European Economic integration and its impact on foreign trade

The essence of European economic integration. The consequences of economic integration in trade, the consequences of Market integration of the European Union and its impact on foreign trade. Threats, challenges in the last stage of economic integration.

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Specialty 365.1 - World Economy and International Economic Relations

European economic integration and its impact on foreign trade


student gr. EMREI-132

E. Cararus


      • 1.1 Understanding the European Economic Integration
    • 1.2 The effects of economic integration over trade: theory and prospective
      • 2.1 Empirical evidence on the trade effects of economic integration
      • 2.2 Case study: The impact of EU membership on British trade
      • 3.1 Inherent differences and persistent tensions
      • 3.3 Threats and challenges in the last stage of economic integration
      • In an increasingly internationalized world economy, the integration processes have been rapidly progressing. The integration of regional economy or regionalization implies the formation of blocs or groups of nearby countries that erase trade barriers when trading with each other, while maintaining the restrictions associated with trade policies with the rest of the world.
      • The agreement between the countries involved in the Integration Process is initially characterized by the creation of trade; this means that when economic integration increases, the barriers to trade between markets decline. This process usually involves on one hand, an increase in the volume of trade between member countries of the agreement, effect called redirection of trade, on other hand modification of the exchange of goods and services with third countries not involved in the integration, called trade diversion effect.
      • Trade agreements can be bilateral, when implemented by two countries, and multilateral, when more countries sign. Economic integration schemes are generated from the latter.
      • To the extent that there are institutional and legal conditions, integration processes tend to the formation of commercial blocks. A trade bloc is an international organization that brings together a group of countries with the purpose of obtaining mutual benefits in international trade and economic matters, even if there are reasons otherwise, in most cases political. These forms of union between countries are arranged by signing international treaties. Usually, these are regional economic blocs, made up of countries with geographical proximity.
      • Trade blocs can be classified according to their degree of economic integration into: preferential trade area that is characterized by the tariff advantages that member countries grant each other. Free trade area-it is where the exemption of customs duties is agreed directly between the member countries. Customs Union, which is characterized by two mechanisms. On one hand, are the unique tariffs for the exchange of goods between all member countries on the other hand, the unique tariffs for interchanging goods with third countries. Common market that is formed only when the free movement of goods, people and factors of production is provided. Economic Union that is formed if the countries involved agree on a common or harmonized economic policy. This may include monetary union formed between countries that adopt a single currency. Economic and political integration is achieved only when the member countries decide to merge their organisations, legal institutions and government.
      • The economic, monetary, and social integration of the European Union is the model which, best emphasizes the economic integration process, having successfully passed through all the above mentioned stages of integration process.
      • The European Union (EU) is an economical and monetary union of 28 member states. The main objectives of the European Union are to assure peace, prosperity and freedom for its citizens, in a fairer and safer world. With more then 500 million citizens, the EU produces about 25% of global GDP.
      • The EU has developed a common market through a system of law that applies to all Member States, guaranteeing the free movement of goods, services, people and capital. The economic policy of the European Union (EU) covers the definition of legal norms that regulate the actions of private and public economic agents (management policy) and state intervention in economic processes (political process). Nineteen of its member countries have adopted the common currency- the euro. It has also developed a common foreign policy that represents the EU in organizations such as the WTO, the G8 and the UN.
      • The European Union is both a common market (as it provides the free circulation of goods, services, capital and factors of production) and a customs union (since its countries adopt an unified approach when setting a tariff in commerce the rest of the world). The trade policy competence of the Member States was delegated to the European Community in 1970. The European Commission, empowered by the European Council presents proposals for the development of the common commercial policy to the EU Council.
      • In our days the economy and politics are closely related. This is why an economic integration process will bring direct effects upon commercial activity.
      • The purpose of this research paper is to study the effects that the European economic integration brought upon commerce. The process of European economic integration will be elucidated. The static and dynamic changes produced in the commercial activity at each of the stages of the integration process will be analysed, aiming to deduct the extent to which this process has favoured or disfavoured the commercial activity of the involved states. For a more specific investigation, the author will use the example of United Kingdom's membership in the EU and will estimate the effects it brought upon the country's commercial situation. The decision of the country's a possible exit from the European Union and its potential effects upon foreign trade will be considered.
      • Quantitative and qualitative research will be used in order to better underline the specifics of the topic in addition, a case study will be utilized. Different scientific articles such as: The European Union: Current Challenges and Future Prospects by Kristin Archick; and The Great British trade-off. The impact of leaving the EU on the UK's trade and investment by John Springford and Simon Tilford all of which are related to the topic, will be consulted. General concepts from books A Comparative History of Commerce and Industry by David McNabb; and European Business by Simon Mercado will be discussed.
      • This analysis consists of three chapters, each divided into two subchapters. In the first chapter the European Integration Process is defined and described, the effects that this process has brought upon the foreign trade are illustrated at the theoretical level. The static and dynamic effects brought upon commerce will be discussed from the theoretical point of view. The second chapter focuses on the practical aspect of the topic. The possible effects of the economic integration over trade are explained via the example of Croatia, her being the last country to enter the European Union. The author will bring empirical evidence regarding the concepts of trade creation and trade diversion. This chapter also contains a case study focused on the United Kingdom's experience. The trade related advantages and disadvantages of her, leaving the EU will be exposed. The last chapter focuses on the trade challenges that EU encounters at the present moment, during the last stages of economic integration.
      • Positive and negative aspects of the given process will be discussed for a more accurate description of the effects that the European economic integration brings upon foreign trade.

