10

Regional Economic Integration

INTRODUCTION

Economic integration is the process of removal of trade barriers between two or more nations and the establishment of cooperation and coordination between them. It may be viewed as a manifestation of the process of globalization, which is concerned with the growing economic interdependence of countries. Thus, economic integration may be viewed as a spectrum of understanding between nations. At one end of the spectrum lies a truly global economy in which all countries share a common currency and agree to a free flow of goods, services, and factors of production. At the other extreme are a number of closed economies, where each is independent and self-sufficient. In actual fact, most integrative agreements lie along the middle of this spectrum.

 

Market integration is the extent to which one or more separated markets combine to form a single market. Integration is evident in increased cross-border flows of goods, services, capital, and labour. Goods consist not only of the final consumer products but also intermediate inputs and raw materials as firms reorganize their activities around regional markets for both inputs and outputs, spurred in part by greater foreign direct investment (FDI). As both government and private-sector decision makers pursue greater institutional and policy coordination to encourage market integration, technological and institutional advancements in transportation and communications also accelerate this process.

The key to market integration is the elimination of policies—tariffs, quotas, import licensing, limits on the amount of foreign ownership in a particular firm or industry, and the differential treatment of foreign and domestic investors—that hinder international trade and investment. All of these policies are common to all the markets examined in this chapter.

This chapter begins with an explanation of different levels of economic integration. It then takes you through some important regional agreements and explores their effects on the regional and world economic system. It also outlines the implications of integration for international business managers.

LEVELS OF ECONOMIC INTEGRATION

There are five levels of economic integration, as illustrated in Figures 10.1(a) and (b):

1. Free trade area (FTA): A free trade area is the loosest form of economic integration between nations. It is an agreement in which member nations remove all trade restrictions among themselves, but continue to have any number of such restrictions vis-à-vis their other trading partners. An interesting feature of a free trade area is that member countries continue to have their own individual policies vis-à-vis non-members. No discriminatory taxes, quotas, tariffs or other trade barriers are allowed. The North American Free Trade Agreement (NAFTA) and the Latin American Free Trade Area (LAFTA), now replaced by the Latin American Association of Integration (ALADI), are examples of this form of cooperation. An example of the freedom of members in terms of bilateral trade agreements is Mexico's bilateral treaty with the European Union (EU) and Chile to improve trade and FDI. The United States similarly has free trade agreements with Israel, Jordan, Chile and Singapore, and is negotiating with countries of the Central American Common Market (CACM).

    

   A free trade area is the loosest form of economic integration between nations. It is an agreement in which member nations remove all trade restrictions among themselves, but continue to have any number of such restrictions vis-à-vis their other trading partners.

    

   Figure 10.1 (a) Layers of Economic Integration

   

    

   Figure 10.1 (b) Stages in Regional Economic Integration

   

    

2. Customs union: This is the next step in the process of regional economic integration. A customs union is characterized by the removal of barriers between member countries and the establishment of a common trade policy with respect to non-member countries. This typically takes the form of a common external tariff, where exports from non-members are subject to the same tariff when sold to any member country. Tariff revenues are shared among members according to a predetermined formula. The South African Customs Union is the oldest example of this form of integration. Other examples are the CACM and the Caribbean Community and Common Market (CARICOM).

    

   A customs union is characterized by the removal of barriers between member countries and the establishment of a common trade policy with respect to non-member countries.

3. Common market: Further along the spectrum of economic integration is the common market, which has no barriers to trade among members and a common external trade policy. In addition to this, there is free mobility of the factors of production, including labour, capital and technology, among member countries. Thus, restrictions on immigration, emigration and cross-border investments are abolished. Free mobility of the factors of production leads to capital, labour and technology being employed in their most productive uses, contributing to economic growth. Members of a common market need to cooperate in terms of fiscal and monetary policies. Furthermore, while a common market is beneficial for its members in the aggregate, it is not clearly proved that it is beneficial for individual members as well. The Southern Common Market Treaty (MERCOSUR) is an example of this form of cooperation.

    

   A common market has no barriers to trade among members and a common external trade policy. In addition to this, there is free mobility of the factors of production, including labour, capital and technology, among member countries.

4. Economic union: An economic union is a common market which has unified fiscal and monetary policies. This requires harmonization of monetary, fiscal and government policies among member countries and the adoption of a common currency. The formation of an economic union implies giving up a significant portion of national sovereignty to a supranational authority in community-wide institutions such as the European Parliament. This leads to member countries becoming the states of a larger “economic country”. For example, the ratification of the Maastricht Treaty by the then-12-member countries led to the creation of the European Union with effect from 1 January 1994. This treaty, jointly with the treaty of Amsterdam, laid the foundation for the Economic and Monetary Union (EMU) with the euro as the common currency.

    

   An economic union is a common market which has unified fiscal and monetary policies. This requires harmonization of monetary, fiscal and government policies among member countries and the adoption of a common currency.

5. Political union: The political union is the final stage of integration, which requires participating nations to become unified in both an economic and political sense. It involves the establishment of a common parliament and other political institutions.

    

   The political union is the final stage of integration, which requires participating nations to become unified in both an economic and political sense through the establishment of a common parliament and other political institutions. Countries like Pakistan, Vietnam, South Korea,

The features of each level of economic integration have been further discussed in Table 10.1.

 

Table 10.1 Levels of Economic Integration

EFFECTS OF INTEGRATION

There are four major effects of integration that are discussed here.

Trade Creation and Trade Diversion

The economic benefits of integration of economies were initially enumerated by economist Jacob Viner¹ through an examination of the case of the customs union. He termed these benefits “trade creation” and “trade diversion”.

Trade creation is the benefit that a member of a customs union gets in the form of increased exports due to the elimination of tariff barriers. Viner explained this with the example of the United States and Spain. They were both wheat producers and exporters subject to a common tariff rate, but the cost of production was lower in the United States than in Spain. However, when Spain joined the EU as a member, its products were no longer subject to the common external tariff which non-members had to pay. Exports of wheat to EU countries from Spain now cost less than they would from the United States, which was subject to the external tariff. This resulted in increased exports from Spain to other EU countries. This benefit of increased exports to Spain as a result of its EU membership is termed trade creation.

As a result of EU membership, trade between the EU and Spain increased, while trade between the EU and the United States declined. When the source of trading competitiveness shifts in this manner from one country to another, it is known as trade diversion.

Trade creation brings with it the benefits of free trade in the form of lower prices for consumers of member nations (the EU); trade diversion, on the other hand, has the negative impact of shifting the competitive advantage away from the once-low-cost producer (United States) to the high-cost producer (Spain). Hence, while economic integration benefits both the producer and consumers of member nations, it has a negative impact on other global producers and their exports. Economic integration is, therefore, beneficial for members but not for non-members.

Reduced Import Prices

We saw in Chapter 6 that the imposition of tariff increases the price of goods as the seller increases their price to cover the tariff. This, in turn, leads to a fall in demand. If the tariff is imposed by a bloc of countries, the fall in price may lead to a substantial fall in demand, causing the producer to reduce the price. The possibility of reduced prices is the result of the increased market power of the bloc of nations relative to that of a single country. This may result in an improved trade position for the importing bloc of countries but would be disadvantageous for the exporting country.

