Q1: Describe economic integration as well as its difficulties and benefits.

Use the European Union to

Regional economic integration refers to the growing economic interdependence that results from the
formation of an economic bloc. This refers to a geographic area that consists of two or more countries that
agree to pursue economic integration by reducing restrictions to the cross-border flow of products, services,
capital, and labor to gain mutual advantages. Similarity in economies, political systems, culture, and
language among the countries in an economic bloc are factors that help regional integration success. E.g. the
European Union.

There are five possible levels (stages) of regional integration . These levels progress from a low level of
integration to the ultimate degree of integration which no countries have yet achieved.

The free trade area is the first and most common arrangement, in which member countries agree to
eliminate formal barriers gradually to trade within the bloc. Each member maintains an independent
international trade policy with countries outside the bloc. E.g. NAFTA. It emphasizes the pursuit of
comparative advantage for a group of countries rather than for individual states. Governments may specify
that locally produced products must contain a minimum proportion of locally manufactured parts, or the
product becomes subject to the tariffs imposed on nonmember countries.

The second level is the customs union. It is similar to a free trade area except that member states harmonize
their external trade policies and adopt common tariff and nontariff barriers on imports from nonmember
countries. E.g. MERCOSUR in Latin America. Determining the most appropriate common external tariff is
challenging because member countries must agree on the percentage level of the tariff and on how to
distribute profits from the tariff among the member countries.

In the third stage, member countries establish a common single market, in which trade barriers are reduced
or removed, and common external barriers are established. Like a customs union, a common market also
establishes a common trade policy with nonmember countries. E.g. The EU is a common market. A worker
from an EU country has the right to work in other EU countries, and EU firms can freely transfer funds
among their subsidiaries within the bloc.

An economic union is the fourth stage of regional integration, in which member countries enjoy all the
advantages of early stages but also strive to have common fiscal and monetary policies. At the extreme, each
member country adopts identical tax rates. An economic union enables firms within the bloc to locate
productive activities in member states with the most favorable economic policies.

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The fifth stage is the political union, a large consolidated group of nations or states that share a joint
internationally acknowledged government.

Europe has the longest experience with regional integration and is home to several economic blocs. The
most important of these is the EU established in 1992, featuring 28 countries from Eastern and Western
Europe. The EU has taken the following steps to become an economic union.

1. Market access, tariffs and most nontariff barriers have been eliminated for trade in products and
services. Rules of origin favor manufacturing using inputs produced in the EU.

2. Common market, barriers to the cross-national movement of production factors—labor, capital, and
technology—have been removed. For example, an Italian worker now has the right to take a job in
Ireland, and a French company can invest freely in Spain.
3. Trade rules, customs procedures and regulations have been eliminated, streamlining transportation and
logistics within Europe.
4. Standards harmonization, technical standards, regulations, and enforcement procedures related to
products, services, and commercial activities are being harmonized. For example, where British firms
once used imperial measures (pounds, ounces, and inches), they have converted to the metric system that
all EU countries use.

In the long run, the EU is seeking to adopt common fiscal, monetary, taxation, and social welfare policies.
Introduction of the euro simplified cross-border trade and enhanced Europe’s international competitiveness.

In pursuing regional integration, nations seek advantages such as expanding market size, achieving
scale economies in production and marketing, enhancing the efficiency of productivity and resource usage,
attracting direct investment from outside the bloc, and acquiring stronger defensive and political posture.
Broadly speaking, countries are more powerful when they cooperate than when they operate alone. E.g.
although Belgium has a population of just 10 million, membership in the EU gives Belgian firms free access
to a total market of nearly 500 million EU buyers.

On the other hand, many managerial implications face regional integrations. Regional integration
pressures or encourages member companies to internationalize into neighboring countries within the bloc.
E.g. Home Depot expanded in Mexico following passage of the North American Free Trade Agreement.
Also, managers develop strategies suited to the region as a whole rather than to individual countries. As
firms increasingly view the bloc as one large market, they tend to standardize their products and marketing.
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They start selling the same products, using similar marketing approaches, to all countries inside the bloc.
Lastly, an economic bloc makes a region more attractive to companies based outside the bloc. Many will use
FDI to establish a physical presence inside the bloc to access better all the benefits the bloc can offer.

