Levels of Economic Integration and Regional Trade Agreements

Levels of Economic Integration

There are five types of regional trade agreements:

1. Preferential Trade Agreement: Two or more countries liberalize trade in a selected group of product categories.
2. Free Trade Area (FTA): Trade in goods and services is fully liberalized between two or more countries.
   • North American Free Trade Agreement (NAFTA)
3. Customs Union (CU): An FTA plus a common external tariff.
   • European Union in the 1970s and 1980s
   • MERCOSUR in South America
4. Common Market: A customs union plus free mobility of factors of production.
   • European Union in the 1990s
5. Economic Union: A common market with coordination of macroeconomic policies (including a common currency and harmonization of standards and regulations).
   • European Union

Data on Preferential Trade Agreements (PTAs)

The following database provides information on PTAs (Preferential Trade Agreements Database). According to the Global Preferential Trade Agreements Database (GPTAD), there are more than 330 PTAs around the world, including agreements that have not been notified to the World Trade Organization (WTO).

Free trade agreements constitute the vast majority (86% of existing PTAs and 99% of arrangements currently being negotiated). More than half of all PTAs are bilateral. The others are "plurilateral" agreements (including at least three countries).

PTAs are densely concentrated in Europe and the Mediterranean region. Agreements between countries in Western, Eastern, and Central Europe, and in the Mediterranean account for almost 50% of PTAs in operation. North and South America take second place, accounting for about 12 percent.

The Case for PTAs

Why Have PTAs Proliferated, Especially Since 1990?

A Country's Desire to Gain More Access to the Market of an Important Trading Partner

• Example: Canada signed NAFTA to enter the U.S. market and avoid the U.S. using anti-dumping policies (which were widely used in the 1980s).

Signaling a Government's Commitment to Economic Reform

• Examples: Mexico entering NAFTA, and Eastern Europe and the EU.

Increasing a Country's Bargaining Power in Multilateral Trade Negotiations

Overcoming the Impasse in WTO Negotiations (the Doha Round)

States seek other paths to pursue their trade policy goals.

• Digital Trade: Despite its growing importance, the issue was kept out of the Doha Round. Within the mega-regionals, governments could negotiate extensive rules.
• Global Value Chains: Agreements to protect investments, harmonize product standards across national markets, and make it easier and cheaper to ship goods across national boundaries.

Evolution of the European Union

The EU is the most advanced example of economic integration in the world. It is an economic union, with:

• Free flow of products and factors of production (capital and workers) between members
• The adoption of a common external trade policy
• A common currency
• Harmonization of the member countries' tax rates
• A common monetary and fiscal policy

The forerunner of the EU was the European Coal and Steel Community (formed in 1951). The Treaty of Rome established the European Economic Community in 1957. The name was changed to the EU in 1994.

The Establishment of the Euro

The Maastricht Treaty (1991) committed EU members to adopt a single currency, the euro. The euro is used by 19 of the 27 member states.

• Several countries where the euro has not yet been adopted will join once they have met the necessary conditions: Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, and Sweden.
• Denmark (and previously the UK) has opted out of the euro zone.

The euro zone created the second-largest currency zone in the world, after that of the U.S. dollar. Participating countries have agreed to give up control of their monetary policy.

How Countries Join the Euro Area

In order to join the euro area, EU member states are required to fulfil so-called "convergence criteria", binding economic and legal conditions agreed in the Maastricht Treaty (1992).

Enlargement (and Contraction) of the European Union

Many countries, particularly from Eastern Europe, have applied for membership in the EU.

• 10 countries joined in 2004, expanding the EU to 25 states, with a population of 450 million people and a single continental economy with a GDP of €11 trillion.
• In 2007, Bulgaria and Romania joined.
• In 2013, Croatia joined, bringing membership to 28 countries.
• Turkey has also applied for membership.
• However, in 2016 the UK voted to leave the EU, which took effect in 2020.

In several European countries, euroscepticism has spread.

Economic Integration in the Americas

Regional economic integration has a long history in the Americas, but its performance has been uneven. The most significant attempt is the North American Free Trade Agreement (replaced by the USMCA). Other agreements include:

• The Andean Community: Customs union
• MERCOSUR: Customs union
• Caribbean Community: Common market
• Central American Integration System (SICA): Free trade area

There are also attempts to form a Free Trade Area of the Americas.

Economic Integration in Asia and the Pacific

The Association of Southeast Asian Nations (ASEAN, 1967) aims to foster freer trade between member countries and to achieve some cooperation in their industrial policies. Members include Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Vietnam, Myanmar, Laos, and Cambodia.