Increased Competition and Economies of Scale

Economic integration increases market size, thereby reducing the monopoly power of certain producers. This is because a larger market increases the number of competing firms, leading to greater efficiency and lower prices for consumers. Industries such as steel and automobiles, which require large-scale production in order to be viable, benefit from the creation of a large trading bloc and, thus, a market. The creation of a large market then results in lower production costs called internal economies of scale. In a common market, there may be external economies of scale as well, resulting from the free flow of factors of production such as capital, skilled labour, and superior technology.

Higher Factor Productivity

Free movement of the factors of production in a common market causes them to seek out areas of higher productivity. This has a two-fold effect:

1. The movement of people leads to the movement of ideas, skills, and values embodied in them, fostering greater cross-cultural understanding.
2. Free movement of the factors of production in a common market does not necessarily benefit all members equally as the much-needed resources of a country may move to another area of higher productivity. A poorer country may lose talented workers to better opportunities in other countries. For example, multinationals such as Koninklijke Philips Electronics N.V. and Goodyear Corporation have shifted their MERCOSUR production from Argentina to Brazil to take advantage of lower costs and incentives provided by the Brazilian Government.

Despite the overwhelming arguments in favour of regional economic integration, an objective analysis reveals that the real benefits of regional integration depend on the amount of trade creation as against trade diversion. A regional free trade agreement benefits the world economy only if the amount of trade it creates exceeds the amount of trade it diverts.

 

REGIONAL TRADING AGREEMENTS

There are a number of regional trading agreements across the world. Some of the important ones have been discussed here.

European Union (EU)

The European Union (EU) is a political and economic union of 27 member states, located primarily in Europe. It was established on 1 January 1995, as a result of the signing of the Treaty on European Union, also known as the Maastricht Treaty. The treaty was signed in February 1992 and enforced in November 1993. The first EU members comprised 15 countries: Belgium, the Netherlands, Luxembourg, France, Germany, Italy, Denmark, Ireland, the United Kingdom, Greece, Spain, Portugal, Finland, Sweden, and Austria. These EC member states constitute the core as well as the deepest level of European economic integration. The outer tier of trade and economic liberalization around the European Community is composed of countries in Central and Eastern Europe, as well as Mediterranean countries (for example, Slovenia, Malta, and Turkey), with which the European community has reciprocal trade agreements. With almost 500 million citizens, the EU combined generated a gross domestic product (GDP) of USD 14.43 trillion in 2009.²

 

Eu Membership Timeline

The EU membership increased from six in 1952 to 27 in 2007. The timeline is as follows:³

• 27 May 1952: The six founding members of the European Union were Germany, France, Italy, the Netherlands, Belgium, and Luxembourg.
• 1 January 1973: The six became nine when Denmark, Ireland and the United Kingdom formally entered the EU.
• 1 January 1981: Membership of the EU reached double figures when Greece joined. It had been eligible to join since its military regime was overthrown and democracy restored in 1974.
• 1 January 1986: Spain and Portugal entered the EU, bringing up the membership to 12.
• 1989: Communism collapsed across Central and Eastern Europe. It began in Poland and Hungary, and was symbolized by the fall of the Berlin Wall in 1989. Faced by a mass exodus of its citizens to West Germany, the East German Government threw open its gates. Germany became united after more than 40 years, and its eastern part joined the EU (October 1990).
• 1 January 1995: Austria, Finland and Sweden joined the EU. The 15 members now covered almost the whole of Western Europe.
• 1 May 2004: Eight countries of Central and Eastern Europe—the Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland, Slovenia, and Slovakia—joined the EU, finally ending the division of Europe decided by the Great Powers (Britain, France and the United States) 60 years earlier at Yalta. Cyprus and Malta also became members.
• 1 January 2007: Two more countries from Eastern Europe, Bulgaria and Romania, joined the EU, bringing the number of member states to 27 countries. Croatia, the former Yugoslav Republic of Macedonia, and Turkey are also candidates for future membership.

Formation of an Integrated Europe

The historical roots of the European Union lie in the Second World War. The devastation of the War made Europeans determined to prevent such killing and destruction from repeating itself. Soon after the War, Europe was split into the East and West as the 40-year-long Cold War began. West European nations created the Council of Europe in 1949. It was the first step towards cooperation between them, in which six countries wanted to go further. Important landmarks in the formation of the European Union have been outlined here:

• On 9 May 1950, French Foreign Minister Robert Schuman presented a plan for deeper cooperation. Based on the Schuman Plan, six countries signed a treaty to run their heavy industries (coal and steel) under a common management. The Coal and Steel Treaty of 1952 was signed with the objective of the formation of a common market in coal, steel, and iron ore for member countries. In this way, none of them could make weapons of war on their own to turn against the other, as in the past. The six were Germany, France, Italy, the Netherlands, Belgium, and Luxembourg—the founding members of the European Union.
• Building on the success of the Coal and Steel Treaty, the six countries expanded cooperation to other economic sectors. They signed the Treaty of Rome in 1957, creating the European Economic Community (EEC), or the “common market”. The idea was for people, goods, and services to move freely across borders.
• In 1967, the European Coal and Steel Community (ECSC) and EEC, as well as the European Atomic Energy Community (EURATOM), were merged to form the European Community (EC).
• In 1987, the Single European Act was signed. This is a treaty which provided the basis for a vast six-year programme aimed at sorting out problems with the free-flow of trade across EU borders and is the basis of the concept of the single market.
• In 1992, the Treaty on European Union was signed in Maastricht. It was a major EU milestone, setting clear rules for the future single currency as well as for foreign and security policy and closer cooperation in justice and home affairs. Under the treaty, the name “European Union” officially replaced the name “European Community” on 1 January 1993.
• The single market and its four freedoms were established in 1993, making the free movement of goods, services, people, and money a reality. More than 200 laws have been passed since 1987, covering tax policy, business regulations, professional qualifications, and other barriers to open frontiers.
• On 26 March 1995, the Schengen Agreement took effect in seven countries—Belgium, Germany, Spain, France, Luxembourg, the Netherlands, and Portugal, making travel on a single passport possible for people of any of these nationalities. Other countries have since joined the passport-free Schengen area.
• In December 1997, EU leaders agreed to start the process of membership negotiations with 10 countries of Central and Eastern Europe: Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia. The Mediterranean islands of Cyprus and Malta were also included. In 2000, treaty changes agreed on in Nice paved the way for the enlargement of the Union by reforming EU voting rules.
• On 1 January 1999, the euro was introduced in 11 countries (joined by Greece in 2001) for commercial and financial transactions only. These euro countries were Belgium, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland. Denmark, Sweden and the United Kingdom decided to opt out.

Characteristics of the Eu

The main characteristics of the EU are:

• It has developed a single market through a standardized system of laws which apply in all member states, guaranteeing the freedom of movement of people, goods, services, and capital.
• It maintains a common trade policy, agricultural and fisheries policies, and a regional development policy.
• Seventeen member states have adopted a common currency, the euro.
• It has developed a role in foreign policy, representing its members in the World Trade Organization (WTO), at G8 summits, and at the United Nations.
• Every citizen in each of its member states is eligible to obtain a European passport due to the abolition of passport control between many member states under the Schengen Agreement.

The EU is a hybrid organization characterized by intergovernmental and supranational features. It is a unique entity with characteristics that distinguish it from any other existing organization or body. It is neither a federation of states like the United States nor an organization for cooperation between governments like the United Nations, and nor is it a state intended to replace existing states. It is a body of states which have voluntarily agreed to set up common institutions to which they delegate some of their sovereignty so that decisions on specific matters of joint interest can be taken democratically in the interest of Europe.⁴ This pooling of sovereignty has led to the EU acquiring a character over and above its member nation states, which can be termed supranational.

