978-0134200057 Chapter 8 Lecture Notes

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CHAPTER EIGHT

CROSS-NATIONAL COOPERATION

AND AGREEMENTS

OBJECTIVES

8-1 Define the three major types of international economic integration

8-2 Explain what the World Trade Organization is and how it is working to reduce trade

barriers on a global basis

8-3 Summarize the major benefits of regional economic integration

8-4 Compare and contrast different regional trading groups

8-5 Describe the forces that affect the prices of commodities and their impact on

commodity agreements

CHAPTER OVERVIEW

Chapter Eight first introduces the forms of economic integration and examines the roles

of the General Agreement on Tariffs and Trade (GATT) and the World Trade

Organization (WTO) in the expansion of world trade. It then discusses the major benefits

of regional economic integration. It also examines and compares the major regional

trading groups. The chapter concludes with a discussion of various commodity

agreements and producer alliances, including the Organization for Petroleum Exporting

Countries.

CHAPTER OUTLINE

OPENING CASE: TOYOTA’S EUROPEAN DRIVE

Toyota, the largest auto manufacturing company in the world, sells vehicles in 170

countries and regions, has 54 manufacturing companies in 28 countries and regions

outside of Japan, and has R&D facilities worldwide. In Europe, Toyota has

manufacturing facilities in six countries, including France where the Yaris is

manufactured. It also has R&D facilities in Belgium, the U.K., Germany, and France.

So why has it taken Toyota so long to crack into the competitive European market, and

why are European companies only now beginning to feel the pressure from Asian

manufacturers? Many analysts have pointed to an agreement between the Japanese

government and the European Community (predecessor to the European Union) in which

the two negotiated a quota each year for the number of Japanese cars imported into

Europe. When the quota system and other restrictions were lifted in 1999, Toyota

responded by establishing a European Design and Development center in southern France

and capturing distinct cost advantages by setting up additional production centers in East

Europe. Toyota’s European market share and profitability began to grow steadily.

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Riding on its success in Europe in the mid-2000s and its growth internationally, Toyota

had ambitious goals for the future. However, the global financial crisis and the ongoing

difficulties posed by international recalls of more than 9.5 million vehicles have put a

crimp in those plans. In addition, the 2011 earthquake and tsunami in Japan severely

disrupted Toyota’s supply chain. By 2015, Toyota had only 4.2 percent of the European

market, well behind market leader VW with 24.9 percent.

I. FORMS OF ECONOMIC INTEGRATION

Trading groups are a significant influence on the strategies of MNEs because they define

the size of regional markets and the rules by which companies must operate. Economic

integration is the political and economic agreements among countries that give

preference to member countries in the agreement. Approaches to economic integration

include global integration via the World Trade Organization, bilateral integration via

cooperation between two countries, and regional integration via cooperation between

countries in the same geographic proximity.

II. THE WORLD TRADE ORGANIZATION (WTO)—Global Integration

The World Trade Organization has become the primary multilateral forum through which

governments conclude trade agreements and settle associated disputes.

A. GATT: The Predecessor to the WTO

The General Agreement on Tariffs and Trade (GATT) was established in 1947 by

twenty-three nations as a multilateral agreement whose objective was to abolish

quotas and reduce tariffs.

1. Trade without Discrimination. The fundamental principle of “trade without

discrimination” was embedded in the Most Favored Nation (MFN) clause, i.e.,

the principle that each member nation must open its markets equally to every

other member nation. Several major rounds of negotiations from 1947 to 1993

led to a wide variety of multilateral reductions in both tariff and nontariff

barriers. At the conclusion of the Uruguay Round in 1994, the World Trade

Organization was created in 1995 for the purpose of institutionalizing the GATT.

B. What Does the WTO Do?

The World Trade Organization (WTO) was founded in 1995 as a permanent world

trade body for the purposes of (i) facilitating reciprocal trade negotiations and (ii)

enforcing trade agreements between or among member nations. The WTO adopted the

principles and agreements reached under the auspices of the GATT, but it expanded its

mission to include trade in services, investment, intellectual property, sanitary measures,

plant health, agriculture, textiles, and technical barriers to trade. Currently, the 153

member countries of the WTO collectively account for more than 97 percent of the value

of world trade. Major decision-making units include: the Ministerial Conference, the

General Council, the Council for Trade in Goods, the Council for Trade in Services, and

the Council for Trade-Related Intellectual Property Rights (TRIPS).

