What are the various forms of economic integration? How is trade diversion different from trade creation? Elucidate

What are the various forms of economic integration? How is trade diversion different from trade creation? Elucidate

Economic integration refers to the process by which countries or regions reduce barriers to trade and economic cooperation, moving toward a more unified economic space.

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This can involve various forms of integration, each with different implications for trade and economic relations. Here’s an overview of the different forms of economic integration and an explanation of trade diversion versus trade creation.

Forms of Economic Integration

1. Preferential Trade Agreements (PTAs):

• Description: PTAs involve reducing tariffs and other trade barriers between member countries on a preferential basis. These agreements do not necessarily cover all trade among the countries and may only apply to specific products.
• Example: The African Growth and Opportunity Act (AGOA) between the United States and certain African countries.

1. Free Trade Areas (FTAs):

• Description: In an FTA, member countries agree to eliminate tariffs and other trade barriers on goods traded among themselves but maintain their own external trade policies (tariffs) towards non-member countries.
• Example: The North American Free Trade Agreement (NAFTA), now replaced by the United States-Mexico-Canada Agreement (USMCA).

1. Customs Unions (CUs):

• Description: A customs union involves member countries eliminating internal trade barriers and adopting a common external tariff (CET) for non-member countries. This creates a unified trade policy for imports from outside the union.
• Example: The European Union (EU) Customs Union.

1. Common Markets:

• Description: A common market builds on a customs union by allowing for the free movement of goods, services, capital, and labor among member countries. It aims to create a single market with fewer barriers to economic activity.
• Example: The European Single Market within the EU.

1. Economic Unions:

• Description: An economic union combines elements of a common market with coordinated economic policies, including fiscal and monetary policies. Member countries often harmonize regulations and may adopt a common currency.
• Example: The European Union (EU) with its Economic and Monetary Union (EMU) and the Euro currency.

1. Political Unions:

• Description: A political union represents the highest level of economic integration, where member countries merge into a single political entity with a unified government and policies.
• Example: The United Arab Emirates (UAE), which is a federal union of emirates.

Trade Creation vs. Trade Diversion

Trade Creation and Trade Diversion are concepts used to evaluate the effects of economic integration, particularly in the context of regional trade agreements.

1. Trade Creation:

• Definition: Trade creation occurs when economic integration leads to the replacement of higher-cost domestic production with lower-cost imports from member countries, resulting in an increase in the overall volume of trade.
• Mechanism: By reducing trade barriers, such as tariffs and quotas, economic integration makes it more economically attractive for countries to source goods and services from more efficient producers within the integrated area. This often leads to increased trade among member countries and can result in a more efficient allocation of resources.
• Example: If a free trade area leads to the reduction of tariffs, consumers in member countries may start purchasing goods from more efficient producers within the FTA, replacing less efficient domestic producers.

1. Trade Diversion:

• Definition: Trade diversion occurs when economic integration causes trade to shift from a more efficient producer outside the trade area to a less efficient producer within the trade area due to the preferential treatment given to member countries.
• Mechanism: Trade diversion can happen when a customs union or free trade area imposes higher tariffs on imports from non-member countries, making goods from member countries more attractive despite potentially being more costly or less efficient. This shift can lead to a decrease in overall economic efficiency.
• Example: If a customs union imposes a common external tariff on non-member countries, and a member country with higher production costs benefits from preferential access, trade may divert from a more efficient non-member producer to the less efficient member producer.

Summary

Economic integration involves various forms, from preferential trade agreements to full political unions, each with different degrees of economic cooperation and policy coordination. Trade creation refers to the increase in trade volume resulting from the removal of trade barriers within an integrated area, leading to more efficient resource allocation. Trade diversion refers to the shift of trade from a more efficient external producer to a less efficient internal producer due to preferential trade policies. Understanding these concepts helps in assessing the overall impact of economic integration on global trade and economic efficiency.