Institutions of the Eu

The EU's decision-making process in general and the co-decision procedure in particular involve three main institutions:

1. The European Parliament, which represents the EU's citizens and is directly elected by them
2. The Council of the European Union, which represents the individual member states
3. The European Commission, which seeks to uphold the interests of the Union as a whole

This “institutional triangle” produces the policies and laws that apply throughout the EU. In principle, it is the Commission that proposes new laws, but it is the Parliament and Council that adopt them. The Commission and the member states then implement them, and the Commission ensures that the laws are properly taken on board. Besides these, other institutions such as the Court of Justice, which upholds the rule of European law, and the European Central Bank also play a key role.

 

European Parliament   The European Parliament, elected by the people of the member states every five years, is truly representative of the people of Europe. The Parliament is one of the EU's main law-making institutions, along with the Council. It meets in Strasbourg, France, and is primarily a consultative body. It debates and passes European laws with the Council; scrutinises other EU institutions, particularly the Commission, to make sure that they are working democratically; and debates and adopts the EU's budget with the help of the Council. A major debate in Europe concerns is focused on whether the Council or the Parliament should ultimately be more powerful.

 

European Council   The European Council comprising the governments of the member states defines the general political direction and priorities of the European Union. The European Council was created in 1974 with the intention of establishing an informal forum for discussion between heads of state or government. It rapidly developed into the body which fixed goals for the Union and set the course for achieving them, in all fields of EU activity. It acquired a formal status in the 1992 Treaty of Maastricht, which defined its function as providing the impetus and general political guidelines for the Union's development. It acquired the status of an official institution as a result of the Treaty of Lisbon coming into force on 1 December 2009.

It consists of the heads of state or government of the member states, together with its president and the president of the Commission. The high representative of the union for foreign affairs and security policy also takes part in its work. The basic function of the Council is to define the general political directions and priorities of the Union and provide the necessary impetus for its development. It does not exercise any legislative functions. It meets every six months at Brussels in Belgium and most of its decision making is based on consensus. The number of votes that a country gets in the council depends on its size; England, for instance, has 29 votes compared to Denmark, which is much smaller and, therefore, gets only 7 votes.

 

European Commission   The European Commission, which is the executive body, is responsible for proposing new laws to the Parliament and the Council, managing the EU's budget and allocating funds, enforcing EU law (together with the Court of Justice), and representing the EU internationally, for example, by negotiating agreements between the EU and other countries.

Headquartered in Brussels, Belgium, the Commission has representation of members from all states of the union. It has a monopoly in proposing European Union legislation, but all legislation needs ratification from the European Council and Parliament. The Commission acts as a policeman and is also responsible for ensuring compliance with EU laws, most of which are delegated to member states for implementation. In the absence of states complying through persuasion, the Commission may refer a case to the Court of Justice. An important area of operation of the Commission in recent years has been in the area of competition policy, to ensure that no business enterprise uses its market power to drive away competition. Some of the important decisions of the Commission have been the rejection of a proposed merger between Time Warner of the United States and EMI Group Limited of the United Kingdom, and US telecommunication giants Worldcom Group, Inc. and Sprint.

 

European Court of Justice   The European Court of Justice, represented by one judge from each of its member countries, attempts to interpret EU law to ensure its uniform application in all EU countries. It is also the forum for the settlement of legal disputes between EU governments and EU institutions. Individuals, companies, or organizations can also bring cases before the Court if they feel that their rights have been infringed on by an EU institution.⁵

 

European Central Bank   The European Central Bank (ECB) is one of the key EU institutions. The Bank has a pivotal role as it works with the central banks in all 27 EU countries, which together are known as the European System of Central Banks (ESCB). It also ensures close cooperation between central banks in the euro area—the 17 EU countries that have adopted the euro—known as the eurozone. The cooperation between this smaller, tighter group of banks is referred to as the eurosystem.

The ECB's main functions include:

• Keeping inflation under check, especially in countries that use the euro
• Ensuring stability in the financial system by making sure that financial markets and institutions are properly supervised by national authorities, and that payment systems function smoothly
• Setting key interest rates for the eurozone and controlling the money supply
• Managing the eurozone's foreign-currency reserves and buying or selling currencies when necessary to keep exchange rates in balance
• Authorizing central banks in eurozone countries to issue euro banknotes
• Monitoring price trends and assessing the risk they pose to price stability

Euro

The euro, the common European currency, was adopted by 11 EU member countries on 1 January 1999. The number has gone up to 17 as of 2011,⁶ the newest members being Estonia, Slovakia, Cyprus, and Malta. However, important EU members such as the United Kingdom, Denmark, and Sweden have still not adopted the euro. Although the euro was introduced in 1999, it remained a virtual currency used only for accounting purposes till 2002, when it came into circulation as notes and coins. All participating nations have a fixed parity against the euro and by implication against each other.

In order to be able to adopt the common currency, member countries had to fulfil important economic criteria such as a high degree of price stability, a sound fiscal situation, stable exchange rates, and converged long-term interest rates. It also meant having to give up control over national monetary policy for the greater good of the Union.

The use of a common currency meant savings in transaction costs and the elimination of exchange rate uncertainty. It was said that people travelling across Europe came back with half the original amount they started out with, on account of conversion costs prior to the introduction of the common currency. Savings on account of transaction costs would, therefore, accrue to all participants in the system—individuals, companies, and governments.

A related benefit was on account of exchange rate uncertainty as companies would save on hedging (the practice of taking a position in one market to offset and balance against the risk adopted by assuming a position in a contrary or opposing market or investment) costs incurred against foreign exchange risks. The common currency would also make it easier to compare prices across Europe, with attendant benefits in the form of channelizing resources towards more competitive firms and giving more choice to the consumer.

The euro also implies strong macroeconomic discipline for participating governments to ensure overall stability in the Union. For instance, Greece has imposed austerity measures to secure international funding for its immense domestic debt and to avert imminent bankruptcy in the face of massive discontent and public outcry from its people.⁷

The common currency has also facilitated the development of a continental capital market with depth and liquidity comparable to the United States. An integrated European financial market instead of fragmented, illiquid national markets with a localized regulatory framework is likely to lead to lower cost of capital and increased firm value.

The main cost of the monetary union is the loss of monetary and exchange rate policy independence for member countries. An instance of this is the repercussions of the spiralling domestic debt in Greece, which had all member nations worried as it resulted in a decline in the value of the euro.

It is similarly difficult for countries to adhere to fiscal discipline, according to the provisions of the Stability and Growth Pact signed in 1997, which commits them to keeping budget deficits within 3 per cent of GDP. This forced Portugal to painfully slash public spending, increasing domestic recession and unemployment, but did not prevent France and Germany from free riding and refusing to bring down fiscal deficit, in open defiance of the agreement.

Critics also argue that the EU is not an optimum currency area in a strict economic sense. According to the theory of optimum currency areas, originally conceived by Robert Mundell⁸ of Columbia University, the relevant criterion for identifying a common currency zone is the degree of factor mobility. A high degree of factor mobility provides an adjustment mechanism to the union as an alternative to painful country-specific monetary and currency adjustments. In an optimum currency area, similarities in macroeconomic structure make it feasible to adopt a single currency and a common exchange rate. In the EU, differences in wage rates, tax policies, and business cycles make macroeconomic policy management difficult and complicated.

