Theories of Economic Integration: A Survey of the Economic and Political…
Theories of Economic Integration:
A Survey of the Economic and Political Literature
Balassa --> The abolition of discrimination within an area
Kahnert et al --> The process of removing progressively those discriminations which occur at national borders
Allen --> Economic integration may mean something different to nearly everyone
Furthermore for the Economic Integration Theory --> The theory of customs unions may be defined as that branch of tariff theory which deals with the effects of geographically discriminatory changes in trade barriers [among countries],
Machlup --> Process of combining separate economies into a larger economic region.
Why study economic integration theories? --> Chou, the main reason behind studying the traditional theory of economic integration is to evaluate the desirability of a customs union from the world's welfare point of view using static effects as criteria
Balassa --> The Theory of Economic Integration, important contribution to an adequate understanding of economic integration.
Havens --> Making a worthwhile contribution to the theory of economic integration
Ingram's --> Balassa has succeeded extremely well in explaining the theory of economic integration
Allen's --> The basic ingredient of any integration form is the elimination of barriers to trade among two or more countries. Traditional international trade theory has dealt with the effects of reduction of trade barriers, a separate theoretical framework is needed to study issues of economic integration.
Customs Union (CU)
Is an FTA in which member countries apply a common external tariff on a good imported from outside countries.
Example: The European Community (EC), formed in 1957 by West Germany, France, Italy, Belgium, the Netherlands, and Luxembourg
This is usually referred to as "factor integration"
Common Market (CM)
Is a CU which further allows free movement of labor and capital among member nations.
Free Trade Area (FTA)
Is a PTA in which member countries do not impose any trade barriers (zero tariffs) on goods produced within the union.
Each country keeps its own tariff barriers to trade with non-members.
Example: North American Free Trade Agreement (NAFTA) formed by the United States of America (USA), Canada, and Mexico in 1993
Where the monetary and fiscal policies of member states are harmonized and sometimes even completely unified.
This is usually referred to as "policy integration"
Example: Is the countries of the EU who use a single currency, the Euro.
Preferential Trade Arrangements
Usually entail lower tariff barriers among participating nations than with non-member nations.
Panagariya --> Arrangement between two or more countries in which goods produced within the union are subject to lower trade barriers than the goods produced outside the union.
Example: The trade arrangement among the eight Muslim countries of the Developing 8 Organization
The Gains from Economic Integration
Two phases of evolution reflecting the contrasting policy concerns of its time
Traditional Economic Integration Theories
Pioneer of the Study <-- Viner (1950) “The Customs Union Issue”
Vine’s Traditional Customs Unions Theory
Statics Analysis --> First to identify concrete criteria to distinguish between the possible advantages and disadvantages of economic integration
Two or more countries enter into a trade agreement. Trade shifts from a high-cost supplier member country to a low-cost supplier member country in the union.
Trade creation raises the home country's welfare, while trade diversion lowers it.
Imports are shifted from a low-cost supplier of a non-member country of the union to a high-cost supplier member country inside the union.
The whole customs union issue can be disentangled in the free trade-protection argument.
The main purpose of any customs union is to shift sources of supply. If this shift is from a high-cost to a low-cost source, customs unions are considered a movement towards free trade. If the shift is in the other direction, then customs unions are considered a movement towards free trade. If the shift is in the other direction, then customs union may become a device for making tariff protection more effective.
Economies of scale, where the larger the economic area of the customs union, the more likely is a customs union to operate in the free trade direction.
Viner’s General Conclusion
Customs unions are unlikely to provide more economic gains than harm, unless strict circumstances prevail.
Trade-diverting effects of customs union may outweigh their trade-creating effects, even if the resulting union tariff is lower than the average level of the previous tariff --> worldwide non-discrimination of trade barriers.
Countries are motivated to integrate if integration is likely to produce static gains more than losses --> trade creation more than trade diversion.
Developments made to the Viner Analysis
Trade expansion vs Trade creation and diversion
Customs union may actually lead to misallocation of the world's resources. Viner's analysis is only true under conditions of inelastic demand and completely elastic supply.
If demand was allowed to be more elastic, Meade concludes that a customs union may actually increase the volume of trade even though there is trade diversion.
Production of Consumption effects of Customs Unions
The good thing --> Trade creation in the sense that production shifts from the high-cost source to the low-cost source is considered
Bad thing --> trade diversion is considered the "bad thing" in terms of economic welfare
When a customs union is formed, relative prices in the domestic markets of member countries change as a result of the reduction in tariff barriers between them
May actually be welfare-increasing if we take into account both production and substitution effects
The Welfare Sense
The diversion to a high-cost supplier country may be more than outweighed by the welfare gains resulting from the reduced prices to consumers due to the elimination of tariff on imports.
Additional welfare may be gained if we consider the secondary effects on complements and substitute goods
Must trace out the repercussions of the tariff reduction of a single commodity on all the quantities of all the products traded internationally to be able to assess the actual effect of this change on the economic welfare of the country.
Small vs Large Tariff reductions
A small reduction in tariffs must raise welfare, while a large reduction may raise or lower it.
Economic welfare is more likely to raise in the case of tariffs being merely reduced, than being completely removed.
