IB 303 Chapter 7: Cross-National Cooperation and Agreements
Terms in this set (12)
Economic integration is a term used to describe the political and monetary agreements among nations and world regions in which preference is given to member countries. There are three major ways to approach such agreements:
1) Global integration: countries from all over the world decide to cooperate through the WTO
2) Bilateral integration: two countries decide to cooperate more closely together, usually in the form of tariff reductions
3) Regional integration: a group of countries located in the same geographic proximity decide to cooperate, as with the European Union
Trade groups define the size of the regional market and the rules under which a company must operate.
Reason for existing: increase in market size
As a company expands internationally, it must change its organizational structure and operating strategies to continually benefit from these alliances.
* Triad regions: Europe, North America, and Asia
- firms are likely to generate a reasonably high percent of revenues from their home regions
The World Trade Organization: Global Integration
World Trade Organization (WTO):
- the successor to the General Agreement on Tariffs and Trade (GATT)
- major multilateral forum through which governments can come to agreements and settle trade disputes.
- 1947, 23 countries formed the GATT under the UN to abolish quotas and reduce tariffs.
- WTO replaces GATT in 1995 (125 members)
- GATT's contribution to trade liberalization enabled the expansion of world trade in the second half of the twentieth century
1) Trade without discrimination:
- fundamental principle of the GATT: each member nation must open its markets equally to every other member nation. "trade without discrimination"
- most-favored-nation (MFN) clause: once a country and its trading partners had agreed to reduce a tariff, that tariff cut was automatically extended to every other member country, irrespective of whether the country was a signatory to the agreement.
- GATT's success leads some governments to devise craftier methods of protection (services were not covered by GATT)
- Could not enforce compliance with agreements.
- market trends and organizational challenges made trade agreements harder to work out
- restoring an effective means for trade liberalization led officials to create the WTO in 1995.
* What does the WTO do?
The WTO is the major body for:
- reciprocal trade negotiations
- enforcement of trade agreements
- The WTO adopted the principles and trade agreements reached under the GATT but expanded its mission to include trade in services, investment, intellectual property, sanitary measures, plant health, agriculture, and textiles as well as technical barriers.
- 159 members account for more than 97 percent of world trade and include the BRIC countries
- members make significant decisions by consensus, but there are provisions for a majority vote in the event of a non-decision. Agreements then must be ratified by the governments of the member nations.
1. Most favored nation
WTO continues the most-favored-nation clause of the GATT, and the benefits are exclusive to official members except:
- developing countries' manufactured products have been given preferential treatment over those from industrial countries.
- concessions granted to members within a regional trading alliance, such as the EU, have not been extended to countries outside the alliance.
- countries can raise barriers against member countries who they feel are trading unfairly.
- exceptions are made in times of war or international tension.
2. dispute settlement
- countries may bring charges of unfair trade practices to a WTO panel, and accused countries may appeal.
- time limits, WTO's rulings are binding.
- effectiveness of this system is under debate, given the ambiguity and time-consuming nature of certain cases.
- Ex: Airbus and Boeing first try to resolve it outside of WTO, but resort to WTO's measures in 2004.
- Ex: dispute resolution between U.S. and China: U.S. claims that China established restrictions and requirements on foreign companies that wanted to process electronic services for the payment of credit card transactions. 2010-2012.
(3 Councils in WTO:
1) General Agreement for Trade in Services
2) Council for Trade in Goods
3) Council for Trade-Related Aspects of Intellectual Property Rights)
3. Doha Round
- Most of WTO's agenda was established by negotiations, or rounds, held by GATT
- Uruguay Round: took place from 1986 to 1994 and led to the creation of the WTO.
- Most complex issue of WTO, being worked through the Doha Round (Doha Ministerial Declaration): Qatar in 2011, focus on giving a boost to developing countries on the world scene.
- disputes result in a split between developed members and developing countries over the large agricultural subsidies maintained by the richer nations and the industrial subsidies enforced by developing countries.
- Initial deadline for the Doha agenda was January 1, 2005, but countries could not agree on key issues by 2009.
- "Doha Lite" or "Plan B" is approved by the WTO members in 2011, but has not gained significant traction: better coordinated exports rules and procedures and export incentive for developing countries
The Rise of Bilateral Agreements
- U.S. signs free trade agreements with Colombia and South Korea, both of which reduced tariffs and other trade barriers for industrial products and agricultural products while strengthening intellectual property rights and trade in services.
- U.S. exports to Korea rose in the first year of the agreement, but Korean exports to the U.S. rose even more, resulting in a widening of the trade deficit.
* Bilateral agreements can be between two individual countries or may involve one country dealing with a group of other countries.
