Economic integration is the unification of economic policies between different states, through the partial or full abolition of tariff and non-tariff restrictions on trade.
The trade-stimulation effects intended by means of economic integration are part of the contemporary economic Theory of the Second Best: where, in theory, the best option is free trade, with free competition and no trade barriers whatsoever. Free trade is treated as an idealistic option, and although realized within certain developed states, economic integration has been thought of as the "second best" option for global trade where barriers to full free trade exist.
Economic integration is meant in turn to lead to lower prices for distributors and consumers with the goal of increasing the level of welfare, while leading to an increase of economic productivity of the states.
Comparative advantage refers to the ability of a person or a country to produce a particular good or service at a lower marginal and opportunity cost over another. Comparative advantage was first described by David Ricardo who explained it in his 1817 book On the Principles of Political Economy and Taxation in an example involving England and Portugal.[1] In Portugal, it is possible to produce both wine and cloth with less labour than it would take to produce the same quantities in England. However, the relative costs of producing those two goods are different in the two countries. In England, it is very hard to produce wine and only moderately difficult to produce cloth. Both are easy to produce in Portugal. Therefore, while it is cheaper to produce cloth in Portugal than England, it is cheaper still for Portugal to produce excess wine, and trade that for English cloth. Conversely, England benefits from this trade because its cost for producing cloth has not changed but it can now get wine at a lower price, closer to the cost of cloth. The conclusion drawn is that each country can gain by specializing in the good where it has comparative advantage, and trading that good for the other.
Economies of scale refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer's average cost per unit to fall as the scale of output is increased. Economies of scale is a long run concept and refers to reductions in unit cost as the size of a facility and the usage levels of other inputs increase.[2] Economies of scale is also a justification for economic integration, since some economies of scale may require a larger market than is possible within a particular country— for example, it would not be efficient for Liechtenstein to have its own car maker, if they would only sell to their local market. A lone car maker may be profitable, however, if they export cars to global markets in addition to selling to the local market.
Besides these economic reasons, the primary reasons why economic integration has been pursued in practise are largely political. The Zollverein or German Customs Union of 1867 paved the way for partial German unification under Prussian leadership in 1871. "Imperial free trade" was (unsuccessfully) proposed in the late 19th century to strengthen the loosening ties within the British Empire. The European Economic Community was created to integrate France and Germany's economies to the point that they would find it impossible to go to war with each other.
Success factors
Among the requirements for successful development of economic integration are "permanency" in its evolution (a gradual expansion and over time a higher degree of economic/political unification); "a formula for sharing joint revenues" (customs duties, licensing etc.) between member states (e.g., per capita); "a process for adopting decisions" both economically and politically; and "a will to make concessions" between developed and developing states of the union.
A "coherence" policy is a must for the permanent development of economic unions, being also a property of the economic integration process. Historically the success of the European Coal and Steel Community opened a way for the formation of the European Economic Community (EEC) which involved much more than just the two sectors in the ECSC. So a coherence policy was implemented to use a different speed of economic unification (coherence) applied both to economic sectors and economic policies. Implementation of the coherence principle in adjusting economic policies in the member states of economic block causes economic integration effects.
Economic theory
The framework of the theory of economic integration was laid out by Jacob Viner (1950) who defined the trade creation and trade diversion effects, the terms introduced for the change of interregional flow of goods caused by changes in customs tariffs due to the creation of an economic union. He considered trade flows between two states prior and after their unification, and compared them with the rest of the world. His findings became and still are the foundation of the theory of economic integration. The next attempts to enlarge the static analysis towards three states+world (Lipsey, et al.) were not as successful.
The basics of the theory were summarized by the HungarianeconomistBéla Balassa in the 1960s. As economic integration increases, the barriers of trade between markets diminish. Balassa believed that supranational common markets, with their free movement of economic factors across national borders, naturally generate demand for further integration, not only economically (via monetary unions) but also politically—and, thus, that economic communities naturally evolve into political unions over time.
The dynamic part of international economic integration theory, such as the dynamics of trade creation and trade diversion effects, the Pareto efficiency of factors (labor, capital) and value added, mathematically was introduced by Ravshanbek Dalimov. This provided an interdisciplinary approach to the previously static theory of international economic integration, showing what effects take place due to economic integration, as well as enabling the results of the non-linear sciences to be applied to the dynamics of international economic integration.
Equations describing:
enforced oscillations of a pendulum with friction;
price-output dynamics and the dynamic matrix of the outputs of an economy;
regional and inter-regional migration of labor income and value added, and to trade creation and trade diversion effects (inter-regional output flows).
