Economic integration is a grouping of countries in a geographical region for the purpose of reducing or removing trade restrictions among members. It involves the formation of trade blocs to encourage trade among the members, promote the free movement of resources and harmonise macroeconomic policies.
Levels of economic integration
The levels or stages of economic integration include free trade area, customs union, common market, monetary union and full economic union.
Free trade area
This is the simplest level of integration. It involves the removal of trade barriers among the member countries. Each member is free to adopt different tariffs and other restrictions against non-members. In other words, members do not have a common external tariff. An example of a free trade area is The United States-Mexico-Canada Agreement (USMCA), formerly The North American Free Trade Agreement (NAFTA). It is a treaty signed by Canada, Mexico and the United States that eliminated most tariffs among the countries. NAFTA was established on Jan. 1, 1994 and was replaced by USMCA on July 1, 2020.
A customs union has the feature of a free trade area, i.e. removal of trade restrictions among members. In addition, members adopt common tariffs and restrictions against non-members. Southern African Customs Union (SACU), the oldest customs union, was established in 1910. Its members are Botswana, Eswatini, Lesotho, Namibia and South Africa. There is free trade among the members of SACU; members share all customs revenues collected in the customs area.
A common market has the features of a customs union, namely the removal of tariffs among members and common tariffs against non-members. Besides, it allows the free movement of resources among members and the harmonisation of policies such as tax.
MERCOSUR is a South American common market that has both full and associate members in Latin America. The purpose is to promote free trade and the free movement of productive resources among Latin American countries. Members of MERCOSUR include Argentina, Brazil, Paraguay and Uruguay.
Economic and Monetary union
The characteristics of this union include the abolition of trade restrictions, common external tariffs and common policies. Besides, members adopt a common currency. There will be a central bank for monetary policies. An example of an economic union is the European Union (EU). The EU comprises 27 European countries that promote trade and harmonise policies such as migration, health, security, climate and environment. The use of a common currency, the euro, has boosted trade among members. There is a high degree of integration since members give up a considerable amount of their national sovereignty.
Complete economic union
This has all the features of a monetary and economic union. The members operate as components of one nation as well. This leads to a political union in which the member countries are under one central political system that coordinates the economic, social and foreign policies of the member states. The United Kingdom (UK) is an example of a political union comprising England, Northern Ireland, Scotland and Wales.
Benefits of economic integration
Efficiency in the use of resources
Member countries within a trade bloc would specialise in what they have a comparative advantage in since they can always obtain other goods from other members without restrictions. This will ensure that a country concentrates on what it is better at and avoid wastage of resources in areas of comparative disadvantage. This will increase each country’s output and encourage exchange among members.
Competition within the union
Firms within the union compete with one another, regardless of the country of location. This will reduce monopoly in any of the member countries and encourage investment and innovation.
Expansion of market
A free trade area or economic union is a way of expanding the reach of a country’s products. Products can now be sold in member countries without restrictions like tariffs and embargoes. Sales would not only be limited to a country of location as firms can sell in foreign countries that are members of the union. Sales revenue accruing to each country would increase as a result. For example, being a member of the EU means that a firm can reach over 400 million people. Firms can also enjoy economies of scale and provide consumers with cheaper products.
Free movement of productive resources
Unrestrained movement of labour, capital, finance and other resources will encourage the inward flow of investments into a country. It will expand a country’s productive capacity and encourage faster economic growth.
The inward flow of investments will create jobs for the people. In addition, the export expansion will aid the growth of domestic firms and increase the number of people employed.
Faster regional development
Economic integration promotes economic activities in the region as a whole and makes a wide range of products available to citizens of the constituent countries. Living standards are bound to increase when citizens can access a variety of products and jobs from other parts of the regional grouping.
The transport network is improved due to free trade among the members. Good roads and railways would make it easier and less expensive to export or import goods.
Fosters better relations
Countries cooperate in different areas such as trading, agriculture, education, transport and security. An economic union can also lead to the harmonisation of policies and standards such as immigration and pollution. The economic interdependence among members engenders friendliness and makes it difficult for the countries to go to war with each other. The formation of trade blocs, therefore, promotes peace.
The free movement of investment and labour can help in the transfer of skills across the region. Technological skills and managerial skills can be passed to the indigenes of a member country by foreigners from other member countries. Thus, it aids faster technological development in component countries.
Problems of economic integration
Loss of independence
Economic integration involves surrendering a country’s economic independence to the common union. A member country loses its peculiarities in a bid to harmonise policies and standards and ensure similarities across the region. For example, many EU members lost their currencies by adopting the euro. The maintenance of sovereignty and cultural identity of each member country is a constant concern whenever trade blocs are formed.
Differences slow down decision making
The member countries have different political and economic ideologies which can hamper quick decision-making by the bloc. Ideologies adopted by countries include conservatism, liberalism and multiculturalism. These affect the harmonisation of policies such as immigration. Some members may favour policies that promote an egalitarian society and reduce inequality; others may support a free market which could increase inequality. There may also be disagreement in choosing between expansionary and contractionary monetary/fiscal policies.
Language differences create communication problems and hinder the free movement of goods and labour within a trade bloc.
Fear of domination
There is a disparity in the level of development in member countries. It raises suspicion that a strong member may want to dominate the weaker ones. Thus economic and social inequalities between the rich and poor members may create problems for the bloc. Also, resources tend to move to more efficient member countries, thereby leaving out other countries in the region.
Being a member of an economic union is not free. Members have to make annual contributions to the budget of the union. This reduces the money available to individual governments.
Poor transportation and communication systems hamper the free movement of goods and resources among member countries. It is only when countries are connected by well-developed transport and communication networks that obstacles to economic integration could be minimised.
This is a great hindrance to economic integration. No meaningful economic activities can take place in a politically unstable country. It will lead to poor economic performance due to policy inconsistency and policy myopia. And the unstable country will not be able to benefit from being a member of a trade bloc as it may not produce enough products for export.
Diseconomies of scale
Economic integration leads to the emergence of large businesses because firms can increase in size to take advantage of the lack of trade barriers within the union. These big businesses may start experiencing problems such as communication problem, coordination problem and delay in decision-making.
Effects of economic integration: trade creation and trade diversion
It is the increase in the sales of a low-cost producer within a trade bloc. Due to the absence of restrictions, firms specialise in what they have a comparative advantage in. They can produce at a lower cost and sell export to other member countries because there is no tariff that can make it difficult to compete in terms of price with domestically produced products. High-cost domestic producers lose their sales to more efficient firms in other member countries. And this will force domestic firms to concentrate on products in which they have a comparative advantage and export to other markets within the union.
This means that low-cost producers outside the union lose their sales to high-cost producers within the union. Normally, consumers should buy from the most efficient firm in the world. But the existence of preferential trading agreements means that tariffs are imposed on firms operating in countries outside the union. This makes their prices higher compared to other firms within the union. Consumers, as a result, would patronise firms within the union that now have cheaper products.