North American Free Trade Agreement (NAFTA)

The North American Free Trade Agreement (NAFTA) is a comprehensive economic and trade agreement that establishes a free trade area encompassing Canada, Mexico, and the United States. NAFTA is structured as three separate bilateral agreements: the first between Canada and the United States, the second between Mexico and the United States, and the third between Canada and Mexico. The first accord, the Canada–US Free Trade Agreement (CUSTA), took effect on 1 January 1989, and was subsumed by NAFTA. The second and third agreements are embodied in NAFTA itself, which took effect on 1 January 1994.

 

Tariff elimination for the items addressed by CUSTA concluded on 1 January 1998. However, CUSTA exempted a number of agricultural products from US–Canada trade liberalization, such as US imports of dairy products, peanuts, peanut butter, cotton, sugar and sugar-containing products, and Canadian imports of dairy products, poultry, eggs and margarine. The quotas that once governed bilateral trade in these commodities were redefined as tariff-rate quotas (TRQs) to comply with the Uruguay Round Agreement on Agriculture (URAA), which took effect on 1 January 1995. NAFTA also exempted dairy and poultry products from Canada–Mexico trade liberalization. Tariff elimination for the items addressed by NAFTA concluded on 1 January 2008.

Besides tariffs and quotas, NAFTA also establishes key principles regarding the treatment of foreign investors, including a commitment from each NAFTA country to treat investors from other member countries no less favourably than its own domestic investors. It also prohibits the imposition of certain performance requirements, such as a minimum amount of domestic content in production, on foreign investors. These provisions reinforce similar changes that Mexico made to its foreign investment laws prior to NAFTA.

It also includes side agreements on labour adjustment, environmental protection, and import surges. The side agreement on labour adjustment was introduced in response to the concern of American workers about loss of jobs to lower paid Mexican workers. The agreement involves issues relating to child labour, health and safety standards, and minimum wages. Similarly, the side agreement on environmental cooperation explicitly ensures the rights of the United States to safeguard the environment. NAFTA upholds all existing US health, safety and environmental standards. The side agreement on import surges creates an early warning mechanism to identify those sectors where a sudden explosive trade growth may do significant harm to the domestic industry.

Under NAFTA, all non-tariff barriers to agricultural trade between the United States and Mexico were eliminated. In addition, many tariffs were eliminated immediately, with others being phased out over five to fifteen years. For import-sensitive industries, long transition periods and special safeguards allowed for an orderly adjustment to free trade with Mexico.

Nafta Provisions

The key provisions under NAFTA are:

• Sanitary and phytosanitary measures: The NAFTA imposes disciplines on the development, adoption, and enforcement of sanitary and phytosanitary (SPS) measures. These are measures taken to protect human, animal and plant life or health from risks that may arise from animal or plant pests or diseases, or from food additives or contaminants. Disciplines contained in NAFTA are designed to prevent the use of SPS measures as disguised restrictions on trade, while still safeguarding each country's right to protect consumers from unsafe products, or to protect domestic crops and livestock from the introduction of imported pests and diseases. Although NAFTA encourages trading partners to adopt international and regional standards, the agreement explicitly recognizes each country's right to determine the necessary level of protection. Such flexibility permits each country to set more stringent standards, as long as they are scientifically based. NAFTA also allows state and local governments to enact standards more stringent than those adopted at the national level, so long as these standards are scientifically defensible and are administered in a forthright, expeditious manner.
• Export subsidies: The three NAFTA countries work towards the elimination of export subsidies worldwide. The United States and Canada are allowed to provide export subsidies into the Mexican market to counter subsidized exports from other countries. Neither Canada nor the United States is allowed to use direct export subsidies for agricultural products being sold to the other, and both countries are required to consider the export interests of the other whenever subsidizing agricultural exports to third world countries.
• Internal support: Under NAFTA, the parties are expected to endeavour to move towards domestic support policies that have minimal trade or production distorting effects, or toward policies exempt from domestic support reduction commitments under the WTO.
• Grade and quality standards: The United States and Mexico agreed that when either country applies a measure regarding the classification, grading, or marketing of a domestic product destined for processing, it will provide no less favourable treatment for products imported for processing.

Importance of Nafta

The NAFTA is an important pact for the following reasons:

• It is the first ever reciprocal free trade accord between the developed and the developing world.
• Its creation led to the formation of a tri-national market of more than 360 million people with a combined purchasing power of about USD 6.5 trillion.
• The establishment of the NAFTA helped producers of North America (especially the United States) to compete globally. It has also helped to improve the investment climate in the region and has given companies a larger market than before.

Impact of Nafta

NAFTA has mainly affected trade and employment in North America.

 

Trade enhancement   Mostly economic analysis of NAFTA's trade effects has focused on the United States and Mexico, largely because US–Canada trade liberalization was well underway by the time of NAFTA's negotiation. Early studies on the impact of NAFTA found arguments both for and against its beneficial effects. The earliest findings were of the opinion that growth in trade between the United States and Mexico had begun to change nearly a decade before NAFTA came into effect, as a result of Mexico's liberalization of its trade regime in response to the requirements of the General Agreement on Tariffs and Trade (GATT). It was also said that the trade growth in sectors which had undergone trade liberalization was, thus, only marginally higher than sectors which had not.

An assessment of NAFTA's impact on US–Mexico trade prepared for the Congressional Budget Office suggests that the impact has risen gradually with the agreement's implementation.⁹ The study estimated that NAFTA boosted US exports to Mexico (agricultural and non-agricultural) by 11.3 per cent in 2001 and US imports from Mexico by 7.7 per cent. Considering the value of bilateral agricultural trade in 2001, these percentages would correspond to an additional USD 751 million in agricultural exports to Mexico and an additional USD 376 million in agricultural imports from Mexico in that year alone.

NAFTA has enabled the United States and Mexico to benefit more fully from complementary agricultural trade. Grains, oilseeds, meat, and related products make up about three-fourths of US agricultural exports to Mexico in terms of value, while beer, vegetables, and fruit account for roughly 70 per cent of US agricultural imports from Mexico. Since Mexico does not produce enough grains and oilseeds to meet domestic demand, the country's food and livestock producers import sizable volumes of these commodities to make value-added products, primarily for the domestic market. In turn, US fruit and vegetable imports from Mexico are closely tied to Mexico's expertise in producing a wide range of produce, along with its favourable climate and a growing season that largely complements the US growing season. Successful efforts to market specific brands of Mexican beer in the United States have made that product Mexico's leading agricultural export to the United States. In 2008, US beer imports from Mexico approached USD 1.6 billion, compared with just USD 163 million in 1993.

In contrast, US–Canada agricultural trade is marked by a substantial amount of intra-industry trade, particularly in value-added products, such as grains and feeds, wheat, beef, and pork.¹⁰ The two agreements, NAFTA and CUSTA, also give Canadian consumers much freer access to US and Mexican fresh produce. In 2008, US fruit and vegetable exports to Canada approached USD 4 billion, with fresh produce accounting for nearly three-quarters of this amount.

 

Employment   Input–output analysis suggests that US agricultural exports to Canada and Mexico helped to create about 243,000 jobs in the US economy in 2006, which is a small number compared to the total workforce of approximately 142 million,¹¹ and the number of US farm operators at around 3.2 million, counting both primary and secondary operators.¹² It was estimated that NAFTA's net impact on US agricultural employment was likely to be small; only about 0.7 per cent larger than it would have been in the absence of NAFTA.¹³ A more recent study of NAFTA's impact on the US economy as a whole, concurs with these earlier results, and indicates that the agreement contributes several hundredths of only 1 per cent to US GDP.¹⁴ A possible explanation of this is that strong productivity growth, coupled with the sheer size of US agriculture, is resulting in little impact on US agricultural employment.