The straightforward conclusion from the findings is that one may use the accumulated knowledge of the exact and natural sciences (physics, biodynamics, and chemical kinetics) and apply them towards the analysis and forecasting of economic dynamics.
Dynamic analysis has started with a new definition of gross domestic product (GDP), as a difference between aggregate revenues of sectors and investment (a modification of the value added definition of the GDP). It was possible to analytically prove that all the states gain from economic unification, with larger states receiving less growth of GDP and productivity, and vice versa concerning the benefit to lesser states. Although this fact has been empirically known for decades, now it was also shown as being mathematically correct.
A qualitative finding of the dynamic method is the similarity of a coherence policy of economic integration and a mixture of previously separate liquids in a retort: they finally get one colour and become one liquid. Economic space (tax, insurance and financial policies, customs tariffs, etc.) all finally become the same along with the stages of economic integration.
Another important finding is a direct link between the dynamics of macro- and micro-economic parameters such as the evolution of industrial clusters and the GDP's temporal and spatial dynamics. Specifically, the dynamic approach analytically described the main features of the theory of competition summarized by Michael Porter, stating that industrial clusters evolve from initial entities gradually expanding within their geographic proximity. It was analytically found that the geographic expansion of industrial clusters goes along with raising their productivity and technological innovation.
Domestic savings rates of the member states were observed to strive to one magnitude, and the dynamic method of forecasting this phenomenon has also been developed. Overall dynamic picture of economic integration has been found to look quite similar to unification of previously separate basins after opening intraboundary sluices, where instead of water the value added (revenues) of entities of member states interact.
Stages
Stages of economic integration around the World (each country colored according to the most integrated multilateral agreement that it participates in):
These differ in the degree of unification of economic policies, with the highest one being the completed economic integration of the states, which would most likely involve political integration as well.
A "free trade area" (FTA) is formed when at least two states partially or fully abolish custom tariffs on their inner border. To exclude regional exploitation of zero tariffs within the FTA there is a rule of certificate of origin for the goods originating from the territory of a member state of an FTA.
A "customs union" introduces unified tariffs on the exterior borders of the union (CET, common external tariffs). A "monetary union" introduces a shared currency. A "common market" add to a FTA the free movement of services, capital and labor.
An "economic union" combines customs union with a common market. A "fiscal union" introduces a shared fiscal and budgetary policy. In order to be successful the more advanced integration steps are typically accompanied by unification of economic policies (tax, social welfare benefits, etc.), reductions in the rest of the trade barriers, introduction of supranational bodies, and gradual moves towards the final stage, a "political union".
members (including dual-representation with the European Union)
Draft Working Party Report or Factual Summary adopted
Goods and/or Services offers submitted
Memorandum on Foreign Trade Regime submitted
observer, negotiations to start later or no Memorandum on FTR submitted
frozen procedures or no negotiations in the last 3 years
no official interaction with the WTO
Globalization refers to the increasing global relationships of culture, people, and economic activity.
With economics crisis started in 2008 the global economy has started to realize quite a few initiatives on regional level. It is unification between the EU and US, expansion of Eurasian Economic Community (now Eurasia Economic Union) by Armenia and Kyrgyzstan. It is also the creation of BRICS with the bank of its members, and notably high motivation of creating competitive economic structures within Shanghai Organization, also creating the bank with many multi-currency instruments applied. Engine for such fast and dramatic changes was insufficiency of global capital, while one has to mention obvious large political discrepancies witnessed in 2014–2015. Global economy has to overcome this by easing the moves of capital and labor, while this is impossible unless the states will find common point of views in resolving cultural and politic differences which pushed it so far as of now.
Etymology
In economics the word integration was first employed in industrial organisation to refer to combinations of business firms through economic agreements, cartels, concerns, trusts, and mergers—horizontal integration referring to combinations of competitors, vertical integration to combinations of suppliers with customers. In the current sense of combining separate economies into larger economic regions, the use of the word integration can be traced to the 1930s and 1940s.[4]Fritz Machlup credits Eli Heckscher, Herbert Gaedicke and Gert von Eyern as the first users of the term economic integration in its current sense. According to Machlup, such usage first appears in the 1935 English translation of Hecksher's 1931 book Merkantilismen (Mercantilism in English), and independently in Gaedicke's and von Eyern's 1933 two-volume study Die produktionswirtschaftliche Integration Europas: Eine Untersuchung über die Aussenhandelsverflechtung der europäischen Länder.[5]
Balassa, В. Trade Creation and Trade Diversion in the European Common Market. The Economic Journal, vol. 77, 1967, pp.1–21.
