Regional Trading Agreements

1. Regional Trading Agreements

2. 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 non-members • 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

3. 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

5. 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

6. 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.

7. 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

8. 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

9. Trade Diversion versus Trade Creation in Joining a Trade Bloc: UK Market for Imported Compact Cars British Better Off British Worse Off

10. 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 by-products 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

11. European Union Treaty of Rome – 1957 – established European Community – precursor to EU 1957: Belgium, France, Italy, Luxembourg, Netherlands & West Germany 1973: United Kingdom, Ireland & Denmark 1981: Greece 1987: Spain & Portugal 1995: Austria, Finland & Sweden 2004: Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia & Slovenia 2007: Bulgaria & Romania

12. 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

13. EU Agricultural Subsidies EU purchases any surplus surplus then sold on world market for lower price

14. 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

15. 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

16. Agricultural Policy • Export subsidy • Ensures that any surplus agricultural output will be sold overseas • Government support for agriculture (Table 8.1)

18. Arguments Against Regionalism Bhagwati views the formation of regional trade arrangements (RTAs) as undermining the WTO Regionalism is harmful because it encourages trade diversion

19. 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

20. 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)

21. NAFTA

24. Figure 12.3 – Estimates of the Effects of the North American Free Trade Area on National Incomes and Wage Rates

25. Figure 12.4 – Effects of an Embargo on Exports to Iraq

26. Figure 12.5 – Two Kinds of Economically Unsuccessful Embargoes