a continental capital market: The common currency has also helped to create a continental capital market instead of several small, fragmented, illiquid national markets with a localized regulatory framework.

Costs of the Monetary Union

The main cost of the monetary union is the loss of monetary and exchange rate policy independence for member countries. Being part of a union imposes a penalty on all member states as a result of problems in the economy of any member nation.

It is similarly difficult for countries to adhere to fiscal discipline, according to the provisions of the Stability and Growth Pact signed in 1997, which commits them to keeping budget deficits within 3 per cent of GDP.

Bird’s-eye View

The European Union (EU) is the world’s largest and the most successful regional integrative agreement. It has a membership of 28 countries, with a population of over 500 million and a combined GDP of USD 17.35 trillion dollars.

NORTH AMERICAN FREE TRADE AGREEMENT (NAFTA)

The North American Free Trade Agreement (NAFTA) is a comprehensive economic and trade agreement that establishes a free trade area between Canada, Mexico, and the US. NAFTA is structured as three separate bilateral agreements: the first between Canada and the US, the second between Mexico and the US, and the third between Canada and Mexico.

 

The North American Free Trade Agreement (NAFTA) is a comprehensive economic and trade agreement that establishes a free trade area encompassing Canada, Mexico, and the US.

NAFTA establishes rules on tariffs and quotas in accordance with the provisions of the WTO. It also sets out key principles regarding the treatment of foreign investors, It also prohibits the imposition of certain performance requirements, such as a minimum amount of domestic content in production, on foreign investors.

It also includes side agreements on labor adjustment, environmental protection, and import surges.

NAFTA Provisions

The key provisions under NAFTA are:

  • Sanitary and phytosanitary measures: The NAFTA imposes discipline on the development, adoption, and enforcement of sanitary and phytosanitary (SPS) measures. These are measures taken to protect human, animal and plant life or health from risks that may arise from animal or plant pests or diseases, or from food additives or contaminants. Disciplines contained in NAFTA are meant to prevent the use of SPS measures as disguised restrictions on trade, while still safeguarding each country’s right to protect consumers from unsafe products, or to protect domestic crops and livestock from the introduction of imported pests and diseases. Although NAFTA encourages trading partners to adopt international and regional standards, the agreement explicitly recognizes each country’s right to determine the necessary level of protection. Such flexibility permits each country to set more stringent standards, as long as they are scientifically based. NAFTA also allows state and local governments to enact standards more stringent than those adopted at the national level, so long as these standards are scientifically defensible and are administered clearly and quickly.
  • Export subsidies: The three NAFTA countries work towards the elimination of export subsidies worldwide. The US and Canada are allowed to provide export subsidies into the Mexican market to counter subsidized exports from other countries. Neither Canada nor the US is allowed to use direct export subsidies for agricultural products being sold to the other, and both countries are required to consider the export interests of the other whenever subsidizing agricultural exports to third world countries.
  • Internal support: Under NAFTA, the parties are expected to try and move towards domestic support policies that have minimal trade or production distorting effects, or toward policies exempt from domestic support reduction commitments under the WTO.
  • Grade and quality standards: The US and Mexico agreed that when either country applies a measure regarding the classification, grading, or marketing of a domestic product destined for processing, it will provide no less favourable treatment for products imported for processing.

Bird’s-eye View

The NAFTA is an important FTA among US, Canada and Mexico consisting of three separate bilateral agreements.

