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Trade Blocs and Monetary Unions

Trade Blocs and Monetary Unions. Mauro F. Guill én. Multilateralism: The GATT Rounds (General Agreement on Tariffs and Trade). * Ended with the creation of the WTO. ** Started by the WTO. The WTO. Dark green: founding members in 1995. (Today there are 153.). Types of Blocs.

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Trade Blocs and Monetary Unions

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  1. Trade Blocs and Monetary Unions Mauro F. Guillén

  2. Multilateralism: The GATT Rounds(General Agreement on Tariffs and Trade) * Ended with the creation of the WTO. ** Started by the WTO.

  3. The WTO Dark green: founding members in 1995. (Today there are 153.)

  4. Types of Blocs • A group of countries that agrees to one or more of the following: • Reduce tariffs for certain goods [preferential trade area]. • Remove internal trade barriers [free trade area]. • Coordinate external trade barriers [customs union]. • Allow for the free movement of capital • Allow for the free movement of labor • Coordinate indirect tax policy • Coordinate regulatory & competition policies • Coordinate macroeconomic policies [economic union]. • Introduce a common currency [monetary union]. • Merge treasuries and fiscal policies [fiscal union]. • Coordinate foreign & defense policies [political union]. • The European Union meets criteria 2-7 & 9 (8?). • The NAFTA meets criteria 2 and 4. • The Mercosur/Mercosul meets criteria 1-4. [common market]. [single market].

  5. Trade Blocs Tend to Include Countries: • At similar levels of development. • Geographically close or adjacent. • With similar trade regimes. • Sharing a desire to organize regionally.

  6. How Common are They? • 1834: Zollverein, first modern trade bloc. • There are 219 trade blocs presently in force, and registered with the WTO http://rtais.wto.org/UI/PublicAllRTAList.aspx • 1990s: Trend towards continental-size blocs.

  7. Main Trade Blocs

  8. What are Trade Blocs, Really? • People are very excited about trade blocs. • Officially, an attempt to enhance trade. • In reality, trade blocs destroy, divert, and create trade in complex ways. • They can be an attempt to privilege insiders relative to outsiders.

  9. NAFTA • Only large trade bloc that includes both rich & developing countries: • Mexico is “so far away from God, and… …” • Very controversial (“social dumping”). • It’s a “free trade area” + free capital flows: • Origin & content rules are necessary. • Various unintended consequences/effects. • External trade policies are not coordinated. • Some product & environmental regulations. • Trucking issue: first Mexican truck crossed the border in October 2011.

  10. Automobile Assembly in Mexico(thousand units) Sources: Automotive News; Asociación Mexicana de la Industria Automotriz.

  11. A maquila worker inserts electronic components at an assembly line for video turners, Tuesday, Nov. 18, 1998 at the Samsung Electromechanics plant in Tijuana, Mexico. Sprawled across a hillside on Tijuana's outskirts, Samsung's state-of-the-art manufacturing complex is a hive of activity, except for the cavernous blue-and-beige building on the campus' eastern edge. Built as part of a planned $400 million expansion, the empty building now serves only as a reminder of the long reach of the Asian financial crisis.(AP Photo/Damian Dovarganes)

  12. FTAs: Origin and Content Rules • For a good to be sold duty-free anywhere within the FTA, it must exceed a minimum level of “local content.” • For instance, in the NAFTA, an automobile is deemed to be “North American” if the percentage of local (i.e. within bloc) value attributable to 69 key components (e.g., engines, transmissions, bumpers) exceeds 62.5% .

  13. A Sudden Devaluation • In late 1995 and early 1996, over a period of 5 weeks, the Mexican peso lost 45% of its value relative to the dollar. • What was the consequence of this change for companies wishing to comply with the 62.5% local content rule? • How could they adapt to the new situation?

  14. Economic Controversies • Competitive implications: • Economies of scale. • Improved terms of trade (through either bargaining power or specialization): • Welfare implications: trade creation, diversion, and destruction, depending on the characteristics of the bloc (FTA vs. CU, level of external tariff(s), etc.). p is price, q is quantity. X is exports, M is imports. c is the current period. 0 is the base period. i is the product. Source: Edward D. Mansfield and Helen V. Milner, “The New Wave of Regionalism.” International Organization 53(3) (Summer 1999):589-627.

