Economic integration

Economic integration refers to trade unification between different states by the partial or full abolishing of customs tariffs on trade taking place within the borders of each state. This is meant in turn to lead to lower prices for distributors and consumers (as no customs duties are paid within the integrated area) and the goal is to increase 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.

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. 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.

Objective

An increase of welfare has been recognized as a main objective of economic integration. The increase of trade between member states of economic unions is meant to lead to the increase of the GDP of its members, and hence, to better welfare - a goal of any state around the world. This is one of the reasons for the global scale development of economic integration, a phenomenon now realized in continental (ASEAN, the North American Free Trade Agreement (NAFTA), SACN, European Union (EU), Eurasian Economic Community (EurAsEC) and proposed for intercontinental (Comprehensive Economic Partnership for East Asia (CEPEA), Transatlantic Free Trade Area (TAFTA)) economic blocks.

The other objective for the states pursuing economic integration is to stay/become regionally and globally competitive, as the goods in the states outside economic blocks become more expensive (i.e., less competitive). This is the other reason making global economic integration inevitable.

Stages

Stages of economic integration around the World:
(each country colored according to the most advanced agreement that it participates into.)

  Economic and Monetary Union (CSME/EC$, EU/€)

  Economic union (CSME, EU)

  Customs and monetary union (CEMAC/franc, UEMOA/franc)

  Common market (EEA, EFTA)

  Customs union (CAN, CUBKR, EAC, EUCU, MERCOSUR, SACU)

  Multilateral Free Trade Area (AFTA, CEFTA, COMESA, GAFTA, GCC, NAFTA, SAFTA, SICA, TPP)

Free trade around the World:

  Multilateral free trade agreements or more advanced agreements

  Bilateral free trade agreements or more advanced agreements

  No free trade agreements, but World Trade Organization members

The degree of economic integration can be categorized into six stages:

1. Preferential trading area
2. Free trade area, Monetary union
3. Customs union, Common market
4. Economic union, Customs and monetary union
5. Economic and monetary union,
   • Fiscal union
6. Complete economic integration

These differ in the degree of unification of economic policies, with the highest one being the political union of the states.

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".

  [partial] — [substantial] — [none or not applicable]

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 Hungarian economist Béla 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:

1. enforced oscillations of a pendulum with friction;
2. predator-prey oscillations;
3. heat and/or gas spatial dynamics (the heat equation and Navier-Stoxes equation)

were successfully applied towards:

1. the dynamics of GDP;
2. price-output dynamics and the dynamic matrix of the outputs of an economy;
3. 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 rate 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.

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.

Obstacles to economic integration

Obstacles standing as barriers for the development of economic integration include the desire for preservation of the control of tax revenues and licensing by local powers, sometimes requiring decades to pass under the control of supranational bodies. The experience of 1990-2009 has shown radical change in this pattern, as the world has observed the economic success of the European Union. So now no state disputes the benefits of economic integration: the only question is when and how it happens, what exact benefits it may bring to a state, and what kind of negative effects may take place.

Economists argue that the negative consequences of economic integration include the suppression of local industries causing unemployment. Others say that there is no other way to exist in the current global economic environment for a state if it wishes to prosper. The conclusion is to prepare a state for economic integration before it will actually take place. There are different models of how to do it. The "South East Asian model" of economic integration is export oriented, while the "Latin American" one has fully open doors to imports consequently forcing local manufacturers to increase their standards of production.

Global economic integration

Members of WTO and negotiations status:

  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

Global unification of financial markets, which preceded formal global economic unification, along with turbulent 2008 economic crisis de facto raised an issue of the global regulation of the markets. At the same time, this seems impossible without global supranational bodies being in place.

This is a dilemma posed in discussions in the main international panels of the world (G8; G20; UN General Assembly): economic integration is both pushed by world economic development and stopped at the political level, including cultural differences between states (e.g., Iran and Israel).

Bibliography

• 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. The dynamics of the trade creation and diversion effects under international economic integration, Current Research *Journal of Economic Theory, 2009, vol. 1, issue 1; www.maxwellsci.com
  
• Dalimov R.T. Dynamics of international economic integration: non-linear analysis. Lampard Academic Publishing, 2010, 276 p.
  
• 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.
  
• Machlup, Fritz (1977). A History of Thought on Economic Integration. New York: Columbia University Press. ISBN 0231042981.
• 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.
  
• INTAL; http://www.iadb.org/intal/index.asp?idioma=ENG

See also

• List of trade blocs (from PTA to EMU)
• List of international trade topics
• Trade pact
• Trade bloc
• Regional integration
• Middle East economic integration