UNIT 2 THE GLOBAL TRADE AND

INVESTMENT ENVIRONMENT

MODULE 8
REGIONAL ECONOMIC INTEGRATION

WRITER:
MA. MERLE A FACULTAD, PhDBM(Cand.)
Assistant Professor 3
University of Rizal System Antipolo Campus

Learning Outcomes:
After you have read this module you should:
1. Be able to explain the different levels of regional economic integration.
2. Understand the economic and political arguments for regional economic
integration.
3. Be familiar with the history, current scope, and future prospects of the world’s
most important regional economic agreements.
4. Understand the implications for business that are inherent in regional economic
integration agreements.
Case
NAFTA and Mexican Trucking
When the North American Free Trade Agreement (NAFTA) went into effect in 1994, the
treaty specified that by the year 2000, trucks from each participating nation would be allowed to
cross each other’s borders and deliver goods to their ultimate destination, uninterrupted. Such
an arrangement had in fact been in place between Canada and the United States since the
early 1980s. NAFTA extended the agreement to include Mexico. The argument for doing so was
that such a policy would lead to great efficiencies. Before NAFTA, Mexican trucks stopped at
the border, and goods had to be unloaded and reloaded onto American trucks, a process that
took time and cost money. It was also argued that greater competition from Mexican trucking
firms would lower the price of road transportation within NAFTA. Given that two thirds of cross-
border trade within NAFTA goes by road, supporters argued that the savings could be
significant.

This provision, however, was vigorously opposed by the Teamsters Union in the United
States, which represents truck drivers. The union argued that Mexican truck drivers had poor
safety records and that Mexican trucks did not adhere to the strict safety and environmental
standards of the United States. To quote James Hoffa, the president of the Teamsters:
“Mexican trucks are older, dirtier and more dangerous than American trucks. American truck
drivers are taken off the road if they commit a serious traffic violation in their personal vehicle.
That’s not so in Mexico. Limits on the hours a driver can spend behind the wheel are ignored in
Mexico. Although they did not state so explicitly, the Teamsters were also clearly motivated by a
desire to protect the pay and employment opportunities for American truck drivers.

Under pressure from the Teamsters, the U.S. dragged its feet on implementation of the
trucking agreement. Ultimately, the Teamsters sued to prevent it from taking effect. An
American court rejected their arguments, stating that the country must honor the treaty, and
convened a NAFTA dispute settlement panel. This group ruled in 2001, that the United States
was violating the NAFTA treaty and gave Mexico the right to impose retaliatory tariffs. Mexico
decided not to do that, instead giving the United States a chance to honor its commitment. The
Bush administration tried to do just that, but was thwarted by opposition in Congress, which
approved a measure setting 22 new safety standards that Mexican trucks would have to meet
before entering the United States.

In an attempt to break the stalemate, in 2007 the U.S. government set up a pilot program
under which trucks from some 100 Mexican transportation companies could enter the United
States, provided they passed American safety inspections. The Mexican trucks were tracked,
and after 18 months, the program showed that the Mexican carriers actually had a slightly better
safety record than their U.S. counterparts. The Teamsters immediately lobbied Congress to kill
the pilot program. In March 2009 an amendment attached to a large spending bill did just that.

This time the Mexican government did not let the U.S. off the hook. As allowed under the
terms of the NAFTA agreement, Mexico immediately placed tariffs on some $2.4 billion of goods
shipped from the United States to Mexico. California, an important exporter of agricultural
products to Mexico, was hit hard. Table grapes now faced a 45 percent tariff, while wine,
almonds, and juices will pay a 20 percent tariff. Pears, which primarily come from Washington
state, also faced a 20 percent tariff (4 of 10 pears the U.S. exports go to Mexico). Other
products hit with the 20 percent tariff include exports of personal hygiene products and jewelry
form New York, tableware from Illinois, and oil seeds from North Dakota. In response, the U.S.
government said it would try to develop a new program that both addressed the “legitimate
concerns” of Congress and honored its commitment to the NAFTA treaty. What that agreement
will be, however, remains to be seen.

