Regional Integration in the Emerging Global Economy: The Case of NAFTA

GLEN ATKINSON* University of Nevada, Reno

The rationale

for international trade is that nations should specialize in production and trade to take advantage of their different resource bases. The emerging global

economy differs from the international economy in that resources are becoming more mobile and intra-industry trade is becoming more important. Evidence is presented that these developments require compatibility and harmonization of technical and policy standards. It is easier to harmonize standards on a regional level than globally; thus the rise of regional integration movements. However, because the standards to protect workers, the environment and intellectual property rights are so different between Mexico on one hand, and Canada and the United States on the other, it is very difficult to develop compatibility in the case of NAFTA. Negotiations over these standards will be difficult in the NAFTA region without institutional development.

The concept of free international trade was developed as the nation state emerged as the dominant institutional form governing economic relations. It is instructive that Adam Smith inquired about the causes of the wealth of nations rather than of individuals, families or the world. Smith assumed that the wealth of these other entities would be improved through the proper development of the national institutions. Smith and his followers worked to explain that rewards ought to go to those who increased production rather to those who simply owned scarce means of production. Landlords owned resources they did not produce and to the extent that income from production was distributed to land rent, capital accumulation would be stifled which would harm labor

*Direct all correspondence to: Glen Atkinson. 89557. Telephone: (702) 784.6678.

Department

of Economics,

University

of Nevada, Rena, Nevada

The Social Science Journal, Volume 35, Number 2, pages 159-168. Copyright 0 1998 by JAI Press Inc. All rights of reproduction in any form reserved. ISSN: 0362-3319.

160

THE

SOCIAL

SCIENCE

JOURNAL

Vol. X/No.

211998

as well as the emerging business class. The separation of capitalists and labor was not as distinct as now and the separation of ownership and management lay in the unseen future. Classical economists were not anti-labor, instead they reasoned that both capitalists and workers would be harmed by the privileged class of landlords. This reasoning led them to conclude that the deleterious effects could be eroded by abolition of the Corn Laws in pursuit of free trade rather than a social revolution which would be required to dismantle the feudal land practices of primogeniture and entail (Fite and Reese, 1965, pp. 33, 120). Unfortunately, neoclassical economists ignored the social basis inherent in classical economics and reduced all behavior to the level of the individual, and the nation became an aggregation of individuals. Instead of continuing to explore the institutional basis of domestic and international economic life, modern economic theory holds to the myth that an individual Canadian trades with an individual Mexican without the aid of mediating institutions. Moreover, the received axioms of economic theory lead to the conclusion that institutions can only harm welfare, they can never do good. Another myth needing examination is that free trade existed in the nineteenth century, despite the fact that nations outside Europe and North America were generally colonial subjects . The field of economic development was created to deal with the process of decolonization in the post World War II period as these nations tried to modernize according to political science and industrialize according to economics literature. The distinction made between economic growth and development was that development required institutional change. As development literature has become more technical over the decades, the institutional development proposed by economists seems to have been reduced mainly to those institutions necessary for the operation of free markets.

COMPARATIVE

ADVANTAGE

IN A GLOBAL

ECONOMY

The concept of comparative advantage is the foundation for the advocacy of free international trade. Comparative advantage rests on all of the assumptions required of free domestic markets except for the assumption of mobile resources. In fact, comparative advantage assumes that resources are immobile across national borders. Comparative advantage demonstrates that each country should specialize in production and if each country specializes in production, then each country must trade to receive the other goods needed. Specialization is the opposite of self-sufficiency. The classical economist, David Ricardo, introduced the concept of specialization based on comparative advantage. Ricardo predicted that each country would export the commodity it produces relatively cheaply in the absence of trade. However, the classical statement fails to explain why production costs vary among countries in the first place (Neary, 1985, p. 411). The modern, or neoclassical, version of comparative advantage rests on the work of Heckscher and Ohlin who argued that production costs vary because each good uses a different mix of resources and each country has a different endowment of resources (Neary, 1985, p. 411). Thus land rich countries will produce goods which use a lot of land and trade for goods which use a lot of labor in production. Comparative advantage is based on an uneven endowment of resources around the globe and these resources are assumed to be owned by resident nationals. Since resources are immobile, a nations wealth is dependent on how well it is endowed and how effec-