When nations join in an economic bloc, definitely there are drawbacks. A bloc can become an ‘economic
fortress’ leading to -more within and less between- bloc trade, which can reduce global free trade.
Regional integration gives rise to both trade creation and trade diversion. Trade creation means trade is
generated among the countries inside the economic bloc because, as barriers fall, each member country
tends to begin trading more with members than with nonmembers. As this occurs, members begin trading
less with countries outside the bloc, leading to trade diversion. Increased cross-border contact makes
members lose their national identity and be more similar to each other. In response to NAFTA, Canada has
restricted the ability of U.S. movie and TV producers to invest in the Canadian film industries. In later
stages, a central authority is set up to manage the bloc’s affairs. Members must sacrifice some autonomy to
the central authority, such as control over their own economy.

Additional drawbacks of regional integration include the concentration of economic power in the hands of
fewer, more advantaged firms. Regional integration also encourages mergers and acquisitions within the
bloc, leading to the creation of larger rivals that can dominate smaller firms. Also, as trade and investment
barriers decline, protections are eliminated that previously shielded smaller or weaker firms from foreign
competition. Finally, increased competitive pressures and corporate restructuring may lead to worker
layoffs or reassignments to distant locations. When they negotiate regional integration agreements, national
governments have a responsibility to reduce harmful effects such as job losses and the failure of small or
weak firms.

Conclusion:
Today there are some 400, in various stages of regional economic integration developments. Governments
continue to liberalize trade policies, encourage imports, and restructure regulatory regimes, largely via
regional cooperation. Many nations belong to several free trade agreements. The evidence suggests regional
economic integration will gradually give way to a system of global free trade worldwide.

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Q2: Explain the limitations of early trade theories, and the significance of born global firms, using examples
derived from real-world practice. (1200)

Trade enables countries to use their national resources efficiently through specialization and enables
industries to be more productive to help keep the cost of everyday products low, to raise living standards.
Without international trade, most nations would be unable to feed, clothe, and house their citizens at current
levels. There are Six classical theories for trade among nations: Mercantilism, Absolute advantage,
Comparative advantage, Factor proportions theory, International product life cycle theory, and New trade
theory.

In the 16th century, mercantilism theory argued that national prosperity results from maximizing exports and
minimizing or impeding imports. Many people still believe that running a trade surplus is beneficial. They
subscribe to a view known as neo-mercantilism. Labor unions, farmers, and certain manufacturers all tend to
support neo-mercantilism.

Mercantilism tends to harm the interests of firms that import, and the interests of consumers, because
restricting imports reduces the choice of products they can buy, leading to higher prices and inflation.
Extreme mercantilism may invite “beggar thy neighbor” policies, promoting the benefits of one country at
the expense of others. E.g. England Navigation Act of 1651 prohibited foreign vessels engaging in coastal
trade. Mercantilism is not a philosophy for increasing global growth and reducing global problems.
Increasing the wealth of other countries can lead to selfish benefits, E.g. growth of Japan and Germany led
to increased export markets for UK and US. Mercantilism stresses government regulation, and monopoly
often lead to inefficiency and corruption. It justifies Empire building and leads to tit for tat policies, and high
tariffs on imports.

In 1776, Smith introduced the absolute advantage principle which states that Each country can increase its
wealth by specializing in the production of goods in which it has unique advantages, exporting those goods,
and then importing other goods in which it has no particular advantage.

In the 18th century, Ricardo created the theory of comparative advantage which states that it will be
beneficial for two countries to trade with each other as long as one is relatively more efficient at producing
goods or services needed by the other. The principle of comparative advantage is the foundational logic for
free trade among nations today. E.g. Japan focuses on car manufacturing, China and Finland, focus on
making cell phones.

