Percy S. Mistry

Regional Integration
Arrangements
in Economic Development
Panacea or Pitfall?

FONDADThe Hague
From: Regional Integration Arrangements in Economic Development: Panacea or Pitfall?
FONDAD, The Hague, 1996, www.fondad.org

ISBN: 90-74208-08-8© Copyright 1996 by Percy S. Mistry and the Forum on Debt and Development. Permission must
be obtained from them prior to any further reprints, republications, photocopying, or other useof this work.
The views expressed in this book do not necessarily represent those of the Forum on Debt andDevelopment.
Additional copies may be ordered from FONDAD at
N oordeinde 107 A, 2514 GE The Hague, the Netherlands
Tel: 31-70-3653820 Fax: 31-70-3463939 E-mail: fondad@pi.net

From: Regional Integration Arrangements in Economic Development: Panacea or Pitfall?
FONDAD, The Hague, 1996, www.fondad.org

Contents

Abbreviations
Preface1

A Retrospective on Regional Integration Arrangements
Introduction
A Tour d'Horizon ofRIAs Around the WorldThe Role of Regionalism in the Emerging World Order

2

36
41
44
45

The Experience of Developed vs, Developing Countries
Why First-Generation RIAs Failed in Developing Countries
Lessons for the Future

.5

23
23
25
26
28
33
33

Reducing Non-Tariff Barriers
Barriers to Trade Gains
Barriers to Production
Barriers to Cross-Border Investment
Other Barriers

4

11
12
20

The Role ofRIAs in Fostering Economic Development
Introduction
Lessons from the Past
The Inadequacy of Classical Theoretical Constructs
Orthodox (Static) Gains from RIAs
Unorthodox (Dynamic) Gains from RIAs
Political Commitment to RIAs and the Issue of Credibility
Equity and Regional Policy

3

7
9

48
52

Second-GenerationRIAs in the Developing World
Determinants of Success
Linking Up with Large Trade Blocs

54
56

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6

Options for Creating Regional Trade Preferences Among
Developing Countries
The Role of Bilateral Agreements
The Role of Customs Unions
The Role of Preferential and Free Trade Areas

7

58
59
61

Regionalisation vs. Globalisation: The Issues
Regionalism as a Mezzanine Step
Trade Blocs
GATIRules
Theoretical Objections and Practical Benefits

8

Synopsis and Conclusions
The Road Ahead for Developing Countries
The Political Dimension
The Role of Donors
Learning from Experience
Distribution of Costs and Benefits
Regional Adjustment Programmes
External Linkages
A Pragmatic Approach to Strengthening RIAs
in Developing Countries

72
74
75
76

77
78
80

81

Annexes

85

Bibliography95

From: Regional Integration Arrangements in Economic Development: Panacea or Pitfall?
FONDAD, The Hague, 1996, www.fondad.org

Abbreviations

ACP
AFTA
ANZCERTA
APEC
ASEAN
CACM
CAP
CARICOM
CARlITA
CEAO
CET
CFA
CMEA
COMESA
CU
EAC
EC
ECO
ECU
EFTA
EMS
EU
FDI
ITA
GATT
GCC
GDP
IFls

IMF
IOC
LAC
LAFTA
MERCOSUR
MFN
MIGA
MMA
NAFTA
NATO
NICs
OAU

Africa, Caribbean and the Pacific
ASEAN Free Trade Area
Australia-New Zealand Closer Economic Relations Trade Agreement
Asia Pacific Economic Cooperation
Association of South-East Asian Nations
Central American Common Market
Common Agricultural Policy (of the European Union)
Caribbean Community
Caribbean Free Trade Association
Economic Community of West Africa
Common External Tariff
Communaute Financiere Africaine
Council for Mutual Economic AssistanceCommon Market for Eastern and Southern Africa
customs union
East African Community
European Community
Economic Cooperation Organisation
European Currency Unit
European Free Trade Association
European Monetary System
European Union
foreign direct investment
free trade area
General Agreement on Tariffs and Trade
Gulf Cooperation Council
gross domestic productinternational financial institutions
International Monetary Fund
Indian Ocean Commission
Latin America and the Caribbean
Latin American Free Trade Association
Southern Common Market
most-favoured nation
Multilateral Investment Guarantee Agency (of the World Bank)
Multilateral Monetary Agreement
North American Free Trade Agreement
North Atlantic Treaty Organisation
newly industrialised countries
Organisation of African Unity

OECD

Organisation for Economic Co-operation and Development (which

PECC
PTA
RIAs
RoW
RSA

comprises 23 developed country members as well as Mexico and Turkey)
Pacific Economic Cooperation Conference
Preferential Trade Area (for Eastern and Southern Africa)
regional integration arrangements
rest of the world
Republic of South Africa

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SAARC
SACU
SADC

South Asian Association for Regional Cooperation
Southern African Customs Union
Southern African Development Community (former SADCC + South
Africa)

SADCC
SArrA
SAPs
SAPTA
SDR
TCR
TRIMS
UDEAC
UK
UN
UNCTAD
US
VAT

WTO

Southern African Development Coordination Conference
South Asian Free Trade Area
structural adjustment programmes
South Asian Preferential Trade Arrangement
Special Drawing Right (in the IMF)
regional cooperation tax
trade-related investment measures
Customs and Economic Union of Central Africa
United Kingdom
United Nations
United Nations Conference on Trade and Development
United States of America
Value Added Tax
World Trade Organisation

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Preface
Regional economic integration is a complex and much debated issue among
analysts and policymakers in almost every corner of the world. Recently, it has
gained particular interest and momentum with the European Union's envisaged
deepening - the introduction of a single currency - and widening - theinclusion of East European countries - of its integration process. Excitement, or
fear, about the prospects of regional integration has been spurred further by thesurge of the "new regionalism" in Latin America and the emergence ofspectacular mega-initiatives such as the Asia Pacific Economic Cooperation(APEC) agreement between the United States, Japan, China, Canada, Mexico,
Australia and a dozen other countries bordering the Pacific Ocean.
The challenge that the new wave of regional integration efforts poses todeveloping as well as industrial countries has led the Forum on Debt andDevelopment (Fondad) to embark on a three-year research project which aims
to explore how regional integration as well as multilateral cooperation can bepromoted, in a mutually reinforcing manner, at the same time. This study,
written by one of the stimulating forces in the project, Indian economist andinvestment banker Percy S. Mistry, is one of the results. Earlier drafts served asa framework paper to guide and inspire the thinking of participants in Fondad
conferences.
In the book, Mistry reviews issues arising from experience with arrangements
for regional economic cooperation and integration in developing and developed
regions of the world. Given the plethora and complexity of the issues involved ranging from trade, finance and monetary matters to institutional, social andpolitical affairs - the author has chosen a broad approach. However, at various
points Mistry also presents some of his more detailed insights and policy
suggestions.
Following an introductory retrospective on the history and role of regional
economic integration arrangements (RIAs), the study deals with: the costs andbenefits of RIAs in facilitating development; the reasons for the successes andfailures of first-generation RIAs in different parts of the World; arguments about
whether second-generation RIAs are likely to facilitate or impede global multilateral cooperation; and finally, the main lessons for developing countries thatcan be drawn from past and present-day experience.
Fondad is grateful to VSB Fonds Den Haag en Omstreken and the Dutch
Ministry of Foreign Mfairs for making the publication of this study possible.
Jan Joost Teunissen
Director
August 1996
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1

A Retrospective on Regional
Integration Arrangements

Introduction
Even with the limited objective in mind of using resources more efficiently
by reconfiguring the geography in which they are deployed, the "urge tomerge" has afflicted an overwhelming majority of countries throughout theworld. At present, almost every member of the Organisation for Economic
Cooperation and Development, and virtually every developing country as
well, is either engaged in, or flirting with, some form of regional integration.
Regional integration arrangements (RIAs) are not new. Many of theirfeatures, e.g. free trade areas and monetary unions, emerged and were
continually refined under colonial rule between 1850 and 1950 in much ofwhat is now the developing world. The genesis of RIAs in Europe is ascribedto the Anglo-French accord of 1860. That agreement impelled other European
countries to sign similar accords with France in a fashion reminiscent of therecent rush on the part of countries to emulate Mexico and Israel in signing
free trade agreements with the United States. RIAs existed under the British
and French empires in South and East Asia, the Middle East, in sub-regionsof Mrica and in the Caribbean.! These were predated by arrangements whichbound together the former colonies of Spain in Central and South America.
In Asia, such arrangements also existed between colonial Japan, and colonised
Korea and Formosa (now Taiwan) between 1890 and 1945. 2
Perhaps the most successful form of RIA that evolved and culminated infull economic and political union on a voluntary, democratically determinedbasis, was the progressive expansion and formation of the United States ofAmerica between 1820 and 1920. This unique experience, however, is not
usually seen as an example of an RIA among sovereign nations as such but as
exemplifying the evolution and expansion of a federation welding together
fractious, semi-sovereign, constituent provincial states.

1 The structures of the British, French and Spanish imperial arrangements were, in theirearly stages, essentially incomplete RIAs and the countries included were not geographicallycontiguous. In these arrangements the economic concept of a region was different from one thatcartographers would normally employ; extending to all territories of empire but with differencesin different areas. Yet they had many of the features of RIAs: e.g. monetary unions, common
currencies, common fiscal administrations, customs unions, convergent fiscal policies, internalconventions on cross-border investments and the like.

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Between 1915 and 1945 colonial RIAs, which had become entrenchedworld-wide, gradually became looser and less pervasive. That period witnessed
two World Wars, a global depression and the breakdown of the British andFrench empires. The aftermath of the Second World War saw a different
economic order emerge. It was characterised, between 1945 and 1975, by: theeconomic hegemony of the United States; the establishment and consolidationof the East Bloc as a countervailing military - if not economic - power; andthe emergence of a raft of independent nation states obsessed with exercising
their new sovereignty and, unfortunately, much less concerned about theefficiency of resource use. Many RIAs evaporated under the heat of US vs.
Soviet competition to draw emerging developing countries within theirrespective spheres of political, military and economic influence as Pax
Americana and Pax Sovietica replaced Pax Britannica.

A Tour d'Horizon ofRlAs Around the WorldIn the aftermath of the Second World War, the world has beencharacterised by several different types of RIAs in developed and developing
regions. These are discussed briefly below according to the geographical (andeconomic) parts of the world in which they occurred.
First WorldIn the first world, the most ambitious and successful RIA, of course, is thestill evolving European Union (ED). Beginning humbly as a coal and steel
community between six countries, it is now virtually a full economic union
involving fifteen developed Western European countries. Four of these(Greece, Ireland, Portugal and Spain) acceded when they were still classified
as middle-income developing countries. Their economies and standards of2 Various attempts at regional integration, though not necessarily achieved throughcooperation, date even much further back in history, to the time of ancient empires whose
relatively superior technology permitted conquests of terrain beyond their borders and resulted
in relatively quick, if somewhat brutal, economic integration (largely because life was not quite socomplicated or politically correct then). They were not driven explicitly by the needs of popular
democracies aiming to improve their standards of living through the benefits of comparativeadvantage, market expansion, rationalised industrialisation, efficient import-substitution, staticand dynamic trade creation, externalities and scale-economies. Perhaps for that reason, theseendeavours are not generally viewed as falling into the category of respectable RIA efforts byeconomists, even though they are by historians; especially military historians. Insofar as recorded
history can be relied on, few of these initiatives were triggered by voluntary efforts on the part ofthe states involved at achieving economic integration; except in the rare cases of a successful
arranged marriage among royal families leading to the durable cementing of dowry-endowed
territories. This quaint approach to RIAs has, alas, disappeared in modern times.

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living have progressed rapidly since they joined the European Union although
their absorption, as is often supposed, has not been a matter of easy
digestibility. Together these four accounted for 20% of the European
Union's population when they joined, but for only 8% of its total GDP. They
now account for about 11% of regional GDP. With its recent enlargement(in 1995) through the entry of Austria, Finland and Sweden, the European
Union now embraces 375 million people and a total GDP (1994) of around
US$8 trillion.
The North American Free Trade Agreement (NAFTA) embracing the US,
Canada and Mexico has aroused even more interest in the developing world
than the European Union with regard to the potential of RIAs. NAFTA has
excited imagination because it is perceived as an unprecedented bonding
arrangement between highly developed and developing states in the same
region, presaging a different future with new possibilities for such arrangements.
While NAFTA is certainly unusual in that respect it is not unprecedented.
As observed, the European Union achieved the same conjunction a decade
earlier when Southern European countries joined it. Like the European
Union, NAFTA embraces about 370 million people with a collective 1994
GDP of about US$7.5 trillion. In this arrangement, Mexico accounts forabout 23% ofNAFTA's total population but only 4% of regional GDP. The
development disparity between Mexico and its partners in NAITA is thus
much greater than that between the Southern and Northern European
countries when the former became members of the European Union.
The key characteristic of both the European Union and NAFTA, and thereason why these two blocs may eventually succeed in evolving towards someform of economic union, is the relatively high proportion of intra-regional
trade, investment and capital flows already occurring in both blocs relative totheir total trade. In NAFTA, however, the question of unimpeded labour
mobility across internal borders may prevent full labour market integration
for some time, even as other factor markets integrate. The same could be trueof the European Union if it were to widen, by embracing new Eastern
European members, before it deepened. Recent events suggest that theprospects for further deepening under the timetable of the Maastricht Treaty,
especially in achieving monetary union, may be set back and be achievedmuch later than was earlier anticipated.

Second WorldIn what was formerly the second world, members of the former East Bloc
were bound together under the Council for Mutual Economic Assistance(CMEA). Though CMEA was primarily an arrangement among geographically contiguous countries in the Soviet Union and Eastern Europe, it
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embraced three (non-regional) third world members, i.e. Cuba, Mongolia ~nd
Vietnam. CMEA's role as an RIA in the post-war world has perhaps been
understated because it was a statist rather than a market arrangement. Evenso, for nearly thirty years CMEA engendered reasonably rapid growth in its
member economies. Its usefulness came to an end when the limitations ofrigid command economies - in responding to technological developments,
meeting evolving domestic consumer demands, and holding their own under
rapidly changing global product-market conditions - became painfully
manifest.
CMEA was clearly not an RIA voluntarily entered into by free, democratic
states exercising free choice. Its role in the former Soviet empire was not so
different from the trade, exchange and monetary regimes which prevailed in
the former British, French and Spanish colonial empires. The only difference
was that laissez faire market economics played no role at all in determining
CMEA's design.
Four former CMEA members (The Czech Republic, Slovakia, Hungary and
Poland) - commonly known as the Visegrad countries - are presently attempting
a new form of RIA among themselves before joining the European Union,
which is their ultimate aim. So are the three Baltic Republics which are
simultaneously developing associated RIAs with the European Union and theNordic community.
Third WorldThe developing, third world has experimented with a number of RIAs ofvarying looseness. Some existed prior to the independence of many young
countries which were colonies for a longer period than they have beensovereign. Pre-independence RIAs in former colonies of Seutheast Asia
(Malaysia-Singapore and Indo-China), Africa, the South Pacific (withAntipodean linkages) and the Caribbean were quite successful in terms of
their limited objectives.
Certainly these RIAs supported a reasonable domestic macroeconomic
policy framework for growth and prosperity in the individual colonies. But
the gains derived from these arrangements did not necessarily lead toequitable growth in these economies, nor to effective or appropriate
industrialisation. Even less did they benefit indigenous populations, though
they yielded substantial benefits for owners of plantations and mines who
were mainly metropolitan investors in imperial capitals.
A few pre-independence RIAs continued in a different form although they
were viewed by post-colonial governments as part of the unwanted baggageof an exploitative, market colonialism which had no place in new societies.
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closed their economies, while continually relaxing their fiscal and monetary
regimes in the face of successive external shocks. Consequently, economic
resilience and adjustment response capacity were systematically destroyed
over a prolonged period, resulting in inefficiency and uncompetitiveness of
productive structures throughout the developing world.
The RIAs - especially the monetary arrangements - previously in force, if
properly administered, might have exerted a brake on such excesses. In
retrospect, and with the benefit of hindsight, such a brake might have beenquite useful, given what has happened in too many developing countries,
especially in Africa, South Asia and the Eastern Caribbean. Some newly
independent governments, believing that aspects of these colonial RIAs were
beneficial, tried to replicate particular features under new voluntarily agreed
RIAs. But because of a lack of political will few of the post-independence
RIAs were long-lived.
Africa and the Middle East

Of the seventeen RIAs which existed in 1990 around the world, eight werein Africa where experiments with first-generation RIAs yielded desultory
results; with the exception of the franc zone (the Communaute Financiere
Africaine, CFA) and the Southern African Customs Union (SACU). The
monetary unions of the franc zone were stable and enforced sound monetary
policies. But they became overly rigid in resisting parity adjustment for too
long, thus impairing the adjustment and growth prospects of their members
through the 1980s. A long-delayed devaluation of the CFA franc finallyoccurred in early 1994 after much damage had been done. SACU was basedon keeping smaller satellites in orbit around the South African apartheid
regime. It was more successful than the franc zone RIAs, perhaps because
South Africa under apartheid was willing to pay a visible budgetary price- toacquire a modicum of political respectability in its immediate neighbourhood.
The Indian Ocean Commission (IOC), a loose RIA among islands off theEast African coast, has also had modest success. But other Africanarrangements in East and Central Africa and in Southern Africa outside of
SACU, heavily backed by donors, have proven ineffectual. Some have3

RecentlY7 the South African government has drawn attention to the high price it has paid

for supporting the SACU arrangement. That is only true in a visible budgetary sense althoughthat is a partial and distorted perspective. In an overall economic sense South Africa's private,heavily protected manufacturing sector has gained much by retaining these captive markets
under SACU with South African transfer payments to its captive neighbours often amounting tolittle more than hidden export subsidies for its own relatively inefficient manufacturingindustries.

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subsequently corne apart. Their net economic benefits, in terms of incremental
economic and developmental gains derived by the member states, probably
did not offset even the cost of the large and elaborate bureaucracies set up toadminister them.
After their demise, new arrangements were put in place in the form of aPreferential Trade Area for Eastern and Southern Africa (PTA) and theSouthern Africa Development Coordination Conference (SADCC). Neitherof these arrangements has achieved very much despite substantial donor
support. Yet both have recently transformed themselves into more ambitious
economic communities. PTA has now become the Common Market for
Eastern and Southern Africa (COMESA) while SADCC has evolved into aSouthern African Development Community (SADC) with South Africa
joining in early 1995. Both hope to achieve more in the future although theirwidely overlapping membership has generated concerns about whether twoorganisations are needed to achieve much the same purpose.
Despite the obvious failures and limited successes of first-generation RIAs in
Africa there is, in the 1990s, a renewal of interest - fostered to some degree by
the example of the European Union - in strengthening these arrangements
through efforts at widening and deepening them.
Further north, optimistic aims for the Mahgreb Customs Union set up in
1960 and for the even wider Arab Common Market have not materialised.
Still, even more ambitious plans for achieving closer economic integration
among the Arab countries of North Africa, the Arabian peninsula in West
Asia and the Middle East remain alive. The financial and labour markets of
the Gulf countries are closely intertwined. But given the nature of their oil
economies there is little intra-regional trade among them, although they
cooperate actively on regional issues within the framework of the Gulf
Cooperation Council.
The Middle Eastern peace accord opens new vistas for economicallybeneficial regional cooperation in an area where that was inconceivable just a
short while ago. With the emergence of a Palestinian state, RIAs involving
Israel with its former neighbouring enemies are now being seriously discussed.
Despite the unexpected longevity of present regimes in Iran and Iraq, suchdevelopments could transform the economic scene in West Asia and Arabia, as
could the inevitable pressures for democratisation and politicalliberalisation in
the Gulf kingdoms. But the translation of economic potential into politicalreality in this volatile, combustible cauldron may take some time yet.
Latin America and the Caribbean

Prior to the Second World War, there were no RIAs among the independent countries of Latin America and the Caribbean (LAC). Now nearly all of
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them are involved in one type of RIA or other; indeed some are involved inseveral. The development of RIAs in LAC was based on philosophicalunderpinnings which provided the foundation for most of the first-generation
RIAs in developing countries. In 1960, Raoul Prebisch envisaged RIAs in
LAC as being aimed at building inward-looking, protected trade blocs withbarriers to the outside world. Regional integration was to be a means ofundertaking more complex import-substitution on a regional scale inestablishing industries that were too large and complex for smaller domestic
markets to develop or absorb." Such thinking led to a spate of RIAs in the
1960s with the formation of the Latin American Free Trade Association(LAFfA) and the Central American Common Market (CACM) in 1960, theCaribbean Free Trade Association (CARIFTA) in 1968, and the AndeanGroup in 1969.
In 1971 Bela Belassa took a different view.> Arguing that market enlargement through integration could bring benefits to LAC over and above thoseobtainable through trade liberalisation alone, he suggested combining RIAs
with unilateral trade liberalisation and recommending policies that would
ensure full exploitation of the benefits of both. Belassa's thesis was that tradeliberalisation would enhance the benefits of RIAs by reducing the prospects
for inefficient industrialisation in LAC countries. That view was not
immediately popular; partly because as has been suggested,6 the earlyprotectionist RIAs in LAC achieved substantial growth in intra-regional
trade."
Between 1960 and 1980, such trade grew by a multiple of: (a) 20 in LAFfA
where members' trade with the rest of the world (RoW) grew by a factor of10; (b) 40 in CACM compared with growth in trade with RoW by a factor of9; (c) 17 in CARIFTA compared with an increase in total trade by a multipleof 10; and (d) 50 within the Andean Group compared with only an 8-foldgrowth in exports to RoW. All these arrangements were supported by
payments and settlements facilities to economise on the use of scarce foreignexchange in settling intra-regional trade accounts. But even with high growth

4 Prebisch, R. (i) The Economic Deuelopment of Latin America and its Principal Problems,
UN-ECLAC, New York, 1950 and (ii) Towards a Dynamic Development Policy for Latin America,
UN, New York, 1964, p. 69.
5 Belassa, B., Regional Integration and Trade Liberalisation in Latin America, World Bank,
Economic StaffWP No. 120, Washington DC, 22 October 1971.
6 Massad, C., A New Integration Strategy, CEP AL Review No.3 7, CEPAL, Santiago, Apri11989.
7 Although intra-regional trade expansion is necessary for significant advantages from
integration to accrue, such expansion by itself is not an adequate criterion for judging the successof RIAs. Judgements based on intra-regional trade expansion alone can: (a) be misleading if such
expansion occurs from an extremely low base, as it did in most of LAC; and (b) reflect both tradecreation and trade diversion.