Regional Economic Integration
* Regional trade agreements are reciprocal pacts between two or more partners that lie somewhat between bilateral and global integration agreements. (integration confined to a region and involving more than two countries).
- 354 RTAs were in force as of mid-January 2013.
Ex: European Union (EU), European Free Trade Association (EFTA), North American Free Trade Agreement (NAFTA), Southern Common Market (MERCOSUR), Association of Southeast Asian Nations (ASEAN), Free Trade Area (AFTA), Common Market of Eastern and Southern Africa (COMESA).
Regional Economic Integration: Geography Matters
Neighboring nations tend to ally for several reasons:
- The distances that goods need to travel are short
- Consumers' tastes are likely to be similar, and distribution channels can easily be established
- Most RTAs are established according to proximity, but not all.
Ex: South Korea and U.S.; Canada and Israel
- if the physical distance between two countries increases by 1 percent, international trade drops by 1.1 percent.
- trade is likely to rise by 80 percent between countries with a common border, 200 percent with a common language, and 340 percent with a common currency
- trade among bloc members is likely to rise by 330 percent once an agreement is established.
THREE MAJOR TYPES OF ECONOMIC INTEGRATION
1. Free Trade Agreement (FTA): the goal of an FTA is to abolish all tariffs between member countries.
- begins modestly by eliminating tariffs on goods that already have los tariffs
- implementation period: all tariffs are eliminated on all products included in the agreement
- each country maintains its own external tariffs against non-FTA countries
- about 90 percent of RTAs identified by the WTO are free trade agreements
2. Customs Union: in addition to eliminating internal tariffs, member countries levy a common external tariff on goods being imported from nonmembers in order to establish a customs union.
- driven more by political rather than economic reasons
- less than 10 percent of the number of RTAs identified by the WTO
3. Common market/economic integration agreement: enhancing cooperation in a variety of other ways
- free mobility of production factors such as labor and capital + customs union: common market.
Regional Economic Integration: the effects of integration
1. Static and dynamic effects:
* static effects: shifting of resources from inefficient to efficient companies as trade barriers fall
1) Trade creation: production shifts to more efficient producers for reasons of comparative advantage, allowing consumers access to more goods at lower prices than would have been possible without integration.
2) Trade diversion: trade shifts to countries in the group at the expense of trade with other countries, even though the nonmember companies might be more efficient in the absence of trade barriers. FDI increases from firms outside the FTA.
* dynamic effects: the overall growth in the market and the impact on a company caused by expanding production and by its ability to achieve greater economies of scale.
- Economies of scale: the market grows when trade barriers come down, and companies can increase their production, resulting in lower costs per unit. This can result in more trade between the member countries (trade creation) or an increase in investment in the region by local or foreign companies as the market grows.
- Increased competition: greater efficiency due to not only EOS, but increased competitions. This could result in an investment shifting from less efficient to more efficient companies, or it could result in existing companies becoming more efficient.
Major regional trading groups
Two ways to look at different regional trading groups:
1) Location (ex: EU)
2) Type (ex: FTA, customs union, common market)
Major regional trading groups: the European Union
- The largest and most comprehensive regional economic group
- began by abolishing internal tariffs
- formation of European Parliament and the euro make it the most ambitious of all the regional trade groups
- Need for greater cooperation among their countries to help speed up recovery after World War II
- European Economic Community (EEC): brought together the European countries into the most powerful trading bloc in the world
- European Community, then EU.
2. Organizational Structure:
- EU encompasses many governing bodies, including:
* European Commission:
- provides the EU's political leadership and direction.
- comprised of commissioners nominated by each member government and approved by the European Parliament for five-year terms of office.
- president of the commission is nominated by the member governments and approved by the European Parliament.
- commissioners run the different programs of the EU on a day-to-day basis rather than serve as representatives of their respective governments.
- drafts laws that it submits to the EP and the Council of the European Union
* European Council
- comprised of representatives of each member country whose interests it represents
- along with EP, is responsible for passing laws and making and enacting major policies, including those in the areas of security and foreign policy.
- respective ministers of each country meet periodically to discuss issues
- presidents/prime ministers meet up to four times a year to set broad policy
* European Parliament
- composed of 754 members from all member nations
- elected every five years
- membership is based on country population
- three major responsibilities: legislative power, control over the budget, and supervision of executive decisions.
- members are grouped by political affiliation rather than nationalities
- approve legislation presented by the commission, which is then submitted to the council for adoption
* European Court of Justice
- ensures consistent interpretation and application of EU treaties.
- cases can be brought to the court, which serves as an appeals court for individuals, firms, and organizations fined by the commission for infringing treaty law.