The ASEAN Free Trade Area (AFTA, 2003) between the six original members of ASEAN came into full effect to reduce import tariffs among members. Vietnam, Laos, and Myanmar have all joined.

Asia-Pacific Economic Cooperation (APEC) was founded in 1989 to increase multilateral cooperation in view of the economic rise of the Pacific nations and the growing interdependence within the region. It is a mega-PTA. APEC currently has 21 members, including the United States, Japan, and China.

Regional Trade Blocs in Africa

There are several trade blocs on the African continent. However, progress toward the establishment of meaningful trade blocs has been slow. Many countries believe that they need to protect their industries from unfair foreign competition, making it difficult to create free trade areas or customs unions.

Mega-PTAs

Since 2008, mega-PTAs have proliferated:

• Regional Comprehensive Economic Partnership (RCEP): A free trade agreement (FTA) between the 10 member states of ASEAN and its five FTA partners (Australia, China, Japan, New Zealand, and the Republic of Korea).
  • Intended to reduce tariffs and red tape.
  • Includes unified rules of origin to facilitate international supply chains and trade (to avoid tariffs, quotas, etc.).
  • Prohibits certain tariffs.
  • Does not focus on labor unions, environmental protection, or government subsidies.
• The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP): A free trade agreement and successor of the TPP, which did not enter into force. It came into force on December 30, 2018.

PTAs: Economic Consequences

Because PTAs provide tariff-free market access to some countries but not to others, they are inherently discriminatory. Although such discrimination is inconsistent with the core principles of the WTO, the WTO allows countries to form regional trade agreements (RTAs) as long as the level of protection against nonmembers is no higher than the level of protection applied by the countries prior to forming the arrangement. Nevertheless, the discriminatory aspect of PTAs makes many worry about the impact they will have on the nondiscriminatory trade encouraged by the WTO. Several analysts see PTAs as a major threat to the world trading system.

What Is the Effect of PTAs?

Several studies confirm that PTAs have:

• Had a positive impact on trade between members
• Caused changes in patterns of international trade

However, estimating the trade effect of PTAs is not straightforward due to the impact of many different variables.

Trade Creation and Trade Diversion

We have to distinguish between the effects of "trade creation" and "trade diversion":

• Trade creation: New trade flows across members as a result of the PTA.
• Trade diversion: Fewer trade flows with non-PTA countries.

If more trade is created than diverted, the PTA has liberalized trade. If more trade is diverted than created, the PTA has pushed the world toward protectionism.

Which of these effects predominates? It is difficult to evaluate trade creation and diversion. A PTA that originally diverts more trade than it creates might over time create more trade than it diverts. By contrast, the creation of a large PTA in one region could encourage the formation of rival and more protectionist PTAs in other regions (was NAFTA an American response to the EU?).

The World Bank (2000) stated: "It is not possible to conclude that trade diversion has been a major problem." It is also difficult to estimate the effects of economies of scale and competition dynamics.

An Assessment of Trade Policy: A Political Economy Approach

The contemporary trading system rests on liberal principles, but governments alike put restrictions on trade. How can we explain this paradox? We can explain trade intervention as the outcome of different interests held by different groups and/or societies, or as a result of domestic institutions privileging certain interests and policies.

Interest-Based Theories of Trade Policies

Governments regulate trade to protect national interests, or to protect certain social interests.

• State interests in trade policy
• Societal interests and trade policy: Some social groups prefer protectionism, others liberalization.
• Diverse interests between workers and capital (the factor model)
• Diverse interests across sectors (the sector model)

Institutional Theories of Trade Policy

Different institutional frameworks represent preferences in a different manner.

State Interests in Trade Policy

International trade can have significant effects on the international distribution of wealth, power, and military capabilities. Some sectors are considered especially significant for national interests (e.g., defense). However, where does this argument for protection stop? What if the security argument results in the country being less specialized? Besides, different countries opt for different trade-offs (different choices) in different circumstances.

The Strategic Role of Technology

The argument: Leading-edge technologies allow countries to achieve dynamic gains in global competition, ensuring higher productivity and long-run growth (and power).

The idea is that high-tech industries have positive externalities for the national economy (e.g., artificial intelligence may have significant implications for productivity in a range of manufacturing industries). Additionally, governments may have concerns about relying on key components from foreign countries. This is used to justify government promotion of particular sectors through a combination of trade and industrial policy.

