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firms in the member countries. Specialization, plant rationalization andincreased product variety will be the other related benefits.Many large and medium-sized developing economies made significantendeavors to liberalize unilaterally after the mid-1980s. However, theyfrequently had to stop this after a while because its domestic politicalunpopularity meant it was not feasible. It is an axiom that at political level,there is a strong mercantilist bias in trade-policy thinking. This bias is notconfined to developing economies but is to be found in the industrialeconomies as well. Bringing down trade barriers is seen as a concession givento the trade partners. Due to this mindset, unilateral trade liberalization has itslimits. Liberalization in an RIA context allows liberalization endeavors to gofurther than this limit (Panagariya, 1998). Under the aegis of an RIA, tradeliberalization can be made more acceptable to the electorate than unilateralliberalization. Trade policy is endogenous to any economy and is heavilyinfluenced by domestic politics as well as lobbyists and vested interest groups.In trade policy, they are a disturbing fact of life. RIAs can help the trade policymove towards liberalization. As the lobbying activity tries to influence thelevel of tariffs and NTBs, an RIA can lower the level of lobbying by makingthe benefits of lobbying more diffused. They can also make the free-riderproblem more acute regionally and force the free-rider to comply with the RIAnorms in a short timespan.9Evidence for the decade of the 1990s shows that many developingeconomies liberalized their economic regimes to be a part of regionaleconomic integration endeavors (Sharer, 1999). Demonstration effect wasfrequently found to operate. In many of the developing economies, RIAscontributed substantially to structural reforms by creating incentives toeliminate restrictive trade practices and licensing procedures, streamliningcustoms procedures and regulations, integrating financial markets, andsimplifying transfers and payments procedures. A few countries in Africa havegone beyond this, harmonizing investment incentives and tax treatment, aswell as standards and technical regulations. In sub-Saharan Africa, manyeconomies took these measures during the late 1990s. It must be noted,however, that most countries in Africa were slow to start liberalization, Egyptand Morocco were two exceptions in this regard.3.1 Regional Versus Global LiberalizationIn a global economy that is full of RIAs, an autarkic economy that isembarking on its path to liberalization is faced with two choices: whether toliberalize its trade regime globally in a non-discriminatory-non-preferentialmanner or to liberalize preferentially in a limited fashion for its RIA partners.Few empirical or theoretical studies have addressed the issue of whether
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liberalizing broadly to the global economy is a superior alternative toliberalizing to an RIA. Participation in an RIA does not explain the crosscountry GDP growth differentials, although the generalization holds that openeconomies grow faster and autarkic ones record tepid GDP growth rates,regardless of their RIA participation (Vamvakidis, 1997 and 1998).Comparing the before-and-after scenarios of growth performance ofliberalizing economies can be illuminating in this regard. It can reveal theimpact of discriminatory and non-discriminatory liberalization on GDPgrowth performance of the liberalizing economy.Based on the data set for the 1950-92 period, Vamvakidis (1999) estimatedthe growth performances of economies that liberalized broadly to join theglobal economy and those that liberalized preferentially to join an RIA. Hisstudy had 109 cases of liberalization aimed at joining an RIA and 51 cases ofbroad liberalization to join the global economy. His inference was thatautarkic economies that want to open their markets to free trade should choosenon-preferential non-discriminatory liberalization. On an average, economieswere found to grow faster, both in the short and long term, after broad, nonpreferential liberalization. Vamvakidis (1999) presented time series evidenceto this effect.The same could not be said about the economies whose liberalization waslimited to the preferential variety. In cases where liberalization was limited tothe RIA partners, growth was even found to be negative and statisticallysignificant in most empirical specifications. Thus, one can conclude that onlynon-discriminatory liberalization fosters growth. In terms of short- and longterm growth benefits, a liberalizing economy was found to be better offintegrating with the global economy than with an RIA. To test the robustnessof these results, Vamvakidis (1999) used two measures of openness. First, theopenness index constructed by Sachs and Warner (1995) and second, the tradeshare, that is, the ratio of total trade to GDP. Both were found to be positiveand statistically significant in fixed-effects regressions, when either growth orinvestment share is the dependent variable.Although liberalization in the context of an RIA and broad globalliberalization are not mutually exclusive theoretically, economies seldomfollowed them simultaneously. In general, one was taken up at the exclusionof the other. However, in more recent liberalization episodes, there were manycases of two paths of liberalization being followed simultaneously.3.2 RIAs and Domestic Policy IntegrationIn international trade, some domestic policies may have an impact identicalto that of trade policy measures applied at the border. Reference here is tothe domestic policy areas like tax structure, labor market regulations,