Gradual Tariff reductions
Initial stages of tariff reductions raise welfare, while final stages lower it, depending on the specific assumptions made in that study.
The Terms of Trade effect
The welfare impacts of economic integration so far have assumed that the country at question is a small country with no effect on world prices.
Large Country --> change world prices, and if this country levies a tariff, it will reduce the demand for imports and will therefore cause the prices of those imported goods to fall in world markets relative to its exports, and thus improving its terms of trade
Allowing for the terms of trade effect, will dramatically alter the perspective of the analysis.
Integration between Competitive vs. Complementary countries
Viner, Meyer and Lipsey --> Gains will arise between countries of a union if they are producing the same commodity
Makower and Morton --> gains will be larger the larger is the difference between the costs at which the same commodity is produced in the countries of the union, under the assumption of fixed demand
Meade --> customs union may be welfare increasing if the partner countries are actually competitive but potentially complementary
Trade between countries of similar vs. different levels of income
model of factor-proportions states that a country will have a comparative advantage in those products which require factors of production that are relatively abundant and therefore relatively cheap within its borders.
That a country cannot enjoy a comparative advantage in any good without it being produced or demanded for the domestic market first
Countries should enjoy more trade potential if they have similar per capita incomes according to the Linder hypothesis, or different per capita incomes according to the comparative advantage theory or the H-O model.
New Economic Integration Theories
Dynamic vs. Static analysis of integration
Balassa and Cooper and Massell --> Firts ones in introduced this term
This analysis added a new dimension to this area of study.
Principle dynamic effect of integration for Allen and Balassa
The impact of integration on market structure and competition
Risk and uncertainty
Brada and Mendez --> integration is assumed to raise investment and reduce risks by the fact that a larger market will raise the expected return on investments and reduce uncertainty by enabling firms to lower their costs as a result of increased economies of scale, and a bigger pool of consumers
Schiff and Winters --> anything that affects the country's rate of economic growth over the medium term.
Old Regionalism vs. New Regionalism
"New regionalism" --> represented by dynamic effects such as increased competition, investment flows, economies of scale, technology transfer, and improved productivity.
"Old regionalism"--> The static effects and developments of the theory of economic integration so far (Viner and developments)
Current forces driving integration
Lawrence --> pointed out that the forces driving the current integration developments differ radically from those driving previous waves of regionalism.
Issues of private sector participation, competition, foreign direct investment (FDI), and the increased importance of services all contributed to changing the scenes from those that prevailed during the Viner and following near period.
Economies of Scale
Corden --> first introduced the concept of economies of scale into the customs union theory.
Result from the efficient use of factors of production at large outputs.
Balassa and Stoutjesdijk --> Small markets increase costs, limit the extent of product specialization, reduce competition, and lessen the incentives for technological improvements.
Investment creation and Investment diversion
When investment barriers are removed, investment creation is the case when production is moved from a high-cost source to a lower-cost source in the union.
Investment diversion occurs when production is moved from a low-cost non-member country to a higher-cost member country of the union as a result of the PTA.
Increased importance of Private sector participation
The current wave of regionalism or integration is a supported by private firms.
Increased importance of Services
The world services sector has been booming both in terms of contribution to world trade and world GDP.
Increased importance of Foreign Direct Investment
Direct investment is nowadays much more prominent, and is growing faster than trade.
Foreign direct investments are nowadays considered a major incentive of integration between countries, especially if integration is between developing countries, because of its link with two important variables; exports and economic growth.
Lawrence --> Foreign investment and exports are increasingly becoming complementary activities, and that the relation between them may work in both ways
FDI can lead to better economic integration benefits in terms of trade expansion, while others argue that economic integration can lead to more FDI flows to the region.
Theories of Economic Integration for Developing Countries
Economic integration theories adjusted to the special needs of developing countries.
Meier, Abdel Jaber, Andic and Dosser --> have argued that the Viner analysis of economic integration has limited relevance, if any, to the case of developing countries
Production effects are the tool that one can use to study the effect of economic integration on welfare.
Limitations of Production Effects
Production effects are not sufficient
Mikesell --> There are further limitations to this analysis if one looks at it from a developing country perspective.
Demas, Sakamotoand Abdel Jaber --> Welfare impacts of economic integration among developing countries should not be confined to production and consumption effects only, but should also include employment, productivity, and income effects
Andic, Dosser, Balassa and Stoutjesdijk --> Economic integration in the case of developing countries should be treated as an approach to economic development, not as a tariff issue
The long-run objective of integration between developing countries should not be to decrease trade with the rest of the world, but rather to change its pattern over time --> Mikesell and Kitamaru
Kreinin --> Potential gains from economic integration are especially pronounced in small and medium-sized member countries.
Bhambri and Chou --> Trade diversion may actually be beneficial in the case of developing countries
Linder and Axline --> Trade diversion translates into import substitution over a wider area, which will enable the integrated region as a whole to spend higher proportions of its foreign exchange on imports of capital goods, therefore contributing to increased levels of investment and economic growth.
