Transcript Slide 1
Regional Trading
Agreements
Types of Regional Agreements
free-trade area – agreement to remove
trade barriers among members
example: NAFTA
customs union – agreement to remove trade
barriers among members and impose
uniform trade restrictions against nonmembers
example: Benelux
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
economic union – common market
agreement with :
common national, taxation, fiscal, and social policies
among members
transfers of sovereignty to a supranational authority
example: Belgium and Luxembourg 1920s
monetary union – economic union with
additional characteristic of common
monetary policy and common currency
examples: United States and the Euro currency
area
Trade Diversion and Trade Creation
Effect of Trade Blocs
Consider three countries A, B, and C
A trade bloc reduces tariffs between A
and B. A and B maintain tariffs with C
Trade Creation: A imports more
products from B
Trade Diversion: Part of the increase in
trade between A and B is a result of a
decrease in trade between A and C
Trade Creation and Trade Diversion
Effects of A Free Trade Area
Trade Diversion—a shift in the pattern
of trade from low-cost world producers
to higher-cost FTA members;
welfare-reducing effect.
Trade Creation—an expansion in world
trade resulting from formation of an FTA;
welfare-increasing effect.
Static Effects of Customs Union
With Tariff:
(before customs
union)
red triangle =
consumer surplus
green triangle =
producer surplus
black rectangle =
tariff revenue
a + b = deadweight
loss
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
Static Effects of
Customs Union
Trade Diversion versus Trade Creation in Joining a
Trade Bloc: UK Market for Imported Compact Cars
British Worse Off
British Better Off
Dynamic Effects of Trade
Arrangements
economies of scale – access to a larger
market allows producers to become more
efficient through greater specialization,
better equipment, and usage of byproducts
greater competition – increased number of
producers makes collusion less likely and
forces firms to become more efficient
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
EU members removed tariffs in 1968 leading to
fivefold increase in trade
EU adopted common external tariffs in 1970
making it a customs union
trade creation: machinery, transportation
equipment, chemicals & raw materials
trade diversion: agricultural commodities and
raw materials
EU saw increases in economies of scale,
competition & investment
EU Agricultural Subsidies
EU purchases
any surplus
surplus then sold
on world market
for lower price
Government Procurement
Government purchases previously were
limited to domestic producers.
In 1992 EU required bidding process from
EU firms
benefits:
•
•
increased competition
remaining firms produce
with economies of scale
EU Agricultural Policy
Substantial elements of this policy:
Support of prices received by farmers
for their produce
Exports of any surplus quantities of EU
produce have been assured through
the adoption of export subsidies
Agricultural Policy
Export subsidy
Ensures that any surplus agricultural
output will be sold overseas
Government support for agriculture (Table
8.1)
Arguments Against Regionalism
Bhagwati views the formation of
regional trade arrangements (RTAs) as
undermining the WTO
Regionalism is harmful because it
encourages trade diversion
Arguments Favoring Regionalism
Krugman argues that trade diversion from
FTAs is low because trading blocs are
“natural” trading areas
Due to proximity and similarity of cultures
and standards of living, regional trade
agreements stimulate trade that would
have occurred even in the absence of an
agreement
Affects of a Trade Embargo
Consider 3 countries; A, B, and C
Initially, Country C imports from A and B
Then A imposes an embargo on C, but B
does not
Economic Effects
Imports from A go to zero (PSA down)
Imports from B increase (PSB up)
Price in C increases (CSC down)
Production in C increases (PSC up)
Price in A decreases (?) (CSA up)
Price in B increases (?) (PSA down)
NAFTA
Figure 12.3 – Estimates of the Effects of the
North American Free Trade Area on National
Incomes and Wage Rates
Figure 12.4 – Effects of an Embargo on
Exports to Iraq
Figure 12.5 – Two Kinds of
Economically Unsuccessful Embargoes