1.1 Understanding the European Economic Integration

The European Union is a relatively new concept that is characteristic for our time. It would be absurd to propose a union of such type during the Middle Ages. In such a way, EU becomes our product, the result of all our past experiences: dictatorships, first and second world wars, Fascism, Nazism, the cold war, fanatical terrorism, social revolutions, etc.

The world needed to pass through a series of unpleasant events in order to evolve and to understand the importance of collaboration. This is why at this stage it is ready to accept the conception of The European Union.

What is really the European Union? There is no strict definition- we can call it an organization, an association of states or a socio-economic union. There are 28 European member states that ceded from their sovereignty for an idea. An idea that offered Europe over 60 years of peace, stability and prosperity.

The EU in its actual form is the end product, the result of several decades of talks, attempts and collaboration activities. Let us now, make an inquiry into the history of European Integration, for a better understanding of the phenomenon.

Since the end of the First World War, the idea of a unified European continent becomes more and more frequently discussed. The first who took the initiative was Count Richard von Coudenhove-Kalergi, who wrote the manifesto Paneuropa in 1923. It is considered the starting point of all the further European unification attempts, and the base on which the Paneuropean Movement started.

Winston Churchill, the British Prime Minister and a prominent figure in the history starting with the Second World War, was also a strong ally of the unification idea. His aim was to eliminate the European ills of nationalism and war-mongering once and for all. He formulated his conclusions drawn from the lessons of history in his famous `Speech to the academic youth' held at the University of Zurich in 1946: There is a remedy which ... would in a few years make all Europe ... free and ... happy. It is to re-create the European family, or as much of it as we can,

and to provide it with a structure under which it can dwell in peace, in safety and in freedom. We

must build a kind of United States of Europe.

As a result in 1948, the delegates from different European countries met at what was later called The Grand Congress of Europe (Hague, The Netherlands). It culminated with the establishment of an international organization that for more then 65 years fights for peacekeeping, protection of human rights, and economic development- The Council of Europe (1949).

Europe suffered the most, during the Second World War. The national economies of the continent that was the birthplace of the Western civilization was now in ruins. And it needed much time to recover.

In order to help rebuilding Europe's economy and make it flourishing again, The United States of America proposes the Marshall Plan (1948). It was officially called the European Recovery Program, by which America gave to Western Europe 13 billion of US dollars (approx. 130 billions in current value) to support the regeneration of European economies.

One of the extracts of the Act states that: The remedy lies in breaking the vicious circle and restoring the confidence of the European people in the economic future of their own countries and of Europe as a whole. The manufacturer and the farmer throughout wide areas must be able and willing to exchange their products for currencies the continuing value of which is not open to question.

In order to administer the Marshall Plan, and to assure equitable distribution of the US aid a new organization was created- The Organization for European Economic Cooperation (OEEC). The main objectives were to avoid a potential future rise of radical ideologies such as Fascism, Nazism also, the abolition of protectionism. The future trade links would assure the establishment of peace and prosperity.

Another crucial figure that must be mentioned is Jean Monnet. Being a French businessman and investment banker, he promoted the idea of unification throughout his life. He was at the helm of The High Authority of the European Coal and Steel Community (branch of European Coal and Steel Community), and is remembered as one of the founding fathers of EU.

