Regional Economic Issues

INTERNATIONAL ECONOMICS, 1/e

By W. Charles Sawyer
and Richard L.Sprinkle
Introduction
 What are regional trade agreements?
 How do these differ from multilateral
trade agreements?
 What are the different types of regional
trade economic integration?
 What is the economic impact of regional
integration on countries involved and
world?
Regional Trade Agreements
 Trade agreements between two or
more countries that reduce trade
barriers for countries involved
 Reduction of trade barriers in them are
discriminatory
 Amount of trade between countries is
reduced, but countries not part of
agreement lose some trade
Types of Agreements
 One side is an agreement that has
limited reduction in trade barriers
between the countries
 Other end is an agreement that causes
countries to act as if the group was one
distinct country in every economic
respect
Levels of Integration
1. Tariffs abolished on a limited number
of commodities
 Preferential trade agreement
 Illegal under rules of WTO
 WTO requires trade barriers to be lifted on
“substantially all” of trade between countries
 Waivers can be granted
 1962 US-Canadian Agreement on Trade in
Automobiles and Parts
Levels of Integration
2. Free-trade area - FTA
 Countries agree to eliminate tariffs and
other non-tariff barriers between them
 Again must cover “substantially all” trade
 May just cover non-agricultural products
 May cover all merchandise trade
 May cover all trade in goods/services, foreign
direct/portfolio investment
Levels of Integration
2. Free Trade Area -FTA (cont.)
 Country maintains own separate national tariff
schedule
 Trade deflation may occur – diversion of exports
to a country with in a FTA that has lower tariffs
on a good
 Can lead to establishment of “screwdriver
plants”
 Plants designed to provide minor assembly work
produced in “foreign country” but within FTA
Levels of Integration
2. FTA (cont.)
 Rules of origin
 Duty free treatment requires certain percent
of value added performed in a member
country
 Phased in over time
 May take many years to establish
 Signed agreement does not mean instant free
trade like between states
Levels of Integration
3. Customs union
 Agreement between countries to maintain
a free trade area and a common external
tariff
 Common external tariff – each country
replace national tariff schedule with
common tariff schedule applicable to all
member countries
 US exporting to EU faces one tariff schedule
Levels of Integration
3. Customs Union (cont.)
 Takes time for nation schedules to
harmonize with common external tariff
 Not all free trade areas include trade in
agricultural products, services and
financial flows
 Level of economic integration is usually
“deeper” than that implied by FTA
Levels of Integration
4. Common Market
 Capital and labor are free to move within
member countries
 More efficient allocation of capital
 More efficient allocation of human capital
 Large wage differentials may induce large
amount of migration – noticeable effect
on national wage rates
 Problems with common regulations
Levels of Integration
5. Economic Union
 Maintain
 FTA
 Common external tariff
 Free mobility of capital and labor
 Some degree of unification in government
policies and monetary policies
 Requires common currency
 Common Central Bank
Levels of Integration
5. Economic Union
 Each national government must align
national policies with other member
countries
 Tax rates
 Antitrust law
 Labor regulations
 Environmental regulations, etc.
Trade Effects of Integration
 Trade Creation (TC)
 Increase in trade between two countries
from mutual elimination of tariffs
 If Mexico and US eliminate tariffs to each
other, US will import more from Mexico
and vice versa
 Losses to other countries as trade shifts
from them to member countries
Trade Effects of Integration
 Trade Diversion (TD)
 Export losses to other countries
 US will import from Mexico instead of from
other countries
 The larger the tariff before the agreement,
the larger the loss to other countries
 Change in world trade depends on
larger effect: trade creation or diversion
 Economic Effects - Example
Before NAFTA
US Exporter Other Exporter
Import Price to $24,000 $21,600
Mexico 20% Tariff 20% Tariff
After NAFTA
Import Price to $20,000 $21,600
Mexico 0% Tariff 20% Tariff
Economic Effects - Example
 Mexico purchased cars from other
countries at lower price before NAFTA
 After NAFTA, shifted purchases to US
 US is less efficient producer – cost of
production higher
 Trade is diverted from more efficient
producers to less efficient producers
 Yields losses in world output
Price of Cars – Trade Agreement
Economic Impacts
 To receive exception for free trade area
or customs union
 Must show level of protection would not be
higher on average for an area than before
agreement
 Trade creation would be larger than trade
diversion
 Losses still exist in countries outside
agreement
Economic Impacts
 Number of free trade areas and
customs unions rising quickly
 New agreements increase world welfare
but increase trade diversion
 May create problems for companies
doing business in many different
markets
Static Effects of Customs Union
 Supply/demand model can be used to
show effect of lowering trade barriers
among members
 Mexico, US, Japan – Mexico & US for
customs union
 Mexico is small country relative to
Japan and US
 Japan in most efficient supplier of cars
Static Effects of Customs Union
 Japan free trade price of P1
 Japan tariff price of P3
 US free trade price is P2
 Tariff inclusive price of P4
 Mexico buys all cars from Japan at P3
before agreement
 Mexico buys Q3 cars and Q2
domestically produced
Mexico Trade - Before
Mexico Trade – After
 Mexico removes tariff on US cars only
 US price is now lower than Japan and Mexico
buys all cars from US
 Increase in welfare
 Increase cars purchased – Q4
 Q1-Q4 imported from US
 Increase in consumption for Mexico – A
 Less domestic production gain of B
 Over all gain of A + B
Mexico Trade – After
 Decrease in Welfare
 Trade Diversion
 Higher price supplier (US) replaces imports
from lower price supplier (Japan)
 Welfare loss of C
 As long as A+B > C, increase in world
welfare
Mexico Trade – After

