Regional economic integration: exchange rates


Regional Economic Integration can best be defined as an agreement between groups of countries in a geographic region, to reduce and ultimately remove tariff and non-tariff barriers to allow free flow of goods, services, and factors of production between each other.

Regional economic integration: Merits of a fixed and floating exchange rate

Floating exchange rates have the following advantages:

1. Automatic Stabilization:

Any disequilibrium in the balance of pay­ments would be automatically corrected by a change in the exchange rate. For example, if a country suffers from a deficit in the balance of payments then, other things being equal, the country’s currency should depreciate. This would make the country’s exports cheaper, thus increasing demand, while at the same time making imports expensive and decreasing demand. The balance of payments equilibrium would therefore be restored. On the contrary, a balance of payments surplus would be automatically eliminated through a change in the exchange rate.

2. Freeing Internal Policy:

Under the floating exchange rate system the balance of payments deficit of a country can be rectified by changing the external price of the currency. On the country if a fixed exchange rate policy is adopted, then reducing a deficit could involve a general deflationary policy for the whole economy, resulting in unpleasant consequences such as unemployment and idle capacity. Thus, a floating exchange rate allows a government to pursue internal policy objectives such as full employment growth in the absence of demand-pull inflation without external con­straints (such as debt burden or shortage of foreign exchange).

3. Absence of Crisis:

The periods of fixed exchange rates were frequently characterized by crisis as too much pressure was put on central bank to devalue or revalue the country’s currency. However, the central bank that devalued a currency by giving out too much of it would soon either stop or run out of it. Similarly the central banks that revalued a currency by giving out too little of it in exchange for other currencies would soon be flooded with that currency as it would get relatively large amounts of other curren­cies. Under floating exchange rate system such changes occur automatically. Thus, the possibility of international monetary crisis originating from ex­change rate changes is automatically eliminated.

4. Management:

J. E. Meade has pointed out that under the floating exchange rates system national governments enjoy considerable discretion. To be more specific, governments are free to manipulate the external value of their currency to their own advantage.

5. Flexibility:

Changes in world trade since the first oil crisis of 1973 have caused great changes in the values of currencies. How these could have been dealt with under a system of fixed exchange rate is not yet clear.

6. Avoiding Inflation:

John Beardshaw has argued that, “A floating exchange rate helps to insulate a country from inflation elsewhere. In the first place, if a country were on a fixed exchange rate then it would ‘import’ inflation by way of higher import prices. Secondly, a country with a pay­ments surplus and a fixed exchange rate would tend to ‘import’ inflation from deficit countries.”

7. Lower Reserves:

Finally, floating exchange rates should mean that three is hardly any need to maintain large reserves to develop the economy. These reserves can therefore be fruitful in importing capital goods and other items in order to promote faster economic growth.

Regional economic integration: Foreign Direct Investment(FDI)

A foreign direct investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country. Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets in a foreign company. However, FDIs are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies. Many third-world countries, or at least those with history of colonialism, worry that foreign direct investment would result in some kind of modern day economic colonialism, which exposes host countries and leave them vulnerable to foreign companies’ exploitations.

Advantages of Foreign Direct Investment

1. Economic Development Stimulation.

Foreign direct investment can stimulate the target country’s economic development, creating a more conducive environment for you as the investor and benefits for the local industry.

2. Easy International Trade: regional economic integration

Commonly, a country has its own import tariff, and this is one of the reasons why trading with it is quite difficult. Also, there are industries that usually require their presence in the international markets to ensure their sales and goals will be completely met. FDI will be make all these easier.

3. Employment and Economic Boost.

Foreign direct investment creates new jobs, as investors build new companies in the target country, create new opportunities. This leads to an increase in income and more buying power to the people, which in turn leads to an economic boost.

4. Development of Human Capital Resources.

One big advantage brought about by FDI is the development of human capital resources, which is also often understated as it is not immediately apparent. Human capital is the competence and knowledge of those able to perform labor, more known to us as the workforce. The attributes gained by training and sharing experience would increase the education and overall human capital of a country. Its resource is not a tangible asset, but instead something that is on loan. With this in mind, a country with FDI can benefit greatly by developing its human resources while maintaining ownership.

5. Tax Incentives.

Parent enterprises would also provide foreign direct investment to get additional expertise, technology and products. As the foreign investor, you can receive tax incentives that will be highly useful in your selected field of business.

6. Resource Transfer.

Foreign direct investment will allow resource transfer and other exchanges of knowledge where various countries have permission to access new technologies and skills.

7. Reduced Disparity Between Revenues and Costs.

Foreign direct investment can reduce the disparity between revenues and costs. With such, countries will be able to make sure that production costs will be the same and can be sold easily.

8. Increased Productivity.

The facilities and equipment provided by foreign investors can increase a workforce’s productivity in the target country.

9. Increment in Income.

Another big advantage of foreign direct investment is the increase of the target country’s income. With more jobs and higher wages, the national income normally increases. As a result, economic growth is spurred. Take note that larger corporations would usually offer higher salary levels than what you would normally find in the target country, which can lead to increment in income.

Disadvantages of Foreign Direct Investment

1. Hindrance to Domestic Investment.

As it focuses its resources elsewhere other than the investor’s home country, foreign direct investment can sometimes hinder domestic investment.

 2. Risk from Political Changes.

Because political issues in other countries can instantly change, foreign direct investment is very risky. Plus, most of the risk factors that you are going to experience are extremely high.

3. Negative Influence on Exchange Rates.

Foreign direct investments can occasionally affect exchange rates to the advantage of one country and the detriment of another.

4. Higher Costs.

If you invest in some foreign countries, you might notice that it is more expensive than when you export goods. So, it is very imperative to prepare sufficient money to set up your operations.

5. Economic Non-Viability: regional economic integration

Considering that foreign direct investments may be capital-intensive from the point of view of the investor, it can sometimes be very risky or economically non-viable.

6. Expropriation.

Remember that political changes can also lead to expropriation, which is a scenario where the government will have control over your property and assets.

7. Negative Impact on the Country’s Investment.

The rules that govern foreign exchange rates and direct investments might negatively have an impact on the investing country. Investment may be banned in some foreign markets, which means that it is impossible to pursue an inviting opportunity.

8. Modern-Day Economic Colonialism.

Many third-world countries, or at least those with history of colonialism, worry that foreign direct investment would result in some kind of modern day economic colonialism, which exposes host countries and leave them vulnerable to foreign companies’ exploitations.

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