Trade Blocs and Trade Blocks

8/8/2019 Trade Blocs and Trade Blocks

http://slidepdf.com/reader/full/trade-blocs-and-trade-blocks 1/15

JB

TRADE BLOCS AND

TRADE BLOCKS



Preferential trading agreements are trade

agreements between countries in which they lower

tariffs for each other but not for the rest of the world.

Under the WTO, such discriminatory trade policiesare generally not allowed:

Each country in the WTO promises that all countries will pay

tariffs no higher than the nation that pays the lowest: called

the “most favored nation” (MFN) principle. An exception to this principle is allowed only if the lowest tariff

rate is set at zero.

PREFERENTIAL TRADING AGREEMENTS



There are two types of preferential trading

agreements in which tariff rates are set at

or near zero:

1. A free trade area : an agreement that allows

free trade among members, but each

member can have its own trade policy

towards non-member countries An example is the North America Free Trade

Agreement (NAFTA).


(CONT.)



2. A customs union: an agreement that allows

free trade among members and requires a

common external trade policy towards non-

member countries. An example is the European Union.


(CONT.)



Are preferential trading agreementsnecessarily good for national welfare?

No, it is possible that national welfare

decreases under a preferential tradingagreement.

How? Rather than gaining tariff revenue from

inexpensive imports from world markets, acountry may import expensive products frommember countries but not gain any tariffrevenue.


(CONT.)



Preferential trading agreements increase national

welfare when new trade is created, but not when

existing trade from the outside world is diverted to

trade with member countries.

Trade creation

occurs when high cost domestic production is replaced by low

cost imports from other members.

Trade diversion occurs when low cost imports from non-members are diverted

to high cost imports from member nations.


(CONT.)



Three countries: Britain($8)>French($6)>US($4) forwheat production.

Suppose British Import tariff =$5.

Suppose Britain and French forms a customs union.

British consumer will buy products domesticallysince 8<9<11 without a customs union

With a CU, then British consumer will purchase fromhis member country — French since 6<8.

This is trade creation since Britain only needs to pay$6 to foreign country compared to its own initial cost$8.

TRADE CREATION



Three country: Britain($8)>French($6)>US($4) for

wheat production.

Suppose British Import tariff =$3.

Suppose Britain and French forms a customs union. British consumer will buy products from U.S. since

7<8 without a customs union

With a CU, then British consumer will purchase from

his member country — French since 6<7. Trade diversion: (1) US wheat is really cheaper than

French; (2) Import Tariffs revenue disappear.

TRADE DIVERSION





ECONOMIC BLOCK TYPOLOGY

Free trade

among

members

Common

external

tariff

Free factor

movements

Macro Policy

Harmonization

Free TradeArea

X

Custom

UnionX X

CommonMarket

X X X

Economic

UnionX X X X



PP’ is the partner -country supply curve.

Tariff removal cuts domestic price from OT to OP,expands imports to M’N’, and raises welfare by

areas 2+4.

Here supply curve is perfectly elastic supply so thatunlimited quantity is available at price OP.

British consumers enjoy a gain in surplus 1+2+3+4.

But area 1 is formerly the production gain.

Area 3 is the tariff revenue.

Net benefit=2+4=production benefit + consumptionbenefit

WELFARE EFFECTS OF TRADE CREATION



FIGURE 1 WELFARE EFFECTS OF TRADE

CREATION



Britain and France form the CU, but US has a lowest

cost.

Pb indicates pretariff supply price in partner country —

France

Pc is the pretariff supply price in the U.S.

Tariff preference lowers internal price from Tc to Pb.

Lowering a tariff (even preferentially) allows a gain to

British consumers (areas 3+4)

But areas 3+5 measure the total tariff revenue.

Therefore, welfare loss occurs if area 5 exceeds area 4.

WELFARE EFFECTS OF TRADE DIVERSION



FIGURE 2 WELFARE EFFECTS OF TRADE

DIVERSION



For trade creation predominates trade diversion, UK

and FR should be actually competitive before the

union and potentially complementary after it comes

into effect.

Trade creation gains are greater when protected

production is reduced more.

This happens when protective tariffs have made the

output pattern of the two economics look similar. To avoid trade diversion, each member of the PTA

must also be the most efficient producer of goods

protected.

NET GAINS OR LOSSES?

Trade Blocs and Trade Blocks

Documents