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An Economic and Monetary Union is a union of two or more economies or markets to form a single market with a common currency. It is considered the fifth stage of economic integration. The largest Economic and Monetary Union at present is the European Union.

The process of economic integration and the formation of an Economic and Monetary Union is a gradual process comprising the following stages:

  • Preferential trading area
  • Free trade area
  • Customs union
  • Common market
  • Economic and monetary union
  • Complete economic integration

Preferential trading area

A Preferential Trading Area is formed through a trade pact between nations to form a trading block. The trade block usually allows preferential access to select goods within the block via the reduction of duties, but not necessarily by abolishing them. It is the first step towards economic integration.

Free Trade Area

A Free Trade Area is formed between two or more nations by a trade pact that removes tariffs and quantitative restrictions for trading of most goods amongst themselves. Members of a Free Trade Area are usually free to follow their own trade policies with non member nations. A Free Trade Area works well in the case of non-competing nations. In the case of nations having competitive goods, a Customs Union is the more favored type of trade area.

Customs Union

This is the third stage of economic integration, which leads to the formation of a common trade area with common external tariff policy unlike in the Free Trade Area. While, a Customs Union follows a common external trade policy, some nations in the Union may be allowed to retain import quotas for some time to allow their select industries protection, which they need to gear themselves to face foreign competition.

Common Market

A Common Market is fourth stage of economic integration and a level more advanced than the Customs Union. A Common Market is formed with the objective of removing barriers for the free movement of capital, goods, services and labor. The Common Market zone follows a common external trade policy as in the Customs Union. A slightly more advanced stage of the Common Market is termed as a Single Market, which attempts to harmonize taxation, technical standards and reduce the impact of political boundaries.

A Single Market is formed with the objective of bringing in greater efficiencies in allocation of resources and enhancing the element of competition. It also usually leads to a closure or rationalization of inefficient companies and to economies of scale achieved out of a single larger market.

Economic and Monetary Union

The formation of a single market as yet lacks one crucial aspect. The area as yet has not adopted a single currency. Once a Single Market has adopted a common currency, it is termed as an Economic and Monetary Union. It is considered as the fifth stage of economic integration and it brings in greater efficiencies into the Single Market area. The formation of an Economic and Monetary Union requires harmonization between central banks and their monetary policies. Adoption of a single currency does away with the need of currency exchange and hedging forward contracts within the Single Market area. This leads to considerable savings for businesses.

The European Union is the largest and most successful example of an Economic and Monetary Union.

Complete Economic Integration

This is considered the final stage of economic integration, which leads to a near complete harmonization of fiscal and monetary policies. It also amounts to the loss of political independence of member nations as they are unable to use the monetary or fiscal lever independently. Such complete economic integration is usually found within large nations such as the USA and is usually not concurrent with a union of distinct political geographies.

Some proposed Economic and Monetary Unions

  • Caribbean Community
  • Economic Community of West African States (ECOWAS)
  • East African Community (EAC)
  • Gulf Cooperation Council (GCC)
  • Economic and monetary union of the Southern African Development Community (SADC)
  • Union of South American Nations (Unasul)
  • African Economic Community (AEC)

As may be evident from the list above, the continent of Africa has an ambitious proposal of formation of regional unions, which propose to finally form the AEC, with a single currency uniting the majority of the continent. Economists have also discussed the possibility of a Eurodollar as a common world currency in the future. Then would the Eurodollar sound the death knell for the currency trader!!!