Production Networks in an Economically Integrated Region

I. Introduction The process of regional integration has tended to follow a fairly set pattern. In the early stages, the focus is on liberalizing trade in goods. Subsequent initiatives address trade in services, the movement of labour and capital, co-ordination of regulatory and other policies, and monetary union. Each successive stage makes its inroads on national sovereignty and policy independence. Still, it is typically not until the very end of a long and drawn-out process that market segmentation may be said to have been effectively eradicated and the region can be truly called a single market. This article argues that the nations of Asia-Pacific might benefit from restructuring the process of regional integration so as to assign top priority to the spread of regional production systems. There are significant reasons to doubt that a small grouping among any subset of countries in the Asia-Pacific region provides the basis for a viable preferential trade area of the traditional variety. Even when the static framework is broadened to allow for dynamic elements such as scale economies and endogenous growth, most arrangements would not pass the test on strictly economic grounds. An important characteristic of the traditional approach to regional integration is that structural and market transformation are initially quite limited, so that the benefits of trade liberalization depend almost entirely on the extent to which existing resources can be used more efficiently. Significant changes in industrial structure typically do not take place until economic integration has reached the "deeper" stages. In the European Union (EU), for example, the Single Market project ("Europe 1992") occurred decades after the creation of the original customs union (European Economic Community or EEC) and free trade area (European Free Trade Area or EFTA) in the 1950s. It represented the community's response to the failure of the earlier phases of integration to eliminate market segmentation. This article examines an approach to regional integration which allows industrial structure to change early in the process. The structural change envisaged here involves creation of regional production networks and dispersion of manufacturing processes across national frontiers. The result would be regional as opposed to national industries. Regional initiatives are more likely to be welfare-improving if they include economic integration based on cross-border production networks. Section II develops the basic idea and establishes a benchmark example of traditional integration against which to evaluate the effects of the proposed alternative. Section III introduces regional production into the framework and assesses the welfare gains thereof. Section IV discusses varieties of cross-border procurement and the role of foreign direct investment (FDI) and multinationals in the context of regional production networks. Section V deals with trade liberalization in the presence of production networks to show how the latter tends to create pressures favouring non-discriminatory trade liberalization. It also considers the effect of offshore procurement on wages and employment. Section VI considers dynamic factors like scale economies. Section VII concludes. II. Creating a Regional Economy Regional economic integration has been an important part of the globalization of many national economies. While Europe provides the most complex example of the interplay of multilateral and regional forces, both the Western Hemisphere and the Pacific Rim have seen significant regional initiatives. Unlike Europe, however, most of these approaches have been more cautious, with members wary of becoming too involved with their trading partners and losing too much sovereignty and economic policy autonomy in the process. Although Mercado Commun del Sur (MERCOSUR) in the Southern Cone of Latin America has opted for customs union, most initiatives have been more circumspect. …