2000 word report (international trade)

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3001IBA Lecture Notes 5/Week 5 Topic 3.2 Economic Integration/Regionalism/ The WTO Text: Carbaugh R J (2013), International Economics, 14th Edition Regional Trading Arrangements

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Learning Objectives

Discuss Economic Integration – the types of regional agreements

Discuss and analyse the Static economic effects of economic integration:

Trade creation and welfare

Trade diversion and welfare

3. Discuss the Dynamic economic effects of regional integration

Give a Brief overall assessment of the effects of economic integration

Provide a Case Study of the European Union

Briefly discuss the WTO

Types of Regional Trading Arrangements

Economic integration

Process of eliminating restrictions on international trade, payments, and factor mobility

Results in the uniting of two or more national economies in a regional trading arrangement

Motivations for regional trading arrangements

Prospect of enhanced economic growth

Economies of large-scale production & attract foreign investment

Foster a variety of noneconomic objectives

Managing immigration flows

Promoting regional security

Enhance & solidify domestic economic reforms

Types of Regional Trading Arrangements

Free-trade area

Association of trading nations

Members agree to remove all tariff and nontariff barriers among themselves

Each member maintains its own set of trade restrictions against outsiders

North American Free Trade Agreement (NAFTA)

Canada, Mexico, and the United States

Types of Regional Trading Arrangements

Free-trade area (continued)

Association of trading nations

Agreement among members to remove trade barriers among members while retaining independence in forming trade policies with nonmembers.

Examples: multilateral - N(orth) A(merican) F(ree) T(rade) A(greement) Canada, Mexico, and the United States; bilateral – recent Australia-US FTA.

Types of Regional Trading Arrangements

Customs union

Agreement among two or more trading partners

To remove all tariff and nontariff trade barriers between themselves

Each member nation imposes identical trade restrictions against nonparticipants

Example:

Benelux

Belgium, the Netherlands, and Luxembourg – formed 1947; absorbed into ECM 1958

Types of Regional Trading Arrangements

Common market

Group of trading nations

Customs union plus agreement that permits (1) free trade among members; (2) common external trade restrictions; and (3) free movement of factors of production

Example: E(uropean) C(ommon) M(arket) before it evolved to the next type of arrangement

Types of Regional Trading Arrangements

Economic union

Common market agreement plus:

unification of main economic institutions and coordination of economic policy between members.

Early example: Belgium and Luxembourg 1920s

National, social, taxation, and fiscal policies are harmonized and administered by a supranational institution

Requires an agreement to transfer economic sovereignty to a supranational authority

Types of Regional Trading Arrangements

Monetary union

Ultimate degree of economic union

So is economic union plus:

Unification of national monetary policies

Acceptance of a common currency administered by a supranational monetary authority

Examples: United States, E(uropean) U(nion)

So all of above Types include trade liberalization for 2 or more countries.

Question: What is APEC, & which above type does it represent? (www.apec.org)

Effects of a Regional Trading Arrangement

Static effects of economic integration

On productive efficiency

And consumer welfare

Trade creation takes place when there is a shift in product origin from a higher-resource-cost domestic producer to a lower-resource-cost member country producer. The shift represents movement towards the free trade allocation.

Trade diversion takes place when there is a shift in product origin from a lower-resource-cost nonmember producer to a higher-resource-cost member country producer. The shift represents movement away from the free trade allocation.

Dynamic effects of economic integration

Relate to long-term rates of growth

Effects of a Regional Trading Arrangement

Static effects

Trade-creation effect

Welfare gain

Some domestic production of one customs-union member

Replaced by another member’s lower-cost imports

Consumption effect

Production effect

Trade-diversion effect

Welfare loss

Imports from a low-cost supplier outside the union

Are replaced by purchases from a higher-cost supplier within the union

Effects of a Regional Trading Arrangement

Trade creation and welfare

Consider a Customs Union (as defined previously), CU

Assume:

(1) Three countries L(uxembourg), US & G(ermany).

(2). No transportation costs

(3). Single good, produced in Countries US, G, and L.

SU.S. is the world price (faced by L, a price taker, (small country). Under current trade arrangements (without a CU), L imposes tariffs on imported grain – US is L’s lower cost supplier at SU.S. + tariff, (since G’s supply price is SG + tariff)

Now L joins a CU with Country G, so it removes its tariff on G’s grain exports (- which is now, at price SG, the lower-resource-cost member). Since U.S. is a non-member of the CU, the price of its grain exports to L is still SU.S. + tariff.

Welfare effects for trade creation (see diagram FIGURE 8.1)

There is Consumer surplus gain, a loss of producer surplus, and a loss of tariff revenue

Adding all of these, the welfare gains = a + b which is positive

Effects of a Regional Trading Arrangement

Trade diversion and welfare

Again, Consider a Customs Union (as defined previously)

Assume same countries and product (grain) as previously.

Under current trade arrangements (without a CU), L imposes a tariff only on imported grain from G – so US is L’s lower cost supplier at SU.S. (the world free trade price), since G’s supply price is SG + tariff.

