5.2 Political and economic effects of integration
The political aspects of integration are interrelated with the economic aspects highlighted above, but the incentive to create a free trade area usually has strong political motivation. Integration implies some degree of dependence on neighbouring states. This degree of dependence increases the desire for political cooperation and in turn has two effects:
- It enhances the integrated group's economic and political clout. This is particularly important for the original six states of the EU because it enables them to deal on more or less equal terms with the US and the former USSR .
- It reduces the likelihood of war. This was a major consideration for France and Germany , who have fought each other three times since the Germanic states became united under Prussia in 1870. However, the recent ethnic/religious wars in the former Yugoslavia are a reminder that economic integration is no guarantee against violent conflict.
The basic economics of regional integration concern the shifts in business activities which occur as a result of the integration process. These changes may be static or dynamic.
As we noted in Chapter 3, the imposition of tariff and non-tariff barriers disrupts the free flow of goods and therefore the allocation of resources. When trade barriers are reduced, consumers tend to purchase goods with the best quality at the cheapest price. The static effect of economic integration implies that resources shift from the least efficient to the most efficient producers of goods that consumers demand. This means that trade is diverted from one country to another because of the reduction of barriers and the ability of consumers to gain access to new goods (note Hill's (2005) use of the term trade diversion in your textbook, page 274).
Companies which are protected in their domestic markets face competition from more efficient producers in other markets when barriers are eliminated. A well-known example of this was the decline of East German companies after the reunification of Germany . Protected from outside competition since the end of World War II, East German businesses had lost the 'competitive edge'. They were inefficient in their use of resources, clumsily managed and poorly structured. The more sophisticated, efficient and economically experienced West German businesses quickly began to dominate the old East German market.
The dynamic effect of economic integration relates to changes in total consumption and increased internal and external efficiencies as a result of growth in the size of the market. The reduction of barriers usually increases demand immediately. As resources shift to the more efficient producers, firms are able to expand output to take advantage of the larger market.
This results in trade creation (see Hill, 2005, p. 274) to take advantage of the larger market. This dynamic change in market size allows firms to produce goods at a cheaper price since the fixed costs of the business are spread over more units of production.
The concept of trade creation is illustrated in Figure 5.1.
Figure 5.1 Trade creation in product X between countries 1 and 2
Source: Adapted from Wall and Rees 2004, p. 83.
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