UNIT 2

CROSS-NATIONAL COOPERATION
AND AGREEMENTS

OBJECTIVES

To identify the major characteristics and challenges of the World Trade Organization
To discuss the pros and cons of global, bilateral, and regional integration
To describe the static and dynamic impact of trade agreements on trade and
investment flows
To define different forms of regional economic integration
To compare and contrast different regional trading groups, including but exclusively
the European Union (EU), the North American Free Trade Agreement (NAFTA), the
Southern Common Market (MERCOSUR), and the Association of Southeast Asian
Nations (ASEAN)
To describe other forms of global cooperation, such as the United Nations and the
Organization of Petroleum Exporting Countries (OPEC)

CHAPTER OVERVIEW

Regional economic integration represents a relatively new phenomenon in the history of

world trade and investment. Chapter Eight first examines the roles of the General
Agreement on Tariffs and Trade and the World Trade Organization in determining the
ground rules of the world trade environment. It then introduces the basic types of
economic integration and explores the potential effects of the process. Next it examines
in detail both the European Union (its structure and its operations) and the North
American Free Trade Agreement and briefly describes a variety of other regional
economic groups. The chapter concludes with a discussion of various commodity
agreements and producer alliances, including the Organization for Petroleum Exporting
Countries.

CHAPTER OUTLINE

I. INTRODUCTION
Trading groups are a significant influence on the strategies of MNEs because they
define the size of regional markets and the rules by which companies must operate.
Economic integration is the political and economic agreements among countries
that give preference to member countries in the agreement. Approaches to economic
integration include global integration via the World Trade Organization, bilateral

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 integration via cooperation between two countries, and regional integration via
cooperation between countries in the same geographic proximity.

II. THE WORLD TRADE ORGANIZATION (WTO)

The World Trade Organization has become the primary multilateral forum through
which governments conclude trade agreements and settle associated disputes.
A. GATT: The Predecessor to the WTO
The General Agreement on Tariffs and Trade (GATT) was established in
1947 by twenty-three nations as a multilateral agreement whose objective was to
abolish quotas and reduce tariffs.
1. Trade without Discrimination. The fundamental principle of trade
without discrimination was embedded in the most-favored-nation (MFN)
clause, i.e., the principle that each member nation must open its markets
equally to every other member nation. Several major rounds of negotiations
from 1947 to 1993 led to a wide variety of multilateral reductions in both
tariff and nontariff barriers. At the conclusion of the Uruguay Round in
1994, the World Trade Organization was created in 1995 for the purpose of
institutionalizing the GATT.
B. What Does the WTO Do?
The World Trade Organization (WTO) was founded in 1995 as a permanent
world trade body for the purposes of (i) facilitating reciprocal trade negotiations
and (ii) enforcing trade agreements between or among member nations. The
WTO adopted the principles and agreements reached under the auspices of the
GATT, but it expanded its mission to include trade in services, investment,
intellectual property, sanitary measures, plant health, agriculture, textiles, and
technical barriers to trade. Currently the 150 member countries of the WTO
collectively account for more than 97 percent of the value of world trade. Major
decision-making units include: the Ministerial Conference, the General Council,
the Council for Trade in Goods, the Council for Trade in Services, and the
Council for Trade-Related Intellectual Property Rights (TRIPS).
1. Normal Trade Relations. The WTO replaced the GATTs most-favored-
nation (MFN) clause with the concept of normal trade relations, which
prohibits any sort of trade discrimination. With the following exceptions, it
restricts this privilege to official members:
Developing countries manufactured products have been given
preferential treatment over those from industrial countries.
Concessions granted to members within a regional trading alliance,
such as the EU, have not been extended to countries outside the
alliance.
Exceptions can be made in times of war or international tension.
2. Dispute Settlement. Under the WTO there is now a clearly defined
mechanism for the settlement of disputes. Countries may bring charges of
unfair trade practices to a WTO panel; accused countries may appeal; WTO
rulings are binding. If an offending country fails to comply with a
judgment, the rights to compensation and countervailing sanctions will
follow. The Doha Round began in Doha, Qatar in 2001 to address disputes

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 between developed and developing nations. Issues surrounding agricultural
subsidies have been particularly difficult.

III. THE RISE OF BILATERAL AGREEMENTS

Currently, bilateral agreements, also known as preferential trade agreements
(PTAs) (and also referred to by some as free trade agreements (FTAs)) are sometimes
negotiated by partner nations as a way to circumvent the multilateral trading system
and meet their mutual trading objectives.

