Effects of economic integration

There are several forms of economic integration such as Preferential Trading Arrangement (PTAs), Free Trade Areas (FTAs), Custom Unions (CU), Common Market Economic Unions. According to relevant issues, different trade zones have independent agreements. PTAs, FTAs, and CU are the most popular forms. Besides, trade regulation of GATT/WTO also let worldwide trading change a lot. Related studies of effects on economic integration between member and non-member countries are reviewed as follows.

Currently, by judging the effects on worldwide welfare through economic integration, Viner (1950) indicated “trade creation” and “trade diversion” as the main issues. The concept of trade creation means that using imported products from low-cost member countries to replace domestic high-cost manufacturers. Trade

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creation represents a movement in the direction of the free-trade allocation of resources and thus is presumably beneficial for welfare; Trade diversion decreases welfare because importers switch from low-priced world sources to higher priced member country sources after tariffs drop to zero on trade zone. Therefore, effects of welfare are dependent on the integration of trade creation and that of trade diversion.

Most related studies only indicated the results of integration of trade creation and trade diversion for this issue, which are reviewed those pros and cons as follows.

Trade agreement can lead to trade creation. Kennan and Riezman (1990) found that all FTAs members are willing to reduce external tariffs after entering in an FTA.

Under lower external tariffs, there is no discrimination for non-member country;

therefore, trade diversion is able to be eliminated. Richardson (1993), Bagwell and Staiger (1999), and Ornelas (2002) further illustrate that FTAs have positive motivation to reduce external tariffs. Moreover, this can positively confirm that trade diversion can be eliminated after FTAs reduces external tariffs. Bohara et al. (2003) illustrate that trade liberalization can stimulate to reduce external tariffs. Krueger (2000) and Clausing (2001) indicate general equilibrium models result in an obvious outcome of preferential trading blocs and trade diversion is not existed. Krugman (1991) illustrated that most FTAs are formed by natural trading partners, so the influence of trade diversion is quite weak and “prospective moves toward regional free trade would almost surely do more good than harm to the members of the free trade areas”. Furthermore, relevant studies on European trade blocs, Asian and North American, and Latin America all represented that trade agreements can lead to a confirmative effect for trade creation (e.g., Aitken, 1973; Bergstrand, 1985; Thursby, 1987; Frankel and Wei, 1996; Frankel, 1997; Soloaga and Winters, 2001). Rose (2000), Feenstra et al. (2001) and Frankel and Rose (2002) all found that regional trade agreements, in general, is trade creating. Clausing (2001) illustrated that after

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implementing trade integration, the effect of trade creation is larger than that of trade diversion. Baier and Bergstrand (2007) obviously pointed out a FTA approximately doubles two members’ bilateral trade after 10 years. Bastos and Kreickemeire (2009) indicate under the condition of free trading integration, the labor wages, social welfare of member and non-member countries are going up. If one economic integration with fewer member countries, it can create a larger welfare.

However, under the different economic integrations, those do not definitely generate welfare of trade creation effect. Soloaga and Winters (2001) represented the effects of 58 countries of import index signed Preferential Trade Agreement, PTAs during 1980 and 1996. The result indicated that EU and EFTA exists the effect of trade diversion. Kandogan (2009) found that there is an obvious trade diversion occurred in the European non-member developing countries that with similar industries of member countries. The trade diversions of these countries are obviously represented on GDP. Bond et al. (2004) illustrated reasons of why social welfare is getting less. They implemented simple three-country general-equilibrium trade model to analyze how the effect between two countries influences the tariff and welfare levels of all trade partners under FTA. Their results regard FTA as an agreement of economic integration such as NAFTA to increase business trading and welfare for member and non-member countries. It creates an incentive for member to reduce their external tariffs and imply relatively less aggressive tariff setting for their members.

Thus, FTAs can elevate worldwide welfare. On the other hand, using tariff alliance as economical integration model such as Customs Union on, CU, there is a smaller external tariff reduction (or even an increase). When alliance members choose external tariffs, the main objective is to maximize welfare for member countries.

Therefore, even though non-member countries manufacturing same products with lower production cost, its product price is still largely high due to external tariffs.

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Therefore, by implementing tariff alliance, member countries still choose doing business with alliance members, resulting in inefficient resource distribution and elevation. Furthermore, FTA may be welfare-improving in the Pareto sence relative to no cooperation at all.

Different economic integrations generate different effects. Magee (2008) illustrates effects on tariff alliance among trading groups are large on a long term basis. By contrast, free trading agreements affect smaller on group by a shorter time.

Moreover, Preferential trading arrangement creates fewer trading creation which is usually generated after few years of forming trading group

In conclusion, de Melo and Panagariya (1993) illustrate that regionalism can reduces protection but increases welfare. Peretto (2003) considers elements of technical skills and labor supply, economic integration can stimulate the growth of domestic companies and increase market competitiveness in order to achieve the development of domestic social welfare. Lawrence (1998, p. 59) wrote:

Free trade areas may well be an endogenous variable—that is, a response to, rather than a source of, large trade flows...Presumably, (governments) are more likely to form free trade areas, the benefits outweigh the costs.

Maoz et al. (2011) based on the two-sector growth model, used a relative price of consumable capital asset to discuss the effect of free trade between two countries.

This study pointed out that under the FTA of rich-poor countries, the developed country exports capital goods and the developing one exports consumption goods. In a competitive market, signing FTA is able to alternate worldwide capital allocation and increase total world production. Thus, economic integration not only stimulates group development, but also maximizes effects of free trading as well as increasing worldwide welfare.

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