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environmental norms, and competition laws. Although they can be used astrade barriers, often their influence on trade is unintended. Even if policymakers have no intention of discriminating against imports, domesticindustries may perceive the differences in regulatory regimes as ‘unfair’treatment of foreign firms in the domestic markets. Under an RIA regime if aneconomy moves towards free trade, some consumer, environmental, and laborinterest groups may be apprehensive about erosion of national standards. Thereverse is also feasible and often happens. That is, domestic consumer,environmental, and labor interest groups may feel that under the RIA regime,trading partners should be asked to adopt changes in their policy regime.These domestic concerns and external pressures have plagued numerous RIAmembers, which has led the constituent member economies to negotiatedisciplines for domestic regulatory regimes under the RIA.Domestic policy integration is defined as actions taken by constituentmembers of an RIA to reduce market segmenting effects of differences innational regulatory regimes through either coordination and harmonization orby way of mutual recognition of national laws, regulations, and enforcementmechanisms (Hoekman et al., 1998). The first objective of policy integrationis to ensure a ‘level playing field’ for the firms from the member countriesoperating in the RIA. A second objective is to ensure that there is noresurgence in trade barriers through the back door in the member economies.Third, domestic policy integration is also driven by a desire to internalizeexternalities, reduce waste and redundancy, and increase competition in thedomestic markets. A good example of this could be the harmonization ofhealth and safety standards in the industrial sector, or having uniformcompetition or antitrust regulations for firms, in all the constituent members ofthe RIA.One of the strongest benefits of domestic policy integration for theconstituent members is enhancement of the contestability of markets.Lowering tariffs is only one way of bringing down barriers that have the effectof insulating markets for similar goods in the member countries, policyintegration is another important instrument for attaining the same objective. Itcan deliver large economic benefits to the constituent members as well as tothe non-member economies. All the members of an RIA can benefit fromcommon administrative procedures and unified product standards. Theultimate effect of policy integration is reduction in administrative costs. If thatdoes take place, the attractiveness of an RIA as an instrument of trade andinvestment policy reforms for the members is enhanced.Hoekman et al. (1998) contend that where policy integration is beingpursued, the optimal domain must be considered properly. In some cases, theoptimal domain would be regional while in many cases it would be global.Nation states pursue multilateral efforts all the while to agree on common
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standards and norms in various areas of trade and other economic activity. Insome instance these endeavors succeed in the creation of multilateralinstitutions like the International Organization for Standardization (IOS), theBasle Committee on Banking Supervision, and the International Telecommunications Union (ITU). These organizations then become the fora wherecommon norms and standards continue to develop. To be sure, regulatorynorms are best developed at the global level. When RIAs take initiative todevelop them, they need to be conscious of these norms being internationallycompatible (Hoekman et al., 1998; Vamvakidis, 1998).Quantifying the welfare implications of policy integration is not a simpleand straightforward exercise, although it should be attempted because policydecisions in this area would necessarily benefit from such an input.Notwithstanding the benefits of policy integration, it is not wise to presumethat RIAs incorporating elements of policy integration have better welfare andsocial implications than those without. This is because the latter may havemore far-reaching economic implications than those that do incorporate policyintegration. The economic impact of traditional trade liberalization, which islimited to integration of trade policies, can easily dominate the impact ofintegration of domestic policies.So far domestic policy integration has been an item low on the agenda ofmost RIAs and has not played a major role. In RIAs where it does figure, ithas remained confined to fiscal and monetary policies. This was noticed incase of Union économique et monétaire de l’Afrique occidentale (UEMAO).Integration of microeconomic policies has only been noticed in RIAsinvolving industrial economies, like the EU and CER. Some recent RIAs,which have developing, emerging-market and industrial economies asmembers, do have broad future objectives of economic policy integration.MERCOSUR, Euro-Mediterranean Partnership Agreement (EMPA), theFTAA and APEC come under this category (Hoekman et al., 1998;Vamvakidis, 1998).
