Regional Economic Integration

Chapter 09 - Regional Economic Integration

Regional Economic Integration

Learning objectives 

Describe the different levels of regional economic integration.

Understand the economic and political arguments for regional economic integration.

Understand the economic and political arguments against regional economic integration.

Explain the history, current scope, and future prospects of the world‘s most important regional economic agreements.

Understand the implications for business that are inherent in regional economic integration agreements.

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This chapter discusses regional economic integration, agreements among countries within a geographic region to achieve economic gains from the free flow of trade and investment among themselves. There are five levels of economic integration. In order of increasing integration, they include free trade area, customs union, common market, economic union, and full political union. Integration is not easily achieved or sustained. Although integration brings benefits to the majority, it is never without costs for the minority. Concerns over sovereignty often slow or stop integration attempts. The creation of single markets in the EU and North America means that many markets that were formerly protected from foreign competition are now more open. This creates major investment and export opportunities for firms within and outside these regions. The free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes make it possible for firms based in a free trade area to realize potentially enormous cost economies by centralizing production in those locations within the area where the mix of factor costs and skills is optimal. The opening case explores the implications of a recent ruling by the European Court of Justice supporting the principles of the Single Market. The ruling allows consumers to bypass agreements regarding the exclusive rights to local broadcasts of Premier League soccer matches. The closing case explores the implications of NAFTA for the trucking industry, and in particular the power of certain parties to limit the implementation of the agreement.


Chapter 09 - Regional Economic Integration

OUTLINE OF CHAPTER 9: REGIONAL ECONOMIC INTEGRATION Opening Case: I Want My Greek TV Introduction Levels of Economic Integration The Case for Regional Integration The Economic Case for Integration The Political Case for Integration Impediments to Integration The Case Against Regional Integration. Regional Economic Integration in Europe Evolution of the European Union Political Structure of the European Union The Single European Act The Establishment of the Euro Enlargement of the European Union Management Focus: The European Commission and Media Industry Mergers Country Focus: Creating a Single European Market in Financial Services Country Focus: Sovereign Debt Crisis in the Euro Zone Regional Economic Integration of the Americas The North American Free Trade Agreement The Andean Community MERCOSUR Central American Common Market, CAFTA and CARICOM Free Trade Area of the Americas Regional Economic Integration Elsewhere Association of Southeast Asian Nations Asia Pacific Economic Cooperation Regional Trade Blocks in Africa Implications for Managers Opportunities Threats Chapter Summary Closing Case: NAFTA and Mexican Trucking


Chapter 09 - Regional Economic Integration

CLASSROOM DISCUSSION POINT Choose either the European Union or the North American Free Trade Area, and then ask students to think about what economic integration means for companies inside the bloc. Then, ask students to consider economic integration from the perspective of a firm outside the bloc. Next, ask students to consider economic integration from the perspective of a consumer. Try to organize student responses in a positive/negative chart on the board, and then at the end of the discussion, ask students whether they would support economic integration or not.

OPENING CASE: I Want My Greek TV The opening case explores the fallout from a recent ruling by the European Court of Justice on the rights of companies like Sky Broadcasting Corporation to limit local viewing options for consumers. Prior to the ruling Sky Broadcasting and ESPN had exclusive rights to show broadcasts of English Premier League soccer matches. Under the agreements, the companies divided the European market into segments and charged consumers different prices in each market. The ruling now gives consumers the right to access cheaper broadcasts being shown in other European Union markets. The Court defends the ruling arguing that it upholds the basic principles of a single Market system. Discussion of the case can revolve around the following questions: 1. Explore the implications of the recent ruling by European Court of Justice on the broadcasts of Premier League matches. What doe the ruling mean for consumers? How does it affect companies? How might advertisers change their strategies? 2. The recent ruling caught both ESPN and Sky by surprise as well as the soccer clubs themselves. Consider the decision from the perspective of the European companies. How should they respond to the decision? What are the long term implications of the ruling? 3. Reflect on your response to the first two questions, then discuss the benefits and challenges of economic integration. Is it always beneficial for all parties? Explain your response.


Chapter 09 - Regional Economic Integration

LECTURE OUTLINE This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor‘s manual. The PPT slides include additional notes that can be viewed by clicking on ―view‖, then on ―notes‖. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives. Slide 9-3 Introduction Regional economic integration refers to agreements between countries in a geographic region to reduce tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other. Despite the rapid spread of regional trade agreements designed to promote free trade, there are those who fear that the world is moving toward a situation in which a number of regional trade blocks compete against each other. In this scenario of the future, free trade will exist within each bloc, but each bloc will protect its market from outside competition with high tariffs. Slides 9-4-9-7 Levels of Economic Integration The five levels of economic integration are: free trade area, customs union, common market, economic union, and political union. The most enduring free trade area in the world is the European Free Trade Association. EFTA currently joins four countries-Norway, Iceland, Liechtenstein, and Switzerland. Other free trade areas include the North American Free Trade Agreement (NAFTA). Another Perspective: A site with information and additional links on NAFTA is available at {}. The site includes downloadable power point presentations on the benefits of NAFTA Another Perspective: To find out more about EFTA, go to {}, and click on ―EFTA AELE‖. From here you can click on several icons to get quick facts, more in- depth reports, information on the European Economic Area, and many other issues related to EFTA. Customs unions around the world include the current version of the Andean Pact (between Bolivia, Columbia, Ecuador and Peru). Currently, MERCOSUR, the South America grouping that includes Brazil, Argentina, Paraguay, and Uruguay, is aiming to eventually establish itself as a common market. The European Union (EU) is an economic union, although an imperfect one since not all members of the EU have adopted the euro, the currency of the EU, and differences in tax rates across countries still remain.


