Chapter 17 Economic Integration Mc GrawHillIrwin Copyright 2010

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Chapter 17 Economic Integration Mc. Graw-Hill/Irwin Copyright © 2010 by The Mc. Graw-Hill Companies,

Chapter 17 Economic Integration Mc. Graw-Hill/Irwin Copyright © 2010 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Learning Objectives § Differentiate among the four basic levels of economic integration. § Identify

Learning Objectives § Differentiate among the four basic levels of economic integration. § Identify the static and dynamic effects of economic integration. § Analyze the real-world impact of economic integration on countries in the EU and NAFTA. § Summarize current economic integration efforts in the world. 17 -2

Economic Integration § Economic integration occurs when two or more countries come together for

Economic Integration § Economic integration occurs when two or more countries come together for purposes of trade and/or economic coordination. § Greater integration may yield additional benefits, but it may also involve giving up increasing sovereignty. 17 -3

4 Types of Integration § § Free Trade Areas (FTAs) Customs Unions (CUs) Common

4 Types of Integration § § Free Trade Areas (FTAs) Customs Unions (CUs) Common Markets Economic and/or Monetary Union 17 -4

Free Trade Areas § Members remove tariffs and other trade barriers on each other.

Free Trade Areas § Members remove tariffs and other trade barriers on each other. § Each member maintains its own tariff structure for non-members. § Possible problem: transshipment § Example: NAFTA 17 -5

Customs Unions § Tariffs between members are eliminated (just like a FTA), but also:

Customs Unions § Tariffs between members are eliminated (just like a FTA), but also: • members agree to a common set of external tariffs and other trade barriers, and • members speak with one voice in external trade negotiations. § Example: Southern African Customs Union (SACU) 17 -6

Common Markets § Tariffs between members are eliminated, a common external tariff is established

Common Markets § Tariffs between members are eliminated, a common external tariff is established (all of the features of CUs) plus free movement of labor and capital. § Example: European Community (1957 – 1993) 17 -7

Economic and/or Monetary Union § Similar to a common market: • Tariffs between members

Economic and/or Monetary Union § Similar to a common market: • Tariffs between members are eliminated. • A common external tariff is established. • Factors can move freely between member countries. § But economic policy is coordinated by a supranational institution in the economic and/or monetary union. 17 -8

Welfare Effects of Integration: Static Issues § Jacob Viner argued that integration leads to

Welfare Effects of Integration: Static Issues § Jacob Viner argued that integration leads to two welfare effects: • trade creation: increases a country’s welfare • trade diversion: decreases a country’s welfare § Whether economic integration is welfare-enhancing depends on which effect is larger. 17 -9

Trade Creation and Trade Diversion: An Example § Suppose we have three countries: Uganda,

Trade Creation and Trade Diversion: An Example § Suppose we have three countries: Uganda, Sudan, and Kenya. § Initially, Uganda imports textiles and applies a 50% tariff to textiles from both Sudan and Kenya. § Suppose that Sudan is able to produce a unit of textiles for $1, whereas it costs Kenyan producers $1. 20 per unit. 17 -10

Trade Creation and Trade Diversion: An Example 17 -11

Trade Creation and Trade Diversion: An Example 17 -11

Trade Creation and Trade Diversion: An Example § Prior to integration, Uganda imports from

Trade Creation and Trade Diversion: An Example § Prior to integration, Uganda imports from the most efficient supplier, Sudan. § Suppose now that Uganda enters into a free trade agreement with Kenya, but not Sudan. § That is, Sudanese textile imports are dutiable, but Kenya textiles can enter duty-free. 17 -12

Trade Creation and Trade Diversion: An Example 17 -13

Trade Creation and Trade Diversion: An Example 17 -13

Trade Creation and Trade Diversion: An Example § Notice that Uganda will now import

Trade Creation and Trade Diversion: An Example § Notice that Uganda will now import from Kenya, although Sudan is the more efficient producer. § Uganda loses tariff revenue, but reverses some of the deadweight loss caused by the protectionism. 17 -14

Trade Creation and Trade Diversion: An Example P PS rises as a result of

Trade Creation and Trade Diversion: An Example P PS rises as a result of initial protection. S $1. 50 Tariff price $1. 00 Free trade price 160 200 D Q 17 -15

Trade Creation and Trade Diversion: An Example P CS falls as a result of

Trade Creation and Trade Diversion: An Example P CS falls as a result of the initial protection. S $1. 50 Tariff price $1. 00 Free trade price 160 200 D Q 17 -16

Trade Creation and Trade Diversion: An Example P Revenue rises as a result of

Trade Creation and Trade Diversion: An Example P Revenue rises as a result of the initial protection. S $1. 50 Tariff price $1. 00 Free trade price 160 200 D Q 17 -17

Trade Creation and Trade Diversion: An Example P Welfare declines overall by the DWL

Trade Creation and Trade Diversion: An Example P Welfare declines overall by the DWL triangles. S $1. 50 Tariff price $1. 00 Free trade price 160 200 D Q 17 -18

Trade Creation and Trade Diversion: An Example P With FTA, CS rises. S Tariff

Trade Creation and Trade Diversion: An Example P With FTA, CS rises. S Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q 17 -19