Regional integration m the Emerging Global Economy

161

tively it uses the resource base. Specialization, skilled labor and accumulated capital equipment could enhance the natural endowment. However, all resources are considered to be immobile; hence free trade in goods would be necessary to make the most of the planets limited resource base. It follows that if resources were perfectly mobile, trade in goods would be unnecessary. That is because particular resources would flow to countries where they would earn the highest return which is where they are the most scarce. In that case earnings for each resource would be equalized around the world through market processes. However, it is not necessary for resources to move to get that result, if goods are able to move freely across national borders. Factor prices could be equalized internationally through either movement of goods or resources through free markets. It is not necessary that a country have an absolute advantage in production costs relative to another country in order to engage in and benefit from trade, it needs only a comparative advantage. For example, the so-called silicon valley of California is well suited to producing oranges and computer software. Since earnings are higher in computers than oranges, San Jose will specialize in computers and buy orange juice from areas that have higher production costs for oranges. However, comparative advantage cannot tell us how computer production got started in San Jose in the first place, or why land prices have not become equalized between San Jose and Mississippi. Comparative advantage attempts to explain patterns of trade in an international economy, but does a global differ from an international one? Do regional trading blocs affect trade patterns and if so why? It seems that people make a distinction between an international economy and a global one in two respects. There are many questions currently being raised about the ability of the theory of comparative advantage to explain trading patterns (Helpman and Krugman, 1985; Learner, 1984). The focus of this article, however, is the effect of regional integration in a globalizing economy on trade relations. There are two major difference between global and international economic trade. First, globalization implies more mobility of resources than is the case in the theory of international trade. Second, international economics concentrated on trade in finished goods, while much of the trade is intra-industry. Intra-industry trade means components are being traded across borders rather than finished goods only. Automobile parts are being moved around the globe and it is difficult to determine the nationality of a car by its brand name, for instance. It will be argued that each of these characteristics raises important social, as well economic issues, which are being debated. It will also be argued that regional integration is in part a response to these concerns and also exacerbates them. The theory of comparative advantage is the technical relation of converting physical inputs to output, and this relation is stripped of any institutional or cultural context. Natural, labor, and capital resources can be converted to final products at any place in the world that has an identical endowment according to trade theory. Trade improves economic welfare of both parties to the trade because of differences in the costs of production due to relative endowments of resources. This would be important in situations where natural resources were the major input, but as capital and technology became more important inputs an institutional component is required to explain factor immobility. The technical constraints on the movement of real capital equipment or

162

THE

SOCIAL

SCIENCE

JOURNAL

Vol. 35iNo.

2/l 998

technical knowledge are minimal compared is technically feasible to set up high-tech structure would be inappropriate.

to the institutional ones. In other words, it facilities in areas where the institutional

REGIONAL

INTEGRATION

IN A GLOBAL

ECONOMY

Regional integration has raised the question of what happens when capital and labor become mobile internationally? Are the effects different if labor and capital can move as well as goods and services? What happens if capital is more mobile than labor? The effects of mobile labor and capital and the differential between capital and labor mobility become greater as the natural resource content of production becomes smaller as it seems to have done as we move into the information age of the post-industrial economy. The rise of the post-industrial economy has been accompanied by an increasing importance of intra-industry trade relative to inter-industry trade. What this means is that many traded goods and services are resources for further production at a new location. This is an element in the definition of the global economy because as inputs are moved around the globe it makes it more difficult to determine the national origin of the traded goods. Experience in regional integration has demonstrated that removal of the tariff and quotas, agreements dealing with differential working conditions in the region, protection of intellectual property rights and relative costs of environmental protection quickly become the dominant issues as tariffs are removed. Regional content measures must be imposed because of the importance of intra-industry movements of components. Regional integration is not a move in comparative statics from a before integration position to an after integration position. Instead it must be an evolutionary process of continuous institutional development to address these type of issues as they emerge. Removal of barriers to trade such as tariffs and quotas is called negative integration policies, while institutional development is called positive policy. It is at this point where fair trade becomes the obvious concern Regional integration is, at least, an implicit recognition that comparative advantage is not a sufficient condition for international economic policy when resources as well as goods are mobile across borders . The need for shared institutions among the parties is critical for integration, which will lead to a weakening of national sovereignty in some areas of interest. Sovereignty, however, must reside someplace in order to enforce regional working conditions, intellectual and other property rights and other concerns which establish the legitimacy of particular markets. In fact, the mobility of factors of production and intra-industry trade seem to be two of the critical elements distinguishing a global economy from an international one. However we have not created the institutions at the global level to sufficiently define markets. There are those who have noted that the reduction of tariffs through GATT has made the limits of negative integration apparent because GATT does not have the mandate or ability to bring about the necessary institutional change required to build a foundation for the emerging global economy. According to Miles Kahler the new agenda of many regional arrangements extends well beyond the traditional goal of lowering or eliminating tariff barriers (Kahler, 1995, p. 9). These agendas are being shaped by corporations that want to establish operations in the region and they want to reform a