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in intra-regional LAC trade in the first two decades, these arrangements did
not endure. 8
All the RIAs in Latin America set up between 1960 and 1970 unravelled in
the mid-1970s and virtually disintegrated during the 1980s in the face ofadverse external circumstances, a regional debt crisis of cataclysmic proportions, fading political will, violent intra-regional conflict (especially in Central
America), and a changing ethic of open competition. As Carlos Massad (1989)
noted, in the 1980s it became'... a matter of each individual country's seeking
integration with the outside world rather than with its neighbours, andfinancing the process with external indebtedness.'
All the LAC arrangements were resuscitated and reinforced in the late1980s and early 1990s under different names with different rules and aims.
These RIAs: (a) have become more ambitious and comprehensive in aiming
at closer integration rather than being limited only to cooperation; (b) are
outward-looking, and aimed at promoting efficiency and competitiveness;(c) carry greater political commitment and conviction; and (d) are morerobustly designed and constructed. Chile and Mexico have entered .into an
economic cooperation agreement, while Argentina, Brazil, Paraguay, andUruguay (i.e. the Southern Cone countries) have formed a common market(MERCOSUR) which by 1995 had integrated at a rate much faster than firstenvisaged.
Asia

Two examples of formal RIAs were attempted in opposite corners of Asia.
The first was the Regional Cooperation for Development arrangement
among Iran, Pakistan and Turkey. This quickly became defunct and was
succeeded by the Economic Cooperation Organisation (ECO), which also
proved to be of little value. The second was a more successful and durable
arrangement involving the Association of South-East Asian Nations(ASEAN) in 1969.
From being a security-focused arrangement ASEAN is now evolving towards
an economic Asian Free Trade Area which is being widened with the inclusionof Vietnam. Also in East Asia a Greater China region has emerged through freeflows of trade and investment between the People's Republic of China, Hong
Kong and Taiwan under non-formal RIAs among these territories. Of course
the smaller two are not recognised as sovereign states by the People's
8 At the end of the day, in 1983 intra-bloc trade as a proportion of total exports was only
22% in CACM, 10% in the Latin American Integration Association (LAIA, the successor to
LAFfA) and 9% in the Caribbean Community (CARlCOM), which succeeded CARlITA(Robson: 1993).

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Republic of China despite their independent profiles as trading entities ofglobal significance.
ASEAN is deemed to have been successful, at least partially, because it was
not geared to achieving free trade or economic union objectives at the outset.
It focused instead on being a regional political platform for: (a) increasing thebargaining power of its member states in international negotiations; and (b)intra-regional conflict resolution on a peaceful basis. ASEAN took nearly adecade after its formation to act on achieving any serious form of regional
economic cooperation. Interestingly, as RIAs in other parts of the world werebeginning to unravel, ASEAN in its slow and cautious way gained graduallyin strength year by year mainly by setting low expectations and invariably
exceeding them.
Intra-ASEAN trade has grown dramatically, faster than in any otherdeveloping region. This has happened largely as a result of close inter-linkages
between businesses owned in its member states by the overseas Chinese
community, without ASEAN as a regional body doing all that much toaccelerate or encourage it. Intra-ASEAN trade growth is, of course, somewhat distorted by the unusually large amount of trans-shipment, entrepot
trade that occurs through Singapore for various reasons. Other members have
now agreed to Thailand's proposal to create the ASEAN Free Trade Area
(AFTA) which may have very high potential for generating intra-regional
efficiencies and growth because its members meet all the requisite
preconditions for successful economic integration.
South Asia has been slower than East Asia to develop effective RIAs mainly
because of the unresolved conflict between India and Pakistan over Kashmir.
Yet the South Asian Preferential Trade Arrangement (SAPTA) among
members of the South Asian Association for Regional Cooperation (SAARC)
is lurching hesitantly towards becoming a South Asian Free Trade Area
(SAFTA).9 The opportunities for SAARC and SAFTA to realise their fulleconomic potential will remain constrained until the Indo-Pakistani dispute isdefinitively resolved. "When that happens regional economic arrangements
will probably revert to the state which existed prior to 1947, when virtually
the entire sub-continent was a single economic (and politically united) area.

Pacific, Indian Ocean and North Atlantic
Though negligible compared to other developed country groupings, a free
trade area also exists in the Antipodes between Australia and New Zealandunder the Australia-New Zealand Closer Economic Relations Trade Agreement
9 See: The Economic Times of India, India likely to offer more tariff reliefs under SAPTA,
Bombay, India, Thursday, 15June 1995.

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(ANZCERTA), which has been the most successful example of an RIA in theSouthern Pacific.
Perhaps as a defensive response to emerging trade blocs in the two largest
markets of the world (NAFrA and the European Union), there was early
concern that the formation of another giant trade bloc might be triggered in
Asia; a market which promises to become even larger than the European
Union and NAFrA in the not-too-distant future. Indeed, precisely such a
trade bloc was suggested by the Prime Minister of Malaysia in 1992.
Partly to forestall such a possibility, a new type of inter-bloc RIA has emerged
to link the Asian and NAFrA regions with the formation of the Asia Pacific
Economic Cooperation Forum (APEC). Its main purpose is to advance
GAIT-consistent trade liberalisation between NAFrA members and theircohorts including Japan as well as the other East Asian, Antipodean and Latin

American countries bordering the Pacific Rim.
Following the creation of APEC, the Gulf Cooperation Council has
proposed a similar arrangement with the European Union. In a related vein,
an interesting new initiative involving the Indian Ocean Rim has also
emerged in early 1995 which may provide an umbrella RIA among thecountries of South Asia, Eastern and Southern Africa, East Asia and Australia.
More recently, the concept of a North Atlantic Free Trade Area (a kind of
super-NAFrA) between NAFrA .and the European Union is gaining
momentum among European and American politicians.

The Role ofRegionalism in the Emerging World OrderAs a result of a number of dynamic forces, countries around the world are
at a cross-roads as the next millennium approaches. The 1990s evoke disconcerting shadows of the 1890s. A century ago instability and flux prevailed
over the crumbling of an established order of national and global governance,
defined by competitive tensions among waning (imperial European) andemerging global powers (the US and Japan). As is happening now, that order
was eroded by innovations in technology, transport, munitions andcommunications. In the 1990s it is becoming clear that innovations in thesame fields have enabled the continued globalisation of markets for ideas,
money, commodities, other goods and services (but not yet for labour) on ascale and at a pace which has far outrun the capacity of established politicaland social systems to cope.
A global production and marketing structure is now taking shape withincreasing rapidity and pervasiveness. Global products and brands producedby transnational corporations are becoming entrenched in a global
consumption culture. That culture is, in turn, being supported by emerging,but still imperfect, global markets in information, technology, commodities,
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services, media, communications, transport and finance. The emerging international system requires effective overall governance; ideally it demands aframework for stimulating and regulating not just trade and capital flows but
other forms of economic and non-economic interaction as well.
The construction of such a framework is proceeding in an inefficient andunsatisfactory manner, While national governments lack the political will toaddress global issues in an appropriate way, the framework for governance isbeing left to a patchwork quilt of existing supranational institutions. These
institutions - the United Nations, the World Bank, IMF, GATTIWTO,
NATO, etc. - have proven unable to evolve responsively in ways that reflect
emerging global shifts in economic and political power. That structural
weakness is leading to a drift away from a multilateralism that does not work,and toward a less structured system of global governance which appears as if
it may, for an interregnum of unknown duration, be based on interactions
among regional blocs rather than among nation-states. In that sense theemergence of the new regionalism may well be an intermediate step towards
the evolution of a new multilateralism.
What is becoming clear is that nationally oriented institutional structuresand systems of governance, created through the last two centuries to guide,
regulate and channel productive human endeavour, are ,no longer adequate.
Nation-states are undergoing kaleidoscopic changes of the kind that theformer Soviet Union, Yugoslavia, Ethiopia, Somalia and the Sudan may be
precursors to, although the temptation to over-interpret what has been
happening in these countries and simplistically extrapolate it to the rest of theworld should be eschewed.
What is equally clear is that the horizons of economics and finance arewidening, i.e. going me~o and macro, while the focus of polities and societies
seems to be narrowing, i.e. going micro, along precisely the ethnic lines which
nation-states were, for unfortunately too short a while, successful in
suppressing. The nation-state as shaped through the 19th and 20th centuries
is being squeezed by the opposing forces of macro-markets and microethnicity. Consequently, the raison d'itre that justified its formation andmaintenance is coming increasingly under question.
Successful regional integration among nations, carried to its logicalconclusion, may inevitably spell the end of constituent nations as sovereign,or even as relevant, entities if their distinct ethnic groups prefer devolution.
Conversely, the future of presently large and ethnically diverse states in thedeveloping world (India, Nigeria, even China) is in question. They may only
have a viable future as more loosely federated economic unions of ethnicallydistinct states, which 'are permitted to exercise more independent politicaldecision-making on a far wider range of matters than they can under theirpresent constitutional structures.
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Fibrillations, tremors and aftershocks of different intensities keep being
generated after the end of the Cold War in various parts of the world, notleast in the erstwhile second world. How that formerly integrated politicoeconomic system will eventually settle is as yet unclear with the shape of its
future steady-state remaining difficult to define. Some parts of it (theVisegrad four, the Baltic three and some of the independent republics offormer Yugoslavia) will probably integrate with the European Union in the
distant future. Other parts may come together under reconfigured RIAs
among members of the former Soviet Union. Yet others may become
members of RIAs in West, Central and East Asia.
Elsewhere, new geopolitical realities - e.g. the emergence of post-apartheid
South Africa as an acceptable member of the African sovereign community,
and similarly of Vietnam, Laos and Cambodia in Southeast Asia - havecombined to create major .external challenges and new regional opportunities
in the developing world. All of these developments point to a new andenhanced role for regionalism to play in the future evolution of international
economic and political relations. Yet that role is often seen as a threat rather
than the opportunity which it actually may be.

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2

The Role of RIAs in Fostering
Economic Development

Introduction
Available evidence suggests that free trade areas, customs unions, andpartial preferential trade areas that have been established at different times indifferent regions of the developing world have in their previous incarnations
generated only limited immediate, tangible benefits, inevitably eroding
political support for their continuation. Poor sequencing and ill-chosen instruments and structures have in some cases contributed to failure. Where RIAs
have succeeded in generating gains, the distribution of such benefits has often
been perceived to be inequitable by the less-developed members of the group.
For these and other reasons, most RIAs among developing countries havelacked credibility in the eyes of their own governments, bilateral aid donors,
international agencies and private investors (domestic and foreign). Of
course, exogenous factors, such as the oil, debt and commodity crises, andtheir international repercussions, have contributed to the failure of RIAs inthe developing world. The specific policy responses to the financial crises
produced by such shocks, have aggravated extant economic maladjustments
and distortions and rendered earlier RIAs in continents such as Africa andLatin America even less effective and indeed, inappropriate.

Lessons from the Past
The new regionalism which is emerging appears to be built on the recognition
that past failures must be avoided. Second.. . generation RIAs are therefore
different from those devised in the 1960s and 1970s in some important ways.
These arrangements: (a) involve greater diversity among regional members;(b) have different objectives with an outward-orientation; (c) go beyond simple
trade liberalisation in goods subject to GATT regulations to include liberalisation of trade in services, investment, technical and regulatory standards,
customs formalities and government procurement practices; (d) are mor~outward-looking in aiming to achieve or maintain the global competitivenessof the region as a whole and that of its members; (e) are based on partnershipamong members which have' already carried out significant unilateral tradeliberalisation; and (t) have developed a more North-South character insteadof the North-North and South-South arrangements which characterised
earlier integration efforts.

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Moreover, the policy conditions for making the new regionalism work toaccelerate progress in the developing world are more favourable today thanthey have been for four decades. Yet there is no wide consensus either on thekinds of RIAs that should emerge among developing countries or on whattypes of accompanying institutional structures would be appropriate. Nor isthere agreement on the geographical scope and sequencing of regional
cooperation either on a world scale, or in particular developing regions. More
importantly, little thought has been given as to how RIAs in the developingworld might be endowed with long-term credibility, even though suchcredibility is a crucial determinant of any RIA's ability to bring about arestructuring of production on which significant gains might ultimately
depend.
What is much clearer now than it was before is that the success of RIAs
needs to be envisioned in a context that involves economic as well as noneconomic considerations. It is also clear that if RIAs are to yield significant
developmental benefits to their members they must be based on the rightchoices of partners. Such choices cannot be rooted in lofty politicalaspirations or in popular and evocative notions of solidarity - as they often
have in the developing world - but in opportunities based on realistic andattainable economic objectives. The main lesson that the experience of firstgeneration RIAs in developing countries teaches is that adopting a framework
for cooperation inappropriate to economic realities is a certain recipe forsubsequent failure.
There have been many false starts with RIAs in the developing world.
There is no need to add to them. Market integration may be too ambitious toattempt immediately in most of the developing world. Yet even opportunities
for simple investment coordination in specific sectors within any region can
only be fully capitalised on if institutional structures emerge which enable
progressive movement towards wider and deeper RIAs. For the same reason,these opportunities can only be properly evaluated in the context of an overall
rationale which envisages less ambitious forms of economic cooperation in
the short run leading eventually to full regional integration in the long run.
An appropriate strategy for the design of RIAs in any developing region
must have as its starting point not just the significant political and economicchanges taking place in that region, but also the rethinking that is taking
place on the appropriate role of regionalism itself. In assessing that role it is
becoming clear that the prisms through which RIAs have traditionally beenviewed in terms of their success or failure are too unidimensional, probably
faulty and imperfectly constructed. They need to be changed.

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The Inadequacy of Classical Theoretical Constructs
Second-generation RIAs have become multi-dimensional in character. But
regional integration theory and analysis continue to be underpinned by thetwo basic Vinerean concepts of trade creation and trade diuersum.i') These
concepts emphasise the welfare effects of trade flows among nation states andthe manner in which such flows might be affected by RIAs. But these concepts lose their relevance as useful analytical constructs with the increasing
globalisation of production and investment.
Gains from trade creation can accrue to non-member countries whose
firms have a physical presence in the region concerned or may benefit fromother inter-firm arrangements (technology licensing, cross shareholdings,
strategic alliances etc.) with firms inside the region. Conversely, regionalfirms with a large presence outside the region might be affected by the effectsof trade diversion on non-member countries in which they are located.
More importantly, the mere presence of RIAs can generate direct andportfolio investment impulses with their own primary and secondary effects.
The consequences of investment flows and accompanying flows of hard andsoft technology are not taken into account by classical Vinerean analysis, eventhough such flows may in many instances be more important than trade flows
per see

The relentless market-driven globalisation of production structures, evenin the absence of RIAs or multilateral arrangements, makes it less possible todraw clear-cut analyses or conclusions about exactly which countries benefit,
and which ones lose, from trade-creating or diverting and investmentcreating or diverting effects of RIAs in a particular region. For example, it
could be strongly argued that American and Japanese transnational
companies located in Europe, but servicing the interests of their domestic or
global shareholders, may be among the main beneficiaries from closer
integration in the European Union.
The Vinerean framework for analysis focuses only on static efficiency
gains. It is too partial and inadequate for evaluating the unorthodox or dynamic
gains derived from: efficiency effects, externalities, sectoral investment
coordination, incremental foreign investment, regional adjustment or macropolicy coordination. It therefore does not permit a proper assessment of thefull costs and benefits of RIAs. Present theory does not just fail to incorporate
the dynamic economic consequences of RIAs. It is incapable of providing theright kind of framework within which to assess their not inconsiderable noneconomic costs and benefits.
10 See, for example, de la Torre, A. and M.R. Kelly, Regional Trade Arrangements, IMF
Occasional Paper No 93, Washington D.C., March 1992.

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A more holistic theory of regional integration therefore needs to be developed
to take these effects into account. But that is easier said than done. The
blending of the economics of regionalism, with their international relations
dimensions, employing an amalgam of economic theory with political science
theory into a cohesive framework has often been conceived but remains
elusive. Yet it is just such a framework which needs to be developed in order
to assess properly the real value of second-generation RIAs.

Orthodox (Static) Gains from RIAs in Developing Countries
The basic justification for encouraging RIAs among developing countries
is rooted in the belief that developmental benefits can be captured by using
certain policy instruments and investment opportunities beyond those thatcan be obtained by their unilateral use. But, it does not follow that such
benefits will automatically be enhanced by a progression from cooperation to
integration (for a definition of the terms 'cooperation' and 'integration', see
Annex I) or, in other words, from looser to tighter RIAs.
It cannot even be assumed that, a priori, RIAs will always lead to welfare
gains through enhanced efficiency, for the region as a whole, for its individual
members, or even in terms of global welfare. In general terms, the expecteddevelopmental benefits from RIAs and particularly from full integration canbe derived from:(a) gains from reducing allocative, administrative, efficiency and transaction
costs associated with market distortions and barriers resulting fromnational policies;(b) gains from coordination when economies of scale can be realised in public
sector operations, or significant beneficial external repercussions can result
from coordinated policy or coordinated investment in infrastructure.
These two sources embrace the usual arguments for RIAs: achieving
economies of scale; taking advantage of externalities associated with market
expansion; achieving allocation efficiencies through trade creation; turning
short-term trade diversion disadvantages into long-term trade creation
potential by capturing dynamic efficiency; and so on. One self-evident
constraint on the pursuit of such developmental gains through RIAs is that
account must be taken of regional equity considerations. The costs andbenefits of RIAs must be - and be seen to be - equitably distributed. All
partners must gain if RIAs are to endure and deepen - a principle which every
successful regional arrangement recognises and which unsuccessful ones did
not do enough to respect.
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The potential for achieving substantial trade gains from market integrationin most developing regions clearly exists. Theoretical modelling shows forexample that a welfare-enhancing free trade agreement can always bedesigned (Kemp and Wan: 1976). In a practical sense, that does not depend as is often theoretically asserted - on whether members of an RIA are at thesame level of development and have the same economic weight. Clearly,
significant inequalities among the economic capacities of members create
complications which need to be accommodated through regional policy, butthey do not necessarily preclude efficient or effective RIAs from being
designed.
The traditional motivation for RIAs has been the pursuit of allocational
efficiency gains from market integration. The primary instrument for achieving
this outcome has been trade liberalisation through market forces, sometimes
modified by parallel inter-governmental agreements on industrial specialisationor fiscal mechanisms to promote the spreading of industrial development.
Such market-focused approaches are expected to have a favourable effect on
the allocational efficiency of participating economies through rationalisationof their extant and emergent economic structures. This effect is usuallyreflected through trade creation, expansion, investment rationalisation andproduction integration. RIAs are also expected to give rise to expanded
domestic and foreign investment inflows into the integrated area as a result ofinvestment creation.
The removal of tariff barriers under RIAs should - theoretically at least result in the growth of intra-regional trade. Whether it actually results inefficient trade creation - i.e. movement of trade from high-cost to low-cost
producers within the region - or inefficient trade diversion - movement fromlow-cost extra-regional producers to high cost intra-regional producers depends on: the pre-integration level of tariff rates among regional members;
the level of post-integration external tariffs compared with prior tariffs ineach member country; the elasticities of demand for the imports on which
duties are reduced; and the elasticities of supply of exports from regional
members and foreign sources.
Trade creation is more likely to result from integration when: (a) eachmember's pre-integration tariffs on the products of other members are high;(b) production structures of members' economies are roughly similar in their
output mix but different in the pattern of relative prices at which similar
products are produced; (c) external tariffs applied by the region's members
are common and low in comparison with pre-integration tariffs; and (d) the
production structures of members are sufficiently responsive to permit intraregional import-substitution at the same or lower cost than the cost of thesame products from extra-regional sources. When any of these conditions is
not met trade diversion may occur. The risk of trade diversion increases with

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each additional condition that is not met. When all these conditions are not
met trade diversion will certainly result.
RIAs can have both static and dynamic efficiency effects. Static effects occur
from the relative size of trade creation gains versus trade diversion losses.
These gains occur on the supply side because production efficiencies result
from the more effective reallocation of resources toward high-yield, low-cost
production. On the demand side they occur because consumer welfare isenhanced by lower prices and greater choice. Static gains can also arise when
RIAs achieve a lowering of product costs as a consequence of loweringtransport costs, especially when trade is intra-regionally oriented.
Other sources of static gains involve reductions in rents from preferential
market access that regional exporters enjoy. When RIAs accord priority toindustrialisation, static gains can sometimes be derived from a reduction in
the costs of highly protected, domestic-market-oriented industries while atthe same time achieving the desired level of industrial activity, albeit at theexpense of some continued inefficiency.

