8.3 Practical Gains from Regional Economic Integration

In this section, we consider the experience of two important geographic regions with economic integration – the formation of regional trading blocs. These regions are the Europe and North America. We will specifically examine the experience of the European Union (EU) and the North American Free Trade Agreement (NAFTA) and its successor, the United States-Mexico-Canada Agreement (USMCA).

The European Union (EU)

Economic integration in Europe began with the Treaty of Rome in 1957, with six countries as members – Belgium, France, Italy, Luxembourg, the Netherlands, and West Germany. The EU eventually expanded to include 28 member countries by 2020. However, the United Kingdom formally left the EU at the end of 2020. The EU’s current members are Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, and Sweden. Ukraine, Georgia, and Moldova have recently submitted applications for membership.

Since 1957, the EU has increased the degree of economic integration among its members, moving from a free trade area in 1968 to a customs union in 1970, to common market status in 1992, and eventually, to the economic union in 2002, which included a harmonized monetary policy and the euro as a single currency. Not all members of the EU use the euro as their currency. As of 2024, 20 of the EU’s 27 members use the euro.

Economic studies of the impact of the European Union on its members have concluded that the net benefits from the formation of the EU were positive but relatively small (Carbaugh, 2015; Pugel, 2020). However, these studies were limited because they considered just the manufacturing sector and only the static economic effects. Given their focus on the manufacturing sector, these studies ignored the likely significant social costs of the Common Agricultural Policy. Moreover, these studies failed to examine the dynamic effects on economic well-being from economies of scale, increased competition, improvements in productivity, increased investment, and greater product diversity.

The specific conclusions of the available studies are the following:

• With regard to the manufacturing sector, the EU has created sufficient trade to lead to small but positive net benefits (Carbaugh, 2015; Pugel, 2020);
• The static benefits from the manufacturing sector were likely not sufficient to offset the losses related to the common agricultural policy, premised on income support policies for farmers and export subsidies;
• Whether the EU has benefited overall from economic integration depends on the size of the dynamic gains from economies of scale, competition, productivity improvements, investment, and product diversity.

Free Trade in North America (NAFTA/USMCA)

The North American Free Trade Agreement (NAFTA), which incorporated the Canada-US Free Trade Agreement (CUSFTA) and extended free trade to include Mexico, came into effect in 1994. NAFTA (and its successor) removed tariff and non-tariff barriers to trade among the three countries. Besides, the Mexican government got rid of content and export requirements that it had previously imposed on foreign companies operating in Mexico. NAFTA also eliminated barriers to investment in certain service industries, including financial services. However, NAFTA does not permit the free movement of labour among the three countries.

There is general agreement that NAFTA/USMCA has promoted significant increases in the volume of trade in goods and services among the three countries. Some studies have indicated that trade creation exceeded trade diversion, even though trade diversion was reportedly quite large in the case of some products such as textiles (Carbaugh, 2015; Pugel, 2020). As for the European Union, NAFTA/USMCA has likely produced dynamic benefits due to increased competition, economies of scale, investment, productivity improvements, and greater product diversity.

Of the three participating countries, Mexico has likely benefited the most from free trade in North America. Its gains in well-being are reportedly proportionally greater than for the more economically advanced countries of Canada and the United States (Pugel, 2020; Carbaugh, 2015). The removal of trade barriers has led to increased production in industries in which Mexico has a comparative advantage, including certain agricultural products (e.g., sugar, fruits and vegetables, appliances and motor vehicle parts). Mexico also benefited from an influx of investment that has lifted employment and wage rates and promoted technology transfer (Carbaugh, 2015).

Canada’s benefit from North American free trade is largely that it has been able to preserve the trading arrangements which it previously had with the United States under the Canada-US Free Trade Agreement and to expand access to the Mexican market (Pugel, 2020). Some observers contend that Canada’s gains from trade with Mexico under NAFTA/USMCA have been limited due to the small amount of trade between these two countries. Still, there has been a notable increase in trade in goods and services between Canada and the United States since NAFTA/USMCA has been in effect. There is also evidence of large productivity improvements in Canada as a result of NAFTA/USMCA (Pugel, 2020).

Economic benefits for the United States have been estimated to be limited because of the US economy’s large size in comparison to that of Mexico (Carbaugh, 2015; Pugel, 2020). Besides, barriers to trade between Mexico and the United States were substantially reduced before NAFTA was implemented. The effects of NAFTA/USMCA for the U.S. economy include increases in U.S. gross domestic product and increases in trade in goods and services, especially with Mexico. Still, concerns about job losses and the relocation of business operations within the trading bloc have remained notable “bones of contention” in the United States.

References

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

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