Gbm unit-07 (regional economic integration)

07/06/10 1
By :
Prof. Amit Kumar

07/06/10 2
“A student pursuing management education from IILM-
Graduate School of Management, for example may find
himself or herself placed in a firm located in a totally
different country. Knowledge about international
business keeps the youngster mentally prepared to
accept assignment in an alien environment. Forewarning
is definitely forearming, for the fresh management
graduate”.
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Importance of this course
Global Business Management

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Course: International Business Management
1. Globalization
2. Global Trade & Theory
3. Global Technological Environment
4. Global Economic Environment
5. Global Political-Legal Environment
6. Foreign Direct Investments
7. Regional Economic Integration
8. Strategy and Structure of International Business
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Global Business Management

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IILM-GSM
International Business Management Regional Economic Integration

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Contents
• Opening Case : NAFTA The Mexican Story
• Levels of Integration
• Impact of Integration
• Presentation on : Major Regional Trading Groups
• EU
• NAFTA
• SAARC
• ASEAN
• APEC
• Mercosur
• WTO
• GCC
• ECOWAS
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Major Regional Trading Groups
• EU- European Union
• NAFTA- North American Free Trade Agreement
• SAARC- South Asian Association for Regional
Cooperation
• ASEAN- Association of Southeast Asian Nations
• APEC- Asia-Pacific Economic Cooperation
• Mercosur - RTA among Argentina, Brazil, Paraguay &
Uruguay
• WTO- World Trade Organization
• GCC- Gulf Cooperation Council
• ECOWAS- Economic Community of West African States
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NAFTA: The Mexican Story
‘ Located in the middle America-surrounded by the US, the Gulf of
Mexico, the Caribbean Sea, Belize, Guatemala, and the North
Pacific Ocean- Mexico has an area of 19,64,375 sq km and a
population of more than 100 million. The country is the largest
nation in Latin America, followed by Brazil and Argentina.
Like Brazil, Mexico is a newly
industrialized country with abundant resources and vast
economic potential. It has a large manufacturing base, fertile and
productive agricultural land , and an enormous potential export
market to its immediate north in the US. Despite this, Mexico
like Brazil, suffered from high population growth,
widespread poverty, excessive income inequalities, severe
unemployment and a massive foreign debt-burden’.
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‘ But this changed in 1994 when Mexico signed the North
America Free Trade Agreement (NAFTA). Ten years into
the huge trading block, Mexico has gained immensely.
FDI poured into the economy, factories sprang up, export
surged, and thousands of jobs have been created. Delphi
alone created jobs for 70,000 Mexicans. Being in league
with big partners- US and Canada- Mexico has gained
enormously. Buoyed by its success from NAFTA, Mexico
signed trade agreements with 30 other countries. Millions
of Mexicans are a proof of benefits of forming trading
blocks’.
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Delphi is an automotive parts company headquartered
in Troy, Michigan, USA. Delphi is one of the world's
largest automotive parts manufacturers and has
approximately 146,600 employees (18,900 in the
United States).
With offices worldwide, the company operates 150
wholly owned manufacturing sites, 44 joint ventures,
53 customer centers and sales offices, and 33
technical centers in 38 countries.
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Introduction
‘Integration between countries’ focus on arrangements
between nations.
The Great Depression plunged the world into a period
of isolation, trade protectionism, and economic chaos.
In the mid to late-1940s, countries realized that greater
cooperation was needed to help them emerge from the
wreckage of World War II. The spirit of cooperation
was designed to promote economic growth and
stability.
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Integration means Regional Trading Block
‘ In the 1950s and 1960s regional integration gained significant
momentum. Integration, also called regional trading block,
involves the organizing of individual countries into groups that
eventually abolish trade restrictions with member countries and
also may engage in other activities that promote their citizens
welfare.’
When we say integration, it means economic integration between
nations, bordering sometimes on political integration too.
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‘ Any type of arrangement in which countries
agree to coordinate their trade, fiscal, and/or
monetary policies is referred to as economic
integration. Obviously, there are many
different degrees of integration ‘.
Level of Integration
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Preferential Trading Agreement
Reduced tariffs or special quotas allowing
Preferential access to markets
Free Trade Area
Formal tariff-free trading area between countries
Customs Union
Free trade area plus a common external tariff
Common Market
Customs union plus the free movement of goods,
Services, people and capital
Economic Union
Common market plus full economic policy harmonization
Political Union
Group of nations with shared sovereignty or complete
Unification of nations
LOOSE ECONOMIC INTEGRATION
FORMAL ECONOMIC INTEGRATION
POLITICAL INTEGRATION
1
2
3
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5
6
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• Preferential Trading Agreement is the loosest form of
economic integration. Under this, a group of countries
have a formal agreement to allow each other’s goods
and services to be traded on preferential terms.
• This requires that the tariffs are reduced between the
countries so that special quotas allow preferential
access for their products.
A good example is the ‘Lome’ Agreement among the
African, Caribbean, and Pacific (ACP) group of
countries and European Union.
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• Lome Agreement mainly covers agricultural products,
which are the main exports of the ACP countries.
