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 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

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 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 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
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 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 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
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 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 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
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 trading 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.
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.

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 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 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 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.
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 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 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

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 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 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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