Regional Integration in the Emerging Global Economy

163

host of domestic regulatory structures . . .because of their implications for market entry and their perceived effects on the competitive position of domestic and foreign firms (Kahler, 1995, p. 9). The new World Trade Organization might be able to begin to work on these issues, but it seems more likely that regional institutions will grow more quickly to define markets than truly global ones. Thus, sovereignty will be shared by national and regional institutions within an overall World Trade Organization framework. DEEPENING OF INTEGRATION

Widening occurs as additional countries are brought into the agreement. The evolution of integration from negative policies to positive policies of institutional development is called deepening. It is generally conceded that deepening is more likely to occur among similar countries that have similar market institutions. The lowest level of integration is a free trade area which involves only the removal of tariffs and quotas among the parties. If a common external tariff is added, then a customs union has been created. The next level, or a common market, requires free movement of people and capital as well as goods and services. It is this stage where institutional development becomes critical. The stage of economic union requires a high degree of coordination or even unification of policies. This sets the foundation for political union. It is a thesis of this article that attempts to hold integration to the lowest level will not be successful. If the parties to a free trade agreement cannot negotiate to a deeper level, then the agreement will likely wither. This is because trade must not only be free, it must be considered fair. Some of the first issues to arise even in a free trade agreement are health safety and environmental standards. Conflict resolution institutions must be developed to determine when such standards are for the protection of the health and safety of the respective populations and when are they simply used to protect national markets. If the integration of the European Union market and the attempts to develop markets in the wake of the disintegration of the Soviet Empire has taught us anything, it is that markets are artificial, cultural constructs (Atkinson and Oleson, 1994). As such they must be consistent with a set of core values of the population. The widening of integration to encompass more countries will make it difficult to negotiate to a deeper level of institutional development. THE CASE OF NAFTA NAFTA has evolved over several stages beginning with the Canadian-U. S. automobile pact of 1965. and the Canadian-U. S. Free Trade Agreement of 1989. Many Canadians were concerned that they had been harmed by the CUSFIA because of the weak social programs and protection of worker rights in the U.S. relative to Canada. Some blamed the prolonged recession in Canada to the bilateral agreement and were reluctant to extend the agreement to include Mexico which had an even poorer record on social programs and labor protection. Canadian political leaders finally recognized that they had no choice because the Mulroney government could not risk the prospect