Free trade advocates argue this may have undesired consequences for consumers and technological lock-in. How can government detect high-tech winners (sectors) and resist demands from vested interests?

Societal Interests in Trade Policy

The state is not a unitary actor, and there are different interests. Indeed, domestic distributional consequences shape trade policy choices.

The hypothesis: Politicians are assumed to be motivated primarily by their concern to be (re)elected. Specific outcomes are a product of competition for political influence between groups with divergent interests. Thus, even if free trade was the economically best policy, politics is the reason why protectionism is so common in practice.

• According to free trade advocates, protectionist outcomes may reduce aggregate economic welfare, but they redistribute income toward particular societal groups.
• Politicians favor these groups because they are well organized and provide electoral support, producing a structural bias toward protectionism.
• The majority of ordinary voters (consumers) lose in the process. Consumer interests are poorly represented because the costs of protection are spread relatively thinly across society, and because of collective action problems.

What are the different societal groups having different interests?

• Factors of production (workers vs. capital owners and landlords)
• Sectors

Factor Interests in Trade Policy

The factor model suggests that the debate over trade policy is a conflict over the distribution of national income between workers and business.

Stolper-Samuelson: Trade benefits the relatively abundant factor of production and hurts the relatively scarce factor of production.

In advanced economies:

• Because trade reduces the income of workers in labor-intensive industries as jobs move to developing countries, workers oppose further liberalization.
• Because trade raises the return to businesses, they support globalization.

Sectoral Interests in Trade Policy

The argument: Trade policy is driven by competition between industries (not by competition between workers and capital owners). Whenever tariffs are raised (lowered), wages and the return to capital in some industries rise, whereas in other industries both fall. Trade, therefore, pits workers and capital in one industry against another industry.

This assumes that factors are not easily moved from one industry to another: machines cannot relocate, workers have industry-specific skills, and quitting a job in one industry to take a job in another requires workers to physically relocate.

There is no unified interest along capital and class lines: some workers and firms lose from trade (e.g., the apparel industry), other workers and firms gain (e.g., software).

In general: Labor and capital employed in industries that rely intensively on society's abundant factor (that is, the country's comparatively advantaged industries) both gain from trade. These are the export-oriented sector.

Conversely, labor and capital employed in industries that rely intensively on society's scarce factor (that is, the country's comparatively disadvantaged industries) lose from trade. These are the import-competing sector.

Organizing Interests for Trade Policy Demands

Interest-based theories assume that certain social groups are capable of influencing trade policies. But actors' preferences are not transformed automatically into political pressure for specific trade policies. Transforming preferences into political demands requires that the actors who share a common preference organize.

Groups often can't organize because they confront a collective action problem (consumers do not organize to act collectively, even if in principle they benefit from trade). This helps explain why producers rather than consumers dominate trade politics.

The logic of collective action suggests that trade politics will exhibit a bias toward protectionism (it benefits producers against consumers). It also explains why governments rarely liberalize trade unilaterally, but have been willing to do so through negotiated agreements.

The Distribution of Authority

Political institutions shape how competition between organized interests unfolds. They establish rules that influence how people organize, and thus determine whether interests organize.

• Rules influence how organized interests exert pressure on the political process.
• Rules influence which interests politicians must respond to, and thus determine which interests gain representation.

Two key institutions: The distribution of authority and decision-making between the executive and the legislative.

• The authority to set the agenda usually resides within the executive (i.e., the prime minister), but its real power is constrained by other institutions (e.g., the parliament, rules, etc.). Overall, presidents with authority over trade policy may overcome protectionism because they are not so tied to vested interests.

The Electoral System

Electoral Systems and Trade Politics

The electoral system affects trade politics in two ways:

• Shaping how groups organize to pursue their trade policy objectives.
• Affecting the level of protection adopted by governments.

Recall, there are two types of electoral systems:

• Majoritarian: Combines single-member districts and first-past-the-post elections. Voters cast a vote for a single candidate, and the candidate with the most votes wins the election.
• Proportional representation (PR): Multimember districts to distribute legislative representation in proportion to the share of the popular vote each party attracts.
  • PR tends to organize around factors, i.e., some political groups represent workers' interests (left-wing political parties) and others business interests (right-wing political parties).
• Versus majoritarian systems, which tend to organize around sectors.

In general, PR is expected to keep lower tariffs, but it depends on governments' political orientation. Versus majoritarian systems, in which small groups can more easily influence policy.