Chapter 09 - Regional Economic Integration

Slide 9-8 The Economic and Political Case for Integration Regional economic integration can be seen as an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO. 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, and 2) by linking countries together, they have greater clout and are politically much stronger in dealing with other nations. Slide 9-9 Impediments to Integration There are two main impediments to integration:  although a nation as a whole may benefit significantly from a regional free trade agreement, certain groups may lose  concerns over national sovereignty 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. Slides 9-10-9-11 Regional Economic Integration in Europe There are two trade blocks in Europe:  the European Union (EU)  the European Free Trade Association The EU is by far the more significant, not just in terms of membership, but also in terms of economic and political influence in the world economy. Slides 9-12-9-13 Evolution of the European Union The EU is the product of two political factors:  the devastation of two world wars on Western Europe and the desire for a lasting peace  the European nations‘ desire to hold their own on the world‘s political and economic stage. 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 EEC was formed in 1957 at the Treaty of Rome. While the original goal was for a common market, progress was generally very slow.


Chapter 09 - Regional Economic Integration

Another Perspective: The EU web site is {}. The site contains a broad array of information about the historical role and current activities of the EU in the global economy. 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. Slide 8-14 Political Structure of the European Union The main institutions of the EU are:  the European Council (ultimate controlling authority within the EU)  the European Commission (responsible for implementing aspects of EU law and monitoring member states to ensure they are complying with EU laws)  the European Parliament (debates legislation proposed by the commission and forwarded to it by the council)  the Court of Justice (the supreme appeals court for EU law). Slides 8-15-8-16 The Establishment of the Euro The Treaty of Maastricht, signed in 1991, committed the EU to adopt a single currency, the euro, by January 1, 1999. The euro is used by 17 of the 27 member states. By adopting the euro, the EU has created the second largest currency zone in the world after that of the U.S. dollar. Since its establishment January 1, 1999, the euro has had a volatile trading history with the U.S. dollar. Initially, the currency fell in value relative to the dollar, but has since strengthened. Another Perspective: The European Union has a web page devoted to the euro {}. Students can explore the site and click on the pages to see pictures of the coins and notes, the advantages of participating in the euro zone, and frequently asked questions about the euro. Another Perspective: The European Central Bank maintains a web site with current information on the euro. The site is available at {}. Another Perspective: At one point in time, joining the Euro Zone had been the goal of many Eastern European countries. Now however, given the recent financial crises that is threatening the future of the euro, many are rethinking their plans. To learn more, go to {}.


Chapter 09 - Regional Economic Integration

Slide 8-17 Enlargement of the European Union Several countries, particularly from Eastern Europe, have applied for membership in the EU. In December of 2002, the EU formally agreed to accept the applications of 10 countries, and they joined on May 1, 2004. Today, membership is up to 27 countries. Slide 9-18-9-19 Regional Economic Integration in the Americas The North American Free Trade Agreement (NAFTA) is the most significant attempt at economic integration in the Americas. Other efforts include the Andean group and MERCOSUR. In addition, there are plans to establish a hemisphere wide Free Trade Area of the Americas (FTAA.) Slides 9-20-9-23 The North American Free Trade Agreement The free trade agreement between the United States, Canada, and Mexico became law January 1, 1994. Another Perspective: More on NAFTA can be found at {}. Following approval of NAFTA by the U.S. Congress a number of other Latin American countries indicated their desire to eventually join NAFTA. Currently the governments of both Canada and the U.S. are adopting a wait and see attitude with regard to most countries. Another Perspective: Many organizations are anxious to take advantage of the opportunities offered by NAFTA. The NAFTA Register {}is a directory of export management companies, export service providers, and trading companies that want to profit from NAFTA by helping buyers and selling take advantage of NAFTA related opportunities. Slide 9-24 The Andean Community The Andean Pact, originally formed in 1969, was based on the EU model, but was far less successful in achieving its stated goals. In 1990, the Andean Pact was re-launched, and now operates as a customs union.

Another Perspective: To see new developments with the Andean Community go to {}. Slide 9-25 MERCOSUR In some industries MERCOSUR is trade diverting rather than trade creating, and local firms are investing in industries that are not competitive on a worldwide basis. Another Perspective: MERCOSUR's Homepage, which includes a broad array of useful information, can be accessed at {}.


Chapter 09 - Regional Economic Integration

Slide 9-26 Central American Trade Agreement Market and CARICOM

There are two other trade pacts in the America, the Central American Trade Market and CARICOM, although neither has made much progress as yet. Slide 9-27 Free Trade of the Americas If the FTAA is established, it will have major implications for cross-border trade and investment flows within the hemisphere. The FTAA would create a free trade area of 850 million people. Another Perspective: Additional information on the Free Trade of the Americas can be found at {}. Slide 9-28 Regional Economic Integration In Asia Several efforts have been made to integrate in Asia One of the most successful is the Association of Southeast Asian Nations (ASEAN) Slides 9-29-9-30 Association of Southeast Asian Nations Formed in 1967, ASEAN currently includes Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, and, most recently, Vietnam, Myanmar, Laos, and Cambodia. The basic objectives of ASEAN are to foster freer trade between member countries and to achieve some cooperation in their industrial policies. Slides 9-31-9-32 Asia Pacific Cooperation APEC currently has 21 members including such economic powerhouses as the United States, Japan, and China. The stated aim of APEC is to increase multilateral cooperation in view of the economic rise of the Pacific nations and the growing interdependence within the region. Another Perspective: For more on APEC, go to its web site at {}. Slide 9-33 Regional Trade Blocks in Africa There are nine trade blocs on the African continent however progress toward the establishment of meaningful trade blocs has been slow. Slide 9-34 Implications for Managers The EU and NAFTA currently have the most immediate implications for business. 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 firms to realize potentially enormous cost economies by centralizing 9-8

