Introduction to Global

Business
Chapter 3
Regional Economic Integration

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 After studying this chapter, you should be able to:

1. Explain regional economic integration, its

evolution, and its benefits and costs.
2. Identify how economic geography helps explain,
promote, and segment regional integration blocs.
3. Identify the primary reasons why countries are
now seeking to pursue regional integration at the
expense of multilateral trade liberalization.
4. Explain why the European Union is seen as the
most advanced regional integration bloc.
 After studying this chapter, you should be able to:

5. Describe how NAFTA has affected U.S.–

Mexico bilateral trade in goods and services.
6. Explain the importance of ASEAN and indicate
why Asia may become the most important
free trade region for this century.
What Is Regional Economic
Integration?
• Regional integration
Implementation of a multitude of economic and/or
political steps by member states to increase their
global competitiveness, including preferential
trade access
• Spatial transformations
The process of allowing efficient geographic
distribution of business activities within and
among countries
Stages of Regional Integration

Economic
Free- Common
Customs and Political
trade (or single)
union monetary union
area market
union
EXHIBIT 3.2 FORM AND STAGES OF REGIONAL INTEGRATION

Harmonization
Abolition of Common and Unification
Tariffs and External Tariff Abolition of of Economic
Stage of Quotas Among and Quota Restrictions on Policies
Integration Members System Factor Movements and Institutions

Free-trade area Yes No No No

Customs union Yes Yes No No

Common market Yes Yes Yes No

Economic union Yes Yes Yes Yes

Free trade area: two or more countries agree to eliminate barriers to trade but keep own external
tariff to non members.
Customs union: a group of free trade members that have adopted a common external tariff with
non members
Common market: market formed when customs union countries remove all barriers to allow
movement of capital and labor among them
Economic union: members of common market agree to implement common social programs and
coordinated macro economic policies that would lead to single regional currency
Benefits of Regional Integration
• Creating a larger pool of consumers with growing incomes
and similar culture, tastes, and social values
• Encouraging economies of scale in production, increasing
the region’s level of global competitiveness, and enhancing
economic growth through investment flows
• Freeing the flow of capital, labor, and technology to the
most productive areas in the region
• Increasing cooperation, peace, and security among
countries in the region
• Encouraging member states to enhance their social
welfare to match that of the most progressive states. e.g.
migration related issues may occur alone with economic
integrations
Costs of Regional Integration
• Undermining the most-favored-nation status rule, an
essential principle of the WTO
• Imposing uniform laws and regulations that at times do
not take into account national economic, cultural, and
social differences
• Eliminating jobs and increasing unemployment in
protected industries
• Losing sovereignty, national independence, and identity
• Reducing the powers of the national government
• Increasing the problems of illegal drugs and terrorism due
to the ease of cross-border labor movement
The Economic Geography of Regional Integration
Economic geography
The study of principles that govern the Steps to Regional
efficient spatial allocation of economic Integration
resources and the resulting
consequences
1 Start small

2 Think global

Positive changes related to market

size, location, and openness to Compensate the
3
trade are essential for successful least fortunate
regional integration
Does Regional Integration
Confound Global Trade?

North
American
European
Free Trade
Union (EU)
Agreement
(NAFTA)

Association
Regional
of South East
Integration in
Asian Nations
Latin America
(ASEAN)
The European Union (EU)
• EU is most highly evolved regional integration:
EU grew out of European Coal and Steel Community
(ECSC).
The Treaty of Rome in 1957 established the European
Economic Community (EEC).
The Maastricht Treaty in 1992 created the EU as a full
economic union with free movement of labor among
its member countries.
The euro was adopted as a common currency in 1992.
Economic coordination and fiscal stability is challenged
by the sovereign debt crisis of some members.
The North American Free-Trade
Agreement (NAFTA)
• Canada, United States, and Mexico reached a
comprehensive trade agreement in 1994.
• Major NAFTA objectives:
Trade expansion through the phased elimination of
all trade barriers
Protection of intellectual property rights
Creation of institutions to address unfair trade
practices, trade disputes, environmental
protection, worker’s rights, competition policies,
and implementation of NAFTA rules and
regulations
Association of South East Asian Nations
(ASEAN)
• ASEAN’s objectives:
To accelerate economic growth, social progress, and
cultural development in the region
To promote peace and stability through the rule of
law in relationships among countries in the region
• Bases for ASEAN:
ASEAN Security Community (ASC)
ASEAN Economic Community calls for one single market but
does not call for free labor movements
ASEAN Sociocultural Community
Regional Integration in Latin
America
• The Treaty of Montevideo in 1960 created the
Latin American Free Trade Association (LAFTA).
• Bolivia, Chile, Colombia, Ecuador, and Peru
created the Andean Group in 1969.
• Treaty of Asunción in 1991 among Argentina,
Brazil, Paraguay, and Uruguay, created the
Southern Cone Common Market, or MERCOSUR
(Mercado Común del Sur).
• DR-CAFTA (Dominican Republic and Central
American Free Trade Agreement) became
effective in 2005.
 Key Terms
regional integration economic and monetary union
spatial transformations political union
free-trade area economic geography
customs union
common market or single
market
 Chapter 4
The International Flow of
Funds and Exchange Rates

