8.1 Types of Economic Integration Arrangements

Economic integration occurs when two or more countries engage in trading arrangements and other areas of cooperation. The number of economic integration arrangements or trading blocs, mostly regional, has risen notably from around 70 in 1990 to over 300 today (Carbaugh, 2015). This trend is partly due to the slower pace of trade liberalization occurring under the World Trade Organization. Since they reduce barriers to trade among relatively small s of countries, regional trading arrangements are discriminatory and represent a departure from the most favoured nation (MFN) principle under the WTO. Economic integration arrangements span a spectrum, depending on the extent to which barriers to trade and factor mobility are reduced and other forms of cooperation are involved. The North American Free Trade Agreement (NAFTA) and its successor, the United States-Mexico-Canada Agreement (USMCA), the European Union (EU), and the European Free Trade Agreement (EFTA) are examples of regional trading arrangements. We will now discuss the major types of trading arrangements based on the degree of integration involved.

Free Trade Agreement

In a free trade agreement, participating countries undertake to remove all tariff and non-tariff barriers to trade in goods and services among themselves. However, these countries are free to adopt their own policies with regard to trade with other countries – outside the free trade area (FTA). NAFTA/USMCA is an example of a free trade agreement in that it allows free trade in goods and services among Canada, Mexico and the United States. Each of these countries, however, have different trading policies with other countries. Specifically, there is no common external tariff (CET) on imports into the free trade area. Most regional trading arrangements are free trade agreements (Pugel, 2020). Because of the different external tariffs, free trade agreements usually include “rules of origin.” These rules are designed to prevent goods from being imported into FTA member countries with relatively low tariffs and then being shipped to other countries with the FTA.

Customs Union

In a customs union, participating countries agree to remove all tariff and non-tariff barriers among themselves. However, they go a step further and adopt the same set of tariffs – a common external tariff – with respect to other countries. Harmonization of trade policy with respect to other countries strengthens the momentum toward free trade within the trading bloc. Examples of customs unions are Benelux, involving Belgium, the Netherlands, and Luxembourg; MERCOSUR in South America; and the Southern African Customs Union (SACU). An objective of a customs union is increasing economic efficiency within the trading bloc. A customs union avoids the problem of developing complicated rules of origin but introduces the problem of policy coordination. With a customs union, participating countries must agree on tariff rates across many different import industries (Saylor Academy, n.d.).

Common Market

A common market builds on the idea of a customs union. Not only do participating countries engage in free trade in goods and services in a market that is protected by a common external tariff, but they also permit the free movement of factors of production, such as labour and capital, within the trading bloc. A common market, therefore, represents closer economic integration among the member countries than is possible under a free trade agreement or customs union. The European Union became a common market in 1992 (Pugel, 2020; Carbaugh, 2015).

Economic Union

In an economic union, participating countries harmonize economic policies, including monetary and fiscal policies as well as policies toward trade and factor mobility (Carbaugh, 2015; Pugel, 2020). Belgium and Luxembourg have been an economic union since 1921 and the European Union is progressing toward economic union. However, the status of economic union is not easy to attain as it requires nations to give up economic sovereignty. The harmonization of monetary policy will likely involve a Common Central Bank and a single currency. Therefore, by becoming a member of an economic union, a nation will likely give up its ability to adjust the exchange value of its currency.

For a practical example of an economic union, we can look at the United States or Canada, where individual states and provinces are tied together by a common monetary; trade in goods and services is free among the states and provinces; capital and labour can move freely; and the federal government conducts fiscal policy.

References

Carbaugh, R.J. (2015). International economics, (15th ed.). Cengage Learning.

Pugel, T. A. (2020). International economics, (17th ed.). McGraw-Hill.

Saylor Academy. (n.d.). International economics: Theory and policy, (v.1) [PDF]. The Saylor Foundation. https://resources.saylor.org/wwwresources/archived/site/textbooks/International%20Economics%20-%20Theory%20and%20Policy.pdf