Chapter 09 - Regional Economic Integration

production in those locations where the mix of factor costs and skills is optimal. Through specialization and shipping of goods between locations, a much more efficient web of operations can be created. Just as the emergence of single markets in the EU and North America creates opportunities for business, so it also presents a number of threats.

CRITICAL THINKING AND DISCUSSION QUESTIONS QUESTION 1: NAFTA has produced significant benefits for the Canadian, Mexican and U.S. economy. Discuss. ANSWER 1: NAFTA‘s proponents argue that the agreement should be viewed as an opportunity to create an enlarged and more productive base for the U.S., Canada, and Mexico. As low-income jobs move from Canada and the United States to Mexico, the Mexican economy should be strengthened giving Mexico the ability to purchase highercost American and Canadian products. The net effect of the lower income jobs moving to Mexico and Mexico increasing its imports of high quality American and Canadian goods should be positive for the American and Canadian economies. In addition, the international competitiveness of U.S. and Canadian firms that move production to Mexico to take advantage of lower labor costs will be enhanced, enabling them to better compete with Asian and European rivals. QUESTION 2: What are the economic and political arguments for regional economic integration? Given these arguments, why don't we see more integration in the world economy? ANSWER 2: The economic case for regional integration is straightforward. As we saw in Chapter 5, unrestricted free trade allows countries to specialize in the production of goods and services that they can produce most efficiently. If this happens as the result of economic integration within a geographic region, the net effect is greater prosperity for the nations of the region. From a more philosophical perspective, regional economic integration can be seen as an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO. The political case for integration is also compelling. Linking neighboring economies and making them increasingly dependent on each other creates incentives for political cooperation between neighboring states. Also, the potential for violent conflict between the states is reduced. In addition, by grouping their economies together, the countries can enhance their political weight in the world. Despite the strong economic and political arguments for integration, it has never been easy to achieve (on a meaningful level). There are two main reasons for this. First, although economic integration benefits the majority, it has its costs. While a set of nations as a whole may benefit significantly from a regional free trade agreement, certain groups may loose. The second impediment to integration arises from concerns over national sovereignty.


Chapter 09 - Regional Economic Integration

QUESTION 3: What effect is the creation of a single market and a single currency within the EU likely to have on competition within the EU? Why?

ANSWER 3: By creating a single market and currency, member countries can expect significant gains from the free flow of trade and investment. This will result from the ability of the countries within the EU to specialize in the production of the product that they manufacture the most efficiently, and the freedom to trade those products with other EU countries without being encumbered by tariffs and other trade barriers. In terms of competition, the competition between European firms will increase. Some of the most inefficient firms may go out of business because they will no longer be protected from other European companies by high tariffs, quotas, or administrative trade barriers. Companies from those countries that have not adopted the euro may find that their costs are higher as they deal with currency exchanges. In addition, because it will be easier to compare prices across markets, firms in the euro zone will be pushed to lower prices and become more efficient. QUESTION 4: Do you think it is correct for the European Commission to restrict mergers between American companies that do business in Europe? (For example, the European Commission vetoed the proposed merger between WorldCom and Sprint, both U.S. companies, and it carefully reviewed the merger between AOL and Time Warner, again both U.S. companies). ANSWER 4: Many students will probably suggest that the European Commission has a right to regulate the European market, even if the regulation involves American companies. Students taking this perspective will probably suggest that such restrictions should be made independently of other considerations, even when the parent governments of the companies have approved the mergers. Other students however, may argue that the European Commission does not have the right to restrict a merger that has been approved by parent governments. In doing so, the European Commission is in effect protecting domestic companies from foreign competition, and violating the spirit of the WTO. QUESTION 5: How should a U.S. firm that currently exports to only ASEAN countries respond to the creation of a single market in this regional grouping? ANSWER 5: A U.S. business firm that is currently exporting to only ASEAN countries should seriously consider opening a facility somewhere in this grouping, as the economics of a common market suggest that outsiders can be at a disadvantage to insiders. The opening of borders within the ASEAN bloc also has the potential to increase the size of the market for the firm. Of course it is possible, after careful consideration, that exporting may still be the most appropriate means of serving the market. QUESTION 6: How should a firm with self-sufficient production facilities in several ASEAN countries respond to the creation of a single market? What are the constraints on its ability to respond in a manner that minimizes production costs?


