Regional Integration and Economic Blocs

7.5 Understand regional integration and economic blocs.

Related to government intervention is the worldwide trend toward regional economic integration. Also known as regional integration, regional economic integration refers to the growing economic interdependence that results when two or more countries within a geographic region form an alliance aimed at reducing barriers to trade and investment. As happened following formation of the European Union (EU), regional integration increases economic activity and makes doing business easier among nations within the alliance. At a minimum, the countries in an economic bloc become parties to a free trade agreement, a formal arrangement between two or more countries to reduce or eliminate tariffs, quotas, and other barriers to trade in products and services. The member nations also undertake cross-border investments within the bloc.

In the past half century, most countries have sought to cooperate with others, aiming for some degree of regional integration. Today, more than 50 percent of world trade occurs as part of a preferential trade agreement signed by groups of countries. The trend is based on the premise that, by cooperating, nations within a common geographic region connected by historical, cultural, linguistic, economic, or political factors can gain mutual advantages.38

Regional integration results from the formation of a regional economic integration bloc or, simply, an economic bloc. This refers to a geographic area that consists of two or more countries that agree to pursue economic integration by reducing tariffs and other restrictions to the cross-border flow of products, services, capital, and, in more advanced stages, labor. (In this text, following convention, we use the French term bloc instead of block.) Two of the best-known examples are the European Union (EU) and the North American Free Trade Agreement (NAFTA). NAFTA consists of Canada, Mexico, and the United States.

More advanced economic blocs, such as the EU, permit the free flow of capital, labor, and technology among their member countries. The EU is also harmonizing monetary policy (to manage the money supply and currency values) and fiscal policy (to manage government finances, especially tax revenues) and gradually integrating the economies of its member nations. However, recent crises in Greece, Italy, Spain, and Portugal and general discord among EU members are challenging the progress of regional integration in Europe.

Why would a nation opt to be a member of an economic bloc instead of working toward a system of worldwide free trade? The main reason is that it is much easier to reach agreement on free trade with a handful of countries than with all the nations in the world. This helps explain why there are hundreds of regional trade integration blocs around the world today. They present both opportunities and challenges to internationalizing firms.39
Levels of Regional Integration

Exhibit 7.8 identifies five possible levels of regional integration. We can think of these levels as a continuum, with economic interconnectedness progressing from a low level of integration—the free trade area—through higher levels to the most advanced form of integration—the political union. The political union represents the ultimate degree of integration among countries, which no countries have yet achieved.

Exhibit 7.8

Five Potential Levels of Regional Integration Among Nations
A table presents five potential levels of regional integration among nations (for example, a customs union has the features of a free trade area plus common external tariffs.)

Source: Based on Bela Balassa, The Theory of Economic Integration (Milton Park, Oxford, UK: Routledge Revivals, 2012). Note: the five levels above build upon each other. For example, a customs union has the features of a free trade area plus common external tariffs.

The free trade area is the simplest and most common arrangement, in which member countries agree to eliminate formal barriers gradually to trade in products and services within the bloc. Each member country maintains an independent international trade policy with countries outside the bloc. NAFTA is an example. The free trade area emphasizes the pursuit of comparative advantage for a group of countries rather than for individual states. Governments may impose local content requirements. They specify that locally produced products must contain a minimum proportion of locally manufactured parts and components. If the content requirement is not met, the product becomes subject to the tariffs that member governments normally impose on nonmember countries.

The second level of regional integration is the customs union. It is similar to a free trade area except that member states harmonize their external trade policies and adopt common tariff and nontariff barriers on imports from nonmember countries. MERCOSUR, an economic bloc in Latin America, is an example of this type of arrangement. The adoption of a common tariff system means that an exporter outside MERCOSUR faces the same tariffs and nontariff barriers when trading with any MERCOSUR member country. Determining the most appropriate common external tariff is challenging because member countries must agree on the percentage level of the tariff and on how to distribute proceeds from the tariff among the member countries.

