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Economic Integration

Agreements between countries that usually include the elimination of trade barriers and aligning monetary and fiscal policies

What is Economic Integration?

Economic integration involves agreements between countries that usually include the elimination of trade barriers and aligning monetary and fiscal policies, leading to a more inter-connected global economy. Economic integration is consistent with the economic theory, which argues that the global economy is better off when markets can function in unison with minimal government intervention.

 

Economic Integration

 

Understanding Economic Integration

Economic integration, like the name implies, involves the integration of countries’ economies. Another term to describe it is globalization, which simply refers to the inter-connectedness of businesses and trading among countries. An economy is defined as a set of inter-related activities that determine how limited resources are allocated. In the modern economy, all economies feature a form of a market system. A market-based economy utilizes the economic forces of demand and supply in order to distribute these limited resources.

Traditionally, economies were thought of as separate for each region or country, with each country managing its own separate economy and largely unrelated to other countries. However, globalization allows the movement of goods, services, capital between countries and blurred the distinctions between economies.

Today, there is no economy that functions completely isolated from other economies. There is a simple reason for such an occurrence – trade benefits all economies in most cases. It allows for specializations of economies with comparative advantages and can trade with other economies that possess alternative comparative advantages.

 

Comparative Advantage Example

For example, consider a country that happens to possess an abundance of oil sands located within its borders. The country can extract the oil and trade it for other resources that it lacks, perhaps food such as corn or wheat.

Another country may enjoy optimal weather for growing such crops and therefore can specialize in growing corn or wheat and trade it for oil to provide energy for their society. It illustrates how trade can benefit all economies by taking advantage of specialization and comparative advantages.

 

Stages of Economic Integration

Economic integration is expected to improve the outcomes for all economies by many economists and policymakers. Within economics, there are seven stages that lead to complete economic integration:

  1. Preferential Trading Area
  2. Free Trade Area
  3. Customs Union
  4. Common Market
  5. Economic Union
  6. Economic and Monetary Union
  7. Economic Integration

 

Many countries move in and out of the above stages with other partner countries. The best example of complete economic integration is with the European Union (EU). The EU is made up of separate member countries, including:

  • Germany
  • France
  • Sweden
  • Spain
  • Italy

There are also many other countries in the EU, totaling 27 separate nations. However, each country functions separately politically and keeps defined borders, different laws, and government systems. Economically, the 27 countries function as one – with free trade between the countries and unified monetary policies and fiscal policies.

 

Benefits of Economic Integration

Economic integration is beneficial in many ways, as it allows countries to specialize and trade without government interference, which can benefit all economies. It results in a reduction of costs and ultimately an increase in overall wealth.

Trade costs are reduced, and goods and services are more widely available, which leads to a more efficient economy. An efficient economy distributes capital, goods, and services into the areas that demand them the most.

The movement of employees is liberalized under economic integration as well. Normally, employees would need to deal with visas and immigration policies in order to work in another country. However, with economic integration, employees can move freely, and it leads to greater market expansion and technology sharing, which ultimately benefits all economies.

Lastly, political cooperation is encouraged, and there are fewer political conflicts. Political conflicts usually end with economic losses stemming from trade wars or even military wars breaking out, resulting in extreme costs for all combatants.

 

Drawbacks of Economic Integration

Nationalists, or people who believe that their country is superior to others, are critical of economic integration. In order to appeal to nationalists, some countries employ forms of protectionism, which leads to higher tariffs and less free trade between other countries.

The notable feature of economic integration is the loss of individual central banks who control monetary policy. It leads to less national sovereignty, and the responsibilities of central banks are delegated to an external body instead. The external control becomes troublesome in terms of managing a cohesive fiscal and monetary policy among many different countries.

 

Related Readings

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Comparative Advantage
  • International Trade
  • Market Economy
  • Non-Tariff Barriers

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes!