What is Multilateralism? Explain the impact of Regional Economic Groupings.


Multilateralism refers to the system that governs the trading among various countries without any discriminatory restrictions. Multilateralism system has been established over the years as a result of the international trade negotiations among the various countries. These negotiations provide the guidelines to member countries for the formulation of their policies governing international trade.

The objective of multilateralism is to provide a stable and predictable environment in which business enterprises from different countries can trade with each-other under conditions of the fair and equitable competition. Thus multilateralism  is based on non-discriminatory treatment having no trade preferences.

Impact of Regional Economic Groupings

Trade Diversion.

Trade diversion is a situation where trade with non-member countries is diverted to member countries, consequent upon the formation of regional grouping. Trade diversion is detrimental to welfare. Trade diversion worsens the international allocation of resources by shifting the source of supply from a low cost producer to a high cost producer. In the case of the European Union, intra-trade accounts for more than 65% of the total trade as compared to about 30% during 50s.

Trade Creation.

Trade creation effect refers to the beneficial effect of the regional grouping. Trade creation results shifting supply from a high-cost domestic source to a lower-cost source of a partner. (i.e. another member of the grouping). The formation of the regional grouping results in the creation of some new trade for non-member countries.


The regional grouping removes, at least to some extent, the protection to domestic industries. This helps to break the monopoly or oligopolistic structure. Increased competition leads to the existence of efficient units. Thus, the opening up of the economy to increased competition ensures higher efficiency, as well as the stimulation of research and development.

Regional groupings results more . competition both from within and outside the region. From within the region, companies will have the benefit of larger size orders leading to reduced unit cost. From outside region, large size of market will motivate the firms to enter into regional market.

Economies of Scale and Ease of Entry.

The small size of the market is regarded as one of the chief constraints in achieving the economies of scale. Hence, it is believed that economic integration will permit the exploitation of economies internal to the firm that had previously not been forthcoming, because of the limited size of the market.

It follows that such gains could not be obtained if the integrated national economies had been large enough to exploit all sources of internal economies prior to integration. Balassa argues, however, that, in a present day integration projects, economies of scale can be appropriated, at least in some branches of production, in a wider market. Thus, increase in market size will have two implications:

  • The size of export order would be large leading to benefits of increased sales and scale of economies.
  • If an exporter is able to enter one country in the region, he will be able to reach his products to other countries in the grouping.

Reduction in Marketing Costs.

The concept of external economies comprises all forms of intra-industry and inter-industry relationships that contribute to reduction in cost of production as well as cost of marketing. Reduction in marketing costs is more visible in case of homogeneous or standardized products.

Impact of Foreign Direct Investment Flow.

Formation of regional grouping tends to stimulate investment. An increase in competition and technological changes lead to additional investments made to cope with the new situation and to take advantage of the newly created opportunities. The existence Of high cost producers and technological changes may however cause some disinvestment also though the new investment are likely to be more than the disinvestment’s.

The increased opportunities created by the regional grouping nay accelerate foreign investment in the member countries. Apart from the foreign firms already operating in the regional grouping to take advantage of the increasing opportunities. Some economists attribute the massive American investments in Europe after 1955 to the formation of the European Economic Community. The EC 1992 also stimulated a lot of foreign investment in the EU.

As Balassa points out, economic integration will reduce risk and uncertainty in the economic intercourse between the union members. In the present-day world various factors contribute to the riskiness of foreign transactions. Uncertainties are associated with the complexity of trade regulations and with the possibility of unilateral changes in tariffs and other forms of trade restrictions, foreign exchange regulations, and economic policies in general. Integration tends to foster development by reducing such uncertainties.

However, regional grouping also results outflow of foreign direct investment along with inflow of foreign direct investment. In a regional grouping all countries may not be at the same stage of economic development. Hence, there is a possibility that more economically developed country will attract more FDI, while FDI is needed more in lesser economically developed country. The impact on FDI flow has its positive and negative sides.

Terms of Trade Effect.

Terms of trade means the rate at which a country’s exports are exchanged for imports. Regional grouping results in trade creation which leads to increase in demand. Increase in demand means more imports from non-member countries. Thus increase in demand may lead to better prices for the products exported by third countries. This will have a beneficial effect on the terms of trade of those countries. This, however, depends on the relative position of the exporting country. Whether is a monopoly supplier or not, the price and income elasticity of import demand etc.

Mergers and Acquisitions.

Merger is a situation where two or more firms join together and form a single firm. Acquisition is a situation where one country takes over one or more companies. Since the size of the regional grouping and the possible impact of integration on the prosperity of the grouping are likely to motivate combination and consolidation there will be mergers and acquisitions. Formation of regional grouping facilitates the cross-border mergers and acquisitions, to take advantages of the large regional market.

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