Economic Integration (Part 2)

In our previous mini-post about economic integration, we emphasized that “economic integration”, rather than being an end per se, is done for the sake of greater synergy, for various higher-order goals. The caveat, however, is that there exist a set of conditions to be met prior to the completion of a certain stage of integration. For instance, member states of a union (like the EU), who share common currency, are normally required to ensure synchronization of business cycles. Failure to comply can result in a rather depressing outcome; for instance, contractionary monetary policy aimed at tackling economic boom in one nation can potentially put another nation (who is experiencing economic slowdown) in a bust or recession. It is like a bunch of students living together, but with different exam schedule. Their decisions can affect each other’s performance. If one throws a party, the others are likely to suffer from study performance drop. This is just one of the many scenarios things can go wrong.

Mentioned as well, integration can be divided into stages as: PTA (Preferential Trade Agreement), FTA (Free Trade Agreement), common market, monetary union, etc. As we move up the hierarchy of integration, nations will begin to lose a certain degree of their individual freedom (or national sovereignty) and become tightly bound by the union’s policies, rules and regulations. This is due to the fact that their economies become more inter-dependent, or to put in another way, a nation’s internal policy will have a greater impact on the regional economic bloc as a whole compared to the time prior to the formation of the union.

Okay, this sounds cumbersome, and trust me, it does not get any better in practice. But then, what is all the fuss about integration? There must be something good in it for everyone, right? Definitely, yes.

In more than one way, countries find great returns in being a part of a bigger family. Political reasons like geopolitics, international credibility, bi-lateral and multi-lateral negotiation power, and so forth are indeed factored in. Social reasons like higher sense of cooperation among citizens of member countries and even biological reasons like greater gene pool are parts of the goodies. But, these will not be discussed. Instead, we will focus solely on economic factors to see if integration can improve the overall health of our economy. The following merits of integration will help explain the rationale:

1. MORE INTRA-REGIONAL TRADE: GREATER EFFICIENCY, MORE INNOVATIONS, CHEAPER GOODS

A somewhat obvious result of economic integration. The significantly (I suppose) lower trade barriers or their complete abolition will give birth to a larger regional market for producers of all kinds. This permanent upgrade in the market size will result in greater long-term demand for products and services, but there is a catch. Rather than increasing the price to rip benefits of the higher demand (as what normally happens in the short-run), firms will find it more sensible to invest more capital into whatever they are producing or serving. Why? Because larger market also implies more intense competition among suppliers of goods and services, and thus, it naturally enforces a more uniform and lower price across the board. Charging higher price is a no-no because that would mean much slower inventory turnover rate (selling less and thus lower/negative profit). Therefore, firms will have to increase their production capacity or make use of any excess capacity they have to survive (increasing efficiency). Of course, those managing to stay in the game will end up selling more and probably earn more, and the least-efficient firms will drop out of the competition. This increases the overall economic efficiency because only the best players remain.

What makes this even more impressive is that in a large competitive market environment of the integrated economies, where there exist lots of imports and exports, lots of exposure to new products and services (new encounters and interactions), lots of pressure on cost-cutting and quality assurance, new innovative ideas are often highly rewarded and fostered. Plus, as firms learn from both their own industry and other industries, opening border to trade will expose local firms to new ideas and information that can later be employed for their own benefits, and thus, the so-called “knowledge spillover”.

In addition, for those considering yourself being at the consumer end, as integration opens up more trade, you will also have access to a wider selection of products (more quality and price options), and cheaper products and services will also leaving more cash on hands for you to purchase more (encouraging more outputs). Since per capita economic well-being is partly a measurement of the amount of outputs obtainable by a person, then we can safely say that consequently, your standard of living will increase (you own more stuffs!).

2. INTERNAL AND EXTERNAL ECONOMIES OF SCALE

Well, we sort of stepped into this area a bit earlier. Firms that are able to tap into the larger regional market will invest more in new equipment, facilities and technologies to gain the edge in competition. Once they have grown sufficiently large, their average cost per unit of goods produced will become considerably lower. This can happen within any firm for a variety of reasons. The most obvious one is the fact that fixed cost (like cost of renting machine and land) are spread over a larger number of the firm’s outputs. Say, if a car manufacturer’s fixed-cost is $1,000, its per unit fixed-cost would be $100/unit assuming it produces only 10 cars, and significantly lower at only $10/car if it instead raise production to 100 cars (hence, cheaper cars for consumers). Other reasons can be the increase in more specialized workforce as the growing firm breaks down their production line into simpler steps which improves the speed/productivity of workers. This is, to be specific, referred to as “Internal Economies of Scale”. Another type is called “External Economies of Scales” which arises due to the increase in industry size (thus, better access to raw materials and market).

On top of all these, larger firms may find it way easier to diversify risks and to finance themselves whether through equity-financing or debt-financing (due to its higher credibility, increase in revenue and assets).

3. MORE JOBS AND KNOWLEDGE SPILLOVER

Of course, bigger firms and bigger industries mean more employment opportunities, and since productivity rises as mentioned, wages tend to rise. It gets even more interesting than that.

As member countries become more integrated and capital is allowed to move freely across borders, firms can move their manufacturing facilities to new labour market that is more suitable to their needs. That is to say, labour-intensive industries that look for cheap unskilled labour can move to member countries that are in early stage of development with relatively abundant supply of low-level workforce. Firms that seek higher-trained workers will probably move to more developed nations. Sometimes, they import labour (skilled or unskilled) instead of physically relocating themselves.

You know what this does to the regional production? It increases the production capability. Why? Because it is expensive and inefficient to hire skilled people to do unskilled manufacturing work, and likewise, it is expensive to train unskilled workers to do skilled work. Think for a bit more. The opportunity cost of hiring a relatively skilled worker to produce, say, a t-shirt is probably a whole computer that could have been produced by that same worker. So, producing t-shirts in developed member states is not just ridiculously expensive in terms of absolute cost, but also entails high opportunity cost. Being able to move to access a new labour market or import labour will help solve this problem, and thus, improve the efficiency and total outputs.

Sometimes, it also gives people in less developed member countries a chance to join organizations of higher standard in other member nations, and this creates a learning-environment that will later on improve industry standard across all member countries.

4. AND OTHERS…

There are many more, but this is getting pretty long, so let us just list a couple more merits:

– More FDI (Foreign Direction Investment) due to the more attractive combined markets (larger regional commodities market and more access to raw materials),
– Lower interest rate for firms in need of debt-financing because the bigger integrated financial market also comes with higher liquidity and more loanable fund (pushing down interest rate).

The presence of demerits is not to be neglected though. An economic integration among countries like those in the ASEAN community, if not properly managed, can be detrimental, say, to SMEs which employs a huge proportion of the member states’ population. We will look into this in our later post.

This is it for now.

Cheers,