1.1. Forms of Regional Economic Groupings
Regional economic groupings aim at creating a larger economic unit from smaller national economies. For this purpose, they aim to remove trade barriers and establish closer co-ordination and co-operation among the countries involved.
Depending upon the level of integration, regional economic groupings may be classified into six major groups as follows:
1. Preferential trade areas;
2. Free trade areas;
3. Customs unions;
4. Common markets;
5. Monetary unions;
6. Economic unions.
A preferential trade area is the weakest form of economic grouping. The member countries reduce customs tariffs in some product categories. They apply a preferential treatment to some groups of goods from the member countries as compared to the rest of the world. Higher tariffs would remain in place for all remaining product categories.
In free trade areas, participants aim mainly to expand trade activities among themselves. For this purpose, they eliminate customs tariffs on the products they produce themselves. However, they maintain their own external tariff on imports from third parties. For this reason, free trade areas are criticised on the ground that import products from third countries may penetrate into the grouping through the customs of the Member State with the lowest tariff and may then be re-exported to the other participants. In order to prevent such trade, free trade areas generally develop very elaborate rules of origin.
A customs union, on the other hand, is a higher form of free trade area, and eliminates the deficiency mentioned above. In a customs union, the participants not only agree to abolish or reduce tariffs between themselves, they also set a common external tariff policy against third parties. In this manner, the member countries, on the one hand, secure the free or privileged flow of tradable goods amongst themselves, and on the other hand, they form a discriminatory trade bloc against the nonmember countries. In this case, the main concern becomes the coordination of the trade policies amongst the member countries instead of developing elaborate rules of origin.
A common market allows a free flow of not only the goods but also the services and the factors of production such as capital, labour, entrepreneurship, etc., across countries. It also establishes a common external tariff policy against third parties. However, such a scheme necessitates the co-ordination of commercial and industrial policies. Citizens of a common market can work and invest in any member country without any restriction.
A monetary union establishes a central monetary authority, which will determine monetary policy for all the participating countries. That authority issues a common currency to be circulated among the member countries. The EU members have concentrated their efforts on reaching that stage of integration. In this context, they introduced the single European currency (the Euro) on 1st January 1999. At this stage, the Euro is being used as a unit of account in bank operations. The Euro notes and coins will be circulated together with the national currencies starting from 1st January 2002. The Euro will completely replace the national currencies after 1st July 2002.
In an economic union, the participants will maintain free trade in goods and services, set common external tariffs among members, allow the free mobility of capital and labour. Additionally, they also agree to harmonise their national economic policies, and act as a single economic unit. The European Union (EU) is also a very good example of such an integration scheme. In the EU, the integration efforts extended even to the harmonisation of social policies.
1.2. Gains from Regional Economic Groupings
As we have mentioned earlier, when countries form a regional economic grouping, two types of effect may arise: trade diversion and trade creation. Trade diversion is the resulting shift in the direction of trade in favour of the member countries and against third parties. On the other hand, trade creation will induce economic activity in the region and give an impetus to income creation.
Formation of a regional economic grouping will, first of all, enlarge the volume of demand for commodities produced in the region. As a result, when any investment decision is to be taken, entrepreneurs will consider the whole region and invest in large-scale production units. This fact will have two effects. First, it may increase efficiency and competitiveness through economies of scale in production of goods already being produced in the region. Secondly, it may also make possible the production of new commodities within the region. These two results are the direct effects of economic groupings. These will bring about more income creation within the region.
Due to the expansion of the market, trade and income creation will result in increased exports, increased trade exchanges, more investment, more output, higher rate of employment, new business opportunities, new goods produced in the region. Foreign trade structure and production possibilities will change. Expanded exports will improve the balance of payments, and that, in turn, may decrease the debt burden on the economies. A greater market may induce foreign capital from third parties. Structural changes will improve the quality and quantity of the products in the region. Specialisation and better division of labour would increase production, productivity and economic growth. Larger markets for commodities and factors of production will give an impetus to technological changes. The overall benefits will be reflected on the increased output, income and welfare of the people.