4. IMPACT OF RIA CREATIONWhen tariff barriers are eliminated and an RIA is created, share of importsfrom partner economies rises. Schiff and Winters (2003) made a before-andafter comparison and found that it is correct in around 80 percent of the RIAs.These results look like cause for celebration, for strong international tradeperformance is now generally accepted as one of the main determinants ofeconomic prosperity. However, before breaking out the champagne we need to askwhether every increase in trade is desirable and whether these increases are actuallydue to regionalism.
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If exports from a constituent member of the RIA displace domestic output inthe importing economy because once the tariff is eliminated the exportingpartner’s product becomes more competitive in the domestic market, thedomestic economy benefits from two classical sources of gains from trade.First, real domestic resources are saved and production is diverted in thedirection of comparative advantage of the economy. Second, domesticconsumers benefit from lower, undistorted prices. This is trade creation and itsimpact is unambiguously favorable for the domestic economy.Forming an RIA affects trade flows and their directionality and, therefore,production patterns in the economies that are constituent members of that RIA.Locations of production in the constituent member countries are seriouslyinfluenced by RIA formation. As alluded to above, enlargement of national or‘home’ market by way of regional integration is another major economicimpact of an RIA. Schiff and Winters (2003) noted that:A well crafted trade bloc can raise efficiency – and economic welfare – in itsmember countries by facilitating consumer choice and increasing the competitionthat producers face. Dropping tariff barriers enlarges markets and gives moreefficient producers entry into countries where their prices had been inflated byduties and other trade barriers.
Here the emphasis needs to be on well crafted.To be sure, the larger regional market provides scale economies to firms,which lead to efficiency gains. A larger market also tends to attract greaterinvestment, including more FDI. This argument applies a fortiori to thecontemporary wave of new regionalism. Larger manufacturing and servicessector projects for which market size matters, become feasible for the firsttime due to the formation of an RIA. Dismantling of regional trade barriersalso forces firms from different member countries into more intensecompetition with each other than was feasible before the RIA was formed.This induces firms to make efficiency improvements and raise their level oftotal factor productivity. Thus, the immediate impact of enlarged markets islarger firms and enhanced competition.Trade theory posited that trade liberalization improves economic welfare byenhancing efficiency in the liberalizing economy. Trade policy liberalizationundertaken to join an RIA takes an economy towards this objective, althougha better motive would be to liberalize in a non-discriminatory manner, inkeeping with the most-favored-nation principle promoted by Article I of theWTO, Article II of the GATS and Article IV of the TRIPS (Trade RelatedAspects of Intellectual Property Rights) agreement. The language Article I ofGATT-1947 is subsumed in GATT-1994, which unequivocally states that:With respect of customs duties and charges of any kind … any advantage, privilege,favor, or immunity granted by contracting party to any product originating in or
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Regionalism in global tradedestined for any other country shall be accorded immediately and unconditionallyto the like product originating in or destined for the territories of all othercontracting parties. (GATT, 1994).10
