When Does Integration Pay

1
When Does Integration Pay?
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• Europe has been rather spectacularly successful
  in its integration efforts. Many others have been
  far less successful. What makes for success?

3

• Consider again the prices that play a role in a
  customs union integration scheme

P domestic
P tariff
P part count
P world
4

• In your groups, discuss the proximities of given
  price lines in the set and elasticities of supply
  and demand that will make integration successful.

P domestic
P tariff
P part count
P world
5
First, check elasticities
The relative sizes of these gains depend on 1.
elasticities, the flatness of the curves.
Imports
Imports
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First, check elasticities
Where they are relatively elastic (flat), the
imports will be greater and gains go with more
extensive trade.
Imports
Imports
7
Price spread in integration

• Gains are greatest when the difference is
• small between partner and world.
• great between partner countries and us.

c
c
8

• Large gains here. Large imports at near world
  prices (far better than our prices)

P domestic
P tariff
P part count
P world
9

• Small gains here. Small imports at prices near
  ours and way above world prices.

P domestic
P tariff
P part count
P world
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Preferential Trading ArrangementsGainers and
Losers from Regional Trading Blocs,Rosson,
Runge, and Moulton
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• More than 23 forms of Preferential Trading
  Agreements (PTAs) or Trading Blocs have been
  identified among 119 countries that account for
  82 of world trade.

12

• Article 1 of GATT prohibited preferential tariff
  rates, but an exception was allowed by Article
  XXIV. A free trade area was permitted to retain
  barriers to trade with nonmembers.

13

• This leaves the prospect of the world economy
  fractured into openly hostile trading blocs.
• But GATT strategy seems generally to have been
  successful, since tariff rates for manufactured
  goods have declined from approximately 40 to
  around 4.

14

• At the same time, quotas and other barriers have
  risen dramatically, and
• We still have lots of work to do in freeing trade
  in services.

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The First Five Years of the NAFTA
AgreementJoanna Moss
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• Economic cooperation had been growing with
  Mexico.
• Bracero program Mexican workers to cross the
  border to do seasonal work (canceled in the early
  60s)
• Maquiladora program foreign-owned firms could
  set up operations in Mexico and import inputs
  duty-free if products were exported.

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• Mexico cut tariffs in half to an average of about
  12 after joining GATT in 1986.

18

• The Canadian-US Free Trade Agreement was
  inaugurated in 1989. A free trade area formed
  over a 10 year period.
• Mexican president Carlos Salinas proposed NAFTA
  in 1990. Eliminate tariffs over a 10-15 year
  period.

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• Provisions
• Free trade in agricultural products over 15
  years.
• Freer trade in textiles
• No more Mexican tariffs on autos and auto parts
• Cross-border investment liberalized

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• NAFTA Side Agreements
• Environmental Protocol. Fines and sanctions
  agreed upon if a country fails to enforce its own
  environmental laws. Cleanup funds set aside for
  Mexican-US border.
• Labor Protocol. Fines for labor abuses, sanctions
  for failure to implement min-wage laws.
• Snap-back Provision. Safety-net for industries
  endangered by surge of imports.Pre-NAFTA tariffs
  can be imposed for 3 or 4 years.

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• First five years of NAFTA
• With over-valued peso, Mexico went on spending
  spree in early 90s. The capital inflow that
  covered debts dried up and Mexico issued bonds.
  Late 1994 investors began pulling money out.
• Exhaustion of reserves forced a Peso devaluation.
  The US and Canada bailed them out with loans.
• The recovery was faster than usual. Heavy exports
  to the US helped the recovery.
• Investment funds returned to Mexico.

22

• First five years of NAFTA
• The US labor market didnt appear to suffer under
  NAFTA as some predicted. The boom of the 90s
  certainly didnt hurt in that respect.
• NAFTA hasnt met the dire predictions of its
  detractors, nor has it fulfilled the dreams of
  its supporters Economic relations have been
  stable in an otherwise tumultuous period.

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European Monetary UnionMichael W. Klein
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• European cooperation was strengthened by the
  decline of the Bretton Woods system.
• Europe did not want to follow the US toward
  higher inflation. How does a fixed exchange rate
  help?
• It allows for less trade uncertainty
• It shows anti-inflationary commitment.

25

• European cooperation was strengthened by the
  decline of the Bretton Woods system.
• The Bretton Woods System was
• It was eliminated in 1973 by Richard Nixon, a man
  of uncanny economic instincts

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• European cooperation was strengthened by the
  decline of the Bretton Woods system.
• Europe did not want to follow the US toward
  higher inflation. How does a fixed exchange rate
  help?
• It allows for less trade uncertainty
• It shows anti-inflationary commitment.