Trade Creation and Trade Diversion: An Example P With FTA, PS falls. S Tariff

Trade Creation and Trade Diversion: An Example P With FTA, PS falls. S Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q 17 -20

Trade Creation and Trade Diversion: An Example P With FTA, revenue falls. S Tariff

Trade Creation and Trade Diversion: An Example P With FTA, revenue falls. S Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q 17 -21

Trade Creation and Trade Diversion: An Example P Lost revenue transferred back S to

Trade Creation and Trade Diversion: An Example P Lost revenue transferred back S to domestic consumers Lost revenue not transferred back to domestic consumers Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q 17 -22

Trade Creation and Trade Diversion: An Example P Overall, we must compare the gain

Trade Creation and Trade Diversion: An Example P Overall, we must compare the gain in welfare (trade creation) with the lost revenue (trade diversion). S trade creation trade diversion Tariff price $1. 50 $1. 20 $1. 00 160 200 FTA price Free trade price D Q 17 -23

Trade Creation and Trade Diversion § When is it likely that trade diversion outweighs

Trade Creation and Trade Diversion § When is it likely that trade diversion outweighs trade creation? • When the excluded countries are much more efficient than the included countries. • When there are only a few members of the FTA (consider a global FTA: there would be no trade diversion because no country would be excluded). 17 -24

Dynamic Welfare Effects § In the long run, integration may increase a country’s welfare

Dynamic Welfare Effects § In the long run, integration may increase a country’s welfare because: • increased competition may occur, leading to lower prices, • larger markets may allow economies of scale to be realized, • more investment may be attracted, and • increased factor mobility may lead to greater efficiency. 17 -25

The European Community: A Brief History § 1951: France, Italy, West Germany, and Benelux

The European Community: A Brief History § 1951: France, Italy, West Germany, and Benelux countries form European Coal and Steel Community. § 1958: ECSC expanded to all products; name changed to European Economic Community (EEC). 17 -26

The European Community: A Brief History § Other countries joined over the years: •

The European Community: A Brief History § Other countries joined over the years: • • • 1973: Denmark, Ireland, U. K. 1981: Greece 1986: Portugal and Spain 1995: Austria, Finland, Sweden Recent additions: Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia, Slovenia 17 -27

EC 92 § During the 1980 s, there were still various and sundry barriers

EC 92 § During the 1980 s, there were still various and sundry barriers to trade between member countries. § 1985: Single European Act (commonly called EC 92): elimination of all barriers to the flow of goods, services, people, and capital by 1992. § It wasn’t 1992, but it eventually happened. 17 -28

Further Integration: Monetary Union § 1999 • Accounts could be stated in terms of

Further Integration: Monetary Union § 1999 • Accounts could be stated in terms of euros, but member countries’ currencies remained legal tender. • Each members’ exchange rate was fixed in terms of euros. • Monetary policy was made by the ESCB; each member no longer controlled its own money supply. 17 -29

Further Integration: Monetary Union § 2002 • In January, euro notes and coins were

Further Integration: Monetary Union § 2002 • In January, euro notes and coins were issued by the ECB. • In July, national currencies were withdrawn. § Members: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Monaco, Netherlands, Portugal, San Marino, Slovenia, Spain, and the Vatican 17 -30

NAFTA § On January 1, 1994 the North American Free Trade Agreement came into

NAFTA § On January 1, 1994 the North American Free Trade Agreement came into being. § It allows for a dismantling of trade barriers between Canada, Mexico, and the U. S. § It created a market comparable in size to the EU and EFTA combined. 17 -31

NAFTA: Some Provisions § Many tariffs were eliminated immediately; others will be phased out

NAFTA: Some Provisions § Many tariffs were eliminated immediately; others will be phased out over 5, 10, or 15 years. § Restrictions on trade in services (esp. banking) phased out. § All U. S. environmental standards will remain in force. 17 -32

Worries Over NAFTA § GDP • Most studies estimate a sizeable increase in Mexican

Worries Over NAFTA § GDP • Most studies estimate a sizeable increase in Mexican GDP, with more modest (but positive) effects on Canadian and U. S. GDP. § Employment • There were some dire forecasts of job loss, but U. S. employment has risen. § Wages • NAFTA has shifted low-skill employment to Mexico. • U. S. wages have continued to grow. 17 -33

Worries Over NAFTA § There have also been concerns about • environmental degradation, and

Worries Over NAFTA § There have also been concerns about • environmental degradation, and • Mexico’s lower labor standards. 17 -34

Recent Discussions of NAFTA § In the 2008 presidential campaign, both Hillary Clinton and

Recent Discussions of NAFTA § In the 2008 presidential campaign, both Hillary Clinton and Barack Obama called for revisions to NAFTA. § However, it appears the Obama administration plans to move forward with new free trade agreements. 17 -35

Other Major Economic Integration Efforts § MERCOSUR § U. S. -Central America Free Trade

Other Major Economic Integration Efforts § MERCOSUR § U. S. -Central America Free Trade Agreement – Dominican Republic (CAFTA-DR) § Free Trade Area for the Americas (FTAA) § Chilean trade agreements § Asia-Pacific Economic Cooperation (APEC) 17 -36