Importance of NAFTA

The NAFTA is an important pact for the following reasons:

  • It is the first ever reciprocal free trade accord between the developed and the developing world.
  • Its creation led to the formation of a tri-national market of more than 360 million people with a combined purchasing power of about USD 6.5 trillion.
  • The establishment of the NAFTA helped producers of North America (especially the US) to compete globally. It has also helped to improve the investment climate in the region and has given companies a larger market than before.
  • NAFTA has mainly affected trade and employment in North America, especially between US and Mexico.
  • All three countries have enjoyed increased trade, economic growth and higher wages since NAFTA was approved in 1994. There has been an increase in trade between US–Mexico valued at USD 481.5 billion in 2015, which is an increase of 255 per cent. Similarly, US–Canada trade was USD 518.2 billion in 2016, which was a rise of 63.5 per cent.
  • US Agricultural exports to Canada and Mexico rose by more than 400 per cent, from USD 8.9 billion to USD 38.1 billion, between 1993, and 2016. Mexico and Canada are now the most important overseas markets for US-grown commodities including corn and soybeans, apples and high-fructose corn syrup.
  • NAFTA has also benefited supply-chain-related sectors including transportation. This is due to NAFTA provisions which allow for liberal regulation of land transportation regarding streamlining licensing and processing for truckers through an open US–Mexico border.
  • NAFTA had driven down costs making it possible for North America to emerge as a single manufacturing platform and to become a major force in global automotive trade. As a result of NAFTA membership, it was possible for automotive companies in the US, Canada and Mexico to build a car using an engine from Mexico and a transmission from Canada, and put it all together in the US. It was possible to get the benefits of the NAFTA preferential treatment, as long as 62.5 per cent of the value of an automobile was produced within the three countries.
  • As a result, recent years saw huge foreign investments made by Asian and German brands in Mexico. This includes Mazda’s facility, with an estimated annual production of 185,000 vehicles; Nissan’s, with an annual capacity of 149,000 vehicles and Audi’s, with annual capacity for 150,000 vehicles.
  • The emergence of Mexico as an export hub has had an overall impact of increased productivity across sectors. MNEs from the US, Japan and Korea have invested in world class factories and the best equipment in electronics, especially appliances, automotive parts, furniture and also in aerospace and computers for the export market, leading to increased productivity across sectors.
IMPLICATIONS OF A NEW AGREEMENT

The three countries began re-negotiation of NAFTA in August 2017. US President Trump has been a key advocate of renegotiating or abolishing the treaty, claiming that the agreement is unfair to the US. There are two clear goals of the US in pushing for a changed treaty.

  • First, it wants to update the 23-year-old agreement to reflect a modern economy that covers intellectual property, digital trade, anticorruption, technical standards, financial services, and others.
  • Second, it is felt that NAFTA has become very lopsided and needs to be rebalanced, since it is responsible for the huge and recurring trade deficit of the US economy.

The new proposals for NAFTA have the following features:

  • It is contended that US content in automobiles should be at least 50 per cent to qualify for NAFTA’s zero tariffs. A complementary demand is to raise the minimum value of automotive components sourced within the three countries from the current 62.5 per cent to 85 per cent.
  • A second issue is the US demand for a so-called ‘sunset clause’, where the three countries must renew the 23-year-old agreement after five years, or else it would lapse. The demands are aimed at helping to bring automobile manufacturing jobs back to the US and to correct the US trade deficit.
  • NAFTA3 is blamed for shifting US manufacturing jobs to Mexico from Canada. The estimated loss of jobs is estimated at 17 million from 1994 to 2017. These jobs have been shifted to Mexico, which is a lower-cost employment destination. The automobile industry is the largest beneficiary of lower cost work being moved to Mexico from the US. This is one of the main reasons for the US leaving NAFTA.
  • Manufacturing enclaves in Mexico are called Maquiladoras. It has been seen that programmes implemented in these Mexican enclaves exploit Mexican workers, who have to work at lower wages due to competition. A majority of the employers in these enclaves are US MNEs, especially from the automobile sector.
  • The US has had a major gain in the renegotiated agreement with Mexico as the two countries have agreed to the change in the rules of origin for automotive products favouring American content. About 75 per cent of auto content will be made in the US and Mexico, and 40–45 per cent will be made by workers who are assured of a minimum wage of USD 16 per hour. The assured minimum wage is likely to lead to an increase in the cost of production an obvious adverse impact on sales. This may push US automobile MNEs to look for alternate low-cost destinations in Latin America or Asia and move production to those countries.
  • The US and Mexico have also reached an agreement covering protection of intellectual property rights, digital trade, financial services, and labor and environmental obligations.
  • A related agreement covers agricultural trade between the two countries, and its highlight is the retention of zero tariffs. The countries have agreed to revisit the deal after six years.
  • Canada has taken a tough stand on two issues in the context of NAFTA. The first issue is regarding the US demand for removal of Chapter 19. This chapter allows for a dispute resolution mechanism where actions by either of the participating countries could be challenged by independent panels.
  • Another problem area for Canada is the issue of imposition of Canadian tariffs on US poultry eggs and traditional dairy products.
ASSOCIATION OF SOUTHEAST ASIAN NATIONS (ASEAN)