Chapter 09 - Regional Economic Integration

ANSWER 6: The creation of the single market means that it may no longer be efficient to operate separate duplicative production facilities in each country. Instead, the facilities could either be linked so that each specializes in the production of only certain items or several sites should be closed down and production consolidated at the most efficient locations. Existing differences between countries as well as the need to be located near important customers may limit a firm‘s ability to fully consolidate or relocate production facilities for production cost reasons. Minimizing production costs is only one of many objectives. For example, location of production near R&D facilities can be critical for new product development. The location decision needs to examine long run economic success, not just cost minimization. QUESTION 7: After a promising start, MERCOSUR, the major Latin American trade agreement, has faltered and made little progress since 2000. What problems are hurting MERCOSUR? What can be done to solve these problems? ANSWER 7: MERCOSUR originated in 1988 as a free trade pact between Brazil and Argentina. The pact was expanded in 1990 to include Paraguay and Uruguay with the goal of becoming a full free trade area by 1994, and a common market sometime after. While initially considered a success, critics began to question whether the trade diversion effects of MERCOSUR outweighed it trade creation effects. Then, in 1998 member states slipped into a recession and in 1999, Brazil‘s financial crisis led to a significant devaluation of its currency creating further turmoil. Finally, in 2001, Argentina beset by economic stresses asked that the customs union be temporarily suspended, effectively ending MERCOSUR‘s quest to become a fully functioning customs union. However, in 2003, Brazil‘s new president announced his support for a revitalized and expanded MERCOSUR that would be modeled after the EU, but by 2011, little progress had been made. Another Perspective: Students can check the current status of the agreement online {}. To solve the problems of MERCOSUR, the countries should reduce or eliminate high tariffs on products that can be produced more efficiently in other parts of the world. It should strive to develop industries in which it has a comparative advantage and direct its financial resources to those industries. Finally, it should begin to develop an economy that fosters the free flow of trade and goods throughout the region. QUESTION 8: Would establishment of a Free Trade Area of the America‘s (FTAA) be good for the two most advanced economies in the hemisphere, the United States and Canada? How might the establishment of FTAA impact the strategy on North American firms? ANSWER 8: In 1994, a Free Trade of the Americas (FTAA) was proposed. If the agreement comes about, it would effectively create a free trade area of nearly 800 million people responsible for more than $18 trillion in GDP in 2008. However, the U.S., while initially a strong advocate of the agreement, has lessened its support for the FTAA


Chapter 09 - Regional Economic Integration

recently. The question of whether the agreement is good for the U.S. and Canada will likely produce a lively debate among students. QUESTION 9: Reread the Management Focus case on the European Commission and Media Industry Mergers, then answer the following questions: a) Given that both AOL and Time Warner were U.S. based companies, do you think the European Commission had a right to review and regulate their planned merger? b) Were the concessions extracted by the European Commission from AOL and Time Warner reasonable? Whose interests was the Commission trying to protect? c) What precedent do the actions of the European Commission in this case set? What are the implications for managers of foreign enterprises with substantial operations in Europe? ANSWER 9: a) This question deals with the delicate issue of just how far a country can extend the reach of its law, and should set the stage for a good debate. While some students will argue that the European Commission is overstepping its boundaries by restricting mergers between American companies doing business in Europe, other students will recognize that the U.S. might act in a similar fashion if American firms were being threatened by foreign companies seeking to merge and operate in the U.S. market. b) Time Warner and EMI, bowing to pressure from the European Commission, agreed to drop their joint venture plans after the European Commission raised concerns about the size of a jointly owned company, which would have been three times that of the next largest competitor. According to the European Commission, the joint venture would have too much market power. The European Commission‘s goal was to preserve a competitive market for consumers. A similar situation existed with the Time Warner AOL deal, which if approved would dominate the emerging market for downloading music over the Internet. The companies involved had little choice in the matter, if they wanted to operate in the European market, they had to follow the rules. c) Some students will argue that the European Commission had no right to become involved in the business decisions of the companies, especially the ones from the United States. Others however, will probably note that one of the roles of the European Commission is to preserve a fair market system that protects consumers. In this particular case, that meant that the deals had to be blocked.

CLOSING CASE: NAFTA and Mexican Trucking The closing case explores the implications of regional economic integration for various groups. Under the North American Free Trade Agreement (NAFTA), Mexican truckers were to have been allowed to drive their trucks directly into the United States and avoid the costly and time consuming border unloading and loading that took place prior to the agreement. However, fearing job losses in the industry, the U.S. Teamsters Union rigorously opposed the legislation. Although the group ultimately lost its fight, the United States still did not give Mexican truckers freedom to deliver their goods, prompting Mexico to institute retaliatory measures affecting $2.4 billion of goods


Chapter 09 - Regional Economic Integration

exported from the United States. Discussion of the case can revolve around the following questions: QUESTION 1: What are the potential economic benefits of the trucking provisions in the NAFTA treaty? Who benefits? ANSWER 1: Under the NAFTA agreement trucks from Mexico are no longer required to unload their goods and reload them onto U.S. trucks. Instead, Mexican trucks can simply cross the border and continue to their final destination. These changes save time and also money – efficiencies that can then be passed along to consumers. In addition, because U.S. truckers must now compete with Mexican truckers, further savings should be created. Most students will probably suggest that if the NAFTA agreement is followed, U.S. consumers should benefit as should Mexican truckers. The real losers appear to be U.S. truckers. Most students will probably recognize that this situation accounts for the strong stance the Teamsters have taken against the agreement. QUESTION 2: What do you think motivated the Teamsters to object to the trucking provisions in NAFTA? Are these objections fair? Why did Congress align itself with the Teamsters? ANSWER 2: The Teamsters have rigorously objected to the provisions of NAFTA allowing Mexican truckers to cross U.S. borders and deliver their goods to their destination. Prior to NAFTA, Mexican trucks were required to reload their goods onto U.S. trucks at the border. The Teamsters are worried not only about the loss of this business, but also the new competition that the Mexican truckers will introduce. Many students will probably realize the challenges faced by the Teamsters and may sympathize with them, but will ultimately probably agree that the bloc as a whole is better off if the provisions outlined in NAFTA are upheld. Students may suggest that it is only because of the union‘s power that the United States delayed implementing the agreement. QUESTION 3: Does it make economic sense for the United States to bear the costs of punitive tariffs as allowed for under NAFTA, as opposed to letting Mexican trucks enter the United States? ANSWER 3: When the United States initially failed to abide by provisions set forth in NAFTA regarding trucks, Mexico gave the country a second chance to honor its commitment. The United States responded with bureaucratic measures designed to block Mexican trucks from entering the country. Mexico immediately implemented new tariff policies on various U.S. goods destined for Mexico. Under the new policies, grape exporters faced 45 percent tariffs and other U.S. exporters faced 20 percent tariffs. Most students will probably agree that Mexico‘s response was justified and suggest that the effort by the United States to protect the Teamsters simply hurt another group of Americans. Students may also note that U.S. consumers and companies should benefit from the efficiencies that the agreement should provide, and that the efforts to protect a single group are misguided.


