Cooperative agreements form a major part of the economic environment in which international businesses operate. To be successful, international businesspeople must understand these agreements and use them to create business opportunities for their firms and counteract their competitors. Of particular importance is the growth of regional trading blocs, such as the Mercosur Accord and NAFTA, which are designed to reduce trade barriers among their members. By far the boldest of these regional economic integration efforts is that of the European Union (EU).
This chapter’s learning objectives include the following:Explaining the importance of the GATT and the WTO to international business. Contrasting the different forms of economic integration among cooperating countries. Analyzing the opportunities for international businesses created by completion of the EU’s internal market. Describing the other major trading blocs in today’s world economy.
To ensure that the post–World War II international peace would not be threatened by trade wars, representatives of the leading trading nations met in Havana, Cuba, in 1947 to create the International Trade Organization (ITO). The ITO’s mission was to promote trade; however, the organization never came into being. Instead its mission was taken over by the General Agreement on Tariffs and Trade (GATT), which had been developed as part of the preparations for the Havana conference. The GATT provided a forum for trade ministers to discuss policies and problems of common concern. In January 1995, it was replaced by the World Trade Organization, which adopted the GATT’s mission.
The GATT’s goal was to promote a free and competitive international trading environment benefiting efficient producers, an objective supported by many multinational corporations (MNEs). The GATT accomplished this by sponsoring multilateral negotiations to reduce tariffs, quotas, and other nontariff barriers.
Because high tariffs were initially the most serious impediment to world trade, the GATT first focused on reducing the general level of tariff protection. It sponsored a series of eight negotiating “rounds,” generally named after the location where each round of negotiations began during its lifetime. The cumulative effect of the GATT’s eight rounds was a substantial reduction in tariffs. These tariff reductions have contributed to dramatic growth in world trade since the end of World War II.
To help international businesses compete in world markets regardless of their nationality, the GATT sought to ensure that international trade was conducted on a nondiscriminatory basis. This was accomplished through use of the most favored nation (MFN) principle, which requires that any preferential treatment granted to one country must be extended to all countries. Under GATT rules, all members were required to utilize the MFN principle in dealing with other members. However, there are two important exceptions. First, members may lower tariffs to developing countries without lowering them for more developed countries. Such reduced rates offered to developing countries are known as the generalized system of preferences (GSP). The second exception is for comprehensive trade agreements that promote economic integration, such as the EU and NAFTA.
The final round of GATT negotiations began in Uruguay in 1986. Ratified by GATT members in 1994, the Uruguay Round agreement took effect in 1995. Uruguay Round participants also agreed to create the World Trade Organization (WTO). They established its initial agenda and granted it more power to attack trade barriers than the GATT had possessed.Headquartered in Geneva, Switzerland, the WTO includes 153 member and 30 observer countries. Members are required to open their markets to international trade and to follow the WTO’s rules. The WTO has three primary goals:Promote trade flows by encouraging nations to adopt nondiscriminatory, predictable trade policies. Reduce remaining trade barriers through multilateral negotiations. Establish impartial procedures for resolving trade disputes among members.
While it was designed to build on and expand the successes of the GATT, the WTO differs from the GATT in two important dimensions:First, the GATT focused on promoting trade in goods. The WTO’s mandate also includes trade in services, international intellectual property protection, and trade-related investment. Second, the WTO’s enforcement powers are much stronger than those enacted under the GATT.
Another challenge facing the WTO is reducing barriers to trade in services. The Uruguay Round developed The General Agreement on Trade in Services (GATS). This agreement advances principles under which such trade should be conducted. The Uruguay Round agreement enacted the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). It includes measures to strengthen intellectual property rights of entrepreneurs, artists, and inventors. However, many believe that theft of intellectual property has increased, due to lax enforcement by governments that are unwilling to keep their Uruguay Round commitments. The Trade-Related Investment Measures Agreement (TRIMS) isa first step toward eliminating national regulations on FDI that may distort or restrict trade. The TRIMS agreement affects trade-balancing rules, foreign-exchange access, and domestic sales requirements. Enforcement of WTO Decisions is also a challenge.A country failing to live up to the WTO agreement may have a complaint filed against it. If a WTO panel finds the country in violation of the rules, the country will be asked to eliminate the trade barrier. If the country refuses, the complaining country can impose off-setting trade barriers on the offending country.
