3-2b Major Classes and Characteristics of Regional Integration

Regional integration group. The West African Economic and Monetary Union helps less fortunate members.

HABIB KOUYATE/AFP/Getty Images

Monetary Union adopted a common, external, revenue-sharing tariff in 2000. The two more economically advanced countries of the union, Ivory Coast and Senegal, collected 60 percent of customs proceeds, but retained only 12 percent. They shared the remainder with the other member countries to help develop those regions.4

The merits of global versus regional trade agreements have been debated for many years. In global trade agreements, the tariff and nontariff barriers that were discussed in Chapter 2 are reduced or eliminated using WTO’s most favored nation (MFN) rules. Under regional trade agreements, conversely, tariff and nontariff barriers are reduced only among regional member countries. When regional or bilateral trade pacts do not discourage trade with countries in other regions, they can help; otherwise, regional integration is not advisable. How countries can best gain access to markets within their neighborhoods and across the world becomes a lingering question. With the right combination of policy actions, countries that are the most geographically disadvantaged (e.g., landlocked countries) can overcome their challenges. This can be measured by determining whether or not market access noticeably improves with the implementation of new policies.

In general, countries within trading blocs that have significantly lowered trade barriers have done better economically than others. Cyprus, for example, decided to join the European Union in 1990 and started the process of lowering its tariff barriers to EU levels. By 2004, when Cyprus was officially admitted to the EU, economic growth had started to

accelerate. Cyprus has been able to achieve efficiency through economies of scale in production as well as specialization with access to major European markets.

When the various regional integration blocs are analyzed from an economic geography perspective, they fall under three general categories—regional blocs close to major world markets, remote regions with large local markets, or remote regions with small local markets. According to the World Bank’s WDR, what differentiates these three categories is their distance from large world markets and whether or not there is a large country nearby.

3-2b-(i) Regional Blocs Close to World Markets Market access is essential for economic growth, and proximity to major world markets is an asset for just-in-time production, exports of perishable goods (fresh fruits, vegetables, and flowers), and tradable services, such as marketing, research, and complex IT tasks. Countries close to major markets have the advantage of connecting to markets, suppliers, and ideas. In addition, developed countries seek these regional trading blocs to (1) expand their growth potential abroad as domestic markets mature, and (2) deliver low-cost manufacturing platforms for locally based firms. Regional trading blocs that are close to world markets—such as the North American Free Trade Agreement (NAFTA), the Dominican Republic–Central America Free Trade Agreement (DR-CAFTA), the Caribbean Community (CARICOM), as well as the bilateral U.S. free trade with Chile and Colombia—have all benefited from privileged access to U.S. markets (See Exhibit 3.3).

Similarly, access to the rich European market has been a boon to Eastern European countries as they sought entry through eastward enlargement of the European Union. The Balkan states have also signed an intraregional free-trade agreement, the Central European Free Trade Agreement (CEFTA), and the region’s proximity to the EU permits close

Exhibit 3.3 REgIons ClosE To WoRld maRkETs

Regional Blocs Close to World Markets

Moldova

U n i t e d S t a t e s

Croatia Serbia Bosnia and Herzegovina Montenegro Kosovo Albania Macedonia

Dominical Republic

Guatemala El Salvador Honduras Costa Rica Nicaragua

Colombia

European Union

C h i n a Japan

Myanmar

India

Thailand Malaysia Cambodia Brunei Darussalam

Laos Vietnam Philippines

Singapore

Indonesia

Major markets Regional blocs Chile

© Cengage Learning 2014

integration of its companies into pan-European production networks. The Association of South East Asian Nations (ASEAN) is intensifying its free-trade relations with the huge markets in China, India, Japan, and South Korea. India plays an important role in the South Asian Association for Regional Cooperation (SAARC). As indicated in Exhibit 1.2 in Chapter 1, this is “Asia’s century” as China, India, and Japan are likely to be among the world’s top four largest markets by 2020, with long-term benefits for all countries.

