Regional economic integration allows for countries located in a specific region to trade freely and openly between each other. This cooperation among nations has many benefits, along with some implications regarding what the world trading system will look like in the future. Although regional economic integration takes place all over the world; today, the most significant developments of regional economic integration have occurred in Western nations, particularly, Europe’s formation of the European Union and Canada, Mexico, and US’s NAFTA agreement. These members enjoy lower tariffs, economic and political cooperation (for the most part), increased flow of inward and outward investments (Mexico is a large beneficiary of this), factors of production are able to move more freely and member countries achieve a higher level of economic growth. A trade bloc occurs when tariff and nontariff barriers are reduced or eliminated within a region for cooperating member states. There are several levels of economic integration, which we will discuss; and each takes significant cooperation and a “give and take” mentality among participating nations. As we will see integration is far from easy; however it can benefit many nations, so enduring short-term pains can help create long-term gains for all parties involved.  Is regional economic integration always an effective option? Not when trade diversion offsets trade creation. Furthermore, trade blocs could pose an interesting scenario if the world was grouped in “blocs,” instead of “countries.” How does the world circumvent rising trade barriers if this does happen? The answer is not cut in stone, but first let’s discusses the five different levels of economic integration.

There are five levels of integration. At the most basic, two or more countries create a free trade area where all barriers to the trade of goods and services among member countries are removed, however each country is allowed to create policies in regards to non-members. NAFTA is an example of a free trade area between the US, Canada and Mexico. If countries achieve this and want to further integrate they enter into a customs union, where trade barriers are eliminated and member countries adopt a common external trade policy. The Andean community of Bolivia, Ecuador, Columbia and Peru are an example of this, as they impose a common tariff for non-members between 5-20%. If this is achieved the cooperating countries enter into a common market, where, there are no barriers to trade, a common external trade policy is enacted and factors of production can move freely between member states. This requires member states to change their policies on immigration, emigration, and cross border flow of capital. In addition to this in order to achieve economic cooperation member countries must agree on employment, fiscal and monetary policies. This is where it gets tricky because many nations don’t want to give up their national sovereignty to a single representative. However if this is achieved, an economic union can be formed. An economic union includes all of the above with the addition to common currency, single tax rate among members and a common monetary and fiscal policy. To put into perspective how difficult this is, the EU consists of twenty seven different countries, and it has been stuck on this “step” for years; because getting all of these countries to agree is no easy feat. For example, Great Britain, has not adopted the euro, and therefore is out of the Eurozone, tax rates vary from country to country and so on. One argument out there is how can all of these countries possibly agree and give up control over their economies when complex political issues are at stake and may have severe implications for a particular country? I think that the concerns over whether the ECB can keep inflation in check and the fact that the EU is not an optimal currency area are valid issues to take into account.  Beyond my skepticism, if this can be achieved then then the EU would move on to become a political union (a powerful one at that) which is a central political apparatus that coordinates the economic, social and foreign policy of member states. An obvious example of this would be the United States where there are member states run by local officials who are run by state officials who are run by the federal government.

There are strong political and economic reasons that tell us what regional integration can offer all members involved. Regional integration allows for member countries to exploit gains from free trade in the form of specialization in what a country can produce most efficiently (so long as trade divergence doesn’t occur) which results in more production of quality goods and services. Through inward investments poorer countries can receive valuable transfers of resources in the form of technology, managerial experience and marketing experience. For example, the NAFTA agreement has allowed Mexico to gain access to valuable knowledge from the more efficient economies of the north. Since Mexico is learning these practices, the overall economy will grow because they can produce products more efficiently than they could previously. Another perspective of this argument is that the WTO isn’t able to get countries to agree as quickly than if the countries set up agreements with each other. Will eventually affect the WTO’s status of “overseer” of international trade? If countries can achieve “blocs” by themselves, will they take into account what the WTO recommends; or will each “bloc” have to form their own mock-WTO where they report to another agency that will be set up in the future? Or will the WTO simply be the police of the trading blocs? For now, this is up for debate, but it should be interesting to look at a couple of decades from now. The political argument is simple; when countries depend on each other economically they are more likely to cooperate in other areas such as politics; which reduces the potential for retaliation and wars. By becoming a trade “bloc,” it increases the amount of people who are affected, and therefore, the political weight of these larger areas is increased. Creating trading blocs do have some limitations, not everyone wins and each nation is required to give up a degree of national sovereignty. For example, the NAFTA agreement hurt workers in low-skill low-wage jobs in the US (even though the impact was minimal), try telling that to the worker who was laid off. Second, national sovereignty is very important to nations, they want to control over particular interest. For example, Mexico feared that its oil industry would be overtaken by US and Canadian firms (they were probably right), so the US and Canada had to agree to exempt this from the agreement. The case against economic integration is when trade diversion offsets trade creation. Trade creation occurs when high-cost domestic producers are replaced by low-cost producers within a trade area or when higher-cost external producers are replaced by lower-cost external producers in the free trade area. Trade diversion occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area (tariffs are too high for external suppliers to import at a profit). If the WTO is given the authority to manage trade diversion, this might be a good way to monitor the formation of trading blocs and oversee their progress to ensure tariff barriers don’t reach level in which competition is halted between the blocs.