With his Monnet Plan (1945) he is in charge of the economic modernization of France. The Second World War left France devastated and completely dependent on natural resources of other countries, especially on the German coal. In 1945, Monnet came up with a proposal of dispossessing Germany from the extremely rich in coal and steel, regions Ruhr and Saar and giving France control over them. The objective was to weaken Germany's industrial power and to strengthen the French production sector of the economy. In 1946, Charles de Gaulle adopted the Monnet Plan and the economy of France soon began to recover.

This proposal was reluctantly accepted and heavily discussed among the great powers. The United Kingdom and The United States of America were particularly hesitant as they saw in this a chance for Russia to rise in power. During a long period talks were hold, and different conflicts of interests appeared.

To stop the misunderstandings and to avoid a future war, the French foreign minister came up with the Schuman Plan (1950), a kind of perpetuation of the Monnet Plan. In 1950, Robert Schuman makes a declaration in which he proposes to put together the coal and steel production of Germany and France under a single authority. At the beginning the great powers did not believe that a collaboration of such type (between two historic rivals) would be ever possible. Still, history shows us that this idea was not just achievable but also very benefic first for Europe and second, for the world. Once the European Coal and Steel Community was established, other European countries were free to join.

Among the key quotes of the declaration that originated the ECSC were:

"World peace cannot be safeguarded without the making of creative efforts proportionate to the dangers which threaten it."

"Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity."

"The pooling of coal and steel production... will change the destinies of those regions

which have long been devoted to the manufacture of munitions of war, of which they have been the most constant victims."

Among the most important suggestions from the Schuman Declaration were: By pooling basic production and by instituting a new High Authority, whose decisions will bind France, Germany and other member countries, this proposal will lead to the realization of the first concrete foundation of a European federation indispensable to the preservation of peace.

The common High Authority entrusted with the management of the scheme will be composed of independent persons appointed by the governments, giving equal representation. A chairman will be chosen by common agreement between the governments. The Authority's decisions will be enforceable in France, Germany and other member countries. Appropriate measures will be

provided for means of appeal against the decisions of the Authority.

Six European Countries founded the ECSC in 1951: The Federal Republic of Germany, France,

Belgium, The Netherlands, Luxembourg and Italy.

From the 1960s one of the ECSC's main tasks was to supervise its members' reduction of their excess production of coal as that mineral was replaced by petroleum as an industrial fuel. This involved the closing of inefficient or uneconomic coalmines in member countries. Similarly, in the 1970s the ECSC began to supervise the elimination of its members' excess steelmaking capacity when low-cost steel from Japan and other countries put western European steelmakers at a competitive disadvantage. Under the ECSC's aegis, an international group of steelmakers, the European Federation of Iron and Steel Industries (Eurofer), was formed in 1977 to rationalize the industry. The headquarters of the ECSC were in Brussels.

Starting with 1957 two other related organizations joined the ECSC (see table 1.1.1). With the Treaty of Rome (signed in 1957, coming in force in 1958) was established the European Economic Community (EEC). The treaty was settled having the prototype of ECSC treaty-The Treaty of Paris, 1951, but with more clearly specified objectives.

Table 1.1.1 European Union's Treaty Agreements


In Force


European coal and Steel Treaty -Treaty of Paris 1951



European Economic Community Treaty-Treaty of Rome 1957



European Atomic Energy Community - Treaty of Rome 1957



Treaty establishing a Single Council and a Single Commission of the European Communities- Merger Treaty 1965



European Election Act 1976



Single European Act 1986



Treaty of the European Union- Maastricht Treaty 1992



Treaty of Amsterdam 1997



Treaty of Nice 2001



Treaty of Lisbon 2007


Source: Main Treaties of EU (cited on 4.04.2016)

The EEC creation was signed by Belgium, France, Italy, Luxembourg, the Netherlands, and West Germany. The United Kingdom, Denmark, and Ireland joined in 1973, followed by Greece in 1981 and Portugal and Spain in 1986. The former East Germany was admitted as part of reunified Germany in 1990. The EEC was designed to create a common market among its members through the elimination of most trade barriers and the establishment of a common external trade policy. The treaty also provided for a common agricultural policy, which was established in 1962 to protect EEC farmers from agricultural imports. The first reduction in EEC internal tariffs was implemented in January 1959, and by July 1968 all internal tariffs had been removed. Between 1958 and 1968 trade among the EEC's members quadrupled in value.

The European Atomic Energy Community or the Euratom was the second international organization established together with The European Economic Community. Its main provision was related to the creation of a single market of atomic energy related products with common standards and legislation. The main objectives were the avoidance of a potential Third World War, and peace preservation.