However, the oil-rich regional economy of the Middle East and North Africa, despite its close proximity to the European Union market, has been unable to grow fast enough to create jobs for its growing population. Governments in the region have started the transition

EConomIC PERsPECTIvEs The Ascent of the Maghreb Union

Change in geopolitics and mutual economic need is making the Maghreb the new frontier for European investments. The Maghreb Union comprises the five North African countries of Algeria, Libya, Mauritania, Morocco, and Tunisia; it was formally created in 1989. The members of the Maghreb have quite different political systems, ranging from anarchy in Libya to monarchy in Morocco to a semblance of democracy in Tunisia (the “Arab Spring” initiative of 2011 that raised hope and optimism for democracy also unleashed the unexpected—political repression, sectarian fighting, and chaos—in what had been authoritarian societies. Hopefully, real democratic and stable economies will develop over time), but share the same goal of forming an economic and political union of North Africa. These Muslim nations, with some of the world’s lowest population density (almost three-fourth’s of the region is covered by the Sahara Desert) are strategically located along the Mediterranean Sea across southern Europe. Major companies like Japan’s Sumitomo Electric Industries, France’s Renault and Groupe Safran, Europe’s Airbus, and America’s Boeing are all investing millions of dollars in the Maghreb in various manufacturing facilities to supply both the domestic and European markets. Yet, corruption and nepotism are serious challenges in the Maghreb. While Algeria, Morocco, and Tunisia have made some progress in their efforts to eliminate those problems, other Maghreb countries have yet to stabilize and institute effective reforms.

Because of the global financial crisis that originated in the United States in 2008 and the European sovereign debt crisis that started in 2010, investment flows slowed to the Maghreb and delayed the startup of some projects, However, the prospects for the Maghreb look relatively encouraging for several reasons. Algeria and Tunisia are rich in crude oil and natural gas; pipelines under the Mediterranean enable them to supply some of the much needed natural gas to Europe as an alternative to unreliable supplies from Russia. Wage rates in the Maghreb are less than half those in eastern European Union countries, such as Romania and Bulgaria, where wages have been rising since those countries joined the European Union. Furthermore, the 44-hour workweek (five-and-a-half days a week) in the Maghreb, as compared with 35 hours in the European Union, makes the Maghreb attractive as well. And, with Maghreb’s nonunionized labor, it is easier for companies to match production with market demand. Employees in the Maghreb do not object to overtime work nor do they demand the luxury of the five-week annual vacation that Europeans enjoy. Unlike countries in the European Union periphery that have high sovereign debt (prior to the financial and sovereign debt crises) and are now facing severe debt service problems (and are unable to attract foreign investment), the Maghreb countries are relatively debt free and continue to attract foreign investment. When one analyzes the Maghreb as a whole, it appears that the global credit and European sovereign debt crises help the Maghreb Union at the expense of countries such as Portugal, Ireland, Greece, Spain, and Cyprus.

Questi O ns:

1) Name some reasons why the countries of the

European Union periphery may be losing their competitiveness against the Maghreb countries. 2) What are some of the major business reasons why investors find the Maghreb an attractive economic region for future investment?

Source: Based on Carol Matlack and Stanley Reed, “The Rise of the Maghreb,” Bloomberg Business Week, March 16, 2009, pp. 39–41.

from crude oil exports to manufacturing and services, but the region’s investment climate (primarily because of economic and political suppression) is still weak. The Pan-Arab Free Trade Area (PAFTA) and the Arab Maghreb Union (AMU) have had little effect on non-oil export performance. Declining imports from the rest of the world and an accompanying increase in intra-PAFTA and intra-AMU exports suggest that the trade agreements have diverted trade rather than created trade. The region could take advantage of its proximity to Europe by exporting more high-value-added horticultural products, such as fresh vegetables and fruits, especially during the winter.

