Regional Integration Arrangements: Static Economic Theory, Quantitative Findings, and Policy Guidelines
Dean A. DeRosa
ADR International, Ltd.
August 17, 1998
World Bank Policy Research Working Paper No. 2007
This paper reviews the static theory of regional integration arrangements and considers the economic impact of such arrangements, based on recent quantitative studies of customs unions and free trade areas. DeRosa reviews the static theory of regional integration arrangements, identifying and analyzing the impact of such arrangements on the trade and welfare of member countries,nonmember countries, and the world at large. He develops eight policy guidelines that apply mainly to small trading countries unable to influence their international terms of trade or to cease trading entirely with nonmember countries, assuming increasing cost conditions in member countries, homogeneous traded goods, and perfect competition.
The guidelines advise establishing regional facilities for compensatory lump-sum transfers or other intrabloc payments to avoid the possibility that, where a trading bloc would be welfare-improving overall, the bloc would not be formed because of the (justified) recalcitrance of one or more would-be member countries whose economic welfare might be reduced by the adoption of the regional trade arrangement. Other guidelines are appropriate on common sense grounds. For example: Regional trade arrangements will be welfare-improving if they are formed by countries that are predominantly least-cost producers of exportables, or if they give rise to increased imports from all trading partners.
Yet few if any extant customs unions or free trade areas meet such simple guidelines fully. To some extent, customs unions and free trade areas are expected to result in cessation of trade (in homogeneous goods) with nonmember countries. Where trade between member countries and nonmember countries is expected to continue under regional arrangements (as real-world data suggest), internationally determined terms of trade rather than regionally determined terms of trade are likely to prevail within the trading bloc, limiting the welfare-improving effects of creating trade but not the welfare-reducing effects of trade diversion.
Among the most interesting and arguably operational policy guidelines to emerge from DeRosa's analysis are those concerning countries that might choose to join (1) a large rather than small regional trading bloc, (2) a regional integration arrangement to overcome hindrances facing exports to third countries, or (3) a regional integration arrangement that could have strong pro-competitive effects under imperfect competition and increasing returns to scale. Guidelines 1 and 2 concern mostly developing countries; guideline 3 concerns mostly advanced countries. But the economic bases for the three guidelines are relevant and compelling.
This paper - a product of Trade, Development Research Group - is a background paper prepared for a World Bank Policy Research Report, Regionalism and Development.
Number of Pages in PDF File: 124
Date posted: April 20, 2016