Trade Blocs and Trade Blocks

F Economic bloc: A group of countries who act together for a common purpose, united by treaty or agreement F Types of economic blocs - for trade purposes
Good news - Trading opportunities enhanced within bloc Bad news - Trading opportunities discouraged outside bloc Are you enhancing trade with good, low cost partners?

F Theory of Customs Unions

Trade creation and trade diversion effects

F Examples of economic blocs: EU, NAFTA, others F Trade Blocks

Trade embargoes as political or economic policy
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 1

Types of Economic Blocs (1 of 2)

(1) Preferential Trading Club
British Commonwealth Preference System Most Favored Nation (MFN) principle - A trade concession granted to any foreign nation must be granted to all foreign nations with MFN status
u Encourages non-discrimination u GATT has granted dozens of exceptions (EU, NAFTA, )

(2) Free-Trade Area

Free trade within the area, but separate national trade policies with outsiders ( need for customs inspectors) Examples:
u European Free Trade Area (EFTA, 1960) u Latin American Free Trade Area (LAFTA, 1960, deceased 1969) u Association of South East Asian Nations (ASEAN, 1976) u North American Free Trade Area (NAFTA, 1994)
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 2

Types of Economic Blocs (2 of 2)

(3) Customs Union
Free trade within the area, and common national trade policies with outsiders ( no need for customs inspectors) Examples:
u European Economic Community (till 1992)

(4) Common Market

Free movement of all factors of production Examples:
u European Economic Community (after 1992, Single Market)

(5) Economic Union

All economic policies (monetary, fiscal, welfare) shared by all member countries Examples:
u Belgium and Luxembourg (1921) u U.S.A. u Not yet EU
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 3

Trade Discrimination - Good or Bad?

F Trade discrimination
Granting more favorable trade relations to some partners than to other

F Good or bad?
Adding trade barriers generally bad as in analysis of tariffs Relaxing trade barriers intuitively good, except what if you eliminate barriers vis--vis a country that is a high cost producer?
u Trade creation effect: Lower barriers create trade, and gains from trade u Trade diversion effect: Lower barriers with some (not all) countries may tilt (divert) trade toward high cost producers ( loss from trade)

pick your marriage partner carefully

Prof. Levich C45.0001, Economics of IB Chapter 11, p. 4

Customs Unions and Welfare (1 of 2)

Price DA SA

F Consider countries A, B & C F Country A has upward sloping supply and imports from either B or C, with tariff T F Before Customs Union
SB + T SC + T

A D E

B F

C G H

SB SC

As imports from C are Q3 - Q2 Welfare loss (from tariff) = lost consumer surplus - tariff rev {A+B+C+D+E+F+G+H} - {B+F} = {A+D+E} + {C+G+H}

Q1

Q2

Q3

Q4

Prof. Levich

C45.0001, Economics of IB

Chapter 11, p. 5

Customs Unions and Welfare (2 of 2)

F After Custom Union of A & B
Price DA SA

As imports from B are Q4 - Q1 Welfare loss = lost consumer surplus {D+E+F+G+H}

SB + T SC + T

A D E

B F

C G H

SB SC

Q1

Q2

Q3

Q4

F Did customs union of A&B improve welfare? Yes, if {D+E+F+G+H} < {A+D+E} + {C+G+H} or if F < A + C F F: Trade diversion effect F A+C: Trade creation effect

Prof. Levich

C45.0001, Economics of IB

Chapter 11, p. 6

Customs Unions - General Lessons

F Welfare gain when
Trade creation effect > Trade diversion effect

F Welfare gains from customs union favored by

Greater difference between home and partner country supply (cost) curves (partner was subject to high tariff) Smaller difference between partner country and world-wide supply curves (partner almost as efficient as the world) Larger import elasticity of demand for imports

F Caveats
Customs union effects all goods, may be trade creation gains on some goods, but trade divergence losses on others

F Other benefits
Welfare gain a flow, take NPV Static vs. dynamic effects (scale economies, other incentives)
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 7

Examples of European Economic Blocs

F Outline of European economic integration
1950-52: European Coal and Steel Community (6) 1958: Treaty of Rome, European Economic Community (6) 1960: European Free Trade Association - EFTA (7) 1970s: EEC expands, trade barriers reduced, U.K. Commonwealth preferences removed 1978: EEC becomes European Community (EC) 1981 Greece, 1986 Portugal and Spain join EC 1987: Single European Act to eliminate all barriers (including non-tariff barriers) to movements of goods, labor and capital by 1992. Single passport for labor and capital. 1992: Single European Act achieved
C45.0001, Economics of IB Chapter 11, p. 8

Prof. Levich

Gains from European Integration

F Three sources of European gains
Trade creation in manufactured goods (net +) Trade diversion from Common Agricultural Policy (-)
u Britain loses access to low cost food suppliers through Commonwealth Preference System in exchange for higher cost European suppliers

Dynamic gains from scale economies, stimulating productivity improvements, and increased competition
u Probably a (+), but hard to estimate with accuracy. u Cecchini Report (1988) estimated gains ~ 5.3% of EU GDP Gains from removal of non-tariff trade barriers 0.20% Gains from removal of production barriers 2.20% Economies of scale 1.65% Intensified competition 1.25%
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 9

Examples of American Economic Blocs

F Canada - U.S. Free-Trade Area
Canada/US auto agreement in place since 1965 Full Canada/US FTA in place 1/1/89, with 10 year phase in Canada already US largest trade partner, barriers not great

F North American Free Trade Area - NAFTA (1994)

Free trade in goods and capital among US/Mexico/Canada Harmonization of safety and environmental standards (why?)
Pemex allowed to remain nationalized (why?) Estimates of NAFTAs impact u Largest gains for Mexico, then Canada, then US u Distribution of gains: low-skilled manufacturing favors Mexico, trade diversion from Asia, higher skilled and services favor US
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 10

Estimated Impact of NAFTA in % Changes

(Brown, Deardorff, and Stern, 1992)

In In U.S. In In the Mexico Canada R.O.W.