1. Most Favored Nation. The WTO continued the MFN clause of GATT, which

suggests that member countries trade without discrimination giving foreign

products “national treatment.” With the following exceptions, it restricts this

privilege to official members:

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Developing countries’ manufactured products have been given preferential

treatment over those from industrial countries.

Concessions granted to members within a regional trading alliance, such as

the EU, have not been extended to countries outside the alliance.

Countries can raise barriers against other member countries if they feel they

are trading unfairly. Exceptions can be made in times of war or international

tension.

2. Dispute Settlement. Under the WTO there is now a clearly defined

mechanism for the settlement of disputes. Countries may bring charges of unfair

trade practices to a WTO panel; accused countries may appeal; WTO rulings are

binding. If an offending country fails to comply with a judgment, the rights to

compensation and countervailing sanctions will follow. The Doha Round began

in Doha, Qatar in 2001 to address disputes between developed and developing

nations. Issues surrounding agricultural subsidies were particularly difficult. As

of 2009, the Doha agenda is on hold until the economic crisis is resolved. There

is still hope that the Doha agenda is not dead and can be used to reduce trade

barriers and increase world trade.

III. REGIONAL ECONOMIC INTEGRATION

a. Bilateral Agreements

Bilateral agreements can be between two individual countries or may involve one

country dealing with a group of other countries. Regional trade agreements are

reciprocal pacts between two or more partners that lie somewhat between bilateral

treaties and the WTO. Some of the best-known RTAs are the European Union, the

North American Free Trade Agreement (NAFTA), and the ASEAN (Association of

Southeast Asian Nations) Free Trade Area (AFTA).

b. Geography Matters

Geographic proximity is an important reason for economic integration. Geography

matters for several reasons in the case of RTAs. Neighboring countries often share a

common history, language, culture, and currency. Unless the countries are at war

with each other, they have usually developed trading ties already. Close proximity

reduces transportation costs, thereby making traded products cheaper in general. The

major types of economic integration are:

Free Trade Agreements, in which all barriers to trade, i.e., tariff and

nontariff barriers, are abolished among member nations, but each member

determines its own external trade barriers with non-FTA countries.

Customs Unions, in which all barriers to trade, i.e., tariff and nontariff

barriers, are abolished among member nations and common external barriers

are levied against non-member countries.

Common Market. Beyond the reduction of tariffs and nontariff barriers,

countries can enhance their cooperation in a variety of other ways. Adding

free mobility of production factors to a customs union results in a common

market.

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c. The Effects of Integration

Regional economic integration can affect member countries in social, cultural,

economic, and/or political ways. (MNEs are, or course, particularly interested

in the economic effects.)

1. Static and Dynamic Effects. Static effects represent the shifting of

resources from inefficient to efficient firms as trade barriers fall.

Dynamic effects represent the gains from overall market growth, the

expansion of production, the realization of greater economies of scale and

scope, and the increasingly competitive nature of the market. Static

effects may occur when either of two conditions occurs.

a. Trade Creation. Trade creation occurs when production shifts from less

efficient domestic producers to more efficient regional producers for

reasons of absolute or comparative advantage.

b. Trade Diversion. Trade diversion Trade diversion—trade shifts to

countries in the group at the expense of trade with countries not in the

group.

c. Economies of Scale. Dynamic effects of integration occur when trade

barriers come down and markets grow. Because of that growth,

companies can increase their production, which will result in lower costs

per unit—a phenomenon we call economies of scale.

d. Increased Competition. Another important effect of an RTA is greater

efficiency due to increased competition.

IV. MAJOR REGIONAL TRADING GROUPS

Trading groups can be organized by type and/or location. Firms are interested in regional

trading groups because they can serve as potential markets, sources of raw materials, and

production locations.

A. The European Union

The European Union (EU) represents the most advanced regional trade and

investment group in the world today.

1. Predecessors. The EU evolved from the European Economic Community

(EEC) to the European Community (EC) to the European Union (EU). [Key

milestones are summarized in Table 8.2.] The European Free Trade

Association (EFTA) consists of Iceland, Liechtenstein, Norway, and

Switzerland; all but Switzerland are linked to the EU via a customs union.

2. Organizational Structure. Detailed information on the history, structure,

and function of the EU is available on its extensive Web site. [see Map 8.1.]

a. Key Governing Bodies.

The European Commission provides political leadership, drafts laws,

and runs the various daily programs of the EU.

The Council of the European Union, or European Summit, is

composed of the heads of state of each member country.

The three major responsibilities of the European Parliament are

legislative power, control over the budget, and supervision of executive

decisions.

