Regional Economic Integration: Developing Countries Benefit More From ''NorthSouth'' Agreements Than ''South-South'' Agreements

06 Oct 2003

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.

''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.

Tony Venables

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