International Economics By Robert J. Carbaugh 10th Edition

1. International EconomicsBy Robert J. Carbaugh10th Edition Chapter 8: Regional Trading Arrangements

2. Regional trade agreements Economic Integration • Process of eliminating restrictions on international trade, payment and factor mobility. • Result in uniting of two or more national economies in a regional trading agreement. Carbaugh, Chap. 8

3. Regional trade agreements Types of regional trade arrangements • Preferential trade arrangement (PTA) • Free trade areas (FTA) • Customs unions (CU) • Common markets (EU) • Economic/monetary union Carbaugh, Chap. 8

4. Regional trade agreements Preferential trade arrangement (PTA) • Members countries agree to erect lower barriers to trade within the group than to trade with non-member countries. • Loose • E.g: British Commonwealth Preference Scheme (1932), ASEAN (1977) Carbaugh, Chap. 8

5. Regional trade agreements Free trade areas (FTA) • Members countries agree to remove all tariff and NTBs among themselves. • However, maintain its own set of trade restriction against outsiders (non-members) • NAFTA (North American Free Trade Agreement) – Canada, Mexico, US Carbaugh, Chap. 8

6. Regional trade agreements Customs unions (CU) • Members countries agree to remove all tariff and NTBs among themselves. • In additions, each member nation imposes identical trade restrictions against non-members • Common external trade policy is to permit free trade within the CU, whereas all trade restriction imposed against outsiders are equalized. • BENELUX – Belgium, Netherlands and Luxembourg) - 1948 Carbaugh, Chap. 8

7. Regional trade agreements Common Market • Permits: • Free movement of goods and services • Common external trade policy against non-members • Free movement of factor production (capital and labor) • European Union (1992) Carbaugh, Chap. 8

8. Regional trade agreements Economic Union (EU) • National, social, taxation and fiscal policy harmonized and administrated by a supranational institutions. • Unification of national monetary policies, and acceptance of a common currency. • E.g: USA, EU Carbaugh, Chap. 8

9. Regional trade agreements Effects of regional trade agreements • Static effects • Trade creation effect (consumption effect, production effect) • Trade diversion effect • Dynamic effects • Economies of scale • Greater competition • Investment stimulus Carbaugh, Chap. 8

10. Regional trade agreements Effects of regional trade agreements • Trade creation effect • Occurs when some domestic production replace by another member’s lower-cost import. • Increased welfare – because it leads to increased production specialization according to principle of comparative advantage. • Consist - consumption effect & production effect Carbaugh, Chap. 8

11. Regional trade agreements Effects of regional trade agreements • Trade diversion effect • Occurs when import from a low-cost supplier outside the union are replaced by purchases from a higher-cost supplier within the union. • World production reorganized less efficiently. Carbaugh, Chap. 8

12. Regional trade agreements Static effects of a customs union Carbaugh, Chap. 8

13. Regional trade agreements: case studies The European Union • Created by the Treaty of Rome (1957) • Policy aims included: • Abolition of tariffs, quotas and other restrictions • Common external tariff • Free movement of capital, labor and business • Common policies on transport, agriculture, and competition and business conduct • Coordination of monetary and fiscal policies Carbaugh, Chap. 8

14. Regional trade agreements: case studies The European Union (cont’d) • Lowering of barriers caused within-region trade to grow much more quickly than overall world trade in the 1960s • Steps to remove remaining barriers (1985-92) further increased integration • Maastricht Summit (1991) began process of economic and monetary union (EMU) • EMU came into full effect in 2002 with the introduction of a common currency, the euro Carbaugh, Chap. 8

15. Regional trade agreements: case studies EU Economic & Monetary Union • Member nations which met economic criteria by 1999 replaced their national currencies with the euro in 2002 • New European Central Bank created to control monetary and exchange rate policy • “Convergence criteria” required for membership: • Price stability • Low long-term interest rates • Stable exchange rates • Sound public finances Carbaugh, Chap. 8

16. Regional trade agreements: case studies European Union enlargement • The EU admitted 10 nations, mostly transition economies in eastern Europe, to EU membership in 2004 • Candidate members had to demonstrate their fitness by achieving: • Stability of institutions, and guaranteed democracy, rule of law, human rights and protection of minorities • A functioning market economy which is ready to compete in the EU market • Adherence to the EU’s aims of political, economic and monetary union Carbaugh, Chap. 8

17. Regional trade agreements: case studies Other key EU policies • Common agricultural policy (CAP) • Support payments to farmers • Variable import levies • Export subsidies • Government procurement policies • All EU businesses can bid for larger contracts in any nation Carbaugh, Chap. 8

18. Regional trade agreements: case studies Costs & benefits of EMU • Europe does not meet all the requirements of a theoretical “optimal currency area” • Advantages of EMU - real but small: • Lower transaction costs • Price comparisons easier • Exchange rate risk eliminated • Stimulates competition Carbaugh, Chap. 8

19. Regional trade agreements: case studies Costs & benefits of EMU (cont'd) • Disadvantages of EMU: • Loss of monetary policy and the exchange rates as economic adjustment tools • Use of fiscal policy for adjustment is also constrained • Adjustment to shocks therefore depends on wage flexibility and labor mobility, which are both low in Europe Carbaugh, Chap. 8

20. Regional trade agreements: case studies North American Free Trade Agmt. (1994) • Gradual and comprehensive elimination of trade barriers among US, Mexico and Canada over 15 years: • Full, phased elimination of import tariffs • Elimination of most NTBs • Protection of intellectual property rights • Dispute settlement procedures • Side agreements on environmental protection and labor law Carbaugh, Chap. 8

21. Regional trade agreements: case studies NAFTA's benefits • Mexico stood to gain the most, with access to large industrial markets and new inward investment flows • Canada maintained its preferences in the US market and hoped for future access to South American markets • US stood to gain from access to the Mexican market and cheap labor and parts, access to reliable oil supplies, and less immigration pressure; but the benefits were modest Carbaugh, Chap. 8

22. Regional trade agreements: case studies Concerns about NAFTA • Main US losers from NAFTA would be import-protected industries competing with Mexican producers, and unskilled workers • US industrial workers also worried about lower pay scale in Mexico and plant relocations • Concerns Mexico would not enforce environmental protection measures • Side agreements on environment and labor law were concluded to address those concerns Carbaugh, Chap. 8

23. Regional trade agreements: case studies NAFTA’s impact so far • Trilateral trade increased significantly • Most of the increase in US trade with Mexico and Canada resulted from trade creation, but Canada-Mexico trade increases came mostly from trade diversion • Some US jobs were lost to Mexico, but the numbers were small compared to job creation that came with US growth • Larger effects were felt in sectors more exposed to intra-NAFTA trade Carbaugh, Chap. 8

24. Regional trade agreements: case studies NAFTA’s impact so far (cont’d) • Changes in investment flows were small (in relation to total US foreign investment) • Closer political ties were built among the three nations (especially between the US and Mexico), and they refrained from building new trade barriers even during recession Carbaugh, Chap. 8