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The European Court of Justice ensures consistent interpretation and

application of EU treaties.

3. Antitrust Investigations. The EU has been very aggressive in enforcing

antitrust laws in a variety of areas, including high-tech companies like

Microsoft and Google on charges that they were harming competitors

because of their dominant market positions, Apple and Amazon on suspicion

that they were receiving unfair tax advantages from Ireland and Luxembourg

respectively, and Facebook on allegations that it was violating privacy

policies.

4. The Single European Act. The EU has been moving toward a

single market ever since the passage of the Single European Act. It is

designed to eliminate any remaining nontariff barriers to trade in Europe.

5. Monetary Union: The Euro. The Treaty of Maastricht, signed in 1992,

sought to foster both political and monetary union within the EU. While the

move toward a common currency has partially eliminated different currencies

as a barrier to trade, not all members have adopted the euro. As of 2016, 19 of

the 28 EU members had adopted the euro. Others are preparing to do so as

well, while only Denmark and the United Kingdom have opted out of the

common currency. Other European countries also use the euro, even though

they are not EU members.

6. The Schengen Area. To facilitate the free flow of people from country to

country within the EU, the Schengen Agreement was signed in 1990 with

gradual implementation allowing citizens to cross-internal borders without

having to go through border checks. Not all members of the EU, including the

UK and Ireland, have opted to be in the Schengen Area, whereas some

non-EU states, such as the EFTA countries, are part of it.

7. Migration: A Threat to Schengen. Migration and terrorism are threatening

the open borders that are at the heart of the Schengen Agreement.

8. Expansion. The EU expanded from 15 to 25 countries in 2004 with

countries from mostly Central and Eastern Europe. Romania and Bulgaria

were admitted in 2007 and Croatia in 2013, bringing the number to 28.

9. Bilateral Agreements. In addition to reducing trade barriers for

member countries, the EU has signed numerous bilateral free trade

agreements with other countries outside the region.

10. The Transatlantic Trade and Investment Partnership (T-TIP). One

of the more intriguing potential agreements involves the United States

and the EU. Even though tariffs between the two superpowers are

already low (the United States and the EU have the world’s largest

trading relationship and account for nearly half of the world’s economic

output), the new agreement would eliminate the remaining tariffs, boost

trade between the regions, and aid in harmonizing product standards

between them.

7. How to do Business with the EU: Implications for Corporate

Strategy. There are at least three ways in which the competitive strategies of

foreign firms that choose to do business within the EU are affected. First,

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they must determine their production site location(s) on the basis of total costs

that include labor, transportation, and other strategic factors. Second, foreign

firms must decide upon an entry strategy, i.e., new investments, expanding

existing investments, or joint ventures and mergers. Third, firms must be

sensitive to essential national differences, particularly in areas such as

economic growth rates and cultural traditions. In addition, the trade-offs

between the advantages of pan-European strategies and more localized

strategies must be continually examined.

B. North American Free Trade Agreement (NAFTA)

Effective as of January 1, 1994, the North American Free Trade Agreement

(NAFTA) incorporates Canada, Mexico, and the United States into a regional

trade bloc of countries of quite different sizes and sources of national wealth.

1. Why NAFTA? More than a mere free trade agreement and claiming a total

GNI greater than that of the 27-member EU, NAFTA calls for the

elimination of tariff and nontariff barriers, the harmonization of trade rules,

the liberalization of restrictions on services and foreign investment, the

enforcement of intellectual property rights, and a dispute settlement process.

NAFTA makes logical sense in terms of geographical location and trading

importance. Two-way trade between the United States and Canada is the

largest in the world. NAFTA extends its cooperation beyond tariff

reductions to include provisions for services, investments, and intellectual

property. NAFTA has provided both static and dynamic effects. Canada and

the U.S. benefit from the lower-cost agricultural products from Mexico and

U.S. producers benefit from the growing Mexican market. NAFTA is a good

example of trade diversion in which Canadian and U.S. companies have

shifted some production facilities to Mexico from Asia due to the benefits of

the trade agreement.

2. Rules of Origin and Regional Content. NAFTA’s rules of origin

require that at least 50 percent of the net cost of most products originate

within the region if those products are to be eligible for the more liberal

tariff conditions within the bloc.

3. Special Provisions. NAFTA is a unique sort of trade agreement in that it

also addresses two side issues: (i) regional labor laws and standards and (ii)

strengthened environmental standards.