3-2b-(ii) Remote Regions with Large Local Markets This second group of countries is far from world markets, such as the United States, the European Union, and large Asian economies, like China, India, and Japan. A large local market gives countries the advantage of attracting industrial activities. If the country’s infrastructure is also well connected to world markets, this advantage is reinforced. Brazil is farther than Central America and the Caribbean from the United States, the European Union, and the big Asian markets. South Africa, another country with a large domestic market, and the leading economy in Africa, is also far from the major markets just mentioned. Australia is another example, as it is also far from the big markets (See Exhibit 3.4).

Effective institutions, good governance, and solid regional infrastructure can help resource-rich economies like Australia, Brazil, and South Africa to grow through increased production, specialization, and access to world markets. Each of these countries can complement its global integration with efforts to build stronger regional economic blocs focused upon its own growing economy. For the smaller economies of the regional bloc, modern infrastructure is especially important to reduce the distance to large neighboring countries and to use those neighbors as a further conduit to world markets. Examples of such regional

Exhibit 3.4 REGIONS WITH LARGE LOCAL MARKETS BUT LOCATED FAR FROM WORLD MARKETS

Regions with Large Home Markets but Located Far from World Markets

U n i t e d S t a t e s European Union

C h i n a

India Japan

Major markets Regional blocs Paraguay Brazil Democratic Republic of Congo Zambia Angola

Zimbabwe Namibia Tanzania Seychelles Mozambique Madagascar Mauritius

Argentina Uruguay South Africa Botswana Malawi

Swaziland Lesotho Australia

© Cengage Learning 2014

trading blocs are MERCOSUR (Mercado Común del Sur), the Southern African Development Community, and Australia–New Zealand cooperation. 3-2b-(iii) Remote Regions with Small Local Markets International integration is most difficult for countries in regions that are divided, far from world markets, and lack the economic size of a large local economy. These regions, which Paul Collier5 (2007) calls the “bottom billion,” are located in Central Asia; East, Central, and West Africa; and the Pacific Islands. All of these regions could gain from effective regional cooperation. Central Asia (Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan) has the highest proportion of landlocked countries. In sub-Saharan Africa, there are also several landlocked countries, many with a small population and GDP, which are some of the world’s poorest nations and those most prone to conflicts. The small Pacific Islands are the most geographically fragmented “sea-locked” countries.

Various regional integration blocs exist for such countries: (1) the Commonwealth of Independent States and the Shanghai Cooperation Organization, both focused on Central Asia; (2) the Central African Customs and Economic Union, the East African Community, the Economic Community of West African States, and the Economic Community of Central African States, all dealing with Africa; and (3) the Asia Pacific Economic Cooperation (APEC), which addresses Pacific Island issues as well as Asian Pacific Rim issues (See Exhibit 3.5).

The challenge for these three regions is to find ways to successfully integrate regionally and internationally. Many countries in these regions have minerals (including crude oil and natural gas) and other natural resources that are best exploited on a regional basis, since pipelines or railroads must pass through neighboring countries in order to reach the major global markets. Regional integration is paramount for resource-led economic growth and to more broadly spread the benefits of this growth. This will require institutional reform; increasing infrastructure investments to improve market access; and incentives such as preferential access to world markets, liberalized rules of origin, and skills development.

Exhibit 3.5 REgIons WITh small loCal maRkETs loCaTEd faR fRom WoRld maRkETs

Regions with Small Countries Located Far from World Markets

U n i t e d S t a t e s European Union

Kazakhstan

Uzbekistan Kyrgyzstan

Tajikistan Turkmenistan

C h i n a

Africa between the tropics

India Japan

Paci c Islands

Major markets Regional blocs

s E v PECTI s ER al P IC h T E

The Chinese Syndrome6

International integration is most difficult for countries in regions that are divided, far from world markets, and lack the economic size of a large local economy. This is the situation that the Democratic Republic of Congo (DR Congo) faces despite its size and rich mineral wealth. China’s massive appetite for mineral resources has attracted it to DR Congo.

