3. Essays on economic regional integration assume different dimensions, Free Trade Areas being their simplest form. The next stage are Customs Unions and their more complex version is usually known as Common Markets. Each one of these models have their own characteristics and imply different objectives to achieve. So, to start from the beginning, Free Trade Areas include:
- the elimination of intra group tariffs and non-tariff barriers, which assure free access of the products of each member country into the markets of the others. As a result, producers inside the grouping have access to a bigger market than the ones where they are located. As a consequence, economies of scale are achieved, innovation is stimulated and the price of products tend to decrease;
- the increase in the supply of products provides new options for consumers, stimulating the competition and forcing the amelioration of the quality and the technological level of the products offered;
- the free exchange of goods favors the optimization of the productive resources on a regional scale, through the interconnection of the productive chains and the maximization of comparative advantages of each member country in the grouping;
- the increase in competitiveness provides a basis for the opening of new markets, inside and outside the grouping.
4. The second stage – that of Customs Union – comprises all the elements of the Free Trade Areas mentioned before and includes new elements of integration, such as:
- the adoption of a Common External Tariff, which has the effect of equalizing the costs of imports for all member countries;
- the equalization of costs of imports creates conditions for the eventual redistribution of investments inside the group, since one important aspect of the cost of production becomes equal to all;
- the dimension of complementarity and common interest generated by this ensemble of measures provide the basis for a future harmonization of macroeconomic policies and, in a next stage, the adoption of supranational bodies;
- on the international level, economic integration tends to increase the political weight of each of the members of the grouping, making “the whole bigger than the sum of the parts”.
5. Those assertions imply an almost irresistible invitation to integrate into a regional economic grouping. Like all theories, only the benign effects are emphasized and don’t take into consideration structural and aleatory factors such as the dimension of the internal markets, the consumption power of their inhabitants and other economic indicators, to which we should add the political stability and the economic environment for investments, resulting from the business climate and the regulatory burden prevailing in each one of the individual countries belonging to the regional economic grouping.
6. If we leave the “world of ideas” and land on the concrete world, we shall identify various practical reasons for a country to integrate a regional economic grouping. These comprise the advantages included in the menu listed above and some other motivations, imposed by political or economic realities, like (i) the intention to organize the region around one project (on the basis of common shared goals) and/or (ii) to counter the influence of political competitors and/or (iii) to try to impose limits to the actions of a major power in the region and/or (iv) to ensure participation in the enlarged market, even as a way not to be displaced by other members of the grouping. Each one of these assumptions are identified, in different degrees, in the creation or operation of the major regional economic integration projects in existence. In this context:
a) for over the past half-century, European countries succeeded in consolidating a strong regional market, making the present European Union a relevant actor in the international economic arena. That move strengthened the intra-regional economic forces and made possible to overcome the risks identified in the predominant economic thought of the time, that Europe would succumb to an “American challenge”, consisting of an overwhelming penetration of American goods, services and ideas (as predicted, in 1967, in the famous book by Jean-Jacques Servan-Schereiber);
b) the creation of the Eurasian Economic Community (EEC) is attributed by many to intentions by Russia to reintegrate the former Soviet Republics under Moscow’s influence and to counter Chinese and European economic penetration in affluent Eurasian markets;
c) Brazil viewed the formation of MERCOSUL as a means to consolidate a friendly political alliance with Argentina and to expand access of its industrial products in the region. Which did not avoid some to view the move as a Brazilian attempt to affirm its leadership in the region and to attract neighboring countries away from joining alternative projects offered by the USA;
d) The unaccomplished Free Trade Area of the Americas (FTAA) was generally seen in Latin America as an instrument of American “economic imperialism”, taking into consideration the weight of the American industrial and service economy.
True or false, these perceptions play an important role in day-to-day politics and influence (with more or less intensity, depending on the democratic structure of the country) the decision making process, before and after the adherence of a country to an economic integration project.
7. To better counter the influence of foreign powers, a regional economic group has necessarily to achieve at least the second stage, that of a Customs Union. In that dimension, the manipulation of the Common External Tariff and the imposition of non-tariff barriers are the usual instruments for that purpose. When they assume a “negative character”, they tend to become less functional in the long run, due to restrictions or limits imposed by the rules of the World Trade Organization (to which most countries belong to) and especially to internal contradictions, as they perpetuate the existence of non-competitive actors inside the grouping.
8.Besides that, “small economies” may see the coordination brought about by the development of a common economic project as a way to influence the acts of the “strong” ones. That assumption tends to be more effective in the stage where supranational bodies are created to regulate economic and trade matters inside the grouping and might explain the refusal of some countries in the European Union (like France) to approve the treaty to streamline E.U. decision-making eight years ago.
