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4. Economic 4. Economic Integration Integration Theory and Theory and PracticePractice
Definition of economic integrationDefinition of economic integration
� The combination of several national economies into a larger territorial unit.
� It implies the elimination of economic boarders between countries.
� Economic borders: any obstacle which limits the mobility of goods services and factors of production between countries.
Definition of economic integrationDefinition of economic integration
• Jan Tinbergen: all processes of economic integration include two aspects:– Negative integration: the elimination of obstacles. – Positive integration: harmonization, coordination of
existing instruments.
Number of regional trade agreements, 1948-2002
Source: WTO (2003)
Levels of economic integrationLevels of economic integration
• There are several levels of economic
integration:
– A. Free trade area
– B. Customs union
– C. Common or single market
– D. Economic and monetary union
Types of Regional Trade AgreementsTypes of Regional Trade AgreementsThe EU
FECHA PAIS FECHA AMPLIACIONES FECHA AMPLIACIONES
Alemania Dinamarca 2004 Hungría
Francia Irlanda 2004 Polonia
Italia Reino Unido 2004 República Checa
Bélgica 1981 Grecia 2004 Eslovenia
Holanda España 2004 Estonia
Luxemburgo Portugal 2004 Chipre
Austria - Turquía
Suecia 2004 Malta
Finlandia 2007 Rumanía
2007 Bulgaria
2004 Letonia
2004 Lituania
2004 Eslovaquia
1958
1973
1986
1995
FECHA PAÍS FECHA PAÍS FECHA PAÍS FECHA PAÍS
Reino Unido Austria Austria Noruega
Austria Noruega Noruega Suiza
Dinamarca Portugal Suecia IslandiaNoruega Suecia Suiza Liechtenstein
Portugal Suiza Islandia
Suecia Islandia FinlandiaSuiza Finlandia Liechtenstein
Islandia Liechtenstein
FinlandiaLiechtenstein
19731986
1960
1995
EFTA
EUROPEAN ECONOMIC AREA (EEA)
FECHAS PAÍSESUE-15EFTA (menos Suiza) Noruega Islandia Liechtenstein
1994
Types of Regional Trade AgreementsTypes of Regional Trade Agreements
ACUERDOS FECHAS PAÍSESUSACanadáMéjicoArgentinaBoliviaBrasilChileColombiaEcuadorMéjicoParaguayPerúUruguayVenezuelaArgentinaBrasilParaguayUruguay
NAFTA 1994
ALADI 1980
MERCOSUR 1991
ACUERDOS FECHAS PAÍSESBoliviaPerúEcuadorVenezuelaCosta RicaEl SalvadorGuatemalaHondurasNicaraguaAntigua/BarbudaBahamasBarbadosDominicaGranadaGuayanaJamaicaMontserratSanta LucíaSan Cristobal/NievesSan Vicente y GranadinasTrinidad y Tobago
PACTO ANDINO
1969
MERCADO COMÚN
CENTRO-AMERICANO
1960
COMUNIDAD DEL CARIBE
1973
Types of Regional Trade AgreementsTypes of Regional Trade Agreements
Theory: Preliminaries
• Demand curve shows how much consumers would buy of a particular good at any particular price.
• It is based on optimisation exercise:
– Would one more be worth price?
• Market demand is aggregated over all consumers’ demand curves.
– Horizontal sum.
price
mu’
p*
quantityc*c’
mu”
c”
Marginal
utility curve is
the demand
curve for one
consumer
9
Theory: Preliminaries
• Supply curve shows how much
firms would offer to the market
at a given price.
• Based on optimisation:
– Can increase production as
long as price you can sell at
is equal or above mc.
• Market supply is aggregated
over all firms.
– Horizontal sum.
price
mc”
p*
quantity
Marginal
cost
q*q’
mc’
q”10
A firm’s supply curve is its marginal cost curve.
Theory: Preliminaries
• Since demand curve based
on marginal utility, it can
be used to show how
consumers’ well-being
(welfare) is affected by
changes in the price.
• On the right we have the
market demand for a
product.
• Gap between marginal
utility of a unit and price
paid shows ‘surplus’ from
being able to buy c* at p*.
price
p*
quantity
Demand
curve
c*
Triangle is sum of
all gaps between
marginal utility
and price paid
(summed over
total consumption)
11
= MU
Theory: Preliminaries
• If the price falls:
– Consumers obviously better off.
– Consumer surplus change quantifies this
intuition.
• Consumer surplus rise, 2 parts:
– Pay less for units consumed at old price;
measure of this = area A.
• A = Price drop times old consumption.
