Chapter 08 Regional Trading Arrangements

Regional Trading
Arrangements
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Eastern Illinois University
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Regional Integration vs. Multilateralism
• WTO
• Promote trade liberalization through
worldwide agreements
• Trade liberalization by any one nation
• Extended to all WTO members, 153 nations
• Nondiscriminatory
• Regional trading arrangements
• Nations reduce trade barriers only for a small
group of partner nations
• Discriminating against the rest of the world
• Regional block – stumbling blocs to
multilateralism
• Members not greatly interested in worldwide
liberalization
• May not realize additional economies of scale from
global trade liberalization
• May want to invest their time and energy in
establishing strong regional linkages
• Rather than investing them in global negotiations
• Regional block – building blocks to global free
trade and investment
• When structured according to principles of
openness and inclusiveness
• May achieve deeper economic
interdependence among members
• Greater commonality of interests
• Simpler negotiating processes
• Regional block – building blocks to global free
trade and investment
• Self-reinforcing process
• Encourages the partial adjustment of workers
• Out of import-competing industries in which the
nation’s comparative disadvantage is strong
• Into exporting industries in which its comparative
advantage is strong
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
• 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
• 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
• Benelux
• Belgium, the Netherlands, and Luxembourg
• Common market
• Group of trading nations
• Free movement of goods and services among
member nations
• Initiation of common external trade restrictions
against nonmembers
• Free movement of factors of production across
national borders within the economic bloc
• European Union (EU), 1992
• Economic union
• 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
• Monetary union
• Ultimate degree of economic union
• Unification of national monetary policies
• Acceptance of a common currency
administered by a supranational monetary
authority
• The United States - Monetary union
• Fifty states with a common currency
• Federal Reserve
• Single central bank for the nation
• Free trade among the states
• Labor and capital move freely
• The United States - Monetary union
• Federal government
• Nation’s fiscal policy
• National defense
• Retirement and health programs
• International affairs
• States can keep their identity within the union
• Police protection and education
GLOBALIZATION
Missing benefits: the United States
falls behind on trade liberalization
• 2009
• 266 bilateral or regional trade pacts
• United States
• Had trade deals with only 17 countries
• European Union, Japan, and China
• Trade alliances ranging from customs unions to
large free-trade pacts with a total of 40
countries
GLOBALIZATION
Missing benefits: the United States
falls behind on trade liberalization
• Expansion of bilateral and regional trade deals
• Countries losing faith in the ongoing Doha
Round of multilateral trade talks
• Bilateral and regional deals as a method of
liberalizing beyond what the Doha Round
would achieve
• Foster alliances or promote political influence
TABLE 8.1 Examples of trade deals involving countries
other than the United States
South Korea-European Union, 2009
• Applies to $96 billion in annual trade
• Eliminates virtually all tariffs
• Decreases Korean regulatory barriers on imports of automobiles
Canada-Colombia, 2008
• Applies to $1.2 billion in annual trade
• Phases out most Colombian agricultural tariffs
• Addresses Colombian food-safety standards that restrict trade
Japan-Association of Southeast Asian Nations, 2008

• Applies to $211.4 billion in annual trade
• Eliminates Japanese tariffs on 93 percent of import value
• Eliminates six countries’ tariffs on 90 percent of Japanese imports
Impetus for Regionalism
• Motivations for regional trading arrangements
• Prospect of enhanced economic growth
• Economies of large-scale production
• Foster specialization and learning-by-doing
• Attract foreign investment
• Foster a variety of noneconomic objectives
• Managing immigration flows
• Promoting regional security
• Enhance & solidify domestic economic reforms
Effects of a Regional Trading Arrangement
• Static effects of economic integration
• On productive efficiency
• And consumer welfare
• Dynamic effects of economic integration
• Relate to long-term rates of growth
• 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
• Static effects
• 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
FIGURE 8.1 Static welfare effects of a customs union
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.
• United Kingdom (UK)
• Entered the European Union in 1973
• Turned away cheaper agricultural produce from
Australia
• Increased farm output
• Purchased produce from its more expensive
European neighbors
• Trade diversion
• Produce prices – increased by 25%
• Decreased national welfare
• United Kingdom (UK)
• Purchased cheaper manufactured goods from
European neighbors
• Trade-creation
• Increase national welfare
• Trade creation - stronger effect
• UK’s overall welfare improved by joining the EU
• Dynamic effects
• Creation of larger markets
• By the move
• Dynamic gains
• Economies of scale
• Greater competition
• Stimulus of investment
The European Union
• European Community / European Union
• Trade liberalization
• Treaty of Rome in 1957
• Belgium, France, Italy, Luxembourg, the
Netherlands, West Germany
• By 1973
• The United Kingdom, Ireland, Denmark
• 1981 – Greece
• 1987 – Spain, Portugal
The European Union
• European Community / European Union
• 1995 – Austria, Finland, Sweden
• 2004 – ten other Central and Eastern European
countries
• Cyprus, the Czech Republic, Estonia, Hungary,
Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia
• 2007 – a total of 27 countries
• Bulgaria and Romania
The European Union
• European Union – customs union
• Economic integration to an economic union
• 1957 – trade liberalization
• 1968 – free-trade area
• 1970 – customs union
• 1985 – detailed program for becoming a
common market
• Elimination of remaining nontariff trade barriers by
1992
The European Union
• European Union - monetary union
• The Maastricht Treaty, 1991
• Full-fledged European Monetary Union (EMU) by
2003
• Single currency, the euro
The European Union
• Convergence criteria, EMU
• Align economic and monetary policy
• Price stability
• Low long-term interest rates
• Stable exchange rates
• Sound public finances
The European Union
• European Union - monetary union
• The euro - official currency of 16 of the 27
member states of the European Union
• The eurozone:
• Austria, Belgium, Cyprus, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, Malta, the
Netherlands, Portugal, Slovakia, Slovenia, and Spain
The European Union
• The euro
• Also used in another five European countries
• Used daily by some 327 million Europeans
• Over 175 million people worldwide
• Use currencies that are pegged to the euro
• The second largest reserve currency
• The second most traded currency in the world
The European Union
• Countries joining the European Union
• Obligated to join the EMU
• To adopt the euro as their national currency
• Must first satisfy the convergence criteria as
mandated by the Maastricht Treaty
The European Union
• 2004, new constitutional treaty
• Changes to the EU’s original governing
constitution
• Abolish the EU’s rotating presidency
• Appoint a single individual as president of the
European Council for up to five years
• New foreign minister
• Increasing the powers of the European Parliament
• Simplifying EU voting procedures
The European Union
• French and Dutch voters sidetrack integration
• Rejected the new constitution, 2005
• Undermine social protections
• Express dissatisfaction
• Their unpopular national governments
• The EU bureaucracy
• Turkey’s prospective EU membership
• Reduced French influence within the EU
• Dutch - EU’s big countries - already too strong
The European Union
• Agricultural policy
• Abolished restrictions on agricultural products
traded internally
• Common agricultural policy
• Support of prices received by farmers
• Deficiency payments, output controls, and direct
income payments
• Variable levies
• Export subsidies
The European Union
• Variable levies
• Levy – determined daily
• The difference between the lowest price on the
world market and the support price
• More restrictive than a fixed tariff
• Discourages foreign producers
• From absorbing part of the tariff
• From cutting prices to maintain export sales
FIGURE 8.2 Variable levies
The common agricultural policy of the EU has used variable levies to protect EU farmers from low-
cost foreign competition. During periods of falling world prices, the sliding-scale nature of the
variable levy results in automatic increases in the EU’s import tariff.
The European Union
• Export subsidies
• Ensure that any surplus agricultural output will
be sold overseas
• EU farmers - incentive to increase production
• Reduce the domestic supply
• Eliminate the need for the government to
purchase the excess
TABLE 8.2 Government support for agriculture, 2007
The European Monetary Union
• European Monetary Union (EMU), 1999
• Single currency (the euro)
• Lower the costs of goods and services
• Facilitate a comparison of prices within the EU
• Promote more uniform prices
• European Central Bank - Frankfurt, Germany
• Controls the supply of euros
• Sets the short-term euro interest rate
• Maintains permanently fixed exchange rates for the
member countries
• Optimum currency area
• Region in which it is economically preferable to
have a single official currency
• Rather than multiple official currencies
• Gains
• More uniform prices
• Lower transaction costs
• Greater certainty for investors
• Enhanced competition
• Promote price stability
• Costs
• If interest-rate changes affect different economies
in different ways
• Loss of two policy instruments
• Independent monetary policy
• Option of changing the exchange rate
• Various reactions to economic shocks
• Mobility of labor
• Flexibility of prices and wages
• Automatic mechanism for transferring fiscal
resources to the affected country
• Best chance of success
• Similar business cycles and economic structures
• Single monetary policy should affect all the
participating countries in the same manner
• No legal, cultural, or linguistic barriers to labor
mobility
• Wage flexibility
• System of stabilizing transfers
TABLE 8.3 Advantages and disadvantages of adopting a
common currency
Advantages Disadvantages
The risks associated with exchange Absence of individual domestic monetary
fluctuations are eliminated within a policy to counter macroeconomic shocks.
common currency area.
Inability of an individual country to use
Costs of currency conversion are inflation to reduce public debt in real terms.
lessened.
The transition from individual currencies to a
The economies are insulated from single currency could lead to speculative
monetary disturbances and speculation. attacks.
Political pressures for trade protection