Neo-classical analysis would support this line of logic. As stated above, RIAsare widely considered the second best approach to trade liberalization. It isalso well established that RIAs make a valuable contribution by givingearly partial delivery of some of the benefits which can be expected from fullMFN-consistent liberalization. However, Scollay (2000) has emphasized thatthis favorable impact of an RIA is subject to the proviso that adequateprecaution is taken to ensure that trade diversion effects do not outweigh tradecreation ones, and the dynamic gains arising from regional liberalization,which can include productivity gains stimulated by increased competition andexploitation of economies of scale made possible by access to a large market.RIAs also enable developing economies to phase in their integration intoglobal markets.The favorable impact of an RIA is conditional. The limiting condition is thatRIAs are able to achieve a deeper degree of economic integration than themultilateral trading system. This is well within the realm of feasibility becauseRIAs usually entail neighboring like-minded countries. A smaller forummaking negotiations on new trade issues easier than a larger group ofcountries, has a fighting chance of working. A smaller group of like-mindedneighboring countries also makes it possible to establish the necessarycentralized institutions or federalizing policy-making and enforcementinstitutions. Economic theory suggests that RIAs can be so designed as to havefavorable impact and be welfare improving, but in a real-life situation ‘therequired information and the rights to manipulate the trade policy to achievethis result are generally missing’.Also, politically regions may well be more willing to agree to liberalizationthan individual economies. The post-war experience with the EEC confirmsthis observation. The Kennedy Round (1964–67) would not have taken offwithout EEC support. During that period, individual economies were reluctantto deepen their trade liberalization. France and Italy were resisting the idea ofmaking any trade concession in the 1960s and Germany would not have madeconcessions in isolation from its close trading partners. However, as a group,the EEC supported the Kennedy Round MTNs.4.1 Choice of Partners and their ImpactWhen the constituent members of an RIA are at varying levels of economicdevelopment, that is, when RIAs are formed between developing, emergingmarket and industrial economies, it is known to promote technologytransfers from the high-income, matured, industrialized economies to the
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lower-income less-developed constituent members. Therefore, the possibilityof enhancing such technology transfer motivates developing economies toform RIAs with the emerging-market and industrial economies. Althoughthe mechanisms of technology transfer are neither clear nor fully understood,an important body of literature argues that it is promoted through tradeflows.When members of an RIA are at varying levels of economic development,their knowledge accumulation also varies. Despite the limitations of patentsand copyright, knowledge is an international public good and could betransferred to other RIA member economies through trade, FDI and scientificexchanges, affecting their growth, which is at the heart of the development.Coe and Helpman (1995) and Coe et al. (1997) constructed an index of totalknowledge capital in each industrial country. They posited that tradingpartners get access to a country’s stock of knowledge in proportion to theirimports from that country. They found that access to foreign knowledge is astatistically significant determinant of the rate of total factor productivityacross the 30 Organization for Economic Co-operation and Development(OECD) countries and developing countries.11 Thus, an RIA might worktoward promoting technology transfer through trade expansion. Similarly,RIAs are known to promote FDI, which in turn is a well-known source oftechnology transfer.Again, when the constituent members of an RIA are at varying levels ofeconomic development, it helps in importing a growth-stimulatingenvironment and institutions of the partner developing economies. Thus, theultimate benefit to them is that the formation of an RIA is able to enforce amore stable domestic macroeconomic environment (WB, 2000). In theprocess, it might be able to reform its labor, investment and industrial policiesas well as corporate governance. Lejour et al. (2001) examined the economicimpact of the enlargement of the European Union (EU) when the eight Centraland East European Countries (CEEC) join in 2004.12 This study focused on theintegration process, which inter alia involved accession to the internal market,equalization of external tariffs and free movement of labor and capital. Theyadopted a computable general equilibrium model for the world economy,called WorldScan, to quantify the implication of EU enlargement. Theirprincipal conclusion was that the EU enlargement would result in modest orminuscule gains for the EU economies, but large gains for the newly accedingCEEC economies. Average increase in per capita GDP in the CEEC countrieswas estimated at 8 percent in the long run (by 2020), with Hungary showingthe maximum increase because it is relatively more open than the other nineeconomies. They suggested that compared to the customs union and freemovement of labor and capital, accession to the internal EU market yielded thelargest economic benefits. They computed a 0.2 percent expansion of