* European Central Bank
3. Antitrust investigations
- the EU has been very aggressive in enforcing antitrust laws in the high-tech area, where IP is a sensitive issue
- Ex: 2009 Microsoft allows users of its Windows software to have the option of choosing which browser they want to use. Google agrees in 2013 to change how it displays search results in Europe.
4. The Single European Act and the Lisbon Treaty
- Single European Act of 1987: designed to eliminate the remaining barriers to a free market, such as customs posts and different certification procedures, rates of value-added tax, and excise duties.
- the Act also results in closer cooperation in trade, foreign policy, and the environment.
- remaining barrier: labeling. the EU is considering mandating country-of-origin labels for products sold in the EU to protect companies the currently manufacture in Europe. (public safety and product quality).
- The Lisbon Treaty: goes into effect on December 1st, 2009
* Strengthen the EU's governance process and improve its ability to make and implement decisions.
* Some view it as part of an agenda to create a stronger federalist union that reduces national sovereignty.
5. Monetary union: the euro
- 1992: members of the EU sign the Treaty of Maastricht to establish a monetary union
- Is administered by the European Central Bank
- Was established on January 1, 1999
- Resulted in new bank notes in 2002.
- 2013, 17 of the members have adopted the Euro, with only Denmark, Sweden, and the UK opting out of the common currency. Does not include eight of the new entrants to the EU.
- non EU members also use the euro.
- threats to the euro: inability of some countries to meet their external debt obligations forced other European countries to come to the rescue
6. The Schengen Area:
- Schengen Agreement of 1990: allows citizens to cross internal borders without having to go through border checks.
- Not including EU members: UK, Ireland, Romania, and Bulgaria
- Includes non-EU members: Iceland, Norway, and Switzerland.
- New member Croatia intends to join in 2015.
- May 2004 expansion has been its larges and included Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, the Slovak Republic, and Slovenia.
- 2007: Bulgaria and Romania
- 2013: Croatia becomes the 28th member
- official candidates for membership: Iceland, Turkey, Montenegro, Serbia, and former Yugoslav Republic of Macedonia.
- other potential candidates: Albania, Bosnia and Herzegovina, and Kosovo
- In March 2013, the euro area unemployment rate was 12.1 percent and in the EU it was 10.9 percent. In Spain, it was over 27 percent.
"The EU has made Europe a much more cohesive economy, which is good when things are going up. But when things are going down, the multiplier is very strong.
An outgoing tide lowers all ships."
8. Bilateral Agreements:
- EU signs bilateral agreements with Pan Arab Free Trade Area & Japan
9. The Transatlantic Trade and Investment Partnership
- U.S. and EU have the world's largest trading relationship and account for nearly half of the world's economic output
- the new agreement would eliminate remaining tariffs and boost trade between the regions and aid in harmonizing product standards between them.
- negotiations began in 2013, but challenges arose:
* French wanted to continue providing subsidies and quotas to support its film and music industries and thus exclude the cultural industries from any future trade talks.
* U.S. farmers were upset about European agricultural safety standards and viewed them as protectionist.
10. How to do business with the EU: implications for corporate strategy
1) determining where to produce:
- one strategy is to produce in a central location in Europe to minimize transportation costs and the time it takes to move products.
- costs are highest in central Europe.
2) determining whether to grow through new investments, through expanding existing investments, or through joint ventures and mergers:
- Ex: Toyota joined with PSA Peugeot-Citroen to build a new factory in the Czech Republic and take advantage of the European carmaker's supplier network.
- European market is still considered fragmented and inefficient, so mergers, takeovers, and spinoffs must continue in Europe.
3) balancing "common" denominators with national differences
- the national differences are wider in the EU than it is between U.S. states
- widely different growth rates
- smaller nations like Ireland and Belgium's attractiveness to FDI grew due to membership in the EU.
The North American Free Trade Agreement (NAFTA)
1. Why NAFTA?
- Canada-U.S. Free Trade Agreement of 1989 eliminates all tariffs on bilateral trade by 1998.
- February 1991, Mexico approaches the U.S. to establish an FTA
- NAFTA becomes effective on January 1, 1994.
- NAFTA is a powerful trading bloc with a population and GDP slightly less than the EU.
- NAFTA is a free trade agreement in goods and services rather than a customs union or a common market, and there is no common currency- but it also includes provisions for services, investment, and intellectual property in addition to tariff reduction.
- As of January 1, 2008, all tariffs and quotas were eliminated on U.S. exports to Canada and Mexico.
