Economic integration

Economic integration

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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
Theory of the Second Best
In welfare economics, the theory of the second best concerns what happens when one or more optimality conditions cannot be satisfied. Canadian economist Richard Lipsey and Australian economist Kelvin Lancaster showed in a 1956 paper that if one optimality condition in an economic model cannot be...

: where, in theory, the best option is free trade
Free trade
Under a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from...

, 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
Horizontal integration
In microeconomics and strategic management, the term horizontal integration describes a type of ownership and control. It is a strategy used by a business or corporation that seeks to sell a type of product in numerous markets...

 referring to combinations of competitors, vertical integration
Vertical integration
In microeconomics and management, the term vertical integration describes a style of management control. Vertically integrated companies in a supply chain are united through a common owner. Usually each member of the supply chain produces a different product or service, and the products combine to...

 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
Fritz Machlup
Fritz Machlup was an Austrian-American economist. He was notable for being one of the first economists to examine knowledge as an economic resource....

 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
Welfare
Welfare refers to a broad discourse which may hold certain implications regarding the provision of a minimal level of wellbeing and social support for all citizens without the stigma of charity. This is termed "social solidarity"...

 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. This is one of the reasons for the global scale development of economic integration, a phenomenon now realized in continental economic blocks
Trade bloc
A trade bloc is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, are reduced or eliminated among the participating states.-Description:...

 such as ASEAN, NAFTA
North American Free Trade Agreement
The North American Free Trade Agreement or NAFTA is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada – United States Free Trade Agreement...

, SACN, the European Union
European Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...

, and the Eurasian Economic Community
Eurasian Economic Community
The Eurasian Economic Community originated from the Commonwealth of Independent States customs union between Belarus, Russia and Kazakhstan on 29 March 1996...

; and proposed for intercontinental economic blocks, such as the Comprehensive Economic Partnership for East Asia
Comprehensive Economic Partnership for East Asia
The Comprehensive Economic Partnership for East ASIA is a Japanese led proposal for trade co-operation, free trade agreement, among the 16 present member countries of the East Asia Summit.- Countries involved :The 16 countries are:...

 and the Transatlantic Free Trade Area
Transatlantic Free Trade Area
The Transatlantic Free Trade Area is a proposed free trade area between the United States and the European Union in reaction to the growing economic power of the People's Republic of China. It was considered in the 1990s and again in 2007 but no firm plan has been made...

.

The other objective for the states pursuing economic integration is to become or stay regionally and globally competitive, as the goods of the states outside economic blocks become more expensive.

Stages


The degree of economic integration can be categorized into six stages:
  1. Preferential trading area
    Preferential trading area
    A Preferential trade area is a trading bloc which gives preferential access to certain products from the participating countries. This is done by reducing tariffs, but not by abolishing them completely. A PTA can be established through a trade pact. It is the first stage of economic integration...

  2. Free trade area
    Free trade area
    A free trade area is a trade bloc whose member countries have signed a free trade agreement , which eliminates tariffs, import quotas, and preferences on most goods and services traded between them. If people are also free to move between the countries, in addition to FTA, it would also be...

    , Monetary union
  3. Customs union
    Customs union
    A customs union is a type of trade bloc which is composed of a free trade area with a common external tariff. The participant countries set up common external trade policy, but in some cases they use different import quotas...

    , Common market
  4. Economic union
    Economic union
    An economic union is a type of trade bloc which is composed of a common market with a customs union. The participant countries have both common policies on product regulation, freedom of movement of goods, services and the factors of production and a common external trade policy.The countries...

    , Customs and monetary union
    Customs and Monetary Union
    An customs and monetary union is a type of trade bloc which is composed of a customs union and a currency union. The participant countries have both common external trade policy and share a single currency....

  5. Economic and monetary union
    Economic and monetary union
    An economic and monetary union is a type of trade bloc which is composed of an economic union with a monetary union. It is to be distinguished from a mere monetary union , which does not involve a common market. This is the fifth stage of economic integration...

    ,
    • Fiscal union
      Fiscal union
      Fiscal union is the integration of the fiscal policy of nations or states. Under fiscal union decisions about the collection and expenditure of taxes are taken by common institutions, shared by the participating governments...

  6. Complete economic integration
    Complete economic integration
    Complete economic integration is the final stage of economic integration. After complete economic integration, the integrated units have no or negligible control of economic policy, including full monetary union and complete or near-complete fiscal policy harmonisation.Complete economic...