CARICOM

The Caribbean Community and Common Market (CARICOM) was established by the Treaty of Chaguaramas, which was signed by Barbados, Jamaica, Guyana, and Trinidad and Tobago, and came into effect on 1 August 1973. Subsequently, eight other Caribbean territories joined the CARICOM. Suriname became the fourteenth member state of the Caribbean Community on 4 July 1983. In July 1991, the British Virgin Islands and the Turks and Caicos Islands became associated members of the CARICOM. Twelve other states from Latin America and the Caribbean enjoy observer status in various institutions of the Community and CARICOM ministerial bodies.

As of 2011, Antigua and Barbuda, Belize, Grenada, Montserrat, St. Vincent and the Grenadines, The Bahamas, British Virgin Islands, Guyana, St. Kitts and Nevis, Suriname, Barbados, Dominica, Jamaica, Saint Lucia, and Trinidad and Tobago are members of the CARICOM.

The objectives of the CARICOM are:

• The major objective is to achieve economies of scale in the regional production of services such as transportation, education, and health.
• It also aims to pool financial resources for investment in a regional development bank.
• It also targets the coordination of economic policies and development planning.

MERCOSUR

The Southern Common Market Treaty (MERCOSUR) originated as a free trade pact between Brazil and Argentina in 1988. This agreement is one of the many agreements falling under the ALADI. The success of this pact in bringing down tariffs and quotas by about 80 per cent led to the addition of Paraguay and Uruguay in March 1991 with the signing of the Treaty of Asuncion. The Asuncion Treaty is based on the doctrine of the reciprocal rights and obligations of the member states. MERCOSUR initially targeted free trade zones, then customs unification, and, finally, the common market, where, in addition to customs unification, the free movement of the workforce and capital across the member nations’ international frontiers was possible, and depended on equal rights and duties being granted to all signatory countries. During the transition period, as a result of the chronological differences in actual implementation of trade liberalization by the member states, the rights and obligations of each party had to be initially equivalent but not necessarily equal. In addition to the reciprocity doctrine, the Asuncion Treaty also contained provisions regarding the most-favoured-nation concept, according to which the member nations had to undertake to automatically extend (after actual formation of the common market) to the other Treaty signatories any advantage, favour, entitlement, immunity, or privilege granted to a product originating from or intended for countries that were not party to the ALADI.

 

The Treaty of Ouro Preto of 1994 added much to the institutional structure of MERCOSUR and initiated a new phase in the relationship between the countries, when they decided to start implementing a common market. A transition phase was set—the phase was to begin in 1995 and to last until 2006—with a view to realizing the common market.

In 1996, association agreements were signed with Chile and Bolivia, establishing free trade areas with these countries on the basis of a “4 + 1 formula”, which led to the addition of other countries besides the original four. During this period, MERCOSUR also created a common mechanism for political consultations, which was formalized in 1998, in which the original four countries as well as Bolivia and Chile participated as full members of the so-called “political MERCOSUR”.

The objectives of MERCOSUR are:

• Free transit of production goods, services, and factors between the member states with the elimination of customs rights and lifting of non-tariff restrictions on the transit of goods or any other measures with similar effects
• Fixing a common external tariff (TEC) and adopting a common trade policy with regard to non-member states or groups of states, and the coordination of positions in regional and international commercial and economic meetings
• Coordination of macroeconomic and sectoral policies of member states relating to foreign trade, agriculture, industry, taxes, monetary system, exchange and capital, services, customs, transport and communications, and any others they may agree on, in order to ensure free competition between member states
• Ensuring the commitment of the member states in making the necessary adjustments to their laws in pertinent areas to allow for the strengthening of the integration process

Andean Pact

The Andean Pact began life with five member nations in 1969 and was based on the EU model, but has been far less successful in achieving its stated objectives. Its integration program included an internal tariff reduction program, a common external tariff, a transportation policy, a common industrial policy, and special concessions for Bolivia and Ecuador.

The pact almost collapsed by the mid-80s without achieving most of its stated objectives. It could not survive because of the magnitude of its problems with low economic growth, hyperinflation, high unemployment, political unrest, and high debt. The dominant political ideology of radical socialism was also inherently opposed to market philosophy further hampering any chances of integration.

Changes in the political ideology of Latin American governments resulted in another attempt, and the Andean Pact was re-launched in 1990 with five members (including four of the members of the original pact)—Bolivia, Colombia, Ecuador, Peru, and Venezuela. The aim was the creation of a free trade area with the objectives of a common internal tariff by 1994 and a full common market by 1995. This did not succeed, partly because Peru and Ecuador conducted a border war in early 1995. Significant differences between the more economically advanced countries, Venezuela and Colombia, and the less advanced Bolivia and Ecuador, also made it difficult to achieve harmonization of economic policies and the building up of a true common market. The Andean community now operates as a customs union, and has restarted negotiations for the creation of a free trade area with MERCOSUR.

Association of Southeast Asian Nations (ASEAN)

The Association of Southeast Asian Nations (ASEAN), an economic and political association, was established on 8 August 1967 in Bangkok by Indonesia, Malaysia, the Philippines, Singapore, and Thailand. Subsequently, the State of Brunei Darussalam joined on 8 January 1984, Vietnam on 28 July 1995, Lao People's Democratic Republic and Myanmar on 23 July 1997, and Cambodia on 30 April 1999.

Objectives of Asean

The stated objectives of the ASEAN are:

• To accelerate economic growth, social progress, and cultural development in the region
• To promote regional peace and stability through abiding respect for justice and the rule of law in the relationship among countries in the region and adherence to the principles of the United Nations Charter

In 2003, the ASEAN Leaders resolved that an ASEAN Community shall be established comprising three pillars, namely, ASEAN Security Community, ASEAN Economic Community, and ASEAN Socio-Cultural Community. Launched in 1992, the ASEAN is a Free Trade Area (AFTA) which aims to promote the region's competitive advantage as a single production unit. The elimination of tariff and non-tariff barriers among member countries is expected to promote greater economic efficiency, productivity, and competitiveness. Table 10.2 compares values of key ASEAN indicators (population, area, GDP, trade, and FDI flows) in 2010 and 2011.

The highest decision-making organ of ASEAN is the meeting of the ASEAN heads of state and government. The ASEAN Summit is convened every year. The ASEAN Ministerial Meeting comprising foreign ministers of member countries is held annually. Ministerial meetings on sectors such as agriculture and forestry, economics (trade), energy, environment, finance, health, information, investment, labour, law, regional haze, rural development and poverty alleviation, science and technology, social welfare, telecommunications, transnational crime, transportation, tourism, and youth are also held regularly. Supporting these ministerial bodies are committees of senior officials, technical working groups, and task forces.