Effects of removing trade barriers within NAFTA, with no effects of capital flows Real national income 1.6 0.1 0.7 -0.0 Real average wage 0.7 0.2 0.4 -0.1 rate Effects of removing trade barriers within NAFTA, with induced capital flows into Mexico Real national income 5.0 0.3 0.7 -0.0 Real average wage rate

9.3

0.2

0.5

-0.0

Lindert/Pugel, Fig. 11.3

C45.0001, Economics of IB Chapter 11, p. 11

Prof. Levich

Estimated Impact of NAFTA on U.S. (1 of 3)

F On Trade in North America
1/3 of US trade w/Mex & Can, growing at 44% (r/t 33% ROW) Exports to Mex & Can support 2.3 million US jobs, 311,000 Exports to Mex ~ to Japan, even though Mex(GDP) ~1/12 of J.

F On Trade Barriers
1993 Average Mex. tariff (on US) 10%, in 1996 ~2.9% 1993 Average U.S. tariff (on Mex) 2.1%, in 1996 ~0.65%

F On U.S. Economy
Challenge - estimate impact of NAFTA, controlling for other factors, + Uruguay Round tariffs reductions were scheduled Small positive impacts on U.S. net exports, income, investment, and jobs supported by exports
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 12

Estimated Impact of NAFTA on U.S. (2 of 3)

F On Mexican Economy
Faster recovery time after Mexico financial crisis (Dec 1994) vs. Mexico debt crisis (Feb 1982)
u Recovery of US exports to Mexico u Return of Mexico to capital markets

F On Key Sectors
US suppliers have dominant share (75.5%, up from 69.3%) in Mexico imports. Reflects drop in Mexico tariffs vs. U.S. Larger in some sectors (electronic goods, transport equip.) In textiles, % US imports from Mexico , from Asia

Prof. Levich

C45.0001, Economics of IB

Chapter 11, p. 13

Estimated Impact of NAFTA on U.S. (3 of 3)

F On Labor Protection
North American Agreement on Labor Cooperation Legal process for enforcement of national labor laws Cooperation of various labor issues - occupational safety, child labor, gender issues, ...

F On the Environment
2,000 mile border with Mexico NAFTA includes environmental safeguards, has led to greater cooperation on environmental issues and monitoring Issues cover - infrastructure projects, movement of hazardous wastes, wildlife, banning certain pesticides Source: U.S. Trade Representatives Report on NAFTA, 1997.
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 14

Other Trade Bloc Examples

F Latin American Free Trade Area (LAFTA)
Started in 1960 with Mexico + South America Disbanded in 1969, splitting into smaller groups

F Central American Common Market (1960)

Disbanded in 1970s

F Association of South East Asian Nations (ASEAN)

Started in 1976, up and down experiences

F Mercosur - common market of the south

1991 by Argentina, Brazil, Paraguay, Uruguay

F Why trade blocs have often failed

Lack of commitment to opening trade To get scale economies, must concentrate production, but where?
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 15

Trade Blocks
F Denial of trading opportunities used as politicaleconomic weapon F Types of trade blocks
Sanctions - General term for restrictions of some sort
u Ban on textiles, sneakers & soccer balls made with child labor

Embargoes & boycotts - complete ban on trade NOT Trade War tariff, retaliation, further retaliation, etc.

F Long history of use

US boycott of British goods in 1760s to protest Stamp Act Used by US (and others) against many countries over last 50 years - Cuba, Nicaragua, Serbia, South Africa, North Korea, others
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 16

Trade Blocks - Success or Failure?

Size: large countries impose sanctions on small countries
u Small country can be heavily trade dependent (low elasticity)

Relative costs: low to large country, high on small country

u Large country retains trade with other non-sanction countries

Scope: sanctions on more goods puts larger cost on small country Friends: more effective when large country enlists others to cooperate, less effective if target maintains trade with others Timing: extreme, sudden sanctions more effective; more time allows more time to adjust Politics: dictatorship may retain power even when economic costs are high
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 17

Blocs and Blocks - Summary

F Trade blocs remove trade barriers among countries
Encouraging trade may be good, but weigh cost / benefits Marriage partner matters: Trade creation > trade diversion

F Policy concern about regional trade blocs

May promote costly trade diversion May leave tariffs between blocs However, regional cooperation often easier than multilateral Still a role for multilateral trade policy making

F Regional trade bloc successes

EU and NAFTA - largest gains go to smallest countries

F Trade block mixed success

South Africa - Yes; many others - No; politics matters
Prof. Levich C45.0001, Economics of IB Chapter 11, p. 18