* Static and dynamic effects:
static: lower cost agricultural products from Mexico
dynamic: U.S. producers benefit from the enlargement of the Mexican market, which has a huge appetite for U.S. products
* Trade diversion:
NAFTA is a good example of trade diversion: some U.S. trade with and investment in Asia have been diverted to Mexico.
Ex: IBM was making computer parts in Singapore, but moved to Mexico.
- Non-NAFTA members are also investing in Mexico to take advantage of its FTA with Canada and the U.S.
Ex: Sony, Samsung, Sanyo, Panasonic, LG and Sharp in Tijuana, Mexico.
2. Rules of Origin and Regional Content
- FTA, not a customs union: each country sets it own tariffs to the rest of the world.
- criticism: rules of origin are complex and detract from the spirit of multilateral tariff reductions in the WTO.
* Rules of origin: goods and services must originate in North America to get access to lower tariffs.
- major contrast from EU.
* Regional value content requirement:
- the percentage of value that must be from North America for the product to be considered North American in terms of country of origin
- 5o percent for most products, 62.5 percent for autos
3. Special Provisions
- labor standards: right to unionize
- upgrade of environmental standards and strengthening of compliance
- dispute resolution mechanism
4. Impact of NAFTA
- trade and investment increased significantly since the agreement was signed in 1994.
- Canada is the largest export market for U.S. goods, and Mexico is second
- Canada and Mexico are the second and third largest suppliers of good to the U.S.
* Immigration: more than a million farm jobs in Mexico has disappeared due to U.S. competition.
- undocumented workers in the U.S. and sent money home through wire transfers, more than what Mexico receives in FDI.
5. How to do business with NAFTA: implications for corporate strategy
- each member has entered bilateral agreements with other countries.
- allows members to add additional scale through countries that have bilateral agreements with other members in the FTA
6. Rationalization of Production
- automobiles, VW in Puebla, Mexico
7. Mexico as a consumer market
- Mexico is also a consumer market and not just a production location
- income is rising as more investment enters and export rises
- demand is rising for foreign products
Regional Economic Integration in the Americas
Six major regional economic groups in the Americas.
Central America (excluding Mexico):
1. Caribbean Community (CARICOM)
- classified by WTO as an Economic Integration Agreement (common market)
- initiatives have come through CSME (CARICOM Single Market and Economy)
- mirror changes in EU, though in a smaller scale
* challenge of export reliance: countries in Latin America and the Caribbean rely heavily on countries outside the region for trade
2. Central American Common Market (CACM)
3. Central American Free Trade Agreement (CAFTA-DR)
- includes members of CACM but also Honduras, DR, and the U.S.
1. Andean Community (CAN)
- customs union
- been around since 1969
- focus has shifted from isolationism and statism to being open with trade and investment.
- Colombia: one of the founding members of CAN
- Peru was also a member
2. Southern Common Market (MERCOSUR)
- common market
- established in 1991 by Brazil, Argentina, Paraguay, and Uruguay.
- major goal is to become a customs union by the WTO for trade in goods and economic integration agreement for trade in services
- significant because of its size
- generates 75 percent of South America's GDP, making it the third largest trading bloc in the world in terms of GDP after the EU and the NAFTA
- Suspension of Paraguay and inclusion of Venezuela led to the creation of the Pacific Alliance
* Pacific Alliance: Mexico, Colombia, Peru, and Chile (more hospitable to trade and investment due to democratic values and the rule of law rather than the protectionist philosophies or populist ideals of the countries in CAN and MERCOSUR)
- Trying to be a bridge between Latin America and the Asia Pacific region.
3. Union of South American Nations (UNASUR)
- created in 2008 with the goal of merging CAN and MERCOSUR into a larger group like the EU.
- initiated by Brazil to foster political cooperation and to replace a U.S. initiative to create a 34-nation FT of the Americas.
- Still in initial phases
- Formed to increase market size, so Latin American companies can achieve economies of scales and be more competitive worldwide.
Regional Economic Integration in Asia
* Most important: Association of Southeast Asian Nations (ASEAN)
- integration has not been as successful as in Europe or North America because most of the countries in the region have relied on U.S. and EU markets for as much as 20 to 30 percent of their exports.
- China and Japan are NOT member of ASEAN/AFTA.
- formed in 1967
- includes Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.
- ASEAN FTA (AFTA) : officially formed on January 1, 1993.
- reduced tariffs, attracted FDI, and turned the region into a huge network of production, leading to "factory Asia".
APEC (Asia Pacific Economic Conference)
- all but three of the members of ASEAN
- NOT considered an FTA
- 21 countries
Trans-Pacific Partnership (TPP)
- initiated by the U.S.
Regional Economic Integration in Africa
Africa is the new frontier.