Economic Integration Is the Wave of the Future

In an effort to gain secure access to foreign markets, and in turn achieve a higher degree of economic security while maneuvering into the twenty-first century, many countries have entered into trade agreements with one another. Some of these agreements are between two countries; others are among many, creating trade blocs. Three agreements, however, have grown to encompass countries with massive economic might, to the extent that they have already come to dominate continents.

Within each bloc, small and large, free trade has and will likely continue to become more entrenched. However, future trade among blocs is not so clear. Some argue that these blocs are a stepping stone to global free trade. Others believe they will turn inward and become protectionist. And others feel that although global free trade may eventually come to be, the path will be full of mine fields and dangerous for quite some time. Fear that these trade blocs will become inwardly focused and protectionist, not allowing cost-efficient, non-member producers to sell their products on the basis of competition, has promoted a race among nations to achieve the largest and most powerful trade area.

Whether or not trade blocs become protectionist, one thing is for certain: any outcome will have a profound affect on international trade and investment.

From 1947 to the end of 1994, a total of 108 regional trade agreements were notified to the General Agreement on Tariff and Trade (GATT), the international body that governs approximately 90% of world trade. These trade agreements include: the Central American Common Market, Asia-Pacific Economic Cooperation Forum, Arab League, Andean Pact, Economic Community of West Africa, Lome Convention, Association of South East Asian Nations, and the East Asia Economic Caucus.

Over the years, three powerful trading blocs have emerged: the European Union, chiefly involving West European countries; the North American Free Trade Agreement among Canada, the United States and Mexico; and an informal bloc in East Asia dominated by Japan. Based on past trade patterns and policies, and anticipated policies, these blocs will continue to develop, gaining increased strength and influence.

The European Union Is Expanding into Eastern Europe

The 15-member European Union (EU) encompasses Belgium, Britain, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. On January 1, 1995, Austria, Sweden and Finland became members. In years to come, it is likely that East European countries join the 350 million population of the EU, expanding the market to include 850 to 900 million consumers.

The implosion of Soviet Communism and the fall of the Berlin Wall have exposed East Europeans to a free market economy for the first time in several decades. In an attempt to shift from central planning to a free market, the economies and political systems of most East European countries have experienced chaos to various degrees. And the eruption of ethnic conflict in former Yugoslavia and elsewhere in Eastern Europe has accelerated the economic deterioration.

Much of the EU's vested interest in allowing East European countries to eventually become full members is primarily aimed at preventing a potentially large mass migration westward. By integrating East European economies with the EU, the economic and political stability of the region will likely improve.

The North American Free Trade Agreement (Nafta) Will Likely Expand Southward

In an effort to increase the competitiveness of the United States and the region as a whole, The North American Free Trade Agreement (Nafta), which built on the achievements of the U.S.-Canada FTA, was implemented on January 1, 1994.

Preferential access to Mexico and Canada, guaranteed by Nafta, has put U.S. companies at a competitive advantage relative to rapidly expanding European and East Asian trade blocs. Nafta not only opens up the Mexican market of 92 million customers, but creates a trade area of 360 million consumers ensuring secure markets for U.S. products. Importantly, Nafta promotes greater efficiency, making U.S. products more competitive not only in North America, but in Europe, Asia and throughout the world.

On December 9, 1994, the leaders of 34 Western Hemisphere nations met in Miami for the Summit of the Americas. The goal: to establish a free trade area of the Americas by the year 2005, further building on the achievements of Nafta. During the Summit, Chile was invited by the United States, Canada and Mexico to begin negotiations to accede to the trade bloc.

Trade Representative Mickey Kantor says that by the year 2010 the United States will export more goods to Latin America than to Japan and Europe combined. The pursuit of an expanded Western Hemispheric trade bloc goes further, and again ups the ante with regard to our economic strength and negotiating position compared to the EU and East Asia.

East Asian Economic Integration Is Accelerating Under Japanese Domination

In recent years, trade among East Asian nations has increased at a much faster pace than trade outside the region. Through the development of several trade agreements, such as Asean, with a population of 325 million comprising Malaysia, the Philippines, Singapore, Thailand, Brunei and Indonesia, the region is becoming more trade-cohesive. However, economic integration is mostly influenced by Japanese investment in the region, which is creating an informal trade bloc.

According to Harvard Professors Kenneth Froot and David Yoffie, Japan appears to be the only major industrial country whose domestic market remains protected from both foreign trade and direct investment. They conclude that with Japanese expansion in East Asia, North American firms may increasingly lack access to an East Asian bloc.

The Uruguay Round Agreements of the GATT Promote Global Integration

The GATT Uruguay Round Agreements (URA), implemented by the United States and well over 100 other countries on January 1, 1995, further integrate trade policies among its members. It phases out quotas and cuts tariffs by about one-third on most products traded globally.

GATT is responsible for reducing international tariffs from an average of 40% in 1947 to 5% in 1990, and has permitted international trade to expand enormously, national incomes to substantially increase and international competition to flourish resulting in higher quality, lower priced goods.