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consumption in the EU as a group. This conclusion is in line with the previousmodel stimulations of EU enlargement by Brown et al. (1997) who estimatedreal GDP gains for CEECs, ranging from 3.8 percent to 7.3 percent, withconsumption gains to the EU of 0.1 percent. Similarly, Breuss (2001)computed gains in real GDP between 4 percent and 9 percent for the CEECsand one tenth of this for the EU.It is accepted that after joining the EU, Greece, Portugal and Spain clearlybenefited from similar gains.13 However, income convergence betweenmember states was far from uniform or steady. While Ireland, Portugal andSpain are known for rapid catch up, Greece is not. Summary measures of thecross-country dispersion of per capita income were computed for the EUeconomies by Puga (2002), which indicated significant convergence throughthe decades of 1960s and 1970s. During the 1980s, no further aggregatechange was found. However, convergence resumed across the EU economiesin the late 1980s. This was accompanied by divergence at the sub-nationallevel.14Mexico is another example of an emerging-market economy reaping similarbenefits by joining large industrial economies in an RIA (see Chapter 6,section 8). Aggregate and micro data on trade between the US, Canada, andMexico were used by Krueger (1999) to attempt to assess the early effects ofMexican entry into NAFTA. Although the fraction of Mexican trade with theUS and Canada has risen sharply, a number of factors have contributed to thisresult. Mexican reduction of tariffs and quantitative restrictions (QRs) and thealteration of exchange rate policy at the end of 1994 were both important incontributing to the sharp rise in Mexican trade volume.As a rule of thumb, RIAs between industrial and developing economiesare of FTA variety. The NAFTA and Euro-Mediterranean PartnershipAgreement (EMPA) are good examples of such RIAs. When developingeconomies are involved as custom union (CU) partners with industrialeconomies, as in case of the EU-Turkey CU, the partner developing economyis effectively obliged to adopt the lower tariff rates of the industrialpartners, which implies substantial measure of trade liberalization. Such alarge liberalization is indeed a source of gains to the member developingeconomy.4.2 On Developing EconomiesWhen RIAs are created between developing economies, feasibility ofknowledge, technology and capital transfers between the member economiesare minimal – even non-existent. Growth inducing effects of such transfers aremissing in RIAs between the developing economies. Furthermore, the impactof forming an RIA between the developing economies tends to be problematic
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in several respects (WB, 2000). Some empirical studies have called intoquestion the economic benefits of such RIAs. Several of them advancedpessimistic conclusions regarding RIAs in Africa.15 Other than doubtful noneconomic benefits, RIAs between developing economies are more likely tospawn trade diversion than trade creation, particularly when common externaltariff rates are high. Detailed time series data analysis for sub-Saharan AfricanRIAs revealed that judged by the variance in their trade patterns from thatwhich their comparative advantage would predict, RIAs have negative effectson members and non-members alike. If RIAs succeed in diverting regionalimports from low to high cost sources, they would naturally retard theindustrialization and real GDP growth endeavors of the member countries(Yeats, 1998).A lower share of intra-trade was found for RTAs between the developingeconomies, particularly in Africa, than those between the industrialeconomies. In an intertemporal analysis, a negative impact of RIAs on tradewas not only found for Africa, it was also found and predicted for LatinAmerica (Nagarajan, 