Friday, 18 July 2014 06:33


For a variety of reasons it often makes sense for nations to coordinate their economic policies. Coordination can generate benefits that are not possible otherwise.  If countries cooperate and set zero tariffs against each other, then both countries are likely to benefit relative to the case when both countries attempt to secure short-term advantages by setting optimal tariffs. This is just one advantage of cooperation. Benefits may also accrue to countries which liberalize labor and capital movements across borders, who coordinate fiscal policies and resource allocation towards agriculture and other sectors and who coordinate their monetary policies.

Any type of arrangement in which countries agree to coordinate their trade, fiscal, and/or monetary policies is referred to as economic integration. The different forms of integration are as follows:

Preferential Trade Agreement (PTA)

A preferential trade agreement is perhaps the weakest form of economic integration. In a PTA countries would offer tariff reductions, though perhaps not eliminations, to a set of partner countries in some product categories. Higher tariffs, perhaps non-discriminatory tariffs, would remain in all remaining product categories. This type of trade agreement is not allowed among WTO members who are obligated to grant most-favored nation status to all other WTO members.

Free Trade Area (FTA)

A free trade area occurs when a group of countries agree to eliminate tariffs between themselves, but maintain their own external tariff on imports from the rest of the world. The North American Free Trade Area is an example of a FTA. Because of the different external tariffs, FTAs generally develop elaborate "rules of origin". These rules are designed to prevent goods from being imported into the FTA member country with the lowest tariff and then transshipped to the country with higher tariffs.

Customs Union

A customs union occurs when a group of countries agree to eliminate tariffs between themselves and set a common external tariff on imports from the rest of the world. The European Union represents such an arrangement. A customs union avoids the problem of developing complicated rules of origin, but introduces the problem of policy coordination. With a customs union, all member countries must be able to agree on tariff rates across many different import industries.

Common Market

A common market establishes free trade in goods and services, sets common external tariffs among members and also allows for the free mobility of capital and labor across countries. The European Union was established as a common market by the Treaty of Rome in 1957, although it took a long time for the transition to take place. Today, EU citizens have a common passport, can work in any EU member country and can invest throughout the union without restriction.

Economic Union

An economic union typically will maintain free trade in goods and services, set common external tariffs among members, allow the free mobility of capital and labor, and will also relegate some fiscal spending responsibilities to a supra-national agency. The European Union's Common Agriculture Policy (CAP) is an example of a type of fiscal coordination indicative of an economic union.

Monetary Union

Monetary union establishes a common currency among a group of countries. This involves the formation of a central monetary authority which will determine monetary policy for the entire group. The Maastricht treaty signed by EU members in 1991 proposed the implementation of a single European currency (the Euro) by 1999. At present 16 countries of EU have Euro as their official currency.