Economic integration refers to the process by which countries eliminate barriers to trade and coordinate economic policies to achieve a higher level of economic cooperation.

Get the full solved assignment PDF of MEC-007 of 2023-24 session now.

There are several forms of economic integration, ranging from less integrated to more integrated arrangements. The main forms include:

Free Trade Area (FTA): Member countries eliminate tariffs and quotas on trade among themselves but maintain their own external trade policies. The North American Free Trade Agreement (NAFTA) was an example, later replaced by the United States-Mexico-Canada Agreement (USMCA).
Customs Union: In addition to free trade, member countries establish a common external trade policy. This means they apply a common set of tariffs to non-member countries. The Southern Common Market (Mercosur) is an example.
Common Market: In addition to customs union features, a common market allows for the free movement of goods and factors of production (such as labor and capital) among member countries. The European Union (EU) is an example.
Economic Union: This involves a higher level of integration than a common market. It includes the coordination of economic policies, common currency, and a common central bank. The Eurozone, which uses the euro as a common currency, is an example.
Political Union: The most integrated form, where member countries not only coordinate economic policies but also share political institutions. The United States is an example, where states have a high degree of economic integration and share a federal political system.

Now, regarding trade diversion and trade creation:

Trade Creation: This occurs when economic integration leads to the production of a good shifting from a high-cost producer to a low-cost producer within the integrated area. As a result, the overall efficiency and welfare of the integrated region increase. Trade creation is a positive outcome of economic integration.
Trade Diversion: On the other hand, trade diversion occurs when economic integration leads to a shift in production from a more efficient producer outside the integrated area to a less efficient producer within the area. While trade diversion benefits the less efficient producer within the integrated region, it can lead to a decrease in overall efficiency and welfare. Trade diversion is a potential downside of economic integration.

In essence, trade creation enhances economic efficiency, while trade diversion may result in less efficient resource allocation within the integrated area. The assessment of economic integration considers the balance between these two effects to determine its overall impact.