Introduction
In this module we will take a close look at the arguments for regional economic
integration through the establishment of trading blocs such as the European Union and
the North American Free Trade Agreement. The case presented in this module illustrate
some of the promise and problems associated with integrating the economies of
different nations into regional trading blocs. The provision in NAFTA treaty intends to
remove the barriers to trucking across orders was meant to encourage greater
efficiencies, with the lower costs benefiting the citizens of all three countries.
In Regional Economic Integration, it means agreements among countries in a
geographic region intends to reduce, and ultimately remove, tariff and nontariff barriers
to the free flow of goods, services, and factors of production between each other. The
last two decades have witnessed the unprecedented proliferation of regional trade blocs
to promote regional economic integration. The members of World Trade Organization
are required to notify WTO of any regional trade agreements in which they participate.

LEVELS OF ECONOMIC INTEGRATION

Economic integration is an arrangement among nations that typically includes
the reduction or elimination of trade barriers and the coordination of monetary
and fiscal policies. Economic integration aims to reduce costs for both
consumers and producers and to increase trade between the countries
involved in the agreement. https://www.investopedia.com/terms/e/economic-integration.asp

Advantages of Economic Integration

The advantages of economic integration fall into three categories: trade

benefits, employment, and political cooperation. More specifically, economic integration
typically leads to a reduction in the cost of trade, improved availability of goods and
services and a wider selection of them, and gains in efficiency that lead to greater
purchasing power.
Economic integration can reduce the costs of trade, improve the availability of goods
and services, and increase consumer purchasing power in member nations.
Employment opportunities tend to improve because trade liberalization leads to market
expansion, technology sharing, and cross-border investment.
Political cooperation among countries also can improve because of stronger economic
ties, which provide an incentive to resolve conflicts peacefully and lead to
greater stability. https://www.investopedia.com/terms/e/economic-integration.asp

Source: https://transportgeography.org/contents/chapter7/globalization-international-
trade/economic-integration-levels/

In a free trade area, all barriers to the trade of goods and services among member
countries are removed. In the theoretically ideal free trade area, no discriminatory tariffs,
quotas, subsidies, or administrative impediments are allowed to distort trade between
members. Each country, however is allowed to determine its own trade policies with
regard to non-members.

Economic integration can be classified into five additive levels, each present in
the global landscape:

Free trade. Tariffs (a tax imposed on imported goods) between member countries are
significantly reduced, some abolished altogether. Each member country keeps its own
tariffs regarding third countries. The general goal of free trade agreements is to develop
economies of scale and comparative advantages, promoting economic efficiency.
Custom union. Sets common external tariffs among member countries, implying that
the same tariffs are applied to third countries; a common trade regime is achieved.
Custom unions are particularly useful to level the competitive playing field and address
the problem of re-exports (using preferential tariffs in one country to enter another
country).
Common market. Services and capital are free to move within member countries,
expanding scale economies and comparative advantages. However, each national
market has its own regulations, such as product standards.
Economic union (single market). All tariffs are removed for trade between member
countries, creating a uniform (single) market. There are also free movements of labor,
enabling workers in a member country to move and work in another member country.
Monetary and fiscal policies between member countries are harmonized, which implies
a level of political integration. A further step concerns a monetary union where a
common currency is used, such as with the European Union (Euro).
Political union. Represents the potentially most advanced form of integration with a
common government and where the sovereignty of a member country is significantly
reduced. Only found within nation-states, such as federations where there are a central
government and regions (provinces, states, etc.) having a level of autonomy.
As the level of economic integration increases, so does the complexity of its regulations.
This involves a set of numerous regulations, enforcement, and arbitration mechanisms
to ensure that importers and exporters comply. The complexity comes at a cost that
may undermine the competitiveness of the areas under economic integration since it
allows for less flexibility for national policies and a loss of autonomy. The devolution of
economic integration could occur if the complexity and restrictions it creates, including
the loss of sovereignty, are no longer judged to be acceptable by its members.
https://transportgeography.org/contents/chapter7/globalization-international-trade/
economic-integration-levels/

ECONOMIC CASE FOR INTEGRATION

The case for integration is typically not accepted by many groups within a
country, which explains why most attempts to achieve regional economic
integration have been halting.