‘ It is said that Preferential Trading Agreement is
merely a trading agreement between countries
rather than integration. Often, these are
agreements between developing and developed
countries and are designed primarily to support
the latter countries’ economic development’.
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Free Trade Area
Customs Union
Common Market
Economic Union
Political Union
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Free Trade Area
• A free trade area is usually a permanent arrangement
between neighbor countries. It involves complete removal of
tariffs on goods traded among the members of the free trade
area. The arrangement does not, in general, apply to
agriculture, fishing and services.
• Member countries are free to levy their own external tariff on
goods from outside the free trade area.
• Each member thus retains autonomy over trade with external
countries and there is little need for formal institutions and
policies other then to maintain the internal tariff-free area.
NAFTA is the best example. Others include EFTA and
AFTA (Asian Free Trade Area).
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Free Trade Area
Customs Union
Common Market
Economic Union
Political Union
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2
3
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6
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Customs Union
• Members of a customs union remove barriers to trade in
goods and services among themselves.
• In addition, the customs union establishes a common trade
policy with respect to non-members. Typically, this takes the
form of a common external tariff, whereby imports from non-
members are subject to the same tariff when sold to any
member country.
• Tariff revenues are then shared among members according to
a prescribed formula.
EU, a customs union, was established among the original six
members by the late 1960s. This has since been extended
to each of the new EU member states.
The EU agreed to form a customs union with Turkey in 1995.
Another example is Mercosur in South America.
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Free Trade Area
Customs Union
Common Market
Economic Union
Political Union
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2
3
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6
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Common Market
• Like the Custom Union, a common market has no barriers to
trade among members and has a common external trade
policy.
• In addition, the common market removes restrictions on the
movement of factors of production (labor, capital and
technology) across borders. Thus, restrictions on immigration,
emigration and cross-border investments are abolished.
The best example of common market is the EU, which
achieved this status in the 1990s as a result of a 35-
year struggle to end barriers to free movement of
labor, capital and technology.
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Common Market
The European Union was established as a common
market by the Treaty of Rome in 1957, although it took
a long time for the transition to take place.
Today, EU citizens have a common passport, can
work in any EU member country and can
invest throughout the union without
restriction.
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Free Trade Area
Customs Union
Common Market
Economic Union
Political Union
1
2
3
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5
6
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Economic Union
• It represents integration of economies of two or more
countries.
• In addition to eliminating internal trade barriers,
adopting common external trade policies and abolishing
restrictions on the mobility of the factors of production
among member (i.e. common market), an economic
union requires its member to coordinate their economic
policies (monetary policies, fiscal polices, taxation, and
social welfare programmes) so as to blend their
economies into a single entity.
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Economic Union
• Formation of one economic union requires nations
to surrender a large measure of their national
sovereignty.
• Needless to say formation of economic union is
extremely difficult since member countries strong
desire to retain the power of nation-state, and
attempts to undermine the authority of the state will
encounter opposition.
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Economic Union
The Belgium-Luxembourg Economic Union, founded in
1922, is the best existing example of this form of
economic integration.
• The economic union of these two European neighbors
has been facilitated by the tight bonds between their
two currencies.
• The two nations coordinate their monetary policies and
maintain a fixed exchange rate of one Luxembourg
franc to one Belgium franc, and Belgium franc is
commonly used to conduct business in Luxembourg.
• However, a much larger economic union is yet to emerge.
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Monetary Union as a part of Economic Union
Monetary union establishes a common currency
among a group of countries. This involves the
formation of a central monetary authority which will
determine monetary policy for the entire group.
The Maastricht treaty signed by EU members in 1991
proposed the implementation of a single European
currency (the Euro) by 1999. The degree of monetary
union that will arise remains uncertain in 1998.
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Monetary Union as a part of Economic Union
Perhaps the best example of an economic and monetary
union is the United States.
Each US state has its own government which sets policies
and laws for its own residents. However, each state cedes
control, to some extent, over foreign policy, agricultural
policy, welfare policy, and monetary policy to the federal
government.
Goods, services, labor and capital can all move freely,
without restrictions among the US states and the Nations
sets a common external trade policy.
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Free Trade Area
Customs Union
Common Market
Economic Union
Political Union
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2
3
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6
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Political Union