Unorthodox (Dynamic) Gains from RlAs in Developing Countries
RIAs can often lead to more than one off increases in regional income andwelfare resulting from static efficiency gains. 11 Dynamic efficiency effects canlead to sustained increases in the rate of real income growth within a region.
Such effects can arise through: economies of scale in trade-supporting
industries and services which are caused by market enlargement; 12 spillover
11 Efficiency gains could be captured by enlarging markets and overcoming functional losses
in allocative, administrative, and transaction costs associated with: small market size; market
distortions; and barriers to the movement of productive factors, as well as of goods and services,
resulting from protective national policies. Efficiency gains from regional market integration
usually occur (and occur first to the private sector) as a result of market-based trade liberalisation
which rationalises national economic structures, expands and rationalises investment flows, andintegrates production to achieve cost-efficiency.
12 Scale gains would result in major industrial or infrastructural project investments. Large
cost savings can be realised in most developing regions through coordinated investments in thephysical - and perhaps even the social and institutional - infrastructure of geographicallycontiguous countries. Such gains could be particularly large from rationalising investments in
power generation, transmission and distribution, road systems, rail networks, airline systems,
airline regulation and airport management authorities, shipping and sea-port management, river
basin management, and investments in health care and educational facilities. Such gains would
also derive from investments in commercial agriculture and agro-industry; manufacturing,mining and construction industries which might need large regional markets to justify their local
establishment. As de Melo et al. point out, scale economies by themselves do not provide arationale for regional integration. They only strengthen the case for integration when anintermediate objective - usually that of industrialisation - has to be met. If industrialisation is themain objective, then scale gains provide a rationale for preferring regional integration overunilateral trade liberalisation. Scale economies only therefore reinforce the case for integration
providing such a case already exists.

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effects resulting from wider knowledge transfers across the region on both an
intra-industry and inter-industry basis.l ' increased competition; increased
levels of investment; stepped up pace of technological change; and consumption smoothing during business cycles.
Potential dynamic gains are increased to the extent that RIAs go beyond
reductions in tariff barriers towards achieving greater flexibility andintegration in labour and other factor markets, financial markets (to permit
adjustment and industrial restructuring to occur through privatisations,mergers, acquisitions and divestitures), and in the liberalisation of otherconstraints to free circulation of goods, services and factors within a region.
Dynamic gains can be enhanced by the harmonisation of macroeconomic
policies which lower the risks and uncertainties - and thus costs - for regional
investors.
Acknowledging that dynamic benefits can accrue from RIAs and enumerating these possibilities is of course easier than specifying and measuring theirindividual effects for any particular regional bloc. At a general level, statisticalevidence on relationships between the dynamic effects of RIAs on output
growth, and on intra-regional trade expansion, is inconclusive. But there issome evidence from cross-country studies to suggest that market integration
has achieved greater success among large developed economies than amongsmall developing ones in capturing dynamic efficiencies.
Such evidence points, for example, to the positive effects of RIAs on extraregional trade expansion by providing a training ground for regional firms.
Regional market integration behind a common external tariff (CET) can
provide breathing room for productive enterprises in many developing
regions to become internationally competitive by first becoming regionallycompetitive through the process of restructuring, merger, acquisition andprivatisation. Economies of scale and spillover effects can provide a rationale
for RIAs based on a temporarily high CET. In buying time for firms to move
down their cost curves, temporary protection can be a springboard forachieving progressively higher levels of efficiency and for eventual export
expansion. Regional market integration in the developing world can also
foster greater competitiveness in the operations of small local firms ofindividual member economies which produce, distribute and service consumer
13 At the production level, four types of gains are emphasised. First, by establishing larger
markets, integration promotes competition and contributes to an improvement of production
methods and to a decrease in monopolistic mark-ups. Second, larger markets encourage longer
production runs with cost-reducing effects. Third, market integration may enable regional
consumers to benefit from greater product diversity. Fourth, larger markets encourage firms tospecialise and to concentrate on a narrower range of products achieving economies of scale andencouraging further cost reduction.

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durables as well as capital goods. Such an effect, usually transmitted throughsub-contracting relationships, fosters the growth of entrepreneurship by
opening up means of entry and of mobility, especially to segments of the
population which have been deprived from equal access to 'such opportunities. The two specific dangers with the training ground argument however
are that: (i) many developing regional groupings may not offer sufficient
market size for exploiting economies of scale; (ii) even when regional
economies of scale are achieved - with the rents accruing from protection
contributing to regional welfare because the same income would not berealised without such protection - prolonged maintenance of temporary tradebarriers might lead to excessive entry, with ensuing surplus capacity
increasing average costs and absorbing profits assured through protection bycausing inefficiencies owing to too many firms operating below optimal scale.
RIAs can, by stimulating supply-response, accelerate successful structuraladjustment in some developing regions (e.g. Africa) where it remains elusivedespite a decade of intensive adjustment effort. RIAs can facilitate adjustment
by buying sufficient time for enterprises to become regionally competitive
before becoming internationally competitive. However, unless RIAs aredesigned to ensure that regional competitiveness is an intermediate step
towards achieving global competitiveness, market enlargement behind highcommon external tariffs can result in welfare losses rather than gains if the
dynamic advantage of converting short-term trade-diverting effects into longterm trade-creating opportunities is foregone. 14
Some dynamic gains can be secured in the short run on the basis of existingproduction structures. Others, however, materialise in the longer term, after
industrial restructuring has taken place. Longer-term changes hinge on
investors' perceptions of the credibility and permanence of any marketenlarging arrangements. They also depend on the strategic responses oftransnational corporations to market integration in any particular region.
Dynamic gains from externalities also include the effects of technology
transfer and catch-up effects, human capital development, improved education,
research and development, better public health care, social safety nets andquality standards, improved bargaining power on the part of a consolidated

14 As de la Torre and Kelly Cop. cit.) observe, this argument hinges on regional markets being
fairly large and on ensuring that a policy of temporary protection for future export promotion
can in fact be implemented successfully without protection becoming an entrenched feature due

to successful lobbying by regional industries. Entrenched protection has for example become acharacteristic feature of industries in South Asia. Along with other political factors, it has
prevented successful regionalisation from taking hold in that region. Such entrenchment
postpones the gains derivable from structural adjustment. By contrast in East and Southeast Asia
initial protection has been progressively reduced enabling firms in that region to become
internationally more and more competitive.

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trade bloc dealing with other blocs, reduced transport costs and improved
market access, better management of natural resources, and coordinatedapproaches to environmental management especially in regions with fragile,unique ecosystems. Under RIAs, enhanced intra-regional competition canlead to better resource allocation by strengthening the reliability of relative
prices as indicators of relative scarcity. In turn this leads to more efficiency,
higher transparency, and reductions in the social costs of collusion and ofother abuses of market power.
Dynamic gains can also be achieved from increased foreign investment,
reduced fiscal inefficiency, and improved policy coordination. Appropriately
designed RIAs can attract more foreign investment for the production of
consumer durables in developing regions as a whole than in their fragmented
national markets. Foreign firms which straddle the global productionmarketing structure are interested in investments which cater to large
markets and not to markets of countries which are not of continental or subcontinental dimensions. The attractiveness of regional investment increases
for foreign investors for defensive reasons as well, i.e. to avoid the losses due
to possible trade diversion. Larger regional markets also make investment
attractive by enabling certain fixed costs (innovation, research, development,
advertising, market-channel establishment etc.) to be spread out over a larger
market base.

High costs from fiscal impediments to market unity are often incurred bydeveloping countries. Even when the actual yield from tariff collection is low,
the costs of non-collection can be high when smuggling, combined with thecosts of rent-seeking activities of officials - encouraged by fiscally-induced
price differences - is reflected in the size and growth of informal trade inparallel markets. In such conditions - endemic throughout Africa and South
Asia - the institution of a customs or tax union could yield substantial benefits
for countries that constitute an appropriate customs or tax area (e.g. theSouthern African Customs Union). These gains are worth pursuing throughRIAs, even if other benefits are not immediately significant. In some cases
RIAs could enhance efficiency and probity in overall public revenue
administration and collection for both direct and indirect taxes, especially if
tax regimes were simplified, regionally harmonised and made moreinvestment-friendly.
A lowering of regional trade barriers - both tariffs and non-tariffs barriers- under RIAs, coupled with greater intra-regional currency convertibility,
could induce the absorption of parallel market activity in many developing
regions into the official economy. Once a parallel market is created, which is
accustomed to operating without any payment of taxes - except in the form ofcorruption - it is, of course almost impossible to absorb all such activity into
the official economy until revenue administrations become much more

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proficient and incentives change dramatically. Nevertheless, the removal ofmajor price distortions has been seen to officialise a large amount of parallelmarket activity, especially illegal exports, and to ease the artificial hardcurrency constraints to development and growth which presently apply inmany regions, most especially in South Asia and Africa.
Dynamic gains can also accrue from improved intra-regional policy andinvestment coordination. In regions where trade has previously been based on
artificial tariff rates, correcting those distortions may have an initially adverse
adjustment impact which regional cooperation might be able to ameliorate.
At another level, improvements in transport networks or changes in transport
regulations in one country inevitably have repercussions on another. Whenthese are taken into account in policy formulation and public-sector planningunder properly designed RIAs, significant gains can accrue.
RIAs can achieve more than unilateral actions when regional linkages andconsultation yield larger pay-offs from policy improvements than those atnational level. It was to capture precisely such benefits that European Union
members agreed to coordinate monetary policies, transport regimes, andconsumption and excise taxes. Similarly, because improved policy coordinationand harmonisation can yield welfare gains (or minimise welfare losses) as aresult of national policies being modified with regional effects in mind (e.g.
exchange rates or labour market policies), there have been several proposals
calling for structural adjustment programmes (SAPs) in Africa to beregionally sensitive. It is clear that such SAPs have not taken into enoughaccount the impact that devaluations, trade liberalisation or financial sector
liberalisation in one country can have on the trade and capital flows ofneighbouring countries, as the experience of competitive devaluations in
Scandinavia, the European Union, Africa and Latin America have clearlyshown.
In a similar vein, the policies of individual governments bent on achieving
self-sufficiency and security in electricity supply (in Asia, Africa and Latin
America particularly) have led to a series of sub-optimal investments insurplus generating capacity with much higher environmental risks than would
have been necessary if a regional perspective had been taken. RIAs designed
to coordinate such investments could yield substantial tangible gains in a very
short period of time, as recent studies for the Southern African region clearly
indicate. IS
In attempting to assess the significance of unorthodox gains from market
integration, - often characterised as the costs of non-integration - the only
recent quantitative indicators are to be found in studies of market completion

IS

Economic Integration in SoutbernAjrica, (Vol. 1-3), African Development Bank, Abidjan, 1993.

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in the European Union context. These studies point to short-term output
gains from eliminating non-tariff trade barriers of 2.7%, and longer-term
gains of up to an additional 4%, of regional GDP. These percentages areseveral times larger than the commonly estimated integration gains of lessthan 1% from orthodox trade creation. Even so, these estimates have beencharacterised as too low because of their failure to account for other dynamic
gains that can be expected to result from associated increases in savings andinvestment and in increased financial market efficiencies in particular.
The European Union's estimates take no account of another important
aspect, namely, the transaction costs entailed by the existence of multiple
currencies, to say nothing of other costs that they impose. Separatecalculations made in connection with the economic benefits of parallel European
monetary unification and common currency initiatives have shown the latterto be considerable. However, the political costs of such initiatives arepresently perceived to be quite high in terms of popular resistance to the lossof national currencies despite business sentiment in favour.
The absolute and relative magnitudes of these estimates for the European
Union of course have no direct application to the other regions. In particular
the relative importance of gains from trade creation might be larger in someregions and smaller in others. What is significant in any particular regional
context, however, is: (i) the distribution of unorthodox gains between the
short run and long run - gains in the long run being dependent on improved
cross-border investment flows; and (ii) the linking of unorthodox gains to theelimination of non-tariff barriers rather than to tariff reductions.
Future research requires unorthodox benefits through dynamic effects tobe specified more carefully, analysed further and, where possible, quantified.
Their realisation will depend on the exertion of political will by regional
governments to cooperate in meaningful ways and to subordinate narrow,short-term national interests to the wider regional good and to the longerterm benefit of all members. The extent to which such benefits are realised
will also depend on acknowledgement by members that the emergence of aregional community may transform completely the vista and scope for RIAs.
It may increase by a multiple, the potential for economic gains to be accrued
both from market expansion and from cooperating on infrastructuralinvestment in regions which adopt inclusive rather than exclusive approaches.

Political Commitment to RIAs and the Issue ofCredibility
Whatever the economic potential for deriving gains from RIAs might be, itis the political importance attached to capturing such gains which will
eventually determine the course and content of RIAs in the developing world.
Mere acknowledgement of the case that the potential for such gains exists is

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not, by itself, enough. The fact that different types of gains can be derived
from RIAs does not mean that, in any particular region, they will be derived.
An absence of coherence and consensus on the part of members as to thepolitical and economic significance of RIAs usually impedes their progress,
whether in mature arrangements like the European Union or in less.
integrated developing regions.
Commitment to cooperation is widely expressed by member governments
in developing regions where regional institutional frameworks exist, butintent is rarely translated into determined action. Judged by their actions, theagenda of governments often contradict commitments. For instance, there
are often divergent views about regional cooperation strategy within politicalcamps in a country (e.g. the divergent views that exist within and between the
British Conservative and Labour parties on the UK's role in the European
Union). Even if they agree on the objectives of integration, governments may
often differ on modalities and sequencing, i.e. on how further regional
integration should take place, and what the institutional arrangements forincreased regional interaction should be.
Publicly expressed apprehensions about the dominance of anyone country
in the region appear to be contradicted by the unseemly haste with which
other like-minded governments 'informally agree to arrangements among
themselves as an inner core, instead of making progress on a generally
accepted regional framework within which all countries can participate
constructively and non-threateningly. Carried too far, such inner-groupagreements in the name of variable geometry and multi-speed approaches may
impair the development of an appropriate multilateral agenda for regional
cooperation and achieve a result opposite to that intended.
Movement towards deeper integration therefore depends on national
perceptions about gains or losses from RIAs and the political will thatnational governments are able to muster in favour of movement toward
widening or deepening. The pace of regional integration is a function of thepace of domestic political evolution in the member countries concerned.
Surveying the political flux in member countries of a number of regions,
there is little room for optimism about how smooth the process of evolution
in these regions is likely to be.
Even in the European Union, only a few countries appear to havepolitically secure governments at the present time. In most developing
regions, a large number of countries are either at, or are rapidly coming to,
the threshold of major political and economic policy change. Inevitably, thisis resulting in overstretched systems with machineries for governance having
to manage several simultaneous transitions - political and economic. In someinstances these pressures may well result in overloading the circuits andsetting back, albeit temporarily, the regional agenda. On the whole, the thrust34
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of political and economic evolution throughout the developing world ispresently aimed at more democratisation and liberalisation. These twoforces
may lead to a renewed thrust toward RIAs once governments accept theinevitability of a regional dynamic and take pro-active measures to capture
the benefits that accelerated regionalisation has to offer.

Equity and Regional Policy
Although it is now widely acknowledged that appropriately constructed

RIAs can result in substantial benefits - economic, political and securityrelated - to members, there is legitimate concern in many developing regionsthat gains from market integration will accrue mainly to the larger or moreindustrially developed member countries. These countries are in the mostadvantageous position to capture immediately the additional income benefits
from an openly accessible regional market.
Asymmetries in the relative economic weight and capability of regional
partners has contributed in the past to the disintegration of many RIAs in thedeveloping world despite specific measures to redistribute some of the gains
captured. Such problems have been encountered in East Africa and in the
Andean Pact countries, and have slowed down the process of closer
integration in ASEAN.
RIAs in the developing world (and even more so those which embrace bothdeveloped and developing countries) will therefore need to include more
effective arrangements for equalising the gains from regionalisation to secure
the continued commitment of the smaller, less developed economies to aregional market for sufficiently long for the gains from credible integration to
emerge and be felt. To be effective, second-generation RIAs will need toincorporate mechanisms for redistributing regional benefits more equitably
to other partners in ways that accelerate their levels of overall development.
The design of future arrangements to achieve successful redistribution ofregional welfare gains through compensatory policies will need to learn from
more successful experiences and overcome their deficiencies if the present
round of regional cooperation in the developing world is to succeed andendure.

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3

Reducing Non-Tariff Barriers

The potential orthodox and unorthodox gains to be derived from RIAs areunlikely to be realised if tariff barriers are reduced, but non-tariff barriers tointegration remain. Non-tariff barriers that segment regional markets in thedeveloping world can be distinguished as those that affect (i) trade; (ii)production; and (iii) investment. These are taken up below in turn.

Barriers to Trade Gains
Non-tariff barriers affecting trade include quantitative restnctions or
voluntary restraints that. reinforce tariff protection, and payments barriers
that may not be protective in intent but may nevertheless end up having that
effect. One feature of these restrictions, particularly of payments restrictions,is that they are apt to work in practice to discriminate against intra-regional
trade which is often perceived to involve less essential products.
In the past, non-tariff barriers have been used to protect a particularcountry's market from competition not only from the rest of the world, butalso from other members of an RIA. Such measures are rarely transparent.
Their significance cannot easily be determined without laborious research
into their quantitative effects. In most of the developing world where thecurrencies are usually non-convertible, monetary and payments barriers are
two of the most significant barriers to trade.
Currency Convertibility and Monetary Harmonisation

The acute shortage of foreign exchange throughout some regions especially in Africa and, to a decreasing extent, in South Asia and the former
CMEA countries - limits the ability of countries to trade with one another.
This shortage is, of course, exacerbated by inconvertibility not only into hardcurrencies but also into regional currencies. Clearing house arrangements
have attempted to overcome this barrier but the settlement of net outstandingbalances between countries in hard currencies remains a limiting factor.
The extent to which inconvertibility of currencies and state-controlled
exchange rates limit intra-regional trade is partly measurable through theamount of unrecorded trade that occurs at unofficial, parallel market rates.
Such trade has been estimated by various studies to be in the range of 15-70%
of officially recorded cross-border trade in different regions of the world.
Even when currencies are convertible, as in the European Union, they
impose significant barriers through the high transactions costs involved in
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exchange. Such costs include those of buying, and selling foreign currencies,
and uncertainties about future movements in intra-bloc parities which may
require forward cover to be bought by firms (at extra expense) in order toprotect the value of their revenues. Short of monetary union with a common
currency, these costs cannot be entirely eliminated, although clearing andpayments unions can help to reduce them. With inconvertible currencies,
exchange controls typically constitute a decisive, binding barrier to market
unity, outweighing fiscal and tariff barriers in their significance.
Within some common monetary areas in the developing world, and inregions where currency convertibility has been largely achieved, there is bothcurrent account convertibility and a fairly liberal capital transfer regime. But
in several developing regions there are still severe monetary obstacles tointra-regional trade and investment which arise from overvalued exchange
rates and other policy responses to macro-disequilibrium. Their elimination
is a prerequisite for effective measures toward further markets integration
requiring harmonisation of both current and capital account regimes. Some
progress has been made throughout the developing world in the 1980s and1990s towards bringing official exchange rates closer to market-clearing
levels. One approach has been via the operation of dual systems (second
windows) under which the exchange rate is fully or partially determined by
the market for certain types of transactions.
Studies have been done in developing regions of monetary harmonisation
programmes that would be needed if exchange restrictions were to be
removed, exchange rates stabilised and inflation rates brought into line.
These outline the scale and sequence of required further economic adjustments, and usually lead to proposing monetary unions with a common
currency. Such strategy seems to be supported by the experience of theEuropean Union. In the case of NAITA, however, the problem is partiallyresolved with all members' currencies being linked to the US dollar in way or
another.
The harmonisation element of the programmes proposed is usually seen asa prerequisite to further integration, even though monetary union is something which most members of RIAs are not yet ready to accept. Even theEuropean Union, which is the farthest advanced along these lines, faces
serious problems in moving towards it. More precisely targeted proposals for
attaining full convertibility therefore. need to be worked out in mostdeveloping regions, focusing first on countries which are most advanced
along the adjustment path.
The removal of monetary obstacles to trade is of course a necessary but
insufficient condition for integration. Once major policy disequilibria in the
countries concerned have been corrected, mechanisms have to be put in place
to encourage the continued pursuit of policies which assure currency stability

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and the maintenance of convertibility and, in so doing, to facilitate the progressive strengthening and deepening of RIAs.

