Common Markets, Economic Unions, Monetary Unions

22/12/2020 1 By indiafreenotes

Common Markets

A common market is a formal agreement where a group is formed among several countries in which each member country adopts a common external tariff. In a common market, countries also allow free trade and free movement of labor and capital among the members in the group. This trade arrangement is aimed at providing improved economic benefits to all the members of the common market.

Conditions Required to be Defined as a Common Market

To be defined as a common market, the following conditions must be satisfied:

  • Tariffs, quotas, and all barriers regarding importing and exporting goods and services among members of the common market are eliminated.
  • Common trade restrictions such as tariffs on other countries are adopted by all members of the common market.
  • Production factors such as labour and capital are able to move freely without restriction among member countries.

Benefits of a Common Market

  1. Free movement of people, goods, services, and capital

In addition to the removal of tariffs among member countries, the key benefits of a common market include the free movement of people, goods, services, and capital. Therefore, a common market is often regarded as a “single market” as it allows the free movement of production factors without the obstruction created by national borders.

  1. Efficiency in production

For an economy, a common market facilitates efficiency among members – factors of production become more efficiently allocated, resulting in stronger economic growth. As the market becomes more efficient, inefficient companies eventually shut down due to fiercer competition.

Companies that remain typically benefit from economies of scale and increased profitability, and innovate more to compete in a more intensely competitive landscape.

Costs of a Common Market

  1. Less competitive countries may suffer

The transition to a common market comes with a few drawbacks. For one, companies that have previously been protected and subsidized by the government may struggle to remain afloat in a more competitive landscape. The migration of production factors to other countries may hinder the economic growth of the country they leave and lead to increased unemployment there.

  1. Trade diversion

Trade diversion occurs when efficient non-members are crowded out of the common market. Furthermore, a country may exhibit depressed wages if it faces an influx of migration of production factors where supply exceeds demand.

List of Common Markets:

  1. Andean Community (CAN)
  2. Caribbean Community Single Market (CARICOM)
  3. Central American Common Market (CACM)
  4. Economic and Monetary Community of Central Africa (CEMAC)
  5. European Economic Area (EEA) between the European Countries (EC), Norway, Iceland and Liechtenstein

Proposed Common Markets:

  1. Eurasian Economic Community (EAEC)
  2. Southern African Development Community (SADC)
  3. Southern Common Market (SCM)
  4. ASEAN Economic Community (AEC)
  5. African Economic Community (AEC)
  6. Gulf Cooperation Council (GCC)
  7. vii. North American Union (NAU)
  8. viii. Economic Community of West African States (ECOWAS)
  9. Economic Community of Central African States (ECCAS)
  10. South Asia Free Trade Agreement (SAFTA)

Economic Unions

An economic union is a type of trade bloc which is composed of a common market with a customs union. The participant countries have both common policies on product regulation, freedom of movement of goods, services and the factors of production (capital and labour) and a common external trade policy. When an economic union involves unifying currency, it becomes an economic and monetary union.

Purposes for establishing an economic union normally include increasing economic efficiency and establishing closer political and cultural ties between the member countries. Economic union is established through trade pact.

Additionally, the autonomous and dependent territories, such as some of the EU member state special territories, are sometimes treated as separate customs territory from their mainland state or have varying arrangements of formal or de facto customs union, common market and currency union (or combinations thereof) with the mainland and in regards to third countries through the trade pacts signed by the mainland state.

Proposed

  • African Economic Community (AEC) – proposed for 2023
  • Andean Community (CAN)
  • Arab Customs Union and Common Market – proposed for 2020
  • CANZUK
  • Central American Common Market (CACM)
  • Closer Economic Relations of Australia and New Zealand
  • East African Community (EAC): Extension of existing customs union proposed in 2015
  • Economic Community of Central African States (ECCAS)
  • Economic Community of West African States (ECOWAS)
  • Southern African Development Community (SADC) – proposed in 2015
  • Union of South American Nations (USAN)

List of economic unions

  • CARICOM Single Market and Economy
  • Central American Common Market: Common market since 1960, customs union since 2004.
  • Eurasian Economic Union: Customs union since 2010, common market since 2012.
  • European Union: Economic union between all EU member states, but those of them inside the Eurozone are also part of an economic and monetary union.
  • Gulf Cooperation Council

Monetary Unions

A currency union (also known as monetary union) is an intergovernmental agreement that involves two or more states sharing the same currency. These states may not necessarily have any further integration (such as an economic and monetary union, which would have, in addition, a customs union and a single market).

There are three types of currency unions:

  • Informal: Unilateral adoption of a foreign currency.
  • Formal: Adoption of foreign currency by virtue of bilateral or multilateral agreement with the monetary authority, sometimes supplemented by issue of local currency in currency peg regime.
  • Formal with common policy: Establishment by multiple countries of a common monetary policy and monetary authority for their common currency.

The theory of the optimal currency area addresses the question of how to determine what geographical regions should share a currency in order to maximize economic efficiency.

Advantages

  • A currency union helps its members strengthen their competitiveness in a global scale and eliminate the exchange rate risk.
  • Transactions among member states can be processed faster and their costs decrease since fees to banks are lower.
  • Prices are more transparent and so are easier to compare, which enables fair competition.
  • The probability of a monetary crisis is lower. The more countries there are in the currency union, the more they are resistant to crisis.

Disadvantages

  • The member states lose their sovereignty in monetary policy decisions. There is usually an institution (such as a central bank) that takes care of the monetary policy making in the whole currency union.
  • The risk of asymmetric “shocks” may occur. The criteria set by the currency union are never perfect, so a group of countries might be substantially worse off while the others are booming.
  • Implementing a new currency causes high financial costs. Businesses and also single persons have to adapt to the new currency in their country, which includes costs for the businesses to prepare their management, employees, and they also need to inform their clients and process plenty of new data.
  • Unlimited capital movement may cause moving most resources to the more productive regions at the expense of the less productive regions. The more productive regions tend to attract more capital in goods and services, which might avoid the less productive regions.

Convergence and Divergence

Convergence in terms of macroeconomics means that countries have a similar economic behaviour (similar inflation rates and economic growth). It is easier to form a currency union for countries with more convergence as these countries have the same or at least very similar goals. The European Monetary Union (EMU) is a contemporary model for forming currency unions. Membership in the EMU requires that countries follow a strictly defined set of criteria (the member states are required to have specific rate of inflation, government deficit, government debt, long-term interest rates and exchange rate). Many other unions have adopted the view that convergence is necessary, so they now follow similar rules to aim the same direction.

Divergence is the exact opposite of convergence. Countries with different goals are very difficult to integrate in a single currency union. Their economic behaviour is completely different, which may lead to disagreements. Divergence is therefore not optimal for forming a currency union.