Objectives of trading blocs

8 Regional Economic Integration

Learning Objectives

After studying this chapter, you should be able to

1 Define regional economic integration and identify its five levels.

2 Discuss the benefits and drawbacks of regional economic integration.

3 Describe regional integration in Europe and its pattern of enlargement.

4 Discuss regional integration in the Americas and analyze its future prospects.

5 Characterize regional integration in Asia and how it differs from integration elsewhere.

6 Describe integration in the Middle East and Africa and explain the slow progress.

 A LOOK BACK

Chapter 7 examined recent patterns of foreign direct investment. We explored the theories that try to explain why it occurs and saw how governments influence investment flows.

 A LOOK AT THIS CHAPTER

This chapter explores the trend toward greater integration of national economies. We first examine the reasons why nations are making significant efforts at regional integration. We then study the most prominent regional trading blocs in place around the world today.

 A LOOK AHEAD

Chapter 9 begins our inquiry into the international financial system. We describe the structure of the international capital market and explain how the foreign exchange market operates.

Nestlé’s Global Recipe

Vevey, Switzerland — Although based in small Switzerland, Nestlé (www.nestle.com) sells its products in nearly every country on the planet. Nestlé is the world’s largest food company. It operates across cultural borders 24 hours a day and earns just 2 percent of its sales at home.

Nestlé is known for its ability to turn humdrum products like bottled water and pet food into well-known global brands. The company also takes regional products to the global market when the opportunity arises. For example, Nestlé first launched a cereal bar for diabetics in Asia under the brand name Nutren Balance and is now taking it to other markets worldwide.

Nestlé must navigate cultural and political traditions in other countries because food is an integral part of the social fabric everywhere. Nestlé learned from its past and does all it can to ensure mothers use pure water to mix its baby milk formulas. Today, the company makes every effort to be sensitive to the traditional ways in which babies are fed. Nestlé must also watch for changes in attitudes due to greater cross-cultural contact caused by regional integration. Pictured above, a pharmacist in Rome, Italy, reaches for a package of Mio brand baby milk made by Nestlé.

Source: Alessia Pierdomenico/CORBIS-NY.

The laws of regional trading blocs also affect the business activities of Nestlé. When Nestlé and Coca-Cola announced a joint venture to develop coffee and tea drinks, they first had to show the European Union (EU) Commission that they would not stifle competition across the region. Firms operating within the EU also have to abide by EU environmental protection laws. Nestlé works with governments to minimize the packaging waste that results from the use of its products by developing and managing waste-recovery programs. As you read this chapter, think of all the ways business activities are affected when groups of nations band together in regional trading blocs.1

Regional trade agreements are changing the landscape of the global marketplace. Companies like Nestlé of Switzerland are finding that these agreements lower trade barriers and open new markets for goods and services. Markets otherwise off-limits because tariffs made imported products too expensive can become quite attractive once tariffs are lifted. But trade agreements can be double-edged swords for many companies. Not only do they allow domestic companies to seek new markets abroad, but they also let competitors from other nations enter the domestic market. Such mobility increases competition in every market that takes part in an agreement.

Trade agreements can allow companies to alter their strategies, sometimes radically. As we will see in this chapter, for example, nations in the Americas want to create a free trade area that runs from the northern tip of Alaska to the southern tip of South America. Companies that do business throughout this region could save millions of dollars annually from the removal of import tariffs under an eventual agreement. Multinationals could also save money by supplying entire regions from just a few regional factories, rather than have a factory in each nation.

We began Part Three of this book by discussing the gains resulting from specialization and trade. We now close this part of the book by showing how groups of countries are cooperating to dismantle barriers that threaten these potential gains. In this chapter, we focus on regional efforts to encourage freer trade and investment. We begin by defining regional economic integration and describing its five different levels. We then examine the benefits and drawbacks of regional trade agreements. Finally, we explore several long-established trade agreements and several agreements in the early stages of development.

What Is Regional Economic Integration?

The process whereby countries in a geographic region cooperate to reduce or eliminate barriers to the international flow of products, people, or capital is called regional economic integration (regionalism). A group of nations in a geographic region undergoing economic integration is called a regional trading blocs.

regional economic integration (regionalism)

Process whereby countries in a geographic region cooperate to reduce or eliminate barriers to the international flow of products, people, or capital.