Chapter 09 - Regional Economic Integration

Another Perspective: To learn more about the trucking conflict between the United States and Mexico go to {} and {}.

INTEGRATING iGLOBES There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:

Title: ‗No Clear Path Forward‖ For Eurozone As Economic Woes Continue Run Time: 9:55 Abstract: This video explores the crisis in the European Union, and specifically within the Eurozone countries, and what it could mean for the United States if it is not quickly resolved.

Key Concepts: European Union, euro, Eurozone, global economy, exports, trade, foreign investment, political economy, globalization, global capital markets, economic integration, globalization of production, political and economic risk

Notes: The problems in the European Union and specifically in the Eurozone countries have gone from bad to worse with two previously ―strong‖ countries, France and Germany, now showing signs of weakness. The bloc‘s problems emerged almost two years ago when the European Union‘s poorer countries including Greece, Portugal, Italy, and Spain began to show signs of trouble. Now, thanks to both general fear and real problems, it seems that the financial uncertainty has spread to what had been relatively healthy economies. Germany, long a dominant force in the Eurozone, relies on other Eurozone countries as markets for about two-thirds of its exports. As growth in these markets has stalled so too has demand for German products. In fact, the bloc as a whole grew just two-tenths of one percent in the second quarter of 2011. Now, in recognition of the fact that a coordinated policy is necessary if the bloc is to survive, discussions are underway to create European fiscal union. When the Eurozone was established a decade ago, a common currency was introduced, but a common fiscal policy was not implemented. Now, France‘s President Nicholas Sarkozy and German Chancellor Angela Merkel are leading the charge to coordinate the group‘s corporate and tax base policy. Even with this new effort however, there is still concern that it may not be enough. Analysts warn that bold actions are necessary. The United States is watching the situation in Europe carefully. The European Union buys some 25 percent of U.S. exports so it is critical to the health of the U.S. economy


Chapter 09 - Regional Economic Integration

that Europe‘s economy is stable and growing. Already the U.S. Treasury Department, the Federal Reserve, the European Central Bank, and the European financial authorities are meeting regularly to assess the situation and consider alternative actions. Perhaps most alarming however, is that conditions in both the United States and Europe seem to be getting worse, not better. Furthermore, there is no clear strategy going forward of how best to address the situation and in doing so, ward off a potential crisis.

Discussion Questions: 1. Explain the various levels of economic integration. What level of integration has the European Union achieved? How will plans to create fiscal union change the relationship between member countries? 2. Why is Germany now leading the charge for fiscal coordination? How has Germany‘s reliance on the Eurozone countries contributed to its own economic slowdown? 3. Reflect on the notion of fiscal union within the European Union. Why is it becoming necessary? Can it be achieved quickly enough to avert financial disaster within the trading bloc? 4. Consider the crisis in Europe from the perspective of the United States. How would financial collapse in Europe affect the United States?

INTEGRATING VIDEOS There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 6:

Title: Twitter and Haiti Learning Objectives The purpose of this video is to help you:  Understand how social media platforms are increasing the pace of globalization.  Examine how new methods of communication are replacing more traditional ones.  Recognize the marketing implications of how people communicate via social media.  Explore how social media platforms may be changing social activism.

Key Words     

Globalization Global economy Technological change Cultural change Levels of economic development


Chapter 09 - Regional Economic Integration

Synopsis When the earthquake hit Haiti last year, many people, both within the country and outside, immediately got on Twitter and Facebook to get information about what was happening, and to communicate with each other. This crisis was one of the first of its kind in that rather than using more traditional forms of communication like the telephone or television, large numbers of people turned to new forms of technology like Twitter and Facebook. Even news reporters were scanning postings to learn more about the crisis. This may reflect a global trend in which social media platforms are replacing long established means of communication. After the earthquake, many people posted messages to family members indicating that they had survived and providing information about other friends and families. Some people also provided details about what had occurred and what they had seen. Some postings included information about problems that would probably occur as a result of the earthquake such as shortages of medical supplies and water. People outside Haiti were able to learn from these accounts of the extent of the devastation, and get a feel for what was ahead for the Haitian people and the country as a whole. Twitter and Facebook were also the first choice for many social activists and global health organizations involved with the crisis. Social activists were able to leverage the power of the social media platforms to reach out to people for help. Wyclef Jean, a popular Haitian musician, asked his 1.3 million Twitter followers to donate money to help for example. Interestingly, the efforts of activists like Jean were made easier because of the availability of social media platforms and cell phones. People could respond to their requests simply by sending a text message indicating their willingness to donate money. Global organizations like the Red Cross were also able to use social media platforms to raise awareness of the needs of the Haitian people and to organize contributions.