– Gain surplus on the new units consumed
(those from c* to c’); measure of this =
area B.
• B = sum of all new gaps between
marginal utility and price
price
p*
quantity
Demand
curve
c*
p’
c’
A B
12
Theory: Preliminaries
• Since supply curve based
on marginal cost, it can be
used to show how
producers’ well-being
(welfare) is affected by
changes in the price.
• On the right have the
market supply of the
product.
• Gap between marginal cost
of a unit and price received
shows ‘surplus’ from being
able to sell q* at p*.
price
p*
quantityq*
Triangle is sum of
all gaps between
price received and
marginal cost
(summed over
total production)
13
S=MC
Theory: Preliminaries
• If the price rises:
– producers obviously better off.
– Producer surplus change quantifies this
intuition.
• producer surplus rise, 2 parts:
– Get more for units sold at old price;
measure of this = area A.
• A = Price rise times old production.
– Gain surplus on the new units sold
(those from q* to q’). Measure of this =
area B.
• B= sum of all new gaps between
marginal cost and price.
price
p*
quantity
Supply
curve
p’A B
q’q*
14
Price
Supply
P*
P”
P’
Z’ C’Quantity
Z” C”
Demand
A B C D
World price: P’
Domestic price: P*
Price with tariff: P’’
Effect of tariff
On trade:
Reduces imports
On welfare
Consumer surplus:
-A-B-C-D
Producer surplus: +A
Tariff revenue: +C
Dead weight losses: +B+D (why?)
Benefits from the creation of a Benefits from the creation of a free trade areafree trade area
Benefits of a customs unionBenefits of a customs union
• Effects of a customs union: static and dynamic.
• A. Static effects, 2 groups:– A.1. Trade creation
• Production effect• Consumption effect (also known as trade expansion)
– A.2. Trade diversion• B. Dynamic effects
Static effects. Trade creationStatic effects. Trade creation
• Replace domestic production by cheaper imports from another member of the customs union:
– Production effect: reduce inefficient local production and minimize the inefficient use of resources
– Consumption effect: increase demand since price has fallen
Static effects. Trade diversion. Static effects. Trade diversion.
• Replace imports from cheaper 3rd countries by more expensive imports from members of the customs union.
• The customs union has a positive welfare effect if trade creation > trade diversion. This will tend to happen when:– The more inclusive the customs union (fewer 3rd
countries). – The higher the initial tariff eliminated by the creation of
the customs union (PF-P G in the following figure) – The smaller the difference between the price which
emerges from the customs union and the price which could be had from importing from the most efficient producer who by definition is a 3rd country.
Static effects. Example, France & Germany Static effects. Example, France & Germany form a customs union leaving the US outsideform a customs union leaving the US outside
P
Quantity
PUS
PG
PF
0a
Supply
Demand
A B C D E F
g
k
r u
l
h i
m n
jSw
l m
The US is the most efficient producer (Pus)
Before the CU:
France imports ru from the US applying a tariff which leads to PF. T = ruhi
CU: Germany faces no tariffs but the US does: France imports kn from Germ.
Loss of tariff revenue and reduction of producer surplus: ruhi + PFrkPG (in favour of consumers) Trade creation:•Consumption effect: umn•Production effect: rkl
Trade deviation: lmhi (what you don’t import from the US multiplied by PA-PUS)
Net welfare effect: rkl+umn-lmhi
Customs union and tradeCustoms union and trade
0%
20%
40%
60%
80%
100%
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
EEC-6 Other 6 Europe Rest of W orld
$0
$10
$20
$30
$40
$50
$60
$70
$80
$90
$100
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
$ billion (current prices) EEC
Total imp orts
Note: Left panel shows share of EEC6’s import from the three regions. Other Euro-6 are the 6 countries that joined the EU by the mid 1980s, UK, Ireland, Denmark, Spain, Portugal and Greece. Source: Table 5, External Trade and Balance of Payments, Statistical Yearbook, Recapitulation, 1958-1991,
Dynamic effects of a customs unionDynamic effects of a customs union
• More difficult to measure• Increases productivity and thus potential
growth rates due to:– More specialization with the CU.– Greater competition with the CU. – Capacity to explore economies of scale
and thus compete with 3rd countries.
Benefits of a common marketBenefits of a common market
• Free movement of K and L:– More efficient allocation of resources– Convergenece of wages and capital incomes within the
CM. – But:
• K moves easier than L (transport and cultural costs).
Capital movements in the Common Market
• M&A activity is high in EU.
• much M&A is mergers within member state.
– about 55% ‘domestic.’