In the third stage of regional integration, member countries establish a common market (also known as a single market), in which trade barriers are reduced or removed, common external barriers are established, and products, services, and factors of production such as capital, labor, and technology are allowed to move freely among the member countries. Like a customs union, a common market also establishes a common trade policy with nonmember countries. The EU is a common market. It has gradually reduced or eliminated restrictions on immigration and the cross-border flow of capital. A worker from an EU country has the right to work in other EU countries, and EU firms can freely transfer funds among their subsidiaries within the bloc. In the EU, Germany has seen an influx of workers from Poland and the Czech Republic because these workers can earn much higher wages in Germany than they can in their home countries.

An economic union is the fourth stage of regional integration, in which member countries enjoy all the advantages of early stages but also strive to have common fiscal and monetary policies. At the extreme, each member country adopts identical tax rates. The bloc aims for standardized monetary policy, which requires establishing fixed exchange rates and free convertibility of currencies among the member states, in addition to allowing the free movement of capital. This standardization helps eliminate discriminatory practices that might favor one member state over another. Through greater mobility of products, services, and production factors, an economic union enables firms within the bloc to locate productive activities in member states with the most favorable economic policies.

The EU has made great strides toward achieving an economic union. For example, 19 EU countries have established a monetary union in which a single currency, the euro, is now in circulation. Monetary union and the euro have greatly increased the ease with which European financial institutions establish branches across the EU and offer banking services, insurance, and savings products. The single currency also makes trading and investment easier for European firms doing business within the union.

The United States provides a good analogy for an economic union. Imagine each state is like an individual country, but all are joined in a union. The members have a common currency and a single central bank with a uniform monetary policy. Trade among the members takes place unobstructed, and both labor and capital move freely among them. The federal government applies a uniform tax and fiscal policy. Just as would occur in an economic union, the individual U.S. states also govern themselves in such areas as education, police protection, and local taxes. This analogy only goes so far, of course. The United States is a country, and unlike members of a real economic union, the states cannot withdraw.

Figure 7.8 Full Alternative Text: Long description

The features for the different levels of integration are as follows:

Members agree to eliminate tariffs and non-tariff trade barriers with each other but maintain their own trade barriers with non-member countries. Examples: NAFTA, EFTA, ASEAN, Australia and New Zealand Closer Economic Relations Agreement (CER).

Features: Free Trade; Common Union; Common Market; Economic and (sometimes) Monetary Union; Political Union

Common external tariffs. Example: MERCOSUR.

Features: Common Market; Economic and (sometimes) Monetary Union; Political Union

Free movement of products, labor, and capital. Example: Pre-1992 European Economic Community.

Features: Economic and (sometimes) Monetary Union; Political Union

Unified monetary and fiscal policy by central authority. Example: The European Union today exhibits common trade, agricultural, and monetary policies.

Features: Economic and (sometimes) Monetary Union; Political Union

Perfect unification of all policies by a common organization; submersion of all separate national institutions. Example: Remains an ideal; yet to be achieved.

Features: Political Union

What Is Economic Integration?

Economic integration is an arrangement among nations that typically includes the reduction or elimination of trade barriers and the coordination of monetary and fiscal policies. Economic integration aims to reduce costs for both consumers and producers and to increase trade between the countries involved in the agreement.1

Economic integration is sometimes referred to as regional integration as it often occurs among neighboring nations.

Economic Integration Explained

When regional economies agree on integration, trade barriers fall and economic and political coordination increases. 

Specialists in this area define seven stages of economic integration: a preferential trading area, a free trade area, a customs union, a common market, an economic union, an economic and monetary union, and complete economic integration.2 The final stage represents a total harmonization of fiscal policy and a complete monetary union.

Key Takeaways

  • Economic integration, or regional integration, is an agreement among nations to reduce or eliminate trade barriers and agree on fiscal policies.
  • The European Union, for example, represents a complete economic integration.
  • Strict nationalists may oppose economic integration due to concerns over a loss of sovereignty.