Two regional trade blocs that are of significant importance to business managers today are the EU and NAFTA. The formation of the EU was by and large one of the most successful formations of an economic union to date. The EU was formed to create peace after two world wars and so that they would have more political weight in the world; rather than twenty seven different countries proposing ideas that would be swept under the rug. The political structure is set up with some form of checks and balances. The European commission is responsible for proposing legislation, implementing it and monitoring the cooperation of member states. The most recent responsibility has been in the form of competition policy where the commissioner reviews proposed mergers and acquisitions to ensure fair competition. This may be a threat to non-members of the EU who must invest in subsidiaries now to ensure they aren’t “shut out” of the bloc. The European Council is the controlling authority and represent individual state interests. The European Parliament are elected representatives by citizens of each nation state, which now has co-equal influence as the Commission due to the Treaty of Lisbon, that recommends amendments, elects a president president, and can appoint commissioner and even veto some laws. Lastly, the Court of Justice ensures that treaty requirements are met both by the government and the member countries, companies and institutions. The Single European Act was an pushed the EU to form a single market in which many barriers to trade were lifted. This Act established the official name of the EU (formally the EC) and allowed these countries to become common market. The next step was the establishment of the euro, where the EU has run into some problems due to members not wanting to give up their national sovereignty in terms of monetary policy. By adopting a common currency however, it is easier to manage transactions the border over. This makes it easier for consumers to spend money, compare prices, increase competition because of the increased spending which results in producers finding lower-cost production sites; and in turn, driving down prices for consumer products. It also increases the efficiency of pan-Europe as these producers move to the optimal area for production and ultimately their position in the competitive market. Lastly, the EU makes borrowing money easier for both businesses and consumers, because investors are able to diversify their risk which lowers the cost of capital and creates more efficiency. The reason why, however, countries such as Great Britain, Sweden and Denmark have thus far opted out of the euro is due to their uncertainty of the European Central Bank which acts as the Fed of sorts to control inflation rates, and the fact that there are too many differences in the underlying structure of economic activity that makes it feasible to adopt a single currency and use a single exchange rate as an instrument of economic policy. These countries want to see the economies flow in the most similar direction as possible, this means that policies such as wage rates, business cycles, tax rates and the like should be similar across the EU. Nevertheless, the euro has remained strong against the dollar for the most part of its life and foreign investors are expressing confidence in it by investing in the EU.

On the other side of the world, an agreement between Mexico, the US and Canada has taken place under NAFTA. While NAFTA’s real gains won’t be known for a while, any gains that have happened have been positive ones for all members. Mexico, took the most risk; however if theories of international trade are correct, in the future they will also gain the most. As mentioned above Mexico benefits from the transfer of technology, managerial skills and marketing skills; they also benefit from increased employment in low-wage and skill industries, political stability, and lastly they benefit from rising living standards and greater purchasing power. The economies of the United States and Canada too benefit, while some jobs are lost to Mexico, the benefits have largely outweighed the costs. The US and Canada benefit in the form of increased incomes due to higher demand for products in Mexico (economy expands to encompass more people and purchasing power), lower prices for consumers since production is decreased and increased international competitiveness all around. There are other regional blocs in formation at different integration levels spanning from the Caribbean, to Africa, to Asia; however until they are formally established and cooperative their impact is minimal today, but could pose an interesting scenario in the future. What would happen if countries around the world formed several different trading blocs? How would this affect tariff and non-tariff barriers when these blocs want to trade with one another? Would the WTO be able to police such a scenario and would the blocs listen?  As more trade blocs are set up the WTO has a long way to go in terms of what type of policing they will have to do internationally. A potential problem may be that one bloc is more efficient than the other, so, the least-efficient blocs may put up protectionist measures and thus, support inefficient economies and create a more isolated world.  Furthermore if trade barriers were put up to non-members of a bloc, competition and prices would only be as efficient as the member-nations involved. This would discourage trade, specialization, and halt economic progress than if the blocs were openly trading with one another. This scenario will take decades to come to fruition and may be a long-term byproduct of integration, nevertheless it’s interesting to think about what the world economy would look like if countries were set up in blocs, as opposed to individual nations.

Managers today however, should concern themselves with the happenings of today, and therefore take a keen interest in NAFTA and the EU as potential markets to enter. First, a members within the trading bloc gain access to new markets and thus potential location-sites, labor forces, skills and the like. Due to the free movement of goods and services across borders within the bloc, synchronization of product standards and tax rates a company can save money on production by locating in the area that has the best factor costs and skills. If a company wishes to enter the EU, it should do so now, because in the future barriers to trade may be set up. In a more integrated world, first mover-advantages need to be at the forefront of an international business managers mind. Thus, as we have seen these new blocs develop we will also see a shift in trade patterns; and this has implications for almost every nation around the world.