ib chapter 9 regional economic integration

International Business: The New Realities

by

Cavusgil, Knight and Riesenberger

Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall


Learning ObjectivesRegional integration and economic blocsLevels of regional integrationThe leading economic blocsAdvantages of regional integrationSuccess factors for regional integrationEthical dilemmas and drawbacks of regional integrationManagement implications of regional integrationCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


*Introduction Globalization has increased interactions between national economic systemsThis requires closer regional integration among countries in order to be competitive in the global economy The trend of protectionism and trade distortion in certain regions has intensified the need for countries or economic systems to cooperateA general definition of economic integration:The merging of the economies and economic policies of two or more countries in a given region

Regional Economic IntegrationOver 50 percent of world trade today occurs under some form of preferential trade agreements signed by groups of countries. Cooperating nations obtain: increased product choices, productivity, living standardslower prices, andmore efficient resource use.

The growing economic interdependence that results when nations within a geographic region form an alliance aimed at reducing barriers to trade and investment. Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Economic BlocA geographic area consisting of two or more countries that agree to pursue economic integration by reducing tariffs and other barriers to the cross-border flow of products, services, capital, and, in more advanced cases, labor Examples: European Union, NAFTA, MERCOSUR, APEC, ASEAN, and many othersThere are five possible levels of economic integrationCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


International Business: The New Realities*

International Business: The New Realities

Levels of Regional IntegrationFree trade area: Simplest, most common arrangement. Member countries agree to gradually eliminate formal trade barriers within the bloc, while each member maintains an independent international trade policy with countries outside the bloc. One example is NAFTA.Customs union: Similar to a free trade area except the members harmonize their trade policies toward nonmember countries, by enacting common tariff and nontariff barriers on imports from nonmember countries. MERCOSUR is an example.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Levels of Regional Integration (contd)Common market: Like a customs union, except products, services, and factors of production such as capital, labor, and technology can move freely among the member countries. E.g., the EU countries put in place many common labor and economic policies. Economic union: Like a common market, but members also aim for common fiscal and monetary policies, and standardized commercial regulations. The EU is moving toward an economic union by forming a monetary union with a single currency, the euro.

Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


The EU: A Full-Fledged Economic UnionMarket access. Tariffs and most nontariff barriers have been eliminatedCommon market. Barriers to cross-border movement of production factorslabor, capital, and technology Trade rules. Cross-national customs procedures and regulations have been eliminated, which has streamlined transportation and logistics within EuropeStandards harmonization. Technical standards, regulations, and enforcements have been harmonized Common fiscal, monetary, taxation, and social welfare policies is the ultimate goal over timeCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Four Institutions that Govern the EUCouncil of the European Union. The main decision-making body, it decides on economic policy, budgets, foreign relations, and admission of new member countries. European Commission. Represents the interests of the EU as a whole. Proposes legislation. Responsible for implementing decisions of the Parliament and the Council. European Parliament. Has up to 785 representatives who meet in session every month to devise EU legislation, supervise EU institutions, and decide on the EU budget. European Court of Justice. Interprets and enforces EU laws and settles legal disputes between member states.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


The European Union Today27 members. Founders members are Belgium, Italy France, Germany, Luxembourg, and the NetherlandsNew members such as Poland, Hungary, Czech Republic are low-cost manufacturing sites.Peugeot, Citron (France) factories in Czech RepublicHyundai (South Korea) Kia plant in SlovakiaSuzuki (Japan) factory in Hungary Most new EU entrants are in Eastern Europe one-time satellites of the Soviet Union, most are emerging markets with fast economic growth ratesCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


NAFTA (Canada, Mexico, the United States) Passage of NAFTA in 1994 was facilitated by the maquiladora program, thru which U.S. firms located factories just south of the U.S. border to access low-cost labor without significant tariffs. NAFTA:Eliminated tariffs and most nontariff barriers for products and services.Established trade and investment rules, uniform customs procedures, and intellectual property rightsProvided procedures for settling trade disputesCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


NAFTA ResultsTrade among the members more than tripled, and now exceeds $1 trillion per year. Between 1994 and 2008, annual exports from Canada to Mexico and the U.S. more than doubled; Mexico to the U.S. grew from $50 to $220 billion;the U.S. to Mexico grew from $40 to $150 billion;the U.S. to Canada grew from $120 to $260 billion.Both Canada and Mexico now have some 80 percent of their trade with, and 60 percent of their FDI stocks in the United States.



How NAFTA Benefited the Mexican EconomyMexican exports to the U.S. more than quadrupledAccess to Canada and the U.S. helped launch many Mexican firms in industries such as cars, electronics, textiles, medical products, and services Yearly U.S. and Canadian investment in Mexico rose from $4 billion in 1993 to over $20 billion by 2008 Mexicos per capita income rose to over $10,000 by 2010, making it a leading emerging market worldwideCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


El Mercado Comun del Sur (MERCOSUR)The leading economic bloc in South America, accounting for nearly all of the regions GDPLaunched in 1991, the four initial members were Argentina, Brazil, Paraguay, and Uruguay. Established free movement of products and services, common external tariff and trade policy, and coordinated monetary and fiscal policies. May be integrated with NAFTA and DR-CAFTA as part of a future Free Trade Area of the Americas.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


*What Is The Association Of Southeast Asian Nations?The Association of Southeast Asian Nations (ASEAN, 1967)currently includes Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Vietnam, Myanmar, Laos, and Cambodiawants to foster freer trade between member countries and to achieve some cooperation in their industrial policiesAn ASEAN Free Trade Area (AFTA) between the six original members of ASEAN came into effect in 2003ASEAN and AFTA are moving towards establishing a free trade zone

*What Is The Asia-Pacific Economic Cooperation?The Asia-Pacific Economic Cooperation (APEC)has 21 members including the United States, Japan, and Chinawants to increase multilateral cooperationmember states account for 55% of worlds GNP, and 49% of world trade

Other Economic BlocsCaribbean Community and Common Market (CARICOM)

Comunidad Andina de Naciones (CAN)

Association of Southeast Asian Nations (ASEAN)

Asia Pacific Economic Cooperation (APEC)

Australia and New Zealand Closer Economic Relations Agreement (CER)Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Why Do Nations Pursue Economic Integration?Expand market size Increases size of the marketplace for firms inside the economic bloc. Belgium has a population of just 10 million; the EU has a population of nearly 500mBuyers can access larger selection of goodsEnhance productivity and economies of scaleBigger market facilitates economies of scaleInternationalization inside the bloc helps firms learn to compete outside the blocCompetition and efficient resource usage inside the bloc leads to lower prices for bloc consumersCopyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Why Nations Pursue Economic Integration (contd)Attract investment from outside the bloc Compared to investing in stand-alone countries, foreign firms prefer to invest in countries belonging to an economic bloc. General Mills, Samsung, and Tata have invested heavily in EU-member countries.Acquire stronger defensive and political posture Belonging to a bloc provides member countries with a stronger defensive posture relative to other nations and world regions. This was a key motive for formation of the European Union.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


What Factors Help Regional Integration Succeed?Economic similarity. Strong similarity on wage rates, economic conditions, and other factors helps ensure success. Most EU countries are similar in this way.Political similarity. Countries should have similar political systems, share aspirations, and be willing to surrender national autonomy. This is a key success factor of the EU. Similarity of culture and language. MERCOSUR and Australia/New Zealand CER are similar in this way.Geographic proximity. Facilitates intra-bloc movement of products, labor, and other factors. Often, neighboring countries share a common history, culture and language. Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Drawbacks of Regional IntegrationTrade creation As barriers fall, trade is generated inside the blocTrade diversion As within-bloc trade becomes more attractive, member countries discontinue some trade with nonmember countries Aggregate effect National trade patterns are altered. More trade occurs inside bloc; less trade occurs with countries outside the blocA bloc can become an economic fortress leading to more within-bloc trade and less between-bloc trade, which can reduce global free trade.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Drawbacks of Regional Integration (contd)Loss of national identity. Increased cross-border contact makes members more similar to each other. In response to NAFTA, Canada has restricted the ability of U.S. movie and TV producers to invest in the Canadian film and broadcasting industries. Sacrifice of autonomy. In later stages, a central authority is set up to manage the blocs affairs. Members must sacrifice some autonomy to the central authority, such as control over their own economy. E.g., Britain in the EU.



Drawbacks of Regional Integration (contd)Transfer of power to advantaged firms. Integration can concentrate economic power in the hands of fewer, larger firms, often in the most advantaged member countries. Failure of small or weak firms. As barriers fall, protections are eliminated that previously shielded smaller or weaker firms from foreign competition. Corporate restructuring and job loss. Restructuring and increased competitive pressures may lead to layoffs or re-assigning employees to distant locations, disrupting workers and entire communities.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Implications of Regional Integration for the FirmInternationalization by firms inside the economic bloc. Regional integration facilitates company internationalization. ExampleHome Depot expanded in Mexico following passage of the North American Free Trade Agreement. Expansion into neighboring countriesprovides valuable experience, prompting internationalizationto other markets worldwide.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Implications for the Firm (contd)

Rationalization of operations. By restructuring an consolidating company operations, managers can develop strategies and value-chain activities suited to the region as a whole, not just individual countries. Goal is to cut costs and redundancy, and increase efficiencies via scale economies. Firms centralize production and marketing, instead of decentralizing them to individual countries.Mergers and acquisitions. Economic blocs lead to M&A, the tendency of one firm to buy another, or of two or more firms to merge and form a larger firm.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Implications for the Firm (contd)Regional products and marketing strategy. Firms cut costs by standardizing products and services. Case Inc. reduced its Magnum line of tractors from 17 to only a few versions in Europe, following integration of the EU.Internationalization by firms from outside the bloc. Because external trade barriers mainly affect exporting, many foreign firms prefer to enter a bloc through FDI. In this way, after formation of the EU, Britain became the largest recipient of FDI from the United States.



Regional Economic Integration: Future ProspectsIn 1990, there were about 50 regional economic integration agreements worldwide. Today there are some 400, in various stages of development.Governments continue to liberalize trade policies, encourage imports, and restructure regulatory regimes, largely via regional cooperation. Many nations belong to several free trade agreements. The evidence suggests regional economic integration will gradually give way to a system of global free trade worldwide.Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall9-*


Chapter 9 will discuss how regions around the world are becoming economically integrated.*Learning objectives will include discussions of the leading economic blocs and how successful they have been.*Regional economic integration refers to the growing economic interdependence that results when two or more countries within a geographic region form an alliance aimed at reducing barriers to trade and investment. Since the end of World War II, most nations have sought to cooperate, with the aim of achieving some degree of economic integration. The trend is based on the premise that, by cooperating, nations within a common geographic region connected by historical, cultural, linguistic, economic, or political factors can gain mutual advantages. Two of the best-known examples are the European Union (EU) and the North American Free Trade Agreement (NAFTA). NAFTA consists of Canada, Mexico, and the United States. At a minimum, the countries in an economic bloc become parties to a free trade agreement, a formal arrangement between two or more countries to reduce or eliminate tariffs, quotas, and other barriers to trade in products and services.

*More advanced economic blocs, such as the EU, permit the free flow of capital, labor, and technology among their member countries. In recent years, cross-border merger and acquisition deals have increased markedly among firms from Austria, Britain, France, and other member countries. There are hundreds of regional trade integration blocs around the world today. They present both opportunities and challenges to internationalizing firms.

*The Exhibit identifies five possible levels of regional integration. We can think of these levels as a continuum, with economic interconnectedness progressing from a low level of integrationthe free trade areathrough higher levels to the most advanced form of integrationthe political union. The political union represents the ultimate degree of integration among countries, which no countries have yet achieved.

*The free trade area is the simplest and most common arrangement, in which member countries agree to gradually eliminate formal barriers to trade in products and services within the bloc, while each member country maintains an independent international trade policy with countries outside the bloc. NAFTA is an example. The customs union is the second level of regional integration, similar to a free trade area except that member states harmonize their external trade policies and adopt common tariff and nontariff barriers on imports from nonmember countries. MERCOSUR, an economic bloc in Latin America, is an example of this type of arrangement.

*In the third stage of regional integration, member countries establish a common market in which trade barriers are reduced or removed, common external barriers are established, and products, services, and factors of production such as capital, labor, and technology are allowed to move freely among the member countries. The EU is a common market. Common markets are hard to create because they require substantial cooperation on labor and economic policies. An economic union is the fourth stage of regional integration, in which member countries enjoy all the advantages of early stages but also strive to have common fiscal and monetary policies. The bloc aims for standardized monetary policy, which requires establishing fixed exchange rates and free convertibility of currencies among the member states, in addition to allowing the free movement of capital. This standardization helps eliminate discriminatory practices that might favor one member state over another.

*This map shows the worlds most active economics blocks led by the European Union (EU). *The European Union is made up of countries from Spain to Greece and from Ireland to Finland.*The Exhibit highlights notable features of the member countries in the EU, the worlds most integrated economic bloc. PPP terms in the exhibit refers to purchasing power parity (PPP), which means per-capita GDP figures have been adjusted for price differences. Since prices vary greatly among countries, economists adjust ordinary GDP figures for differences in purchasing power.

*Over time, the EU has taken the following steps on its path to becoming a full-fledged economic union: Market access. Tariffs and most nontariff barriers have been eliminated for trade in products and services. Common market. Barriers to the cross-national movement of production factors labor, capital, and technologyhave been removed. For example, an Italian worker now has the right to get a job in Ireland. Trade rules. The member countries have largely eliminated customs procedures and regulations, which streamlines transportation and logistics within Europe. Standards harmonization. The EU is harmonizing technical standards, regulations, and enforcement procedures that relate to products, services, and commercial activities.Where British firms once used the imperial measurement system (pounds, ounces, and inches), they have converted to the metric system used by all EU countries.

*The EU has four additional institutions. The Council of the European Union is the main decision-making body. Composed of representatives from each member country, it makes decisions regarding economic policy, budgets, foreign policy, and admission of new member countries. The European Commission is similarly composed of delegates from each member state and represents the interests of the EU as a whole. It proposes legislation and policies and is responsible for implementing the decisions of the European Parliament and the Council of the EU. The European Parliament consists of elected representatives that hold joint sessions each month and can have up to 785 total representatives. Finally, the European Court of Justice, based in Luxembourg, interprets and enforces EU laws and settles legal disputes between member states.

*Since 2004, twelve new states have joined, and the recent addition of Bulgaria and Romania brings the total number of member countries to twenty-seven. Most of the newest EU entrants are one-time satellites of the former Soviet Union and have economic growth rates higher than their fifteen Western European counterparts. They are poised to achieve per-capita income levels similar to those of the EUs wealthier countries within several years. The EU faces the challenges of tension between the forces for regional integration and the forces for retaining national identity. *Consisting of Canada, Mexico, and the United States, NAFTA launched in 1994. It is the most significant economic bloc in the Americas and comparable to the EU in size. Since the 1960s the maquiladora program allowed U.S. firms to locate manufacturing facilities in an area just south of the U.S. border and access low-cost labor and other advantages in Mexico without having to pay significant tariffs.

*NAFTA is about the same size as the European Union in terms of population and GDP.*NAFTA increased market access between Canada, Mexico, and the United States. It eliminated tariffs and most nontariff barriers for products and services traded in the bloc. NAFTA also established trade rules and uniform customs procedures and regulations, while prohibiting the use of standards and technical regulations as trade barriers. Since the blocs inception, trade among its three members has more than tripled and now exceeds $1 trillion per year. In the early 1980s. Following NAFTAs passage, Mexicos per-capita income has risen substantially, making Mexico into Latin Americas wealthiest country in per-capita income terms.

*Given Mexicos attractiveness as a manufacturing location, firms like Gap and Liz Claiborne moved their factories from Asia to Mexico during the 1990s.NAFTA stimulated restructuring of the labor market in North America. Falling trade barriers triggered job losses in the North as factories were exported to Mexico to profit from its low-cost labor. Increased purchasing power of Mexican consumers meant they could afford to buy U.S. and Canadian imports. As part of the accord, the member countries were also required to strengthen their labor standards and promote environmental protection.*Established in 1991, MERCOSUR, is the strongest economic bloc in South America. Within its borders, MERCOSUR established the free movement of products and services, a common external tariff and trade policy, and coordinated monetary and fiscal policies. MERCOSUR eventually aims to become an economic union. During its first six years, trade among the member countries tripled. In addition to its regular members, MERCOSUR also has five associate members, which have access to preferential trade but not to the tariff benefits of full members. In the future, it may become integrated with NAFTA and perhaps even part of a proposed Free Trade Area of the Americas (FTAA), bringing free trade to the entire western hemisphere.

*Brazil is by far the biggest member of MERCOSUR in terms of population and GDP but other countries such as Chile have a higher GDP per capita. *Composed of roughly twenty-five member and associate member states around the Caribbean Sea, CARICOM was established in 1973 to lower trade barriers and institute a common external tariff. The bloc has met with little success in stimulating economic development, however, due to economic difficulties of the individual members and their inability to agree on basic issues. Long called the Andean Pact, the CAN was established in 1969. Its main members are Bolivia, Colombia, Ecuador, and Peru. CAN is expected to merge with MERCOSUR to form a new economic bloc that encompasses all of South America. ASEAN was created in 1967 with the goal of maintaining political stability and promoting regional economic and social development in Southeast Asia. In the long run, ASEAN aims to incorporate international trading powerhouses like Japan and China, whose membership would accelerate the development of extensive trade relationships.APEC aims for greater free trade and economic integration of the Pacific Rim countries. It incorporates twenty-one nations on both sides of the Pacific, including Australia, Canada, Chile, China, Japan, Mexico, Russia, and the United States In 1966, Australia and New Zealand reached a free trade agreement (CER)that removed 80 percent of tariffs and quotas between the two nations. Many believe the CER has been one of the worlds most successful economic blocs.

*Regional integration greatly increases the scale of the marketplace for firms inside the economic bloc. For example, while Belgium has a population of just 10 million, the absence of trade barriers with other countries in the EU gives Belgian firms easier access to a total market of roughly 500 million EU buyers. Achieve scale economies and enhanced productivity. Expansion of market size within an economic bloc gives member country firms the opportunity to increase the scale of operations in both production and marketing, gaining greater concentration and increased efficiency. While a German firm may be only moderately efficient when producing 10,000 units of product for Germany, it greatly increases its efficiency by producing 50,000 units for the much larger EU market.

*Addition reasons why nations pursue economic integration include the fact that it attracts direct investment from outside the bloc. Foreign firms prefer to invest in countries that are part of an economic bloc because factories they build there receive preferential treatment for exports to all member countries within the bloc. Another reason is that regional integration strengthens member countries relative to other nations and world regions. This was one of the motives for creating the European Community (the precursor to the EU), whose members sought to strengthen their mutual defense against the expanding influence of the former Soviet Union. Broadly speaking, countries are more powerful when they cooperate than when they operate alone.

*The more similar the economies of the member countries, the more likely the economic bloc will succeed. Significant wage rate differences mean workers in lower-wage countries will migrate to higher-wage countries. Significant economic instability in one member country can quickly spread and harm the economies of the other members. Similarity in political systems also enhances prospects for a successful bloc. Countries that seek to integrate regionally should share similar aspirations and a willingness to surrender national autonomy for the larger goals of the proposed union. Cultural and linguistic similarity among the countries in an economic bloc also provides the basis for mutual understanding and cooperation. Under NAFTA, it was easier for Canadian firms to establish trade and investment relationships in the United States than in Mexico because of the similarities between the two northern countries.Finally,most economic blocs are formed by countries within the same geographic region. Close geographic proximity facilitates transportation of products, labor, and other factors of production. *At least in the short run, regional integration gives rise to both trade creation and trade diversion. Trade creation means trade is generated among the countries inside the economic bloc because, as barriers fall, each member country tends to begin trading more with members than with nonmembers. As this occurs, members begin trading less with countries outside the bloc, leading to trade diversion.

* When nations join in an economic bloc,there are drawbacks. Increased cross-border contact has a homogenizing effect; national cultural identity is diluted as the members become more similar to each other. For this reason, member countries typically retain the right to protect certain industries vital to national heritage or security. For instance, because Canada fears its indigenous culture will be diluted by an invasion of U.S. movie and television programming, it restricts the ability of U.S. movie and TV producers to invest in its film market.Also. the later stages of regional integration require member countries to establish a central authority to manage the blocs affairs. Each participating country must sacrifice some of its autonomy, such as control over its own economy. In this way, nations that join an economic bloc risk losing some of their national sovereignty.

*Additional drawbacks of regional integration include the concentration of economic power in the hands of fewer, more advantaged firms. Over time, economic power gravitates toward the most advantaged firms in the bloc. Regional integration also encourages mergers and acquisitions within the bloc, leading to the creation of larger rivals that can come to dominate smaller firms. Also, as trade and investment barriers decline, protections are eliminated that previously shielded smaller or weaker firms from foreign competition. Finally,many firms must restructure to meet the competitive challenges posed in the new, enlarged marketplace of regional integration. Increased competitive pressures and corporate restructuring may lead to worker layoffs or reassignments to distant locations. When they negotiate regional integration agreements, national governments have a responsibility to reduce harmful effects such as job losses and the failure of small or weak firms. * Initially, regional integration pressures or encourages companies to internationalize into neighboring countries within the bloc. The elimination of trade and investment barriers also presents new opportunities to source input goods from foreign suppliers within the bloc.

*The creation of an economic bloc decreases the importance of national boundaries. Instead of viewing the bloc as a collection of disparate countries, firms begin to view the bloc as a unified whole. Managers develop strategies and value-chain activities suited to the region as a whole, rather than to individual countries. Rationalization is the process of restructuring and consolidating company operations following regional integration to reduce redundancy and costs and increase the efficiency of operations. The formation of economic blocs also leads to mergers and acquisitions (M&A), sometimes due to rationalization. * An economic bloc facilitates the standardization of products and streamlining of marketing activities because, in more advanced stages of regional integration, the member countries tend to harmonize product standards and commercial regulations.The harmonization of EU product standards allows firms to standardize its products appropriate for serving the whole EU market. The most effective way for a foreign firm to enter an economic bloc is to establish a physical presence there via foreign direct investment (FDI). By building a production facility, marketing subsidiary, or regional headquarters anywhere inside a bloc, the outsider gains access to the entire bloc and to advantages enjoyed by local firms based inside the bloc. *In 1990, there were approximately fifty regional economic integration agreements worldwide. Today, some 400 are in various stages of development, and many nations belong to more than one. Economic blocs are joining with other blocs around the world. Several countries, including Canada and India, are negotiating free trade agreements with the EU. The evidence suggests regional integration is gradually giving way to a system of free trade worldwide.

ib chapter 9 regional economic integration

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