Discussion Questions 1. Discuss how new technologies emerged as a preferred form of communication after the earthquake in Haiti. What conclusions might a company targeting consumers in a developing country like Haiti draw from this phenomenon? 2. What challenges do social network platforms like Twitter and Facebook face in developing countries? Why might first mover advantages be important in these markets? 3. Reflect on the differences in how people use social networking platforms based on their geographic location. How can companies capitalize on the growing use of social media networks in developing countries and emerging markets? 4. Discuss how social media platforms are changing the way social activists raise awareness and gain support for their causes. How can companies that support social causes leverage these same opportunities?


Chapter 09 - Regional Economic Integration

INCORPORATING globalEDGE™ EXERCISES Use the globalEDGE™ site {} to complete the following exercises:

Exercise 1 Your company is seeking to expand by opening new customer representative and sales offices in the European Union (EU). The size of the investment is significant and top management wishes to have a clearer picture of the current and probable future status of the EU. A colleague who spent some time living in the EU indicated that Eurostat might be a comprehensive source to assist in your project. After evaluating the state of the EU based on the statistics and publications available, prepare an executive summary describing the features you consider as crucial in completing your report.

Exercise 2 Trade agreements can impact the cultural interactions between countries. In fact, the establishment of the Free Trade Area of the Americas (FTAA) can be considered a threat as well as an opportunity for your company. Identify the main negotiating groups a country must consider when a member. Choose two negotiating groups and justify their importance to member countries.

Answers to Exercises Exercise 1 A variety of reports and statistics can be accessed by searching the term ―Eurostat‖ at At the bottom of the linked Eurostat webpage are a series of publications, tables, and data that are useful for completing this exercise. In addition, the Publications tab found at the top of the webpage can provide considerable material for an analysis. Be sure to click on the Resource Desk link to search this area of the globalEDGE website. Search Phrase: ―Eurostat‖ Resource Name: EUROPE: Eurostat Website: globalEDGE™ Category: ―Research: Statistical Data Sources‖

Exercise 2 A variety of reports and statistics can be accessed by searching the term ―Eurostat‖ at At the bottom of the linked Eurostat webpage are a series of publications, tables, and data that are useful for completing this exercise. In addition, the Publications tab found at the top of the webpage can provide considerable material for an analysis. Be sure to click on the Resource Desk link to search this area of the globalEDGE website. Search Phrase: ―Eurostat‖


Chapter 09 - Regional Economic Integration

Resource Name: EUROPE: Eurostat Website: globalEDGE™ Category: ―Research: Statistical Data Sources‖

End of Part Case Notes Part Three: Logitech 1. In a world without trade, what would happen to the costs that American consumers would have to pay for Logitech‘s products? Answer: Logitech moved its manufacturing to Taiwan and China in an effort to save money and maintain a competitive advantage. While labor costs were a factor in the decision to shift its manufacturing, other costs were also considered. The case notes that Taiwan offered a well-developed supply base for parts, qualified people, and a rapidly developing local computer industry. In addition, the company was able to secure space for only $200,000. In China, Logitech is able to employ workers for just $75 per day. If Logitech were not able to take advantage of opportunities such as these, and export its product back to the United States, American consumers would pay significantly higher prices for the company‘s products. 2. Explain how trade lowers the costs of making computer peripherals such as mice and keyboards? Answer: The theories of Smith, Ricardo, and Hecksher-Ohlin show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself. International trade allows a country to specialize in the manufacture and export of products that can be produced most efficiently in that country, while importing products that can be produced more efficiently in other countries. 3. Use the theory of comparative advantage to explain the way in which Logitech has configured its global operations. Why does the company manufacture in China and Taiwan, undertake basic R&D in Freemont and Switzerland, design products in Ireland, and coordinate marketing and operations from California?


Chapter 09 - Regional Economic Integration

Answer: The theory of comparative advantage suggests that it makes sense for a country to specialize in producing those goods that it can produce most efficiently, while buying goods that it can produce relatively less efficiently from other countries—even if that means buying goods from other countries that it could produce more efficiently itself. Logitech has successfully located the various parts of its value added chain around the world to take advantage of those attributes that are available in each of the locations in which it operates. 4. Who creates more value for Logitech, the 650 people it employs in Fremont and Switzerland, or the 4,000 employees at its Chinese factory? What are the implications of this observation for the argument that free trade is beneficial? Answer: Logitech has taken great care in configuring its global value chain to lower production costs while maintaining the value of those assets that lead to differentiation. Logitech undertakes basic R&D work in Switzerland, and also in Fremont. Fremont is also the location for the company‘s global marketing, finance, and logistics operations. Clearly, Logitech is successfully exploiting the benefits of the American and Swiss labor force, while at the same time taking advantage of the lower costs of production available in China. Logitech‘s operations support the argument that free trade is beneficial. 5. Why do you think the company decided to shift its corporate headquarters from Switzerland to Fremont? Answer: Switzerland is still important to Logitech. Indeed the company undertakes basic R&D work there. However, in an effort to be closer to many of America‘s hightechnology enterprises, Logitech moved its headquarters to Freemont, California. Freemont is now home to the company‘s global marketing, finance, and logistics functions, and is also the location for some additional R&D work. 6. To what extent can Porter‘s diamond help explain the choice of Taiwan as a major manufacturing site for Logitech? Answer: According to Porter, four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage. The four attributes are factor endowments, demand conditions, related and supporting industries, and firm strategy, structure, and rivalry. The first attribute, factor endowments, clearly helps explain the choice of Taiwan as a major manufacturing site for Logitech. Taiwan has a well-developed supply base for parts, as well as qualified people. In addition, Taiwan‘s rapidly expanding local computer industry (related and supporting industries) also puts the country in a strong position to be a major manufacturing site for Logitech.