China’s giant state-owned enterprises are in an enviable position because they are cash rich. Their increasing wealth means that they can afford to make eye-popping acquisitions as well as to undertake complex foreign investments with long-term objectives. But, they are increasingly regarded as unpalatable investors, especially in the West or by private sector-driven economies. China’s state-owned firms have, therefore, preferred to conduct business in places such as Africa, where access to mineral resources can be negotiated with governments in ways that generate mutual benefits, whatever those benefits may be.7 Third parties often wonder if African countries are getting the short end of the stick. A classic example is the $9 billion deal that was signed in 2008 between the DR Congo and China’s massive state-owned enterprises, the China Railway Engineering Corporation (CREC) and SINOHYDRO.

The DR Congo, located in central Africa, is the largest country on the continent—larger than Western Europe—and is rich in mineral resources. Despite the fact that Belgians had colonized it for decades, DR Congo has few paved roads or railway systems, especially after a series of civil wars that ravaged the country since the mid-1990s. According to a BBC news report, the bilateral deal that was signed with CREC and SINOHYDRO in 2008 would provide DR Congo with “desperately needed infrastructure: 2,400 miles of roads, 2,000 miles of railways, 32 hospitals, 145 health centers and two universities.” In return, China would receive 10 million tons of copper and 400,000 tons of cobalt to feed its booming economy.

Although China characterized this barter deal as a “win-win” for both countries, the BBC commented that “the whole arithmetic of the deal unfairly favors the Chinese.” A rights-advocate lawyer in DR Congo, Georges Kapiamba, concurred with this criticism. But the Monaco-based lawyer representing the DR Congo’s state-owned mining company, Gécamines, argued that: “Without the Chinese, all this [the currently disused Kolwezi mine in DR Congo’s Katanga Province] will be just scenery.”

Kolwezi’s proven mineral reserves were significant enough for the Chinese to release the first tranche of $3 billion to commence the DR Congo infrastructure projects. CREC and SINOHYDRO will invest another $3 billion before DR Congo’s copper and cobalt mines become operational. When production began, in late 2011, the final $3 billion was disbursed for construction of roads, railways, and hospitals. The Chinese companies are expected to recoup their investment within 10 years. Thereafter, the joint venture—onethird DR Congolese-owned and two-thirds Chinese— will continue to exploit the mine.

Human rights groups are critical of the deal because the project details were not published. Indications are that the Chinese state-owned enterprises will be exempt from paying taxes on mining income and customs duties on imported machinery until all the infrastructure work is complete. Critics, such as attorney Georges Kapiamba, believe that the deal amounts to a licensed plundering by the Chinese majority owners of DR Congo’s resources, similar to that carried out by the country’s colonial ruler, King Leopold II of Belgium.

Questi O ns:

1) Does the DR Congo-China venture make economic integration sense? Explain. 2) Do you believe that the Chinese are behaving ethically, or are they taking advantage of the DR

Congo? Can you identify other strategic choices that DR Congo could use to develop its mineral resources?

Source: Tim Whewell, “China to Seal $9 Billion DR Congo Deal,” BBC News, April 14, 2008.

Reality Che C k lO-2

Identify the regional integration blocs of which your country is a part. Do you think that being part of these regional integration blocs has helped or hurt your personal welfare? How?

3-3 Does Regional Integration Confound Global Trade?

As was just discussed, groups of countries all over the world have formed various kinds of economic cooperation agreements, primarily to enhance issues of mutual interest—not solely trade. And, with uncertainty surrounding the outcome of the Doha Round of trade negotiations, countries (large and small) are clamoring for bilateral or regional trade agreements to meet their specific agendas. Economists are concerned that as a result of these negotiations, the prospects of creating a truly open global economic system that benefits all countries may recede.8 Some governments may initiate regional pacts (such as the TPP agreement discussed at the beginning of this chapter) to cement diplomatic, environmental, or security ties and risk slowing the momentum behind multilateral (global) trade liberalization.

To further elaborate on this issue, the chapter will now look more closely at how four major diverse regional integration blocs are performing. These regional integration blocs will likely play a profound role during the coming century. Will they confound globalization?