9. Furthermore, a country may also be tempted or inclined to join an economic agreement due to its dependence on the markets of the other members of the grouping. In that case, the country is a natural candidate to accede to a regional economic integration project, not only because its products are sold to them but also because if it does not join, other competitors inside the grouping may displace its products in the regional market.
10. Other aspects, usually neglected in the academic manuals, are:
- that the country with more political leverage or level of industrialization may “impose” its tariffs on its associates. That is a natural consequence of the fact that these economies host a more diversified productive sector, bigger internal markets (which should not be confused with population) and has more vested interests to protect. On the other hand, smaller economies, more dependent on imports, will favor lower tariffs. Also industrial countries face difficulties to converge to the level of tariffs practiced/proposed by service economies or by commodity-driven economies. Some of these asymmetries can be detected in the cases of Mercosul and the EEC, where the size and the weight of the Brazilian and Russian economies are overwhelming. So, it is not a surprise that the Common External Tariffs adopted by each of these integration groups are closer to the previous one in Brazil and Russia (and not to ones in force in Paraguay and Kazakhstan, for example). That divergence of interests makes the decision-making process inside the grouping more complex (although that’s not an impediment to reach consensus);
- that the adoption of higher tariffs – when that occurs – makes the imports of products more expensive in some markets (Paraguay and Kazakhstan, in the previous example), and tend to favor the consumption of items from the “predominant country” (Brazil and Russia, as seen before), sometimes at the expense of quality and price (which implies diversion of trade). In some cases, these consequences are compensated by arrangements of diverse nature, such as programs which give financial support for the development of infrastructure or industry or the establishment of administrative bodies in the capital of the affected country, so as to stimulate its service sector and real estate market ; and
- not negligible is also the consideration that these “strong economies” will tend to attract more foreign investments, despite the theoretical equalization of opportunities created by the adoption of a common external tariff and the free access to the markets of all members. One basic reason for that can be found in the “location advantage”, that is, to enjoy more diversified services, the proximity of previously installed industries and suppliers and, last but not least, a larger consumer market.
11. The touchstone of the success of an economic integration group is identified by the inevitable increase of trade among its partners (brought about by the so called “integration effect”) and by the confirmation that it resulted from “creation of trade” and not by “diversion of trade”. In the first case, all the economic assumptions worked as foreseen and the grouping (or its members) have benefited from the stimuli generated by their association and increased, as a whole, their levels of export and import. In the second case, the global trade also increases, but at the expense of trade with third countries. Usually that means that members of the grouping are changing their partners in benefit of one (or more) countries in the grouping, importing the cost of production of that country and submitting themselves to the prices, quality and technological level of some other member of the grouping.
12. In theory, “small economies” (the terminology is used as a way not to imply unequal rights among countries, which would happen should we adopt the term “small countries”, and also taking into account that countries with small territories - like Japan - are important economic actors) may more easily relinquish sovereignty to a supranational body than “stronger” or large ones. After all, the weight of such “small economies” is increased in such supranational entities by an equal vote, a veto power and/or the coordination with other “small economies”. Other line of consideration to an eventual reluctance of big countries to adhere to such a supranational scheme are the risks that, like Thomas Becket - designated Archbishop of Canterbury to serve King Henry II - bureaucrats may be tempted to serve “the honor of God” (that is, that of the new body, instead of the interests of their countries of origin). But that has to be evaluated on a case by case basis, to better understand its implications and eventual reservations (although, in principle, we may presume that “liberal”and socialist governments - due to a pervasive feeling of solidarity - will be more inclined to accept supranational constraints, than conservative governments, more “power oriented”). Both Mercosul and the EEC have not reached that stage so far.
13. It is very difficult to evaluate which is the divide between a good or bad Common External Tariff for each member of the group. That is why the negotiation of the Common External Tariff should be very judicious, so as to reflect a good balance of the interests and necessities of each individual economy inside the grouping. That is why the alternative – the establishment of a Free Trade Area – is more disseminated, since it allows each country to keep its sovereign decision on the definition of its own external tariffs as a way to maximize its own economic environment through cheap imports of good quality, mostly of lower-priced capital goods for its own industry. That might be, in some ways, the case of Chile, a country with low external tariffs and with links of associations to many free trade areas in the world. Of course that implies that the country can support the effects of an open economy, which presumes a high level of competitiveness inside its own market. In the case of Chile, that is in a way balanced by its major presence as a supplier of copper in the world market and its high efficiency in areas such as fruits, wine, fish and forestry. If a country lacks those conditions, the survival of its industrial park could be at risk (something that might be positive from a strict economic point of view), but the country would surely suffer the consequences of a drastic rise in its unemployment rate, which would increase the level of social dissatisfaction and promote political unrest.
