Benefits, Adverse Effects and implications of Regional Economic groupings

The benefits of regional economic integration primarily are:

1. If the national market is adequate due to the small population and/or low income, it would not be able to provide a viable level of demand for a large number of industries, such as fertilizers, automobiles, or steel. The economic plant size of such industries is large and unless there is a market to absorb the output, the capacity utilization will be low, making final products is costly. On the other hand, if a smaller plant is established, its operating costs would be high. The only solution, therefore, is to integrate several markets so that a plant’s output can move across frontiers without facing barriers.
2. Optimum utilization of resources requires that each country specializes according to its relative comparative advantage. Artificial tariff and non-tariff barriers do not, however, allow national planning of investment according to comparative advantage. The result is that each country continues to produce goods which can be more economically produced elsewhere. If free movement of trade and factors of production is allowed within the region, each country will specialize in certain sectors where it enjoys the most comparative advantage leaving the other sectors to the rest of the region. The region as a whole will be economically better off as a result of such investment planning.
3. Opening up of the domestic economy to competition from member countries of the grouping can result in increased efficiency, lower prices, increased product variety and introduction of new and modern business methods.
4. Local inefficiencies are removed.
5. One important benefit of tariff liberalization at the regional level is trade creation. Trade creation is defined as “substitution of inefficient domestic production in one member-country by cheaper imports from another member-country. Since trade moves in favor of a more efficient producer, this increase welfare of the consumers.

Suppose, there are two countries the UK and Germany and the product being considered is textiles.

Suppose there are three sources of supply to the German market: Italy, Britain, and domestic producers. Before entry to the EEC British cloth was subject to the common external tariff of 20 percent. The duty paid price of British textiles would, therefore, be 60 DM per meter. The people in Germany would therefore prefer to buy either German or Italian cloth which is cheaper. Italy being a member of the EEC enjoys duty free entry in the German Market. After Britain joined the EEC, there would not be any customs duty on cloth imported into Germany from the UK. The price of British cloth would, therefore, come down to only DM 50. As a result, there is strong possibility that buyers would shift their purchases in favor of British cloth. Since the UK is more efficient in cloth production than Germany or Italy, as their costs of production of cloth were 58 and 55 DM respectively as compared to UK’s DM 50, this shift in source of supply is called trade creation.

Adverse Effects:

There is of course a possibility that formulation of a customs union would result in trade diversion rather than trade creation. Trade diversion takes place when a member of the customers union with a higher cost of production replaces a more efficient outside supplier. In the above example, suppose Switzerland was also a supplier in the German Market. Its price was the lowest and, therefore, was in a position to cater to large segment of the market. But after the entry of UK, British cloth would, therefore, replace Swiss cloth. This substitution by a less efficient internal producer of a more efficient external supplier is called trade diversion which has a welfare-reducing effect. Trade can be diverted from optimal partners. There is also a possibility of trade warfare among regional blocks.

Implications for International marketing:

Regional economic groupings are institutional factors which an international marketer must take into account. There are several ways in which these groupings can influence his marketing operations:

1. If the formation of the grouping results in substantial trade creation, the resultant increase in income and investment can lead to an increase in the imports of the grouping as a whole.
2. On the other hand, if trade diversion is the dominating effect, the export prospect to the group members would be adversely affected.
3. Depending upon how high is the common external tariff, it is possible that exporters of certain products would find it easier to penetrate the regional market which was inaccessible under the national tariff walls.
4. The rules and regulations affecting imports from he outside sources would be identical in all the member-countries. The exporting firm will have the added incentive of a larger market.
5. The exporting firm can set up a regional distribution-cum-storage system in a central place anywhere in the grouping which can be utilized to service the requirements of all the member-countries.
6. As the differences in market diminish, there will be greater uniformity in the marketing approach to member countries. The firm will gain economies of scale in product development, pricing, distribution and promotion. For example, as member-nations harmonize their food, drug and labeling laws, the firm can eliminate product and packaging differences which were required solely by the differences in national laws.
7. In spite of the economic grouping, however, the national differences arising out of language, culture and marketing practices do continue, even though increased volume of trade and freer flow of factors of production, including labor, tend to reduce the extent of differences.