This section focused on The General Agreement on Tariffs and Trade and the World Trade Organization. The discussion began with the goal of the GATT, and then reviewed GATT negotiating rounds and the MFN principle. After the World Trade Organization was introduced, the discussion covered the differences between the WTO and GATT, and examined challenges faced by the WTO. The next section will focus on Regional Economic Integration.
Regional alliances to promote liberalization of international trade are an important feature of the post–World War II international landscape. More than 200 such agreements are in existence, although not all have had much practical impact. The past decade in particular has seen a rise in the number of trading blocs, as countries seek to integrate their economies more closely in order to open new markets for their firms and lower prices for their consumers.
This graphic represents the five forms of regional economic integration, starting at the bottom with the least integrated form.A free trade area eliminates trade barriers among its members; however, each member establishes its own trade policies against nonmembers. As a result, they are vulnerable to trade deflection, in which nonmembers reroute exports to the member nation with the lowest external trade barriers. To counter this problem, most free trade agreements specify rules of origin, which detail how a good is classified as a member good or a nonmember good. A customs union eliminates internal trade barriers among its members and adopts common external trade policies toward nonmembers. The uniform treatment of products from nonmember countries minimizes the trade deflection problem. A common market eliminates internal trade barriers among members and adopts a common external trade policy toward nonmembers. It also eliminates barriers that inhibit the movement of factors of production among members. An economic union represents full integration of the economies of two or more countries. Members eliminate internal trade barriers, adopt common external trade policies, and abolish restrictions on the mobility of factors of production among members. In addition, an economic union requires its members to coordinate their economic policies in order to blend their economies into a single entity.A political union is the complete political and economic integration of two or more countries, thereby effectively making them one country.
From the viewpoint of an individual firm, regional integration is a two-edged sword. On the plus side, lowering tariffs within the regional trading bloc opens the markets of member countries to all member country firms. Firms lower their average production and distribution costs by capturing economies of scale as they expand their customer base within the trading bloc. Lower costs also help the firms compete in markets outside the trading bloc.
However, elimination of trade barriers exposes a firm’s home market to competition from firms located in other member countries and FDI from nonmember countries. Both of these situations are threatening less efficient firms. Each form of integration confers benefits on the national economy as a whole, but economic integration can harm specific sectors within that economy. Negotiating any form of economic integration, therefore, is not easy. Special-interest groups may lobby against it. As a result of such internal political pressures, few economic integration treaties are pure, as most contain some exemptions to quiet politically powerful domestic special-interest groups.
This section focused on Regional Economic Integration by reviewing the forms of economic integration and the impact of economic integration on international businesses. The next section will focus on the European Union.
The most important regional trading bloc in the world today is the European Union (EU). With a combined population of 499 million, the EU is one of the world’s richest markets, with a total gross domestic product (GDP) of $16.3 trillion, or about 28 percent of the world economy.
The creation of the European Union (EU) was motivated by the desires of Europeans to promote peace and prosperity through economic and political cooperation. To further this objective, France, West Germany, Italy, Belgium, the Netherlands, and Luxembourg signed the Treaty of Rome in 1957. The treaty established the European Economic Community (EEC) and promoted a common market among the six member states. Over the next five decades, the EEC changed its name twice and expanded its membership dramatically. During the 1970s, the United Kingdom, Denmark, and Ireland joined the EEC, which became commonly referred to as the European Community (EC). During the 1980s, Greece, Portugal, and Spain entered the EC. In 1993, EC members signed the Treaty of Maastricht; as a result, the EC became known as the EU. In 1995, Austria, Finland, and Sweden joined the EU. Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia became EU members in 2004. Bulgaria and Romania joined the EU in 2007, bringing its total membership to 27.
The European Union is a unique institution. Its members are sovereign nations that have ceded certain of their powers to the EU. The EU can be characterized as an intergovernmental government because it is a government of national governments. Since it exercises power above the national level, the EU is also a supranational government. Five organizations perform its executive, administrative, legislative, and judicial functions:The European Council (meets in Brussels, Belgium)The Council of the European Union (headquartered in Brussels, Belgium)The European Commission (also based in Brussels)The European Parliament (normally meets in Strasbourg, France)The European Court of Justice (sitting in Luxembourg)The following slides will provide an overview of these organizations.
The European Council consists of the following: heads of state or government from each of the member states, the President of the European Council, and the President of the European Commission. In addition, the EU’s High Representative of the Union for Foreign Affairs and Security Policy participates in its meetings. Normally convening twice every six months, the European Council shapes the EU’s political priorities and policy agendas. Its decisions are usually based on consensus, unless EU treaties require a different voting rule.
