1The idea in one paragraph

Countries that want to trade with each other keep running into the same obstacle: each other's trade barriers. Economic integration is what they do about it. They agree to lower the barriers between themselves and, at the deeper levels, to run parts of their economies together. These agreements come in a ladder of depths, from a single deal between two countries up to a shared currency, and each rung adds exactly one thing to the rung below it. The whole subtopic is that ladder: what each level adds, what a country gains by climbing it, what it hands over in exchange, and what the World Trade Organization does for countries that would rather lower barriers for everybody at once.

Figure 1 is the ladder, and it is worth memorising before anything else. Learn it as five rungs with one added feature each, because the commonest exam question in this subtopic asks you to distinguish two neighbouring rungs, and the mark is for the added feature. The rest of the notes work up it from the bottom.

2Preferential trade agreements: who is at the table

A preferential trade agreement is an agreement under which countries charge each other lower trade barriers than they charge everyone else. The word preferential carries the meaning: whoever signed gets a preference, and whoever did not sign does not.

The guide names three kinds, and what separates them is how many countries signed.

Bilateral. Two countries. Only two governments have to agree, so these are the quickest to negotiate, and they cover whatever those two want covered and nothing else.

Regional. A group of countries, usually neighbours. One agreement binds all of them. Because neighbours already trade heavily with each other and share borders, regional agreements tend to go deepest: the trading blocs in section 3 are almost all regional.

Multilateral (the World Trade Organization). Most of the world's trading nations at once, negotiated in rounds at the WTO. These are the slowest to reach, because everyone has to agree, but what is agreed applies to every member. That is the difference worth remembering: a bilateral or regional deal lowers barriers for the signatories and leaves outsiders where they were, while a WTO agreement lowers them for the whole membership.

Figure 2 sets the three side by side. Read the labels carefully: these words describe how many countries signed, not how deep the agreement goes. A bilateral agreement can be very deep, covering services, investment and the movement of workers. A multilateral one can be shallow, cutting a few tariffs. Students lose marks by treating "multilateral" as if it meant "most integrated".

3Trading blocs: three depths of the same idea

A trading bloc is a group of countries that have agreed to reduce or remove trade barriers between themselves. The guide names three, and they are a sequence: each one is the one before it plus a single new feature.

Free trade area (also called a free trade agreement). Members remove tariffs and quotas on trade between themselves. Each member keeps its own trade barriers against non-members, and those barriers can differ a great deal from one member to the next.

That last sentence creates a problem, and the problem is the reason the next level exists.

In Figure 3, member A charges non-members a 5% tariff and member B charges them 25%. A producer outside the area who wants to sell in B does not ship to B. It ships to A, pays 5%, and then moves the goods on to B tariff-free, because trade inside the area is free. B's 25% tariff is never paid. To stop this, a free trade area has to check where every good was really made, which is slow and expensive and never quite works.

Customs union. A free trade area plus a common external tariff: every member charges the same tariff on imports from outside the union. Now there is no cheap door to come in through, because every door charges the same. The price of the fix is that no member can set its own external tariff any more, and the union has to negotiate with outsiders as one voice.

Common market. A customs union plus free movement of the factors of production between members. Labour and capital can move to whichever member will pay most for them, so a worker can take a job in another member country without a permit and a firm can build a factory there without special permission. Goods, services, workers and money all cross the internal borders freely.

Those are the three rungs the guide names as trading blocs: rungs two, three and four of Figure 1. Go back and look at the ladder now, because the wording of the added feature is what earns the mark.

A free trade area removes barriers between members. A customs union adds one common external tariff. A common market adds free movement of labour and capital. A monetary union adds one currency.

4What a trading bloc gives its members

The guide names five advantages. The first is HL material and waits for section 6.

Trade creation (HL only). Cheaper production inside the bloc replaces dearer production at home. Section 6.

Greater access to markets, which offers the potential for economies of scale. A firm that could once sell only to its own country can now sell to every member without a tariff. More buyers means more output, and for many industries more output means a lower average cost per unit. Figure 4 shows a firm sliding down its long-run average cost curve from AC₁ to AC₂ as its market widens.

Weigh it, because this is an AO3 line. The gain is only there in industries where average cost really does fall with scale — car assembly, steel, aircraft, software. A workshop making handmade furniture has almost no scale economies to reap, and it now faces competition from every other member. The bloc has widened its market and its rivals' market by exactly the same amount.

With freedom of labour, greater employment opportunities. In a common market a worker living where unemployment is 14% can take a job in a member country with a shortage of workers. Vacancies get filled, workers earn more than they could at home, and some of that money is sent back.

Weigh this too. The region losing workers often loses its youngest and best trained, which makes its own recovery harder, and the region receiving them may find housing and public services under strain. Free movement is a genuine gain in total, distributed very unevenly.

