Wednesday, 2 May 2012

Theory of Regional Economic Integration

Assalaamu'alaikum wa rahmatullah

Economic Theories of Regional Integration

We have four pages of readings here and it is written by Alexis Iche. The agreement in Treaties of Rome 1957 on the premise of economic integration could be channeled for a political aim as to keep people in the Union more closer. In theory, economic benefits from regional economic integration would convince the citizens of Europe that deeper political links between member states would receive similar benefits. In order to analyze the economic rationale behind EU programmes such as the Single Market Programme (SMP) or Economic and Monetary Union (EMU), one needs to understand fundamental concepts and theories used to justify regional economic integration and problems associated with theories.      

Types of Integration

This was outlined by Dutch economist, Jan Tinbergen (1954). He outlines two distinct types of economic integration:

1. Negative Integration

Elimination of obstacles to the free movement of goods and factors of production (FOP). Example is the removal of tariff barriers such as quotas or non-tariff barriers such as differing standards between member states.

2. Positive Integration

The replacement of various national rules with one set of EU rules. Adoption of common policies. Example such as Common Commercial Policy (CCP).

Stages of Economic Integration

Regional economic integration is a gradual process. It exists in several forms. Economist such as Bela Balassa (1950) defined it as the progresses through various stages as it moves towards more integration. Example is EU itself as it developed from from a Free Trade Area (FTA) toward a full economic and monetary union. Integration is an ongoing process. It has its own in-built momentum. Each further step creates problems that can be solved only by deeper regional integration. This phenomenon is also known as spillover.    

Stage One - Free Trade Area

It is exclusively focused on trade in goods while services, labor and capital remained restricted. Tariffs i.e import taxes imposed on foreign goods are abolished within the group. Each members of this area keeps its own external tariffs policy toward the rest of the world. Such example is North American Free Trade Area (NAFTA).  

Problem is that in an FTA, member country keeps its own external tariff on goods from outside the area. Once these goods are inside the area, they can move freely around without any tariff. Example, in an FTA between Sweden and Finland, if Sweden has lower tariff than Finland on product or good such as coffee, companies in Finland will import coffee through Sweden in order to pay lower tariffs.

Solution as to avoid this condition, the FTA needs to move into a customs union with a common external tariff (CET).    

Stage Two- Customs Union

It is exclusively focused on trade in goods while services, labor and capital still remained restricted. Tariffs are abolished within the group. A CET is established for the group. Example for this is European Economic Community (EEC) 1957-1958.

Problem is that CU eliminates tariffs and quota restrictions (tariff barriers) but still allows non-tariff barriers such as differences in technical standards, health and safety requirements which hinder free trade.

Solution for this would be, non-tariff barriers should be eliminated through mutual harmonization of product recognition

Stage Three - Common Market

It has all properties of the previous customs union. Free movement of FOP such as goods, capital, labor and services between all members of the group. Example is European Community or currently European Union (1987-1999). 

Problem with this is that, to achieve complete free movement, the last non-tariff barriers must be eliminated which is the differences in currencies of member states. This is due to that, exchange rate (ER) does not reflect the 'true' price of goods and it acts as non-tariff barriers

Solution, they have only one option which is to adopt a common economic policy. It includes some form of common or coordinated fiscal policy. This would permit fiscal transfers from regions experiencing positive growth to regions suffering from negative growth in order to maintain stability of the system.   

Stage Four - Monetary Union

It has all properties of the previous common market. It is just a prolongation of the previous stage. At this stage, the member states adopt common currency. Example is EU member states who adopt euro since 1999 until present. I guess Denmark and United Kingdom have opt out from monetary union and they still use their own currencies. 

Problem about this, in the past, strains between different economies caused by different growth rates. These floating exchange rates allowed national central banks to set individual interest rates. They are suited to the needs of their economies. In a monetary union, exchange rates irreversibly fixed, and the other adjustment mechanisms such as movement of capital and labor may be insufficient to counterbalance tensions in the system caused by different growth between countries.    

Stage Five - Economic Union

It is a continuation of previous stage. Common economic policies, coordination and harmonization on fiscal issues (single policy for the entire zone) are established. 

There is no good example available between equally sovereign nation-states. The relationship between individual US states may be the nearest example. 

Problem for this, the loss of control over economic and monetary policy is a serious loss of sovereignty for member states

Solution, there is a need to find new balance between nation-states' sovereignty and their economic powers or to integrate further into a small political union modeled on already existing federal states such as Germany.

The further regional integration progresses, the more its economic developments clash with individual political prerogatives of member states. This is true with regard to issues such as monetary policy, taxation and all forms of redistributive policy. They are issues connected with a state's raison d'etre. The result is, while further economic integration leads to a need for more political change, member states are reluctant to yield the sovereignty necessary to move to the next level of integration.  

Sealed with prayers for mercy, peace and love amin! 

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