Another important provision stipulated within the Treaty of Rome (25 March 1957) was the creation of a common market.

A common market is a trade block in which its participants exercise their activity on principals of different types of tax exemptions. Usually the common markets act on the principal of free trade (free from duties) among its members, and commonly established tariffs for imported products from non-member states.

A common market brings various benefits for its members. Among them the most important are:

Prosperity for its participants- a flourishing trade practice, free of barriers certainly benefits a national economy.

Better job opportunities- new firms, new products, new services available for everyone.

Ease of travel- the members of such community have a more accessible and effortless border check.

Opportunities to work, live and study abroad- comparability in the standards and quality of higher education allows for example to study in one country and then to work in another.

Wider product range- the bigger the quantity of producers or supplier entering the market, the wider is the choice of products or services.

Lower prices- a big number of producers/competitors certainly brings benefits to the buyers.

Ease of doing business- this is certainly the best benefit for producers, suppliers and entrepreneurs. As a common framework is established, there are lower taxes and a simplified registration procedure. Also, businesspersons may have access to previously closed information about certain companies.

Besides, Simon Mercado in his book European Business wrote that the eagerness of countries to affiliate themselves to a regional economic grouping (REG) stems from the various benefits offered by economic integration including opportunities for gaining economies of scale (in an enlarged trading market) and the promotion of trade and welfare through increased specialization of production.

Although specific incentives may vary over time and by case- political and security dimensions may also be relevant in the formation of regional economic groupings- REGs are expected to be at their most attractive when the level of economic and commercial interdependency between `members' is at its greatest. This provides conditions for net trade creation. In this context, it is worth nothing that the European situation is unique. The high level of trade conducted within the continental region between European states makes trade with other parts of the world less significant then for countries in other regions.

Since the formation of the European Coal and Steel Community, the trading situation has significantly changed. The establishment of the ECSC in 1952 was made as a desperate attempt to prevent a future war and to somehow free Europe from its ruinous state of affairs. No one would have believed then, that it could arrive, now to be number one player for international trade (see figure 1.1.1).

In 1965 a new treaty was signed in Brussels, Belgium- the merger treaty. Joining the executive bodies of The European Coal and Steel Community, The European Economic Community and The European Atomic Energy Community, made a new step towards full economic integration. This treaty created a single institutional framework and established two of the main institutions of the European Union: the Council of the European Union and the European Commission.

The Single European Act (SEA) revises the Treaties of Rome in order to add new momentum to European integration and to complete the internal market. It amends the rules governing the operation of the European institutions and expands Community powers, notably in the field of research and development, the environment and common foreign policy.

Figure 1.1.1: Main players for international trade, 2014 (billion EUR)

Source: Eurostat (ext_lt_introle) and (ext_lt_intercc).

The SEA, signed in Luxembourg on 17 February 1986 by the nine Member States and on 28 February 1986 by Denmark, Italy and Greece, is the first major amendment of the Treaty establishing the European Economic Community (EEC). It entered into force on 1 July 1987. The chief objective of the SEA was to add new momentum to the process of the European construction so as to complete the internal market. However, this goal was difficult to achieve on the basis of the existing treaties, notably because of the decision-making process at the Council, which imposed unanimity for the harmonisation of legislation.

Still, it is considered that the Maastricht Treaty was the treaty that made possible the transition from a community to a union. Signed on January 7, 1992, The Maastricht Treaty established the European Union. This Treaty is the result of external and internal events. At external level, the collapse of communism in Eastern Europe and the outlook of German reunification led to a commitment to reinforce the Community's international position. At internal level, the Member States wished to supplement the progress achieved by the Single European Act with other reforms. With the Treaty of Maastricht, the Community clearly went beyond its original economic objective, i.e. creation of a common market, and its political ambitions came to the fore. In this context, the Treaty of Maastricht responds to five key goals:

Strengthen the democratic legitimacy of the institutions.

Improve the effectiveness of the institutions;

Establish economic and monetary union;

Develop the Community social dimension;

Establish a common foreign and security policy.

Apart from this, it set up the three main pillars of the European Union. The first one is European Community (EC). It consists of ECSC, EAEC and EEC and it has the highest institutional capacity. The Single market (with its principals, rules of competition) and the common policies (such as: agricultural, fishery, transport, industrial, etc.) are among its principal concerns. The second one is Common Foreign and Security Policy (CFSP). Among its main concerns are: defending human rights, establishing a common foreign policy, establishing a common security policy, etc. The third pillar is Justice and Home Affairs Co-operation (JHA). This pillar has lower institutional capacity then the EC. It assures judicial, customs and police co-operation, apart from co-operation on asylum and immigration, and on the crossing of external borders, etc.