The Council of the European Union is composed of 27 representatives, each selected directly by and responsible to his or her home government. The Council is the EU’s most powerful decision-making body. In most Council decisions, a weighted voting system is used. The allocation of votes is in rough proportion to the population and economic clout of the members. Some Council decisions require unanimous approval, such as entry of new members, taxation, foreign and security policy initiatives, and amending EU treaties. On matters perceived to be less threatening to national interests, Council decisions require only a qualified majority for passage.
The European Commission is composed of 27 people, one from each member state, selected for five-year terms. However, their loyalty is to the EU itself, not to their home countries. The Commission is the “guardian of the Treaties.” Its functions include the following:The Commission proposes legislation to be considered by the Council. It implements provisions of the Treaty of Rome and other EU treaties. It also protects the EU’s interests in political debates, particularly in Council deliberations.The Commission has extensive powers in implementing the EU’s customs union, the Common Agricultural Policy (CAP), and the completion of the internal market. In addition, it administers the EU’s permanent bureaucracy, which employs about 38,000 people, two-thirds of whom work at Commission headquarters in Brussels.
The European Parliament currently comprises 736 representatives elected to serve five-year terms. Seats are allocated in rough proportion to a country’s population. Of the EU’s governing bodies, the Parliament was originally the weakest, playing only a consultative role in EU policy making. Over the years, the Parliament has used its budgetary powers to enlarge its influence within the EU’s governing institutions. It has also gained additional powers under the Maastricht, Amsterdam, Nice, and Lisbon Treaties. Because many Europeans are concerned about the lack of accountability in the EU’s programs and the lack of democracy in its decision-making processes, the role of the European Parliament is likely to expand.
The European Court of Justice consists of 27 judges who serve six-year terms. The judges are selected jointly by the governments of the member states. The Court interprets EU law and ensures that members follow EU regulations and policies.
The co-decision procedure was introduced by the Treaty of Maastricht. It is now a permanent part of the Treaty on the Functioning of the European Union (TFEU). In this procedure, the European Parliament and the Council “co-decide” legislation. In order for the legislation to be enacted, a consensus between the Parliament and the Council must be reached. The EU prefers to develop a strong consensus on issues among its members before it adopts new legislation. As a result, transforming a Commission proposal into an EU law and then implementing that law into national legislation often takes years. The complicated governance arrangements of the EU reflect an ongoing struggle between two forces: the members’ desire to retain their national sovereignty and their wish to create a supranational government with global influence.
The Treaty of Rome’s goal of creating a common market was visionary. For the first 35 years of the EU’s existence, however, progress was slow.To establish a common market, each EU member had to agree to change national laws, product standards, and regulations to ensure that they were compatible with those of other EU members. In practice, the member nations moved cautiously because of political pressures from domestic special-interest groups. The EU relied on a process of harmonization to eliminate such conflicts. This process encouraged member countries to voluntarily adopt common regulations affecting trade in goods and services, as well as the movement of resources. This process moved slowly, however, as political forces within the member states resisted change, creating fears that the EU would disintegrate. In 1979, the European Court of Justice heard the now famousCassis de Dijon case, involving conflicting regulatory standards in France and Germany. The Court’s decision created the concept of mutual recognition: If one member state determines that a product is appropriate for sale, then all other EU members are also obliged to do so under the provisions of the Treaty of Rome.
The Single European Act was signed in 1986. This act promoted the formation of the common market by December 31, 1992. The market-formation process required 279 broad regulatory changes. All changes had not been fully implemented by the 1992 deadline; nevertheless, sufficient progress had been made to convince many experts that the goal of creating a common market was close to being realized.The benefits of the common market are substantial to European firms, economies, and workers. It enables firms to sell their goods in a large, rich market free from barriers to trade. However, firms in EU member countries also face increased competition in their home markets from other members’ firms. This competition lowers the prices that consumers have to pay for goods and services. Costs for marketing, production, and R&D have been reduced because firms have to comply with one, EU-wide set of regulations, instead of 27 separate sets of national regulations. Many firms have been able to restructure their European manufacturing operations to capture economies of scale and lower their production costs. And the EU has been a magnet for new investment from foreign firms that are eager to enter the lucrative European common market.
