The Economic Geography of Regional Integration – Finance Indermit Gill

ITH the future of the Doha Round uncertain, there has been a sharp increase in the number of bilateral and regional trade agreements. This has revived long-running arguments in international economics between those promoting global trade agreements and those favoring regional approaches. But in many ways this has been the wrong debate, especially for the world’s smallest, poorest, and most geographically disadvantaged countries, such as those in Africa and Central Asia. one reason is that the difference between trade agreements and more general mechanisms for integration is often misunderstood. Regional integration includes a multitude of steps that increase the competitiveness of participating countries, not just preferential trade access. Second, this debate often implies a false choice between regional versus global integration. Both are necessary because they support different objectives. Regional integration helps small and remote countries scale up supply capacity in regional production networks. This, in turn, allows these countries to access global markets. To understand why these distinctions matter for policy, the World Bank’s latest World Development Report (WDR), titled “Reshaping Economic Geography,” analyzes trade developments through the lens of economic geography (see box). Development is accompanied by sectoral transformations from agriculture to industry and services. The WDR argues that developing countries must also undertake spatial transformations—that is, allow a geographic distribution of economic activities within and among countries. A crucial element in these transformations is regional integration. To be effective, regional integration strategies need to be tailored to the economic geography—most important, size, location, and openness to interaction with major markets—of each part of the world. A look at the unexpected consequences of falling transportation costs during the 20th century illustrates the role of economic geography in international development. In 1910, British exports were spread almost evenly among Europe, Asia, and other regions. But by the 1990s, 60 percent of British exports went to Europe and only 11 percent to Asia. Standard economic theory would predict that with better and cheaper transportation, trade with faraway places would increase. Instead, trade increased between neighbors. Insights from the new economic geography and international trade theory, for which Paul Krugman received the 2008 Nobel Prize in economics, shed light on this puzzle. The first wave of globalization in the 19th century increased trade based on comparative advantage. Countries exchanged what they could not produce themselves. So Europe traded machinery for Central American bananas, or for South Asian spices. But in the 20th century, transportation costs fell so much that even trade in similar goods or in parts and components made economic sense. So countries exchanged different types of beer or traded parts of cars and computers.