Chapter 8 Outline

The Case for Regional Integration

The case for regional integration is both economic and political. The case for integration is typically not accepted by many groups within a country, which explains why most attempts to achieve regional economic integration have been contentious and halting. In this section, we examine the economic and political cases for integration and two impediments to integration. In the next section, we look at the case against integration.

The Economic Case for Integration

The economic case for regional integration is relatively straightforward. We saw in Chapter 4 how economic theories of international trade predict that unrestricted free trade will allow countries to specialize in the production of goods and services that they can produce most efficiently. The result is greater world production than would be possible with trade restrictions. We also saw in that chapter how opening a country to free trade stimulates economic growth in the country, which creates dynamic gains from trade. Further, we saw in Chapter 6 how foreign direct investment (FDI) can transfer technological, marketing, and managerial know-how to host nations. Given the central role of knowledge in stimulating economic growth, opening a country to FDI also is likely to stimulate economic growth. In sum, economic theories suggest that free trade and investment is a positive-sum game, in which all participating countries stand to gain.

Given this, the theoretical ideal is a total absence of barriers to the free flow of goods, services, and factors of production among nations. However, as we saw in Chapters 5 and 7, a case can be made for government intervention in international trade and FDI. Because many governments have accepted part or all of the case for intervention, unrestricted free trade and FDI have proved to be only an ideal. Although international institutions such as GATT and the WTO have been moving the world toward a free trade regime, success has been less than total. In a world of many nations and many political ideologies, it is very difficult to get all countries to agree to a common set of rules.

Against this background, regional economic integration can be seen as an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as GATT and the WTO. It is easier to establish a free trade and investment regime among a limited number of adjacent countries than among the world community. Problems of coordination and policy harmonization are largely a function of the number of countries that seek agreement. The greater the number of countries involved, the greater the number of perspectives that must be reconciled, and the harder it will be to reach agreement. Thus, attempts at regional economic integration are motivated by a desire to exploit the gains from free trade and investment.

The Political Case for Integration

The political case for regional economic integration has also loomed large in most attempts to establish free trade areas, customs unions, and the like. By linking neighboring economies and making them increasingly dependent on each other, incentives are created for political cooperation between the neighboring states. In turn, the potential for violent conflict between the states is reduced. In addition, by grouping their economies, the countries can enhance their political weight in the world.

These considerations underlay establishment of the European Community (EC) in 1957 (the EC was the forerunner of the EU). Europe had suffered two devastating wars in the first half of the century, both arising out of the unbridled ambitions of nation-states. Those who have sought a united Europe have always had a desire to make another outbreak of war in Europe unthinkable. Many Europeans also felt that after World War II the European nation-states were no longer large enough to hold their own in world markets and world politics. The need for a united Europe to deal with the United States and the politically alien Soviet Union certainly loomed large in the minds of many of the EC's founders.³

Impediments to Integration

Despite the strong economic and political arguments for integration, it has never been easy to achieve or sustain. There are two main reasons for this. First, although economic integration benefits the majority, it has its costs. While a nation as a whole may benefit significantly from a regional free trade agreement, certain groups may lose. Moving to a free trade regime involves some painful adjustments. For example, as a result of the 1994 establishment of NAFTA, some Canadian and US workers in such industries as textiles, which employ low-cost, low-skilled labor, will certainly lose their jobs as Canadian and US firms move production to Mexico. The promise of significant net benefits to the Canadian and US economies as a whole is little comfort to those who will lose as a result of NAFTA. It is understandable then, that such groups were in the forefront of opposition to NAFTA and will continue to oppose any widening of the agreement.

A second impediment to integration arises from concerns over national sovereignty. For example, Mexico's concerns about maintaining control of its oil interests resulted in an agreement with Canada and the United States to exempt the Mexican oil industry from any liberalization of foreign investment regulations achieved under NAFTA. Concerns about national sovereignty arise because close economic integration demands that countries give up some degree of their control over such key policy issues as monetary policy, fiscal policy (e.g., tax policy), and trade policy. This has been a major stumbling block in the EU. To achieve full economic union, the EU is trying to introduce a common currency to be controlled by a central EU bank. Although most member states have signed on to such a deal, Britain remains an important holdout. A politically important segment of public opinion in that country opposes a common currency on the grounds that it would require relinquishing control of the country's monetary policy to the EU--which many British perceive as a bureaucracy run by foreigners. In 1992, the British won the right to opt out of any single currency agreement, and as of 1998, there was little sign that the British government would reverse its decision.