Economic integration is the unification of economic policies of different nations or states through the elimination of tariff or nontariff barriers of trade. This is done to decrease the price for consumers and distributors in order to increase combined productivity. Economic integration incorporates the economic theory of the second best, which is the theory that free trade is the best option when there is free competition and no trade barriers.
Integration is used in economics because the rationale is that it will lead to higher productivity. There are multiple stages in economic integration, from some association between countries in a preferential trade area to a complete economic integration, in which the economies of countries are completed integrated¹. When countries in a geographical region block off imports from non-member countries in order to trade exclusively with each other, it is called a regional trading bloc. Regional trading blocs are said to shape the pattern of world trade, a concept know as regionalism.
The stages of integration are as follows, going from highest level of integration to the lowest²:
1. Political Union
2. Fiscal Union
3. Monetary Union
4. Common Market
5. Customs Union
6. Free Trade Area
7. Preferential Trade Area
8. Independent Economy
Complete economic integration has a single economic market, a common trade policy, a single currency, common monetary policy (EMU) combined with one fiscal policy, tax, and benefit rates². It is the complete union of policies, rates, and trade rules.
Economic integration contains the functions of trade creation and trade diversion, and the Pareto efficiency of factors. It is an important part of studying the trade relationships between countries.
1. Johnson, H. An Economic Theory of Protection, Tariff Bargaining and the Formation of Customs Unions. Journal of Political Economy, 1965, vol. 73, pp. 256–283.
2. Negishi, T. Customs Unions and the Theory of the Second Best. International Economic Review, 1969, vol. 10, pp. 391–398