27

• See the history of progress toward a common
  European currency summarized in the box on p.
  305.
• Europe did not want to follow the US toward
  higher inflation. Members of the EEC worked
  toward eliminating large inflation rate
  differentials by mid 1980s and capital controls
  were lifted by 1987.
• Single European Act, 1986, called for removing
  all internal barriers to trade, capital
  movements, and labor migration by end of 1992.

28

• Maastricht Treaty signed at end of 1981. The
  famous conditions were established for the
  introduction of monetary union.
• Countries sacrificed monetary sovereignty for
  prospective Euro (formerly ECU) membership.

29

• Maastricht Treaty signed at end of 1981. The
  famous conditions were established for the
  introduction of monetary union.
• Countries sacrificed monetary sovereignty for
  prospective Euro (formerly ECU) membership.

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• Budget deficit 3 of GDP or less.
• Gvoernment debt 60 of GDP or less.
• Inflation no more than 1.5 above the average
  rate of the three members with the lowest
  inflation.
• Long-term interest rates no more than 2
  percentage points above the average of the three
  members with the lowest rates.
• Krugmans confusion. Why demand monetary
  management to give up monetary sovereignty?
• Hazing?

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• The convergence pattern of these criteria through
  the 90s.

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• European countries strove valiantly to submit
  their sovereignty. So much did they desire to be
  a part of the Euro scheme!

33

• Benefits of a common currency include ease in
  trading goods and assets over a common currency
  zone. It represents a big reduction in
  transactions costs.
• Prestige of achieving the closer union of
  European economies. As a step toward political
  union? That is the dream.

34

• The cost of union is the forgoing of monetary
  policy.
• In the face of market pressure against a
  currency, a central bank committed to the
  external goal of a fixed exchange rate must raise
  domestic interest rates, even if this means
  forgoing the internal goal of setting interest
  rates with an eye toward domestic economic
  conditions. The only way to maintain monetary
  independence is eithge to allow the currency to
  float or to have in palce controls on the
  international movement of capital. (p, 311)

35

• The cost of union is the forgoing of monetary
  policy. This has added to the structural
  unemployment problems facing the European
  countries over recent years.
• Ten is roughly normal for Europe.

36
The Feldstein View

• For a more detailed discussion of the standard
  American view of the future collapse of the EUs
  Monetary Union, see Martin Feldstein, EMU and
  International Conflict, in the Foreign Affairs
  Anthology.
• Feldstein reviews the struggle, esp. between
  Germany and France, over whether to make
  unemployment or price stability top EU priority.

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The Feldstein View

• Feldstein is convinced that the first significant
  recession will bring serious conflict to Europe
  as countries regret the loss of monetary policy
  and secede from the Union.

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The Euro as a New International Currency A
Dollar Substitute?

• Klein concludes that widespread flight from the
  dollar to the Euro is unlikely, at least for the
  next few years.
• But dollar flight to the Euro, in any major way,
  would cause the value of the dollar to fall
  dramatically.
• The glut of dollars in the world that would
  result from a lack of willingness to hold it,
  could have major ramifications. What would they
  be?

39
The Euro as a New International Currency A
Dollar Substitute?

• To review some of the issues that make the dollar
  a strong international currency, that give
  confidence that dollar flight to the Euro need
  not be a future disaster for that currency, see
  The International Use of Currencies The U.S.
  Dollar and the Euro, by George S. Tavlas
• Why do both the U.S. and the EU have strong
  interests in seeing the dollar and the Euro
  remain competitive currencies, without one
  dominating the other?

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Why is Europe Forming a Monetary Union?Gwen Eudey
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• Make it easier for individuals and institutions
  to buy stocks and bonds in other European
  countries.
• Cut transactions costs (roughly 0.4 percent of
  the GDP) for member participants.
• Prevent competitive devaluations (to promote
  exports). Reducing the value of currency is
  inflationary.

42

• Costs of a Single Currency
• Loss of independent monetary policy (but all
  member countries have representation in monetary
  policy).
• Fiscal policy within a member country could
  increase budget deficits and require government
  borrowing, putting upward pressure on interest
  rates. Increasing the money supply to avoid high
  interest rates would threaten inflation. So EU
  members agreed to avoid debt.

43

• Loss of independent monetary policy (but all
  member countries have representation in monetary
  policy).Still, fiscal policy could be used by the
  EU to address regional imbalances in the currency
  union. See p. 320.

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• Labor Market Flexibility can also speed recovery
  when some region experiences recession.
• If workers are mobile, unemployed or poorly paid
  workers can relocate to countries with higher
  labor demand. That will even out imbalances.
• But cultural and linguistic differences hinder
  labor movements in Europe.

45

• Wage adjustments are another important form of
  labor market flexibility. If workers accept lower
  wages in a recession, employers need not lay them
  off. They can also pass on the reduction in
  payroll costs through price reductions. Lower
  prices promote exports and encourage domestic
  consumption. This increase in demand speeds
  recovery.
• But Europe has problems with wage flexibility
  through legislation and union practices
  preventing it.