The goal of nations undergoing economic integration is not only to increase cross-border trade and investment but also to raise living standards for their people. We saw in Chapter 5, for example, how specialization and trade create real gains in terms of greater choice, lower prices, and increased productivity. Regional trade agreements are designed to help nations accomplish these objectives. Regional economic integration sometimes has additional goals, such as protection of intellectual property rights or the environment, or even eventual political union.

Levels of Regional Integration

Since the development of theories demonstrating the potential gains available through international trade, nations have tried to reap these benefits in a variety of ways. Figure 8.1 shows five potential levels (or degrees) of economic and political integration for regional trading blocs. A free trade area is the lowest extent of national integration, political union is the greatest. Each level of integration incorporates the properties of those levels that precede it.

Free Trade Area

Economic integration whereby countries seek to remove all barriers to trade between themselves, but each country determines its own barriers against nonmembers, is called a free trade area. A free trade area is the lowest level of economic integration that is possible between two or more countries. Countries belonging to the free trade area strive to remove all tariffs and nontariff barriers, such as quotas and subsidies, on international trade in goods and services. However, each country is able to maintain whatever policy it sees fit against nonmember countries. These policies can differ widely from country to country. Countries belonging to a free trade area also typically establish a process by which trade disputes can be resolved.

free trade area

Economic integration whereby countries seek to remove all barriers to trade between themselves, but each country determines its own barriers against nonmembers.

FIGURE 8.1 Levels of Regional Integration

Customs Union

Economic integration whereby countries remove all barriers to trade among themselves, but erect a common trade policy against nonmembers, is called a customs union. Thus the main difference between a free trade area and a customs union is that the members of a customs union agree to treat trade with all nonmember nations in a similar manner. Countries belonging to a customs union might also negotiate as a single entity with other supranational organizations, such as the World Trade Organization.

customs union

Economic integration whereby countries remove all barriers to trade between themselves but erect a common trade policy against nonmembers.

Common Market

Economic integration whereby countries remove all barriers to trade and the movement of labor and capital between themselves, but erect a common trade policy against nonmembers, is called a common market. Thus a common market integrates the elements of free trade areas and customs unions and adds the free movement of important factors of production—people and cross-border investment. This level of integration is very difficult to attain because it requires members to cooperate to at least some extent on economic and labor policies. Furthermore, the benefits to individual countries can be uneven because skilled labor may move to countries where wages are higher, and investment capital may flow to where returns are greater.

common market

Economic integration whereby countries remove all barriers to trade and the movement of labor and capital between themselves but erect a common trade policy against nonmembers.

Economic Union

Economic integration whereby countries remove barriers to trade and the movement of labor and capital, erect a common trade policy against nonmembers, and coordinate their economic policies is called an economic union. An economic union goes beyond the demands of a common market by requiring member nations to harmonize their tax, monetary, and fiscal policies and to create a common currency. Economic union requires that member countries concede a certain amount of their national autonomy (or sovereignty) to the supranational union of which they are a part.

economic union

Economic integration whereby countries remove barriers to trade and the movement of labor and capital, erect a common trade policy against nonmembers, and coordinate their economic policies.

Political Union

Economic and political integration whereby countries coordinate aspects of their economic and political systems is called a political union. A political union requires member nations to accept a common stance on economic and political matters regarding nonmember nations. However, nations are allowed a degree of freedom in setting certain political and economic policies within their territories. Individually, Canada and the United States provide early examples of political unions. In both these nations, smaller states and provinces combined to form larger entities. A group of nations currently taking steps in this direction is the European Union—discussed later in this chapter.

political union

Economic and political integration whereby countries coordinate aspects of their economic and political systems.

Table 8.1 identifies each country involved in the European Union and the members of every regional trading bloc presented in this chapter. As you work through this chapter, refer back to this table for a quick summary of each bloc’s members.

TABLE 8.1 The World’s Main Regional Trading Blocs

EU

European Union

Austria, Belgium, Britain, Bulgaria, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greec e, Greek Cyprus (southern portion), Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden