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Regional Economic Integration

By Myovella G, Dept of Econ and Statistics

Office 119 Block B, 0752097959.

Email, [email protected]

12/3/2013 Myovella G.


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Regional Economic Integration

Today, regionalism has emerged as a forcepotentially rivalling

multilateralism with, as yet, uncertainimplications for the world trading systemand the process of globalization itself.

So with increasing globalisation and theadvent of WTO the Ideal of Regionaleconomic blocks have been embraced.



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Surge of RI initiatives

There has been a surge of RegionalIntegration Agreements since 1990s.

as of 15 May 2011, some 489 RTAs, had

been notified to the GATT/WTO. 358 RTAs were notified under Article XXIV of

the GATT 1947 or GATT 1994;

36 under the Enabling Clause; and

95 under Article V of the GATS. At that same date, 297 agreements were in

force



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RI cont...

The (EU) and (NAFTA) are the two mostprominent regional integration arrangements

Some examples of Regional economicintegrations, EAC -5 members, COMESA-20,SADC,-14, SACU -5 members and oldest CU inAfrica. Economic Community of West AfricanStates (ECOWAS), the Economic Communityof Central African States (ECCAS/CEEAC) andthe Arab Maghreb Union. MERCOSUR, ASEANetc.



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Meaning of REI

Regional economic integration:- A processin which a group of nations reduces tariffand non-tariff barriers to allow for the free

flow of goods, services and factors ofproduction including labour and capital.

The overall goal is to raise the growth ratesof participating economies via an increasein economic activity.



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Dimensions of Integration

(i) geographic scope - illustrating the number ofcountries involved in an arrangement (variablegeometry),

(ii) the substantive coverage or width that is thesector or activity coverage (trade, labor mobility,macro-policies, sector policies, etc.), and

(iii) the depth of integration to measure the

degree of sovereignty a country is ready tosurrender, that is from simple coordination orcooperation to deep integration.



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Stages of Regional Economic

IntegrationPreferential Trade Area (PTA) or Agreement, where member states

charge lower tariffs to imports produced by fellow membercountries than they do for non-members;

Free Trade Area (FTA), a PTA without any tariffs on fellow membersgoods; eg, NAFTA

Customs Union, an FTA using the same or common tariffs on importsfrom non-members; EU 1957

Common Market, a customs union with free movement of the factorsof production; eg. EU achieved this at the begining of 1993

Economic Community, a single-currency common market or monetary

union in which fiscal and monetary policies are unified. If politicalsovereignty is given up, an economic community becomes afederation or political union with common legislationand politicalstructures. Eg. Benelux



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Stages of Regional Economic Integration



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ECONOMICS OF CUSTOMS UNION

Jacob Viners theory



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Theory of Regional Integration

The impetus for regional integration drawsits rationale from the standard trade theory,which states that; free trade is superior toall other trade policies.

As an extension of this basic principle,therefore, free trade among two or more

countries will improve the welfare of themember countries as long as thearrangement leads to a net trade creation inthe Vinerian sense.



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SIMPLE MODEL OF A CUSTOMS UNION

Customs Union

A group of countries among which trade takes

place freely without being restricted by thebarriers of tariffs (customs duties) or quotas(quantitative restrictions) on trade, and whichadopts a common external tariff - all membercountries impose the same tariffs on countries

outside the customs union



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Elimination of tariffs on imports frommember countries

Adoption of a common external tariff onimports from the rest of the world

Apportionment of customs revenueaccording to an agreed formula



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Assumptions:

Pure competition in commodity and factor markets

Factor mobility within countries but not between

them

No transportation costs

Tariffs are the only form of trade restrictions

Prices reflect the opportunity costs of production Trade is balanced

Resources are fully employed



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Until the beginning of the 1950s it was commonly heldthat the customs unions and free trade areas were stepspromoting free international trade, only after pioneeringwork of Jacob Viner was published in 1950 it was realisedthat customs unions might as well be seen as a step

towards protectionism

Jacob Viner (1892-1970) was Canadian economist,professor at Chicago University and Princeton University.

Viner was an international trade theorist. His book TheCustoms Union Issue introduced the distinction between thetrade-creating and the trade-diverting effects of customsunions.



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Any economic theory of regional product marketintegration has to address the question of economicjustification of particular integration forms (the questionwhether an arrangement would be superior to the status

quo and to participation in world-wide tradeliberalisation)

The contribution of Jacob Viner was an introduction of

welfare consideration into the theory of internationaltrade in general and particularly into the theory ofcustoms unions.



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Trade creation and trade diversion

Ground-stones of Viner's theory of customs unions areconcepts of trade diversion and trade creation effects ofdifferent arrangements of regional integration.

Original Viners definition of these concepts wasformulated in terms of trade flows: trade diversion switch in trade from less expensive to more

expensive producers

trade creation switch in trade from more expensive to lessexpensive producers



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We shall use a modified definition in terms ofwelfare changes:

trade creation - welfare change due to thereplacement of higher cost domestic productionand/or higher cost imports by lower-costimports

trade diversion - welfare change due to thereplacement of imports from a low cost source

by imports from a higher cost source



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In terms of world allocation of resources:trade creation is beneficial to welfare, whiletrade diversion worsens allocation, a

customs union is economically justified if itleads to a trade creation, while a customsunion generating a trade diversion leadstowards a deeper protectionism and

decrease of efficiency.



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A Partial Equilibrium Model

Two countries:

H (home country)

P (potential partner country)

W (world market)



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SH(p): domestic supply function

DH(p): domestic demand function for this

commodity in the country H

The supply by the partner country and the

world market supply of the commodity isassumed to be perfectly elastic, hence thecountry H cannot influence the price



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World price: pW

The price in the partner country: pP

The closed equilibrium price in the home

country: pH Let

Then the country H will cover part of itsdomestic demand by import from the worldmarket

21

p


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Fig.1, Country H in a general tariff protection regime



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Assume that country H is considering a possibility ofcustoms union with the country P

After the customs union is created, the trade inside theunion will be tariff free, for the price pCU = pP less thanthe pW + t. The tariff t for the trade with rest of world ismaintained.

The effective supply for country H in the union will beSCU, while domestic supply will decrease to sCU and

domestic demand will increase to dCU. Import will expandfrom dt - st to dCU - sCU. Facing this possibility, is it

beneficial for country H to enter the customs union withcountry P?



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24

p

q

(a)

consumers'

surplus in TP

producers'

surplus in TP

tariff revenuesin TP

Et

EH

dqs

p

pH

W

p +tW

Sw(pw+t)

Sd(p)

Dd(p)

Ht t

Fig. 2, Welfare effect of tariff protection



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25

E

E

p

qs dq

p

p

H

H

H

W

t

t t

consumers'surplus in CU

producers'

surplus in CU

no tariffrevenues in CU

(a) (b) (c) (d)

(e)

sCU

dCU

Scu(pcu)

Sh(p)

Sw(pw+t)ECU

pCU

p

W

+t

Fig. 3, Welfare effect of customs union for country H



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Before the union was created, the country H was

importing from the world market for lower price

than in the customs union with country P.

But we can observe at the same time a

reduction of the more expensive domestic

production in favour of cheaper imports frompartner's country and increase of domestic

supply.



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E

E

p

qs dq

p

p

H

H

H

W

t

t t

consumers'surplus in CU

producers'

surplus in CU

no tariff

revenues in CU

(a) (b) (c) (d)

(e)

sCU

dCU

Scu(pcu)

Sh(p)

Sw(pw+t)E

CUpCU

pW

+t



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The total welfare effect for the home country fromcreating the customs union with country P can beexpressed as follows:

(1) The decrease of the equilibrium price from pW + t to pCU =

pP leads to an increase of consumers' surplus by the amountequal to regions denoted as (a), (b), (c) and (d) in the Fig. 3.

(2) At the same time producers' surplus is decreasing by anamount equal to the area (a).

(3) The government is losing tariff revenues equal to theregions (c) and (e).



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Considering gains and losses we can see that areas (a) and (c) do notrepresent a gain, because they are compensated by losses (inproducers' surplus and government tariff revenues), but only aninternal redistribution of welfare between producers and consumers.

Hence, the positive welfare effects of the customs union for thehome country consists of areas (b) and (d). The trade creation effectwas defined by Johnson as a sum of these two areas, reg (b) + reg (d).

Negative welfare effect is given by the region (e), the loss of tariff

revenues, used before for welfare redistribution. By Johnson thisrepresents a trade diversion effect.



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Defining trade diversion as a negative welfare effectand trade creation as a positive welfare effect, the netwelfare effect given as

indicates, whether the trade creation or the tradediversion prevails in a particular case of the customsunion. We can make no general statement about the

positive or negative effects of customs unions. Anempirical investigation of each particular case isnecessary.

30

reg(e)-reg(d)+reg(b)=w



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TAKE HOME ASSIGNMENT

One commodity market in country H with domestic demandand supply functions:

A potential partner country: P

World price: pW = 4

Non-discriminative ad valorem tariff: t = 1

Price in partner country: pP = 4.5

31

20p-370=(p)D

50p+50-=(p)S

H

H



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Example contd

Case 1: what is the Welfare of closed

equilibrium

Case 2: What is the welfare under Tariff

Protection

Case 3:what is the welfare under Customs

Union of H with P



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The theory of Second Best and other

static welfare effects of CU

We saw that free trade leads to the most efficientutilization of world resources and thus maximizesworld output and welfare.

Therefore, prior to Viners work on CU in 1950 it waswidely believed that any movement towards freetrade would also increase the welfare.