Now L joins a CU with Country G, so it removes its tariff on imported grain from G (- which is now, at price SG, the lower-resource-cost member). Since U.S. is a non-member of the CU, L imposes a tariff on imports of grain from the U.S. so the price of its grain exports to L is now SU.S. + tariff.

Effects of a Regional Trading Arrangement

Welfare effects for trade diversion (see diagram FIGURE 8.1 page 267, Text 14th edition)

There is Consumer surplus gain, a loss of producer surplus, and a loss of tariff revenue from G’s imports, as well as a further loss from the tariff now imposed on U.S. grain imports.

Adding all of these, the welfare gain/loss = a + b - c which may be positive or negative – if negative it is trade diversion.

The closer is the CU partner (Country G) price SG to the low-cost world (Country U.S.) price SU.S., (i.e. the smaller is c,) the more likely that the impact of integration is positive for Country L.

The formation of a customs union leads to a welfare-increasing trade creation effect and a welfare-decreasing trade diversion effect. The overall effect of the customs union on the welfare of its members, as well as on the world as a whole, depends on the relative strength of these two opposing forces.

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Static welfare effects of a customs union

FIGURE 8.1

Effects of a Regional Trading Arrangement

Dynamic effects

Greater competition – increased number of producers makes collusion less likely and forces firms to become more efficient

Economies of scale – access to a larger market allows producers to become more efficient through greater specialization, better equipment, and usage of by-products

Stimulus of investment – because of increased rate of return and ability to spread R&D costs trade makes greater levels of investment more likely

Dynamic benefits from increased factor mobility among the members – both labour and capital can move more freely from areas of surplus to areas of scarcity – higher factor incomes and increased economic efficiency.

Brief Overall Assessment of Regional Integration

Likely positive net effects:

The higher pre-customs union tariffs and the lower the common external tariff

The more elastic supply and demand are in member countries

The greater the numbers of participating members and the larger the group size

The greater the ease in shifting from a higher cost domestic source to a lower cost member source, and the more preunion per-unit cost differences between sources (and the greater the scope for economies of scale and higher foreign investment and technology – dynamic effects).

The lower are the transport costs between members – geographic proximity.

Possible negatives:

The distribution of benefits among member countries is unknown.

Product suitability and choice for the integration arrangements.

Historical trade connections are often lacking for small potential member countries.

Brief Overall Assessment of Regional Integration

Possible negatives cont.:

Increasing emphasis on regional integration (-e.g. appears to be deepening in the Asia-Pacific area – APEC -) may provide stumbling blocks to a multilateral trading system and trade liberalisation as embodied in the W(orld) T(rade) O(rganisation), given the discrimination from within the regional groups:

In particular:

trade barriers may be reduced for a relatively small group of member countries; the regional group may further raise trade barriers to outside non-members:

economies of scale may not be obtained – relatively small markets;

the group members may concentrate on regional trade negotiations instead of participating globally:

domestic economic policies can be more difficult due to loss of control, and lessened sovereignty and independence, for the members.

Question: Any example(s) of difficulties, failed economic integration?

European Union: 1960 - 1985

Treaty of Rome – 1957 – established European Community – precursor to EU

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

trade creation exceeded trade diversion

EU saw increases in economies of scale, competition, investment

1985 EU eliminated nontariff barriers resulting in creation of European common market

European Union & Maastricht

1991 Maastricht Treaty established monetary union and euro as common currency by 2002

European Monetary Union

A common currency also implied the need for a single European Central Bank responsible for all monetary and exchange rate policies of the EMU.

advantages:

eliminated exchange rate risk

reduced currency conversion costs

insulation from monetary disturbance & speculation

disadvantages:

loss of individual monetary authority

transition to common currency could lead to speculative attacks

World Trade Organization

Does WTO Reduce National Sovereignty?

Yes – because of WTO disputes settlement

No – because findings of a WTO dispute-settlement panel cannot force the United States to change its laws

Retaliatory tariffs for WTO enforcement?

Small country impose retaliatory tariffs

Relatively more costly to initiate

No favorable movements in its terms of trade

TRADE CONFLICTS

World Trade Organization

Trade liberalization - harms the environment?

“Race to the bottom” in environmental standards

Social preferences

Trade liberalization - improves the environment?

Trade stimulates economic growth

Key factors in societies’ demand for a cleaner environment

Tougher environmental laws

Trade and growth

Development and dissemination of environmentally friendly production techniques

TRADE CONFLICTS

The WTO

January 1, 1995, GATT transformed into WTO

WTO

153 nations, 97% of world trade

International organization, headquartered in Geneva, Switzerland

Multilateral trading system

Trade in services, intellectual property, and investment

Administers a unified package of agreements to which all members are committed

TRADE CONFLICTS

The WTO (cont.)

WTO

Reverses policies of protection in certain “sensitive” areas

Settling trade disputes

Is not a government

Individual nations - free to set their own appropriate levels of environment, labor, health, and safety protections

Various councils and committees

TRADE CONFLICTS