• While some degree of political integration often
accompanies economic integration, political union
implies more formal political links between countries.
• A limited form of political union may exist where two or
more countries share common decision making bodies
and have common policies.
• In its fullest sense, it involves the unification of
previously separate nations .
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Political Union
The world’s best example of political union occurred when
13 separate colonies operating under the ‘Article of
confederation’ grew into a new country- the USA.
• India as a country, emerge after unification of
numerous kingdoms.
• The unification of East & West Germany in 1990 is
another example of total political union.
• Indeed, the formation of Soviet Union itself brought
political union among its various republics, though
integration was less universally popular.
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Political Union
The Union of Soviet Socialist Republics (USSR) was a
constitutionally socialist state that existed in Eurasia from
1922 to 1991.
Emerging from the Russian Empire after the Russian
Revolution of 1917 and the Russian Civil War of 1918–
1921, the USSR was a union of several Soviet republics.
On December 21, 1991, eleven of the former socialist
republics declared in Alma-Ata (with the twelfth republic
– Georgia – attending as an observer) that with the
formation of the Commonwealth of Independent States
the Union of Soviet Socialist Republics ceases to exist.
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Free Trade Area
Customs Union
Common Market
Economic Union
Political Union
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2
3
4
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6
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Impact of Integration
Impact of
Integration
Prices &
Competition
Dynamic
Effect
Trade Creation
& Diversion
Economics of
Scale
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Trade Creation & Trade Diversion
The entry of Spain into the European Union
provides an interesting example of trade creation
and diversion. In 1986, Spain formally entered the
EU as a member. Prior to membership, Spain- like
all non members such as US, Canada and Japan-
traded with the EU and suffered from the common
external tariff imposed by the EU.
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Imports of agricultural products from Spain or US had
the same tariff applied to their products, for example
20%. During this period, the US was a lower-cost
producer of wheat compared to Spain. US exports to
EU members may have cost $3.00 per bushel, plus a
20% tariff of $.60, for a total of $3.60 per bushel. If
Spain at the same time produced wheat at $3.20 per
bushel, plus a 20% tariff of $.64 for total cost to EU
customers of $3.84 per bushel, Spain’s wheat was
more expensive and therefore less competitive.
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But when Spain joined the EU as a member, its products
were no longer subject to the common external tariffs;
Spain had become a member of the ‘Club’ and therefore
enjoyed its benefits. Spain was the low-cost producer of
wheat at $3.20 per bushel, compared to the price of $3.60
per bushel from the US. Trade flows changed as a result.
The increased export of wheat and other
products by Spain to the EU as a result of its
membership is termed trade creation.
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The elimination of tariff literally created more trade between
Spain and EU. At the same time, because the US is still
outside the EU, its products suffer the higher price as a
result of the tariff application. US exports to the EU fell.
When the source of trading competitiveness
is shifted in this manner from one country to
another, it is termed trade diversion.
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Prices & Competition
• When trade barriers come down, consumers can buy
goods more cheaply. Trade creation increases the
availability of goods enabling the consumers to pick
and choose.
• By removing barriers between national markets,
trading blocks create competition. Longer the trading
areas and higher the level of integration, the more
competition will be created.
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Prices & Competition
Competitions benefits consumers in the form of lower
prices, wider choice and better value for the money. In
addition, competition stimulates innovation, not only
in the products themselves but also in the channels of
distribution, methods of payment and so on.
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Dynamic Effects
• The term dynamic effects describes the continuous
pressure for change that is a feature of an integrated
competitive environment.
• In general, the dynamic effect of integration is that it brings
about a more efficient allocation of resources throughout
the trading block, promoting the growth of some businesses
and decline the others, development of new product &
technology.
This process is creating a large-scale restructuring of
industries and firms in the EU, with the relocation of
industry and many cross-border mergers & alliances.
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Economies of Scale
• Many industries, such as steel and automobiles,
require large-scale production in order to obtain
economies of scale in manufacturing.
• Obviously, industries of this type and others may not
be economically viable in smaller, trade-protected
countries. However, the formation of a trading block
enlarges the market so that large-scale production is
justified. These lower production costs resulting from
greater production for an enlarged market is called
internal economies of scale.
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Economies of Scale
In a common market, external economies of scale
may also be present. Because a common market
allows factors of production to flow freely across
borders, the firm may now have access to cheaper
capital, more skilled labor, or superior technology.
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Trading Groups
EU
Mercosur
SAARC
ASEAN
APEC
NAFTA
Commodity
Agreements
WTO
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Gbm unit-07 (regional economic integration)

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