The Treaty signed on 17 June 1997 at Amsterdam, only six years and a half after the signature

of the Treaty of Maastricht, did not bring fundamental changes to the integration process, but it marked some progress in several policy areas. The most important development was the transfer, under the European Community's wing, thus entailing the Community decision-making method, of policies related to the free movement of persons, notably concerning visas, asylum and immigration .In particular, it made the Union's institutional structure more efficient by extending the co-decision procedure (Parliament/Council) and qualified majority voting in the Council. Another important objective of the Amsterdam Treaty was to place employment and social protection at the heart of the Union. Under its European Union wing, the Amsterdam Treaty strengthened the common foreign and security policy by making the European Council (heads of State or government) responsible for defining common strategies to be implemented by the Union and the Member States and by designating a High Representative for the CFSP (the Secretary General of the Council).

Once with the Amsterdam Treaty a more democratic European Union is established. The functions of the institution of EU are better contoured. The European Union has evolved, and at the moment, it represents the union that best succeeded at doing an economic integration.

An economic integration emphasises a series of arrangements between the potential member states, which favours each of the national economies, and especially the trade.

Using the Integration Theory, we can deduct five stages of the European Integration.

The First stage would be that of a Preferential Agreement. As the first step in negotiations, an accord on tariff barriers should be concluded at each governmental level for specified products or services. Under these agreements, the parties exchange tariff concessions or other preferential treatment. Once a preferential arrangement is in force between the EU and your country or region, this substantially improves market access for your exports to EU as it eliminates or reduces tariffs and facilitates procedures.

The Second stage would be of an establishment of a Free Trade Area. Moving further from some preferential agreements on tariffs and quotas, a free trade area means a zone in which also the imports between the member states are at a zero tariff rate. A free trade area represents a new step towards the economic integration. It encourages commercial interchange, by creating very favourable conditions. In such a way concluding a free trade agreement means:

Access to new markets of goods and services.

Access to different investment proposals.

Optimization of the commercial activity- the abolitions of long and costly procedures at the customs duties allows trade to became faster. Faster usually means cheaper as less effort is spent for the transportation.

Another important factor that must be noted is that a free trade agreement will also raise competition. But, on the long term this results to be an advantage rather then a drawback. Competition might be good for the commercial activity as it:

Encourages innovation- inventing different methods to differentiate from the rest.

Helps companies to better understand their main target and to focus on its accomplishment.

Teach businesses to cooperate- in such a way only qualitative products are made.

Competition is especially beneficial for the customers. The more competitors has a company the more incentivised is to produce qualitative products at fair prices.

The European Union has negotiated a series of important trade agreements. EU has agreements on different levels and with different regions (see figure 1.1.2)

Figure 1.1.2 EU participation in regional Trade Agreements

According to The World Trade Organization among the most notorious, are:

EU-Georgia Deep and Comprehensive Free Trade Area (EU-Georgia FTA)- it concerns trade and investment. It entered in force on September 1, 2014. Valid between Georgia and all EU member states.

EU-Republic of Korea Free Trade Agreement & Economic Integration Agreement. Entered in force on July 1, 2011. This agreement between Republic of Korea and the EU member states is a bilateral agreement, it emphasises the regions of Europe and Asia.

EU - Switzerland - Liechtenstein Free Trade Agreement. In force since January 1, 1973. Among the countries that originally signed the contract were: Belgium, Denmark, France, Germany, Ireland, Italy, Luxembourg, Netherlands, United Kingdom, Liechtenstein, and Switzerland. At the present moment all the 28 countries of the European Union are parties to this agreement. This FTA is plurilateral and covers the goods produced within the countries.

EU-European Economic Area (EEA) Economic Integration Agreement. In force from January 1, 1994. The countries that originally signed the contract were: Belgium; Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, United Kingdom, Iceland, Liechtenstein and Norway. Now it is applied to all EU states and three above-mentioned EFTA states. It is a plurilateral agreement on services.

EU - Israel Free Trade Agreement. In force since June 1, 2000. It is a cross-regional (Europe-Middle East), bilateral agreement on goods. Valid between EU member states and Israel.