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4. The Impact of NAFTA. There are pros and cons to any trade

agreement, and NAFTA is no exception. It is obvious that trade and

investment have increased significantly since the agreement was

signed in 1994. The major challenge to NAFTA is immigration. As trade

in agriculture increased with the advent of NAFTA, more than a million

farm jobs disappeared in Mexico due to U.S. competition. Many of these

farmers ended up as undocumented workers in the United States, sending

home more money in wire transfers than Mexico receives in FDI. Rapid

economic growth in the United States compared with Mexico in the 1990s

also resulted in a rise in migration from Mexico to the United States.

However, that has now changed due to smaller families and a stronger

economy in Mexico.

5. How to Do Business with NAFTA: Implications for Corporate

Strategy. Although NAFTA has not expanded beyond the original three

countries due to political obstacles, each member of NAFTA has entered

into bilateral agreements with other countries.

6. Rationalization of Production. One of the predictions made when NAFTA

was signed was that companies would look at it as one big regional market,

allowing them to rationalize production, products, financing, and the like.

That has largely happened in a number of industries, especially in

automotive products and electronics. An interesting development in recent

years is the decision by Chinese firms to invest more in Mexico as a

platform for manufacturing electronics to ship into Canada and the United

States.

7. Mexico as a Consumer Market An additional benefit is that Canadian and

U.S. companies have realized that Mexico is a consumer market rather than

just a production location.

C. Regional Economic Integration in the Americas

There are six major regional economic groups in the Americas, divided into

Central American and South American [see Maps 8.2 and 8.3], Central America

(excluding Mexico) has the Caribbean Community (CARICOM), the Central

American Common Market (CACM), and the Central American Free Trade

Agreement (CAFTA-DR)—which includes the members of CACM but also

Honduras and the Dominican Republic, along with the United States. The two

major groups in South America are the Andean Community (CAN) and the

Southern Common Market (Mercosur). The Andean Community is a customs

union, whereas Mercosur is set up to be a common market. The major reason for

these different collaborative groups was market size. This economic cooperation

is intended to enlarge the potential market size so that Latin American

companies could achieve economies of scale and be more competitive

worldwide.

1. CARICOM: Benchmarking the EU Model. The Caribbean

Community is working hard to establish an EU-style form of collaboration, one

that would mirror the EU, but on a smaller scale.

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2. MERCOSUR. Mercosur is a customs union among Argentina, Brazil,

Paraguay, and Uruguay.

3. Pacific Alliance. Created in 2012, it has four member states bordering with

pacific: Mexico, Colombia, Peru, and Chile.

4. Andean Community (CAN). Started in 1969, CAN is the second

most important regional group in South America but has not been

successful in

achieving its original goals.

D. Regional Economic Integration in Asia

Regional economic integration has not been as successful in Asia as in the EU or

the NAFTA region because most Asian countries have relied on U.S. and

European markets for their exports.

1. Association of Southeast Asian Nations (ASEAN). The Association

of Southeast Asian Nations (ASEAN) was first organized in 1967. [see

Map 8.4.] On January 1, 1993, it officially formed the ASEAN Free Trade

Area (AFTA) for the purpose of cutting tariffs on interzonal trade to a

maximum of 5% by 2008.

2. Asia-Pacific Economic Cooperation (APEC). The Asia-Pacific

Economic Cooperation (APEC) community was founded in 1989 to

promote multilateral economic cooperation in trade and investment in the

Pacific Rim. It is comprised of 21 countries that border the Pacific on both

the east and the west. It is a large and powerful organization that is focused

on a wide range of activities related to trade and investment, security,

energy, sustainability, anticorruption, and transparency, among other things.

However, it is not an RTA as defined by the WTO and does not show up on

that list of RTAs. The sheer size of APEC is what sets it apart: 55 percent of

global GDP and 43 percent of world trade.

3. Trans-Pacific Partnership (TPP). The TPP was initiated by the United

States to spur economic growth and create jobs, and it involves Australia,

Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru,

Singapore, the United States, and Vietnam. The formation of the initiative

was announced in 2011, the agreement was concluded in October 2015 and

signed by the trade ministers in February 2016. However, the TPP will not

actually come into effect until it is approved by the government of each

member, which is a difficult political task, especially during a contentious

election year in the United States.

E. Regional Economic Integration in Africa

Africa is truly the new frontier. The UN keeps revising its estimates of

population growth in Africa, but the latest estimates are that South Africa’s

population will double to 2.5 billion in 2050, up from 1.2 billion people in 2015,

with Nigeria having a population of 400 million. There are several African trade

groups, but they rely more on their former colonial powers and other developed

markets for trade than they do on each other [see Map 8.5.].

