Week two - economic integration Flashcards by Alicia Scheller

what is economic integration?

elimination of economic frontiers between two or more countries
an economic frontier is any obstacle to the free movement of goods, services and production factors
not just international cooperation like WTO or IMF

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what are the two steps of integration

negative integration: elimination of obstacles to the movement of goods, services and factors
positive integration: modifying existing instruments and institutions and creating new ones at the supranational level

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what are some characteristics of a FTA

removal of tariffs and quotas for imports between members
national barriers to trade with third countries are maintained: prevents trade deflection

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what is trade deflection

imports from an outside country entering the FTA through a low-tariff member country that re-exports them duty-free to high-tariff member countries

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what is a customs union

FTA + common trade/commerical policy, including common external tariffs on trade with non-members

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what is a common market

CU + free mobility of factors of production and removal of non-tariff barriers/restrictions

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what is an economic and monetary union

CM + common monetary policy and single currency and macroeconomic policy coordination

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What are the economic benefits of integration

greater specialisation
economies of scale
improvement in efficiency by increasing competition
better quality and more quantity of productive factors

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what are the political benefits from integration

safeguarding peace in Europe
stabilising the system

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define the static effects on allocative efficiency

changes in trade flows, production and consumption resulting from changes in relative prices caused by the changes in external production

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what can the effects on trade be classified as

trade creation (production or consumption)
trade diversion

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what is trade creation (production and consumption effect)

trade creation is the replacement of domestic production by cheaper imports from another country
- production effect: efficiency gains derived from the reduction of more expensive domestic production
- consumption effect: increase in consumption due to price reduction

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what is trade diversion

replacement of cheaper imports from third countries by more expensive imports from a partner in the CU

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in what conditions will a CU have positive effects

only when trade creation exceeds trade diversion

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what assumptions do we make when modelling the benefits from forming a CU

country 1 is small (supply curves from the rest of the world are perfectly elastic)
P = Mc : perfect competition
homogenous product
constant returns to scale
no transport costs

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graphs that show the formation of customs union

look are lecture slides 2

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how to calculate trade diversion on a graph

replacement of imports from 3 (most efficient non-partner country) by imports from 2 (less efficinet partner country)

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what does this relationship show, trade creation > trade diversion

a positive CU

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what is the net welfare variation

the sum of:
- changes in consumer surplus
- changes in producer surplus
- changes in tariff revenue

what conditions are held for there to be positive effects in CU

static effects for a country removing its tariffs in a CU are larger when:
- there is a higher PED and PES
- there’s a higher level of tariffz
- the higher the price difference between union partners
- the lower the price difference between union partners and the outside world
- CU size

what are the two types of trade creation

interindustrial: differentiation productive structures, bigger adjustement costs
intraindustrial: approximation of productive structures, smaller adjustment costs

what is meant by dynamic effects on growth

economic integration may influence the pattern and the rate of growth through more investment and factor mobility

what are some dynamic effects that occur in the medium and long-run by the enhancement of competition in the enlarged market

increase in competition
market enlargement
firm reorganisation

what happens when the number of producers in the CU increases

increase in competition
reduction in price differentials (not full levelling because there are transport/distribution costs and some goods/services are non-tradeable)
reduction in price margins (price = fixed costs + (1+a)(variable costs)), reducing ‘a’ allows for price reduction in order to remain competitive
internal efficiency improvement
non-price effects: improvements in production techniques and quality of products etc.

what are the assumptions made when modelling a cost reduction due to economies of scale

- two countries integrate - producing the same good - equal demand curve - different levels of efficiency in production - the most efficient country captures all the market

the graph to show the dynamic effects of joining a customs union

check lecture notes 2, slide 45

what does it show when the demand curves are not the same in the two countries when forming a customs union

a perverse specialisation effect where the country with a bigger demand captures all the market despite its lower efficiency

what may firm reorganisation generate?

- firm closures - an increase in the level of concentration (mergers) which might threaten competition

summary of effects of customs union

- gains from trade (comparative advantage) - more competition (efficiency and innovation) - market size effects (economies of scale) -fostered growth, competitiveness and productivity

why does economic integration not yield equal benefits for everyone

- different abilities to take advantage of static and dynamic effects - exploitation of integration benefits demands an adjustment process - there may be social and economic costs

what is the white paper 'completing the internal market' and when was it written

- 1985 - it pointed out the main barriers (tax, physical, technical, public barriers)

what are the two types of taxes

1) direct taxes: personal income tax, corporate tax etc. 2) indirect taxes: VAT and special taxes

how can taxes act as a non-tariff barrier for a country wanting to form a customs union

if two countries produce the same good at different prices and different VAT levels, e.g. country A may have a lower original price but then after taxes have a higher price than country B

how can tax barriers be removed

through harmonisation, i.e. all countries set the same tax rates

why is harmonisation not possible

because member states keep fiscal sovereignty

what was the EU's three step strategy concerning VAT

1) introduction of VAT in all member states (1970) 2) harmonised definition of tax base (1977) 3) harmonisation of tax rates to proceed to origin-based taxes in 1977 (postponed indefinitely)

what is an alternative to the unrealistic strategy of harmonisation

- allow countries to keep national tax rates through setting a threshold and taxing goods where they are consumed at the destination (destination-based taxes) - however this creates a physical barrier because adjustments will need to be made to enable checks/controls at the border

why was harmonisation never considered

- impossible to establish one single rate for every good

what problems do physical barriers present

- frontier delays - tax adjustments - health regulations - transport licensing costs: - indirect: consumers - direct: importing/exporting firms

what did the removement of the 1993 (SEA) border controls demand

- new VAT return system - harmonisation of basic health and safety regulations - principle of mutual recognition and new system for collecting data

what are the technical barriers

- different technical regulations in the production of similar goods, e.g. technical standards or security conditions for production

to what extent can we harmonise technical barriers

- only essential requirements for health and security are harmonised - principle of mutual recognisiton rules for the rest

why is the integration of services much slower than the integration of goods

the treaty of Rome acknowledged the needs to liberalise services including two options: - temporary: freedom to provide services in another member state - permanent: freedom of establishment for providers in another member state

what are the four types of labour mobility in the EU

- long-term mobility - cross-border works (workers reading in one member state and working in another) - posted works (employees sent to carry out a service in another member state on a temporary base) - return mobility

what are the effects of free movement of labour

- no drastic change in labour reallocation - no drastic convergence in wages and unemployment - strong migrant flows from third non-EU countries

contents of the competition policy

- prohibition of collusive agreements - prohibition of abusing dominant position (to squeeze out smaller competitors) - ex ante merger control: vertical agreements (trusts) and horizontal (cartels) - state aid control