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
Certificate of origin
A Certificate of Origin is a document used in international trade. It traditionally states from what country the shipped goods originate, but "originate" in a CO does not mean the country the goods are shipped from, but the country where the goodtion problem in cases where less than 100% of the...

 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 barrier
Trade barrier
Trade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following:* Tariffs* Non-tariff barriers to trade** Import licenses** Export licenses** Import quotas** Subsidies...

s, introduction of supranational bodies, and gradual moves towards the final stage, a "political union".
Stages of Economic integration
Trade pact type  activities inside the trade bloc
Trade bloc
A trade bloc is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, are reduced or eliminated among the participating states.-Description:...

 
common barriers
Trade barrier
Trade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following:* Tariffs* Non-tariff barriers to trade** Import licenses** Export licenses** Import quotas** Subsidies...

 in external
Customs territory
A customs territory is a territory with individual customs regulations.The most common type of customs territory is the sovereign state and the others are the Trade bloc that has a customs union; and the autonomous or dependent territory that has independence in foreign trade and customs...

 relations
eliminating
Freedom of movement
Freedom of movement, mobility rights or the right to travel is a human right concept that the constitutions of numerous states respect...

 barriers for exchange of
Trade barrier
Trade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following:* Tariffs* Non-tariff barriers to trade** Import licenses** Export licenses** Import quotas** Subsidies...

 
| Shared policies goods | services | capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

 
| labour
goods (tariffs
Tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....

)
goods (non-tariff
Non-tariff barriers to trade
Non-tariff barriers to trade are trade barriers that restrict imports but are not in the usual form of a tariff. Some common examples of NTB's are anti-dumping measures and countervailing duties, which, although they are called "non-tariff" barriers, have the effect of tariffs once they are...

)
services  capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

 
labour  monetary
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

 
fiscal
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....

 
Tariff
Common external tariff
When a group of countries form a customs union they must introduce a common external tariff. The same customs duties, import quotas, preferences or other non-tariff barriers to trade apply to all goods entering the area, regardless of which country within the area they are entering...

 
Non-tariff
Non-tariff barriers to trade
Non-tariff barriers to trade are trade barriers that restrict imports but are not in the usual form of a tariff. Some common examples of NTB's are anti-dumping measures and countervailing duties, which, although they are called "non-tariff" barriers, have the effect of tariffs once they are...

Preferential trade agreement TIFA
Trade and Investment Framework Agreement
A Trade and Investment Framework Agreement is a trade pact which establishes a framework for expanding trade and resolving outstanding disputes between countries....

BIT
Bilateral Investment Treaty
A bilateral investment treaty is an agreement establishing the terms and conditions for private investment by nationals and companies of one state in another state. This type of investment is called foreign direct investment . BITs are established through trade pacts...

, TIFA
Trade and Investment Framework Agreement
A Trade and Investment Framework Agreement is a trade pact which establishes a framework for expanding trade and resolving outstanding disputes between countries....

Free trade agreement
Economic partnership
Economic Partnership Agreement
An economic partnership agreement is an economic arrangement that eliminates barriers to the free movement of goods, services, and investment between countries. This agreement can be considered an intermediate step between free trade area and single market in the process of economic integration...

Common market
Monetary union
Fiscal union
Fiscal union
Fiscal union is the integration of the fiscal policy of nations or states. Under fiscal union decisions about the collection and expenditure of taxes are taken by common institutions, shared by the participating governments...

|
Customs union
Customs union
A customs union is a type of trade bloc which is composed of a free trade area with a common external tariff. The participant countries set up common external trade policy, but in some cases they use different import quotas...

Customs and monetary union
Customs and Monetary Union
An customs and monetary union is a type of trade bloc which is composed of a customs union and a currency union. The participant countries have both common external trade policy and share a single currency....

Economic union
Economic union
An economic union is a type of trade bloc which is composed of a common market with a customs union. The participant countries have both common policies on product regulation, freedom of movement of goods, services and the factors of production and a common external trade policy.The countries...

Economic and monetary union
Economic and monetary union
An economic and monetary union is a type of trade bloc which is composed of an economic union with a monetary union. It is to be distinguished from a mere monetary union , which does not involve a common market. This is the fifth stage of economic integration...

Complete economic integration
Complete economic integration
Complete economic integration is the final stage of economic integration. After complete economic integration, the integrated units have no or negligible control of economic policy, including full monetary union and complete or near-complete fiscal policy harmonisation.Complete economic...


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

Economic theory


The framework of the theory of economic integration was laid out by Jacob Viner
Jacob Viner
Jacob Viner was a Canadian economist and is considered with Frank Knight and Henry Simons one of the "inspiring" mentors of the early Chicago School of Economics in the 1930s: he was one of the leading figures of the Chicago faculty.- Biography :Viner was born in 1892 in Montreal, Quebec to...

 (1950) who defined the trade creation
Trade creation
Trade creation is an economic term related to international economics in which trade flows are redirected due to the formation of a free trade area or a customs union. The issue was firstly brought into discussion by Jacob Viner , together with the trade diversion effect...

 and trade diversion
Trade diversion
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.-Occurrence:...

 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
Hungary
Hungary , officially the Republic of Hungary , is a landlocked country in Central Europe. It is situated in the Carpathian Basin and is bordered by Slovakia to the north, Ukraine and Romania to the east, Serbia and Croatia to the south, Slovenia to the southwest and Austria to the west. The...

 economist
Economist
An economist is a professional in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...

 Béla Balassa
Béla Balassa
Béla Balassa was a Hungarian economist and world-renowned professor at Johns Hopkins University; most famous for his work on the relationship between purchasing power parity and cross-country productivity differences .Balassa received a law degree from the University of Budapest...

 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
Trade creation
Trade creation is an economic term related to international economics in which trade flows are redirected due to the formation of a free trade area or a customs union. The issue was firstly brought into discussion by Jacob Viner , together with the trade diversion effect...

 and trade diversion
Trade diversion
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.-Occurrence:...

 effects, the Pareto efficiency
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...

 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
    Heat equation
    The heat equation is an important partial differential equation which describes the distribution of heat in a given region over time...

     and Navier-Stokes equations
    Navier-Stokes equations
    In physics, the Navier–Stokes equations, named after Claude-Louis Navier and George Gabriel Stokes, describe the motion of fluid substances. These equations arise from applying Newton's second law to fluid motion, together with the assumption that the fluid stress is the sum of a diffusing viscous...

    )

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
Gross domestic product
Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....

 (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
Michael Porter
Michael Eugene Porter is the Bishop William Lawrence University Professor at Harvard Business School. He is a leading authority on company strategy and the competitiveness of nations and regions. Michael Porter’s work is recognized in many governments, corporations and academic circles globally...

, 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
European Coal and Steel Community
The European Coal and Steel Community was a six-nation international organisation serving to unify Western Europe during the Cold War and create the foundation for the modern-day developments of the European Union...

 opened a way for the formation of the European Economic Community
European Economic Community
The European Economic Community The European Economic Community (EEC) The European Economic Community (EEC) (also known as the Common Market in the English-speaking world, renamed the European Community (EC) in 1993The information in this article primarily covers the EEC's time as an independent...

 (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 integration effects
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.-Properties:...

.

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



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).

Potential global economic integration may be able to solve an issue of reallocating the capital needed to develop less developed regions, blocs and states - on the one hand, and unwillingness of more industrialized part of the world to do it - on the other hand. As the global competition, sourcing and logistics becomes globally universal, it will eventually cause gradual harmonization of policies (within or outside the blocks, with or no formal global economic integration in place).

See also

  • List of trade blocs (from PTA to EMU)
  • List of international trade topics
  • Trade pact
    Trade pact
    A trade pact is a wide ranging tax, tariff and trade pact that often includes investment guarantees. The most common trade pacts are of the preferential and free trade types are concluded in order to reduce tariffs, quotas and other trade restrictions on items traded between the signatories.-By...

  • Trade bloc
    Trade bloc
    A trade bloc is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, are reduced or eliminated among the participating states.-Description:...

  • Regional integration
    Regional integration
    Regional integration is a process in which states enter into a regional agreement in order to enhance regional cooperation through regional institutions and rules...

  • Middle East economic integration
    Middle East economic integration
    Middle East economic integration has been envisioned, proposed or implemented by various parties in recent history.The stated rationale is that peace, stability and prosperity in the Middle East can only be sustained over the long-run through intra-regional economic cooperation.Governance,...