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Unit 4: Regional Economic Integration
Regional Economic Integration:
Regional economic integration refers to efforts by countries in
a specific geographic region to reduce tariff and non-tariff
barriers to trade and investment with one another.
This can involve various forms of cooperation and agreements
aimed at promoting economic growth and development within
the region.
Regional economic integration includes various levels of
integration:
1) Free Trade Area
2) Custom Union
3) Common Market
4) Economic Union
5) Political Union
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1. Free Trade Area
A Free Trade Area is a form of regional economic integration
in which member countries agree to eliminate or reduce
barriers to trade, such as tariffs and quotas, on goods and
services traded among them.
The lowest level of integration.
Each member country maintains its external trade
policies with non-member countries.
Example – NAFTA, Association of Southeast Asian Nations.
(ASEAN), EFTA.
2. Custom Union
Eliminate tariffs and other restrictions on trade among
member countries.
A higher form of integration than the Free Trade Area.
It involves the coordination of trade policies and the
establishment of a common trade policy towards non-
member countries.
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3. Common Market
It goes beyond a Customs Union.
The free movement of goods, services, capital, and
labour among member countries.
It allows cross-border investment.
Example: Gulf Cooperation Council, 1981.
MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay)
4. Economic Union
Involves deeper levels of integration than a Common
Market.
It includes the adoption of a common currency and
coordinated monetary and fiscal policies.
An example of an Economic Union is the Eurozone,
which consists of countries in the European Union that
have adopted the euro (€) as their common currency.
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5. Political Union
Political Union is the highest form of integration among
nations.
It involves the creation of a single political entity that
encompasses multiple countries, often with a common
government, legal system, and citizenship.
The European Union (EU) is an example of a Political
Union.
Effects of Integration
1) Static Effect:
Static effects often relate to changes in trade patterns,
prices, production, and welfare that occur as a result of
trade liberalization or the formation of trade agreements.
Static effects are the shifting of resources from inefficient
to efficient companies as trade barriers fall.
It includes two situations:
i) Trade Creation
ii) Trade Diversion
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2) Dynamic effects:
Dynamic effects refer to the long-term or indirect impacts
of an economic change or policy on an economy.
Trade liberalization can stimulate investment by creating
larger and more integrated markets, reducing risks, and
increasing returns on investment.
Integration can contribute to regional development by
promoting infrastructure development, job creation, and
economic growth in less-developed regions.
Static Effect
1) Trade Creation:
Trade creation happens when more efficient producers
within the trading bloc replace less efficient domestic
producers or those in other countries outside the bloc.
It also increases the welfare of non-member countries.
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2) Trade Diversion:
This occurs in the trade shifting from more efficient
external producers to less efficient internal producers.
This happens when the common external tariff of the
trading bloc favours less efficient producers within the
bloc over more efficient producers outside the bloc.
Example:
Cost of production of a homogeneous product:
Country A B C
Cost 700 500 400
Assume the cost of production as price:
In a custom union, if A imposes a tariff of 100%,
Demand in A have a choice,
Country A B C
Cost 700 1000 800
In this situation, A will not import goods.
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If A and B form a custom union and impose the same 100%
tariff on imports from C,
Demand in A have a choice,
Country A B C
Cost 700 500 800
This is an example of trade creation.
Let's assume another situation before the custom union,
If A imposes a tariff of 50%, then
Demand in A have a choice,
Country A B C
Cost 700 750 600
In this situation A will import from C.
And if A and B form a custom union and impose the same 50%
tariff,
Demand in A have a choice,
Country A B C
Cost 700 500 600
In this situation A will import form B.
This is an example of trade diversion as the import switch from
low-cost producer to high-cost producer.