US Exports
European Union - History
 Association of European countries
agreeing to free trade area and a
common external tariff
 Developed in 1951 when European Coal
and Steel Community (ECSC) was
formed
 Elimination of tariffs and quotas for coal
and steel industries
European Union - History
 Political goal of ECSC to reduce
probability of another European military
conflict
 In 1957, ECSC signed Treaty of Rome
 Elimination of tariffs and no-tariff barriers
to trade between member communities
 Instituted common external tariff
European Union - History
 Treaty established European Economic
Community (EEC) as a customs union
 Those not in EEC formed European Free
Trade Association (EFTA) in 1960
 Provided free trade in non-agricultural
production among members
 Provided free trade in these products
between itself and EEC
European Union - History
 In 1967, EEC and ECSC merged into
European Union (EU)
 EU has common agricultural policy (CAP)
 Agreement between European countries to
subsidize agricultural sector
 Differences in subsidies can distort trade so
adopted common policy for members
 EU pays subsidy from joint collected revenue
European Union – Ag Subsidy
 Guarantees prices for all farm commodities
within EU
 EU purchases what is not sold on open
market
 Farmer protected by tariff from international
competition
 Problems of chronic oversupply
 Ag commodities sometimes dumped on world
markets
European Union – Ag Subsidy
 Creates friction between EU and US and
other more efficient agricultural
producers
 Controversies over EU policies delayed
Uruguay Round
 Future friction in world trade will come
from common agricultural policies
European Union
 1985 EU commission determined
necessary step to barrier free internal
market in EU
 Maastricht Treaty of 1992 laid plans for
new European currency (the Euro)
 Euro replaced all separate country
currencies in January 2002
NAFTA
 North American Free Trade Agreement
 Sets up free trade area between US,
Canada, and Mexico
 Straight forward trade agreement
 Economic effect relatively small
 Signed in 1989
NAFTA History
 1989 free trade agreement signed by
Canada and US
 Tariff reductions phased in over 10 years
 Covered trade in goods and services,
investment
 Eliminated national preference on most
government contracts
 Freed US and Canada from last restrictions
NAFTA History
 1992 - Canada, US and Mexico agreed to
broaden free trade area
 Tariff reduction phased in over 15 year period
 Covers all merchandise trade, services,
investment, and intellectual property rights
 Trade disputes adjudicated by 5-member
panel
 Agreement for each country to enforce its
own labor and environmental laws
NAFTA Effects
 Gives Canada unrestricted access to
larger market
 Long run appeal to US and Canada
 Mexico economy growing much faster than
US or Canada
 Mexican tariffs were much higher before
trade agreement
NAFTA Effects
 Benefits for Mexico
 Access to world’s two largest markets
 Help advance export-led growth
 Attract investment capital country needed
 Make Mexico’s economic reform process
since 1980’s permanent
NAFTA Future
 Chile has signed free trade agreement
with Mexico and Canada
 Adding Chile to NAFTA being debated
 US committed to free trade within
Western Hemisphere by 2005