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January 17, 2019

Why economic integration is not always favourable

Models draped with flags of the 5 east African members EAC during the official launch of the protocol in Nairobi/ FILE
Models draped with flags of the 5 east African members EAC during the official launch of the protocol in Nairobi/ FILE

In June, the EU fired its first riposte against Washington’s punishing steel and aluminium tariffs, joining Canada and Mexico in a brewing global trade war against US protectionism.

But it would be imperative to understand the politics and economics in international integration to understand such reactions.

Economic integration is discriminatory removal of all trade impediments or barriers between participating countries and establishment of certain defined coordination between them.

All economies could be argued to be as integrated, except those practicing autarky. It could be market-led, where it is without formal involvement of governments or policy led, where it is through inter-governmental frameworks.

In regards to a state’s decision-making, whether economic or political, it is the government of a state that claims internal and external or international sovereignty. However, regional integration, which is basically born out of treaty making in one way or another, limits a state’s sovereignty or independence in making its domestic policies, say individual trading with a certain state.

Dynamic effects of integration are rooted in internal and external economies of scale, faster technological progress as a result of economies of scale, enhanced competition, reduced uncertainty, creation of favourable economic environment and lower costs of capital due to the integration of financial market.

To analyze the consequences of integration for economic growth in a systematic way, there are two lines of theory that have to be distinguished — neoclassical and endogenous growth theory.

In neoclassical growth theory, economic integration and other institutional aspects or economic policy measures have no effect on the steady state growth rate, which is actually solely determined by the exogenous rate of technological progress. Consequently, as a result of diminishing returns to capital the capital stock and output, per efficient worker grow only to the point where the investment-ratio equals depreciation plus the rate of technological progress.

Institutional changes, increases in efficiency or changes in the investment-ratio have only temporary effects on the growth rate; after a transition period it falls back to its steady-state level. Thus, neoclassical growth theory clearly rejects the hypothesis of permanent growth effects.

At the end, both static and dynamic level effects occur. Static effects arise from three main sources — lower trade costs, increased competition and enhanced factor mobility. This increase in efficiency leads to more output from the same amount of inputs in a first round (static effects). But this is not the end of the story. Given a constant investment-ratio, the increase in output also leads to higher investment and an increase in the capital stock, which in turn increases output in a second round (dynamic effects)

Impacts include tariff reductions; the harmonization of external tariff and their the elimination, which are not always favourable to participating states.


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