4.4 Economic Integration

Question 1

What is economic integration?

Answer 1

The merging of national boundaries which separate economic activity in one nation state from another

Question 2

What are free trade areas?

Answer 2

A group of countries where tariffs and non-tariff trade barriers between members are generally abolished, but with no common trade policy towards non-members

Question 3

What are ‘rules of origin’?

Answer 3

Extensive documentation which states where a good was produced/manufactured required in all FTAs -> a costly bureaucratic process

Question 4

What is a customs union?

Answer 4

A group of states that have agreed to charge the same import duties (CET) and usually allow free trade between themselves

Question 5

What are the advantages of a customs union?

Answer 5

• Countries will benefit if trade creation is greater than trade diversion
• Firms may gain economies of scale as the size of the market is potentially much larger
• Likely to be increased competition which leads to innovation, lower costs of production and prices
• Do not need rules of origin

Question 6

What are the disadvantages of a customs union?

Answer 6

• Mergers may lead to an oligopolistic market structure
• Increased inequality within the CU
  - Successful countries will attract more economic activity
  - Countries in the centre of the CU will likely have lower transport costs
• Transaction costs in administering the CU can be high
• If CETs are high, trade diversion is far more likely

Question 7

What is a single market (common market)?

Answer 7

A single market removes all barriers to mobility; workers, capital and other resources are free to move within the area in question

Question 8

What are the advantages of a single market?

Answer 8

• Increase in competition
• The size of the market means firms can exploit economies of scale
• Greater labour market flexibility
• Encourages cross-border technological alliances - can boost dynamic efficiency
• A stronger more integrated EU economy may be less vulnerable to global external shocks

Question 9

What are the disadvantages of a single market?

Answer 9

• Extra budgetary costs for financing EU administration
• Social and economic pressures from inward migration -> increased strain on health, education and social services in countries with high net inward migration
• Brain drain
• Shift of FDI and jobs to lower wage/higher productivity economies
• Disadvantages of CU, less control over trade policy

Question 10

What is a monetary union?

Answer 10

A monetary union is when 2 or more countries share a common currency or decide to pay their exchange rates to keep the value of their currency at a certain level. There is also one monetary policy for all members

Question 11

What are the conditions needed for a successful monetary union?

Answer 11

• Free movement of labour and capital
• Automatic fiscal transfers when individual countries are performing poorly
• Countries need to have some coordination of fiscal policy -> EU ‘stability and growth pact’
• Similar business cycles

Question 12

What are the advantages of a monetary union?

Answer 12

• Greater price transparency -> easier for consumers to compare prices between countries
• Reduced exchange rates costs
• More trade (due to lower exchange rate costs) and greater economies of scale
• Price stability -> central bank focused on price stability
• Imposes discipline on domestic firms -> rising costs cannot be compensated for by a depreciation, domestic firms must stay productive
• Financial support from member states in cases of financial difficulty

Question 13

What are the disadvantages of a monetary union?

Answer 13

• Loss of domestic monetary policy autonomy
• ‘One size fits all’ interest rates are set which cannot be optimal for every country
• Adjustment costs -> the change-over process for introducing a single currency will involve substantial menu costs
• Loss of adjustment of exchange rates to offset BoP imbalances
• Relative deflationary bias (Eurozone) -> mainly because ECB had an asymmetric inflation target until recently (2% inflation ceiling)
• Financial constraints -> ‘growth and stability pact’
• Structural problems -> regions grow at different rates -> inequality
• Critics highlight the lack of economic convergence of members and the fact that common currencies are not optimal currency areas
• Inequality -> more powerful countries may not follow rules (eg. France and Belgium are not following the EU growth and stability pact)

Question 14

How many members does the WTO have?

Answer 14

166

Question 15

What percentage of world trade does the WTO account for?

Answer 15

98%