IV. REGIONAL ECONOMIC INTEGRATION

Regional trade agreements or RTAs involve multiple countries engaged in the
process of economic integration. Neighboring countries tend to ally with one
another because of their proximity, their somewhat similar tastes, the relative ease of
establishing channels of distribution, and a willingness to cooperate with one another
for the greater benefit of the allied parties. The two basic types of regional economic
integration that address barriers to trade are:
Free Trade Agreements, in which all barriers to trade, i.e., tariff and nontariff
barriers, are abolished among member nations, but each member determines its
own external trade barriers with non-FTA countries.
Customs Unions, in which all barriers to trade, i.e., tariff and nontariff barriers,
are abolished among member nations, and common external barriers are levied
against non-member countries.
1. Common Market. When moving beyond the reduction of tariff and
nontariff barriers, a common market may be created, allowing for the free
flow of capital and labor. It may go even further by harmonizing
commercial, monetary, and fiscal policies and establishing a common
currency, plus a supranational political structure dedicated to dealing with
common economic issues.
A. The Effects of Integration
Regional economic integration can affect member countries in social, cultural,
economic, and/or political ways. (MNEs are, or course, particularly interested
in the economic effects.)
1. Static and Dynamic Effects. Static effects represent the shifting of
resources from inefficient to efficient firms as trade barriers fall. Dynamic
effects represent the gains from overall market growth, the expansion of
production, the realization of greater economies of scale and scope, and the
increasingly competitive nature of the market. Static effects may occur when
either of two conditions occurs [See Fig 8.1]:
a. Trade creation. Trade creation occurs when production shifts from
less efficient domestic producers to more efficient regional producers for
reasons of absolute or comparative advantage.
b. Trade diversion. Trade diversion occurs when, as a result of the
imposition of common external barriers, trade shifts from more efficient
external sources to less efficient suppliers within the group. (When
lower cost, externally-sourced products are suddenly confronted by trade

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 barriers, the effective delivered cost of those products increases; thus, the
quantity that can be purchased for a given amount of money is reduced.)
Dynamic effects of integration occur when trade barriers come down and
the size of the market increases. Because of the larger size of the market,
competitors are able to reduce their unit costs by capturing economies of
scale. As a result, customers gain access to a wider variety of lower cost,
higher quality products. Another important effect of the FTA is the
increase in efficiency due to increased competition.

V. MAJOR REGIONAL TRADING GROUPS

Trading groups can be organized by type and/or location. Firms are interested in
regional trading groups because they can serve as potential markets, sources of raw
materials, and production locations.
A. The European Union
The European Union (EU) represents the most advanced regional trade and
investment group in the world today.
1. Predecessors. The EU evolved from the European Economic Community
(EEC) to the European Community (EC) to the European Union (EU). [Key
milestones are summarized in Table 8.1.] The European Free Trade
Association (EFTA) consists of Iceland, Liechtenstein, Norway, and
Switzerland; all but Switzerland are linked to the EU via a customs union.
2. Organizational Structure. Detailed information on the history, structure,
and function of the EU is available on its extensive website. [See Map 8.1.]
a. Key Governing Bodies. The European Commission provides the
EUs political leadership and direction; it consists of commissioners
appointed by member countries for five-year renewable terms. The
commission is responsible for proposing EU legislation, implementing
EU legislation, and monitoring compliance with EU laws by member
nations. The European Council is composed of representatives from the
government of each member country. The Council is responsible for
passing laws and making and enacting major policies. Composed of
785 members (allocated on the basis of country population) elected
every five years, the European Parliament has three major
responsibilities: legislative power, control over the budget, and
supervision of executive decisions. Parliament considers legislation
presented by the European Commission; if the legislation is approved, it
is then submitted to the European Council for final adoption. The
European Court of Justice ensures consistent interpretation and
application of EU treaties. Dealing mostly with economic matters, it
serves as an appeals court for individuals, firms, and organizations fined
by the commission for infringing upon Treaty Law.
3. The Single European Act. The EU has been moving toward a
single market ever since the passage of the Single European Act. It is
designed to eliminate any remaining nontariff barriers to trade in Europe.
4. Monetary Union: The Euro. The Treaty of Maastricht, signed in 1992,
sought to foster both political and monetary union within the EU. While the

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 move toward a common currency has partially eliminated different currencies
as a barrier to trade, not all members have adopted the euro. (Members
adopting the euro at the time of its launch on January 1, 1999, were Austria,
Belgium, Germany, Finland, France, Ireland, Italy, Luxembourg, the
Netherlands, Portugal, and Spain; Greece followed suit on January 1, 2001.
Slovenia adopted the euro on January 1, 2007. Of the 15 members of the EU
prior to the expansion in 2004, only the UK, Denmark, and Sweden elected
not to adopt the euro.) Now one of the most widely traded currencies in the
world, the euro facilitates price transparency for customers and eases pricing
decisions and transaction reconciliations for firms.
5. Expansion. The EU expanded from 15 to 25 countries in 2004 by admitting
countries primarily from central and eastern Europe. [See Map 8.1.]
Although this expansion increased the EUs population and added to its
economic output, the integration of such disparate countries will not be easy
[See Table 8.2]. Most are poor, agriculturally-based, newly democratized
economies which, when taken together, will seriously strain the EUs financial
resources. Another challenge is the issue of governance, because
economically large members of the EU fear that the addition of so many new
countries will weaken their control and influence. In 2007, the EU increased
its membership by two additional countries Romania and Bulgaria, bringing
the total number of member states to twenty seven.
6. Bilateral Agreements. The European Union has signed numerous bilateral
trade agreements with other countries outside Europe. In addition, the EU has
entered into an agreement with the European Free Trade Association (with the
exception of Switzerland) to form the European Economic Area (EEA).
7. How to do Business with the EU: Implications for Corporate
Strategy. There are at least three ways in which the competitive strategies of
foreign firms that choose to do business within the EU are affected. First,
they must determine their production site location(s) on the basis of total costs
that include labor, transportation, and other strategic factors. Second, foreign
firms must decide upon an entry strategy, i.e., new investments, expanding
existing investments, or joint ventures and mergers. Third, firms must be
sensitive to essential national differences, particularly in areas such as
economic growth rates and cultural traditions. In addition, the trade-offs
between the advantages of pan-European strategies and more localized
strategies must be continually examined.
B. North American Free Trade Agreement (NAFTA)
Effective as of January 1, 1994, the North American Free Trade Agreement
(NAFTA) incorporates Canada, Mexico, and the United States into a regional
trade bloc of countries of quite different sizes and sources of national wealth.
1. Why Nafta? More than a mere free trade agreement and claiming a total
GNI greater than that of the 27-member EU, NAFTA calls for the
elimination of tariff and nontariff barriers, the harmonization of trade rules,
the liberalization of restrictions on services and foreign investment, the
enforcement of intellectual property rights, and a dispute settlement process.
NAFTA makes logical sense in terms of geographical location and trading

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 importance. Two-way trade between the United States and Canada is the
largest in the world. NAFTA extends its cooperation beyond tariff
reductions to include provisions for services, investments, and intellectual
property. NAFTA has provided both static and dynamic effects. Canada and
the U.S. benefit from the lower-cost agricultural products from Mexico and
U.S. producers benefit from the growing Mexican market. NAFTA is a good
example of trade diversion in which Canadian and U.S. companies have
shifted some production facilities to Mexico from Asia due to the benefits of
the trade agreement.
2. Rules of Origin and Regional Content. NAFTAs rules of origin
require that at least 50 percent of the net cost of most products originate
within the region if those products are to be eligible for the more liberal
tariff conditions within the bloc.
3. Special Provisions. NAFTA is a unique sort of trade agreement in that it
also addresses two side issues: (i) regional labor laws and standards and (ii)
strengthened environmental standards.

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 4. The Impact of NAFTA. Due to low wages in Mexico, U.S. companies
invested significantly in the country. FDI from the U.S. accounts for about
62% of all foreign direct investment in Mexico. While trade and investment
amongst the NAFTA members has increased significantly, the employment
picture is less clear. Although some investment funds have been flowing
out of Mexico since the maquiladora plants were stripped of their duty-free
status in 2001, other investment funds have been flowing into Mexico from
companies such as Wal-Mart, which is now the largest employer in Mexico.
Further, illegal immigration continues to be a problem in the United States.
It is estimated that 1.3 million farm jobs were eliminated in Mexico due to
competition from American farmers. It is proposed that many of these
displaced Mexican workers illegally cross the border in their search for
work in the United States.
5. How to Do Business with NAFTA: Implications for Corporate
Strategy. Although NAFTA has not expanded beyond the original three
countries due to political obstacles, each member of NAFTA has entered
into bilateral agreements with other countries. The existence of NAFTA is
causing firms from all three member countries to re-examine their trade and
investment strategies. A number of industries (e.g., automotive products
and electronics) already view the region as one large market and have
rationalized their production processes, products, and financing accordingly.
Although much low-end manufacturing has moved south to Mexico, more
sophisticated manufacturing and services operations are increasing in the
United States. In addition, Canadian firms along the U.S.-Canadian border
are generating more competition for U.S. firms along their mutual border
than are Mexican firms along the U.S.-Mexican border. Further, as
Mexican incomes have continued to rise, Mexican demand for Canadian-
and U.S.-sourced products has increased as well.
C. Regional Economic Integration in the Americas
Although there are six major regional economic groups in the Americas [see
Maps 8.2 and 8.3], regional integration in Latin America has not been
particularly successful, because many countries rely more on the United States
for trade than on members of their own groups. The Caribbean Community and
Common Market (CARICOM) and the Central American Common Market
(CACM) are both found in Central America. Five Central American countries
and the Dominican Republic now have a free trade agreement with the United
States (CAFTA-DR) as discussed below in the Point-Counterpoint segment. The
two major groups in South America are the Andean Community (CAN) and the
Southern Common Market (MERCOSUR). In addition, there is the proposed
South American Community of Nations. The primary reason for each of these
groups entering into collaboration is market size.
1. CARICOM: Benchmarking the EU Model. The Caribbean
Community is working hard to establish an EU-style form of collaboration, one
that would mirror the EU, but on a smaller scale.
2. MERCOSUR.The major trade group in South America is MERCOSUR,
comprised of Brazil, Argentina, Paraguay, and Uruguay. Venezuela recently

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 joined the group, however, full membership of Venezuela is still pending
approval of Brazil and Paraguay. Chile, Bolivia, Ecuador, and Peru are
associate members of MERCOSUR, meaning they have duty free access to
MERCOSUR markets without getting involved in the negotiations to
complete the customs union phase.
3. Andean Community (CAN). Stated in 1969, CAN is the second
most important regional group in South America. Since its beginning,
CAN has shifted its focus from one of isolation to being open to foreign trade
and investment.
4. South American Community of Nations (CSN). In 2004 the members
of the Andean Community (CAN), MERCOSUR, and other South
American countries attempted to launch the 12-nation South American
Community of Nations (CSN). The goals of CSN are to liberalize trade
and eventually have a common currency, parliament, and passport.
However, its prospects for success are questionable as the participation of
several countries is at best lukewarm.

POINTCOUNTERPOINT: Is CAFTA-DR a Good Idea?

POINT: The Central American Free Trade Agreement (CAFTA) will link the United
States with five countries in Central America plus the Dominican Republic in the
Caribbean via a free trade agreement. It will open the door for increased trade between
the United States and the region, and it will stimulate economic growth in Central
America by encouraging foreign direct investment, offering shorter international supply
chains, and encouraging political reform in an area historically plagued by dictatorships
and civil wars. Further, the growth that CAFTA will foster in Central American
industries will directly benefit those U.S. exporters whose products are used in their
production processes.
COUNTERPOINT: CAFTA is not a good idea because of the vastly different interests
among countries. Opening the market wont help U.S. agriculture, which actually needs
an increase in world market prices; Central American economies are too small to affect
prices. Further, given its balance of payments deficit, the United States cant tolerate
many more imports. CAFTA is also a bad move for labor and workers rights because it
will trigger the loss of manufacturing jobs in the United States and the loss of agricultural
jobs in Central America. Finally, stringent intellectual property clauses included in the
agreement threaten access to affordable life-saving medicine in the Central American
nations.

D. Regional Economic Integration in Asia

Regional economic integration has not been as successful in Asia as in the EU or
the NAFTA region because most Asian countries have relied on U.S. and
European markets for their exports.
1. Association of Southeast Asian Nations (ASEAN). The Association
of Southeast Asian Nations (ASEAN) was first organized in 1967. [See

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 Map 8.4.] On January 1, 1993, it officially formed the ASEAN Free Trade
Area (AFTA) for the purpose of cutting tariffs on interzonal trade to a
maximum of 5% by 2008. Comprised of Brunei, Cambodia, Indonesia,
Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and
Vietnam, ASEAN holds great promise for market and investment
opportunities because of its large market size.
2. Asia Pacific Economic Cooperation (APEC). The Asia Pacific
Economic Cooperation (APEC) community was founded in 1989 to
promote multilateral economic cooperation in trade and investment in the
Pacific Rim. Comprised of 21 countries that border the Pacific on both the
east and the west, APEC leaders have committed themselves to achieving
free and open trade in the region by 2010 for the industrial nations and by
2020 for the remaining member countries. However, progress toward free
trade is hampered by the number of members, the geographic distances
between nations, and the lack of a binding treaty. Nonetheless, because
APEC includes 41% of the worlds population, 56% of world GDP, and
about 49% of world trade, it has enormous potential to become a significant
economic bloc. APEC is trying to establish open regionalism whereby
individual member countries can determine whether to apply trade
liberalization to non-APEC countries on an unconditional, most-favored-
nation basis or a reciprocal, free trade agreement basis.

