Introduction
Economic integration refers to the unification of economic policies and markets among different countries through the reduction or elimination of trade barriers. It plays a vital role in promoting regional cooperation and increasing trade and investment among member countries. Two key outcomes of economic integration are trade creation and trade diversion, which affect the overall welfare and efficiency of the member nations.
Various Forms of Economic Integration
Economic integration can be classified into different levels based on the degree of policy coordination among countries.
1. Free Trade Area (FTA)
- Member countries eliminate tariffs and trade restrictions among themselves.
- Each country maintains its own trade policy with non-members.
- Example: North American Free Trade Agreement (NAFTA)
2. Customs Union
- In addition to FTA features, members adopt a common external tariff policy against non-members.
- Example: European Union Customs Union
3. Common Market
- Includes the features of a customs union
- Allows free movement of labor and capital among member nations
- Example: European Economic Area (EEA)
4. Economic Union
- Includes features of a common market
- Harmonization of economic policies like taxation, government spending, etc.
- Example: European Union (EU)
5. Political Union
- The highest form of integration
- Includes a unified political structure along with economic integration
- Example: Historical example: United States post-independence
Trade Creation vs Trade Diversion
1. Trade Creation
Trade creation occurs when the formation of an economic union leads to replacement of higher-cost domestic production with lower-cost imports from partner countries. This enhances economic efficiency and consumer welfare.
Example: If India starts importing wheat from Bangladesh (a member in a trade bloc) because it is cheaper than producing it domestically, trade creation has occurred.
2. Trade Diversion
Trade diversion happens when lower-cost imports from non-member countries are replaced by higher-cost imports from member countries due to preferential treatment. This reduces global economic efficiency.
Example: If India imports sugar from Sri Lanka (a member of a trade bloc) instead of Brazil (a non-member offering cheaper sugar), due to preferential tariffs, trade is diverted and overall welfare may decline.
Differences between Trade Creation and Trade Diversion
| Basis | Trade Creation | Trade Diversion |
|---|---|---|
| Efficiency | Improves global efficiency | Reduces global efficiency |
| Effect on Consumers | Lower prices and more choices | Higher prices due to costlier imports |
| Economic Welfare | Increases | May decrease |
| Source of Goods | From more efficient producers | From less efficient producers |
Conclusion
Economic integration offers significant opportunities for enhancing trade, investment, and development among member countries. However, its success depends on whether it leads to trade creation or trade diversion. Policymakers must design agreements that minimize trade diversion and maximize trade creation to ensure overall gains from integration. Regional blocks like ASEAN, SAARC, and the EU must be assessed regularly for their real economic impact.