Chapter 09 - Regional Economic Integration

7. Why do you think China is now a favored location for so much high technology manufacturing activity? How will China‘s increasing involvement in global trade help that country? How will it help the world‘s developed economies? What potential problems are associated with moving work to China? Answer: Foreign companies now account for three-quarters of China‘s high tech exports. Porter‘s diamond would suggest that like Taiwan, China has strong factor endowments and strong related and supporting industries. Together, these attributes make China an attractive location of high-tech manufacturing. China‘s increasing involvement in global trade should help the country by spurring its economic growth. This in turn, should create more demand for imports which should be beneficial to the world‘s developed economies.

The Ecuadorian Rose Industry 1. What is the basis of Ecuador‘s comparative advantage in the production of roses? Answer: Ecuador, with its intense sunlight, fertile volcanic soil, equatorial location, and high altitude provides the perfect conditions for growing roses. In addition, wage rates in Ecuador are relatively low. The country‘s minimum wage is just $120 a month, however, many workers in the rose industry are paid nearly double rate for six days of work per week, per month. Perfect growing conditions combined with low wages give Ecuador a comparative advantage in the production of roses. 2. Most Ecuadorean roses are sold in the United States or Europe. Who in these countries benefits from the importation of Ecuadorean roses, and how do they benefit? Who loses? Do you think the benefits outweigh the costs? Answer: Roses imported from Ecuador have transformed the floral industry in both Europe and the United States. Prior to the growth of Ecuador‘s rose industry, roses were available only in limited quantities and varieties, and were generally very expensive in the United States and Europe. Today, however, consumers in both markets have been able to benefit from the ready supply of high quality flowers available at relatively low prices. Most students will probably recognize that while consumers have benefited from the growth of Ecuador‘s rose industry, growers in the United States and Europe have not. However, many students will probably conclude that in this situation, because Ecuador‘s industry benefits not only its own citizens, but also consumers in other markets like the United States and Europe, the benefits do indeed outweigh the costs. Other students however, may wonder whether the damage to the environment that may be occurring because of the growth in the industry is indeed worth it. 3. How does the rose export industry benefit Ecuador? Do these benefits have any implications for the United States and Europe?


Chapter 09 - Regional Economic Integration

Answer: Ecuador is now the world‘s fourth largest producer of roses. Rose farms in the country support tens of thousands of jobs. Revenues and taxes from the industry have been used to help pave roads, build schools, and construct irrigation systems. Many workers earn more in the industry than they could elsewhere. Some students however, may note that in rose-growing cities like Cayambe, populations have swelled significantly putting pressure on the resources within the region. In addition, environmentalists worry that the industry is not following proper safety precautions with the chemicals it uses. In then end though, many students will probably argue that indeed the industry has been beneficial to the country, and that the growth of the industry may in fact also benefit both the United States and Europe as those markets see their export opportunities increase as a result of greater prosperity in Ecuador. 4. How should developed nations respond to reports of poor working conditions in this industry? Should importers in some way certify Ecuadorean producers, only importing from those who adhere to strict labor and environmental standards?

Answer: The question of whether the working conditions are appropriate in developing nations strikes an ethical chord with many people. Most students probably agree that it is vital for developed countries to challenge developing nations to ensure that workers in their countries are provided safe working conditions. Already, pressure from European consumer groups have prompted some Ecuadorian growers to voluntarily join programs designed to ensure worker safety. Many students will probably suggest that programs like these will put pressure on other growers to implement similar measures. However, students may also note that some growers may be reluctant to adopt safety measures because such programs are likely to increase costs. Students may also recognize that many consumers will continue to buy the cheapest roses available, regardless of how they were grown, and may be unwilling to support efforts to import only from those growers who are certified. Another Perspective: For more information on the rose industry in Ecuador, visit {}.


Chapter 09 - Regional Economic Integration

The European Energy Market 1. What do you think are the economic benefits of liberalizing the EU energy market? Who stands to gain the most from liberalization? Answer: The European Union is hoping to liberalize its energy market. By doing so, increased competition among energy producers should result in greater efficiencies, economies of scale, and lower prices for consumers. Indeed, consumers could ultimately be the biggest winners if the move is successful. 2. What are the implications of liberalization for energy producers in the EU? How will the environment they face change post liberalization? What actions will they have to take? Answer: Efforts to liberalize the energy markets in the European Union have met with considerable resistance from producers and in some cases from local governments. At the heart of the issue is the fact that the energy market in the European Union is currently highly inefficient and nationalistic. Each nation essentially has its own producers, often formerly owned by the state, that serve the majority of the market. Most producers have vertically integrated into other areas of the business, and are unwilling to allow foreign producers to utilize parts of their business to serve local customers. Governments too are reluctant to allow acquisitions by foreign companies because of the local job losses such moves could imply. If the efforts at liberalization continue, it is likely that the business will be split into several areas including generation, transmission, and marketing. Companies will operate in only one of these areas, for example producing power, rather than in all of them as is the case with the current business model.