164

THE

SOCIAL

SCIENCE JOURNAL

Vol. 35/No. 211998

of Mexico achieving benefits in the U. S. market at Canadas expense, Also, Canada did not wish the United States to enmesh itself in a series of hub-and-spoke commercial arrangements (Grayson, 1995, p. 59). Direct Mexican-Canadian economic relations have been more limited than either countrys relations with the U.S. over most of their respective histories. Mexican- U. S. relations have evolved from the Bracero program which encouraged the seasonal entry of migrant Mexican workers at harvest time to the cessation of that program and the development of the maquiladora assembly plants along the border. The maquiladora program had a two-fold effect of allowing cheap access of Mexican assembled products into the U. S. markets and a measure to reduce the flow of Mexican migration into U. S. labor markets. It is easy to conclude from this that policy makers dont mind Mexicans competing with American workers as long as they stay home. Mexico also had liberalized its trading regime following the financial crisis associated with the oil glut. Mexican leaders concluded that they could no longer finance import substitution with oil exports, so they embarked on an export promotion agenda which culminated in their joining GATT in 1986. However, GATT membership alone would not be sufficient for the ambitious transition without adequate capital and social infrastructure facilities, but this would require an inflow of capital finance from the U. S. American capitalists seemed willing and even eager to take advantage of new market opportunities, but only if their property rights would be recognized and secure in Mexico. They would feel more secure if the protection was part of the free trade agreement than if it was just an agreement secured by Mexican law. Here we notice two important features which distinguish free trade from regional integration. First, people seem to react differently to a movement of foreign goods into their country than to a flow of foreign capital or labor into their country. Second, a flow of capital from a country appears benign to many policy makers, whereas a flow of labor into that country seems threatening. Economic theory cannot explain these different reactions. On the first point, economic theory would suggest that resource flows could substitute for trade in goods and enhance global welfare through improved efficiency identical to a free movement of goods. Concerning the second point, it should not matter, theoretically, whether cheap labor produces a good in Mexico with American capital or in the U. S. with Mexican labor and American capital as long as the least cost combination of resources is used. At this point in the argument some will say, yes that is true, but there are other factors to consider. That is the point; what are the other factors and why are they important? These other issues will not arise if we view capital owners and labor as commodities rather than citizens. The theoretical difficulties can be avoided by stripping humans of all attributes other than as inert participants in resource and goods markets without any other institutional mediation other than the securing of rights of physical and intellectual capital for the owners. Jorge Castaneda points out that Mexicans tend to move back and forth several times before settling permanently in California. This pattern of migration has a blow-back cultural effect which is beneficial to Mexico because it introduces tolerance and democratization to Mexico and exposes that society to the closed, archaic and narrow-minded facets of Mexico (Castaneda, 1995, p. 2). This suggests that labor is not simply another commodity to be traded. Instead these types of population movements can affect citizens concept of what is reasonable and fair. However, Castaneda

Regional

Integration the Emerging in GlobalEconomy

165

points out to the extent that California excludes Mexican immigrants from political participation, it weakens democratic institutions in the United States. Kahler believes that the United States favors regional agreements in order to pursue a GAIT-plus agenda (Kahler, 1995, p. 12). In the case of NAFTA the agreement includes areas such as agriculture, services and investment which are difficult to include in global treaties, as well as binational panels to monitor the application of national laws and regulations on dumping. Two side agreements on environmental protection and labor standards also surrendered very little sovereignty to the region. Kahler interprets the pact to say that those agreements extended the content of trade agreements into controversial new areas, but they aimed only at more rigorous enforcement of existing national standards, not explicit harmonization of national policies (Kahler, 1995, p. 12). It is highly unlikely, in my opinion, that harmonization can be held at this level. Graysons interpretation is that the goal of the pact is to achieve compatibility in health, safety, and industrial standards at the most rigorous level in any of the three countries. The signatories also agreed that unreasonable standards would not be used to thwart trade (Grayson, 1995, p. 104). It will be very difficult to achieve the goal of compatibility without pursuing harmonization of standards if the experience of Europe is any guide. It is too tempting to use health, safety or environmental standards as trade protection devices. When these conflicts begin to arise, as they surely will, the creation of regional institutions will be required resulting in more surrender of national sovereignty. If the participants are unwilling to set themselves on this path, the accord will unwind much as the European Free Trade Association did. On the other hand, if they start down the path of harmonization, then institutional development will continue to build regional authority at the expense of national independence. Canada was most reluctant to surrender sovereignty on the side deals. Canada agreed only to allow its own courts to enforce environmental and trade sanction rather than the newly created Commission on Environmental Cooperation. Moreover, the Canadian provinces are not required to abide by the provisions of the environmental side deal. Ontario, British Columbia and Quebec declined to participate. The labor side deal is even weaker than the environmental provision. Non-governmental environmental organizations actively participated in the negotiations and will be involved in the dispute resolution process, but labor abstained. Although officials in the Department of Labor would have preferred a stronger accord, there was no private sector pressure to attain one. Corporate America, which rejoices in the fact that American labor laws are among the most conservative in the developed world, was loathe to see management-labor relations raised as an issue (Grayson, 1995, p. 147). On the other hand investment and intellectual property rights are granted a high degree of protection. The following examples are offered by Grayson:
l