EU - Overseas Countries and Territories (OCT) Free Trade Agreement. In force since January 1, 1971. The current parties to the agreement are: Anguilla, Aruba, the Netherlands with respect to, Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovak Republic, Slovenia, Spain, Sweden, United Kingdom, British Indian Ocean Territory, Cayman Islands, Falkland Islands (Islas Malvinas), French Polynesia, French Southern Territories, Greenland, Mayotte, Montserrat, Netherlands Antilles, New Caledonia, Pitcairn, Saint Helena, Saint Pierre and Miquelon, South Georgia and the South Sandwich Islands, Turks and Caicos Islands, Virgin Islands, British, Wallis and Futuna Islands. It is a plurilateral agreement that involves the regions of: Caribbean, Europe, Africa, South America, Oceania and North America.

EU - South Africa Free Trade Agreement. Entered in force on January 1, 2000. Valid between European Union member states and South Africa. It is a cross-regional, bilateral agreement on goods.

EU - Turkey Custom Union Agreement. It entered in force on January 1, 1996. It is a bilateral trade facilitating agreement between EU and Turkey on goods.

EU - Egypt Free Trade Agreement. Enforceable since June 1, 2004. Parties to the contract are members of the EU and Egypt. It is a cross-regional (Europe and Africa), bilateral agreement on goods.

EU - Chile Free Trade Agreement & Economic Integration Agreement. In force since March 1, 2005. It is a cross-regional (Europe and South America), bilateral agreement on goods and services. Parties to the agreement are Chile and all the EU member states.

EU - Colombia and Peru Free Trade Agreement & Economic Integration Agreement. Enforceable since March 1, 2013. The Current parties to the agreement are: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovak Republic, Slovenia, Spain, Sweden, United Kingdom, Colombia and Peru. It is a cross-regional (Europe-South America) plurilateral agreement on goods and services.

EU - Mexico Free Trade Agreement & Economic Integration Agreement. Enforceable

since October 1, 2000. The original signatories were: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, United Kingdom and Mexico. At the moment is valid between Mexico and all of the EU member states. It is a cross-regional (Europe-North America), bilateral agreement on goods and services.

EU - Republic of Moldova Free Trade Agreement & Economic Integration Agreement. In force since September 1, 2014. The agreement is between all European Union member states and The Republic of Moldova. It is a bilateral agreement on goods and services.

There is a list of potential future regional trade agreements between EU and other states. Among the future partners, based on the fact that an early announce has been made, are: Canada, India, Japan, Singapore, Thailand and Malaysia.

As we can observe from the above-mentioned Free Trade Agreements, The European Union has succeeded to establish powerful trade relation with states from various continents: Africa, Asia, North and South America.

The abolition/reduction of the trade barriers as a result of the second stage of integration (Free Trade Area) increased considerably European Union's position on the world market.

The third stage of integration would be the formation of a Customs Union. The difference between this stage of integration and the previous one is that in this stage, the members have a common external tariff for imports from non-member states. Tariff revenues become common property and are subsequently shared out according to some agreed set of rules.

The European Union has passed through this stage of economic integration. In 1958 it established The European Union Customs Union (EUCU). The protection of the customs of the union was among the principal prerogatives of the European Economic Community and now this

task has passed to its successor The European Union.

This union consists of all 28 member countries and four non-member states (neighbours): Turkey, San Marino, Monaco and Andorra. The EUCU protects the EU citizens, by:

Enforcing rules that protect the environment and health & safety (e.g. refusing entry to contaminated foodstuffs or potentially dangerous electrical appliances).

Ensuring exports of sensitive technology (which could be used to make nuclear or chemical weapons) are legitimate.

Tackling counterfeit goods and piracy - in the interests of health and safety, as well as the jobs of those who work for legitimate manufacturers.

Ensuring anyone travelling with large amounts of cash (or equivalent) is not laundering money or evading tax.

Helping police and immigration services fight trafficking in people, drugs, pornography and firearms - all factors in organised crime and terrorism.

Protecting endangered species, e.g. checking trade in ivory, protected animals, birds and plants.

Protecting European cultural heritage by watching for smuggled art treasures.

Still, as a result of the economic evolution of European Union the customs duties between member states are history, now. This stage of economic integration has been successfully completed.

The fourth stage of integration would be the common market. It is one of the last stages. Precisely at this stage the free trade is guaranteed by abolition of non-tariff barriers, also. A common market means a trade block that basically lacks any type of barriers. Thus, import licencing requirements, import price limits, fees, embargoes, standard disparities must be coordinated or eliminated. According to Simon Mercado and Co., the best example of a group of countries that succeed to establish a common market, was shown by the EC in 1992.

