A World of Trading Blocs

A World of Trading Blocs

Trading blocs have been dramatically expanding throughout the world

economy. In 1992, the European Union (EU) completed the single-market

program and began a historic initiative for monetary union. The United States,

Canada, and Mexico launched the North American Free Trade Agreement

(NAFTA) in1994. Even Japan, for years the only industrial country that was not a

member of any regional arrangement, completed a trade agreement with

Singapore in2001. Overall, half of the regional trade agreements notified to the

General Agreement on Tariffs and Trade (GATT) were negotiated in the last

A trade bloc can be defined as a ‘preferential trade agreement’ (PTA)

between a subset of countries, designed to significantly reduce or remove trade

barriers within member countries. When a trade bloc comprises neighboring or

geographically close countries, it is referred to as a ‘regional trade (or integration)

agreement’. It is sometimes also referred to as a ‘natural’ trade bloc to underline

that the preferential trade is between countries that have presumably low

transport costs or trade intensively with one another. The two principal

characteristics of a trade bloc are that: (1) it implies a reduction or elimination of

barriers to trade, and (2) this trade liberalization is discriminatory, in the sense

that it applies only to the member countries of the trade bloc, outside countries

The integration of countries into trade blocs is commonly referred to as

‘regionalism’, irrespective of whether the trade bloc has a geographical basis or

not. The first waves of PTAs appeared in the 1930s leading to a fragmentation of

the world into trade blocs. This ‘old (first) regionalism’ is also associated with

regional initiatives involving developing countries in the 1950s and 1960s. Based

on the objective of import-substitution industrialization, the rationale was that

developing countries could reap the benefit from economies of scale by opening

up their trade preferentially among themselves, hence reducing the cost of their

individual import-substitution strategy while the trade bloc became more self-

sufficient. More successful experiences followed with the recent proliferation of

trade blocs, the so-called ‘new (second) regionalism’, which involve mostly

EU (European Union): The EU is become a most powerful trade block in the

world. It has members of Austria, Belgium, Denmark, Finland, Germany, Greece,

Ireland, Italy, Lather lands, Porchukcal, Spain, Sweden, and U.K.

to the Latin American Integration Association and Caribbean community and

common market (CARICOM). It has U.S as their major export market. ASEAN

(Association of South East Asian Nations): It is organized in 1967and it has

Cambodia, Indonesia, Malaysia, Myanmar, the Philippines, Singapore, Thailand

and Vietnam. Jan 1, 1993 ASEAN officially formed the ASEAN Free Trade Area

(AFTA). APEC (Asia Pacific Economic Co-operation): It was formed in NOV 1989

to promote multilateral economic co-operation in trade and investment in the

Pacific Rim. EFTA (European Free Trade Association): It was established in Jan

1960, EFTA currently joins 4 countries – Norway, Iceland, Liechtenstein and

Switzerland. Members are Austria, Finland, and Sweden joined on 1/1/1996.

India and Sri Lanka on 28th Dec 1998, a large number of items will be eligible for

duty free trade. It has offered to permit as much as 1000 items on Zero duty from

Sri Lanka and Sri Lanka will allow duty free imports of 900 items from India.

Most of the analyses on the effects of trade blocs focus on FTAs and/or

CUs. The effects of a PTA are of two types: the trade effects and the welfare

effects. The trade effects comprise the impact of a PTA on the volume and

quantity of trade, on the terms of trade (i.e. prices) and on the level of protection

(generally tariffs) for PTA members and excluded countries. In analyzing the

welfare effects of a PTA, it is important to distinguish between the impact of trade

bloc (formation and expansion) on the welfare of.

A standard result of international trade theory is that, in a competitive

environment and in the absence of market distortions and externalities, free

trade will maximize global welfare. Removing trade barriers between a subset of

bloc are ambiguous as they depend on many factors. The demonstration of the

theory of second best situation entailed by a PTA was derived from the seminal

work of Jacob Vainer (1950), which shows that while liberalizing trade between a

group of countries can lead to ‘trade creation’ between members (which should

increase welfare), it can also reduce trade between the CU and its trading

partners. This ‘trade diversion’ can potentially reduce welfare for all as a member

switches from a relatively efficient, low cost producer outside the CU to less

efficient, higher cost producer within the CU, leading to a global misallocation of

resources.

Most of the debate on the static impacts of trade blocs on the global

the demand for (and thus the price of) non-member exports decreases, creating

a positive terms of trade effect for PTA members and a likely deterioration of the

terms of trade for third countries. Hence, trade blocs allow member countries to

exploit their joint market power over their terms of trade. This capacity to

influence its terms of trade is an important element in the analysis of the trade

policy determination and welfare effects of a PTA. Due to their increased market

power, the members of a trade bloc can extract rents from the excluded trading

partners by setting ‘optimal tariffs’ and behaving in a co-ordinate strategic way.

Such considerations also led to some predictions with regards the dynamics of

trade blocs. In particular, it is expected that, if countries are symmetric, trade

expansions seem to be due more to trade diversion than to potential increases in

optimal tariffs.

Ultimately, the optimal number of trade blocs in the world depends on the

one hand on the potential positive welfare effects resulting from trade creation,

and on the other hand on the potential negative welfare impacts result from trade

diversion and adverse changes in the terms of trade. Besides, a larger market

resulting from the creation and extension of trade blocs does not only increase

the market power of its members, but it also provides opportunities for greater

productivity efficiency for industries facing economies of scale and increased

Yet, the main lesson from the new theory of regionalism is that there are no

strict rules and generalizations are dangerous, as the impacts on trade and

welfare of PTAs crucially depends on the model adopted. For instance, although

the notion of ‘natural trade blocs’ (based on lower transport costs associated to

regional trade) is common, it is doubtful that transport costs considerations

provide a justification (over other types of costs) for the desirability or superiority

of regional trade blocs over non-regional blocs. The fact that countries

geographically close trade more together, as suggested by the gravity model,

does not imply that their welfare will improve by forming a trade bloc, nor that

trade barriers with distant trading partners is desirable. Finally, while most

Both GATIT and WTO accommodated regional arrangements. The major

argument for regionalism has been that smaller group of countries would find it

easier to move towards integration than in a much wider multilateral system.

However, as the groupings become larger, this argument tends to lose validity.

Many of the new regional arrangements contain countries as diverse in outlook,

economic size and level of development as any countries in the multilateral

system. Thus the fact remains that regional and geographical arrangements are

exceptions to the MFN principle which is the essence of the WTO rules.