Cooper and Massell --> Protection resulting from import substitution on a wider scale might be an important tool of gradual industrial development
Training Ground Theory = Import-substituting industrialization
Rueda-Junquera --> Most developing countries nowadays aim at making economic integration policies compatible with, and complementary to, other policies to enhance their international competitiveness in general, as part of their overall stabilization and adjustment programs as agreed with international organizations.
Limitations of the Factors affecting the desirability of Economic Integration
Balassa argued that what Vinerand Lipsey --> The benefits of economic integration accruing to competitive countries rather than complementary countries is not at all relevant to the case of developing countries.
Mikesell, Heimenz and Langhammer --> Claimed that developing countries should aim at reaching a substantial degree of complementarity between them.
Traditional theory --> The bigger the size of the countries entering the union, the larger the benefits of economic integration.
Abdel Jaber --> Developing countries' gains from integration will definitely be small or even negligible.
Balassa --> The gains of economic integration do not only depend on the size of the union, but also on the rate at which it increases.
Over population --> We take the size of the union to mean population size, developing countries will surely benefit from integration
Balassa and Bhambri --> Implication should not be taken as given, as the removal of certain factors that limit trade between developing countries should lead to an increase in trade between developing countries entering a trade agreement
Inotai --> Although a growing level or share of intra or inter-regional trade to total trade of the member countries is widely considered as that the best indicator of a successful economic integration agreement, it should not be the only target
Other factors affecting the desirability of Economic Integration
Initial domestic tariffs of most developing countries are usually quite high may actually be beneficial
Meade and Hillmann --> The higher the initial tariff rates between countries entering a customs union, the larger are the expected gains of economic integration between these countries.
Lipsey --> Customs union will more likely produce welfare gains, the lower is the percentage of foreign trade to the member countries' GDP, has to be taken with caution because while low income groups as classified by the World Bank have low trade/GDP percentages compared to high income groups, both middle income country groups and LDCs have trade percentages of GDP higher than that of the high income group.
Shams --> Differences in macroeconomic policies in general plus the lack of coordination between member countries may be the reason behind limited regional trade growth.
Developing countries --> They tend to focus on tariff issues and rarely take such matters into consideration when negotiating trade agreements with each other
The Package Approach <-- Balassa and Stoutjesdijk
Aims at assuring that each member country in a union is responsible for a single integration project from a package of such projects.
This approach can be very appropriate for developing countries because it aims at increasing their levels of economic development hand in hand with increasing their levels of regional trade.
The Political Determinants of Economic Integration
Ezenwe --> Economic integration must be seen as part of a process in which the final outcome will be determined by political factors
Allen --> One cannot really separate the economic from the political elements of integration, as economic losses and gains from integration are in some cases systematically related to political factors.
Political factors of General Importance
Kitamura, Heimenz, Langhammer and World Bank --> One of the possible political motives of economic integration is the ability of the member countries to strengthen their bargaining power in international negotiations
Lorenz, Grossman, Helpman, Schiff and Winters --> Public officials may enter into trade agreements to gain support of certain interest groups/lobbies, whether export-oriented or import-competing sectors, or others such as certain labor unions or those responsible for fiscal sustainability fearing import duty losses
Producers --> Have more political weight than consumers
PTA in general will be favored politically than free non-preferential trade
PTA that is trade-diverting will be favored politically than a PTA that is trade-creating.
Rueda-Juanquera --> Importance of political leadership in any economic integration initiative
Mansfield and Milner --> In order for a PTA to succeed, substantial institutional heterogeneity is needed
Axline --> A smaller group of the former members of an unsuccessful integration scheme may launch a successful integration scheme of their own.
Refers to the need to further change barriers other than tariffs (shallow integration) such as reconciling different national practices with common rules and supra-national implementation mechanisms.
Tariff in exchange
Hirschman --> The prospect of less freedom in implementation of such internal policies is precisely what makes governments so skittish about entering into effective trade integration agreements
Economic integration schemes require strong political commitment on the part of member countries to be able to advance to common objectives
Other political incentives to economic integration
Desire to form economic integration arrangements between political allies that do not permit their adversaries to join the arrangement
Political factors of Special Importance to Developing Countries
The Dependency theory
Axline and Inotai --> politicians and economists of developing countries may actually encourage economic integration schemes with other developing countries as a mean of strengthening their self- reliance and gradually eliminating the historically deep economic and structural dependence of their countries on the developed world.
Economic integration usually precedes political integration.
Haas and Schmitter --> Political interference is critical
The stage of political entrance
Inotai --> The opposite happens in developing countries, where economic integration is often derived from political concepts and efforts, and is then forced to work on economically insufficiently prepared national economic agents
Political and Economic Factors Combined
Haas and Schmitter
Linked the political and economic factors of integration together
The interaction between these two may yield high, mixed, or low ratings of the potential success of a union
Identified four combinations of identical/converging economic aims with strong/weak political commitment.
They provided evidence that favorable political and economic factors combined must be present for an economic integration scheme to succeed.
Roberto Alejandro Delgado Sanchez
Sadek, A. (2013). Theories of Economic Integration: A Survey of the Economic and Political Literature. International Journal of Economy, Management and Social Sciences. 2 (5), 133-155.