The last stage of economic integration is complete economic union. A complete economic union implies a high degree of co-operation between members of the union and will include the co-ordination of monetary and fiscal policies and macroeconomic planning across all member countries. This would usually result in a single currency being used. When this is achieved, while countries may remain individual political units, they cease to be independent economic units. In time many argue, it is likely that their political independence will be reduced and political and economic decisions will be made at the centre, although a high degree of development to regions is likely.

With the realization of the single currency in Europe (the Euro), the EUR-19 grouping of European Monetary Union (EMU) participants (the Eurozone) exhibits many of these traits. The further extension of fiscal and tax harmonization would go some way to realizing a full

economic union amongst these economies.

1.2 The effects of economic integration over trade: theory and prospective

The term commerce relates to all activities that have as an aim the simplification of the exchange of goods and services. Commercial activities can be performed on short scale, by different types of entities (small and large businesses), or on large scale by countries (governments).

Trade on the other hand, refers to a specific business activity of buying and selling commodities, widgets, or services. Wholesalers and retailers perform this kind of activity, in return for money or other goods that must be equal in value. When the transaction happens within the boundaries of a country, we name it national or domestic trade whereas, it happens outside the boundaries of a territory and it involves two or more countries we describe it as international or foreign trade (Figure 1.2.1).

Trade was the chief business activity for centuries before human ingenuity invented the industrial method of producing goods, mass production, and mass distribution-the hallmarks of modern economic activity.

Figure 1.2.1 Different levels and Types of Trade

Source: A Comparative History of Commerce and Industry, Volume I. page 8.

The process of European economic integration and the eventual formation of the European Union have automatically changed the commercial activities. Today, when we trade with European countries, we do not trade with Germany, France or United Kingdom (apart), we trade with the European Union (a single institution).

The unification between the markets of different countries that have distinct levels of development is one of the primary objectives of an economic integration. Thus, trade and commerce of member countries are the first to be directly affected by this process.

Generally speaking a union of such type means the development of free trade and the increase of world welfare. However, apart from positive effects it brings negative effects, too. Every integration process implies also a system of discrimination between nations. In EU for example, the imports from non-member countries are subjects of different barriers. This implies that some countries benefit and other countries are disfavoured. The economists use the Pareto efficiency principle to describe the situation when it is impossible to make something better without worsening another thing.

The economic integration produces changes in the global efficiency, namely in the total capacity of production and in the form of distribution of goods and services that will satisfy human needs. But, as it is not possible to compare the benefits for someone with the harm for another one, the theory of economic integration is centred on studying the effects over the production system, skipping the redistribution effects.

The European economic integration produced static and dynamic effects. Among the static ones, it relocated the resources in the productive system and it made changes in the structure and consumption patterns. The economic integration implies a different treatment for the member countries in comparison with the non-member countries. Although, the net impact in one of the member countries can be ambiguous and for this we should analyse the countries separately. This statement is because, although integration is a movement towards free trade among the member countries, trade can also divert from a nonmember of low cost (which continues to face external tariffs of the group) to a member country (no longer face any tariff). These static effects are divided into two concepts:

The creation of commerce.

The diversion of commerce.

By the creation of commerce we mean the increase in the volume of commerce between the member states once integrated. Also it can mean the substitution of national production with foreign one that is cheaper. This brings effects on the consumption, as the level of consumption increase once with the decrease in prices.

The diversion of commerce means the deviation from the pre-existing commercial roots. This is to say, the fluxes of imports and exports that existed before the European Union, between the member state and other countries (non-member states) are now substituted with imports and exports between member states. Besides, at the present time if non-EU member states want to trade with a country from the union, it is forced to trade with all the member states (single market) and on common terms.

The diversion of commerce generally speaking can be either negative or positive. If we base our assumption on the fact that the member countries produce qualitative products at competitive prices, then the diversion has a positive aspect. But, if theoretically speaking the situation before

the economic integration was more efficient (trade between a member state and non-member state), then the diversion brings a negative aspect.

The dynamic effects produce longer-term consequences on the rate of investment, technological change and economic growth. For example, the reduction of commercial barriers creates a more competitive environment and may diminish the degree of monopoly power that existed before the integration. Moreover, once with the penetration of larger markets (the market of the EU) economies of scale may happen for certain export goods. The economies of scales can happen once with the growth of the company, or once with the reduction in costs of inputs, as a result of external economic exchanges.

