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MGT520 - International Business - Lecture Handout 39

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REGIONAL AND ECONOIC INTEGRATION

The Case for Regional Integration:

  1. The economic case for integration has been largely presented in the previous chapters. Free trade and movement of goods, services, capital, and factors of production allow for the most efficient use of resources. That is positive sum game, as all countries can benefit.
  2. Regional economic integration is an attempt to go beyond the limitations of WTO. While it is hard for 100 countries to agree on something, (e.g.. the United Nations) it is much more likely that only a few countries with close proximity and common interests will be able to agree to even fewer restrictions on the flows between their countries.
  3. The political case for integration has two main points: 1) by linking countries together, making them more dependent on each other, and forming a structure where they regularly have to interact, the likelihood of violent conflict and war will decrease. 2) by linking countries together, they have greater clout and are politically much stronger in dealing with other nations.
  4. In the case of the EU, both a desire to decrease the likelihood of another world war and an interest in being strong enough to stand up to the US and USSR were factors in its creation.
  5. There are two main impediments to integration: 1) there are always painful adjustments, and groups that are likely to be directly hurt by integration will lobby hard to prevent losses, 2) concerns about loss of sovereignty and control over domestic interests. Canada has always been concerned about being dominated by its southern neighbor, and Britain is very hesitant to give much control to European bureaucrats (as of this writing it still has not adopted the euro).
  6. The case on NAFTA and the US Textile Industry shows that although the effects of NAFTA have hurt employment in the US textile industry, the overall effect has actually been positive. The reason: clothing prices have fallen, exports have increased, and sales to apparel factories have surged. Those factors more than compensate for the loss of jobs.

The Case against Regional Integration:

  1. Many groups within a country do not accept the case for integration, especially those that are likely to be hurt or those that feel that sovereignty and individual discretion will be reduced. Thus, it is not surprising that most attempts to achieve integration have progressed slowly and with hesitation.
  2. Whether regional integration is in the economic interests of the participants depends upon the extent of trade creation as opposed to trade diversion. Trade creation occurs when low cost producers within the free trade area replace high cost domestic producers. Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers. A regional free trade agreement will only make the world better off if the amount of trade it creates exceeds the amount it diverts.

Regional Economic Integration in Europe:

  1. Map 8.1 identifies the member countries of the EU. The EU is large economically and politically, and many of the independent countries that were under the influence of the former USSR have sought to join the EU.
  2. The forerunner of the EU was the European Coal and Steel Community, which had the goal of removing barriers to trade in coal, iron, steel, and scrap metal formed in 1951. The Treaty of Rome formed the EEC in 1957. While the original goal was for a common market, progress was generally very slow.
  3. Over the years the EU expanded in spurts, as well as moved towards ever-greater integration.
  4. Many countries that are now members of the EU were initially members of EFTA who either felt that the EU was pushing for too much integration too fast, or were denied entry by other member states. Norway, while always a member of EFTA, has twice had its citizen vote down membership in the EU because they felt they would lose too much control to their much bigger neighbors to the south. Being a small country, they felt they would have little say in policies, and would be forced to adopt policies that were unfavorable to their prospering oil and fisheries industries. (And it is generally true that the EU would like to have the benefits from these industries spread around.) Nevertheless, since most of Norway’s trade is with EU member countries, it has chosen to adopt
    many EU regulations - and is in fact in greater compliance with EU regulations than some of the EU member states.
  5. The economic policies of the EU are formulated and implemented by a complex and still evolving political structure. The five main institutions are the European Council, the Council of Ministers, the European Commission, the European Parliament, and the Court of Justice. Although they are described in some detail in the book, you may not feel that it is important to lecture on these administrative topics.
  6. The problems with lack of progress on the objectives of the EU resulted in a number of problems for firms and governments, and led to adoption of the Single European Act in 1987. The Single European Act called for the removal of border controls, mutual recognition of standards, open public procurement, a barrier free financial services industry, no currency exchange controls, free and open freight transport, and freer and more open competition.
  7. The Management Focus on the EU and the media industry mergers shows the power that the EU has acquired in controlling and regulating mergers of international companies. Through the use of concessions, the EU has been able to dramatically change the shape of an entire industry.
  8. The Treaty of Maastricht took the EU one step further, by specially spelling out the steps to economic union and partial political union. In addition to simply spelling out the steps needed, the Treaty also laid out the future outlines of a common foreign policy, economic policy, defense policy, citizenship, and currency, as well as strengthened the role of the European Parliament. The single currency will eliminate exchange costs and reduce risk, making EC firms more efficient.
  9. The Euro was officially launched on January 1, 1999. It became into full use On January 1, 2002. Member states that have entered into monetary union have fixed exchange rates with the Euro, and hence with each other. The Euro reduces both exchange rate costs and risks, and has been used for many business transactions. The use of national currencies was discontinued in 2002 in favor of the euro, although many member banks will accept their national currency in exchange for the euro. Adoption of the Euro will help citizens more easily compare prices, should increase cross border competition, and lead to lower costs for consumers.
  10. Britain, Denmark, and Sweden have chosen to opt out of joining EMU for now. One reason is a concern over losing control over monetary policy to the European Central Bank. Some believe that currency union should only take place after political union.
  11. A number of countries have applied for membership in the EU, particularly from Eastern Europe. Given the profound differences in income, development, and systems, however, makes near term integration of these countries into the EU difficult.
  12. Many firms and countries (including the EFTA countries) are concerned that the EU will result in a"fortress Europe," where insiders will be given preferential treatment over outsiders. That clearly already exists in agriculture, although whether it will be extended to other areas is a matter of debate.

