Chapter 8 Outline

Introduction

One of the most notable trends in the global economy in recent years has been the accelerated movement toward regional economic integration. By regional economic integration, we mean agreements among countries in a geographic region to reduce, and ultimately remove, tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other. The last decade has witnessed an unprecedented proliferation of regional arrangements. Between 1947 and mid-1997, 163 regional trade agreements were notified to the GATT or its successor, the WTO. Between 1986 and 1991, only five agreements were notified to the GATT, but in the five years between 1992 and 1996, 77 agreements were reported. Of these 163 agreements, about 60 percent are currently in force. Thus, over three-quarters of the operational regional agreements in existence today were established in the 1992 - 1996 period.¹

Consistent with the predictions of international trade theory, particularly the theory of comparative advantage (see Chapter 4), the belief has been that agreements designed to promote freer trade within regions will produce gains from trade for all member countries. As we saw in Chapter 5, the General Agreement on Tariffs and Trade and its successor, the World Trade Organization, also seek to reduce trade barriers. However, with over 120 member states the WTO has a worldwide perspective. By entering into regional agreements, groups of countries aim to reduce trade barriers more rapidly than can be achieved under the auspices of the WTO.

Nowhere has the movement toward regional economic integration been more successful than in Europe. As noted in the opening case, on January 1, 1993, the European Union effectively became a single market with 340 million consumers. But the EU is not stopping there. The member states of the EU are launching a single currency, they are moving toward a closer political union, and they are discussing enlarging the EU from the current 15 countries to ultimately include another 15 Eastern European states.

Similar moves toward regional integration are being pursued elsewhere in the world. Canada, Mexico, and the United States have implemented the North American Free Trade Agreement (NAFTA). This promises to ultimately remove all barriers to the free flow of goods and services between the three countries. Argentina, Brazil, Paraguay, and Uruguay have implemented a 1991 agreement to start reducing barriers to trade between themselves. Known as MERCOSUR, this free trade area is viewed by some as the first step in a move toward creation of a South American Free Trade Area (SAFTA). There is also talk of establishing a hemispherewide Free Trade Agreement of the Americas (FTAA). Along similar lines, 18 Pacific Rim countries, including the NAFTA member states, Japan, and China, have been discussing a possible pan-Pacific free trade area under the auspices of the Asian Pacific Economic Cooperation forum (APEC). There are also active attempts at regional economic integration in Central America, the Andean Region of South America, Southeast Asia, and parts of Africa.

As the opening case on the European Insurance industry demonstrates, a move toward greater regional economic integration can deliver important benefits to consumers and present firms with new challenges. In the European insurance industry, the creation of a single EU insurance market opened formerly protected national markets to increased competition, resulting in lower prices for insurance products. This benefits consumers, who now have more money to spend on other goods and services. As for insurance companies, the increase in competition and greater price pressure that has followed the creation of a single market have forced them to look for cost savings from economies of scale. They have also sought to increase their presence in different nations. The mergers occurring in the European insurance industry are seen as a way of achieving both these goals.

The rapid spread of regional trade agreements raises the fear among some of a world in which regional trade blocs compete against each other. In this scenario of the future, free trade will exist within each bloc, but each bloc will protect its market from outside competition with high tariffs. The specter of the EU and NAFTA turning into "economic fortresses" that shut out foreign producers with high tariff barriers is particularly worrisome to those who believe in unrestricted free trade. If such a scenario were to materialize, the resulting decline in trade between blocs could more than offset the gains from free trade within blocs.

With these issues in mind, the main objectives of this chapter are as follows: (1) to explore the economic and political debate surrounding regional economic integration, paying particular attention to the economic and political benefits and costs of integration; (2) to review progress toward regional economic integration around the world; and (3) to map the important implications of regional economic integration for the practice of international business. Before tackling these objectives, however, we first need to examine the levels of integration that are theoretically possible.