Stronger bargaining power in multilateral negotiations. Twenty countries arriving at the WTO with one agreed position, and a market worth several hundred million consumers, are listened to. The same twenty arriving separately are not. A bloc can also offer something big enough to trade with: access to all of it at once.

The condition is that the members can agree a position at all. On the items where their interests differ — usually farming — a bloc can arrive with no position and no power.

Greater political stability and cooperation. Countries whose economies are woven into each other have far more to lose from a quarrel, and they meet constantly to run the agreement, which builds the habit of settling things by negotiation. This is the oldest argument for integration and the hardest to measure. It also runs the other way when the costs of an agreement fall unevenly and voters in one member decide the bargain is not worth it.

5What a trading bloc costs its members

The guide names three, and the first is again HL material.

Trade diversion (HL only). Imports switch from the world's cheapest producer to a dearer producer inside the bloc. Section 6.

Loss of sovereignty. Sovereignty is a government's power to decide its own laws and policies. Every rung up the ladder hands over another piece of it. A customs union takes away the power to set your own external tariff. A common market takes away the power to decide who may work in your country or who may buy your firms. A monetary union takes away the interest rate and the exchange rate together. None of this is handed to nobody: it goes to a body the members share and run jointly, which is why the argument is political rather than settled.

Whether the loss matters depends on what the country would have done with the power. A small economy that could never win a trade dispute alone may lose little real freedom and gain a great deal of protection. A country with a distinctive economy — one dominant export, an unusual inflation problem — may find the union's common policy is set for somebody else's circumstances.

A challenge to multilateral trading negotiations. Blocs discriminate: that is what a preference means. Every regional agreement leaves non-members facing barriers their competitors inside the bloc no longer face, which is the opposite of what the WTO exists to do. Two further effects follow. Governments spend their negotiating effort on regional deals rather than on global rounds, and once a country has secured good terms with its main partners it has much less left to gain from a global agreement, so it bargains less hard for one. Firms meanwhile face a tangle of different rules, different tariff schedules and different origin checks depending on which agreement a shipment falls under.

7Monetary union

A monetary union is a group of countries that share a single currency, issued and managed by a single central bank which sets one monetary policy for all of them. It sits at the top of the ladder in Figure 1 and is normally built on a common market that already exists.

A member gives up three things on the day it joins, and they are worth listing separately because questions ask for them separately.

• Its own currency. Prices, wages, savings and debts are redenominated into the union's currency.
• Its own interest rate. The union's central bank sets one rate, chosen for the union as a whole.
• Its exchange rate with the other members. There is no longer one to change, because there is no longer another currency to change it against.

What a member usually keeps is fiscal policy: its own taxes and its own government spending, though unions commonly set limits on how large a member's budget deficit may be.

Figure 7 shows the difficulty that follows. Member A is booming with 6% inflation and wants a higher interest rate; member B is in recession with 11% unemployment and wants a lower one. The central bank has one rate to give. Whatever it picks is too loose for A and too tight for B, and neither can fall back on its exchange rate, because they share the currency. Keep this picture: it is the engine of nearly every evaluation of monetary union.

9The World Trade Organization

Objectives. The WTO exists to bring about freer trade between its members and to make trade flow as smoothly and predictably as it can. Predictability matters as much as the freedom: a firm will invest in an export business if it believes the tariff it faces will not be raised next year.

Functions. The WTO administers the trade agreements its members have signed; provides the forum where members negotiate new ones, in rounds; settles trade disputes between members under procedures they have all agreed to; reviews each member's trade policies so the others can see what it is doing; and gives technical assistance and training to officials from developing members. It also works alongside other international organisations.

What limits its influence. The guide names two factors, and both are worth a paragraph.

Difficulties reaching agreement on services and primary products. Farming is protected in nearly every member, for reasons that are only partly economic: food security, rural employment, and farmers who vote. Governments will trade away tariffs on machinery long before they touch farm support. Services — banking, insurance, transport, professional qualifications — are hard for a different reason: they are barely affected by tariffs at all, because what keeps a foreign bank out is domestic regulation and licensing, so opening services means rewriting domestic law. These two items are the hardest on any agenda, and because WTO decisions need the agreement of the whole membership, one refusal is enough to hold up a round. Negotiating rounds have stalled on exactly this.

Unequal bargaining power of members. A large economy comes to the table with a large market, so it can offer more and demand more. A small developing member may not be able to fund a permanent delegation, let alone the legal cost of a long dispute case. And even winning a dispute is worth less to a small member, because the remedy is permission to retaliate against the loser, and retaliating against a much larger trading partner does more damage at home than abroad.

A third pressure comes from section 5. Members keep signing bilateral and regional deals, which are faster to agree and discriminate in their favour, so the effort that would once have gone into a global round goes elsewhere.

The honest summary is that the WTO is not a world government. It can administer and enforce only what its members have already agreed to, and getting them to agree is the hard part.