Reality Che C k lO-3

Are policymakers in your country pushing for more regional integration or global integration? Why? Will that benefit you personally? If so, how?

LO-3

Identify the primary reasons why countries are now seeking to pursue regional integration at the expense of multilateral trade liberalization.

LO-4

Explain why the European Union is seen as the most advanced regional integration bloc.

3-4 The European Union (EU)

The EU, headquartered in Brussels, Belgium, is the most highly evolved example of regional integration in the world. It is already in the fourth stage of the economic integration process (see Exhibit 3.2) and is moving toward the final step that requires political union with common defense and foreign policy institutions. After the devastation of infrastructure in Europe during World War II, the United States helped to rebuild Europe through the Marshall Plan. In addition, as discussed in Chapter 1, the World Bank Group (especially the International Bank for Reconstruction and Development) was established in 1944 to help rebuild and stabilize European economies. The objective of all of these initiatives was to create a strong, democratic, independent, and united Europe based on free-market principles and open economic systems.

The origins of the EU can be traced to the creation of the European Coal and Steel Community (ECSC), which established a common market in coal, steel, and iron ore among the six founding member countries: France, West Germany, Italy, Belgium, the Netherlands, and Luxembourg, in 1952. The objective of ECSC was to encourage member countries to cooperate in steel production, thereby preventing these countries from warring with each other. Thus, peace and prosperity were the primary reasons for the creation of ECSC.

The second major step was to approve the Treaty of Rome in 1957, establishing the European Economic Community (EEC) that called for free trade among members as well as a common external tariff for nonmembers. In 1960, the United Kingdom, Denmark, Sweden, Finland, Switzerland, Austria, and Portugal formed the European Free Trade Association (EFTA). Although the United Kingdom, Ireland, and Denmark applied to join the EEC in August 1961, these countries were not allowed to enter the EEC until 1973 (bringing total membership to nine). The delay occurred primarily because French president Charles de Gaulle showed resistance to the United Kingdom’s joining the EEC; de Gaulle believed that the United Kingdom was a “Trojan horse,” which, once admitted into the EEC, would try to cater to American rather than EEC interests. Greece joined the EEC in 1981, followed by Spain and Portugal in 1986, bringing the membership to 12.

Until that time, the EEC focused upon the establishment of a common market with free movement of goods, services, and capital. However, in 1992 the Maastricht Treaty was

Exhibit 3.6 The european union

European Union Member States

Sweden Finland

Estonia

Netherlands

Belgium

Ireland United Kingdom Denmark

Germany Latvia

Lithuania

Poland

Luxembourg Czech Rep. Slovakia

France Austria

Hungary Slovenia Romania

Italy Bulgaria

Portugal Spain

Countries using “Euro”

Malta Greece

Turkey

Cyprus

© Cengage Learning 2014

signed, and the EEC became a full economic union or single market with free movement of labor among member countries. The European Union (EU), began incorporating (harmonizing and unifying) the fiscal, monetary, and social policies of its member countries. In January 1995, Austria, Sweden, and Finland joined the EU, bringing the membership to 15. In May 2004, 10 new countries (eight from the former Soviet bloc, Cyprus, and Malta) were admitted to the EU, bringing the membership to 25. Bulgaria and Romania were admitted to the EU in January 2007, and Croatia became a member on July 1, 2013, thereby bringing the membership to 28 (see Exhibit 3.6 and Exhibit 3.7 for details).

The EU’s eastward enlargement reflects a common past. It also opens new business and investment opportunities for its members. The enlarged EU will offer tremendous challenges and opportunities for businesses in nonmember countries that seek to become part of the EU. For instance, the 2008 global credit crisis has had a devastating effect on Iceland, and the country has since indicated its interest in joining the EU.

The EU is a regional bloc based on treaties. Through various treaties starting with the Treaty of Rome in 1957 and others, such as the Maastricht Treaty, the Copenhagen Treaty, the Treaty of Nice, and the Lisbon Treaty, the EU is deepening and strengthening its