Implications for Business:

  1. Economic integration creates a number of significant opportunities for business. Larger markets can now be served, additional countries open to trade, and greater economies of scale achieved.
  2. The greatest implication for MNEs is that the free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes, makes it possible for them to realize potentially enormous cost economies by centralizing production in those locations where the mix of factor costs and skills is optimal. By specialization and shipping of goods between locations, a much more efficient web of operations can be created.
  3. The lowering of barriers to trade and investment between countries will be followed by increased price competition, requiring firms to rationalize production and reduce costs if they are to remain competitive.
  4. As other firms become more competitive in their home markets (now expanded), they may be able to enter additional markets and threaten local firms' positions.
  5. Firms also must be concerned that they may be "locked out" of "fortress Europe" or “fortress North America,” and thus may need to establish operations with a region if they are to remain an active player in the market.

THE EUROPEAN UNION:

  1. The European Union (EU) is the most important trading bloc in the world today. Fifteen countries currently “belong” to the EU, making it the world’s richest market, with a total GDP of $7.9 trillion.
  2. The European Economic Community (EEC) was established at the Treaty of Rome in 1957 by six nations (Belgium, France, Luxembourg, Germany, Italy, and the Netherlands). The goal of the EEC was to create a common market. The name EU was a result of a name change in 1993.

Governing the European Union:

  1. The EU is governed by four organizations. The Council of the Economic Union, made up of 15 members, each of whom is responsible to his or her home government, is the EU’s main decision making body. Because of its composition, the Council reflects the desire of member states to retain national sovereignty and power. The European Commission is composed of 20 individuals whose loyalty is to the EU rather than their home countries. Its mandate is to be “guardian of the Treaties.” The European Parliament, made of 626 elected representatives, is the weakest of the governing bodies. It originally acted in a consultative manner in EU policy making, but has
    expanded its role under the Maastrict Treaty. Finally, the European Court of Justice interprets the meaning of EU law and ensures that EU regulations and policies are followed by member states.
  2. The Legislative Process. The legislative process in the EU, which is usually initiated by the Commission, is a complicated one. In fact, transforming a Commission proposal into law may take yearsThe complex process reflects the desires of member countries to retain their sovereignty yet create a supranational government.

Lobbying the European Union:

This Global Learning Box discusses how firms can influence EU decision makers in their legislative actions. EU decision makers have the difficult job of juggling the diverse interests of member nations, and consequently may not take into consideration the interests of foreign firms. Lobbying either the Commission or an ally on the Council may prevent adverse legislative proposals from being passed. This box fits in well with a discussion of the EU, with a discussion of trade barriers, and with Discussion Questions 2, 3, and 5.

