4.4 Economic Integration

Economic integration is the process by which countries deliberately coordinate and link their economic policies in order to reduce or remove barriers to trade and investment between them. Barriers can include tariffs, quotas, differing regulations, and restrictions on the movement of capital or labour. As integration deepens, member countries move from simply trading more freely with each other towards actively harmonizing their economic policies -- and, in the deepest forms, their political institutions.

Economic integration is usually described as a spectrum, or a series of stages, each one building on the previous stage and requiring member countries to give up progressively more independent control over their own economic policy.

Countries that want to trade and cooperate more closely do not have to choose between total separation and full unification -- there is a spectrum of economic integration running from very shallow arrangements to very deep ones. As countries move along this spectrum, they progressively remove barriers to trade and investment, and increasingly coordinate (or even merge) their economic policies. Five commonly recognized stages are used to describe this spectrum, ordered from shallowest to deepest.

At the shallow end, a free trade area (FTA) removes tariffs and quotas between members but allows each country to keep its own trade policy towards the rest of the world. A customs union goes further by adding a common external tariff (CET), so all members treat non-member imports identically. A common market adds the free movement of labour, capital and services on top of free trade in goods, which requires members to harmonize a wide range of regulations (e.g. professional qualifications, product standards). An economic union deepens this further by coordinating monetary and fiscal policy -- sometimes including a shared currency. At the deepest end, a political union merges economic policy-making into a single central government, so member states effectively become regions of one political entity rather than fully sovereign nations acting together.

Moving further along the spectrum brings greater potential gains from trade and cooperation, but it also requires member countries to give up more national policy autonomy -- a trade-off explored elsewhere in this subtopic when weighing the benefits and costs of integration. No real-world bloc has to progress through every stage: many free trade areas remain FTAs indefinitely, while a small number of blocs (most notably the European Union) have moved deep into economic union.

A free trade area (FTA) is the most basic and shallow form of economic integration between countries. In an FTA, member countries agree to remove tariffs, quotas, and other trade barriers among themselves, allowing goods and services to move between member states without the taxes or restrictions that would otherwise apply. However, each member country keeps its own independent trade policy towards non-member countries. This means Country A and Country B in the same FTA can each set a completely different tariff on, say, imported steel from a non-member Country C.

This retained independence over external policy is the single defining feature that separates an FTA from the next, deeper level of integration, a customs union. It gives each member sovereignty over its own trade relationships with the rest of the world, but it also creates a practical problem: because external tariffs differ between members, an importer could bring goods into the low-tariff member and then re-export them tariff-free to the high-tariff member, undermining that country's trade policy. This is called trade deflection.