Since World War Two, there has been a proliferation of regional integration organisations, from general Free Trade Agreements (FTAs) like the North American Free Trade Agreement (NAFTA), more integrative organisations like the Association of Southeast Asian Nations (ASEAN) to more ambitious regional integration organisations like the European Union (EU).
With the ongoing trade negotiations between the United Kingdom and the EU, we assess what the benefits actually are of FTAs and what the advantages of an FTA with the EU might be.
Regional integration organisations like the EU provide benefits for their members by facilitating specialisation, which, in accordance with David Riccardo’s vision of modern trade, allows EU members to utilize comparative advantage.
By ceding the political power to set domestic tariffs to the EU through the Customs Union, members can derive mutual benefits from specialising production in areas in which they are most efficient, catalysing economic growth through efficient production and greater export value.
The EU builds on this integrative economic growth by facilitating the Heckscher-Ohlin Model of Trade, where members can focus on their most efficient factors of production to increase national wealth through greater returns on exports, as demonstrated by 66% of EU imports being intermediate goods in the production process.
A prime example of this is the Airbus A380, where France specialises in manufacturing the cockpit, Germany the fuselage, the Netherlands the spoilers and Spain the tail-plane, combining to make production more efficient and therefore cost-effective.
This economic integration and specialisation raises productivity and accelerates national economic growth, thereby increasing the performance and wealth of member states.
However, the economic benefits of such integration do not stop there. Regional cooperation facilitates processes such as economies of agglomeration, and the subsequent spillover of wealth and innovation this creates. This is most aptly exhibited by the EU’s Single Market, which, according to the OECD, has been ‘been supportive of regional integration’ through states forfeiting power over the movement of capital, goods, services and labour to EU institutions.
This free movement enables spillover of business interaction and workers, as typified by Marshallian Externalities, where the Single Market allows European industries to benefit from the positive spillover of knowledge and investment, thus accelerating regional innovation and consequent growth. This is evident in the technology industry, with the EU making research and development easier due to fewer barrier for states and companies to cooperate.
As a result of these developments, agreements like the ending of EU roaming charges in June 2017 are possible as EU integration facilitated the cooperation necessary to advance technological capabilities in order to benefit members’ citizens by saving them money and improving service quality.
However, the EU's integration can cause problems through free movement of labour. This is exemplified by the fears that ceding domestic power over economic policy would result in lower wages, increased unemployment and lower labour standards, a leitmotif of Brexit. This danger was argued to be seen in the UK where the need for greater trade surpluses created a ‘race to the bottom’ through a cut in labour costs by lowering wages and increasing productivity by downgrading labour protection standards.
That being said, labour freedom and competition is not a zero-sum game, particularly as there are EU institutions overseeing common regulations for workers to the extent that a ‘race to the bottom’ is not likely to develop. Furthermore, the net benefits of EU membership will balance the impact of increased labour competition if there is effective redistribution of the wealth gained by the state from membership.
The EU also provides economic benefits for its members through enabling greater regional investment and intra-member trade, as well as strengthening members’ ability to receive beneficial trade deals from outside the regional organisation. This is encouraged by the free movement of capital within the EU, optimising capital allocation and intensifying competition, fuelling economic growth in the region as investment is made more easily, efficiently and competitively.
This is demonstrated by intra-regional Foreign Direct Investment within the EU increasing exponentially after the Single Market’s founding in 1993, from €50 billion in 1994 to almost €500 billion in 2008. This greater capital flow and exchange resulted in improved regional economic growth, as noted by the European Commission, with EU economies estimated to have grown by 2.4% in 2017, the fastest pace in a decade, providing members with more wealth to distribute domestically to benefit their citizens.
Furthermore, the EU provides economic benefit to members as it puts them in a stronger trading position. It is estimated that members’ overall trade has been 65% higher than it would have been the if the EU’s FTA was absent, with the Confederation of British Industry (CBI) saying that the net benefit of EU membership to the UK could be 4-5% of GDP a year.
Consequently, withdrawal from such a prosperous market will be immensely detrimental to the UK’s trading capabilities, as this strength in prosperity puts members in a far stronger position than if they were to attempt ad-hoc bargaining to which they would otherwise be consigned. In addition, states benefit from having the EU as its trade negotiator, as the EU's market of 500 million people puts it in a far stronger trading position that any European member state alone.
Author: Nicholas Madsen
Nicholas is a scholar of international relations, specialising in Middle Eastern and European security and integration.