Exchange Rate Regime
This poses the important issue of the appropriate exchange rate regime tobe resolved between fixed or more flexible arrangements. Under the realtargets approach, the exchange rate is an indispensable policy instrument
for facilitating adjustment and growth, particularly with inherent volatility inthe terms of trade that confront many developing countries. The nominal
anchor approach rejects the efficacy of nominal exchange rate adjustments, inpart because the monetary regime shapes private sector wage and pricepolicies.
Exchange rate flexibility and floating rate arrangements are favoured by thedonor community and the international financial institutions (IFIs) for
developing countries. In contrast the opposite view is taken by the IFIs andgovernments for developed countries where semi-fixity is preferred to reduce
undue volatility in currency markets.lv Such volatility is seen as vitiating theattempts of governments to pursue sensible fiscal and monetary policies
which the financial market may (for unrelated reasons) disagree with for
longer than is desirabl~. The arguments against stable exchange rates indeveloping countries, however, are not convincing in the face of weak systemsof domestic restraint and the inability of developing country governments toengineer significant changes in real wages. The adoption of a regime of stable
rates, underpinnedby credible and robust regional exchange rate stabilisation
mechanisms, would certainly also encourage cross-border investment.
Evidence now suggests that the tendency to push floating rates in developing
countries may have been overdone, perhaps to the detriment of attracting
much needed flows of foreign and domestic investment which would enable
the desired adjustments in supply-side response to take place.
After major exchange rate misalignments in the member countries of aregion have been rectified, one option is for members to harmonise monetary
policies by fixing common inflation ceilings and bands. In developing
countries, however, such policies are difficult to implement because of
tenuous links between targets and instruments. The use of anchor currencies,
or of baskets of currencies, to which countries can peg their own currencies

16 Excess volatility is sometimes generated simply because foreign exchange traders want totrade currencies and banks want to derive profits from such trading. Somewhat disconcertingly, avested interest now seems to have developed within the international financial community tokeep exchange rates far more volatile and unpredictable than they need to be or than economic
fundamentals suggest they should be.
'

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would be a better strategy. Pegging to the same external anchor under RIAs
can be a useful first step towards monetary harmonisation and stabilisation.
The optimal peg for any particular region would, of course, have to be
determined by the patterns of trade and capital flows. The options essentially
are the US dollar, the ECU, the SDR, a trade-weighted basket or, for the
Asian region, perhaps even the Japanese Yen, just as for West and Central
Africa, on a limited basis, it might still be the French franc. Adoption of acommon anchor currency would be akin to an informal exchange-rate union,
in which the right to change parities would initially be retained.
Monetary initiatives in developing countries usually argue for actions
leading to the introduction of a common currency and monetary unions of
the type that already exist (e.g. the CFA and rand unions). These are not fullmonetary unions, since the currency issues in each country are separately
identified and national balances of payments are calculated, which ultimately
govern national credit and fiscal policies. Contrary to IFI belief, these typesof monetary union do not lead to the effective integration of national money
markets and do not necessarily constitute a barrier to the operation ofcountry-specific adjustment programmes.
It should be emphasised that monetary arrangements appropriate fordeveloping regions do not depend on prior achievement of a high degree of
integration among participating countries. They could just as well precede it.
Nor do such unions require prior fiscal integration, though participants
should accept firm constraints on resort to public deficit financing. Sucharrangements can operate primarily as mechanisms for strengthening
adherence to the conditions necessary for maintaining convertibility and fixedexchange rates, while still permitting the retention of national monetaryidentities and, to a limited extent, the operation of independent national
credit policies. 17

17 For example, in West and Central Africa, the retention of monetary unions for more than
35 years following independence has depended on the availability of an external guarantor(France), the immediate quid pro quo being the acceptance by the countries concerned of
constraints on their fiscal and credit policies directly imposed by the guarantor. If some sucharrangement for an informal exchange-rate union were to be adopted as a long-term objective inother developing regions, a precondition of its credibility, at least for an initial period, would be
support from an equally credible external guarantor (which could be a regional bank or anothermultilateral agency). The benefits of such an arrangement, and its effect on inward investment,
would then be greatly enhanced. Guarantees are evidently unlikely to be forthcoming without

the acceptance of significant constraints on the fiscal and monetary policy sovereignty of member
states, which they may be reluctant to envisage. But past experience shows that exercising such
sovereignty has been a recipe for inflation as many developing governments now acknowledge.
Under structural adjustment programmes effective monetary sovereignty has, in any event, been
circumscribed by the acceptance of externally imposed monetary targets as a precondition foraccess to financing.

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ClearingHouse and Payments UJ!}ion
A related matter to consider in connection with RIAs in developing
countries concerns the role of clearing houses in overcoming payment obstacles,
especially in regions where normal trade finance linkages and instruments areabsent. It may well be that before convertibility is fully attained, there is agood case for adapting this halfway-house in developing regions. An
alternative approach would be the establishment of a payments union,
resembling the European Payments Union of 1950-58, involving theprovision of credit for which external funding has already been sought.
To some extent, a clearing house reduces the need for foreign exchange
dealing in convertible currencies for intra-union transactions. However, theextent to which real gains are actually generated will depend on the extent towhich savings in the use of foreign currencies are offset by the administrative
costs of operating the clearing house itself. In many cases clearing houses
under RIAs have not brought any increases in intra-regional trade flows (e.g.
in the Preferential Trade Area for Eastern and Southern Africa).
Supporting credit facilities might encourage greater intra-regional trade,
but in most developing regions the absence of donor interest in providing
financial support makes such facilities difficult to finance. Sadly, such support
might be developmentally much more effective than the balance of payments
support or the debt service support which donors have traditionally been
more willing to provide.
Parallel market rates might also be used in some cases for settling payments for intra-group trade; but although this might expand clearing house
activity by restoring some unofficial trade to official channels, it would notnecessarily expand intra-regional trade.
If a payments union is to be established under RIAs in developing regions,the case for it must be based on the contribution it makes to liberalising tradeand payments - or to preventing trade from contracting in the face of balanceof payments pressures - during the transitional period before full convertibility
is achieved. In this context, credit facilities would have an important role toplay. Still, where intra-regional trade is relatively low, the role of a payments
union is likely to remain modest. To the extent that some countries might bepersistent creditors in such unions, particular difficulties would arise unlessspecial arrangements were made to reflect their circumstances.
Clearing house and payments union arrangements may not be crucial
elements in RIAs for particular developing regions. If prematurely considered
they may even deflect attention from the real issues. The fundamental
question is whether the encouragement of regional trade by the use ofparallel rates, and discriminatory relaxation of exchange-related non-tariffbarriers, are desirable.

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Whether there is a role for a clearing house should be determined by the
relative efficiency of the commercial banking alternatives available in theregion. If direct access were allowed to commercial banks, and letters ofcredit were more widely used in trade finance transactions, the market itself
might resolve the issue. A clearing house might be partly justified in terms of
its convenience for performing other useful monetary cooperation functions,
including monitoring, not already undertaken by other institutions, thatmight contribute towards more rapid convertibility.

Barriers to Production
Non-tariff barriers affecting production consist of those that affect output
by limiting entry to a market or by restricting competition. Such barriers also
affect trade, but only indirectly. A lack of uniformity in national technicalstandards and regulations may have such effects. In service industries such astransport, regulatory policies often operate in a protective way, raising
operating costs and prices. Public sector monopolies in production anddistribution also restrict entry, as does the protection of domestic labour
markets leading to the maintenance of artificially high real wage rates.
Limited and undiversified indigenous production structures with only afew products, and services which can be easily traded across borders, usually
underline the limited potential for trade among members of less industriallyadvanced developing regions. In these instances, supply-side limitations are amore binding constraint on industrial development than the limitations ofsmall market demand. The scope for eliminating high-cost producers andachieving efficiencies is limited when industrialisation among regional
members is not sufficiently advanced or technologically competent.
The benefits from increased competition do not result immediately when
the region does not have similar ranges of rival products, produced under
different cost conditions in different member countries. Resources will not bebetter utilised through the realisation of scale efficiencies unless industries
already exist which need larger markets than those limited to national
economies. Nor will efficiencies result unless member countries have beenprotecting the same industries but with markedly different ratios of factor
efficiency in protected industries relative to the same ratios in unprotected
ones.
Product Standards and Privatisation

Of the non-tariff barriers to production for regional markets in thedeveloping world, among the most important - especially in the case of landlocked countries where infrastructural links are weak - are additional costs

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created by different national product or service regulations and standards insuch fields as transport, health and safety. These add to the costs ofproduction and inventories and distort production patterns. Inevitably, they
discourage business cooperation and impede the creation of a unified market.
Product standards are becoming increasingly important considerations interms of outward-looking policies. For example, European Union standardisation regulations after 1992 now have to be respected by producers wishing
to export to that market for a much wider range of products than has
previously been the case. The same is the case for NAFTA.
Though the significance of this factor is not easy to establish clearly there
can be little doubt that the prevalence of multiple national standards adds to
production costs, requires larger inventory holdings, distorts production
patterns, discourages cross-border business cooperation by inhibiting subcontracting, and undermines efforts to unify the regional market. This
problem has been recognised by several regional organisations in thedeveloped and developing worlds which have undertaken surveys in thespecific areas of product and service standardisation.
Another critical barrier arises from the pervasiveness of parastatals, i.e.
public sector industries and state trading monopolies which dominate
markets in developing countries. The dominance of state-owned enterprises
throughout the developing world has been a powerful disincentive to regional
cooperation and the design of effective RIAs. Run with national objectives inmind, usually flavoured by political and social rather than commercial
considerations, parastatals are not as amenable to cross-border cooperation,or to cross-investment in one another, as are companies under private
ownership and management. For example, cross-border cooperation amongtransport, power, water and telecommunications companies in many
developing regions might have occurred sooner had commercial rather thanpolitical or security concerns dominated decision-making.
The privatisation trend in developing countries may well lead to more
rapid integration of regional enterprises within the same industry, or at leastof trade between these enterprises, than if parastatal ownership continued toprevail. 18
There is a range of other barriers to production where differences are
attributable to historical and accidental factors rather than to deep-seated policy

18 Railway and airline operations are two areas where cooperation exists in many regions but
is not complete. Road haulage is another service industry in which most developing regions arehindered from operating as integrated areas, usually because of public ownership of haulage
companies, as well as a lack of harmonisation of road transit charges and of truck licensing
procedures. To the extent that these barriers are motivated by protection, their elimination will
confront obstacles similar to those encountered by attempts to reduce other forms of protection.

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or ownership distortions. In such cases, although adjustment costs would be
involved in eliminating barriers, it may still be possible to remove theimpediments fairly painlessly.
Where export markets are sought outside a given region, harmonisation
with the standards of the European Union and/or NAFTA would seem
practical. For purposes of regional integration, the principle of mutual
recognition employed in the European Union might afford an appropriate
strategy for many cases, and would not demand harmonisation, though somederogations would doubtless be necessary if this path were to be followed.
Free Labour Markets

The protection of labour markets resulting from domestic politicalpressures to reduce chronic unemployment in any particular country can be asignificant barrier to achieving cross-regional production efficiencies and canlead to regional dis-integration, quite apart from worsening a particular developing region's international competitiveness. If existing access to labour markets
is denied to workers from neighbouring countries in some developing regions,remittances will fall, as will their purchasing power for consuming the goods
and services of the country that imposed barriers.
If under RIAs labour market protection is accompanied by continued
restrictions on intra-regional investment flows, the damage to prospects forregional cooperation can be further exacerbated. Apart from the direct effectof reduced purchasing power in neighbouring countries, some form of
retaliatory action on their part against protection in adjacent markets mightalso result in compounding the damage to regional cooperation.
Regional interests can be threatened by political pressures within aparticular country or sub-group of countries to maintain artificially high real
wage rates. The social dumping argument in the European Union is a case inpoint. Such pressures pose a serious barrier to any region's achieving
international levels of competitiveness in manufacturing or services. Lower
real wage rates in different pockets of the same region can often prove a
useful equilibrating mechanism to keep overall regional wage rates
sufficiently under control, especially in political environments which are
subject to strong pressures in the opposite direction.
For this to happen, of course, investment and labour flows across theregion (and particularly from high-wage to low-wage countries) must be
relatively free and unfettered. Unrealistically high domestic wage rates insome countries set against much lower wage rates in neighbouring countries
pose a major policy issue which needs to be dealt with in the regional context.
This is becoming a major issue in the European Union and will be even moreof an issue in NAFTA as well as in ASEAN.
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Barriers to Cross-Border Investment
A major benefit of RIAs in the developing world should be an expanded
inflow of foreign direct investment from outside and within the region. To
the extent that these two categories of investment depend on the creation of aregional market, cross-border investment will be influenced both by the tradeand production barriers already discussed, and by the hindrances represented
by investment licensing. The removal of these barriers is a precondition for
exploiting the gains from investment under RIAs.
The main obstacles confronting the expansion of cross-border investment
in developing regions are exchange control regulations. These regulations
can be avoided by using externally held funds or by raising capital overseas. A
further obstacle is represented by the underdeveloped nature of financial andbanking markets. Domestic capital is perceived to be short (when it is usually
misused) and capital markets are generally underdeveloped.
A crucial issue that must be addressed in framing RIAs among developing
countries is that of trade-related investment incentives. Some investment
incentives take the form of duty drawbacks or rebates, while others take theform of tax holidays. Direct subsidies may also be used. All parties to an RIA
have a legitimate interest in the incentives offered by the others, since these
may affect the level and location of regionally justified investment in the bloc
and thus also affect the direction of trade and the distribution of the benefitsof integration. If investment incentives are provided in the context of RIAs,
this should be done directly and openly, in a way that does not raise the priceof products to consumers. If existing incentives could be shifted to such abasis, one of the major distributional obstacles to operating a customs union
would be immediately overcome.
Under RIAs, there must, at the very least, be a willingness on the part ofpartners to agree on a minimum harmonisation of incentives if the benefits ofintegration are not to be dissipated in higher costs due to smaller scale
production than a regional market warrants. This need not mean complete
uniformity of incentives, especially if there are large disparities in the levels ofdevelopment of members of an RIA. In the interests of ensuring that thebenefits of integration are appropriately distributed, it might be appropriate
to allow certain countries to offer more favourable incentives, as ispermissible in the case of the European Union's own regional policy.
Differentiation on such grounds would imply a trade-off between efficiency
and equity, but this may have to be accepted as the price of regional accord
and to achieve the objective of levelling out.
Because of the intra-regional impact of investment incentives on
integration, it may be appropriate for partners in an RIA to harmonise
investment incentives as a precondition for access to any trade or tariff

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concessions. Trade agreements being negotiated between various developing
countries (e.g. in Africa and Latin America) already contain provisions of a
traditional kind, intended to take account of the interests of the participating
country in subsidies and incentives offered by partners, but these do notadequately address the issues involved.

Other Barriers
In addition to barriers which affect trade, production and investment
distinctly, there are a number of barriers that relate to all three.
• The slowness of convergence among developing economies in different
regions in their fiscal regimes, investment incentives, monetary regimes,
exchange and inflation rates, acts as a powerful barrier to increasing intraregional trade and investment. Structural adjustment programmes (SAPs)
underway in several developing countries are attempting to correct thesemacro-imbalances.
• To the extent that such efforts are successful, they may, indirectly, (if inadvertently) achieve a measure of regional convergence. On the other hand,conflicts between national and regional objectives under SAPs may militate
against regionalisation because nationally-focused objectives of SAPs may
not be compatible with maximising intra-regional trade or welfare. 19• Misperceptions of regional opportunity by business communities - especiallyethnically concentrated ones in particular regions - could impede rather
than accelerate regional trade and investment if predatory rather thancooperative positions are adopted at an early stage.
• Many private businesses appear to perceive enlargement of the regional
market in some regions (e.g. South African businesses in Southern Africa or
East Asian businesses in Vietnam) as advantageous only because it enables
them to compete for aid-funded project contracts and expand aid-fundedexports. Establishing more effective long-term business partnerships
through investment and joint ventures across borders is not at the forefrontof their minds; nor is the prospect of undertaking long-term cross-borderinvestments to capture low labour-cost advantages in contiguous countries.
If the early years of business entry into regional markets are characterised

19 This is particularly true of the way in which structural adjustment programrnes in Africa
have caused an implosion in both public and private investment at the national level (because
debt service outflows have been maximised at the expense of domestic investment), and triggered
a competitive regional race for commodity exports in each national economy. This has often had
a deleterious impact on net export earnings at the regional level, e.g. encouraging farmers inneighbouring countries to increase cocoa, tea, coffee, tobacco, or to increase production of thesame mineral commodities simultaneously.

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by predatory behaviour on the part of any single country's or any ethnically
identifiable business community (e.g. in Africa and Asia) the immediate
reactions of countries will be to raise regional barriers rather than to lowerthem.
• Domestic policy instability in anchor countries, caused by fiscal laxity toaccommodate domestic political pressures, can impede the process ofregionalisation. If such instability weakens a particular region's anchor
economy the setbacks to regional integration can be significant. 20 When
fiscal looseness is accommodated by monetary expansion the negative
impact on the regional economy is generally aggravated even further.
Regional integration in the developing world may also be hindered (orpromoted) by the present roles and functions of different regional
institutional structures. Several such structures exist in the form of: (a) large
and well-endowed regional and sub-regional development banks in Asia,
Africa, Latin America, the Caribbean and Eastern Europe; (b) various
regional economic commissions linked to the UN system which are playing asignificant role in promoting RIAs; (c) regional institutions and secretariats
set up on a plurilateral basis under specific regional or sub-regional agreements. The latter aim at lowering intra-regional tariff and non-tariff barriers
as well as at wider objectives such as administering monetary unions, orachieving infrastructural investment (and operational) coordination in key
sectors, as well as broader policy coordination on trade and exchange policies
and on monetary policies.

20 There are two vivid examples of this phenomenon which have occurred recently. The
first was the way in which incompatibility between fiscal and monetary policy in Germany,
immediately following reunification, and before the all-German national elections, disrupted theregion's monetary and exchange regimes and broke the EMS. This happened because the severe
monetary squeeze imposed by the Bundesbank to offset the government's fiscal expansion toaccommodate unification, resulted in a sharp rise in Deutsche Mark interest rates when most therest of Europe needed interest rates to decline in the midst of a deepening recession. The strains
which emerged in the EMS in attempting to maintain parities under this unprecedented interest
rate twist were too great for the system to cope with without very large disorderly changes inparities which were eventually forced by markets. The second example is the case of South Africa
in SACU. That economy has been stagnant for over a decade. It complains about the overt costsof compensation and stabilisation arrangements for the smaller members of SACU even thoughsuch costs effectively constitute a covert export subsidy for South Africa's manufacturingindustry. The cause of economic integration may be severely affected, and extant regionalarrangements seriously endangered, if the South African economy goes off-track. This could
happen if the new South African government indulges in the same kind of fiscal looseness andaccompanying monetary expansion that has occurred in most of the rest of sub-Saharan Africa
immediately after independence, to fulfil the unrealistic populist expectations which have beencreated. Initial signs, however, indicate that it will resist the temptation to indulge in the same
type of profligacy.

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This looks all quite well. The problem, however, is that in many cases there
are competing institutional arrangements. within the same region which all
aim at achieving much the same thing. In addition, there are a number ofmultilateral institutions with global functions (the IMF, World Bank, World
Trade Organisation, and the various UN specialised agencies) which havetaken an interest in the recent burgeoning of RIAs although with ambivalent
perspectives. Duplicative institutional frameworks with overlapping memberships whose bureaucracies (however small) compete for regional attention
and pursue different regional agendas cannot facilitate the integration
process; they can only confound and confuse it. Hence the overlapping roles
and responsibilities of these different institutional players need to besatisfactorily resolved, as does the future evolution of institutional arrangements in different regions aimed specifically at deepening progressively thecontent of RIAs.
The non-tariff barriers to regional cooperation outlined above identify themost pressing constraints which RIAs presently confront.
The path toward knitting together regional economic communities in thedeveloping world will not be easy, especially under evolving, uncertain
economic and political circumstances. Nevertheless, the inevitable emergenceof different global economic arrangements makes it incumbent on national
governments to ensure that RIAs are negotiated on a basis which benefits
both the region and the global economy as a whole. Crucial research issues in
examining the future prospects of RIAs in the developing world concern: (a)identifying and understanding fully the effect of non-trade barriers, a subject
which has been neglected in the normal literature on integration; (b) devisingmeans for overcoming the defects of past initiatives aimed at removing nontrade barriers and ensuring the implementation of new, more effective
initiatives; and (c) stabilising and binding liberalisation measures that are ineffect.

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4

The Experience of Developed vs.
Developing Economies

As the vignettes of RIAs presented earlier suggest, the record of firstgeneration RIAs has been a mixed one. There has been gradual success albeit with a number of hiccups and setbacks - in developed country RIAs
governing the European Union, NAFTA and ANZCERTA whereas earlier
RIAs in many developing country blocs failed, especially in Africa and Latin
America. It is tempting to believe that the difference was because, in typicalWorld Bank terminology, the former were outward-looking, open andefficient, while the latter were inward-looking, closed and inefficient. But
those are partial answers at best and misleading at worst.s! Things are more
complex than that.