The economic case for regional integration is straightforward. As shown in the

economic theories of international trade, it predict that unrestricted free trade will
allow countries to specialize in the production of goods and services that they
can produce most efficiently. This result to greater world production than would
be possible with trade restrictions. It also revealed how opening a country to free
trade stimulates economic growth, which creates dynamic gains from trade.

In the previous chapter, it detailed how foreign direct investment (FDI) can
transfer technological, marketing, and managerial know-how to host nations.
Given the central role of knowledge in stimulating economic growth, opening a
country to FDI is likely to stimulate economic growth. As a whole, economic
theories suggests that free trade and investment is a positive-sum game, in
which all participating countries stand to gain.

Given this economic case, the theoretical ideal is an absence of barriers to the
free flow of goods, services, and factors of production among nations. However,
as presented in the previous chapters, a case can be made for government
intervention in international trade and FDI. Because many government have
accepted part of all of the case for intervention, unrestricted free trade and FDI
have proved to be only an ideal. Although international institutions such as the
WTO have been moving the world toward a free trade regime, success has been
less than total. In a world of many nations and many political ideologies, it is very
difficult to get all countries to agree to a common set of rules. It is easier to
establish a free trade and investment among a limited number of adjacent
countries than among the world community.

THE POLITICAL CASE FOR INTEGRATION

The political case for regional economic integration also has loomed large in several
attempts to establish free trade areas, custom unions, and the like. Linking neighboring
economies and making them increasingly dependent on each other create incentives for
political cooperation between the neighboring states and reduce the potential for violent
conflict. In addition, by grouping their economies, the countries can enhance their
political weight in the world.

These considerations inspired the 1957 establishment of the European Community

(EC), the forerunner of the EU. Europe had suffered two devastating wars in the first
half of the 20th century, both arising out of the unbridled ambitions of nation-states.
Those who have sought a united Europe have always had a desire to make another war
in Europe unthinkable. Many Europeans also believed that after World War II, the
European nation-states were no longer large enough to hold their own in world markets
and politics. The need for a united Europe to deal with the United States and the
politically alien Soviet Union loomed large in the minds of many of the EC’s founders.

IMPEDIMENTS TO INTEGRATION

Despite the strong economic and political arguments in supports, integration has
never been easy to achieve or sustain for two reasons. First, although economic
integration aids the majority, it has its costs. While a nation as a whole may benefit
significantly from a regional free trade agreement, certain groups may lose. Moving to a
free trade regime involves painful adjustments. For example, due to the 1994
establishment of NAFTA, some Canadian and U.S. workers in such industries as
textiles, which employ low-cost, low skilled labor, lost their jobs as Canadian and US
firms moved production to Mexico. The promise of significant net benefits to the
Canadian and US economies as a whole is little compared to those who lose as a result
of NAFTA. Such groups have been at the forefront of opposition to NAFTA and will
continue to oppose any widening of the agreement.

The second impediment to integration arises from concerns over national

sovereignty. Example, Mexico’s concerns about maintaining control of its oil interests
resulted in an agreement with Canada and US to exempt the Mexican oil industry from
any liberalization of foreign investment regulations achieved under NAFTA. Concerns
about national sovereignty arise because close economic integration demands that
countries give up some degree of control over such key issues as monetary policy,
fiscal policy(e.g. tax policy) and trade policy. This has been a major stumbling block in
the EU. To achieve full economic union, the EU introduce common currency, the euro,
controlled by a central EU bank. Although most member states have signed on, Great
Britain remains an important holdout. A politically important segment of public opinion in
that country opposes a common currency on the grounds that it would require
relinquishing control of the country’s monetary policy to the EU, which many British
perceives as a bureaucracy run by foreigners.

