International Economics By Robert J. Carbaugh 8th Edition

1. International EconomicsBy Robert J. Carbaugh8th Edition Chapter 9: Regional Trading Arrangements

2. Regional trade agreements Types of regional trade arrangements • Free trade areas (NAFTA, for example) • Customs unions (Benelux) • Common markets (EU) • Economic/monetary union Carbaugh, Chap. 9

3. 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. 9

4. Regional trade agreements Static effects of a customs union Carbaugh, Chap. 9

5. 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. 9

6. 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) Carbaugh, Chap. 9

7. Regional trade agreements: case studies EU Economic & Monetary Union (1999) • Member nations will replace national currencies with the euro by 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. 9

8. Regional trade agreements: case studies Other key EU policies • Common agricultural policy • 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. 9

9. Regional trade agreements: case studies CAP: variable levies and export subsidies Carbaugh, Chap. 9

10. Regional trade agreements: case studies Opening up government procurement Carbaugh, Chap. 9

11. 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. 9

12. 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. 9

13. Regional trade agreements: case studies US-Canada Free Trade Agmt. (1989) • Elimination of all tariffs and most NTBs over ten years • Binational tribunal created to hear trade disputes • Canada, in particular, is expected to benefit from economies of scale Carbaugh, Chap. 9

14. 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. 9

15. 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. 9

16. 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. 9

17. Regional trade agreements: case studies NAFTA after five years • Trilateral trade increased significantly • Some US jobs were lost to Mexico, but the numbers were small compared to job creation that came with US growth • Changes in investment flows were small (in relation to total US foreign investment) • Closer political ties were built among the three nations Carbaugh, Chap. 9

18. Regional trade agreements: case studies Special case: economies in transition • Nations of eastern Europe and the former Soviet Union have been making a transition from a non-market (planned) economy to a market economy since the early 1990s - which has been very disruptive • These nations’ planned economies required them to be largely isolated from world trade - instead, set up their own trading bloc, the Council for Mutual Economic Assistance (CMEA) Carbaugh, Chap. 9

19. Regional trade agreements: case studies Economies in transition (cont’d) • Even after the collapse of the central planning system, the nations remained tied together because of historical trade links inside CMEA and their common legacy as non-market economies • Financing limitations have hampered an increase in trade: transition nations have generally not been able to increase exports to match imports and must borrow the difference Carbaugh, Chap. 9

20. Regional trade agreements: case studies Economies in transition (cont’d) • Barriers to trade with the West used to make strategies such as countertrade, co-production agreements, joint R&D agreements, and contract manufacturing agreements very common • Gradual elimination of barriers to foreign business in most transition countries has allowed foreign firms to operate in the region more normally in recent years Carbaugh, Chap. 9