3. Why is the de-integration of large energy companies seen as an important part of any attempt to liberalize the EU energy market? Answer: The European Union believes that it is necessary to de-integrate large energy companies in order to liberalize the energy markets in the bloc. At the moment, most nations have a single large company that dominates the market, making it very difficult for new companies to break in. Furthermore, since most companies have vertically integrated into producing, transmitting, and marketing energy, they have resisted efforts to allow other companies into even parts of the business. The European Union wants to de-integrate the business so that independent companies can buy from the cheapest source, resell to consumers and so on, and create the competition necessary to force producers to become more efficient. 4. Why do you think progress towards the liberalization of the EU energy market has been slow so far? Answer: In 2007, national energy ministers rejected a request from the European Commission to de-integrate the energy companies. France and Germany have been


Chapter 09 - Regional Economic Integration

particularly vocal about the request – both countries stand to lose from such a request because they both have large vertically integrated energy companies. Most students will probably agree that progress towards the liberalization of the market is likely to continue to be slow since the major beneficiaries of the market liberalization are consumers, rather than producers. Many students will probably agree that since producers stand to lose from liberalization, and nations could individually be hurt, efforts to slow the process will probably continue. Another Perspective: Students can learn more about this case at {}.

Global Food Prices 1. Who benefits from government policies to a) promote production of ethanol and b) place tariff barriers on the imports of sugar cane? Who suffers from these policies? Answer: Government policies to promote the production of ethanol, like many other types of market intervention, are designed to help the producer with little regard for the consumer. In this particular situation, U.S. and EU farmers are receiving subsidies for growing soy and corn to be used for ethanol production. This has pushed the prices of both products up, and because some farmers are switching from other types of crops like wheat to soy in order to take advantage of the subsidies, the policies have also resulted in an increase in other food prices as well. Most students will probably realize that consumers are certainly on the losing end of the deal, as they face higher prices in the grocery store. Moreover, because the United States and the European Union have also implemented tariffs against an alternative raw material for ethanol production, sugar cane, producers in sugar producing countries like Brazil have also suffered. 2. One estimate suggests that if food prices rise by one third, they will reduce living standards in rich countries by about three percent, but in very poor ones by about twenty percent. According to the International Food Policy Research Institute, unless there is a change in policies, cereal prices will rise by 10-20 percent by 2015, and the expansion of bio-fuel production could reduce calorie intake by 2-8 percent by 2020 in many of the world‘s poorest nations. Should rich countries do anything about this? If so, what? Answer: This is a difficult question that will probably stir some debate. For decades, consumers have enjoyed the benefits of increased productivity and output in the global food industry. In 2007, however, everything changed. The price of wheat reached its highest point ever, and the price of corn rose 60 percent over its 2006 price. Two factors contributed to this situation. The first was the increased demand for food from China and India. The second factor involved tariffs and subsidies for bio-fuels. Farmers in the European Union and in the United States are currently the recipients of subsidies for the production of crops used in bio-fuels. As a result, land that might be used for growing food is being converted to bio-fuel crops, pushing up prices on food. While some experts believe that sugar cane may be a better product for bio-fuel production than corn, tariffs on imported sugar cane effectively are keeping the crop out of the market. While all consumers are feeling the pain of higher food prices, the situation is especially dire for


Chapter 09 - Regional Economic Integration

consumers in poor countries where calorie intake could be reduced by as much as 8 percent by 2020. Many students will probably suggest that the world‘s richer countries do indeed have a moral responsibility to ensure that poorer countries have access to food at affordable prices. While many students will probably agree that it is important to continue with the initiative to develop viable bio-fuels, they will probably also conclude that the goal should not be at the expense of the world‘s poorer nations. Some students may suggest that efforts by richer nations focus on providing the necessary support to poorer nations to allow them to develop their own food sources, while other students may support a program that focuses more on simply providing assistance through donations of food to offset the higher priced food that can be purchased on the open market. 3. The argument for giving subsidies to ethanol producers rests upon the assumption that ethanol results in lower CO2 emissions than gasoline, and therefore benefits the environment. If we accept that global warming is itself a serious problem, should we not be encouraging government to increase such subsidies? What are the arguments for and against doing so? On balance, what do you think is the best policy? Answer: While most students will probably agree that global warming is a serious problem that must be addressed, they will probably also conclude that simply providing subsidies to farmers who produce soy or corn is not a solution. Indeed, most scientists agree that ethanol produced from sugar cane is superior to that produced from corn or soy simply because it is produced using the waste portion of the sugar cane. Consequently, the notion that soy farmers and corn farmer should continue to receive subsidies while tariffs are maintained against sugar cane imports from Brazil suggests a protectionist agenda in both the United States and in the European Union. Some students may also note that ethanol is only part of the solution to the problem of global warming. Other programs with fewer negative effects should also be considered. Some students for example, may suggest that the money spent subsidizing farmers might be better spent installing solar powered panels, or wind turbines. Another Perspective: There are two iGLOBES that deal directly with the issues in this case. The first is Supply, Price of Food Increase Hardship for World’s Poor, and the second is Agricultural Problems Lead to Farmer Suicides in India.



Regional Economic Integration

Chapter 09 - Regional Economic Integration Regional Economic Integration Learning objectives  Describe the different levels of regional economic i...

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