  15. Political Controversies • Domestic: • Who is in favor, and who is against? Exporters (L vs. K-intensive), import-competitors, consumers, investors, etc. • Justification for unpopular adjustment policies. • International: • Pressures towards democratization (e.g. Spain, Portugal, Paraguay, etc.). • Enhanced power in multilateral trade negotiations. • Improved global governance. • Extension of influence over weaker states. Sources: Edward D. Mansfield and Helen V. Milner, “The New Wave of Regionalism.” International Organization 53(3) (Summer 1999):589-627; Andrew G. Brown, and Robert M. Stern, “Free Trade Agreements and the Governance of the Global Trading System.” The World Economy (2011):331-354.

  16. Local Content Formula

  17. Problem Set #2 • Please work individually. • Due in one week from today.

  18. The Euro Cliffhanger:An Avalanche of Thrills

  19. National Currencies: The Post Bretton Woods World Source: Reuven Glick and Andrew K. Rose, “Contagion and Trade. Why are Currency Crises Regional?”Journal of International Money and Finance 18 (1999):603-617.

  20. Monetary Unions

  21. The Governing Council makes decisions by majority vote. Source: Roel Beetsma and Massimo Giuliodori, “The Macroeconomic Costs and Benefits of EMU and Other Monetary Unions.” Journal of Economic Literature 48 (September 2010):603-641.

  22. Consequences of Monetary Unions • Member countries cannot print money to inflate their debt away. • They cannot devalue the currency to regain competitiveness. • In order for a monetary union to work: • Labor needs to be able & willing to move around in search of opportunities. • Fiscal union is advisable. Because members usually retain sovereignty, they usually do not get transfers to make up for revenue shortfalls or increased social spending during a crisis. Nota bene: Robert Mundell won the Nobel Prize for his work on optimal currency areas.

  23. The Way it Was Supposed to Be • The architects of the euro believed that a Greece-like problem would not occur because financial markets would have punished countries with excessive debt by raising the cost of borrowing. They didn’t until the global financial crisis started. • The European Central Bank (ECB): • Prohibits loaning money to service national debts. • Its no-bail-out clause discourages overspending. It did not. • The Stability and Growth Pact should have prevented the situation from worsening: • Deficit/GDP ≤ 3% and Gross debt/GDP ≤ 60%. • It was not enforced,and in 2005 the rules were relaxed at the request of France and Germany. Source: Lorenzo Bini Smaghi, “The Future of the Euro.” Foreign Affairs (2010).

  24. Labor Protections in the OECD Note: The index is based on protections against dismissal for permanent employees, regulation of temporary employment, and requirements for collective dismissal. Source: OECD Employment Protection Legislation database.

  25. EU Banks’ Exposure to Sovereign Debt Source: Adrian Blundell-Wignall and Patrick Slovik, “The EU Stress Test and Sovereign Debt Exposures.” (OECD, August 2010).

  26. Counterparty Risk • Nobody really knows how much because most instruments are traded over the counter. Estimates range between €4 and €100 or more billion of exposure to a Greek “credit event.” • Hedging. • CDSs. • Naked CDSs.

  27. Public Debt as % of GDP Note: Data after 2009 are projections. Source: IMF.

  28. The “PIIGS” Source: IMF, World Economic Outlook (September 2011).

  29. Source: IMF, Global Financial Stability Report (September 2011).

  30. What Are Policymakers Doing?They are meeting…

  31. … and making some decisions… Only €440 in the fund. €100 IT+ES; €70 PIG.

  32. The Euro Deal 27 October 2011 • Greek debt: haircut of 50%. • Bank recapitalization for €106 bn ($146 bn). Must reach 9% of tier 1 capital within 9 months. (But the calculations based on just 70 banks out of the 5,000 in the Euro Zone. • Firewall: €1 trillion European Financial Stability Facility, but with just 20% equity. The rest to be raised through Special Purpose Vehicles issuing collateralized debt obligations (up to a ×5 leverage).

  33. Europe’s Biggest Problem:Lack of Leadership From The Economist, April 2-8, 2011.

  34. Claudio Barbaro (L), a member of the opposition FLI party, fought with Fabio Ranieri (R) from the Northern League in Italy's Parliament on 26 October 2011. Photo Reuters.

  35. Is the Euro Good for Germany? • Eurozone: 2/5 of German exports. • The crisis in the periphery of the Eurozone has depressed the value of the euro. The DM would be overvalued nowadays. • German firms benefited from the investment boom in the periphery. • Large German firms in favor of bailouts; Mittelstand firms skeptical. • The rate of inflation in Germany has been lower than with the DM. • Reserves in € > [DM + FFr + Guilders].

  36. Is the Euro Good for Greece? Source: http://macrotragedy.blogspot.com/2011/10/greek-tradable-sector-odyssey.html

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