The Association of Southeast Asian Nations (ASEAN), an economic and political association, was established on 8 August 1967 in Bangkok by Indonesia, Malaysia, Philippines, Singapore, and Thailand. Subsequently, the State of Brunei Darussalam joined on 8 January 1984, Vietnam on 28 July 1995, Lao People’s Democratic Republic and Myanmar on 23 July 1997, and Cambodia on 30 April 1999.

Objectives of ASEAN

The stated objectives of the ASEAN are:

  • To accelerate economic growth, social progress, and cultural development in the region.
  • To promote regional peace and stability through abiding respect for justice and the rule of law in the relationship among countries in the region and adherence to the principles of the United Nations Charter.

The highest decision-making organ of ASEAN is the meeting of the ASEAN heads of state and government which is convened every year. The ASEAN Ministerial Meeting comprising foreign ministers of member countries is also held annually. Ministerial meetings on sectors such as agriculture and forestry, economics (trade), energy, environment, finance, health, information, investment, labor, law, regional haze, rural development and poverty alleviation, science and technology, social welfare, telecommunications, transnational crime, transportation, tourism, and youth are also held regularly. Supporting these ministerial bodies are committees of senior officials, technical working groups, and task forces.

ASEAN EVOLUTION AND GROWTH

ASEAN began as a Preferential Trading Arrangement in 1977, which aimed at modest integration and economic cooperation. The Arrangement wanted to promote economic cooperation with a focus on basic commodities such as food and security, promotion of intra – ASEAN trade and better utilization of raw materials in member countries. These objectives were utilized through the use of various policy instruments focused at preferential treatment of members in supply contracts, interest rates, non-tariff measures and finance for trade.

ASEAN followed global trends in regional integration in its Framework Agreement on enhancing Economic Cooperation in 1992. This led to the setting up of the ASEAN FTA, the ASEAN secretariat and other areas of cooperation in industry, minerals and energy, finance and banking, food, agriculture and forestry, and transport and communication. There were similar integration agreements being formed at a global level at the same time—the conclusion of the Uruguay Round in 1991, European Single Market in 1993, the US–Canada FTA in 1988.

The main purpose of the APTA was reduction of tariffs in the ASEAN region along with the harmonization of policy under the Common Effective Preferential Tariff (CEPT) scheme. Under the CEPT, tariff rates were to be reduced by 5 per cent till 2008. It also called for gradual elimination of non-tariff barriers and the rules of origin threshold to be 40 per cent for any content sourced from a member state.

The CEPT–AFTA was replaced by the ASEAN Trade in Goods Agreement (ATIGA) in 2010. The main objective of the agreement was to reduce tariffs to zero, but it had some exceptions in the list as well.

The ASEAN community was visualized as a stable, prosperous and highly competitive region with equitable economic development and reduced poverty and socio-economic disparities. It was initially meant to be implemented by 2020, but the timeline has now been moved to 2025.4

The ASEAN agreement on Services (ASAS) was signed in 1995 to encourage integration in the services sector. It identified four priority sectors in 2010. These were: air transport, e-ASEAN, health care and tourism. The logistics sector was added on later.

