REGIONAL ECONOMIC INTEGRATION: DEVELOPING COUNTRIES BENEFIT MORE FROM ‘NORTHSOUTH’ AGREEMENTS THAN ‘SOUTH-SOUTH’ AGREEMENTS

Do regional integration agreements (RIAs) promote convergence or
divergence of per capita income levels among their members? It all depends
on whether the countries involved are high or low income, according to new
research by Professor Tony Venables, published in the October 2003
Economic Journal.

His analysis reveals that the forces of trade creation and trade diversion
systematically produce an outcome in which RIAs among high-income
countries lead to convergence of income levels while RIAs among low-income
countries cause divergence.

This may explain such observations as the success of the European Union in
narrowing per capita income differentials among its members and the
comparative failure of the old East African Common Market, the Central
American Common Market and the Economic Community of West Africa.
And it suggests that developing countries are likely to do better in RIAs with
developed countries – ‘North-South’ agreements – than in RIAs with other developing countries – ‘South-South’ agreements.

Venables’ argument is based on the comparative advantages of RIA
members relative to each other and to the rest of the world. Suppose, for
example, that countries differ in their endowments of skilled and unskilled
labour, and that these differences form the basis of their comparative
advantage.

Take two countries that are abundant in unskilled labour relative to the rest of
the world - say ‘Uganda’ and ‘Kenya’ - and suppose that Uganda, is also
abundant in unskilled labour relative to Kenya. Uganda has an ‘extreme’
comparative advantage and Kenya an ‘intermediate’ one.

What happens if these countries form a RIA? The comparative advantage of
Kenya relative to Uganda leads Kenya to export skilled labour intensive goods
(say manufactures) to Uganda, which in return exports unskilled labour
intensive goods (agriculture).

The first of these flows is trade diverting: Uganda is getting its manufactures
from Kenya rather than the rest of the world in line with comparative
advantage within the RIA rather than global comparative advantage. But the
second flow is trade creating: by increasing agricultural imports from Uganda,
Kenya is trading with the lowest cost supplier in the world, not just within the
RIA.

The general argument is that any country with an ‘intermediate’ comparative
advantage will do better from an RIA than a partner with ‘extreme’
comparative advantage.

Between two poor countries this unequal division of costs and benefits causes
income divergence: the extreme country is the one with the least skilled
labour, and hence initially the poorest. But between two rich countries, the
extreme country is the one with the highest ratio of skilled to unskilled labour.
So exactly the same forces that drive income divergence in an RIA between
Kenya and Uganda lead to income convergence in an RIA between, say,
France and Spain. The implication is that developing countries are likely to do
better in ‘North-South’ RIAs than in ‘South-South’ agreements.

ENDS

Notes for Editors: ‘Winners and Losers from Regional Integration
Agreements’ by Tony Venables is published in the October 2003 issue of the
Economic Journal.

Venables is Professor of Economics at the London School of Economics.
For Further Information: contact RES Media Consultant Romesh Vaitilingam
on 0117-983-9770 or 07768-661095 (email: romesh@compuserve.com); or
Tony Venables via email on a.j.venables@lse.ac.uk.