are reduced.
• Europe - suboptimal currency area
• Advantages
• Improve economic efficiency
• Lower transaction costs of exchanging currency
• Elimination of exchange-rate risk
• Stimulates competition
• Facilitates the broadening and deepening of
European financial markets
• Europe - suboptimal currency area
• Disadvantages
• EU countries – cannot use monetary policy and
exchange rate as a tool in adjusting to economic
disturbances
• Use of fiscal policy - limited by the need to keep
budget deficits in control
• Challenges for the EMU
• Ability of the European Central Bank to focus
on price stability over the long term
• Operation of monetary policy
• Difficulty in reducing budget deficits and debts
• Need for structural reform
GLOBALIZATION
The euro, ten years later: how has
it performed?
• Benefits of the euro
• Removed the cost of exchanging currency
• Eliminated exchange rate risks
• Reduction in cross-border transaction costs
• Fostered economic ties
• Challenges of the eurozone
• Worries about trade imbalances
• One-size-fits-all monetary policy has not met
the needs of all of its members
• Does the Eurozone need a bailout fund?
• Needs a better mechanism to deal with a
financial crisis
• Possible interim solution: European Monetary
Fund (EMF)
• Bailout fund financed out of contributions from
member country governments
• It would put the eurozone in charge of its own
destiny
• Eurozone members would have greater powers to
punish fiscal abusers
North American Free Trade Agreement
• North American Free Trade Agreement, 1994
• NAFTA
• Mexico, Canada, and the United States
• Provide each member nation better access to
the others’ markets, technology, labor, and
expertise
• Economies of scale
TABLE 8.4 Winners and losers in the United States under
free trade with Mexico
U.S. Winners U.S. Losers
Higher-skill, higher-tech businesses and their Labor-intensive, lower-wage, import—
workers benefit from free trade. competing businesses lose from reduced
tariffs on competing imports.
Labor-intensive businesses that relocate to
Mexico benefit by reducing production costs. Workers in import-competing businesses
lose if their businesses close or relocate.
Domestic businesses that use imports as
components in the production process save
on production costs.
Consumers in the United States benefit from