CU would lead to increase in welfare if it would notincrease trade barriers against the rest of the world.



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However, Vinershowed that the formation of the CU

could increase or reduce the welfare of the member

nations and the rest of the world, depending on the

circumstances under which it take place. This is anexample of the theory of the second best



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The theory states that if all the conditions required

to maximize welfare or reach pareto optimum can

not be satisfied, trying to satisfy as many of these

conditions as possible does not necessarily or usuallylead to the second best position.

Thus forming a CU and removing trade barriers only

among the members will not necessarily produce the

second best welfare position.



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Conditions likely for CU to increased

welfare The larger is the economic area of the CU and the more numerous

are the countries of which it is composed, the greater will be thescope for TC. Higher probability tht low-cost producers fall withinthe union

It is likely that TC will be greater than TD if countries joiningtogether in a CU are similar in the range of products they producebefore the formation of the union.

This is because TC occurs through the replacement of domesticproduction by more efficient production within the union.

If future members produce essentially different goods, there willbe little scope for such replacement and, hence, little tradecreation.



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Conditions likely for CU to increased

welfare The closer geographically are the members of the CU, likely is

the TC.

TC is more likely, the greater are the initial tariff rates amongfuture partners (rest of the world).

TC is more likely, the higher is the elasticity of demand forimports on which duties are removed.

The gains from integration are likely to be greater, the greateris the ratio of intra-trade (trade with future partners) to totaltrade.



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Other static effects of CU

i) Administration savings from elimination of customs officers,

border patrols e.t.c

ii) A trade diverting CU can lead to an improvement in collective

terms of trade. By reducing its demand for imports and suply

to rest of the world.

iii) Collective bargaining power. Case of EU, EAC



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Dynamic benefits from CU

Apart from static welfare effects, there are dynamics benefits

from forming a custom union

i. Increased competition leads to efficiency to producers

ii. Economies of scale are likely due to enlarged market

iii. Stimulus to investment

iv. A custom union which is also a Common market there is

free movement of labor and capital hence efficient

utilization of the economic resources of the entire

community



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Dynamic benefits from CU

Dynamic gains resulting from the formation of the customs

union are presumed to be much greater and significant than

the static gains. Eg. The UK joined EU in 1973 because of

them. EAC was establised because of them.

The question is whether regional blocs are building blocks or

stumbling block to free multilateral trade.



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Regional Integration in Africa

The history of regional integration in Africa shows that the

reasons or objectives for integrating have been evolving over

time.

These have shifted from the initial focus on the political

decolonisation of Africa to the current emphasis on socio-

economic integration in the post independence era for

stronger bargaining base in global fora and for mutual benefit

in the form of accelerated growth and development.



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Overview of Review of Progress on African

Integration

Apart from the African Union (AU), which, as the umbrellapolitical Africa-wide body, envisages eventually having acommon currency and central bank by 2025

Following the Lagos Plan of Action (1980) and Abuja Treaty

(1991), various RECs have been initiated.Central Africa:- CEMAC, ECCAS,

East Africa: EAC

Southern Africa: SADC, SACU.

North Africa: CEN-SAD, UMAWest Africa: ECOWAS, UEMOA, MRU

Others: COMESA



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Cont...

One of the aim was the promotion of intra-regional trade, including

preparing members for greater global competition and bargaining power.

However, liberalisation in Africas regional trade has been limited by,

among other factor

costly overlapping memberships, including some bilateral agreements;

different time horizons for full liberalisation of trade among member

states and sub-regions

delays by some member states in signing trade treaties and

Protocols, followed by additional delays in implementation.

Overall, as a share of the continents global trade, intra-regional trade inAfrica is generally low



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East African Community

Members- 5. (kenya, Uganda, Tanzania, Rwanda, and Burundi) Status- Common market July 2010

History

building of a common service i.e. The Uganda Railway in 1895;

establishment of the Customs Collection Centre in 1900

establishment of the East African currency board in 1905;

the Court of Appeal of Eastern Africa was set up in 1909;

the Customs Union came into force in 1919;

the East African income tax board established in 1940;

the Joint Economic Council was set up in 1940;

formation of the East African high commission in 1948;

establishment of the East African Common Services Organisation in 1961;

establishment of the East African community in 1967-1977; collapse of

the East African community in 1977; agreement to revive the East

African cooperation treaty in 1992, which lasted for the period 1993-

2000



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EAC

What led to the collapse of the EAC? And why theNew Community?

After reviving in 2000 the EAC started with theCustoms union, with the following features;

a Common External Tariff (CET) on imports from third

countries; duty-free trade between the member states; and

common customs procedures



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EAC cont...

Different rates are applied for raw materials

(0%), intermediate products (10%) and

finished goods (25%),



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Cont..

Cont eac customs union 1.pptx
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