In moving towards the ASEAN Economic Community in 2003, the ASEAN agreed on the following:

• Institute new mechanisms and measures to strengthen the implementation of its existing economic initiatives including the ASEAN Free Trade Area (AFTA), ASEAN Framework Agreement on Services (AFAS), and ASEAN Investment Area (AIA)
• Accelerate regional integration in priority sectors, such as air travel, agro-based products, automotives, e-commerce, electronics, fisheries, healthcare, rubber-based products, textiles and apparels, tourism, and wood-based products, by 2010
• Facilitate movement of business persons, skilled labour and talents
• Strengthen the institutional mechanisms of ASEAN, including the improvement of the existing ASEAN Dispute Settlement Mechanism to ensure expeditious and legally-binding resolution of any economic disputes

Table 10.2 Key ASEAN Indicators in 2010 and 2011

Key ASEAN indicators	2010	2011
Population	560 million	591.8 million
Area	4.5 million square kms	4.4 million square km
GDP(not per capita)	USD 1,499,401million	USD 1,496,341 million
Trade	USD 1,536,843 million	USD 1,536,843 million
FDI flows	USD 39,623 million	USD 36,113 million

Asean Achievements

The various achievements of the ASEAN are:¹⁵

• Tariffs on almost 99 per cent of the products in the Inclusion List of the ASEAN-6 (Brunei Darussalam, Indonesia, Malaysia, the Philippines, Singapore, and Thailand) have been reduced to no more than 5 per cent. More than 60 per cent of these products have zero tariffs. The average tariff for ASEAN-6 has been brought down from more than 12 per cent when AFTA started to 2 per cent as of 2011. For the newer member countries, namely, Cambodia, Myanmar, Lao PDR, and Vietnam (CMLV), tariffs on about 81 per cent of their Inclusion List have been brought down to within the 0 per cent to 5 per cent range.
• Roadmap for financial and monetary integration of ASEAN in four areas, namely, capital market development, capital account liberalization, liberalization of financial services, and currency cooperation.
• Trans-ASEAN transportation network consisting of major inter-state highways and railway networks, including the Singapore to Kunming Rail-Link, principal ports and sea lanes for maritime traffic, inland waterway transport, and major civil aviation links.
• The adoption of a roadmap for integration of air travel.
• Interoperability and interconnectivity of national telecommunications equipment and services, including the ASEAN Telecommunications Regulators’ Council Sectoral Mutual Recognition Arrangement (ATRC MRA).
• Trans-ASEAN energy networks, which consist of the ASEAN Power Grid and the Trans-ASEAN Gas Pipeline (TAGP) Project.
• Initiative for ASEAN Integration (IAI) focusing on infrastructure, human resource development, information and communications technology, and regional economic integration primarily in Cambodia, Myanmar, Lao PDR, and Vietnam—the CMLV countries.

Asia-Pacific Economic Cooperation Forum (APEC)

The Asia-Pacific Economic Cooperation (APEC) came into existence in November 1994 and as of 2011 has 21 members. The APEC members are Australia, Brunei Darussalam, Canada, Chile, People's Republic of China, Hong Kong-China, Indonesia, Japan, Republic of Korea (South Korea), Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, the Philippines, Russia, Singapore, Chinese Taipei, Thailand, United States, and Vietnam. In 1994, APEC leaders gathered in Bogor, Indonesia, and agreed to build on the commitments made in the Uruguay Round of GATT, by accelerating their implantation and broadening and deepening those commitments.

The APEC works in three broad areas to meet the Bogor Goals of free and open trade and investment in the Asia-Pacific, by 2010 for developed economies and 2020 for developing economies. Known as the APEC's three pillars, these key areas are:

1. Trade and investment liberalization: Trade and investment liberalization reduces and eventually eliminates tariff and non-tariff barriers to trade and investment to protect member states from the harmful effects of protectionism. As we have seen in Chapter 8, protectionism is expensive because it raises prices for goods and services even as it shields the domestic industry initially. Thus, trade and investment liberalization focuses on opening markets to increase trade and investment among economies, resulting in economic growth for APEC member economies and increased standard of living for all.
2. Business facilitation: Business facilitation focuses on reducing the costs of business transactions, improving access to trade information, and aligning policy and business strategies to facilitate growth and free and open trade. Essentially, business facilitation helps importers and exporters in the Asia-Pacific region to meet and conduct business more efficiently, thus, reducing costs of production and leading to increased trade, cheaper goods and services, and more employment opportunities due to an expanded economy.
3. Economic and technical cooperation (ECOTECH): ECOTECH is dedicated to providing training and cooperation to build capacities in all APEC member economies to take advantage of global trade. This area builds capacity at the institutional and personal level to assist APEC member economies and their people gain the necessary skills to meet their economic potential.

The major benefits of the APEC are:

• Economic growth: Since its inception in 1989, the APEC region has consistently been the most economically dynamic part of the world. In its first decade, APEC member economies generated nearly 70 per cent of global economic growth and the APEC region consistently outperformed the rest of the world, even during the Asian financial crisis. By progressively reducing tariffs and other barriers to trade, APEC member economies have become more efficient and exports have expanded dramatically.
• Benefits to the people: The outcomes of APEC's three areas of intervention have enabled APEC members to strengthen their economies by pooling resources within the region and achieving efficiencies. Tangible benefits are also delivered to consumers in the APEC region through increased training and employment opportunities, greater choices in the marketplace, cheaper goods and services, and improved access to international markets.

South Asian Association for Regional Cooperation (SAARC)

The South Asian Association for Regional Cooperation (SAARC) is an economic and political organization of eight countries in southern Asia. In terms of population, its sphere of influence is the largest of any regional organization; the combined population of its member states is almost 1.5 billion people. It was established on 8 December 1985 by India, Pakistan, Bangladesh, Sri Lanka, Nepal, Maldives, and Bhutan. In April 2007, at the Association's fourteenth summit, Afghanistan became its eighth member.

In the late 1970s, Ziaur Rahman, President of Bangladesh, proposed the creation of a trade bloc consisting of South Asian countries. The Bangladeshi proposal was accepted by India, Pakistan, and Sri Lanka during a meeting held in Colombo in 1981. In August 1983, the leaders adopted the Declaration on South Asian Regional Cooperation during a summit which was held in New Delhi. The seven South Asian countries, which also included Nepal, Maldives, and Bhutan, agreed on five areas of cooperation:

1. Agriculture and rural development
2. Telecommunications, science, technology, and meteorology
3. Health and population activities
4. Transport
5. Human resource development

Afghanistan was added to the regional grouping at the behest of India on 13 November 2005 and became a member on 3 April 2007. With the addition of Afghanistan, the total number of member states was raised to eight. In April 2006, the United States and South Korea made formal requests to be granted observer status. The European Union also indicated interest in being given observer status, and made a formal request for the same to the SAARC Council of Ministers meeting in July 2006. On 2 August 2006, the foreign ministers of the SAARC countries agreed in principle to grant observer status to the United States, South Korea, and the European Union. On 4 March 2007, Iran also requested observer status.

The SAARC Secretariat was established in Kathmandu on 16 January 1987. Its role is to coordinate and monitor the implementation of SAARC activities, service the meetings of the Association and serve as the channel of communication between SAARC and other international organizations. The Secretariat comprises the secretary general, the seven directors, and the general services staff. The heads of states or governments of SAARC have taken some important decisions and bold initiatives through the years to strengthen the organization and to widen and deepen regional cooperation.

Over the years, the SAARC members have expressed their reluctance to sign a free trade agreement. Though India has several trade pacts with Maldives, Nepal, Bhutan, and Sri Lanka, similar trade agreements with Pakistan and Bangladesh have been stalled due to political and economic concerns on both sides. India has been constructing a barrier across its borders along Bangladesh and Pakistan. In 1993, SAARC countries signed an agreement in Dhaka to gradually lower tariffs within the region. Eleven years later, at the twelfth SAARC Summit at Islamabad, SAARC countries devised the South Asia Free Trade Agreement which created a framework for the establishment of a free trade area covering 1.4 billion people. This agreement went into force on 1 January 2006. Under this agreement, SAARC members had to bring their duties down to 20 per cent by 2007.

The SAARC's inability to play a crucial role in integrating South Asia is often credited to the political and military rivalry between India and Pakistan. It is due to these economic, political, and territorial disputes that South Asian nations have not been able to harness the benefits of a unified economy. Over the years, the SAARC's role in South Asia has greatly diminished and it is now used as a mere platform for annual talks and meetings between its members.

Closer Economic Relations (CER)

A small but viable free trade area exists in the form of Closer Economic Relations (CER) between Australia and New Zealand. The CER Agreement which came into effect on 1 January 1983 provided for free trade in goods from 1 July 1990. The CER is also being extended into trade in services and used for increased harmonization of the commercial environment. However, difficulties have been experienced regarding rules concerning the origin of goods, divided payments, business laws, and recognition of standards and qualifications.

Economic Integration in Africa

African integration is difficult because market sizes and resource endowments are small. There are nevertheless nine economic blocs trying to achieve some form of economic integration, most at a fairly low level. In general, the countries involved are so poor and economic activity is so low that there is an insignificant base for cooperation resulting in little progress.

The Economic Community of West African States (ECOWAS) was formed in 1975 but remained inactive for the first one and a half decades. It was only in 1992 that fresh initiatives were taken to establish a customs union and then a common market. The ECOWAS includes the countries of Benin, Burkina Faso, Cape Verde, Gambia, Ghana, Guinea, Guines-Bissau, Côte d'Ivoire, Liberia, Mali, Mauritania, Niger, Nigeria, Senegal, Sierra Leone, and Togo. The group has been striving to give a shape to its integration scheme, but the low rate of economic development and other economic problems in the region have hindered its progress.

The Central African Economic and Customs Union (UDEAC) consists of Congo, Gabon, the Central African Republic, Equatorial Guinea, and Cameroon. The UDEAC provides a framework for the free movement of capital throughout the area and for the harmonization of fiscal incentives, as well as the coordination of industrial development.

The East African Economic Community (EAEC) was established in 1967 by Kenya, Tanzania, and Uganda as a common market. It was dissolved in 1979 and the three members later joined with other states to establish the Preferential Trade Area for Eastern and Southern African States (PTA) in 1981. Its goals include the establishment of a common market and the promotion of economic cooperation among its members.

The Gulf Cooperation Council (GCC) was established in 1981 in the Middle East. It was established as a free trade area covering industrial and agricultural products (excluding petroleum products). It has the United Arab Emirates, Bahrain, Saudi Arabia, Oman, Qatar, and Kuwait as members. The GCC has traversed the path to becoming a common market.

The Arab Maghreb Union was set up in 1989 to lay the foundations for a Maghreb economic area. It was established by Algeria, Libya, Mauritania, Morocco, and Tunisia with rotating leadership between members. However, traditional rivalries between Morocco and Algeria have currently put all its activities into cold storage.

COMMODITY ARRANGEMENTS

A distinguishing feature of international economic relations of the present day is the existence of international commodity agreements or organizations. These take the form of commodity price agreements and cartels in which countries cooperate with each other to control the production, pricing, and sale of primary products that are traded internationally. A commodity cartel is a group of producing countries that wish to protect themselves from the fluctuations that often occur in the prices of primary commodities (for example, oil, coffee, rubber, cocoa, etc.) which are traded internationally. The basic objective of a cartel is to look for higher as well as more stable prices for their goods by limiting overall output and assigning production quotas to individual member countries.

 

Countries which rely on export earnings through the sale of primary commodities may be distinguished from exporters of manufactured goods in the following ways:

• There is usually greater price competition among sellers of primary commodities since they are larger in number and also because primary commodities are more or less homogeneous. The manufacture of computers, for example, needs copper. While there are only three to four countries which manufacture computers, there are at least a dozen different producers of copper making its supply more abundant and making it difficult for an individual producer to dictate its price.
• There is also greater supply variability in the market for primary goods because production often depends on uncontrollable factors such as the weather. This causes a great deal of volatility in the prices and export earnings of primary cartels.

The two most important commodity cartels influencing the world economy today are the Organization of Petroleum Exporting Countries (OPEC) and the former Multi Fibre Arrangement (MFA).

Multi Fibre Arrangement (MFA)

The Multi Fibre Arrangement (MFA) governed the world trade in textiles and garments from 1974 to 2004, imposing quotas on the amount that developing countries could export to developed countries. It expired on 1 January 2005. The MFA was introduced in 1974 as a short-term measure intended to allow developed countries to adjust to imports from the developing world. This was especially because developing countries have a natural advantage in textile production since they use labour-intensive technology which is cost-effective.

Although the MFA was signed in 1974, its roots stretch back to the 1930s. At that time, during a period of global economic distress, Japan emerged as the largest exporter of cotton textiles, and the United States and Europe moved to limit imports from Japan to preserve their domestic markets for their own textile industries. These restraints never really went away. By the 1960s, they had been extended to Hong Kong, Pakistan, and India. As the restraints on textile trade became globalized, multilateral negotiations ensued, leading to a series of agreements. Initially, the agreements covered only cotton, but they eventually expanded into “multifibre” arrangements covering textiles and clothing made from all fibres; cotton accounts for about 38 per cent of world fibre consumption.

At the heart of the MFA were a set of bilateral agreements between developed-country importers, such as the United States, and developing-country exporters, such as China and Bangladesh. The MFA did not apply to trade among the developed countries. The number of US bilateral export restraint agreements grew from a single agreement with Japan in 1962 to agreements with 30 countries by 1972 and with 40 by 1994. Each agreement governed trade in as many as 105 categories of textiles and clothing, with new categories added to the agreements as the need to avoid market disruption arose.

Impact of MFA

The MFA had a multifarious impact on different countries of the world. The impact on the United States and the EU was fairly simple. By limiting imports, the United States and the EU raised their domestic prices of clothing. Domestic production rose, and domestic consumption fell.

Outside of these two markets, however, the effects were more complex, as the restraints on one set of countries created opportunities for others, driving changes in world clothing markets. Limits on exports by Japan and Hong Kong increased export opportunities for Taiwan and South Korea. Restraints then imposed on Taiwan and South Korea increased opportunities for Thailand and Indonesia. In this way, the MFA grew, but investment in clothing production also spread. Entrepreneurs from countries limited by the MFA shifted capital and expertise to countries that otherwise lacked the ability to export significant amounts of clothing. So, for some countries, the attempt to limit global exports actually spurred an increase in their exports.

Another twist to the MFA's impact came from the NAFTA and from similar regional trade arrangements between the EU and its neighbouring countries. Typically, these agreements relax or remove the quota restrictions on neighbouring exporters. Examples include Mexico in the case of the United States, and Turkey and other Mediterranean countries for the EU. In this way, Mexico and Turkey benefited indirectly from the MFA's restraints on their competitors.