14. The same disjunction between theory and practice happens for instance on the discourse about privatization. Responsible governments (even the ones in favor of the initiative) have to balance the consequences of the adoption of modernization programs, which imply the sale of non-competitive industries and services, against their social and political impact (mostly if these assets are operated by a large public servant class, under an extensive social security net, like in Belarus). On the other hand, authorities have also to evaluate the costs of keeping inefficient sectors, due to the fiscal burden they represent. In any case, the solution has to contemplate a formula that provides more competition inside the economy, since the ultimate objective should always be to avoid the existence of enterprises with a dominant position, should they be of state or private nature.
15. The same gap between theory and practice can be identified in the present debate, which confronts budgetary discipline against economic growth in Europe. The persistent euro crisis stems from an old combination of uncompetitive economies, too generous welfare states, rigid labor codes, inflated civil services, high taxes and public spending (sometimes aggravated by a high rate of tax evasion), exposed to daylight by the financial turbulence of the last years. As a consequence, a growing number of European countries are now submitted to a (correct) fiscal diet, as prescribed by the books. Essentially, it is the same austerity programs that increased unemployment and reduced consumption, holding back growth and making the debt burden even worse in Latin America, during the so called “lost decade” of the 90’s. The region only left this economic limbo thanks to the expansion of the world market in the 2000’s, especially the new demand derived from the emergence of Asian markets, as dramatized by the sharp increase of prices of mineral and agricultural commodities, for which China played a fundamental role. In that context, the internal markets got a renewed impulse, conditions for new investments were created and Brazil – which had adopted a program for fiscal responsibility and deficit controls in the year 2000, according to the rules of the “Good Book” – had an easier task to accomplish its goals, that is, to practice a healthy adjustment of revenues and expenses. But, by then, the “patient” had already left the Intensive-Care Unit!
16 The proliferation of Free Trade Areas is regarded with suspicion by “multilateralists” and circles close to the WTO. After all, the existence of more than 300 of them in the present day is sometimes seen as an obstacle to the liberalization of markets on a worldwide scale. The difficulties to start negotiations in the Doha Round should confirm these pessimistic expectations. But that also is a half-truth. First, because the core of the negotiations which are expected to be developed at the Doha Round is concentrated on the agricultural agenda – an area where countries of all sorts are reluctant to act, that is, to liberalize. Second, because the lion’s share of the commerce practiced by all countries is realized on a non-discriminatory basis, that is, under the auspices of the Most Favored Nation clause (MFN). Many of the Free Trade Areas don’t comply strictly with the requirements of Article XXIV of the old GATT, in the sense that they don’t necessarily cover “substantially all trade”, condition for its legitimacy under the regulations of WTO. That happens because, in most cases, “sensitive products”, usually protected by high tariffs - like agricultural and food products and labor intensive industrial products, like shoes, textiles and clothing – are in general excluded from preferential trade (when they are included, and assured a free circulation inside the regional market, it is not uncommon to find it affected by the imposition of quotas or other non-tariff barriers, such as import licenses or by the manipulation of legitimate phytosanitary and technical requirements, in a protectionist way). That explains as well why “comprehensive trade agreements”, usually proclaimed by politicians and acclaimed by the press, do not come into being. If one looks to the guidelines approved by Parliaments and adopted by Governments – as the result of pressures from their internal uncompetitive sectors – one can easily realize, without any ideological bias, why the Free Trade Area of the Americas was never completed and why, even among “symmetric partners”, like the U.S. and the European Union (which account for about half of global economic output and one-third of world trade) free trade agreements are difficult to be concluded. The reasons are almost always the same: the exclusion of agricultural products and, in their case, also high tech areas, such as the proposed full scale exclusion of audiovisual industries, recently approved by the European Parliament as pre-condition for negotiations. The blame is usually on both sides, taking into account the whole array of protectionist measures, subsidy policies and technical restrictions adopted by all countries, in a virtual replacement of their tariff barriers. As a consequence, the economic dimension of Free Trade Agreements are, in general, overstated, mostly when – besides all previous factors - they assume, for political purposes, a dimension as a tool for the reaffirmation of union and/or unity of purpose for some countries or regions.
17. Whatever their main rationale – economic or political – the impact of all Free Trade Areas are not the same and their arrangements are not always as deep and wide as its public perception suggests. As usual, the “Essential Truths” of academic manuals tend to be mitigated when confronted to reality. In other words, the idealistic /Platonian formulations of the theory of economic integration have to be considered under the light of Aristotelian empiricism to show its real possibilities and potentiality.