This lesson examines the various levels of economic integration. The guiding question for this lesson is the recognition that economic integration comes in many different forms from a simple trading relationship to full integration such as membership of the EU and that each level of integration contains both costs and benefits.
What is economic integration and what are the various forms of closer integration? What is the difference between trade creation and trade diversion.
Lesson time: 80 minutes, SL 1 hour
Distinguish between bilateral and multilateral (WTO) trade agreements.
Explain the different levels of economic integration from preferential trade agreements to full Political Union. Distinguish between a free trade area, a customs union and a common market.
Explain the concepts of trade creation and trade diversion in a customs union. (HL only)
Explain that economic integration will increase competition among producers within the trading bloc and allow member countries to gain from economies of scale. (HL only)
Discuss the possible advantages and disadvantages of a monetary union for its members.
Economic integration - involves different countries coordinating and linking their economic policies, for example bilateral trade agreements between two nations or at the other end of the scale, a monetary union such as the EU.
Preferential Trading Agreement – examples of this include the EU / African Caribbean trade agreement or ACP (Pacific Group of States). PTAs offer preferential (i.e. lower tariff barriers) between participating nations, but not free trade between members.
Free Trade Area - a more comprehensive arrangement than preferential trading areas. Examples include NAFTA (North America free trade area).
Customs Union - an agreement between member countries to ensure free trade within those countries but also common external barriers.
Common Market - this is a customs union plus, consisting of common standards on goods and services and the free movement of capital.
Economic Union - this involves a common currency, such as the Euro as well as universal monetary policy.
Political Union - this consists of a larger and consolidated group of nations or states, that share a joint government that is internationally acknowledged e.g. UK, UAE.
Bilateral agreement - an agreement between two nations or trading groups that gives each party favoured trade status.
Multilateral agreement - an agreement between a number nations or trading groups that give each party favoured trade trade status.
Trade creation - occurs when entry to a customs union means that the production of a good or service switches from a high cost producer to a lower cost one.
Trade diversion - occurs when the production of a good or service diverts from a low cost producer to a higher cost one.
The activities on this page are available as a class handout at: Economic integration
In small groups investigate the nations that your own country enjoys a partnership with. This could be as part of a trading bloc or perhaps an economic union. What advantages and disadvantages does this offer your nation?
Your response should include factors such as:
- a greater range of products to purchase
- ease of access to travel / work visas
- competition from overseas businesses
- the impact on the local job market of immigrant labour.
Overall do you believe that your country benefits from the relationships that it enjoys with other nations or not?
Start by watching the following presentation which compares different types of economic integration before continuing with the rest of the reading. You may also wish to view this presentation during the discussion on the same topic later on in the lesson:
Activity 1: Different levels of economic integration
Start by watching the following short video and then complete the tasks that follow:
(a) Explain the difference between a Free Trade Area (FTA) and a Preferential Trade Agreement
(b) Explain the difference between a Free Trade Area (FTA) and a Customs Union.
(c) Explain the term common external barriers, illustrated on the customs union diagram to the right:
(d) How does the absence of a common external barrier present a weakness for FTAs?
(e) Why might membership of a customs union brings more benefits to members in the form of increased trade than a simple FTA?
(f) Explain some of the weaknesses of customs union membership?
(g) Explain the term Monetary Union?
(h) Explain the difference between a Customs Union and a full Economic Union?
Activity 2: Free Trade v Customs Union
Watch the following two short videos which compare the impact of a free trade agreement with a full customs union on the economies of different nations. Watch both and then discuss the advantages and disadvantages of a country joining one rather than the other.
Firstly the case in support of a full customs union:
Now watch the following video which describes the arguments in support of a free trade agreement:
1. Which of these arguments do you find most convincing?
2. Would you support your government converting their current free trade agreements into a full customs union? Would you support your government withdrawing from the EU (if applicable) and instead joining free trade agreements?
Activity 3: TOK connections
What criteria can be used to assess the benefits and the costs of increased economic integration? Might increased economic integration ever be considered undesirable?
Activity 4: Monetary Union
Start by watching the short video and then explain the benefits and costs of Monetary Union membership.
Activity 5: A focus on Greece
Start by watching the following short video and then summarise why Greece appears to have suffered as a consequence of Monetary Union membership?
Trade diversion v trade creation (HL only)
Start by watching the video which explains the concepts of trade diversion and trade creation. After the video read the handout that your teacher will give you.
Activity 6: Trade creation
The diagram to the right illustrates the cotton market in Portugal, prior to joining a Customs Union. The nation imported its cotton from Greece and placed a tariff on all imported cotton, indicated by the WS + tariff.
(a) Portugal and Greece join the EU, a customs Union and Portugal is forced to remove the tariff on cotton imports. Indicate this on the diagram and show the following points:
i. welfare gain from increased consumer surplus
ii. welfare gain from greater world efficiency
iii. the increase in trade as a result (the trade creation).
(b) Are there any losers from this trade creation?
Activity 7: Trade diversion
The diagram to the right illustrates once again the domestic raw cotton market in Portugal. The nation imports its raw cotton from Vietnam without tax due to a bilateral trade agreement between themselves and Vietnam.
On joining the EU Portugal is now forced to place tariffs against Vietnamese cotton (this being EU policy). The cheapest cotton available within the EU is from Italy, but is more costly than pre-tariff Vietnamese cotton.
(a) Illustrate this on the diagram and show the following:
i. welfare loss from reduced consumer surplus
ii. welfare loss from reduced world efficiency
iii. the reduction in world trade as a result of the trade diversion.
Activity 8: Link to the assessment (old syllabus)
An example of relevant paper two examination questions:
(a) i. Explain the difference between a free trade area and a customs union? [2 marks]
ii. State two examples of trade protection. [2 marks]
(b) Using an appropriate diagram, explain the impact on the market for a product, following an increase in the size of the tariff from 40% - 80%. [4 marks]
(c) Distinguish between a free trade area, a customs union and a common market. [4 marks]
(d) Using information from the text/data (included in the examination paper) and your knowledge of economics, evaluate the impact of trade diversion and trade creation on a nation joining a customs union. [8 marks]