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1. The African Union. Created in 2002 by 53 African nations, the

African Union took the place of the Organization of African Unity (OAU),

which focused its energy and resources on political issues in Africa (notably

colonialism and racism). The new AU is modeled loosely on the EU,

although this type of integration may prove difficult in Africa.

POINT—COUNTERPOINT: Is Regional Economic Integration a Good Idea

POINT: Regional free trade agreement among a small group of countries is easy to

establish and monitor, unlike the broader agreements of the WTO. It provides a larger

market area, which will increase economies of scale and open up investment

opportunities. Countries are willing to give up sovereignty in order to receive the

economic benefits of being part of a larger community.

COUNTERPOINT: The proponents of regional integration are governments, and

they invest so much political capital in negotiating and signing agreements that they get

trapped and can never get out. Also, a dominant economic power, such as the United

States can impose its will on smaller trade partners such as those in CAFTA-DR. As free

trade agreements progress to a customs union to more extensive integration, national

sovereignty becomes gradually more compromised. It is not uncommon to overstate the

benefits and understate the shortcomings. The British found that out in 2016 as the UK

was faced with “Brexit”—a national referendum on whether or not to exit the EU

F. The United Nations and Other NGOs

1. The United Nations.

The UN was established in 1945 to promote international peace and security

and to help with global issues such as economic development, antiterrorism,

and humanitarian relief. There are 192 member states in the UN General

Assembly. The UN Conference on Trade and Development (UNCTAD) was

established to tackle problems of the developing world concerning trade

issues.

2. Non-Government Organizations (NGOs) Nongovernmental, nonprofit

voluntary organizations are all lumped under the category of NGOs: private

institutions that are independent of any government.

V. COMMODITY AGREEMENTS

A commodity agreement is designed to stabilize the price and supply of a primary

commodity such as petroleum, natural gas, copper, coffee, cocoa, tea, or sugar

because both long-term trends and short-term fluctuations in their prices have

important consequences for the world economy.

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A. Commodities and the World Economy

On the demand side, commodity markets play an important role in industrial

countries, transmitting business cycle disturbances to the rest of the

economy and affecting the rate of growth of prices. On the supply side, primary

products account for about half of developing countries’ export earnings.

B. Consumers and Producers

For many years, countries tried to band together as product alliances or joint

producers to help stabilize commodity prices. However, these efforts, with the

exception of OPEC, have not been very successful.

C. The Organization of Petroleum Exporting Countries (OPEC)

The Organization of Petroleum Exporting Countries (OPEC) is a group of

13 oil-producing countries that have significant control over supply and band

together to control output and price. Its members include Algeria, Angola,

Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the

United Arab Emirates, and Venezuela. Several of the largest oil-exporting

countries, including Russia, Norway, Canada, the United States, and Mexico, are

not members of OPEC. Saudi Arabia is the largest producer of oil, closely

followed by Russia and the United States. Saudi Arabia is also the largest net

exporter of oil, followed by Russia and the United Arab Emirates.

1. Price Controls and Politics. OPEC controls prices by establishing

production quotas on member countries. Because of the importance of

commodities to the production process, it is critical that managers

understand the factors that influence their prices. Politics play an important

role in OPEC deliberations as countries with larger populations are tempted

to exceed their quotas to generate more revenue.

2. Output and Exports. OPEC member countries produce about 33.6

percent of the world’s crude oil and 19 percent of its natural gas. However,

its oil exports represent about 60.4 percent of the oil traded internationally.

3. The Downside of High Prices. Keeping prices high has a downside for

OPEC. Higher prices encourage exploration outside of OPEC member

countries and can cause a global economic slowdown, thus lowering the

overall demand for oil.

LOOKING TO THE FUTURE:

Will the WTO Overcome Bilateral and Regional Integration Efforts?

Although the objective of the WTO is to reduce barriers to trade in goods, services, and

investment, regional groups do that and more. Regional economic integration deals with

the specific problems facing member countries, while the WTO concerns itself with trade

issues facing the world as a whole. As a result, regional integration, which is more

flexible, may help the WTO achieve its objectives as the process leads to the

liberalization of issues not covered by the WTO. Regional economic integration can also

serve to lock in trade liberalization across developing countries. No trade agreement

is easy or perfect. The WTO has serious challenges due to its size. Regional agreements

like NAFTA, the EU, Mercosur, and others have many different challenges as well.

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