185
CHAPTER 17
ECONOMIC INTEGRATION
Learning Objectives:
■ Differentiate among the four basic levels of economic integration.
■ Identify the static and dynamic effects of economic integration.
I. Outline
Introduction
– Promise and Problems of Integration
Types of Economic Integration
– Free-Trade Area
– Customs Union
– Common Market
– Economic Union
The Static and Dynamic Effects of Economic Integration
– Static Effects of Economic Integration
– General Conclusions on Trade Creation/Diversion
– Dynamic Effects of Economic Integration
– MERCOSUR
– FTAA
– Chilean Trade Agreements
– APEC
– Trans-Pacific Partnership
– Transatlantic Trade and Investment Partnership
Summary
II. Special Chapter Features
186
In the Real World: Asian Economic Interdependence Leads to Greater Integration
III. Purpose of Chapter
The purpose of this chapter is to extend the study of trade policy to the situation of
discriminatory policy regimes, exemplified by economic integration units such as free-trade
areas and customs unions. To acquaint the student with real-world economic integration,
considerable attention is devoted to the history and development of the European Union.
Coverage is also given to integration in North America and other major integration units.
IV. Teaching Tips
A. The chapter begins with a brief look at the enlargement of the EU over time. This
provides a nice opportunity to discuss the potential benefits to the EU and why nations would
B. In discussing Figure 2 on trade diversion, it is useful to stress that there is some trade
creation going on in this “trade–diverting” customs union. The 30 units between 100 and 130
constitute creation in Viner’s sense, because those units represent previous domestically–
C. The graph in Concept Box 1 on page 397 may be hard for the students to follow, but we
think that its message is a good one. Emphasis on the graph can also test whether the students
truly understand the neoclassical trade diagram.
187
V. Answers to End-of-Chapter Questions and Problems
1. This customs union has no possibilities for trade creation in the Viner sense because the
two countries have no common domestic industries for yielding displacement of a higher-cost
domestic industry by a lower-cost partner supplier. However, there are great possibilities for
2. The reasoning behind this view is that, because the developing countries produce similar
products, they are not likely to be sources for each other of new, different products vital to the
development effort. Even granting the questionable assumption that the developing countries are
3. The motivation was that the United States feared that Portugal and Spain would, through
trade diversion, switch their purchases of some agricultural goods away from the United States
4. By reducing (usually eliminating) tariffs only on developing-country goods coming into
developed countries, the action is a discriminatory trade policy measure, as is the formation of an
5. Trade diversion against U.S. exports could have occurred as barriers within Europe were
dismantled. Further, dynamic effects such as enhanced technology and scale economies could
6. It can be argued that the development of APEC and the Trans-Pacific Partnership
alongside the efforts in the Western Hemisphere (e.g., NAFTA) represent a movement toward
world free trade in that there are several members (Canada, Chile, Mexico, and the United
7. U.S. workers, especially in labor-intensive industries, worried that freeing up trade with
labor-abundant Mexico would cause U.S. workers to lose their jobs or receive lower wages.
These results were thought to be even more likely because U.S. firms will also switch production
to Mexico because of the lower wages there. Hence, fears arose and continue to arise because of
8. (a) The basis for this statement is the fact that specific coalitions contain elements of
both trade creation and trade diversion. The static effects of these coalitions can thus be negative
if trade diversion effects are greater than trade creation effects, whereas no trade diversion
effects occur with a general lowering of protection by everyone. In addition, there is the fear that
189
blocs that would represent a movement away from freer trade.
(b) The establishment of new trading coalitions should be encouraged because they
represent a clear first step towards freer world trade. This is particularly so if the coalitions
VI. Sample Exam Questions
A.
E
Es
ss
sa
ay
y
Q
Qu
ue
es
st
ti
io
on
ns
s
1. Jacob Viner originally envisioned a situation where, in the demand/supply graph of a
trade-diverting customs union, the demand curve was vertical and all supply curves (including
the supply curve of domestic producers) were horizontal. In this situation, could the trade-
diverting customs union ever enhance the home country’s (country A’s) welfare? Explain.
2. (a) Define “trade creation” in the context of the formation of a customs union. Then,
using a demand/supply diagram of a (small) home country for a good that is produced at
3. Other things equal, would the formation of a customs union with many members be more
likely or less likely to improve welfare for a given member country than the formation of a
customs union with only a few members? Why or why not? Other things equal, would the
190
4. Conceptually, what would happen to relative factor prices in labor-abundant country A
and capital-abundant country B if the two countries joined together into a customs union? Why?
5. How could the formation of an economic integration unit among several countries
actually result in the countries trading to a greater extent in absolute terms with the outside
world than before the union was formed? What factors would you consider in assessing whether
this result would be likely to occur? Explain.
6. When the European Community was originally formed, it was determined that the
common external tariff on outside world products should be equal to the average of the preunion