Dalimov R.T. Modelling international economic integration: an oscillation theory approach. Trafford, Victoria 2008, 234 p.
Dalimov R.T. Dynamics of international economic integration: non-linear analysis. Lambert Academic Publishing, 2011, 276 p.; ISBN978-3-8433-6106-4, ISBN3-8433-6106-1.
Johnson, H. An Economic Theory of Protection, Tariff Bargaining and the Formation of Customs Unions. Journal of Political Economy, 1965, vol. 73, pp.256–283.
Johnson, H. Optimal Trade Intervention in the Presence of Domestic Distortions, in Baldwin et al., Trade Growth and the Balance of Payments, Chicago, Rand McNally, 1965, pp.3–34.
Jovanovich, М. International Economic Integration. Limits and Prospects. Second edition, 1998, Routledge.
Lipsey, R.G. The Theory of Customs Union: Trade Diversion and Welfare. Economica, 1957, vol. 24, рр.40-46.
Меаdе, J.E. The Theory of Customs Union.” North Holland Publishing Company, 1956, pp.29–43.
Negishi, T. Customs Unions and the Theory of the Second Best. International Economic Review, 1969, vol. 10, pp.391–398
Porter M. On Competition. Harvard Business School Press; 1998; 485 pgs.
Riezman, R. A Theory of Customs Unions: The Three Country–Two Goods Case. Weltwirtschaftliches Archiv, 1979, vol. 115, pp.701–715.
Ruiz Estrada, M. Global Dimension of Regional Integration Model (GDRI-Model). Faculty of Economics and Administration, University of Malaya. FEA-Working Paper, № 2004-7
Tinbergen, J. International Economic Integration. Amsterdam: Elsevier, 1954.
Tovias, A. The Theory of Economic Integration: Past and Future. 2d ECSA-World conference “Federalism, Subsidiarity and Democracy in the European Union”, Brussels, May 5–6, 1994, 10 p.
Viner, J. The Customs Union Issue. Carnegie Endowment for International Peace, 1950, pp.41–55.
A customs union is generally defined as a type of trade bloc which is composed of a free trade area with a common external tariff.
A free trade area is the region encompassing a trade bloc whose member countries have signed a free trade agreement (FTA). Such agreements involve cooperation between at least two countries to reduce trade barriers, import quotas and tariffs, and to increase trade of goods and services with each other. If natural persons are also free to move between the countries, in addition to a free trade agreement, it would also be considered an open border. It can be considered the second stage of economic integration.
A single market, sometimes called common market or internal market, is a type of trade bloc in which most trade barriers have been removed with some common policies on product regulation, and freedom of movement of the factors of production and of enterprise and services. The goal is that the movement of capital, labour, goods, and services between the members is as easy as within them. The physical (borders), technical (standards) and fiscal (taxes) barriers among the member states are removed to the maximum extent possible. These barriers obstruct the freedom of movement of the four factors of production.
A tariff is a tax imposed by the government of a country or by a supranational union on imports or exports of goods. Besides being a source of revenue for the government, import duties can also be a form of regulation of foreign trade and policy that taxes foreign products to encourage or safeguard domestic industry. Protective tariffs are among the most widely used instruments of protectionism, along with import quotas and export quotas and other non-tariff barriers to trade.
Free trade is a trade policy that does not restrict imports or exports. In government, free trade is predominantly advocated by political parties that hold economically liberal positions, while economic nationalist and left-wing political parties generally support protectionism, the opposite of free trade.
Protectionism, sometimes referred to as trade protectionism, is the economic policy of restricting imports from other countries through methods such as tariffs on imported goods, import quotas, and a variety of other government regulations. Proponents argue that protectionist policies shield the producers, businesses, and workers of the import-competing sector in the country from foreign competitors and raise government revenue. Opponents argue that protectionist policies reduce trade, and adversely affect consumers in general as well as the producers and workers in export sectors, both in the country implementing protectionist policies and in the countries against which the protections are implemented.
A trade agreement is a wide-ranging taxes, tariff and trade treaty that often includes investment guarantees. It exists when two or more countries agree on terms that help them trade with each other. The most common trade agreements are of the preferential and free trade types, which are concluded in order to reduce tariffs, quotas and other trade restrictions on items traded between the signatories.