1998). The best route to ensure that RIAs among thedeveloping economies result in welfare gains for the members is to liberalizetheir trade regime with respect to the rest of the world. Also, developingeconomies should integrate with each other in the areas of regional publicgoods, which tend to benefit all the partners.One reason why trade diversion was so commonly found in RIAsin sub-Saharan Africa is that the tariff barriers in Africa before the UruguayRound (1986–94) were exceedingly high, perhaps higher than any otherdeveloping country group. Even in the late-1990s, the average tariff in subSaharan Africa was 26.8 percent, more that four times higher than thecorresponding average (6.1 percent) for the OECD economies. Such a highlevel of MFN protection, coupled with the formation of RTAs led, accordingto customs union theory, to high trade diversion effect in the sub-SaharanRIAs (Cernat, 2001).There is dissention in views in this respect and the results of studies thatconcluded that RIAs between developing economies end up diverting tradehave been challenged. For instance, Evans (1998) and Lewis et al. (1999)found a positive net effect of RIAs in South Africa. Taking into account thedynamic impact of RIAs, they concluded that economic integration couldcreate threshold scales necessary to trigger the much-needed strategiccomplementarities within the region.4.3 On Small EconomiesThere are several definitions of small economies. A large majority of smalleconomies are covered under the United Nations’ (UN) classification of least
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developed countries (LDCs). In April 2003, the UN classification included 49countries, of which 30 were members of the WTO and 5 were observers.16 TheWorld Bank classified 41 countries as small states, while the CommonwealthSecretariat categorized 30 countries as small states. The UN also has anothergrouping called the small island developing states comprising 28microeconomies. According to a joint definition of the CommonwealthSecretariat and the World Bank, small states are those that have the populationof 1.5 million or less.17 Here we are only concerned with the low-income smallstates, not the high-incomes one, like the Bahamas, Bahrain, Cyprus, Maltaand Qatar.Vulnerability of low-income small economies to changes in externalenvironment is far greater than that of other economies. Schiff (2002)examined the various optimal policy responses of small states in the face ofon-going globalization and formation of RIAs. A large number of smalleconomies in the Caribbean, South East Asia, and Central, Western andSouthern Africa have formed RIAs with other developing economies. Asnoted earlier, RIAs between developing economies that provide preferentialaccess to the members but do not change their trade policies vis-à-vis the restof the world, may well end up lowering the welfare of the entire trade bloc(WB, 2000). The case of small economies is no different. RIAs between smalland developing economies are more than likely to induce a replacement ofcheaper imports from the rest of the world with more expensive imports fromthe member countries, in effect encouraging the inefficient producers tocontinue production. The smaller the share of intra-regional trade in total tradeof the member countries, the more likely is the possibility of the RIAbecoming trade diverting.It has been observed that larger and more developed members of an RIAbenefit at the expense of smaller and less developed ones. This was observedwhen CARICOM (Caribbean Community and Common Market) finalized itsSingle Market and Economy initiative in 2002. The smaller and lessdeveloped members were much less enthusiastic about this initiative than thelarger and better-off ones. Unless a compensatory mechanism is created, thiscould cause friction between the RIA members. Another method of mitigatingthis problem is to lower the CET because this reduces the size of intra-RIAtransfer, whether positive or negative.Small economies integrating with emerging-market or industrialeconomies are likely to form an RIA which is superior in welfare terms(WB, 2000). It also increases the credibility of the small economy and helpsin attracting FDI from the high-income economies in the neighborhood.Visibility and improvement in international negotiations is anotherbenefit that small states can derive from an RIA membership (refer toChapter 6).