It is of common knowledge that once with the creation of the European Union, the changes in the custom duties modified the general prices of products and modified the structure of consumption (countries from the union and outside it, prefer products that are made in the European Union as they are cheaper or more reliable) on the European continent.

Moreover, The European economic integration allowed a commercial expansion to take place. Countries that have high production costs like Germany or Great Britain move their production towards EU countries with cheaper labour force like Greece or Ireland.

We can draw the following conclusions with respect to the effects of the European economic integration over trade:

Better specialization;

Economies of scales;

Increase in the quality and quantity of factors of production;


International competition.

The main dynamic effects over commerce in the long-term, relate to the economies of scales, competition and economic growth.

The economies of scale means that the businesses of the countries that are subjects to the European Integration can now serve a larger market and increase their production, all this by achieving lower average production costs.

The effects over competition are clear. The European Union encourages competition between the firms of its member states, thus it force improvements in the production efficiency.

The EU also stimulates the innovations, the technological progresses and accelerates the economic growth. It allows the growth in size of the companies and large companies spend proportionately more resources to research.

The freer interaction between consumers in different member-countries can also produce fundamental changes in consumption patterns.

The European economic integration may stimulate greater investment in member countries from both internal sources and external sources.


2.1 Empirical evidence on the trade effects of economic integration

The European economic integration was a complex process that had as an aim the elimination of economic frontiers between its member countries. The necessary and appropriate condition of this economic integration was the unification of all the markets into a single one, through reciprocal trade liberalization.

There are were aspects in the European economic integration:

-The negative integration= the elimination of the barriers on the free movement of goods, services and factors of production (liberalization).

-The positive integration= the modification of the pre-existent instruments and institutions and the creation of new ones at the supranational level.

There are several modalities of integration. The free trade area is characterized by the reduction of tariffs and quotas between partners. An example of such type would be the European Free Trade Association (EFTA) that works in parallel with EU and is composed of four countries: Iceland, Liechtenstein, Norway and Switzerland.

Another way of integrating is via a customs union. It implies common customs tariffs, common commercial policy against third parties. An example can be the Central and Eastern Europe (CEE) a trade bloc consisting mainly of former soviet countries from Eastern Europe.

A single market is another mode of economic integration. It implies the free movement of factors of production (labour and capital), the elimination of non-tariff barriers and also access to public contracts. The European Union classifies under this example, the single market being one of the main achievements of this politico-economic union.

The economic and monetary union is considered the last mode of integration. It implies the unification of monetary policy (usually a single currency) and the coordination of other economic policies. The EU with its EMU or the Eurozone can be an example of economic and monetary union.

As we can observe this are the main stages of economic integration. Usually they derive one from another. The European Union for example, in order to achieve a full economic integration, has passed through all these stages one after another.

The most efficient way and one of the first steps towards achieving a full regional economic integration is by a customs union.

Because of the abolition of tariffs between countries subjects to such union, the customs union becomes an important step towards full economic integration.

As we previously mentioned, there are static and dynamic effects of customs unions. The static effect implies a relocation of resources in the productive system and changes in the structure and consumption patterns.

Static trade effects divide into trade creation and trade diversion. By trade creation we mean the substitution of expensive domestic production with less expensive imports from another member country of the customs union. The trade diversion may imply an opposite effect, if a country substitutes a cheaper import from a non-member country with a more expensive one from a member country of the union.

An important thing to mention is that the effects of economic integration depend on three factors:

1. The efficiency of internal producers relative to external producers.

2. The price elasticity of demand (PED) and price elasticity of supply (PES) in the domestic market.

3. The size of the tariff, or common external tariff (CET).

For a better understanding we will use the example of Croatia, the last country to be integrated in the European Union, and by this the newest member of the European customs union and common market.

Figure 2.1.1 The evolution of Croatia's imports/exports 2004-2014

Source: World Bank organization: WITS

In the above figure we can observe the trading situation, the imports and exports of Croatia

during the years 2004-2014, before and after it integrated in the EU (see figure 2.1.1)

We can observe that as a result of the world's economic crisis of 2007-2008 the imports have

raised with a higher degree then the exports. There is a sudden decrease during 2009 as a result of the consequences that left the crisis. As of 2013, when it became a EU member we can observe a moving increase in the exports as well as imports. Still, the imports exceed the exports, thus the trade balance is negative (as it was before EU accession).

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