Trade barriers are government-induced restrictions on international trade. According to the theory of comparative advantage, trade barriers are detrimental to the world economy and decrease overall economic efficiency.
The Zollverein, or German Customs Union, was a coalition of German states formed to manage tariffs and economic policies within their territories. Organized by the 1833 Zollverein treaties, it formally started on 1 January 1834. However, its foundations had been in development from 1818 with the creation of a variety of custom unions among the German states. By 1866, the Zollverein included most of the German states. The Zollverein was not part of the German Confederation (1815-1866).
The Australia – United States Free Trade Agreement (AUSFTA) is a preferential trade agreement between Australia and the United States modelled on the North American Free Trade Agreement (NAFTA). The AUSFTA was signed on 18 May 2004 and came into effect on 1 January 2005.
The European Union–Turkey Customs Union is a trade agreement between the European Union (EU) and Turkey. The agreement came into effect on 31 December 1995, following a 6 March 1995 decision of the European Community–Turkey Association Council to implement a customs union between the two parties. Goods may travel between the two entities without any customs restrictions. The Customs Union does not cover essential economic areas such as agriculture, services or public procurement.
Trade diversion is an economic term related to international economics in which trade is diverted from a more efficient exporter towards a less efficient one by the formation of a free trade agreement or a customs union. Total cost of good becomes cheaper when trading within the agreement because of the low tariff. This is as compared to trading with countries outside the agreement with lower cost goods but higher tariff. The related term Trade creation is when the formation of a trade agreement between countries decreases the price of the goods for more consumers, and therefore increases overall trade. In this case the more efficient producer with the agreement increases trade.
A preferential trade area is a trading bloc that gives preferential access to certain products from the participating countries. This is done by reducing tariffs but not by abolishing them completely. It is the first stage of economic integration.
A free trade agreement (FTA) or treaty is an agreement according to international law to form a free-trade area between the cooperating states. There are two types of trade agreements: bilateral and multilateral. Bilateral trade agreements occur when two countries agree to loosen trade restrictions between the two of them, generally to expand business opportunities. Multilateral trade agreements are agreements among three or more countries, and are the most difficult to negotiate and agree.
Regional Integration is a process in which neighboring countries enter into an agreement in order to upgrade cooperation through common institutions and rules. The objectives of the agreement could range from economic to political to environmental, although it has typically taken the form of a political economy initiative where commercial interests are the focus for achieving broader socio-political and security objectives, as defined by national governments. Regional integration has been organized either via supranational institutional structures or through intergovernmental decision-making, or a combination of both.
Economic integration involves at least two countries to abolish customs tariffs on inner border between the states. This causes a number of effects, while the phenomenon itself has specific properties for its successful development.
The ASEAN–India Free Trade Area (AIFTA) is a free trade area among the ten member states of the Association of Southeast Asian Nations (ASEAN) and the Republic of India. The initial framework agreement was signed on 8 October 2003 in Bali, Indonesia. and the final agreement was on 13 August 2009. The free trade area came into effect on 1 January 2010. India hosted the latest ASEAN-India Commemorative Summit in New Delhi on 26 January 2018. In the financial year 2017–18, Indo-ASEAN bilateral trade grew by almost 14% to reach US$81.3 billion. India's imports from ASEAN were valued at US$47.13 billion while its exports to ASEAN stood at US$34.2 billion.
A commercial policy is a government's policy governing international trade. Commercial policy is an all encompassing term that is used to cover topics which involve international trade. Trade policy is often described in terms of a scale between the extremes of free trade on one side and protectionism on the other. A common commercial policy can sometimes be agreed by treaty within a customs union, as with the European Union's common commercial policy and in Mercosur. A nation's commercial policy will include and take into account the policies adopted by that nation's government while negotiating international trade. There are several factors that can affect a nation's commercial policy, all of which can affect international trade policies.
The Eurasian Economic Union is an economic union of five post-Soviet states located in Eurasia. The EAEU has an integrated single market. As of 2023, it consists of 183 million people and a gross domestic product of over $2.4 trillion.
The spaghetti bowl effect is the multiplication of free trade agreements (FTAs), supplanting multilateral World Trade Organization negotiations as an alternative path toward globalization. The term was first used by Jagdish Bhagwati in 1995 in the paper: “US Trade policy: The infatuation with free trade agreements”, where he openly criticized FTAs as being paradoxically counter-productive in promoting freer and more opened global trades. According to Bhagwati, too many crisscrossing FTAs would allow countries to adopt discriminatory trade policies and reduce the economic benefits of trade.
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