E. Regional Economic Integration in Africa

There are several regional trade groups in Africa that are registered with the
WTO, including the Southern Africa Development Community (SADC), the
Common Market for Eastern and Southern Africa (COMESA), the Economic
and Monetary Community of Central Africa, and the West African Economic
and Monetary Union (WAEMU). [See Map 8.5] The problem with these groups
is that they rely more on their former colonial powers and other developed
markets for trade than they do on each other.
1. The African Union. Created in 2002 by 53 African nations, the
African Union took the place of the Organization of African Unity (OAU),
which focused its energy and resources on political issues in Africa (notably
colonialism and racism). The new AU is modeled loosely on the EU,
although this type of integration may prove difficult in Africa.

LOOKING TO THE FUTURE:

Will the WTO Overcome Bilateral and Regional Integration Efforts?

Although the objective of the WTO is to reduce barriers to trade in goods, services, and
investment, regional groups do that and more. Regional economic integration deals with
the specific problems facing member countries, while the WTO concerns itself with trade
issues facing the world as a whole. As a result, regional integration, which is more
flexible, may help the WTO achieve its objectives as the process leads to the
liberalization of issues not covered by the WTO. Regional economic integration can also

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serve to lock in trade liberalization across developing countries. The EU will continue its
expansion and faces the difficult issue of the admission of Turkey into the Union. The
challenges faced by the WTO not only come in the form of the growing strength of
regional trading blocks, but also the strong divisions between developed and developing
countries. Countries like Brazil and India fear further reduction of tariffs will cause their
markets to be swamped by Chinese goods.

F. Other Forms of International Cooperation

1. The United Nations.
The UN was established in 1945 to promote international peace and security
and to help with global issues such as economic development, antiterrorism,
and humanitarian relief. There are 192 member states in the UN General
Assembly. The UN Conference on Trade and Development (UNCTAD) was
established to tackle problems of the developing world concerning trade
issues.
2. Non-Government Organizations (NGOs)
Non-government, non-profit volunteer organizations such as the Red Cross
are private institutions that can be involved in transnational activities.
Several NGOs have a focus on the rights of workers in less developed
countries.

VI. COMMODITY AGREEMENTS

A commodity agreement is designed to stabilize the price and supply of a primary
commodity such as petroleum, natural gas, copper, coffee, cocoa, tea, or sugar
because both long-term trends and short-term fluctuations in their prices have
important consequences for the world economy.
A. Commodities and the World Economy
On the demand side, commodity markets play an important role in industrial
countries, transmitting business cycle disturbances to the rest of the
economy and affecting the rate of growth of prices. On the supply side, primary
products account for about half of developing countries' export earnings.
B. Consumers and Producers
For many years, countries tried to ban together as product alliances or joint
producers to help stabilize commodity prices. However, these efforts, with the
exception of OPEC have not been very successful.
C. The Organization of Petroleum Exporting Countries (OPEC)
The Organization of Petroleum Exporting Countries (OPEC) represents a
producer cartel, i.e., a group a commodity-producing countries with significant
control over output and price. Member countries include Algeria, Iran, Iraq,
Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and
Venezuela.
1. Price Controls and Politics. OPEC controls prices by establishing
production quotas on member countries. Because of the importance of
commodities to the production process, it is critical that managers

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 understand the factors that influence their prices. Politics plays an important
role in OPEC deliberations as countries with larger populations are tempted
to exceed their quotas to generate more revenue.
2. Output and Exports. Currently OPECs oil exports represent about 51
percent of the oil traded internationally. Therefore, OPEC can have a strong
influence on the oil market, especially if it decides to reduce or increase its
level of production. Events beyond OPECs control can also influence
prices.

3. The Downside of High Prices. Keeping prices high has a downside for
OPEC. Higher prices encourage exploration outside of OPEC member
countries and can cause a global economic slowdown, thus lowering the
overall demand for oil.

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