Download Lecture Slides Chapter 08

Regional Trade
Agreements
Chapter 8
Copyright © 2009 South-Western, a division of Cengage Learning. All rights reserved.
Regional Integration vs Multilateralism
o regional trade blocs could be a complement to
multilateralism by setting a precedent which
other nations will follow
o can lead to deeper integration
o 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 Agreements
o free-trade area – agreement to remove trade
barriers among members
example: 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 members
2) 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 Arrangements
With Tariff:
(before customs union)
red triangle = consumer
surplus
green triangle =
producer surplus
black rectangle = tariff
revenue
a + b = deadweight loss
Static Effects of Trade Arrangements
With 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 c
lost benefits from lower
cost suppliers
Dynamic Effects of Trade Arrangements
o 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 Union
Treaty of Rome – 1957 – established European
Community – precursor to EU
1) 1957: Belgium, France, Italy, Luxembourg,
Netherlands & West Germany
2) 1973: United Kingdom, Ireland & Denmark
3) 1981: Greece
4) 1987: Spain & Portugal
5) 1995: Austria, Finland & Sweden
6) 2004: Cyprus, Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Malta, Poland,
Slovakia & Slovenia
7) 2007: Bulgaria & Romania
European Union: 1960 - 1985
o EU members removed tariffs in 1968 leading
to fivefold increase in trade
o EU adopted common external tariffs in 1970
making it a customs union
o trade creation: machinery, transportation
equipment, chemicals & raw materials
o trade diversion: agricultural commodities and
raw materials
o trade creation exceeded trade diversion
o EU saw increases in economies of scale,
competition & investment
o 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 2002
o 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 GDP
5) government debt ≤ 60.0% of GDP
EU Agricultural Policy - Variable Levies
o no restriction on agriculture traded internally
o EU policy based in part on variable levies
o adjusted to maintain
desired price levels
o more restrictive than
an import quota in
that foreign
producers cannot cut
prices and absorb
tariff cost to maintain
export sales
EU Agricultural Policy - Subsidies
o export subsidies also used to maintain higher
prices of EU - common policy
o 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 Policies
o government purchases previously limited primarily
to domestic producers
o 1992 EU required bidding process from EU firms
o benefits:
•
•
•
governments
purchase from
lower cost
producers
increased
competition
remaining firms
produce with
economies of
scale
European Monetary Union
A common currency also implied the need for a
single European Central Bank responsible for all
monetary and exchange rate policies of the EMU.
o advantages:
• eliminated exchange rate risk
• reduced currency conversion costs
• insulation from monetary disturbance &
speculation
o disadvantages:
• loss of individual monetary authority
• transition to common currency could lead to
speculative attacks
Optimum Currency Areas
o definition – region in which it is economically
preferable to have a single official currency
o 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 Agreement
o free trade area for U.S., Canada & Mexico but
not a customs union
o 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 Mexico
o substantial benefits for Mexico because it
integrated with much larger economies
o increase in production of goods in which it has
comparative advantage
o gains at the expense of other low-wage
nations
o increases in agricultural goods and labor
intensive goods
o agriculture represents small portion of GDP
but supports roughly 25% of the population
Benefits & Concerns for Canada
o 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 levels
o Possible Cost: closer integration with U.S. as
potential threat to Canada’s social welfare
system
Economies of Scale from NAFTA
o access to additional markets increases demand
o 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 Mexico
o 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 Productivity
o 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 partners
o 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 Americas
o 1994 proposal calling for agreement among
34 nations in North and South America
o 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 model
o challenges:
o other free trade agreements
o subsidies on agricultural goods
Transition Economies
o nations making the transition from centrally
planned to market economy
o countries
opting for
greater
political &
economic
freedom
have seen
improved
performance
and income