Why First-Generation RIAs Failed in Developing Countries
A more satisfactory explanation for the difference in experiences of RIAs isthat for RIAs to succeed, the process and sequence of successive steps towards
closer regional cooperation leading eventually to regional integration, are atleast as important as the direction and ultimate goal of the integrationenterprise. Political will. (or the lack of it) for example, is a more powerfuldeterminant of whether an RIA is successful than the validity of rational
economic argument.
But the question remains: why did first-generation RIAs succeed amongdeveloped countries but fail among developing countries? Is it because
integration would yield benefits only if applied by relatively advanced trading
economies of roughly equal weight, producing a wide range of tradeables, andwith similar production structures? Or is it that RIAs in developing nations
have failed because of the very characteristics that define developing economies:lack of administrative capacity, political immaturity and instability, vulnerability

21 With its wasteful, distortion-ridden and trade-diverting Common Agricultural Policy andthe protection it applies to sensitive industries (i.e. those in which Japan and East Asian countries
are the most competitive), the European Union (ED) is hardly an open, outward-looking, trade
bloc inclined towards inclusivity. It is prone to erecting protective barriers whenever the interestsof its powerful vested industrial or parastatallobbies appear to be threatened. Even so, the EUremains more open than the developing country regional blocs of the 1960s and 1970s were although some second generation RIAs among developing countries are arguably more open now
than the EU. Nor is American trade policy, which governs the ethos of NAFTA, immune to its
own forms of retaliatory bilateralism or protectionism.

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to external trade and financial shocks, etc.? If so, would this mean thatdeveloping countries should not attempt to integrate till they become moredeveloped? The answer is that both theoretical reasons and implementation
failures interacted in determining outcomes of first-round RIAs in thedeveloping world.
The studies that have been done in exploring these issues 22 generally
conclude that:• The Vinerean-J hypotheses which underpin the modern theory of regional
integration and those of Belassa (op. cit.) are basically correct. Both assertthat there are, at best, likely to be few benefits and potentially high costs
unless RIAs are accompanied by unilateral trade liberalisation.
• The greatest benefits are likely to be obtained withRIAs among countries
that have: relatively high initial (intra-regionally oriented) trade ratios;
low intra-regional transport costs relative to the transport costs involvedin trading with the rest of the world; higher, less dispersed levels of
incomes with high elasticities of demand for imports; high propensity forinvestment; and greater supply-side flexibility in their production
structures for responding to competition.
• First-generation RIAs among developing countries failed to raise
efficiency because of: (a) relatively low import demand elasticities; (b)relatively large differences in production cost structures vis-a-vis extraregional sources; (c) widely disparate income levels; (d) divergent rates ofindustrial development which made gains from intra-bloc trade uneven;(e) low levels of initial integration by way of infrastructural links or intraregional trade; (f) similar not complementary structures of production andresource endowments; (g) inward-oriented, protectionist industrial
development policies under which protection was maintained for too long;and (h) divergence and instability in macroeconomic parameters thatmade domestic adjustment, as well as regional adjustment, uncertain,
fragile and burdensome.
• In RIAs among developing economies, the implementation of measures tolower barriers (both tariff and non-tariff) was poor whereas developed
economies were more diligent. The lowering of trade barriers in almost
all RIAs among developing countries was delayed or postponed largely
because of the heavy dependence of the fiscus on trade taxes.
• Processes for lowering tariff and non-tariff barriers under RIAs in developing countries lacked the automatism they had in developed countries.
The tendency instead was to have protracted negotiations to achieve
22 In particular those of (1) de Me10 et aI., (2) Robson, (3) York, (4) Oman and (5) Cable andHenderson, op. cit.
23 Viner, Jacob, The Customs Union Issue, New York: Carnegie; London: Steven and Sons, 1950.

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•

•

•

•

•

•

•

"

multilateral consensus on a product by product basis. At the level of implementation, there was no strict timetable for executing trade barrier
reductions.
Such reductions were based on positive lists rather than across-the-board
liberalisation of tariffs and non-tariff barriers with very restrictive rulesof origin. Positive lists included products which were traded intraregionally prior to the arrangements in question or were not produced in
the region. They generally excluded protected products, the free tradingof which might have engendered greater efficiencies despite inevitabledislocations.
Vulnerability to bouts of exogenously induced macroeconomic instability
in developing economies, or to import surges caused by economic
liberalisation programmes led to immediate unilateral reimposition of
trade barriers (mainly in the form of quantitative restrictions) even in
those arrangements which were initially successful like the Central
American Common Market.
Where customs unions were intended, the implementation of a common
external tariff was not achieved because members invariably sought
exemptions from certain external tariffs (e.g. for essential imports fromextra -regional sources).
Developing country RIAs were unsuccessful, or only partially successful,in freeing intra-regional mobility of all factors - especially labour andcapital.
Satisfactory compensation schemes for losers under developing country
RIAs proved difficult to design and negotiate multilaterally in a manner
acceptable to all members. Problems with implementing structural adjustment programmes also led to conflicts among partners over the equitableregional distribution of costs and benefits.
Too many developing country RIAs set up machinery to allocate resources
through administrative decision-making and fiat rather than market
determination for locating new import-substituting industries among
different countries in an effort to ensure equity rather than efficiency.
These mechanisms encountered administrative problems and frequent
breakdowns of negotiations as a result of inter-country conflicts of interestand the impossibility of determining proper locations for particularindustries in the absence of market-based criteria and incontrovertible
evidence of comparative advantage - always difficult to provide in a
dynamic sense.
Intra-regional trade expansion in integration arrangements among developed
countries occurred through rapid intra-industry trade expansion among
members, Among developing countries trade expansion occurred more on
inter-industry lines.

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•

•

•

•

•

•

•

•

•

•

•

Intra-industry trade specialisation (i.e. trade in differentiated manufactures)and expansion was achieved without major shifts in factor proportions or
entirely new technologies. Therefore it entailed relatively low transitionalcosts of adjustment, particularly in terms of labour dislocations.
Inter-industry trade expansion was generally slower, requiring major
restructuring of firms and industries. It was less susceptible to realisingcost efficiencies and scale economies across a wide range of regional
industries quickly, and required more adjustment assistance for compensatory purposes.
Such costs were substantial in the short run with transitional losses
reflecting long periods of labour retrenchment and re-training when firms
which faced regional competition either failed or took too long to adjust
and compete.
Transitional losses were reduced to the extent that labour and capital were
mobile within the region but that was not the case under most developing
country RIAs.
The political will to sustain RIAs through difficult economic circumstances
was lacking in developing economies with members being prone to take soft
options to ease the immediate pain at the expense of longer-term interests.
Developing country members of RIAs were rarely able to subordinate
short-term national interests to regional goals or to cede essential
sovereignty to regional institutions.
Under developing country RIAs there was a structural incompatibility
between: (i) the pursuit of inward-oriented and inherently protectionist
development policies at the national level and (ii) the ostensible objectivesof intra-regional trade liberalisation. Powerful industrial lobbies prevented
a reduction of domestic protection in key import-substituting industries.
An unpropitious external environment facing most developing regions in
the 197Os and 1980s did little to help matters. Under pressure to liberalise
and adjust, many developing members of RIAs found their commitment
to import-substitution strategies was inconsistent with regionalliberalisation and introduced structural rigidities which were difficult to deal withthrough normal macroeconomic management.
Although many RIAs among developing countries were modelled on
European Union lines, most of them lacked adequate or technicallycompetent institutional support.
National legislation was invariably inconsistent with regional treaty
commitments, but most developing countries delayed the necessarychanges in their laws. Effective enforcement mechanisms and disputesettlement procedures were conspicuous by their absence.
Developing country RIAs were aimed at the wrong objectives (inwardlooking and based on high common external tariff) which did not yield

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significant efficiency gains nor did they result in initial trade-diverting
effects eventually being converted into trade-creating effects by capturing
the potential for dynamic efficiency.
• There was more rapid intra-regional trade growth in developing regions(e.g. Asia) which had no formal regional arrangements for intra-country
trade but which focused on unilateral trade liberalisation first, than there
was when formal PTAlFTAlCU arrangements were entered into before
members had undertaken unilateral trade liberalisation.
There is now a rich body of experience with RIAs in many developing
regions from which various lessons might be learned in designing futurearrangements. As emphasised above, most formal groupings have so far
generally not fared very well, and for essentially the same reasons. Thus, theirexperience serves to underline the need to address the problems identified for
future RIAs in developing countries, rather than to suggest possible
transferable solutions from the experience of developed countries (see Annex
II on Africa).
Lessons for the Future
In the case of the Andean Group, experience underlines one important
point: the dangers of addressing the problem of distributional equity bycontrolling foreign direct investment (FDI) inflows. The Andean Group's
attempt to legislate on FDI inflows and the transfer of technology in order topromote production integration and regional balance found expression in
Decision 24 in 1970. Owing to the virtual drying up of FDI inflows, thedecision was relaxed in 1987, and in 1991 it was replaced by Decision 291.
This assures national treatment to foreign investors and effectively signals theabandonment of the original initiative. The Andean Group went even further
in establishing a common market by the end of 1993 which assured capital
mobility to an unprecedented degree.
The ASEAN bloc is one of the few not to have experienced the difficulties
seen in some African regional blocs. Its members have enjoyed high rates of
economic growth, and its share of intra-bloc trade, at nearly 30% of total
trade, is substantially higher than that of any African group. However,
although this might suggest a positive example, ASEAN is not a particularly
good example of an RIA per se. As observed earlier, until 1993 ASEAN's
objectives were more political than economic. Its most notable achievements
were peaceful conflict resolution and regional security among members.
An ASEAN Preferential Trading Agreement has now been established, but
its practical scope has been deliberately limited. It has not resulted in any
significant trade expansion among the members of the bloc that is notoccurring naturally anyway. Thailand's proposal that ASEAN should establish

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an ITA has been accepted, with members agreeing to create the ASEAN
Free Trade Area (AFfA) within the next 15 years.
The main lesson of ASEAN is that it is possible for fruitful transnational
production links amongst the countries of a sub-region to develop, even
without formal institutional support for RlAs, providing the following
conditions exist: (i) a favourable economic policy climate for businessenterprise - private and public, involving foreign and domestic capital - toflourish; (ii) a regional reservoir of entrepreneurial talent which is ethnicallylinked throughout the region; (iii) administratively capable - if not necessarily
always incorrupt - domestic government; (iv) a will to encourage pragmatic
regional cooperation on a step by step basis, building on small successes andeschewing grand designs; and, (v) above all, the existence of healthy andsizeable economies in which private enterprise is permitted to play thedominant economic role but with governments intervening intelligently in"governing the market".
For future RIAs among developing countries to succeed, most of thestudies done have found that the following conditions would be essential:• Strong and sustained political commitment to RIAs;• Effective mechanisms to distribute equitably the costs/benefits of RlAs;• Regional trade liberalisation as a complement to unilateral trade liberalisation;• Macroeconomic stability among members with a trend toward convergence;• Structural flexibility in converting import-substituting production structures;• Better design of RlAs to be more comprehensive and inclusive.

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5Second-Generation RIAs in theDeveloping World

In considering the prospects for second-generation RIAs in the developingworld and the choice of partners in any RIA, the following determinants
merit particular attention: (a) proximity and other geographical characteristics; (b) differences in levels of macroeconomic adjustment; (c) extent of
convergence in levels of development and in fiscal and monetary policies; and(d) political attitudes towards accepting binding mechanisms that involve atransfer or pooling of sovereignty. These determinants are taken up below in
turn.

Determinants ofSuccessTo achieve significant intra-regional trade expansion, there is substantial
evidence that geographical proximity and consequent low transport costs are
particularly important factors for RIAs to succeed. Other geographicalfeatures, such as natural frontiers, landlocked boundaries, and readily
controlled ports of entry, are relevant as well and quite material to theappropriate scope of fiscal jurisdictions and thus to the adoption of customs
and fiscal unions, as opposed to other, looser forms of RIAs. These
characteristics also illuminate the choice of natural partners24 for eachapproach in terms of geographical scope, as well as the appropriate time scale
and phasing of any process of closer sub-regional integration.
A second prerequisite for effective, beneficial trade-focused RIAs is thatparticipant economies should be sufficiently well adjusted in terms of having
achieved micro- and macro-equilibrium so that trade liberalisation is not
impeded by exchange restrictions and is undertaken at market-clearing prices.
Countries in severe economic difficulties whose structural adjustment
programmes are in their early phases of implementation will not be attractive
partners in RIAs with more developed and stable countries. Differing time24

Natural trading partners are only really determined in retrospect and not before the fact

when the benefits to members have become apparent as a result of their having highly integrated
transport networks, and roughly similar production structures thereby providing scope for
efficiency gains to be realised. Some studies suggest that African countries tied together invarious regional cooperation arrangements may not be "natural partners" because while
countries and borders are organised on a North-South orientation, the natural routes which
minimise transport costs are East-West.

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schedules for implementing each country's structural adjustment programme
may constrain the speed of trade-focused integration if such differences resultin different rates and sequencing of trade liberalisation measures. Significant
gains from RIAs can, however, be exploited even by countries that are atdifferent stages of adjustment if such arrangements are focused on capturing
gains from sectoral investment and policy coordination. Moreover, it may bepossible, by the development of suitable mechanisms, to envisage constructive
regional projects being undertaken outside the public sector in anticipation offurther regional adjustment.
A third important determinant is the degree of convergence amongst
prospective partners across a range of development (and not just monetary,
fiscal and inflation) indicators. Conventional wisdom suggests that tight RIAs
(which lean toward full integration) will be difficult to implement unlessmembers are at comparable levels of development, since only then would
there be a reasonable assurance that all would benefit equally. If, instead,integration takes place between unequal partners, then it will be viable only if
effective compensatory mechanisms can be put in place.
Such a view must, however, be qualified. Except in the case of a simple free
trade area, successful RIAs anywhere in the developing world will usually
demand some form of regional policy to engender equity and accelerate
development in underdeveloped parts of the region. Indeed regional policy isa cornerstone of European integration. But focusing on regional equity
considerations prematurely may have its own drawbacks, as the case of Africa
illustrates.
African RIAs have been concerned with enforcing equity mainly throughadministrative allocation of preferred locations within the region for new
investments and especially for private foreign direct investment. Such an
approach - aimed at directing investment flows by fiat - did not induce
investors to locate production where governments would like. Instead it hadexactly the opposite effect of deterring investment altogether. Even though,on the face of it, the costs of doing investment might initially be higher,
foreign investors prefer to locate production in more advanced countries
rather than invest in a country with a smaller market and offering poorer
infrastructural and business support services.
A fourth determinant of realising the potential benefits of closer
integration therefore centres on the crucial issue of credibility and perceived
durability of RIAs, particularly in the eyes of intra-regional investors who haveto ,take a long-term view. Ultimately, such credibility can only be underpinned when member countries are willing to cede powers to regional agencies
and are prepared to assure the binding nature of any trade liberalisation,monetary cooperation or other regional commitments that are agreed.

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Linking Up with Large Trade Blocs
Another issue that needs to be specifically addressed is whether new types
of RIAs should be sought by developing country regional blocs with OECD
countries, and especially with the European Union (for developing ACP
countries, Eastern European countries and Mahgreb countries) and NAFrA(for developing countries in the Western hemisphere), in order to increase
the gains from RIAs within their own regions.
Trade, investment, exchange and payments support are prominent areas
where new arrangements for North-South cooperation could usefully be
explored, certain aspects of which, unlike the present Lome arrangements,
might call for a measure of reciprocity if they are to attract outside support.
The increase in credibility that such cooperation arrangements mightengender could be crucial for attracting inflows of foreign direct investment
to serve sub-regional markets and, ultimately, even markets beyond thedeveloping region concerned. Additional benefits from greater macroeconomic stability could also be anticipated. In this connection, developing
countries should not ignore the significance of initiatives currently under way
in the western hemisphere involving free trade areas between North and
Latin American countries as well as those in the Caribbean.
These issues need to be urgently addressed by developing countries. Even
with multilateral trading arrangements being liberalised and strengthened
under the Uruguay Round, the world trading system will be strongly
influenced by the .practices of three competing large trading blocs. The
impact of their evolution on different developing regions will be the result of
two opposing forces. On the one hand, to the extent that market unification
results in faster growth within those blocs, third countries may potentiallybenefit through increased markets for their exports, primarily of
manufactures. On the other, the creation of more efficient production units
within the European Union (EU) and NAFrA, resulting from closer
integration, may well reduce the competitiveness of imports from othercountries in these markets.
Whether overall demand in the EU and NAFrA for imports from nonmember developing countries rises or falls will depend on whether the tradediverting competitiveness effect is larger or smaller than the trade-expansion
effect of faster growth in these two large blocs. Any particular developing
region's position in these blocs will depend on the evolution of its relativecompetitiveness vis-a-vis the position of other developing countries andregions; especially that of the Asian NICs which have already developed
significant market share in the EU and NAFrA.
Similar effects may be expected to operate in relation to foreign direct
investment, via the investment-creation and diversion effects that will accom56
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pany the completion of the single market in Europe, and the formation of
trading blocs in North America, East Asia, Latin America and the Antipodes.
Overshadowing all of these are the implications of the further widening of the
ED and the development, already under way, of closer links between it andcountries of the former East Bloc. Many studies point to the conclusion thatthese developments will not have any significant immediate impact on mostdeveloping regions in terms of their present structures of production andtrade. Nevertheless, it can be anticipated that if a particular developing region
does not already have entrenched access in ED or NAFrA markets for suchproducts as textiles and clothing, thesesegments of developed markets will
become even more competitive and more difficult to penetrate. For certain
other products which might be of importance in the future, the harmonisation and improvement of ED standards will themselves constitute tradediverting non-tariff barriers from the point of view of different developing
regions if they do not take steps to respond. It must not be forgotten either
that, in Asia, regional integration is progressing, primarily through transfrontier corporate integration, aided in some cases by special enterprisezones. New initiatives are under way within ASEAN which can be expected
to enhance further the relative competitiveness and rapidly growing significance of the East Asian economies in world trade.
In the face of determined moves towards more effective regionalism
elsewhere, a failure to overcome, or reduce, the costs of market fragmentation in regions whose countries have not yet begun to cooperate will meanthat those regions, as a whole, will be less well placed in the future to attract
the foreign investment, technology and know-how on which they will have todepend for their future economic growth. A good deal of progress must
therefore be made in some regions (especially in Africa) merely for them tomaintain their present modest relative positions. If, additionally, the countriesof these regions wish to prepare themselves to take full advantage of longerterm opportunities, when wage convergence in Europe promises to prompt afurther shift of labour-intensive production from its periphery to proximate
developing' countries (particularly in Eastern Europe and North Africa), thendevelopment strategy in these regions will need to be positively shaped andvigorously pursued with those specific opportunities in mind.

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6

Options for Creating Regional Trade
Preferences Among Developing
Countries

How regional trade preferences are provided among developing countries
involves a range of issues. There are four main options: (a) bilateralpreferential trade agreements; (b) customs unions; (c) free or preferential
trade areas; and (d) a variable geometry approach. To achieve the full benefits
from any of these approaches, investment flows (and ideally, though this may
be more difficult, labour flows) also need to be facilitated, which implies someform of a common market.

The Role ofBilateral Agreements
A number of long-standing bilateral agreements already exist between
countries in many developing regions. Others are rapidly developing in
response to changing circumstances. Typical safeguard clauses are embodied
in most of these agreements relating to dumping, subsidies and, - in thecontext of RIAs - to imports that threaten domestic producers with serious
injury. Not all the bilateral agreements which have been negotiated areequitable or even. The competitive capabilities of neighbours are often afactor in determining the favourability of reciprocal terms.
How should such developments be viewed in terms of a strategy for market
unification and integration in different developing regions? If the preferences
offered by the industrially more advanced members of a region are smaller
than those they receive and, in the limiting case, are zero, this would seem tooffer one way of promoting an equitable distribution of the benefits of market
integration. The main impact of preferential trade agreements is, however, toimprove the terms of trade of the preference receiver rather than to promote
closer integration. Even then, in practice, the incidence of any such benefit islikely to depend on the degree of competition in import-export trade.
Beyond this, it is doubtful whether bilateral agreements would, bythemselves, be perceived as constituting a sufficiently significant added
incentive for foreign direct investment to serve the wider market createdunder such agreements. There are two main reasons to support such a
conclusion. First, the lack of full reciprocity that typifies bilateral arrangements would render any concessions particularly vulnerable in the face ofeconomic difficulties in the country granting them. Second, such agreements
do not specifically address non-tariff barriers to trade, production and invest-

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ment which are the most important constraints presently affecting RIAs amongdeveloping countries.
The experience of most developing countries with extended bilateralagreements - for example under the Generalised System of Preferencesamong such countries agreed under UNCTAD and the concessions offered
to African Caribbean and Pacific (ACP) countries by the European Union
under successive Lome agreements - has been quite disappointing. These two
instances underline the deficiencies of preferential trade agreements inthemselves as instruments for expanding trade and investment, and for
promoting internal market completion.