The EU members were justifiably proud of the progress made under the Single European Act. As the necessary changes were being finalized, the Cold War ended. The Soviet Union dissolved, countries in Eastern and Central Europe abandoned communism, and the threat of nuclear war diminished. Some European politicians believed that Europe should reassert itself on the world’s stage and free itself from the geopolitical influence of the United States. Meanwhile, economists argued that the risks and costs associated with doing business in multiple currencies created a competitive disadvantage for European companies. In order to address these concerns, the EU’s Council of Ministers met in Maastricht in December 1991 to discuss the economic and political future of the European Union.
The result of the meeting was a new treaty that amended the Treaty of Rome. Known formally as the Treaty on European Union, the Maastricht Treaty came into force on November 1, 1993. It rests on three “pillars” designed to further the economic and political integration of Europe:A new agreement to create common foreign and defense policies among membersA new agreement to cooperate on police, judicial, and public safety mattersThe old familiar European Community, with new provisions to create an economic and monetary union among member states After the treaty was implemented, the European Community became known as the European Union,in recognition of the increasing integration of Europe.
The most important aspect of the Maastricht Treaty was the establishment of the economic and monetary union. Its major task has been to create a single currency, called the euro, to replace existing national currencies. As of 2011, seventeen EU countries utilize the euro. The creation of the euro reduced exchange rate risks and currency conversion costs of firms doing business in the eurozone. EU officials estimated that the creation of the euro saved Europeans $25 to $30 billion annually in currency conversion and hedging costs.However, creation of a single currency was not without controversy. Participating members lost control over their own domestic money supplies and economic destinies. The European Central Bank is now responsible for controlling the money supply, interest rates, and inflation. Moreover, under the terms of the Stability and Growth Pact, eurozone participants must limit annual government deficits to no more than 3 percent of their GDPs, thus limiting their ability to use fiscal policy to promote economic growth. Other critics fear that a “one size fits all” monetary policy for the entire eurozone will generate economic problems whenever the national economies of the eurozone countries are at different stages of the business cycle.
The Treaty of Amsterdam (aka the Treaty for Europe) was signed in 1997. Its most important components include the following: a strong commitment to attack the EU’s high levels of unemployment; a plan to strengthen the European Parliament; and the establishment of a two-track system, allowing groups of members to proceed with economic and political integration faster than the EU as a whole.The Treaty of Nicebecame effective in February 2003. It continued the integration process by making modest adjustments in the EU’s governance arrangements. For instance, the treaty reduced the number of areas where unanimity is required for Council approval; yet, more significant steps were needed to reform the EU’s decision-making processes. Therefore, EU members established a Constitutional Convention to resolve these conflicts. Unfortunately, the proposed Constitution was defeated in May 2005.After a two-year “period of reflection,” EU members agreed to the Treaty of Lisbon (or the Reform Treaty), which adopted many of the governance changes proposed by the Constitutional Convention. Important changes included creating a full-time President of the European Council, permitting a reduction in the size of the European Commission, and strengthening the powers of the European Parliament. The Treaty of Lisbon also granted national legislatures the formal right to voice concerns about proposed EU legislation.
Even though the members of the EU have made remarkable progress in implementing the goals of the Treaty of Rome, political conflicts still remain. One divisive issue is state aid to industry. Under EU rules, national governments may not provide subsidies to firms that “distort” competition. Yet many governments don’t want to let domestic firms go bankrupt, especially if local jobs are threatened. Some national governments have tried to protect their domestic corporations from unwanted takeovers by firms headquartered in other EU countries. Such actions are contrary to the goal of creating an EU-wide capital market. France and the United Kingdom are at odds over the EU’s Common Agricultural Policy. This policy benefits French farmers to the detriment of British interests. It also compromises the EU’s relationships with the United States and the WTO. Other countries are concerned about the lack of democracy and accountability within the EU. They believe more power should be given to the European Parliament, the EU’s only directly elected governing body.
This section focused on The European Union. The discussion began with an overview of the creation of the European Union and then reviewed The European Council, The Council of the European Union, The European Commission, The European Parliament, and The European Court of Justice. The next slides covered the legislative process and the struggle to create a common market, which resulted in The Single European Act. Then, the discussion highlighted Europe’s move from a common market to The European Union—focusing on the three pillars of The Maastricht Treaty and the creation of the Euro. The discussion ended by reviewing significant treaties and economic progress, along with challenges faced by the EU going forward. This concludes our discussion of the European Union. The next section will focus on Other Regional Trading Blocs.