The ASEAN Comprehensive Investment Agreement (ACIA) was formulated in 2012 to promote investment in the ASEAN. It added into earlier agreements and focused on portfolio investments, intellectual property and an investor–state dispute settlement mechanism.

ASEAN ACHIEVMENTS
  • The ASEAN region has had a healthy average growth rate of 5 per cent from the 1980s, which is higher than the average growth rate seen in Africa and Latin America.
  • The region has had an increase in per capita GDP from USD 584 in the 1970s to USD 2284 in 2015, which is an increase of almost 400 per cent.
  • The growth witnessed in the ASEAN region has led to a decline in its poverty rate from 57.1 per cent in 1981 to 15.6 per cent in 2010.
  • The ASEAN has also seen a typical change in its sectoral output, as the contribution of the agricultural sector to GDP has declined, but the shares of industry and services sector has increased. The share of the agricultural sector in regional GDP has declined from 32.4 per cent in 1970 to 11.2 per cent in 2015. The share of industry and services has increased by almost 10 per centage points: the share of industry in the total GDP increased from 24.3 per cent to 36.7 per cent and the contribution of the services sector rose from 43.3 per cent to 52.1 per cent from 1970 to 2015.
  • Agriculture has a significant contribution in countries such as Cambodia, Myanmar, Vietnam and Laos. The services sector is dominant in Singapore which contributes the lion’s share of 73.6 per cent to the region’s GDP. Philippines, Thailand and Malaysia are the other countries where the services sector makes a major contribution to GDP.
  • Trade in the ASEAN region continues to be dominated by the primary sector. The contribution of primary products and resource based manufactures in ASEAN’s exports increased from 30.4 per cent in 1995 to 32,9 per cent in 2015. On the other hand, the share of high technology exports declined from 34.9 per cent to 29.8 per cent—the decline was led by electronic and electrical manufactures. Increase in exports of automotive and process manufactures led to an overall increase in medium technology exports from 16.8 per cent to 20 per cent between 1995 and 2015.
  • Tariff liberalization has been ASEAN’s greatest achievement in regional integration. Intra – ASEAN tariff rates have steadily declined since AFTA began in 1993. Tariff rates were further liberalized with the implementation of ATIGA in 2010.
  • The removal of Non-tariff Barriers (NTBs) is an important issue in the AEC Blueprint 2025, but since these depend on voluntary efforts of member countries, their impact is limited.
  • There has been significant improvement in the number of service sector liberalization under AFAS, even though progress is gradual.
SOUTH ASIAN ASSOCIATION FOR REGIONAL COOPERATION (SAARC)

The South Asian Association for Regional Cooperation (SAARC) is an economic and political organization of eight countries in southern Asia. In terms of population, its sphere of influence is the largest of any regional organization; the combined population of its member states is almost 1.5 billion people. It was established on 8 December 1985 by India, Pakistan, Bangladesh, Sri Lanka, Nepal, Maldives, and Bhutan. In April 2007, at the Association’s fourteenth summit, Afghanistan became its eighth member.

In August 1983, the SAARC members adopted the Declaration on South Asian Regional Cooperation and agreed on five areas of cooperation:

  1. Agriculture and rural development
  2. Telecommunications, science, technology, and meteorology
  3. Health and population activities
  4. Transport
  5. Human resource development

Afghanistan was added to the regional grouping at the behest of India on 13 November 2005 and became a member on 3 April 2007. With the addition of Afghanistan, the total number of member states was raised to eight. In April 2006, the US and South Korea made formal requests to be granted observer status. The European Union also indicated interest in being given observer status, and made a formal request for the same to the SAARC Council of Ministers meeting in July 2006. On 2 August 2006, the foreign ministers of the SAARC countries agreed in principle to grant observer status to the US, South Korea and the European Union. On 4 March 2007, Iran also requested observer status.