The Role ofCustoms Unions
A substantial degree of intra-regional trade and market integration can takeplace without the support of a customs union, free trade area or bilateral
trade agreements. Nevertheless, a complete customs union (CD) can make a
substantial contribution to market unification, particularly if it eliminates all
internal fiscal frontiers. Moreover, by reducing private and public administration costs, minimising the need for special transit arrangements, and by
avoiding revenue losses from smuggling, CUs have other important advantages as well.
For a CU to be an appropriate form of cooperation for a group of countries, there should be a willingness to regionalise (i.e. to integrate) customs
administration. 25 Operational reasons require that tariff rates in a CU must
be unified as well, although duty drawbacks and refunds of limited scope

25 Experience in Africa, for instance, supports that view. For example, consider theeffectiveness of SACU, the EAC and the Francophone unions during their periods of greatest
effectiveness. SACU is the only properly functioning customs union in Africa at present though
it has its own stresses and strains. Its 1969 provisions embody a CET, and provision is made forsharing the revenue derived from this source (and from excise and sales duties) amongst the
governments of the member states on whose consumers these taxes fall. Excise and sales duties
were harmonised under the 1969 agreement and subject to the same sharing principles; thereplacement of sales duties by the GST in 1978, and its subsequent replacement in 1991 by
VAT, have eroded the consumption tax union. Provision is made in the agreement forcompensation for disparities in the distribution of the costs and benefits of integration reflectedby the division of revenue shares of RSA's partners. These shares are based on consumption of
dutiable imports plus dutiable domestic production. The inclusion of the latter can be regarded
as compensation for the costs of trade diversion. The so-called enhancement factor provides
further compensation for the loss of fiscal discretion and the costs of polarisation. The agreement
also contains provisions to enable the less-developed members to protect their infant industries
against competition from their more-advanced neighbours, but the Secret Memorandum ofUnderstanding largely ruled out recourse to those provisions. The same revenue-sharing
principles have also been applied to the 'homelands' (TBVC) within South Africa, and to
Namibia.

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might be workable. To the extent that consumption taxes now form a largepart of total tax revenues in many developing countries, harmonisation of
consumption taxes in a CD becomes essential if its full advantages are to be
secured.
Could a customs union have a role in an integration strategy for developing countries? If so, there would be much to be said, in principle, for learningfrom the existing RIAs which invariably incorporate some form ofcompensatory arrangements, as well as mechanisms for the enhancement andstabilisation of revenues. Divergent views are held on the compensation,
revenue enhancement and stabilisation arrangements for achieving equity
under the present CD arrangements in different developing regions. The
industrially more advanced countries in a grouping usually take a budgetary
perspective rather than an overall economic cost-benefit approach and thus
see current patterns of revenue distribution as overgenerous. Occasionallythey attempt to link compensation specifically to the financing of investmentsin the less developed members of the grouping, rather than providing it for
general budgetary purposes.s'' Such compensation, for a period, might
conceivably be envisaged as one element of the regional adjustment programmes
which have often been suggested for African countries.
The basic problem confronting the adoption of CD arrangements on awider basis concerns the distribution of costs and benefits among members.
In a CD, trade imbalances in regional products that compete with dutiable
imports from the rest of the world are likely to be reflected in revenue losses
for net deficit countries. In the absence of non-tariff barriers, these will usuallycorrespond to real income losses. Revenue-sharing formulae incorporated insome CD agreements attempt to deal with this particular element of the
problem. But internal lobbies in the more advanced members of an RIA often
see such a formula as too generous to the smaller less developed members.
Even when the more advanced members in a CD wish to bolster theprosperity of their neighbours, their financial ability to make direct transfers
may be circumscribed by the worsening of their own economic conditions.
Fiscal reforms involving a s-ubstitution of consumption taxation for importduties in developing countries, and external liberalisation coupled with thetariff convergence that structural adjustment programmes imply, should
reduce this problem, but such changes in tax structures cannot eliminate it
altogether. Unless future CDs are based on a non-redistributive attribution ofrevenues, i.e. on a clean basis, they might become much less acceptable to themore advanced members.
26 In CEAO, part of attributable compensation which is based on revenue losses goes, not to
the general budgets of the net benefiting partners, but to FOSIDEC, a solidarity fund whichfunds investment projects of regional development interest.

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For a CU without compensation to be a feasible option, a reduction inprotection or, at least, a switch from price-raising forms of protection to
direct assistance would probably be necessary. An accord on regional traderelated investment measures (TRIMS) and harmonised investment codes mightthen become key components of CU agreements. If such a switch were notnegotiable, fiscal frontiers would have to be retained in any wider or closer
grouping, and tariff-free trade would have to be excluded.
In the longer-term context of reform and liberalisation, if regionalgroupings of developing countries were willing to regionalise customs
administration and harmonise tariffs, as well as rates of consumption andexcise taxes, the introduction of some form of CU would merit consideration.
The regional adoption of a computerised system for processing customs
declarations, controlling the clearance of goods, and producing trade andfiscal data - such as the ASYCUDA system devised by UNCTAD - would be
an indispensable aid to such an initiative, involving the simulation of theeffects on revenues, consumption, and prices for all prospective participants.

The Role ofPreferential and Free Trade Areas
It is difficult to envisage a complete unification of tariffs under full CUs
among developing countries in different regions except in the long term. The
alternative would be to aim at preferential or free trading areas (PTAs or
ITAs). In such areas, each country retains its own external tariff, but trade
within the area is wholly or partly tariff-free. In principle, such PTA-ITAbased RIAs for a selected group of countries have many advantages. Whilethey are capable of capturing many of the benefits of full regional market
integration, PTAs-ITAs reduce demands for compensation, either forrevenue losses, or for the loss of fiscal discretion and autonomy that may bothbe entailed in a CU. At the same time, the harmonisation of customs andconsumption tax schedules, documentation and procedures that occur undersuch RIAs still yields substantial benefits by reducing administrative barriersand costs to cross-border trade and investment and, at the same time, reduces
fiscal incentives to illicit trade.
Furthermore, the PTAIFTA approach enables a variable geometry and/or
multi-speed approach to be taken towards closer (and eventually full)
integration. The adoption of such approaches may be vital if integration is toproceed at a pace faster than that of the slowest country. If market integration
through trade preferences or other means is to proceed on a uniform basis in
the sub-region, it is likely to be at the pace of the slowest. A more flexible
approach would be, for instance, that a core group implements or maintains acustoms union with a common external tariff, while a wider group at the
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group in a free trade agreement on the lines of the ED-EFTA (European
Free Trade Association) arrangement. Other flexible forms of RIAs, forinstance those involving public sector investment and operation - e.g.
involving joint or coordinated operation of utilities or telecommunications
and transport companies -, might be handled similarly, with cooperation forparticular purposes involving overlapping groups.
The PTAIFTA approach has many advantages but, as the experience ofseveral such arrangements show, its implementation is not easy. For it tosucceed, the prior fiscal reforms outlined above for the customs union have tobe adopted. If these have not been undertaken, the problem of compensation
will arise in any event.

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7

RegionaIisation vs. GlobaIisation:
The Issues

Instinct, common-sense, theory and history all suggest that nondiscriminatory free trade across all borders, and not just those divided
arbitrarily by nation or region, is clearly the first best option from theviewpoint of maximising both global and national welfare. That view,
however, rests on traditional concepts rooted in trade theory. In practice, thedifferent and conflicting economic and social objectives of nation states, andthe chronic dependency of the Fiscus in developing countries on trade taxes,
leads to a search for the least worst policy options for multilateral economic
cooperation, especially when the global economy is still very imperfectly
organised and political relationships among nation states are fragmented andin danger of becoming more so.
For these reasons, the resurgence of interest in newer RIAs keeps raising
the question of whether an increased tendency towards regionalisation is an
optimal or an inferior way of moving towards free trade and investment on a
global basis. As one study puts it:'... it is questionable whether the prospective proliferation of (regional) arrangements - which involves overlapping country membership, potentially inconsistent
rules, and increased scope for conflict - is the most efficient way to move toward
free trade on a global basis. Indeed, beyond a certain threshold an undue emphasis
on regionalism would undercut the multilateral trade system and render it
inoperative. The limits on the liberalisation that regional arrangements can deliverin trade-sensitive sectors where protection is most ingrained raises further doubts
about this approach.... a "fortress mentality" (on the part of regional blocs) that
leads to an increase in protection would undermine world welfare. The key
element that could reduce this danger is the extent to which the world economyhas (already) become integrated through trade and through the globalisation of
investment and production.... The recent trend toward regionalism, however, may'be quali tatively different from past efforts and may carry greater risks of becoming
a substitute for, rather than a complement to, multilateralism.' (de la Torre and
Kelly, op. cit.)

Regionalism as a Mezzanine Step
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conclusion that free trade across regions would be even better. The realquestion is whether it is necessary to go through the RIA route as an
unavoidable mezzanine step in order to arrive at global free trade, or whether
that intermediate step can be dispensed with since it might delay rather thanhasten the world's journey towards its inevitable destination?
In this context, the experience of the Uruguay Round is illustrative. As it
turned out, global trade liberalisation was easier to negotiate throughregional bloc formations than through negotiations involving individual
countries. The answer to the question, of course, lies not in economics but inpolitics and social organisation - those of nations as well as of global
multilateral organisations.
As noted earlier, most existing global institutions seem to be approaching
their limits of usefulness. Increasingly, global multilateral organisations
appear to have become vested interests in their own right, more concerned
about protecting their long-established rights and privileges than about
delivering on their obligations to the international community. Moreover,
the type of international discourse that occurs through them suggests thatnation states themselves have reached an impasse. Present national politicaland administrative systems are not geared to providing effective and coherent
direction to multilateral organisations. They are too internally divided - bothwithin and among nations - and have become disconcertingly captive to theexercise of undue influence by special, single-issue lobbies. As a result, mostnational systems are more oriented toward short-term insularity than longterm internationalism. That is not surprising for two reasons.
First, few democratic governments have any incentive to employ aperspective of longer than four years. Second, except in very small countries,
national governments do not attract votes on the basis of how well theyhandle international economic issues. They are therefore mose attuned toappeasing and pandering than toleading; more adept at resisting change thanadapting to it; and more prone to prescribing adjustment for others while
resisting domestic adjustment for themselves when, in fact, embracing
adjustment would, in the long run, be the least cost option both economicallyand politically.
In such a world the question becomes one of whether a regional approachmay, at least for the foreseeable future, be more manageable than a global
approach for myopic nation states and global organisations to cope with. The
example of the European Union, despite its many shortcomings, controversies
and distractions, has made a fundamental difference to thinking about whether
the relative success of that regional arrangement - in contrast to the perceived
daily failures of global endeavours - might not be replicable elsewhere.
When the ideal of globalism fades as a consequence of international

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institutional failure and an erosion of national political will - two forces
which feed on and reinforce each other negatively - the less ambitious
regional undertaking begins to look distinctly more attractive if only on the
grounds of greater tractability. It may just be that increasingly obsolescentsmaller nation states, fighting for their own survival as sovereign entities
against a powerful array of global market forces over which they havediminishing control, have subliminally come to the conclusion that they are
more able to live with processes and institutions over which they think they
still have some control (1~egional) than those over which they obviously havenone (i.e. global).
It may also be that for a variety of reasons which have bred morefamiliarity, regionalism may be more manageable politically from a domestic
point of view. Voters of all social and economic strata are perhaps able tocomprehend and react to regional issues more than they can to global issues.
Whatever the reasons, regionalism may be here to stay, for economic but
mainly non-economic reasons, and therefore may be an unavoidable waystation to globalism. The risk always exists that such a detour might derail
globalism. But it cannot do so altogether and for all time if history is areliable guide. It can only delay the process through temporary setbacks ofvarying severity.
The questions then are: For how long will regionalism delay globalisation?
And at what cost to global welfare? If one accepts that regionalism is here tostay, then the most useful question to answer is: What needs to be done to
make it as friendly to the process of global market development as possible?
And what should be done to make RIAs contribute to, rather than detract
from, global welfare?

Trade Blocs
Clearly the propensity of regional trade blocs to become protectionist in
the face of competitive pressures which create domestic political ructions isdamaging to global welfare. The various studies which have been done on
this subject suggest that the increasing of trade barriers by either theEuropean Union or NAFTA would have large negative effects on global
GDP, on most individual countries, and on all regions, including the region
which increased protection. Such losses would increase if either bloc
retaliated.
For example, in one study, assuming a world comprising the three major
trade blocs, it was estimated that if EC-92 was accompanied by an increase inexternal trade barriers, world GDP (measured in 1988 dollars) would decline
by US$108 billion (US$52 billion in the European Union, US$40 billion in
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NAFTA, and US$16 billion in Asia).27 By the same token, more recent
estimates suggest that the creation of a North Atlantic free trade area would
increase global GDP by about $250 billion (1994 dollars) and generate almosta million new jobs in the European Union and NAFTA.
One study (Krugman: 1990) explored the implications of trade bloc
protectionism in somewhat simplistic terms employing a model of oneproduct monopolistic competition among a large number of identicalcountries with each country producing one variety of the product andimposing the optimum tariff on imports from all other countries. Using thismodel to project different scenarios, the results showed that, as trade blocs
emerged, starting from a large number of identical blocs, tariffs become
positive and welfare declined. With increasing size of blocs the optimum
tariff on extra-bloc trade kept rising, producing both trade-creating anddiverting effects. The trade-creation effect dominated trade-diversion only
after the number of trade blocs declined to three and was maximised when
the world became a single bloc with the optimum tariff diminishing to zero.
Others, arguing that these assumptions precluded inter-industry trade andassumed unrealistic symmetry, have postulated alternative models - withcountries differentiated by factor endowments, in which small numbers of
trade blocs can maximise welfare.2 8 The theoretical debate on this issue is notparticularly illuminating (de Melo: 1993). The more critical issue is how trade
blocs behave vis-a-vis one another once they have been formed. If a dynamic
view is taken, it may still be worthwhile for new trade blocs to emerge which
generate significant intra-bloc efficiencies, even if their trade-diverting effects
diminish global welfare in the short run, provided that such blocs eventuallylead to free global trade. That approach could be seen as taking one step
backwards or sideways in order to go two steps forward.
RIAs, by their very nature, involve preferential treatment among members
and therefore discrimination against countries outside the region. But for
RIAs to avoid excessive damage to the long-term interests of global free tradesuch discrimination must be contained within acceptable bounds.
RlAs among developed countries have limited the damage done by welfarediminishing discrimination mainly because the focus has been on reducing
barriers to trade in manufactures on which most developed countries (insharp contrast to developing ones) have always maintained generally low
levels of intra- and extra-regional protection.
27 Stoeckel, A., Pearce and Banks, Western Trade Blocs: Game, Set or Match for Asia-Pacific andthe World Economy, Centre for International Economics, Canberra, Australia, 1990.
28 (1) Deardorff, and R. Stern, Multilateral Trade Negotiations and Preferential Trading
Arrangements, (mimeo), 1991; (2) Srinivasan, T.N., 'Discussion on Regionalism vs.
Multilateralism by Krugman', In: de Melo, J. and A. Panagariya, New Dimensions in Regional
Integration, (op. cit.), 1993.

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In some cases extra-regional barriers were reduced as RIAs were implemented. In others trade barriers were already low when these arrangements
were agreed. Such outcomes have done little to damage global welfare. But
even in such cases, large negative effects may still be felt by non-regionalcountries whose production and exports are concentrated in products andindustries where discrimination applied by large global trading blocs such as
the European Union and NAFTA - because of the proportion of world trade
which they account for - have been increased or remain high. For example, in
the European Union products discriminated against are in agriculture, coal,steel, shipbuilding, textiles and apparel. These products have enjoyedexcessively high protection for several decades. The European Union has
raised average effective protection for these products above those which
would have prevailed in several member countries in the absence of thecommon markct.s"
RIAs (like those of the European Union in the automobile and electronics
industries) which force defensive foreign direct investment by firms from
non-member countries also damage global welfare. Defensive foreign
investment is FDI which is diverted to a particular region by foreign firms
anxious to establish production capacity within that region and avert the riskof losing market share should that region increase its trade barriers later. It
represents a diminution of global welfare if it reflects a pattern of foreign
investment which is different from what would occur in the absence ofregional trade barriers and guided by undistorted market signals.

GATT Rules
RIAs, by definition, go against the raison d'etre of GAIT, which is foundedon the principle of non-discrimination in trade across all of its signatories(Article 1). Yet GAIT permits RIAs under Article 24 as long as: (a) other
GAIT members are notified of their details; (b) they do not raise tradebarriers against other GAIT members; (c) such arrangements embrace
substantially all trade between the regional members; and (d) RIA partners

29 The absurdity of the ED's Common Agricultural Policy (CAP) has been a glaring
example of regional and global welfare reducing protectionism for a long time. The CAP has
introduced substantial discrimination against non-regional producers (mainly Eastern Europeanand developing countries) in virtually the entire range of agricultural tradeables. CAP sets intraED prices so far above world prices that it encourages over-production and structural oversupply
with very heavy (and costly) stockpiling and even more heavily subsidised dumping in export
markets which depresses world prices even further and drives efficient farmers in other parts of
the world out of business. CAP involves an egregious expense for foreign producers as well as to
ED consumers. It also results in major losses of production efficiency within the ED because of
the amount of resources it compels to be misallocated.

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are committed to reducing barriers to intra-regional trade along a specified
schedule within a reasonable time span.
Article 24 was included in GATT mainly because those who framed theAgreement felt that RIAs could provide a complementary, practical andpossibly, in some areas, faster route to global trade liberalisation. But theclauses in Article 24 were inserted to minimise the adverse effects of RIAinduced trade diversion on members of such arrangements as well as on nonmembers. There was also concern that the number of RIAs within the GATT
system should be limited to those where the intensity of the politicalcommitment to RIAs was commensurate with the liberalisation and structuraladjustment effort required for such arrangements to succeed (Bhagwati:1993).30
GATT's main concern was that the world trading system should not again
fragment into the myriad discriminatory or sectoral, bilateral, and plurilateralarrangements that characterised the 1930s. It also recognised that, if RIAs led
to regional blocs assuming nation-state characteristics as far as their trading
and other economic arrangements were concerned, they might actuallyfacilitate rather than debilitate eventual global integration by reducing thecomplexity involved in global negotiations. It would not be unreasonable toargue that global integration might actually be easier to achieve throughnegotiations among a few large players (e.g. regional blocs which were fullyinternally integrated) than through negotiations involving 200 individual
players of vastly differing weight, size and capacity. Moreover, tradeliberalisation via RIAs could be a useful first step towards globalliberalisation
under future WTO negotiations.
RIA negotiations are less affected than GATT rounds by free riders (i.e.
members who benefit from most-favoured nation (MFN) treatment whileescaping the reciprocal obligations that MFN requires), foot dragging (whenadvantage is taken of rules requiring consensus to block movement) and theconvoy effect (moving at the pace of the slowest).
In 1979, an enabling clause was inserted into GATT which weakened
Article 24 by allowing RIAs involving only developing countries to ignore
Article 24 altogether unless they involved the selective lowering of non-tariffbarriers, in which event approval was required by all GATT members.
Though the intent and spirit (if not the letter) of Article 24 have been
violated extensively by several RIAs, not least by the European Union, it
would be difficult to make the case that such side-stepping of its provisions
has impeded movement towards gradual globalisation of freer trade - as the

30 Bhagwati,]., 'Regionalism and Multilateralism: An Overview', In: de Melo, ]. and
A. Panagariya, New Dimensions in Regional Integration, (op. cit.), 1993.

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completion of the Uruguay Round would suggest is .happening. Despite theproliferation of RIAs, most of them (especially EU and NAFTA) maintainrelatively low external trade barriers except in the egregious cases of certain
protected industries and sectors mentioned earlier (especially agriculture).
Also, the unilateral trade liberalisation undertaken by countries which are
members of RIAs has helped to mitigate the potentially negative effects oftrade diversion. It is generally accepted that RIAs are not responsible for thevarious non-tariff barriers that have crept in since 1980 such as voluntary
export restraints, countervailing duties, anti-dumping measures, orderly
marketing arrangements and legislation like Super 301 in the United States.
Such measures reflect the resistance of most developed economies toundertaking the necessary structural adjustments required by changes indynamic comparative advantage.

Theoretical Objections and Practical Benefits
For RIAs to contribute to the globalisation of free trade, the multilateralsystem must be receptive to commensurate change in order to be able tosubsume effectively and gradually the liberalisation occurring under regional
integration arrangements. As de la Torre and Kelly argue:'The multilateralisation of liberalisation gains under regional arrangements
presupposes; of course, that a credible and well-functioning multilateral system isin place. Thus, steady progress with multilateral liberalisation is essential to:
subsume preferential trading arrangements into a broader and more open trading
system; to hold in check - and indeed to erode - the inherent discrimination ofsuch arrangements; to convert their regionally circumscribed Iiberalisation into
building blocks for freer trade on a global basis; and to prevent regionalism fromfragmenting the world trade system.' (de la Torre and Kelly, Ope cit., p. 44)

Whether RIAs are consistent with, or antithetical to, the strengthening of
the multilateral system is, in the final analysis, more a matter of judgement
than of fact. Assessing whether RIAs (either particular ones or in general) will
help or hinder the cause ofglobalisation is more a matter of ex-post empiricalthan of ex-ante theoretical analysis. Global trade authorities who are also
confirmed multilateralists, like Bhagwati and Schon.I lrcmain sceptical about
the revival of regionalism while acknowledging its popular and politicalappeal. Others take the opposite view in . being somewhat overenthusiastic

31

Schott,]., 'More Free Trade Areas?', In: Schott, J. (ed), Free Trade Areas and US. Policy,
1989.