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Although the concepts of absolute and comparative advantage provide the rationale for international trade,
they overlook factors that make contemporary trade complex, and have some limitations as follows:

Government restrictions such as tariffs, import barriers, and regulations can hamper international trade. Just
as Japan did after World War II, governments may target and invest in certain industries, build
infrastructure, or provide subsidies, all to boost the competitive advantages of home country firms. Further,
large-scale production in certain industries may provide economies of scale and, therefore, lower prices,
which compensate for weak national comparative advantages. Similarly, modern communications and the
Internet tend to reduce the cost and complexity of cross-border trade. The main participants in international
trade are individual firms that differ in significant ways. Far from being homogenous enterprises, many are
highly entrepreneurial and innovative or have access to exceptional human talent, all of which support
international business success. International shipping and insurance are critical for cross-border trade to take
place, relatively costly and make imported goods more expensive. Traded products are not just commodities
anymore, such as milk and beef. Today, most traded goods are relatively complex. Also, many services,
such as banking and retailing, cannot be exported in the usual sense and must be internationalized through
foreign direct investment.

Moreover, these theories make assumptions, that are not always valid. First they assume Full Employment
of resources. When countries have many unused resources, they may seek to restrict imports to employ or
use idle resources. Second, Economic Efficiency. countries also pursue objectives other than output
efficiency. They may avoid overspecialization because of the vulnerability created by changes in technology
and by price fluctuations or because they do not trust foreign countries to always supply them with essential
goods. Third, Division of Gains. Specialization brings potential economic benefits, but does not indicate
how countries will divide increased output. Fourth, Transport Costs. Transporting goods may cost more
than it save. Fifth, Statics and Dynamics. The theories address countries by looking at them at one point in
time. However, the countries' relative conditions change. Sixth, Services. The theories deal with products
rather than services. Seventh, Production Networks. Both theories deal with trading one product for
another. Increasingly, however, portions of a product may be made in different countries. Eighth, Mobility.
These theories assume that resources can move domestically from the production of one good to another and
at no cost, which is not completely valid. The theories also assume that resources cannot move
internationally. Increasingly, however, they do.

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In light of such limitations, scholars have introduced additional theories to explain international
trade:

In the 1920s, Heckscher and Ohlin, proposed the factor proportions theory that suggests each country
should produce and export products that intensively use relatively abundant factors of production, and
import goods that intensively use relatively rare factors of production.

In 1966, Vernon interduced international product life cycle theory, in which, product and its associated
manufacturing technologies go through three stages of evolution: In the introduction stage, the inventor
country enjoys a monopoly in manufacturing and exports. In the maturity stage, manufacturing becomes
relatively standardized, and other countries start producing and exporting the product. In the
standardization stage, manufacturing ceases in the original innovator country, and this country becomes a
net importer of the product.

Beginning in the 1970s, Krugman Argued the new trade theory , that economies of scale are an important
factor in some industries for superior international performance, even in the absence of superior comparative
advantages. Some industries succeed best as their volume of production increases.

In the 1990s, the traditional internationalization theories came to their limits as they lacked explanatory
power about the new phenomenon The Born Global. The emergence of born globals is associated with
international entrepreneurship, in which innovative, smaller firms pursue business opportunities
everywhere, regardless of national borders. Communications and transportation technologies, falling trade
barriers, and the emergence of niche markets worldwide have increased the ability of contemporary firms to
view the whole world as their marketplace, and made doing international business easier than ever before.
E.g. Instagram is a born global. Founded in 2010, the firm soon found a ready market for its photo-sharing
services in markets scattered around the world. And Skype. A common characteristic of such firms is that
their offerings complement the products or capabilities of other global players, take advantage of global IT
infrastructure, or otherwise tap into a demand for a product or service that at its core is somewhat uniform
across national geographic markets.

Conclusion:
Internationalization theories describe how companies expand into international business gradually, usually
progressing from simple exporting to the most committed stages. Born global firms are part of the emergent
field of international entrepreneurship. However, no one model exists that combines plausible explanations
for the distinct realities and needs that exist in firms, particularly at a time when the markets and challenges
are continuously evolving.
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