The Struggle to Create a Common Market:

  1. As a result of pressures from domestic special interest groups, the process of transforming the members of the EU into a common market was a slow one. Even through the 1980s, firms doing business within the area had to comply with 12 different sets of national laws and regulations. The text provides several examples of the regulations followed by different members of the EU.
  2. Initially, the EU relied on a process of harmonization (whereby the EC encouraged members to voluntarily adopt common “harmonized” regulations) to eliminate conflicting regulations. However, because the process moved so slowly (see the text for some examples), one of the EC’s governing bodies, the European Commission, issued the White Paper on Completing the Internal Market. The White Paper called for accelerated progress on ending all trade barriers and restrictions on the movement of the factors of production.
  3. Countries that accepted the White Paper signed the Single European Act and adopted its goal of completing the transformation to a common market by the end of 1992. The goal is known as EC ‘92. Substantial progress toward meeting the goal in the areas of physical, technical, and fiscal barriers has been made.

From Common Market to Economic Union

  1. Many Europeans have argued for further integration, suggesting that the EU become an economic union. To that end, the Treaty on European Union (also known as the Maastricht Treaty) was reached in 1991. The treaty came into force in 1993.
  2. The Maastrict Treaty rests on three “pillars” designed to further the economic and political integration of Europe. First is the agreement to create a common foreign and defense policy among member states. Second is an agreement to cooperate on police, judicial, and public safety matters. Third are new provisions to create an economic and monetary union among member states to augment the basic European Community agreement.
  3. The Maastrict Treaty also grants citizens the right to live, work, vote, and run for election anywhere within the EU, and strengthens the power of the EU’s legislative body, the European Parliament, in budgetary, trade, cultural, and health matters. In addition, a cohesion fund was created to funnel economic development aid to countries with a GDP less than 90% of the EC average. Finally, the name change mentioned earlier occurred as the EC became the EU.
  4. The most important and controversial aspect of the Maastrict Treaty was the creation of economic and monetary union (EMU) among members. The EMU created a single currency, called the euro, for the EU, and a single EU central bank. Denmark, Sweden, and the U.K. chose not to become charter members of the single currency bloc. The euro came into being on January 1, 1999 when the 11 charter participants irrevocably fixed the value of their national currencies to the euro.
  5. During a three-year transition period, the euro existed only as a bookkeeping currency. Actual euro coins and currency were put into circulation at the beginning of 2002.
  6. The ultimate goal of the EU, the creation of a single EU currency, implies that countries lose their ability to control their own domestic monetary supplies and economic destinies, and thus the goal has not been reached without controversy.
  7. In order to participate in the EMU, member countries met certain convergence criteria relating to inflation rates, interest rates, currency values, government budget deficits, and government debt.
  8. The Treaty for Europe (also known as the Treaty of Amsterdam), signed in 1997, allowed for a strong commitment to attack the EU’s high levels of unemployment, a strengthening of the role of the EU’s Parliament, and the establishment of a two-track system.
  9. The Treaty of Nice, which became effective in February of 2003, reduced the number of areas in which unanimity was required in order for new policies to be approved. The following box addresses the issue further.

Three Majorities Are Better than One:

The Treaty of Nice requires that a qualified majority can be obtained only if three conditions (the so-called “triple majority”) are met: (1) the decision receives a specified percentage of the votes cast by Council members. The specified percentage will range between 71 and 74 percent (depending on the number of new members admitted to the EU); (2) a majority of the member states approve the decision; and (3) the decision is approved by members who represent at least 62% of the EU’s population.

  1. Future EU Challenges: Other conflicts continue to be waged within the EU. For example, state aid to industry has been of particular concern to members. While the EU prohibits national governments from making subsidies that result in a distortion of competition, many governments still assist domestic companies that are in danger of bankruptcy.
  2. Another controversy surrounds the question of whether and when the EU should expand its membership. At the heart of the controversy is the “wider vs. deeper” question. Supporters of the wider side suggest that the EU should rapidly expand its membership, even if it makes integration more difficult, while proponents of the deeper side argue that slow expansion is more appropriate.

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