The accord eliminates all equity and market share restrictions in the financial sector by the year 2000. NAFTA vouchsafes a higher standard of protection for patents, copyrights, trademarks, and trade secrets than any other bilateral or international pact.
The agreement expands the definition of investment to encompass not only subsidiaries, but property owned in one of the NAFTA countries by nationals of another, as

166

THE

SOCIAL

SCIENCE

JOURNAL

Vol. 35/No. 2/l 998

well as investment related services conducted in that country. The accord grants national treatment to North American firms in any of the three nations. Should a host country breach the agreements rules, a NAFTA investor, at his option, may pursue monetary damages through binding investor-state arbitration (1995, pp. 101-105). It is quite clear that the rules establishing NAFTA are skewed in favor of capital movements relative to worker rights. It is also widely accepted that Americans saw NAFTA as one means to reduce the flow of migrants from Mexico. The widespread concern over Mexican immigration seems to be determined more by the perceived social costs than the effects on labor markets and wages if the discussion surrounding Californias Proposition 187 is any guide. The capital flows from the U. S. to Mexico could have the same effect on wages as if labor migrated to the U.S., without the controversial welfare and education expenses associated with migration of people. The effect on wages from capital movements would be the same as if labor were mobile, however. It has also been argued that capital could have flowed to Mexico before the NAFTA agreement, but it is clear that capital owners were wary without the protective provisions secured in the negotiations. The arguments that capital flows to Mexico would raise the productivity of Mexican workers and lead to a convergence of wages near the U. S. level contradicts the concern that those same workers locating in the U.S. and mixed with the same capital equipment would tend to reduce wages toward the Mexican level.

REASONABLE

VALUE AND FREE TRADE

John R. Commons concluded that unrestrained competition would not support a concern for ethics because participants must be concerned with survival instead. Commons argued that free labor markets associated with free trade leads to the competitive menace. By competitive menace Commons meant that unrestrained competition will lead to the lowest elements establishing the standards. Social coercion is necessary as against private coercion, not because the state can elevate people to a higher level than attained by the free exercise of their own persuasive powers, but in order to prevent the lower and selfish elements of society from dragging the several institutions down. The state sets the minimum level below which the struggle for existence shall not be permitted to force an institution (Commons, 1967, p. 104). An illustration of the competitive menace is the alleged effect of tabloid journalism on mainstream journalists. In the NAFTA context, who should set the labor and environmental standards; the market, each nation or NAFTA institutions? An inquiry into the nature and causes of the wealth of nations would lead us to understand that markets are structured by public policies and those policies create winners and losers. The argument that the major function of government is to create institutions to secure property rights for owners begs the question of which rights deserve our protection. Commons explained that rights and duties are reciprocal to one another. If society creates a right for one party, they have created a duty for all others to abide by that right. These rights and duties, according to Commons, are the working rules which define markets. The creation of these working rules requires a social theory of value because the rights are not founded in natural law of the natural world.