The EU’s success in enriching its members through trade promotion has stimulated the development of other regional trading blocs. Every inhabited continent now contains at least one regional trading group.
NAFTA was implemented in 1994 to reduce barriers to trade and investment among Canada, Mexico, and the United States. Over a 15-year time span, tariff walls have been lowered, NTBs have been reduced, and investment opportunities have increased for firms located in the three countries. Most experts believe that NAFTA has benefited all three countries, although the gains have been more modest in Canada and the United States than most NAFTA advocates expected. NAFTA’s overall impact on the Mexican economy has been dramatic.
The Caribbean Basin Initiative (CBI) overlaps two regional free trade areas: the Central American Common Market and the Caribbean Community and Common Market. The CBI permits duty-free import into the United States of a wide range of goods that originate in Caribbean Basin countries, or that have been assembled there from parts produced in the USA. However, politically sensitive goods have been excluded from the CBI, such as textiles, canned tuna, apparel, and petroleum. The Central America-Dominican Republic Free Trade Agreement was signed in 2004. It reduced tariffs, NTBs, and investment barriers among the United States, El Salvador, Costa Rica, Guatemala, Honduras, Nicaragua, and the Dominican Republic.In 1991, the governments of Argentina, Brazil, Paraguay, and Uruguay signed the Mercosur Accord. These countries agreed to set common external tariffs and to cut internal tariffs on goods that account for 85 percent of intra-Mercosur trade. Bolivia, Colombia, Chile, Ecuador, Peru, and Venezuela later joined Mercosur as associate members. The Andean Community resulted from a 1969 agreement to promote free trade among Bolivia, Chile, Colombia, Ecuador, and Peru. Venezuela joined the pact in 1973, but Chile dropped out in 1976. During its first 20 years, however, the agreement was not very successful. In 2005, the Andean Community negotiated a cooperative agreement with Mercosur members.
The Australia–New Zealand Closer Economic Relations Trade Agreement (ANZCERTA or CER) took effect on January 1, 1983. Over time, it has eliminated tariffs and NTBs between the two countries. The CER has also fostered cooperation in marketing, investments, tourism, and transportation. Most analysts believe the CER has been one of the world’s most successful free trade agreements.The Association of Southeast Asian Nations (ASEAN) was established in 1967 to promote regional political and economic cooperation. Its founding members were Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand. During the 1990s, Cambodia, Laos, Myanmar, and Vietnam joined. ASEAN increased its stature in the world market in 2003 by signing a free trade pact with China, with the first set of tariff cuts commencing in 2004.To promote intra-ASEAN trade, members established the ASEAN Free Trade Area (AFTA), in 1993. AFTA members promised to slash their tariffs to 5 percent or less on most manufactured goods by 2003 and on all goods by 2010. Asia-Pacific Economic Cooperation (APEC) includes 21 countries from both sides of the Pacific Ocean. It was founded in 1989 to promote free trade and investments among member nations. In 2009, merchandise exports from APEC members were valued at more than $6.8 trillion, about 55 percent of global merchandise exports.
Many African countries have also established regional trading blocs. The three most important of these groups are as follows:The Southern African Development Community (SADC) is a free trade area created by 12 African Countries. The Economic and Monetary Community of Central Africa (CEMAC) promotes regional economic cooperation in Central Africa.The Economic Community of West African States (ECOWAS) was created by 16 West African countries to promote regional economic cooperation.Although these groups were established during the 1970s and early 1980s, they have not had a major impact on regional trade. Intra-Africa trade to date accounts for less than 12 percent of the continent’s total exports. This is due to inadequate intraregional transportation facilities and the failure of most domestic governments to create economic and political systems that encourage significant regional trade.
This section focused on Other Regional Trading Blocs by reviewing NAFTA and other free trade agreements in the Americas, the Asia-Pacific Region, and Africa. This presentation will close with a review of the chapter’s learning objectives.
This concludes the PowerPoint presentation on Chapter 10, “International Cooperation Among Nations.” During this presentation, we have accomplished the following learning objectives: Explained the importance of the GATT and the WTO to international business. Contrasted the different forms of economic integration among cooperating countries. Analyzed the opportunities for international businesses created by completion of the EU’s internal market. Described the other major trading blocs in today’s world economy.For more information about these topics, refer to Chapter 10 in International Business.