The SAARC Secretariat was established in Kathmandu on 16 January 1987. Its role is to coordinate and monitor the implementation of SAARC activities, service the meetings of the Association and serve as the channel of communication between SAARC and other international organizations. The Secretariat consists of the secretary general, the seven directors, and the general services staff. The heads of states or governments of SAARC have taken some important decisions and bold initiatives through the years to strengthen the organization and to widen and deepen regional cooperation.

Over the years, the SAARC members have expressed their reluctance to sign a free trade agreement. Though India has several trade pacts with Maldives, Nepal, Bhutan, and Sri Lanka, similar trade agreements with Pakistan and Bangladesh have been stalled due to political and economic concerns on both sides. India has been constructing a barrier across its borders along Bangladesh and Pakistan. In 1993, SAARC countries signed an agreement in Dhaka to gradually lower tariffs within the region. Eleven years later, at the twelfth SAARC Summit at Islamabad, SAARC countries devised the South Asia Free Trade Agreement which created a framework for the establishment of a free trade area covering 1.4 billion people. This agreement went into force on 1 January 2006. Under this agreement, SAARC members had to bring their duties down to 20 per cent by 2007.

The SAARC’s inability to play a crucial role in integrating South Asia is often credited to the political and military rivalry between India and Pakistan. It is due to these economic, political and territorial disputes that South Asian nations have not been able to harness the benefits of a unified economy. Over the years, the SAARC’s role in South Asia has greatly diminished and it is now reduced to being a platform for annual talks and meetings between its members.

CHAPTER SUMMARY
  • Economic integration is concerned with the removal of trade barriers or impediments between at least two participating nations and the establishment of cooperation and coordination between them.
  • The benefits of economic integration include trade creation and trade diversion, increased competition, lower prices, and higher factor productivity.
  • Regional economic integration takes several different forms, including common markets (for example, EU), free trade areas (for example, NAFTA) and economic and political associations (for example, ASEAN).
KEY TERMS
  • Economic integration
  • Free trade area
  • Customs union
  • Common market
  • Economic union
  • Political union
  • EU
  • NAFTA
DISCUSSION QUESTIONS
  1. What is economic integration? Explain the different stages in the integration of economies giving suitable examples.
  2. Trace the different stages in the formation of the European Union.
  3. NAFTA has produced significant benefits for the Canadian, Mexican and US economies. Discuss these benefits.
  4. Write short notes on:
    1. ASEAN
    2. SAARC
  5. Discuss the costs and benefits of economic integration.
EXAMINATION QUESTIONS
  1. ‘Regional economic integration results in trade creation and trade diversion’. Critically evaluate this statement, giving suitable examples. (15)

    [B.Com (Hons.), 2010]

  2. ‘Economic integration is achieved after passing through different stages’. Analyse the statement giving suitable examples. (15)

    [B.Com (Hons.), 2009, 2012]

  3. ‘The Common Market, Economic Union and Customs Union are different stages in the growth of regional economic integration’. Elaborate. (15)

    [B.Com (Hons.), 2008, 2010, 2014]

  4. Write short notes on any two of the following: (7.5 each)
    1. NAFTA
    2. SAARC
    3. ASEAN

      [B.Com (Hons.), 2014, 2016]

  5. Discuss how successfully ASEAN has promoted integration among various Asian countries. (8)

    [B.Com (Hons.), 2015]

  6. ‘Regional economic integration is a process that passes through different stages’. Explain the statement with clear contemporary examples. (15)

    [B.Com (Hons.), 2016]

  7. What are the important forms of integration? Give a short description of the European Union. (8

    [B.Com (Hons.), 2017

  8. Write a short note on NAFTA. (7)

    [B.Com (Hons.), 2017]

  9. ‘Economic Integration is achieved after passing through different stages’. Analyse the statement with suitable examples. How successfully has ASEAN promoted integration in the Asian region? (15)

    [B.Com (Hons.), 2018]

  10. What is regional Economic Integration? How has ASEAN promoted integration among its constituent members in the Asian region? (5, 10)

    [B.Com 2018]