The new World Trade Organization (WTO), created under the URA and replacing GATT, is expected to enforce international trade rules and settle disputes among members to a better degree than its predecessor. The new WTO will attempt to police the forces that may promote protectionism among trade blocs.

What All This Means

Whether or not you are a manufacturer, exporter, importer, foreign investor or simply work in a business limited to the domestic market, the development of global trade agreements and emerging trade blocs will undoubtedly affect you business. Even if you are retired, these global trends will still affect you -- at least through the selection of consumer goods and their prices.

Under the Uruguay Round, all signatories to the Agreements are phasing out their trade barriers. As a result, it is unlikely, at least in the short-term, that trade blocs turn inward, become protectionist and raise their tariffs. Nevertheless, as a result of trade diversion or regional trade preferences, the effect may be similar.

Trade diversion occurs when members of a trade group buy more goods from each other due to the elimination of internal trade barriers, displacing non-member goods. For example, due to preferential access, the French are likely to buy more goods from the Germans at the expense of United States. Should this diversion become significant, future U.S. exports to the European Union may be curtailed.

Trade within blocs and regions has indeed increased. For example, in 1928, 50.7% of Western European trade was with Western European countries. By 1993, this increased to 70%. During this period, internal North American trade increased from 25% to 33%; internal Latin American trade increased from 11% to 19.4%; and internal Asian trade increased from 45.5% to 49.7%.

In light of these trends, it may be wise to target several diverse markets instead of relying on one region or market when deciding upon an export strategy.

In order for companies to sustain themselves and generate growth well into the next century, they are advised to establish strategies designed to gather and analyze information from throughout the world -- and use this to achieve international expansion. Companies that rely solely on their domestic market will likely go up against greater foreign competition seeking the same market share. Their level of risk will likely increase as the degree of foreign competition increases.

With the advent of Nafta and the benefits derived from the GATT Uruguay Round, international trade and investment opportunities will flourish. However, these opportunities will only benefit those companies whose corporate cultures view the world as one global village -- and act on it.

Trade Agreements Impact Where A Product Is Made and Where Its Components Are Sourced

The rules of origin established under Nafta, for example, favor U.S., Canadian and Mexican manufacturers who source their components in Nafta countries. Under the agreement, a minimum component requirement is necessary in order to classify goods as North American, allowing them to enter any North American country at a reduced duty rate or duty-free depending on the Nafta duty phase-out schedule. Consequently, U.S. and Canadian firms, and others that wish to sell into North America, are likely to choose Mexico as their low-cost manufacturing location.

As a result of the Mexican peso devaluation which brought Mexican wages down about 40%, U.S. companies manufacturing in East Asia and in other low-wage countries for North and South American markets are now more likely to move production to Mexico. This will boost U.S. exports of components to Mexico, which are widely used in Mexican production and assembly, strengthen the Mexican economy, and very importantly, increase North American global competitiveness.

Production sharing, permitted under the U.S. Tariff Code, allows U.S. materials assembled, processed or improved abroad to be shipped back to the United States incurring duty only on the foreign added value. This has allowed some low-skill, labor intensive manufacturing processes to be conducted in lower-wage countries, while the high-skill, capital intensive processes are retained in the United States. According to the U.S. International Trade Commission, production sharing has also been responsible for retaining jobs that would have been lost due to intense foreign competition. Expanded co-production has been a primary goal of Nafta.

The benefits derived from U.S. production sharing have been enhanced when used in conjunction with Mexico's maquiladora program. Mexico's maquiladora law allows the Government to grant licenses permitting companies to import components and machinery free of duty under bond. The components are assembled, processed or improved and eventually exported. Most of the finished goods are exported to the United States -- many of which displace East Asian exports. Because these goods incur no duty in either country and are subject to low-cost labor, their prices are more competitive internationally.

The U.S.-Mexican production sharing program, combined with other factors, resulted in Mexico becoming the United States' largest production sharing partner in 1993. From 1991 to 1994, Mexican production sharing exports to the United States increased more than 60% and accounted for almost half of all Mexican exports to the United States.

Of all the countries currently participating in the U.S. production sharing program, Mexico, by far, utilizes more U.S. components in the finished products. U.S.-made components account for over half the value of U.S. imports from Mexico under the production sharing program; U.S. parts typically account for only 25% of the value of such imports from Asian newly industrialized countries. Because of this, U.S. industry and labor benefit more from greater co-production of goods with Mexico, compared with goods co-produced elsewhere.

Under Nafta, low-cost U.S. production will continue to shift from low labor-cost countries to Mexico. Its no surprise that Japanese production will continue to move to lower-cost producers in East Asia and EU production will continue to move to Eastern Europe and Northern Africa.

This article appeared in Plants Sites & Parks, November-December 1995.
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John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the ManzellaReport.com, is a world-recognized speaker, author of several books, and a nationally syndicated columnist on global business, emerging risks and economic trends. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.




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