Ins~tute for International Economics, Washington DC,

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about the benefits of regionalism versus the intractability of achieving muchat the global level.
Taking the view that RIAs would be less harmful if they were more open tonew (and non-regional) members - because they might then realise thepotential of being building rather than stumbling blocks towards globalisation- the sceptics see the following issues as limiting the extent to which RIAs can
aid the cause of global trade liberalisation:• When negotiations for RIAs and multilateral trade rounds occur simultaneously, as in the Uruguay Round, RIA negotiations divert morecapable and scarce human resources and skills available in participant
governments away from the GATT negotiations. Such diversion occurred
even in cases where members were more committed to the cause ofmultilateralism but felt the need to take a defensive posture in the face ofmoves towards RIAs by major trading partners.
• The cumulative trade-diverting effects of RIAs across several different
regions increase the risk of trade frictions and political pressures forretaliation, thus risking damaging chain reactions and setting back thecause of global free trade.
• Proliferation of RIAs would trigger a number of technical problems suchas mismatching in the phasing of tariff reductions under different overlapping agreements, inconsistent rulings under different dispute settlement mechanisms, and confusion in interpreting and enforcing different
rules of origin.
• Smaller countries would be hurt more by RIAs than by globalisation of
trade liberalisation, particularly if they were undertaking structural adjustment programmes at the same time.
The interested observer might be forgiven for concluding that some ofthese reservations, manufactured in the heat of debate, when it appeared that
the Uruguay Round was in mortal danger, seem to be more contrived thanreal. The Uruguay Round has now been satisfactorily concluded, despite a few
loose ends. It has succeeded in striking a crude bargain between developed anddeveloping countries, with the former conceding the need for further
liberalisation in agriculture and textiles and the latter agreeing to consider
opening their markets in areas not formerly covered by GATT, i.e. services,
investment and intellectual property. Now that the distemper of negotiation
has faded, some of the more imaginative arguments against RIAs havemoderated with an acknowledgement that regionalism is here to stay and thatit may, on balance, be a beneficial development.
It is now more widely accepted that RIAs may bring collateral benefits totrade liberalisation, especially by: (i) cementing economic cooperation in
non-trade areas such as sectoral investment coordination, macroeconomic
policy coordination, financial sector integration and in achieving efficiencies

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in externalities; and (ii) bringing about closer political cooperation andperhaps even providing a framework (it la ASEAN) for the more effective
settlement of disputes on a regional neighbourhood watch basis than themultilateral security system presently provides.
In the last aspect, of course, the UN security apparatus needs to develop
much more effective linkages with regional political organisations (such as
Organisation of Mrican Unity and Organisation of American States) than it
has done so fat with the world community devolving more responsibility tothese regional organisations for resolving conflict and maintaining stability intheir regions.

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8Synopsis and Conclusions

The Road Aheadfor Developing Countries
The preceding sections made the case that developing countries may havemuch to gain from various forms of regional cooperation and from launching
determined efforts to integrate their regional markets despite the difficulties
that confront them. There are in fact few developing regions in which a casemight be made that welfare gains would not emanate from greater integration.
But it has to be acknowledged that, without in-built compensatory mechanisms designed to distribute regional welfare gains equitably across all
members, the pattern of their accrual, left to market forces alone, would
benefit the more developed countries in each region, especially in the shortand medium term. This pattern would be reinforced, at least until such time
as major regional investments in infrastructure and production bore fruit, andthe less developed countries within a region began to benefit from crossborder investments and enhanced intra-regional trade.
Economic development is likely. to .be enhanced through capturing thebenefits of increased regional welfare in the next few decades in mostdeveloping regions. Such benefits are likely to accrue primarily from threesources:
1. Infrastructural investment coordination: Developing countries will gain fromsubstantial cost savings by coordinating investments in physical infrastructure on a regional basis. Such investments have so far been unnecessarily expensive in most developing regions, due to the desire of eachdeveloping country to be self-sufficient and independent of its neighbours
for strategic. reasons. The absence of regional accord and harmony
between neighbouring· states. in several poorer developing regions (South
Asia and Africa) has particularly inhibited rational use of. scarce regionalenergy and water resources, making them more vulnerable to weather for
their agriculture, and to. costly oil imports for their energy needs than iseither desirable or necessary.
2. Cooperation in regions afflicted previously by conflict: Substantial benefits wait
to be realised from trade creation, expansion and intensified cross-borderinvestment between contiguous countries which have previously been in
conflict, in a new era of normalised relations. This would be particularly
true in the Middle East, South Asia, Indo-China, Central Asia andSouthern Africa. RIAs in these areas will enable frictional losses from

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substantial illicit trade, and the inhibitions to more open trade, to bedispensed with. Clearly the trade deficits that less developed countries in aregion are likely to incur vis-a-vis more industrialised neighbours in any
given region will need to be offset by capital inflows and remittances in
the opposite direction over the medium term.
3. The 'externalities' or unorthodox gains from regionalisation which occur whenthe major non-tariff barriers to enhanced regional intercourse are removed
are likely to be even more important than the orthodox net trade creation. gains. These types of gains are numerous and varied, as previous sections
have brought out.
It may be therefore that developing countries need to approach RIAs on
two parallel but connected tracks without holding progress on either hostage
to the other. These involve:
A. Sectoral investment coordination and cooperation on major investments andpolicy harmonisation in key sectors and industries on a regional scale,coupled with closer integration of financial sectors and markets. RIAs inthese areas in most developing regions can proceed almost immediately.
They are not contingent upon, nor should they be delayed by, progress ona more intensive agenda of trade liberalisation and integration.
Coordination in each sector should be encouraged to proceed as fast as
circumstances permit without being affected by the pace of progress inother sectors. This will necessarily mean accepting the concept of multispeed coordination across different sectors. Given different levels ofdevelopment among member countries, coordination should not be held
hostage to universal consensus being reached by every country in theregion on each action. Where coordination can be achieved among a
sufficient number of countries in a particular sector, such coordination
should be arranged to occur at the most rapid possible pace providing, ofcourse, that such progress does not compromise the interests of othercountries in the region.
B. Trade liberalisation and market integration constitute a related but separate
track on which progress can be made with a clear agenda being established
for the reduction of tariffs and non-tariff barriers. Such reductions can be
programmed on schedules which are realistic in the context of evolving
political and economic developments in particular developing regions.
The market integration agenda, though related to the investment
coordination agenda may, in substance, be a distinct one. Progress withthe reduction of tariff barriers can and should be made as rapidly as
possible, especially as their consequences are not as significant as is often
portrayed. Apart from reducing tariffs, the market integration agenda
involves an array of issues in eliminating non-tariff barriers and in achieving

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greater convergence and stability among members in their fiscal andmonetary policies and performance, their inflation targets and theirexchange rate and currency convertibility regimes.
These issues are complex and go to the heart of national economic policymaking. They involve questions about subordinating sovereign national
interests in the short term to achieve regional benefits in the long run whichshould make all national members better off. Given the macroeconomic
divergence which still characterises developing economies in most regions atpresent, and their relative states of political flux, movement on a market
integration agenda will necessarily be slower than the pace at which
coordination cap be achieved in particular regional investments and theharmonisation of operations in particular sectors.

The Political Dimension
Although a strong case could be made for further economic integration inmost developing regions, it would be sanguine to suggest that the acceptanceof such evaluations would rest solely on perceptions of the economic costs andbenefits to be derived either by the region as a whole or by its individual
members. In the final analysis it is political will and commitment that
determine whether regional integration is embarked upon with serious intent
and whether it succeeds or fails.
That fundamental factor has determined the fate of previous attempts at
integration in various parts of the developing world. Matters are not likely to
be different now, despite the new climate in favour of regionalism as anecessary intermediate step towards globalism. Mustering political will for
integration in the individual countries of several regions will depend on how
accurate perceptions are about the costs and benefits of integration in eachcountry, not just in economic but in political terms. And the perceptions
which count in democratic societies are those held by the public at large
rather than those of a technocratic elite.
RIAs must bring prospects not only of prosperity but also of durable peace,security and stability. At a time of intense political flux in most developing(and indeed some developed) regions, the national political will to achieve
closer integration is difficult to muster. Unless individual member governments and political leaderships can be convinced unambiguously that theprocess of closer regional integration will help them deal with their domestic
economic, political and social problems better than they otherwise could,
they are likely to be preoccupied more with managing, in a purely nationalsetting, the simultaneous transitions which are now overstretching theirlimited capacities than with regional issues.

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For regional integration to succeed it must have a large political constituency
among political leaders, technocrats, opinion-makers and the public at large.
It must convince the populace at large that regionalism can be an effective
route to the solution of national problems. But, unfortunately, in thosedeveloped and developing countries which are pivotal to the success of RIAs
in their respective regions, the present political thrust is to turn inward anddeal with the issues of national rather than regional integration.
In other countries leaderships have not yet fully appreciated that theirprospects for mutually advantageous interaction with neighbouring countries.
may be improved through the negotiation of appropriate regional arrangements rather than through bilateral arrangements. That, for them, may prove
to be the strongest political argument. United within the region, smaller
countries can stand and deal with much larger neighbours on mutuallyacceptable terms; divided, they are more likely to fall and be compelled todeal with the dominant economies of the region on the latter's terms.
The danger that must be avoided in the search for closer integration is asituation where countries in a particular region express far-reachingcommitments which do not reflect their national priorities.V Even thoughsome of the requirements that have to be satisfied for RIAs to play adevelopmentally supportive role are well recognised, and are reflected in
specific provisions of RIAs among developing countries, this has not hadmuch effect on policies because of the lack of priority accorded to regional
integration in national development strategies.
Given the obvious potential that exists for mutually beneficial cooperation
among countries in many developing regions, where should they go fromhere? What are the implications for a strategy on the part of developing
countries and for the role of donors and funders? What steps seem to be
indicated, and in what sequence? What can be done in the short run? Whatmechanisms need to be put in place to provide the best assurances that oncethe preconditions for integration have been given and a favourable framework
for cooperation has been created, these will subsequently be maintained?

The Role ofDonors
The role of donors and other external funders in supporting regional
integration for its own sake, or as a means of facilitating structural adjustment,
32 .For example, commitments have been made by various African countries, as members of
the GAD, with respect to RIAs in acceding to the 1991 Abuja Treaty establishing the African
Economic Community which contains an article establishing a Solidarity Development andCompensation Fund. But even in the many sub-regional arrangements which exist in Africa,
implementation lags woefully, not only in relation to tariff preferences but also in relation to themany potentially valuable administrative cooperation measures that have already been agreed.

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must be predicated upon a realistic appraisal of objectives and instruments ina given region. The European Union in particular could playa more broadly
based part, as suggested by the Lome IV Convention and the post-Maastricht
initiative, especially in the light of the problems of information andnegotiation. which developing countries face in negotiating RIAs amongst
themselves.
A separate but related issue is whether an RIA-based framework mightprovide a more appealing and workable set of organising principles for thedevelopment assistance paradigm, changing it from government-togovernment capital aid to various forms of aid-supported, capital andinvestment flows between industries and firms within the private sector. At
the same time greater responsibility might be allocated to private voluntary,
non-governmental organisations for the delivery and management of
humanitarian assistance, emergency relief, and people-to-people assistance
aimed at poverty alleviation and meeting basic human needs.
Such a paradigm shift would provide one possible option for replacing thepresent official aid machinery (bilateral and multilateral) which has evolved
over the years into becoming somewhat sterile and sclerotic. It might also
encourage more genuinely democratic, participatory involvement indevelopment at the recipient end, thereby diminishing developing-country
government domination of that process in a manner which disenfranchises
and disempowers the intended beneficiaries.
Whether such a paradigm shift should replace entirely the existing
structure of the global aid industry, which has become a powerful vested
interest in its own right, or whether it should emerge as a competitive
complement to regalvanise that government-driven structure is an interesting
but somewhat different matter that must be left open for further
consideration.

Learningfrom Experience
RIAs among developing countries which bring them closer in regions
across the world should clearly draw on their own previous experience as wellas lessons learnt from elsewhere. This would mean adopting approaches
which are:(a) aimed at alleviating the binding constraints first;(b) incremental rather than comprehensive in terms of the chosen instruments;(c) open-ended rather than exclusive in terms of membership, focusing
initially on a core group of contiguous countries among which significant
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(d) limited in initial operation to particular classes of enterprise or zones,
though relying on automatism rather than administrative discretion forthe operation of any incentives and preferences; and(e) above all, flexible in accepting the need for variable geometry.
Such an approach would suggest that although a time frame and appropriate
sequencing are important for the success of RIAs, specific proposals for bothwould be out of place until the scope for cooperation in various sectors and in
all factor markets had been tested. There are obvious merits in proceeding on
several fronts simultaneously through packages of measures from which allcountries can expect to benefit. But if RIAs are confined to cooperating inparticular sectors or coordinating certain policies, it will be less easy fordeveloping countries to achieve wider, more comprehensive resource allocation
efficiencies - and yet respect the imperatives of equity among members without some type of regional policy being included in the arrangements
agreed.

Distribution ofCosts and Benefits
The main issue which has influenced national perspectiveson the merits of
RIAs is, of course, the distribution of the costs and benefits of regional
cooperation. There are two ways of dealing with the trade-off between equity
and efficiency. The first is through fiscal compensation. Sole reliance oncompensation is unlikely to be attractive to less advanced countries unless it isso generous that it is also unattractive to the more advanced countries whowill be the net contributors. The alternative is to adopt measures that arecalculated to ensure that moves towards integration are irreversible. Suchmeasures may also be expected to minimise the risk of polarisation without
sacrificing the production gains from regional integration.
If approaches along these lines are insufficient, then some form of regional
investment policy may be necessary. Such a policy would be designed toinfluence the allocation of investment through incentives. However, a strong
interventionist thrust towards planning resource allocation and infrastructuralinvestment on a regional basis (as was the case with many first-round RIA
attempts in the developing world) would be .anachronistic and inconsistent
with the current ethos of structural adjustment.
Such an orientation would, in any event, be opposed by external funders
and donors whose support is crucial. It would go against the grain of
increasing private participation in investment, which individual governments
could encourage on a regional basis by clearing the obstacles they have placedin the way of such investment, rather than attempting to undertake itthemselves. Of course, significant public sector involvement will be necessary77
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in implementing RIAs in the developing world, but outside of a strictly
limited public sector, the role and design of second-generation RIAs must be
such as to create a regional policy environment which enables markets to be
progressively integrated over time.
It must be recognised that RIAs by themselves are unlikely to make asignificant contribution to the convergence of real incomes across economies
in any of the world's developing regions in the foreseeable future. The economic dominance of some large countries, and therefore some degree ofpolarisation, is likely to continue whether or not there is greater movement
towards regional integration. However, it would be self-defeating for developing countries to protect themselves by taking unilateral measures that
discriminate against their more advanced neighbours. If they are to moderate
the effects of existing dominance, it can only be through the development of
RIAs that enhance their own economic attractiveness, and at the same time
promote infrastructure investment coordination so as to level the playing
field for private investment across the region.

Regional Adjustment Programmes
An indispensable impetus to the process of strengthening sub-regional
cooperation might be given by funders through the initiation of a multifaceted regional reform programme. Unlike the World Bank's Regional
Adjustment Programme for UDEAC in Central Africa, however, any suchprogramme for other developing regions should not be confined to measures
which would only make country-specific structural adjustment programmes
more effective. Regional adjustment programmes should instead be aimed
specifically at encouraging integration initiatives by supporting harmonised
reforms needing multilateral negotiation.
Priorities of properly designed regional adjustment programmes would
need to include: (a) currency convertibility, (b) fiscal reform, (c) lowering ofbarriers to entry, (d) trade liberalisation, and (e) arrangements to promotecredibility.
(a) Convertibility: The lack of current-account convertibility is a dominantobstacle to exploiting such feasible trade opportunities as there are, just as
capital convertibility is the dominant obstacle for cross-border investment. The policy measures already taken by most developing countries inreforming their fiscal and monetary regimes will need to be continued,
but their regional dimension and their possible regional repercussions willneed to be addressed.
(b) Fiscal Reform: In most developing regions, the next stages of fiscal reformmust focus on more buoyant and broadly based sources of revenue andindirect taxation. In particular, fiscal reform should be a precondition for:78
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fiscal and monetary stabilisation; the introduction of regional tariff
preferences which might otherwise have adverse revenue implications;moving towards lower tariffs; more efficient and transparent methods ofraising revenues in ways which do not raise prices to consumers. In
unifying markets and reducing transactions costs, harmonisation of tax
structures would have an important role to play so that, for a foreign
investor, familiarity with the tax system of one country would imply afamiliarity with those of the rest. A simplification of tax structures,
particularly for any taxes that are involved in border tax adjustments,
would be equally important. Tax obstacles to regional operation ofenterprises posed by different national regimes for corporate taxationneed to be reduced. Some of these reforms would be required undercountry-specific structural adjustment programmes anyw-ay. If integration
is to be encouraged, the regional implications of such reforms should betaken into account, either on an ad hoc basis, or preferably in conjunction
with a supplementary regional adjustment programme.
(c) Entry Barriers: A third priority is to overcome entry barriers. In someareas, the costs of doing so would be largely administrative, though perhaps
considerable. Action on these lines would help to create a framework for
capturing many of the unorthodox benefits of RIAs which promise to beof greater significance than any immediate trade expansion gains. Oncesuch a framework was in place, the stage would be set for a unified
customs union within which trade could be freed, not only from nontariff barriers, but also from tariffs. Such a union could be underpinned byexpanded foreign direct investment, partly from within the particularregion.
(d) Trade Liberalisation: For a variety of reasons, many developing countries(especially the least developed) have not been directly involved in theprocess of reciprocal negotiations through which world trade has
gradually been liberalised over past decades. Instead, these countries
through UNCTAD and the European Union have sought and obtained
non-reciprocal trade concessions from developed countries en bloc (e.g.
under the ACP arrangements of the European Union). Non-reciprocity
has left some of the least developed country governments free to impose
trade restrictions at will. The resulting climate of protectionism anduncertainty has been highly damaging to the development of enterprise,
regional trade and foreign investment. Of course, in the 1980s tradeliberalisation became a prominent objective of donors and multilateral
funders, and was encouraged by adjustment conditionality, butliberalisation of trade policy encounters the same problem of credibility
as monetary and payments reform. There is a perceived risk in the eyes ofinvestors that it may not be sustained, regardless of rhetorical assurances.

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For trade liberalisation and market integration to be fully credible indeveloping regions, member states would have to be prepared to accept
regional arrangements from which they would have much to lose
if they should resort to a reimposition of national barriers to market
integration.
(e) Credibility: In the early phases of implementing RIAs, it is imperative that
confidence is established in the binding nature of the integration
initiatives and the general policy reforms bearing on them. For example,
once regional currency convertibility has been established, ensuring its
durability becomes crucial. Since few, if any, individual developing
country groupings constitute optimal currency areas, a fixed peg to an
external anchor currency would seem to be the best option. An externalanchor can provide the needed external support by donors for maintaining parity while at the same time imposing the necessary monetary
discipline.t ' In some regions, the level of development of most member
countries might rule out the need for external support. But in any case,the need to devise suitable mechanisms for preventing a dominant
country from inadvertently pushing its own currency as the regional
reserve currency or from pushing other countries' exchange rates in a
direction they did not wish to follow would have to be addressed.

External Linkages
It is arguable whether new kinds of external links may need to be negotiated
if intra-regional trade and investment in developing regions and, ultimately,
outward-looking policies on the part of developing regions as a whole, andnot just their individual members, are to be significantly promoted. The
completion of the European Union's own internal market, its movement
towards a monetary union, and the eventual renegotiation of the Lome
Convention, all provide an opportunity for fresh thinking about anappropriate external context for RIAs in the developing world.
A revised form of association with the European Union, with somereciprocal elements, could have several beneficial effects for countries in
Eastern Europe, the Middle East, Africa, the Caribbean, the Indian Ocean,
33 In Africa, for instance, the recognition of these factors has led several countries outside
the franc-zone monetary unions (Ghana, Equatorial Guinea, Guinea-Bissau and Gambia) tosignify their willingness to abandon monetary sovereignty by accepting the monetary and fiscal
constraints implied by the acceptance of franc-zone membership in return for its benefits. The
acceptance of such obligations has had a significantly favourable effect on the member states ofthe franc-zone currency union's macro-stability. If the franc-zone monetary union arrangements
survive their post-devaluation difficulties, their members will, in effect, become associate
members of the European Monetary Union.

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and the Pacific and even South Asia (especially Bangladesh, Nepal and Sri
Lanka). Such an association could contribute to binding trade liberalisation
by increasing the disincentives to reimposing trade restrictions. It could thus
encourage both intra-regional trade and intra-regional cross-border investment in these different parts of the world.
It could also contribute in the long run to improved performance inEuropean markets by encouraging the creation of capacity. In the case of the
Caribbean, which has ACP entry into the European Union, associatedarrangements are also being sought with NAFTA, although it is questionable
whether a Caribbean Economic Community could actually have preferential
arrangements with both trade blocs. The idea is an intriguing one. It would,of course, be automatically resolved if the super-NAFTA now being mooted
actually came into being.
Many strongly held views and prejudices would, however, have to bediscarded before any such approach could enter the realm of practical politics
in several developing countries. Fears of the loss of economic sovereignty (i.e.
the spectre of recolonisation which would undoubtedly be raised by populist
politicians) need to be allayed.
That this path need not be excluded, a priori, from consideration issuggested by events now taking place in several regions of the developingworld. For instance, in marked contrast to their previous positions, most
Latin American countries are now seeking to forge new and closer links withNAFTA, partly with some of the motives outlined here in mind, while the
Caribbean islands are looking at the utility of external cooperation links inrelation to monetary affairs.