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The Balance of International
Payments
• Balance of payments (BOP)
Shows all transactions between one country and the rest of
the world for a given period of time--it is an objective
standard that shows how ell a country’s economy and
policies are performing
Current account
Shows the activities of consumers and businesses in the economy with respect to
the trade balance, services balance, income balance, and net transfers
Financial account
Consists of domestic-country-owned assets abroad, foreign-owned assets in the
domestic country, and net financial derivatives
 Balance of Payments (BOP)
Current Account

Trade Services Income Net

balance balance balance transfers

Financial Account

U.S. assets Foreign assets Net financial

abroad in the U.S. derivatives
The Financial Account of the
BOP
• Risk premium
The added return required by investors for risk associated with a security
or asset, as foreign investors are reluctant to continue investing in
countries with long period of account deficit
• Foreign direct investment (FDI)
The purchases of fixed assets (such as factories and equipment) abroad
used in the manufacture and sales of goods and services abroad. It
greatly affect a country’s Forreign Assests in its BOP.
• Statistical discrepancy
Reconciles imbalances between the current account and financial
account to ensure that debit and credit entries in the BOP statement
sum to zero—financial account balance is intended to offset the
imbalance in the current account, but the offset is not complete.
 Foreign Exchange Markets

Setting Exchange Rates

Independent floating Managed floating Fixed exchange

exchange rate system exchange rate system rate system

An exchange rate means a price at which one currency can be converted to another one.
In a free market economy system, major currency values are decided by market demand
and supply
International Monetary
Systems
International monetary systems have developed to facilitate
international trade, governments have been working together to
promote stable exchange rates and world trade:

• Gold standard
Monetary system that pegs currency values to the market value of gold
• Bretton Woods Agreement
The 1944 decision to establish a global currency system with the U.S.
dollar pegged at a fixed rate of exchange to gold, and the currencies of
43 other countries fixed to the dollar
• International Monetary Fund (IMF)
The financial authority established under the Bretton Woods Agreement
to help ensure the stability of the international monetary and financial
system
Development of the Flexible
Exchange Rate System
• Smithsonian Agreement
The 1971 decision allowing the United States to devalue the
dollar against other countries’ currencies
• Jamaica Agreement
The 1976 international monetary order that allowed
countries to adopt different exchange rate systems
including floating their currencies in world markets

Currency values are then decided by market demands and

supply—but under influence of factors like current account
balance, economic conditions, inflation and interest rates,
and Central Banks interventions!
Valuing (or Devaluing)
Currencies
• Clean float currency
Monetary system with minimal government intervention;
largely market determined
• Dirty float currency
Monetary system with varying degrees of government
intervention to maintain a range of acceptable values
against other currencies
• Special drawing right (SDR)
A basket of currencies (dollars, euros, pounds, and yen)
created by the IMF for use as a benchmark to value the
currencies of different countries
What’s in Your Wallet?
• Dollarization
The practice of using the dollar or some other foreign
currency together with, or instead of, a domestic currency
in a country
• Hard currencies
Leading world currencies of developed industrialized
countries, including the dollar, euro, yen, and pound
• Soft currencies
Emerging market countries’ currencies that are less stable in
value than hard currencies and are sometimes pegged to
hard currency values
International Flows of Goods
and Capital
With expansion of world trade and foreign investment, international movements
of goods and service tend to integrate economic and financial markets, some key
concerts to be noted:
• Law of one price
Principle stating that identical goods should sell for the same price in
different countries according to local currencies
• Arbitrage
Buying goods in a lower priced market and selling them in a higher priced
market to make profits
• Purchasing power parity (PPP)
Theory stating that a basket of goods should have approximately the
same prices across different countries
Do You Want PPP Fries with That?
The Big Mac Index

• The Big Mac Index

A calculation using the cost of a Big Mac sandwich to
assess the relative values of currencies

What could cause the index to provide inaccurate

estimates of PPP among its comparison countries?
Problems with PPP
• Empirical tests of PPP have found mixed results:
PPP appears to hold in the long run for periods exceeding
five years, but may not hold in shorter periods.
For countries with little difference in inflation rates, PPP does
not reliably explain exchange rate changes.
• PPP predictions are affected by:
Transportation costs and trade barriers
Government intervention in trade and exchange rates
Multinational firms with pricing power
Market expectations about economic factors
Goods not traded but that affect internal prices
 Key Terms
balance of payments (BOP) exchange rate
current account independent floating exchange
trade balance rate system
trade deficit managed floating exchange rate
services balance system
income balance fixed exchange rate system
balance of transfers spot market
financial account bid-ask spread
risk premium direct quotes
foreign direct investment (FDI) indirect quotes
statistical discrepancy forward market
foreign exchange markets forward rate

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ed in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Key Terms (continued)
discount dirty float currency
premium dollarization
hedge hard currencies
inflation soft currencies
gold standard
law of one price
Bretton Woods Agreement
arbitrage
International Monetary Fund
(IMF) purchasing power parity (PPP)
Smithsonian Agreement Big Mac index
Jamaica Agreement interest rate parity (IRP)
special drawing right (SDR) covered interest rate parity
clean float currency uncovered interest rate parity
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitt
ed in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.