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5. THE AGGLOMERATION OR CLUSTERING EFFECTTo be sure, comparative advantage is a force to reckon with in influencing thelocation and/or relocation decisions in an RIA. These decisions are alsosignificantly driven by the agglomeration or clustering effect. Fujita et al.(1999) posited the concept of ‘cumulative causation’ which implies that asclusters of manufacturing activity – or, say, economic activity in general –start to develop in a country and/or in an RIA, a spatial clustering oragglomeration of economic activity takes place assisting location-specificdevelopment. The advantages of starting at a specific location provide anindustry, or economic activity, with a head start.An age-old dictum is that in all economic activity, spatial clustering is allpervasive. Why do towns and cities come into existence? It is becauseeconomic agents – consumers, producers, workers and capital owners –benefit from being in close proximity. There is a strong symbiotic bondbetween them. A particular type of economic activity finds an appropriatelocation and creates a spatial cluster at that location. It has long been the storyof industrialization, of which Detroit and Silicon Valley are two goodcontemporary examples. Banking activity is concentrated in the globalfinancial centers like Wall Street in New York and the City of London for thesame reasons. Numerous other industries provide examples of spatialclustering in one, or a few, locations.Various centripetal forces that pull economic activity towards the spatialcluster are responsible for their creation. One of the most important centripetalforces is the knowledge spillovers and technological externalities which makeit logical for firms to locate in the vicinity of each other. Second, theavailability of industrial skills and labor market pools encourages firms to bein a location where they are readily available, or where trained humanresources are available and their skills can be augmented according tothe specific needs of an individual firm at a reasonable cost. Third, thebuyer–seller proximity is another important force pulling firms together in aspecific location. Some firms produce inputs for the other firms and arevertically integrated with them. If the two sets of firms are close to each other,they both benefit from the proximity. In the theory of unbalanced growth,propounded by Albert O. Hirschman, this phenomenon was explained with thehelp of the ‘backward’ or demand linkage and ‘forward’ or supply linkage.18Fujita et al. (1999) formally established that these linkages create a positiveinterdependence between the location decisions of different firms andindustries. This can give rise to the process of cumulative causation creatingagglomeration of economic activity. Here the assumption is that theproduction activity has an increasing return to scale.The centripetal forces, when they operate at an aggregated level, create
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backward linkages. That is, aggregate demand created by them strengthens thebackward linkages drawing firms from different sectors into locations withlarge markets. At the aggregate level, agglomeration forces generate the needfor a broad class of business activity and create a market demand for basicindustrial infrastructure like financial and telecommunication services. Thereare real efficiency gains from spatial concentration. As opposed to this,centripetal forces can be spatially focused. Need and availability of highlyspecialized inputs or technologically narrow knowledge spillover operate tocreate clusters of narrowly defined industries or mere industrial sectors, ratherthan a broad manufacturing cluster. Silicon Valley is an excellent illustrationof this kind of clustering. Conversely, congestion, pollution, rising prices ofoffice space, land or other immobile factors of production pull a cluster in theopposite direction. A rising level of competition is another factor that can deterthe spatial clustering process. Usually deterrence strengthens process after theclustering acquires a large size, and seems saturated.Membership of an RIA affects the creation or expansion of spatial clusters.With such a membership, tariff and non-tariff barriers go down, or areeliminated. This makes forward and backward linkages stronger. A largernumber of firms can participate in the creation of spatial clusters after the RIAformation. The opposite also holds, that is, an RIA makes it possible to supplygoods to consumers from a small number of spatial clusters. This implies thatforming an RIA tips the balance in favor of creation of larger agglomerations,until the centrifugal forces start operating in the opposite direction.There is a strong possibility that formation of an RIA may generate morespatial concentration of sectors, rather than aggregate level industrialconcentrations in the constituent member economies. For instance, industriesin the US are far more spatially concentrated than in Europe. This observationholds even after controlling for the distribution of population andmanufacturing activity. Therefore, the regional integration process in Europecould well advance agglomeration at the sectoral level. So far there is littleevidence of relocation of industries in the EU on these lines, but if or when ithappens it would result in considerable short-term adjustment costs for theEuropean industrial sector. The industrial structure of member countrieswould change with relocation of industries. As there are real efficiency gainsfrom spatial concentration, on balance there would be benefits from suchindustrial relocation and growth of spatial clusters. Sectoral agglomerationsmay also contribute to a decrease in intra-RIA inequalities because eachmember country may attract industrial or services activity of one kind or theother.One of the