THE CASE AGAINST REGIONAL INTEGRATION

Regional integration is the process by which two or more nation-states agree to co-
operate and work closely together to achieve peace, stability and wealth.
This means that the integrating states would actually become a new country — in other
words, total integration. https://www.google.com/search?
q=Regional+Integration&oq=Regional+Integration&aqs=chrome..69i57j0l3j0i395l6.13537j1j15&sourceid=
chrome&ie=UTF-8

Some point out that the benefits of regional integration are determined by the extent of
trade creation, as opposed to trade diversion. Trade creation occurs when high cost
domestic producers are replaced by low-cost producers within the free trade area. It
may also occur when higher-cost external producers are replaced by lower-cost
external producers within the free trade area. Trade diversion occurs when lower-cost
external suppliers are replaced by the higher-cost suppliers within the free trade area. A
regional free trade agreement will benefit the world only if the amount of trade it creates
exceeds the amount it diverts.

For instance, the United States and Mexico imposed tariffs on imports from all
countries, and then they set up a free trade area, scrapping all trade barriers between
themselves but maintaining tariffs on imports from the rest of the world. If the United
States began to import textiles from Mexico, would this change be for the better? If the
United States previously produced all its own textiles at a higher cost than Mexico, then
the free trade agreement has shifted production to the cheaper source. According to the
theory of comparative advantage, trade has been created within the regional grouping,
and there would be no decrease in trade within the rest of the world. Clearly, the change
would be for the better. If, however, the United States previously imported textiles from
Costa Rica, which produced them more cheaply than either Mexico or US, then trade
has been diverted from a low-cost source—a change for the worse.

In the theory, WTO rules should ensure that a free trade agreement does not result in
trade diversion. These rules allow free trade areas to be formed only if the members set
tariffs that are not higher or more restrictive to outsiders than the ones previously in
effect.

REGIONAL ECONOMIC INTEGRATION IN EUROPE

While the European Union (EU) has long been the most developed model of regional
integration, it was severely shaken by the recent economic crisis, causing increasing
doubts about the integration process. The lack of a timely and coherent response to the
euro crisis called into question the integrity of the eurozone, whose structural and
institutional fault lines have been revealed by the financial crisis. These doubts coincide
with dramatic changes in the global economic order involving the relative decline of the
EU and United States and the rise of Asia. The likely economic adjustments are already
threatening social cohesion and political stability in Europe. The crisis has temporarily
weakened the EU's status as a model for regional integration, but as the EU recovers its
confidence, as it always has after previous crises, it will continue to be the leading
example for other efforts at regional integration.
The EU Model
Since the early 1950s, the EU has been a pioneer in regional integration. The most
important principles underlying the success of the EU project include:
Visionary politicians, such as Robert Schuman of France and Konrad Adenauer of
Germany, who conceived of a new form of politics based on the supranational
"community method" rather than the traditional balance-of-power model. Support from
the United States was also crucial in the early years.
Leadership generated by the Franco-German axis. Despite many problems, Paris and
Berlin have been and remain the driving force behind European integration.
The political will to share sovereignty and construct strong, legally based, common
institutions to oversee the integration project.
A consensus approach combined with solidarity and tolerance. The EU approach is
based on not isolating any member state if they have a major problem (such as Greece
in the most recent crisis), hesitance to move forward with policies until the vast majority
of member states are ready, and a willingness to provide significant financial transfers
to help poorer member states catch up with the norm.
No other regional body is anywhere near the EU in terms of political or economic
cooperation, let alone integration.