less expensive products due to increased
competition with free trade.
• NAFTA & Mexico
• Benefits
• Increase in the production of goods and services –
comparative advantage
• Rising investment spending
• Increase wage incomes and employment, national
output, and foreign-exchange earnings
• Facilitated the transfer of technology
• Costs
• Agriculture – 25% of population
• Devastated by US competition
• NAFTA & Canada
• Benefits / safeguards
• Maintenance of its status in international trade
• No loss of its current free-trade preferences in U.S.
• Equal access to Mexico’s market
• Costs
• Concerns about Canada’s European-style social
welfare model
• Uncompetitive practices and policies
• Downward pressure on the country’s base of personal
and corporate taxes
• NAFTA & the U.S.
• Benefits
• Expanding trade opportunities
• Reducing prices
• Increasing competition
• Economies of large-scale production
• More reliable source of petroleum
• Less illegal Mexican immigration
• Enhanced Mexican political stability
• NAFTA & the U.S.
• Costs
• Industries that rely on trade barriers to limit
imports of low-priced Mexican goods
• Citrus and sugar
• Unskilled workers
• Fear that U.S. companies will move to Mexico
• NO because of different worker productivity
• Concern: Mexico’s environmental regulations
• Greater trade creation than trade diversion
TABLE 8.5 Gross domestic product, employment and labor
productivity, 2007
TABLE 8.6 Trade effects of NAFTA: trade creation and trade
diversion (thousands of dollars)
• NAFTA & trade diversion
• Benefited Mexico’s textile industry
• Increased market share by late 1990s
• The gains could not be sustained
• China – low-cost textiles
• U.S. closes its highways to Mexican cargo
trucks, 1995
• Concern – safety of the trucking system
• Additional safety requirements
• Only for Mexican truckers
• U.S. Teamsters (truckers) union – benefit
• NAFTA arbitration panel: U.S. was in violation
• 2007 - pilot program for Mexican carriers
• Bad news for Teamsters union
• U.S. closes its highways to Mexican cargo
trucks, 1995
• 2009, in violation of NAFTA, U.S. terminated
the pilot program
• Mexico retaliated
• 89 U.S. products - new tariffs of 10-45%
• Mostly agricultural products
• Decreased imports from U.S.
• American agricultural producers paid a dear price
for the protectionism granted the Teamsters union
• Is NAFTA an optimum currency area?
• Degree of economic integration
• Canada, U.S., Mexico
• Similarity of economic structures
• Canada, U.S.
• Mexico – couldn’t use monetary policy
• Canada – concerned about the loss of national
sovereignty
TRADE
CONFLICTS From NAFTA to CAFTA
• 2005, Central American Free Trade Agreement
(CAFTA)
• United States
• Five nations of Central America
• Costa Rica, El Salvador, Guatemala, Honduras, and
Nicaragua
• Caribbean country: the Dominican Republic
• Trade liberalization measures
• About 80 percent of U.S. exports become duty-free
Free Trade Area of the Americas
• 1994, Summit of the Americas
• 34 nations in North and South America
• Except Cuba
• Call for the creation of a Free Trade Area of the
Americas (FTAA)
• If established, FTAA
• Largest trading bloc in the world
• 850 million consumers
• Combined income of more than $14 trillion
• Level the playing field for U.S. exporters
TABLE 8.7 Major western hemisphere regional trade agreements
Free Trade Area of the Americas
• Obstacles to FTAA
• FTAA’s allowance for other trade agreements
• Smaller partners - special assistance
• Agricultural issues
• U.S. refused to lower subsidies and tariffs that
protect U.S. farmers
• Honoring intellectual property rights
• Opening of government contracts to foreign
bidders
Asia-Pacific Economic Cooperation
• Asia-Pacific Economic Cooperation (APEC)
• 1989, the United States
• Australia, Brunei, Canada, Chile, China,
Indonesia, Japan, Malaysia, Mexico, New
Zealand, Papua New Guinea, the Philippines,
Singapore, South Korea, Taiwan, and Thailand
• 1993, vision of an Asia-Pacific economic
community
• Eliminate barriers to trade and investment by 2020
Transition Economies
• Transition economies
• Transition from a centrally planned economy to
a market economy
• Economic reforms in Eastern European nations
in the 1990s
TABLE 8.8 GDP per capita* for the transition economies,
2007 (in dollars)
• Market economy
• Decisions of independent buyers and sellers
• Acting in their own interest
• Govern both domestic and international trade
• Prices are market-determined
• Value alternatives
• Allocate scarce resources
• Play rationing and signaling roles
• Nonmarket economy
• Centrally planned economy
• Less regard for market considerations
• State planning and control
• Govern foreign and domestic trade
• Controls the prices and output
• Fixes prices – insulated from foreign-trade
influences
• Ration arbitrary quantities among buyers
TABLE 8.9 Economies in transition: 2009 index of
economic freedom*
• Motivation for transition
• Failure of the economy to generate a high
standard of living
• No incentives for producers
• To efficiently supply the goods and services
• That consumers wanted to purchase
• Normal operation of markets – obstructed
• Widespread use of price controls
• Reliance on inefficient public enterprises
• Extensive barriers to competition
• Government regulation of production and
investment
• No incentives for entrepreneurs
• Lack of enforceable property rights
• For the communistic countries
• Central plans decided production levels
• Managers – no incentive to modify their output as
long as quotas were realized
• Underproduction of consumer goods
• Widespread rationing
• Absent incentives to innovate
• Inefficient state-owned enterprises
• Public funds were channeled into favored industries
• Weaknesses of the political and economic systems
FIGURE 8.3 For the former Soviet bloc countries, freer
economies grow faster
From 1993 to 2005, economic growth was strongest for the freer countries of the former Soviet bloc.
• Russia’s WTO accession negotiations
• Slow for several reasons
• Still in transition
• Ongoing challenges
• Restructuring its economy
• Privatizing government-owned industries
• Implementing market-oriented economic reforms
• Difficult to reach political consensus on reforms
• 1998 economic crisis
• Rising world oil prices beginning in 2000

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Regional Trading

Japan-Association of Southeast Asian Nations, 2008

Political pressures for trade protection

Consumers in the United States benefit from

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