Life After MFA

According to the pre-expiration academic literature, the MFA expiration was expected to have the following effects on South Asia:

• Benefit to consumers: Elimination of quotas would benefit consumers, basically due to lower prices and an increase in apparel exports.
• Increased trade: The MFA expiration would enlarge world trade of textile and apparel products, and developing countries would further gain market share.
• Production shift to low-cost countries: Production would be reallocated away from high-cost countries that were producing only to take advantage of their quota. Predicted big losers were countries in which more than three-quarters of all apparel exports were in highly restricted quota categories, such as Lesotho, Haiti, Honduras, El Salvador, Nicaragua, and Kenya (Okun 2004).¹⁶ Countries like Pakistan, Vietnam, South Korea, Hong Kong, and Taiwan with preferential access to US and EU markets would, however, benefit.
• Shift to lower-value products: As quotas are measured by quantity, not value, manufacturers seek to produce the highest value products possible under a given quota. Experts, thus, expected a shift to production of lower-value products.
• Shift from Latin America to South Asia: Small exporting countries were at a historical advantage in the MFA system because they were less likely to bump up against quota limits than bigger countries like China and India. Since the mid-1990s, however, relatively large suppliers like Mexico, Turkey, and Central European countries benefited from the quota system as they were given preferences by the dominant importing countries. Thus, experts expected a rejuvenation of market share for South Asia vis-à-vis these countries and regions.
• Incentive to rationalize production: As market share is fixed, quotas reduced the incentive to upgrade technologically to capture market share, thereby, stunting productivity growth. Quotas also kept exporters like Hong Kong in the textile and apparel business long past the time when manufacture in Hong Kong made sense from a pure labour-cost perspective. Therefore, greater post-MFA competition would provide incentives to upgrade facilities and to rationalize production processes. It is expected that countries such as India, in particular, would benefit from reforms aimed at generating more efficient factory-produced outputs of consistent quality. The MFA had encouraged a highly decentralized organization in India that focused on the capture of niche markets leading to more sub-contracting of output than in any other country. Consequently, it is hoped that production would be more regulated and rationalized in the post-MFA regime.

Organization of Petroleum Exporting Countries (OPEC)

The Organization of the Petroleum Exporting Countries (OPEC) is an intergovernmental organization, created at the Baghdad Conference on 10–14 September 1960, by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. The OPEC was created in response to the imposition of import quotas on crude oil and refined products by the United States in 1959. The US government established the Mandatory Oil Import Quota program (MOIP), which restricted the amount of imported crude oil and refined products allowed into the United States and gave preferential treatment to oil imports from Canada, Mexico, and, somewhat later, Venezuela. This partial exclusion of Persian Gulf oil from the US market depressed prices for Middle Eastern oil; as a result, posted oil prices (price paid to the selling nations) were reduced in February 1959 and August 1960.

The five founding members were later joined by nine other members: Qatar (1961), Indonesia (1962), Great Socialist People's Libyan Arab Jamahiriya (1962), United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973–1992), Gabon (1975–1994), and Angola (2007). OPEC had its headquarters in Geneva, Switzerland, in the first five years of its existence. This was moved to Vienna, Austria, on 1 September 1965.

OPEC's objective is to coordinate and unify petroleum policies among member countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry. The decision-making centre of OPEC is the Conference, comprising national delegations of oil ministers, which meets twice each year to decide overall oil output and, thus, prices, and to assign output quotas for the individual members. Those quotas are upper limits on the amount of oil each member is allowed to produce. The Conference may also meet in special sessions when deemed necessary, particularly when downward pressure on prices becomes acute.

OPEC faces the classic cartel enforcement problem—overproduction and price cheating by members. At a higher cartel price, less oil is demanded. As a result, output quotas are necessary so that each member of OPEC has an incentive to sell more than its quota by “shaving” (cutting) its price because the cost of producing an additional barrel of oil is usually well below the cartel price. The methods available to engage in such cheating are numerous—sellers can extend credit to buyers for periods longer than the standard thirty days, sellers can sell higher grades (or blends) of oil for prices applicable to lower grades, sellers can give transportation credits, sellers can offer buyers side payments or rebates, and so on.

This tendency of individual producers to cheat on a cartel agreement is a long-standing feature of OPEC behaviour. Individual producers have usually exceeded their production quotas, and so official OPEC prices have been somewhat unstable. However, unlike the classic “textbook” cartel, OPEC is unusual as it has one producer, Saudi Arabia, which is much larger than the others. This condition has caused Saudi Arabia to serve, from time to time, as the OPEC swing producer, that is, the producer that adjusts its output in order to preserve the official price in the world market. One reason for the Saudis to act as swing producers is that downward pressure on the official price imposes larger total losses on them than on the other OPEC producers in the short run. The Saudis, in their efforts to defend the official OPEC price, have periodically reduced their sales (at times dramatically), thus, reducing their revenues substantially. In 1983, 1984, and 1986, for example, the Saudis produced only about 3.5 million barrels per day, despite their (then) production capacity of about 10 million barrels per day.

OPEC rose to international prominence during the 1970s, as its member countries took control of their domestic petroleum industries and acquired a major say in the pricing of crude oil in world markets. There were two oil pricing crises, triggered by the Arab oil embargo in 1973 and the outbreak of the Iranian Revolution in 1979, but fed by fundamental imbalances in the market; both resulted in oil prices rising steeply.

In the 1980s, prices initially peaked, before beginning a dramatic decline, which culminated in a collapse in 1986—the third oil pricing crisis. Prices rallied in the final years of the decade, without approaching the high levels of the early-1980s, as awareness grew of the need for joint action among oil producers if market stability with reasonable prices was to be achieved in the future. Environmental issues began to appear on the international agenda.

A fourth pricing crisis was averted at the beginning of the 1990s, on the outbreak of hostilities in the Middle East, when a sudden steep rise in prices in panic-stricken markets was moderated by output increases from OPEC Members. Prices then remained relatively stable until 1998, when there was a collapse, in the wake of the economic downturn in Southeast Asia. Collective action by OPEC and some leading non-OPEC producers brought about a recovery. As the decade ended, there was a spate of mega-mergers among the major international oil companies in an industry that was experiencing major technological advances. For most of the 1990s, the ongoing international climate change negotiations threatened heavy decreases in future oil demand.

The early twenty-first century brought the oil market to new heights as demand soared, particularly due to growth in Asia. OPEC members enjoyed the benefits of the boom, with prices rising to an all-time high. However, as the old adage goes, “what goes up must come down”. The 2008 global economic crisis created a plunge in revenue, as prices fell by roughly 80 per cent. However this time, OPEC proved to be more unified, as on 18 December 2008, OPEC members announced the largest production cut in history, which helped them deal with the crisis. Thus, by 2009, oil prices had substantially recovered.

Commodity cartel

Commonn market

Customs union

Economic integration

Economic union

EU

Free trade area

MERCOSUR

NAFTA

Political union

1. What is economic integration? Explain the different stages in the integration of economies giving suitable examples.
2. Trace the different stages in the formation of the European Union.
3. NAFTA has produced significant benefits for the Canadian, Mexican and US economies. Discuss these benefits.
4. Write short notes on:
   1. ASEAN
   2. APEC
   3. SAARC
   4. MERCOSUR
5. Discuss the costs and benefits of economic integration.
6. What are commodity arrangements? Briefly discuss the functioning of OPEC as a leading commodity arrangement.
7. MERCOSUR got off to a promising start but faltered and has made little progress since 2000. How can the functioning of MERCOSUR be made more efficient?

1. An Indian exporter of garments wants to open a representative office in Italy and needs a report on the risks and costs involved in taking such a step. Prepare a report listing the factors you consider relevant to taking such a step, using information from http://ec.europa.eu/youreurope/business/index_en.htm.
2. Estonia adopted the euro on 1 January 2011, switching over from the kroon. Write out a report on the implications of this for Estonian business, using information from http://ec.europa.eu/news/economy/101228_en.htm.