International Economics

By Robert J. Carbaugh 8th Edition

Chapter 9: Regional Trading Arrangements

Copyright 2002, South-Western College Publishing

Regional trade agreements

Types of regional trade arrangements

 Free trade areas (NAFTA, for example)  Customs unions (Benelux)  Common markets (EU)  Economic/monetary union

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Regional trade agreements

Effects of regional trade agreements

 Static effects
 Trade creation effect (consumption effect, production effect)  Trade diversion effect

 Dynamic effects
 Economies of scale  Greater competition  Investment stimulus
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Regional trade agreements

Static effects of a customs union

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Regional trade agreements: case studies

The European Union

 Created by the Treaty of Rome (1957)  Policy aims included:
Abolition of tariffs, quotas and other restrictions Common external tariff Free movement of capital, labor and business Common policies on transport, agriculture, and competition and business conduct  Coordination of monetary and fiscal policies    
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Regional trade agreements: case studies

The European Union (contd)

 Lowering of barriers caused within-region trade to grow much more quickly than overall world trade in the 1960s  Steps to remove remaining barriers (198592) further increased integration  Maastricht Summit (1991) began process of economic and monetary union (EMU)

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Regional trade agreements: case studies

EU Economic & Monetary Union (1999)

 Member nations will replace national currencies with the euro by 2002  New European Central Bank created to control monetary and exchange rate policy  Convergence criteria required for membership:
    Price stability Low long-term interest rates Stable exchange rates Sound public finances

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Regional trade agreements: case studies

Other key EU policies

 Common agricultural policy
 Support payments to farmers  Variable import levies  Export subsidies

 Government procurement policies

 All EU businesses can bid for larger contracts in any nation

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Regional trade agreements: case studies

CAP: variable levies and export subsidies

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Opening up government procurement

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Costs & benefits of EMU

 Europe does not meet all the requirements of a theoretical "optimal currency area"  Advantages of EMU - real but small:
    Lower transaction costs Price comparisons easier Exchange rate risk eliminated Stimulates competition

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Costs & benefits of EMU (cont'd)

 Disadvantages of EMU:
 Loss of monetary policy and the exchange rates as economic adjustment tools  Use of fiscal policy for adjustment is also constrained  Adjustment to shocks therefore depends on wage flexibility and labor mobility, which are both low in Europe

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US-Canada Free Trade Agmt. (1989)

 Elimination of all tariffs and most NTBs over ten years  Binational tribunal created to hear trade disputes  Canada, in particular, is expected to benefit from economies of scale

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North American Free Trade Agmt. (1994)

 Gradual and comprehensive elimination of trade barriers among US, Mexico and Canada over 15 years:
     Full, phased elimination of import tariffs Elimination of most NTBs Protection of intellectual property rights Dispute settlement procedures Side agreements on environmental protection and labor law
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Regional trade agreements: case studies

NAFTA's benefits
 Mexico stood to gain the most, with access to large industrial markets and new inward investment flows  Canada maintained its preferences in the US market and hoped for future access to South American markets  US stood to gain from access to the Mexican Market and cheap labor and parts, access to reliable oil supplies, and less immigration pressure; but the benefits were modest
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Concerns about NAFTA

 Main US losers from NAFTA would be importprotected industries competing with Mexican producers, and unskilled workers  US industrial workers also worried about lower pay scale in Mexico and plant relocations  Concerns Mexico would not enforce environmental protection measures  Side agreements on environment and labor law were concluded to address those concerns
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Regional trade agreements: case studies

NAFTA after five years

 Trilateral trade increased significantly  Some US jobs were lost to Mexico, but the numbers were small compared to job creation that came with US growth  Changes in investment flows were small (in relation to total US foreign investment)  Closer political ties were built among the three nations
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Regional trade agreements: case studies

Special case: economies in transition

 Nations of eastern Europe and the former Soviet Union have been making a transition from a non-market (planned) economy to a market economy since the early 1990s - which has been very disruptive  These nations planned economies required them to be largely isolated from world trade instead, set up their own trading bloc, the Council for Mutual Economic Assistance (CMEA)
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Economies in transition (contd)

 Even after the collapse of the central planning system, the nations remained tied together because of historical trade links inside CMEA and their common legacy as non-market economies  Financing limitations have hampered an increase in trade: transition nations have generally not been able to increase exports to match imports and must borrow the difference
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Economies in transition (contd)

 Barriers to trade with the West used to make strategies such as countertrade, co-production agreements, joint R&D agreements, and contract manufacturing agreements very common  Gradual elimination of barriers to foreign business in most transition countries has allowed foreign firms to operate in the region more normally in recent years
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