RegIonal MegratIon

in the Emerging GlobalEconomy

167

Instead they are artificial creations of society and can have no other origin. Value then is not found by an appeal to some exogenous objective function, but in deciding between competing claims of members of society. Establishing the objective is as much a part of social discourse as prescribing the means to achieve the objective since the objective is not established by nature. Which rights are secured by the social authority and who is exposed to those rights requires that participants regard the outcome to be considered to be reasonable. This search for a reasonable solution is driven by social purpose rather than by an aggregation of individual preferences. Yngve Ramstad has applied Commonss reasonable theory of value to Trade Act of 1974. Following Commons Ramstad concluded that international competition is an instituted process -a set of working rules reflecting the various and sometimes conflicting purposes of those who have had a hand in determining the actual content of those rules. Thus, there is no intrinsically correct or optimal set of rules, only ones that more or less effectively give rise to outcomes representing a reasonable compromise between the many purposes currently embraced by those possessing authority to change the rules (Ramstad, 1987, p. 26). In the context of NAFTA we can conclude that capital and environmental rights were more effectively established than labor. The question that should direct the search for rules to define North American markets rather than distinctly American markets, is what standards should be used to define the working rules? Should we use the best practices in the region or some lower standard. Property rights will enjoy a high level of protection, environmental rights will be at some intermediate level, while workers will be exposed to a lower level of protection. Thus workers will not only be exposed to the low level of worker rights in Mexico, but to increased ability of capital to move to Mexico, and the lower level of harmonization of such policies. The questions about the working rules leads us to conclude that free trade policies without consideration of the fairness of those rules will expose many workers to the menace of competition and could result in a worsening of the general welfare of the nation. One reason for moving toward free trade in regional blocks instead of globally is that it should be easier to define fair working rules at a regional level. On that score, NAFTA has not achieved its potential.

of laws and standards which shape and this process is called positive integration. It not unusual for nations to the process of the naive notion of obvious barriers such as and quotas be sufficient to the national to regional level. Architects of the regional agreements of trade barriers not offer the security of expectations necessary for them to in the broader market. Very quietly capital on regional protection of and other property rights, of environmental standards can bias of firms for those in countries the lowest standards. debate to what is appropriate level to the standards and how should be enforced. to the realization may attempt to or safety standards at to protect domes-

168

THE

SOCIAL

SCIENCE

JOURNAL

Vol. 35/No. 211998

tic markets rather than the avowed purpose. Workers enjoying high wages and fringe benefits will feel exposed to workers in other nations with fewer benefits and seek protection. However, in the case of NAFTA, unlike other regional associations, an avowed purpose was to reduce the flow of workers across national boundaries, which raises the question of what me mean by free trade. Each of these moves calls for positive policies requiring institutional development which is what is meant by the deepening of integration. It is these issues which help us think about the meaning of free and fair trade more deeply than comparative advantage models do. The theory of comparative advantage holds that location of production are due to cost differences based on resource endowment only. That theory does not consider the effects of such standards as health, environment or labor on costs and location decisions. It is the thesis of this paper that if countries choose to compete on the basis of lower standards, it is likely that a path determined by the competitive menace will result. Clearly, institutional development and policy harmonization are required for sustained integration, but we must go further than comparative advantage to determine the appropriate level of worker and environmental protection and the necessary degree of harmonization of such policies.
Acknowledgment:
Association This article is a revised version of a paper originally of Social Economics meetings, San Francisco, January 5, 1996. presented at the

REFERENCES
Atkinson, G. and T. Oleson. (1994). Europe 1992: From Customs Union to Economic Community. Journal of Economic Issues, 28 (4): 977-995. Castaneda, J. G. (1995). The Immigration Highway. The Sacramento Bee (November 26): Forum l-2. Commons J. R. (1967). A Sociological View of Sovereignty. New York: Augustus M. Kelley. Fite, G. C. and J. E. Reese. (1965). An Economic History of the United States, 2nd edition. Boston: Houghton Mifflin. Grayson, G. W. (1995). The North American Free Trade Agreement: Regional Community and the New World Order. Lanham, MD: University Press of America, Inc. Helpman, E. and P. Krugman. (1985). Foreign Trade and Market Structure. Cambridge, MA: The MIT Press. Kahler, M. (1995). Regional Futures and Transatlantic Economic Relations. New York: Council on Foreign Relations Press. Learner, E. (1984). Sources of International Comparative Advantage. Cambridge, MA: The MIT Press, Neary J. P. (1985) International Trade. The Social Science Encyclopedia. A. Kuper and J. Kuper, (Eds). 411412. London, and Henley: Routledge and Kegan Paul. Ramstad, Y. (1987). Free Trade Versus Fair Trade. Journal Of Economic Zssues 21 (1): 5-32.