These four tenets have guided the EU well over the years and enabled the institutions
to survive many crises, from French president Charles de Gaulle's "empty chair" tactic
of withdrawing French representatives from EU political bodies in protest of moves to
introduce qualified majority voting (QMV) to failed referendums on new treaties in a
number of member states, including rejection of the Constitutional Treaty by France and
the Netherlands in 2005 and the Lisbon Treaty by Ireland in 2008. More recently, the
EU has adopted a more flexible approach resulting in a multi-speed Europe with several
tiers of integration. For example, not all member states are in the eurozone, or in the
Schengen passport-free zone; this arrangement has allowed some of the more Euro-
skeptic countries such as the United Kingdom to opt out of certain obligations.
Nevertheless, the core tenet of the EU is readiness to share sovereignty and operate
through strong common institutions.
Other Regional Groupings
There have been several attempts to achieve regional integration outside of Europe—
including the Association of South East Asian Nations (ASEAN), African Union (AU),
Gulf Cooperation Council (GCC), and Mercosur in South America—but they have all
failed to achieve anything resembling the progress of the EU. ASEAN is the most
advanced of these efforts and regularly sends delegations to Brussels to seek ideas
from the EU experience; however, ASEAN remains a strictly inter-governmental body
and there is no indication of interest in sovereignty sharing. It is a similar story
elsewhere: no other regional body is anywhere near the EU in terms of political or
economic cooperation, let alone integration. Indeed, no other grouping has even gotten
to first base in terms of the basic requirements of integration, namely dealing with
historical reconciliation and developing the necessary political will. There have been
innumerable declarations from groupings in Asia, Africa, the Middle East, and South
and Central America about the desirability of closer cooperation and even integration,
but the record shows that the rhetoric has not been matched by action. Although the EU
is also guilty of exaggerated rhetoric, it has steadily moved forward—even if on
occasion it seems to take two steps forward, one step back.
As the EU's experience demonstrates, historical reconciliation is a critical element in
developing the necessary political will for cooperation and, ultimately, integration. The
fundamental basis for the success of the EU is the historical reconciliation between
France and Germany, achieved by years of sustained political effort from the leaders of
both countries. In stark contrast, there has been no such effort in many other parts of
the word where there are ambitions of regional integration. In East Asia, for example,
there can be no integration without genuine reconciliation between Japan and China,
and Japan and Korea. The East Asia experience is replicated elsewhere with
unresolved problems and deep suspicions between, for example, Brazil and Argentina,
India and Pakistan, and Saudi Arabia and its neighbours. Only after historical
reconciliation can countries proceed gradually along the various steps required to create
a regional community such as a free trade area, a customs union, a single market, a
single currency, a common passport area, and a common foreign policy.
https://www.cfr.org/report/european-union-model-regional-integration
 Self Check:
1. NAFTA has produced significant net benefits for the Canadian, Mexican, and
U.S. economies. Discuss.
2. What are the economic and political arguments for regional economic
integration? Given these arguments, why don’t we see more substantial
examples of integration in the world economy?
3. What effect is creation of a single market and a single currency within the EU
likely to have on competition within the EU? Why?
Research Task
Use the globalEDGETM site to complete the following exercises:

Exercise 1
Your company is seeking to expand by opening new customer representative and sales
offices in the European Union (EU). The size of the investment is significant and top
management wishes to have a clearer picture of the current and probable future status
of the EU. A colleague who spent some time living in the EU indicated that Eurostat
might be a comprehensive source to assist in your project. After evaluating the state of
the EU based on the statistics and publications available, prepare an executive
summary describing the features you considered crucial in completing your report.

Exercise 2
Trade agreements can impact the cultural interactions between countries. In fact, the
establishment of the Free Trade Area of the Americas (FTAA) can be considered a
threat as well as opportunity for your company. Identify the main negotiating groups a
country must consider when a member. Choose two negotiating groups and justify their
importance to member countries.

REFERENCES:
Hill, Charles W.L. International Business. Competing in the Global
Marketplace.McGraw-Hill/Irwin. 2011.

https://www.investopedia.com/terms/e/economic-integration.asp

https://www.cfr.org/report/european-union-model-regional-integration
https://www.google.com/search?
q=Regional+Integration&oq=Regional+Integration&aqs=chrome..69i57j0l3j0i395l6.1353
7j1j15&sourceid=chrome&ie=UTF-8