– Remaining 45% split between:
• one is non-EU firm (24%),
• one firm was located in another EU nation (15%),
• counterparty’s nationality was not identified (6%).
23
Capital movements in the Common Market
• Distribution of M&A
quite varied:
– Big 3’s share M&As
much lower than share
of the EU GDP. It, Fr,
D (Ger) 36% of the
M&As, 59% GDP.
– UK share is important
(31.6%).
– Small members have
disproportionate share
of M&A (compared to
GDP).
M&A activity by nation, 1991-2002
B, 2.8%
DK, 2.6%
EL, 1.1%
E, 5.0%
F, 13.5%
IRL, 1.7%
I, 6.2%
L, 0.5%NL, 6.5%
A, 2.1%
P, 1.2%
FIN, 3.9%
S, 5.3%
UK, 31.4%
D, 16.3%
24
Competition rules in the Single MarketCompetition rules in the Single Market
• For creating an effective single market two elements are necessary:
– As we have stated, the removal of national barriers to the trade of goods, the provision of services and the
mobility of factors of production.
– The application of an effective competition policy to ensure that firms do not exercise monopoly power or
abuse their market power to the detriment of
consumers and the efficient allocation of resources in
general.
Competition rules in the Single MarketCompetition rules in the Single Market
• The basic competition law of the EU is contained in Articles 81 to 89 of the TEU and in particular:
– Articles 81 to 86 deal with the infringement of the competition rules by agreement between enterprises
– Articles 87 to 89 deal with state aids.
Competition rules in the Single MarketCompetition rules in the Single Market
• Article 81 deals with collusion between firms and refers to agreements (explicit collusion) and
concerted practices (implicit collusion).
– It specifically prohibits price fixing and market sharing; limit or control of production, markets,
technical development or investment; discrimination,
collective boycotts and tie in clauses (when you
purchase one good or service, you are compelled to
buy another unrelated good or service).
– This list is not exhaustive and in general any collusive practices are prohibited.
Competition rules in the Single MarketCompetition rules in the Single Market
– They apply to both vertical agreements (between producers and retailers) and horizontal ones (between
producers or between retailers).
– The rules apply to all firms operating in the common market.
– There are exemptions of course: The agreements must contribute to the improvement of the production or
distribution of goods or to the promotion of technical
or economic progress, while allowing consumers a fair
share of the resulting benefit.
Competition rules in the Single MarketCompetition rules in the Single Market• Article 82 is an anti-monopoly instrument.
– It prohibits any abuse by one or more undertakings of a
dominant position within the common market or in a substantial
part of it … insofar as it may affect trade between member
states.
– The emphasis is not on the acquiring a dominant position (which
implies market concentration) but on its abuse, primarily in
trade between member states.
– Again cooperation agreements between firms which are
considered beneficial for the consumers by improving
production, distribution or technical progress are exempted.
Competition rules in the Single MarketCompetition rules in the Single Market
• One major drawback of article 82 as an instrument of
merger control is that it can be activated only after a
merger has taken place (remember abuse of monopoly
power is prohibited) and so pre-emptive action by the
Commission is not possible under this article.
• This power was agreed upon in 1989 in the form or two
regulations (4064/89 and 1310/97). Under these
regulations the Commission can preemptively block
mergers with a community dimension:
Competition rules in the Single MarketCompetition rules in the Single Market
• There is a Community dimension where:
– the combined aggregate worldwide turnover of all the companies
is more than 5 000 million, and;
– the aggregate Community-wide turnover of each of at least two
of the companies is more than 250 million, unless each of the
companies achieves more than two-thirds of its aggregate
Community-wide turnover within one and the same Member
State.
• Large companies incorporated outside the EU but generating at least
€100 million of their annual business in the Community are also
subject to these rules if a merger between them threatens to distort
competition in the EU market.
• Proposed mergers must be notified to the Commission.
Competition rules in the Single MarketCompetition rules in the Single Market
• State aids: one of the duties of the Commission is to ensure that in the single market no member state provides its own firms with a competitiveadvantage over the firms of other member states.
– In this vein, article 87 prohibits direct subsidies, tax exemptions, preferential interest rates, loans on especially favorable termsindemnities against losses
– Some state aids may be authorized if the distortions in competition are considered to be offset by advantage to the Union, for example, state aid for companies engaged in high tech. research, or directed to less developed regions. Aid which does not affect trade between member states does not come under this law.
– Public procurement: Countries tend to favor domestic firms in the awarding of government contracts, particularly military contracts and such purchases represent on average 15% of GDP. This is similar to a state subsidy. For this reason the public procurement market is gradually being opened up to intra-community competition – when contracts are of some minimum threshold of expenditure