Regional Trade Agreements Chapter 8 Copyright © 2009 South-Western, a division of Cengage Learning. All rights reserved.

Regional TradeAgreements

Chapter 8

Copyright © 2009 South-Western, a division of Cengage Learning. All rights reserved.

Regional Integration vs Multilateralismo regional trade blocs could be a complement to

multilateralism by setting a precedent which other nations will follow

o can lead to deeper integrationo however regional agreements are also

discriminatory in that some nations are treated differently than others

o decreases incentives for nations to pursue multilateral agreements

o trade bloc members may not gain additional economies of scale through multilateralism

Types of Regional Agreementso free-trade area – agreement to remove trade

barriers among membersexample: NAFTA

o customs union – agreement to remove trade barriers among members and impose uniform trade restrictions against non-members

example: Benelux

o common market – agreement that permits (1) free trade among members; (2) common external trade restrictions; and (3) free movement of factors of production

example: EU

Types of Regional Agreements (cont.)o economic union – common market agreement

with :1) common national, taxation, fiscal, and social

policies among members2) transfers of sovereignty to a supranational

authority example: Belgium and Luxembourg 1920s

o monetary union – economic union with additional characteristic of common monetary policy and common currency example: United States

Static Effects of Trade ArrangementsWith Tariff:(before customs union)

red triangle = consumer surplus

green triangle = producer surplus

black rectangle = tariff revenue

a + b = deadweight loss

Static Effects of Trade ArrangementsWith Customs Union:

agreement with Germany will lower the price to SG

trade-creation effect:welfare losses now part of consumer surplus a = production effect b = consumption effect

trade-diversion effect: area clost benefits from lower cost suppliers

Dynamic Effects of Trade Arrangementso economies of scale – access to a larger

market allows producers to become more efficient through greater specialization, better equipment, and usage of by-products

o greater competition – increased number of producers makes collusion less likely and forces firms to become more efficient

o stimulus of investment – because of increased rate of return and ability to spread R&D costs trade makes greater levels of investment more likely

European UnionTreaty of Rome – 1957 – established European Community – precursor to EU

1)1957: Belgium, France, Italy, Luxembourg, Netherlands & West Germany2)1973: United Kingdom, Ireland & Denmark3)1981: Greece4)1987: Spain & Portugal5)1995: Austria, Finland & Sweden6)2004: Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia & Slovenia7)2007: Bulgaria & Romania

European Union: 1960 - 1985 o EU members removed tariffs in 1968 leading

to fivefold increase in tradeo EU adopted common external tariffs in 1970

making it a customs uniono trade creation: machinery, transportation

equipment, chemicals & raw materialso trade diversion: agricultural commodities and

raw materialso trade creation exceeded trade diversiono EU saw increases in economies of scale,

competition & investmento 1985 EU eliminated nontariff barriers resulting

in creation of European common market

European Union & Maastricht o 1991 Maastricht Treaty established monetary

union and euro as common currency by 2002o convergence criteria:

1) inflation ≤ 1.5% above average inflation of three countries with lowest inflation

2) long term interest rates ≤ 2.0% above average of same three countries

3) exchange rate within target bands of monetary union for 2 years

4) budget deficit ≤ 3.0% of GDP5) government debt ≤ 60.0% of GDP

EU Agricultural Policy - Variable Levieso no restriction on agriculture traded internallyo EU policy based in part on variable levieso adjusted to maintain

desired price levelso more restrictive than

an import quota in that foreign producers cannot cut prices and absorb tariff cost to maintain export sales

EU Agricultural Policy - Subsidieso export subsidies also used to maintain higher

prices of EU - common policyo EU producers

sell for low price but receive higher price

o EU purchases any surplus

o surplus then sold on world market for lower price

Government Procurement Policieso government purchases previously limited primarily

to domestic producerso 1992 EU required bidding process from EU firmso benefits:• governments

purchase from lower cost producers

• increased competition

• remaining firms produce with economies of scale

European Monetary UnionA common currency also implied the need for a single European Central Bank responsible for all monetary and exchange rate policies of the EMU.oadvantages:

• eliminated exchange rate risk• reduced currency conversion costs• insulation from monetary disturbance &

speculation

odisadvantages:• loss of individual monetary authority• transition to common currency could lead to

speculative attacks

Optimum Currency Areaso definition – region in which it is economically

preferable to have a single official currencyo success of common currency area:

• similar business cycles • similar economic structures• single monetary policy affecting all members in

same manner• absence of legal or cultural barriers that would limit

labor mobility• wage flexibility• stabilizing transfer system

o EU concerns based on rigid wages and limited labor mobility tied to cultural factors

North American Free Trade Agreemento free trade area for U.S., Canada & Mexico but

not a customs uniono issues:• U.S. & Canada represented developed

economies while Mexico was a developing economy

• Mexico’s authoritarian political system• substantial difference in standard of living

between Mexico and Canada & U.S.

o decision: integrate Mexico to stimulate development or allow problems in that nation to continue to spill over borders

Benefits to Mexicoo substantial benefits for Mexico because it

integrated with much larger economieso increase in production of goods in which it has

comparative advantageo gains at the expense of other low-wage

nationso increases in agricultural goods and labor

intensive goodso agriculture represents small portion of GDP

but supports roughly 25% of the population

Benefits & Concerns for Canadao Benefits:• maintain status in international trade• free trade preference in U.S. market• equal access to Mexico’s market• inclusion in future free trade area with Central

& South America• economies of scale associated with increased

output levelso Possible Cost: closer integration with U.S. as

potential threat to Canada’s social welfare system

Economies of Scale from NAFTAo access to additional markets increases demando Canadian

producers can sell more autos

o increased consumer surplus due to lower price

o no worse for producers since costs have dropped

Benefits & Costs to the U.S.o Benefits:• expanded trade• increased competition and lower prices• enhanced economies of scale• decrease in illegal immigration• improved political stability in Mexicoo Costs:• U.S. industries competing with imports• impact on unskilled workers domestically• potential for environmental consequences• limited benefits due to relative size of these

economies

Labor Cost Compared to Productivityo Would NAFTA cause many U.S. companies to

relocate to Mexico due to lower wages?o Productivity is a major factor in determining cost

per unit of output.

o Based on higher productivity, U.S. workers can still receive higher wages.

NAFTA as Optimum Currency Area?o measures of economic integration: Canada &

Mexico are the U.S. largest trading partnerso Canada & U.S.: advanced industrial

economies with similar per capita incomes, inflation rates and interest rates

o Mexico: lower average per capita income, higher inflation rate, higher interest rates, and volatile exchange rate

o Mexico adopting U.S. dollar: pro: price & interest rate stability con: loss of independent monetary policy

Free Trade Area of the Americaso 1994 proposal calling for agreement among

34 nations in North and South Americao potential to become largest trading bloc in the

world with 850 million consumers and $14 trillion in combined income

o progressive Latin American trade policies:• reduced governmental management• conventional macroeconomic policies to promote

growth and stability• failure of import substitution modelo challenges:o other free trade agreementso subsidies on agricultural goods

Transition Economieso nations making the transition from centrally

planned to market economyo countries

opting for greater political & economic freedom have seen improved performance and income