A Pragmatic Approach to Strengthening RIAs in Developing Countries
In order to succeed, second-generation RIAs in the developing world will
have to adopt a selective, pragmatic, step-by-step approach towards achieving
progressively greater integration. Such an approach would need to focus
initially on agreeing RIAs within those countries that constitute the mostcohesive groupings and where successes can be quickly achieved.
It is clear that continuing adjustment problems in many developing
regions, and large reconstruction needs in others, will make it difficult or
impossible for all regions, or even all countries within a particular region, to
integrate at a uniform pace, except the pace of the slowest. At best,
integration at several speeds and with a variety of focuses may be the only
practical path to follow for developing countries negotiating RIAs. Even so,
the process of negotiation and agreement-making could be a long one.
Are there more immediate alternatives that might be pursued meanwhile?
Several actions which might promptly be taken in advance of wider integration
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mmatrves in different regions are worth exploring in order to give some
impetus to the process.
1. If current payments obstacles can be overcome by building on bilateral
trade agreements already in place, these may help to encourage further
trade expansion and rationalisation. However, unless this could be done
within a harmonised framework of preferences, it might create in-built
distortions. Without investment guarantees, this approach is unlikely togenerate the cross-border and other investment needed to generatesignificant benefits from regional cooperation. Effective investment
guarantees would require more than merely inter-governmental accord onregional objectives. New forms of independent guarantee institutions,
properly funded by interested states, and perhaps underpinned by externalaid, may be an indispensable precondition for significant progress. As astart, all developing countries should at least join the Multilateral
Investment Guarantee Agency (MIGA), a World Bank affiliate, as anindication of their commitment to fostering and protecting foreign direct
investment.
2. In order to anchor firmly efforts of full convertibility, intra-regional tradein developing countries might be encouraged by ensuring that existingexchange controls do not discriminate against such trade. Such a policy
could go even further than this by encouraging discrimination in favour of
it. The modus operandi for such an operation might be to extend existing
systems of open, general import licenses to cover all intra-regional trade(but administrative and financial difficulties might rule this out). The
abolition of licensing in respect of transactions passed through clearing
houses created to facilitate intra-regional settlement should be agreed at a
mmimum.
3. Attention could be given to extending cooperation and improving theefficiency of public sector operations in the development and maintenanceof infrastructure which are critical for regional economic integration anddevelopment. Such areas include interstate roads, railways, ports, airlines
and airports, telecommunications, water supplies and energy. The
establishment of regional operating authorities in these sectors, jointly
owned by all regional members, has evident attractions in the longer term.
4. Consideration should be given to reorienting the roles of existing regionaland sub-regional development banks specifically to promote RIAs in theregions they serve. The Inter-American Development Bank is playing a
useful and effective role in this regard, while the African Development
Bank is somewhat less effective in the many efforts it too is making tofurther the interests of integration in the various sub-regions of Africa,
The Asian Development Bank has played a relatively small role in this82
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regard, while the newly established European Bank has focused on theissue with some enthusiasm. Sub-regional banks (e.g. in Mrica and the
Caribbean) have focused more heavily on aspects of regional integration
than their larger regional counterparts. Given the characteristics of theirmemberships, regional banks now need to model themselves and theiractivities much more on the lines of the European Investment Bank andmuch less on those of the World Bank. If regional integration is tobecome one of their main concerns the regional banks need to become
strong focal points for the promotion of RIAs with a large proportion of
their funds being specifically earmarked for financing regional adjustment
programmes, large joint regional projects in cooperation with thedomestic and foreign private sector (regional banks operating in this way
could be very effective magnets for attracting foreign investment flows),
developing regional financial and capital markets, and alleviating
the constraints on trade financing and cross-border private investment
financing.
5. Other partial approaches to RIAs - e.g. through the establishment of joint
special free trade and economic zones (such as the growth triangle venture
among Indonesia, Malaysia, and Singaporej-" - could be attempted
although overall experience with such initiatives has been mixed. Regional
wage rate differences play an influential role in determining the
momentum behind, and success of, such initiatives. It will be important totake advantage of wage rate differences in developing regions, either bypromoting arrangements for facilitating additional cross-border labour
flows or by facilitating cross-border investment.
Strategies for achieving progressively closer regional economic integrationin the developing world thus need to be based on three simultaneous prongs:(a) sectoral cooperation, (b) market integration, and (c) an appropriate
institutional framework. In the short term, priority must be given to working
on areas which promise immediate pay-offs in any particular region. Over the
medium term, more progress can be made in other sectors of activity and on
gradual macroeconomic convergence which progressively relieves constraints
on the free regional movement of commodities, manufactured goods, services,24

The success of the growth triangle in the Malacca Straits, which involves transnational

corporations-based production integration, does not rely on trade preferences. Acute labour

shortages in Singapore have been a major factor in stimulating these links; to that extent theirsignificance in other developing regions may be limited. Interestingly enough, a similar situation
has arisen in the Indian Ocean with the spectacular economic success of Mauritius resulting inoveremployment and triangular relationships developing with other Indian Ocean islands as far
afield as Sri Lanka. Another example which is similar, though not based in designated zones assuch, is the success of the maquiladora enterprises located just south of the US border in Mexico.

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people, capital and technology. In these other areas a strategy for RIAs in any
given developing region will still require certain foundation-building
measures to be taken now, even though results can realistically be expected tomaterialise only over a much longer period of time.

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Annex I

Economic Coordination, Harmonisation andIntegration - Definitions

A non-trivial issue concerns the definition of what is meant by thegenerally used terms regional cooperation, coordination, harmonisation andintegration. This concern about semantics goes beyond simple pedantry. It isessential to be clear about these definitions as they involve different
objectives, processes, decision-making arrangements, and institutional
structures. In attempting - but not always succeeding - to adopt consistentterminology throughout, this study adopts the following definitions inascending order:
COORDINATION constitutes the lowest level of economic integration. It
suggests a voluntary alignment of specific national (project) investments
whether public or private in various sectors of activity. It may even involvean alignment of policies at the meso or sectoral level in such key areas as
power, transport, communications, water resource management and soon. It is the level at which several regional integration arrangements(RIAs) in the developing world actually function.
• HARMONISATION is the next higher level of integration. It usually involves
the adoption of common legislation, on a national basis, governing the way
in which countries utilise particular policies or instruments - i.e. tariffs,
non-tariff barriers, fiscal incentives and subsidies, investment and othercapital allowances, direct and indirect taxes, standardisation of specifications for products or qualifications, monetary management, etc.
Although these may be regionally agreed they are nationally controlled andapplied. Preferential Trade Agreements and Free Trade Areas usuallyrequire some harmonisation of domestic legislation governing the tradeand exchange regimes of member countries.
• INTEGRATION, strictly speaking, usually means the assignment ofresponsibility for formulating regional policies, developing rules andregulations, and for applying these policies to all markets at a regional
level, superseding national control. It requires members of an RIA to cedesovereignty over particular economic functions and activities as well as
policies and instruments to an authority or institution which exercises its
power at the regional level. Integration thus means formulating andapplying regional trade, exchange, labour market, fiscal and monetary
policies at the regional level. Integration also implies the development of 'acommon currency and a single central bank or monetary authority which
regulates the monetary - and indirectly the fiscal - parameters within
which national governments function. It implies the free movement of all•

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investment coordination in priority sectors through one institutionalframework, while simultaneously trying to achieve trade liberalisation andeventual market integration through another.
In these instances the coordination option is not a prelude to the normal
trade liberalisation route to integration but an adjunct. A variant of thecoordination route involves greater political cooperation between members at
an earlier stage. This is necessary in order to overcome impediments tointegration on the assumption that a market-based, trade liberalisation
approach may yield limited immediate results given the circumstances inwhich developing countries usually find themselves.
Such a variant stresses the need for achieving equity and balance in relations
under regional trading and investment arrangements which otherwise arelikely to result in the net welfare and efficiency gains accruing from RIAs
being captured unequally by different members (this was a problem which
exercised Indonesia in ASEAN).
Yet another variant of this approach might be called enhanced coordination.
In addition to sectoral investment coordination and political cooperation on awide range of matters, such an approach incorporates the need for compensatory policies, as well as targeted regional investment and development
policies, to accompany coordination and/or trade liberalisation measures so as
to accommodate the needs of the lesser developed members of the region. It
envisions the need for market integration to be accompanied by coordinatedregional industrial development, regionally-decided allocation of investment
resources, and harmonisation of investment flows toward lesser developed
members. This approach was attempted across Latin America, the Caribbean
and in some sub-regional RIAs arrangements in Africa (e.g. in the East
African Community).
Enhanced coordination is subject to the criticism that, rather thancorrecting the causes of market failure in exacerbating maldistribution,
bureaucratic interventions fail to equalise welfare gains through directed
regional investments. Such attempts have usually resulted in costly planningand implementation failures without achieving the distributional ordevelopment objectives intended. The alternative of undirected compensation,as occurs under some regional arrangements (e.g. SACU), has the advantage
to recipients of being a general budgetary resource usable at the discretion of
governments but with the disadvantage that, for precisely that reason, suchrevenue can be used to meet recurrent expenditures thus relaxing budget
discipline and having little developmental impact.

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Annex II

The African Experience with Regional
Integration Arrangements

The arrangements of African blocs that go beyond preferential trading are
similar to those first practised in Europe for customs unions and free tradeareas, but adapted to African conditions. Several such arrangements havebeen attempted in Africa during the colonial period and thereafter. Somehave evolved, many have atrophied and others have been abandoned. The
most notable examples include those in Southern Africa - i.e. PTA, SADC
and SACU-MMA - which were preceded prior to independence by evencloser arrangements such as the Federation of Rhodesia and Nyasaland.
Wide cooperation arrangements also existed during colonial days and postindependence in Central Africa (CAU and UCAS), West Africa (CEAO,UDEAC, WACU and OSRS), the Indian Ocean (laC) and in North Africa(MPCC). Specific and limited cooperative arrangements have been attemptedat the level of sectors and for specific commodities (coffee, cocoa, peanuts,
tobacco, etc.).
It is obviously impossible to recount experience with all of these arrangements, but it is instructive to dwell briefly on two of the more interestingcases: those of the now defunct East African Community (EAC) and theEconomic Community of Francophone West African states (CEAO). The
special interest of these experiences lies in the attempts to deal with the
problem of regional equity.

The East African Community (BAC)
In East Africa, recourse was first made, in 1961/62, to fiscal compensationfrom a distributable pool of revenue, fed mainly by 40% of the revenue fromincome tax on companies' profits from manufacture and finance in the three
East African countries. Its allocation resulted in a redistribution of revenue
from Kenya to Uganda and Tanzania.
The pool was an attempt to compensate the latter two countries for theconcentration of industry in Kenya and for their losses of revenue and real
income sustained by purchases of Kenyan products within the customs unionand common market. The device did not satisfy Tanzania and Uganda.
In 1964, a fresh attempt was made to deal with the problem of inequality inthe operation of the common market by adopting administrative measures toeliminate trade imbalances between the three countries. The chosen means
were the industrial allocation of new single-plant industries in favour of
Tanzania and Uganda, adjustments in the output of existing multiplant firms,
and quotas on exports from surplus countries. The provision of a system of88
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differential incentives to attract manufacturing industry to Tanzania andUganda was also envisaged, but not simultaneously introduced. The industrysharing agreements failed, and Tanzania resorted to large-scale import
restrictions against Kenya.
The 1967 Treaty which established the East African Community
represented a further attempt to devise a framework that would enable thebenefits of economic integration to continue to be enjoyed by the three East
African countries on an equitable basis.
First, there was to be a decentralisation of the headquarters of certain
common services, including railways, harbours, posts and telegraphs, together
with some operational decentralisation.
Second, an East African Development Bank was created to give priority toindustrial development in the relatively less industrially developed partner
states.
Third, so-called 'transfer taxes', which were in effect limited inter-common
market tariffs, were permitted to be imposed by countries that were in deficit
in their total inter-community trade in manufactures on imports from acountry with which it had a trade deficit in manufactures. Fiscal compensation was simultaneously phased out.
The EAC was disbanded in 1977. Foreign policy differences played asignificant part in its demise. Difficulties created by the co-existence of stateplanning in Tanzania and the market-oriented system of Kenya, coupled withproblems created by the break-up of monetary union, were in any caseproving to be extremely damaging, as was the failure to deal with the financial
problems of the common services.

The Economic Community ofWest Africa (CEAO)
One of the few African integration blocs, apart from SACU, to havesurvived and to have substantially implemented its trade provisions is the
CEAO, which was established in 1973. A significant amount of intra-bloctrade (around 10% of total trade) occurs under its auspices. Part of this isunderpinned by preferential tariff arrangements on industrial products andcomplementary fiscal compensation. The preference operates through thesubstitution of the regional cooperation tax (TCR) for import duties. This islevied at a lower level than the corresponding import duties, at rates fixed ona product-by-product basis by the Council of Ministers.
Fiscal compensation is paid by the industrially more advanced members principally Cote d'Ivoire and, to some extent, Senegal - to their lessindustrially advanced partners. The major part is paid automatically tonational budgets through the Community Development Fund to offset twothirds of the assessed net revenue losses of the partner countries arising from89
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the importation of industrial products subject to the TCR. The remainder isdistributed on a discretionary basis among the member states to support
national development projects of Community interest. A Solidarity Fund
(FOSIDEC) also exists to contribute to the regional balance of theCommunity by loans, guarantees and participations. It is required to givepriority to the least developed members.
CEAO has survived and has been modestly successful in operating a partial
free trade area for industrial products, together with liberalised trade in
unprocessed agricultural products. The absence of exchange problems
because of the monetary union that embraces all but one of its members has
been one important factor in its success.
Another major factor is that each state is given substantial discretion overthe degree of industrial integration with its partners through the need formutual prior agreement on TCR eligibility and rates. The corollary of thisdiscretion is that the opportunities that the regional integration systemaffords for generating benefits is correspondingly modest.
Its weakness is reflected in the replication of identical industrial plants inseveral countries where fewer would often have sufficed. The need forlengthy and uncertain negotiations before TCR status can be accorded has
discouraged investment inflows and cross-border investment.

RlAs and Outward Orientation in Africa
African RIAs have been portrayed by some international agencies as having
a protectionist and inward-looking bias. This has undoubtedly been the casein some past arrangements, and partly explains their inability to generate net
benefits, but such a bias is not inherent in RIAs. Even a tariff-averaging
customs union may represent a move towards overall trade liberalisation. If
the formation of a wider customs union or free trade area were to beaccompanied by a general or selective reduction in external tariffs, this could
guarantee a significant overall liberalisation within a framework of regional
market widening.
The question often posed is whether, given the need for policy reforms
within Africa in the context of structural adjustment, regional market
integration should be a priority. This issue is raised on the grounds that any
integration-induced intra-group trade expansion is likely to be insignificant
anyway given present economic structures. Others, while supporting RIAs,
have argued against a market-led strategy.
One influential view sees the role of regional market integration in Africa
primarily as a support to structural adjustment. In that perspective, atransitional role is seen for reducing intra-African tariffs at a more rapid rate
than external tariffs. This is expected to diminish the costs of adjustment by
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forcing companies to compete first with firms that have comparable levels of
efficiency or inefficiency, before they are exposed to the full force of worldcompetition. Such regional competition could offer the prospect of areduction in costs, through mergers and take-overs, significant enough topermit the survival of several African industries which increased global
competition would otherwise eliminate.
On this, and other grounds, some multilateral donors have sought toidentify justifications for supporting regional integration as a component ofdevelopment strategy consistent with other general policy advice. The
conclusion has nevertheless been that benefits are likely to be small, and thatits costs in terms of diverting attention away from liberalisation and arriving
at a regional consensus may be considerable. Regional market integration isperceived to be justified only as part of an overallliberalisation strategy.
As a general proposition, this emphasis on liberalisation is persuasive. But
the often associated conclusion that the net benefits of regional integration,or the costs of non-integration among African countries, are likely to besmall, is less convincing and does not necessarily follow. The reason is thatsuch a conclusion would disregard many other benefits of RIAs that are of
considerable potential, and perhaps greater significance, particularly in the
African context.
Some of these benefits have only very recently been recognised inreappraisals of the gains from trade liberalisation and regionalism. Theseother benefits deserve to be given full weight by donors. Their importanceneeds to be appreciated above all by policymakers in southern Africa, on
whose degree of commitment to integration its success will ultimately
depend.

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Annex III

Membership of Selected Regional Integration
Arrangements

AfricaCEAO (Communaute Economique de l'Afrique de l'Ouest)
Members: Benin, Burkina Faso, Cote d'Ivoire, Mali, Mauritania,

Niger, Senegal
CEPGL (Communaute Economique des Pays des Grands Lacs)
Members: Burundi, Rwanda, ZaIreECOWAS (Economic Community of West African States)
Members: Benin, Burkina Faso, Cape Verde, Cote d'Ivoire, Gambia, Ghana,

Guinea, Guinea-Bissau, Liberia, Mali, Mauritania, Niger, Nigeria,
Senegal, Sierra Leone, Togo (integrates the members of the
CEAO and MRU, and Cape Verde, Gambia, Ghana, GuineaBissau, Nigeria, Togo)
IOC (Indian Ocean Commission)
Members: Comoros, France, Madagascar, Mauritius, Seychelles

MRU (Mano River Union)
Members: Guinea, Liberia, Sierra Leone
PTAICOMESA (Preferential Trade Area for Eastern and Southern
Africa/Common Market for Eastern and Southern Africa)
Members: Angola, Burundi, Comoros, Djibouti, Ethiopia, Kenya, Lesotho,
Malawi, Mauritius, Mozambique, Rwanda, Somalia, Sudan,
Swaziland, Tanzania, Uganda, Zambia, Zimbawbe
SACU (Southern African Customs Union)
Members: Botswana, Lesotho, South Africa, Swaziland

SADC (Southern African Development Community)
Members: Angola, Botswana, Lesotho, Malawi, Mozambique, Namibia,

South Africa, Swaziland, Tanzania, Zambia, Zimbawbe
UDEAC (Union Douaniere et Economique de l'Mrique Centrale)92
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Members: Cameroon, Central African Republic, Congo, Gabon, Chad,

Equatorial Guinea

Asia
ANZCERTA (Australia-New Zealand Closer Economic Relations Trade
Agreement)
Members: Australia, New Zealand
ASEAN (Association of South-East Asian Nations)
Members: Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand

SAARC (South Asian Association for Regional Cooperation)
Members: Bangladesh, Bhutan, India, Myanmar, Nepal, Pakistan, Sri Lanka

EuropeBENELUX (Belgium-Netherlands-Luxembourg Economic Union)
Members: Belgium, the Netherlands, Luxembourg

BFTA (Baltic Free Trade Area)
Members: Estonia, Latvia, Lithuania

CEFTA (Central European Free Trade Area)
Members: Czech Republic, Hungary, Poland, Slovakia

EFTA (European Free Trade Association)
Members: Austria, Finland, Iceland, Liechtenstein, Norway, Sweden,

Switzerland
EU (European Union)
Members: Austria, Belgium, Denmark, Finland, France, Germany, Greece,

Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain,
Sweden, the United Kingdom

Middle East
ACM (Arab Common Market)
Members: Egypt, Iraq,]ordan, Libya, Mauritania, Syria, Yemen

ECO (Economic Cooperation Organisation)
Members: Islamic Republic of Iran, Pakistan, Turkey

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GCC (Gulf Cooperation Council)
Members: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, the United ArabEmirates
The Maghreb Union
Members: Algeria, Libya, Morocco, Tunisia

Western Hemisphere

Andean Group (Andean Pact)
Members: Bolivia, Colombia, Ecuador, Peru, Venezuela (Chile withdrew

in 1976)
CACM (Central American Common Market)
Members: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua

CARlCOM (Caribbean Community)
Members: Antigua and Barbuda, Bahamas, Barbados, Belize, Dominicana,

Grenada, Guyana, Jamaica, Montserrat, St. Kitts and Nevis, St.
Lucia, St. Vincent and the Grenadines, Trinidad and Tobago
LAFTAILAIA (Latin American Free Trade Association/Latin American
Integration Association)
Members: Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico,
Paraguay, Peru, Uruguay, Venezuela
MERCOSUR (Mercado Cormin del Sur)
Members: Argentina, Brazil, Chile, Paraguay, Uruguay
NAFTA (North American Free Trade Agreement)
Members: Canada, Mexico, the United States

GlobalAPEC (Asia Pacific Economic Cooperation)
Members: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia,

Japan, Korea, Malaysia, Mexico, New Zealand, Papua New
Guinea, the Philippines, Singapore, Thailand, Taiwan, the UnitedStates94
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