Download - 4 ECONOMIC INTEGRATION
TU-91.2043 International Economics
by
Hannele Wallenius
Aalto University School of ScienceDepartment of Industrial Engineering and
Management
4 ECONOMIC INTEGRATION
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 2
4 ECONOMIC INTEGRATION
4.1 Institutions of International Finance: World Bank and International Monetary Fund
4.2 Customs Unions and FreeTrade Areas
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 3
The Founding Fathers of World Bank and IMF John Maynard Keynes
and Harry Dexter White
White was the chief international economist at the U.S. Treasury
In 1944, he drafted the American plan for the IMF that competed with the British Treasury blueprint drafted by Keynes
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 4
THE WORLD BANK
Founded in 1944 by 44 countries (now 188 member countries) to finance the reconstruction of the war-ravaged economies of Western Europe
After Western Europe recovered and achieved economic self-sufficiency, the bank turned its attention to assisting developing countries
Dr. Jim Yong Kim is the 12th president of the World Bank Group
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 5
The World Bank is a development Bank which provides loans, policy advice, technical assistance and knowledge sharing services to low and middle income countries to reduce poverty
See also: http://www.worldbank.org
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 6
THE INTERNATIONAL MONETARY FUND (IMF) Was established in Bretton Woods,
USA, in 1944 and started operating in 1946 (first only 29 member countries, now 188)
Christine LagardeManaging Director, IMF
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 7
TO DAY:
“The IMF promotes international monetary cooperation and exchange rate stability, facilitates the balanced growth of international trade, and provides resources to help members in balance of payments difficulties or to assist with poverty reduction.”
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 8
“Through its economic surveillance, the IMF keeps track of the economic health of its member countries, alerting them to risks on the horizon and providing policy advice. It also lends to countries in difficulty, and provides technical assistance and training to help countries improve economic management.”
For more: http://www.imf.org/
International Economics
Hannele Wallenius
CritiqueStructural Adjustment Programs (SAPs)
6 Economic Integration - 6.1 Institutions Of International Finance 9
International Economics
Hannele Wallenius
Critique… Structural Adjustment Programs (SAPs) are a set of
economic policies that are implemented by International Monetary Fund (IMF) and World Bank (WB) in developing countries
They constitute the “conditionality” of loans provided by IMF and WB, leaving heavily indebted developing countries with virtually no choice but to implement them
The principle goal of SAPs is to address balance of payment problems and implement fiscal discipline. They also call for significant cuts in public services, trade liberalization, broadening the tax base, reducing marginal tax rates and minimal state regulation on economic activity
SAPs are traditionally based on a set of economic principles called “Washington Consensus,” a name that alludes to the city that both IMF and WB are headquartered in.
6 Economic Integration - 6.1 Institutions Of International Finance 10
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 11
4 ECONOMIC INTEGRATION
4.1 Institutions of International Finance: World Bank and International Monetary Fund
4.2 Customs Unions and FreeTrade Areas
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 12
International Trade Liberalization: Global Approach
General Agreement on Tariffs and Trade, GATT (founded 1947, lasted until 1994, when it was replaced by the World Trade Organization in 1995)
GATT’s objectives were: To establish the rules of conduct of international
commerce
To provide a forum for multilateral talks aimed at lowering trade protection around the world; aims to reduce tariffs worldwide: First, Second, Third and Fourth Round 1947 - 1956, Dillion, Kennedy, Tokyo, Uruguay Rounds 1986 – 1994, Doha…
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 13
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 14
World Trade Organization (WTO) WTO established during the Uruguay round
and started 1.1.1995
160 members June, 2014) (some 25 more countries applying membership) accounting for more than 97% of world trade
The agreements have three main objectives: to help trade flow as freely as possible to achieve further liberalization gradually
through negotiations to set up an impartial system of settling
disputes
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 15
WTO
Doha Round 2001 - talks have stalled over issues, such as
agriculture, industrial tariffs and non-tariff barriers, and services
significant differences are between developed nations led by EU, USA, and Japan and the major developing countries led mainly by India, Brazil, China, South Korea, and South Africa
See for more http://www.wto.org
Roberto Azevêdo Director-General of the WTO
International Economics
Hannele Wallenius
Trade without Discrimination
Most-favored-nation (MFN): treating other people equally Under the WTO agreements, countries
cannot normally discriminate between their trading partners
Grant someone a special favor (such as a lower customs duty rate for one of their products) and you have to do the same for all other WTO members
Exception: free trade agreements, such as EU and NAFTA
6 Economic Integration - 6.1 Institutions Of International Finance 16
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 17
International Trade Liberalization: Global Approach continued
OECD (Organization for Economic Co-operation and Development)
established by 20 countries in 1960
now 34 full members from the “developed”, industrialized countries* sharing the principles of the market economy,
pluralist democracy and respect for human rights
promoting policies to improve the economic and social well-being of people around the world
* Accession talks with, Russia and enhanced engagement offered to Brazil, China, India, Indonesia and South Africa.
A forum in which
governments share
experiences and seek
solutions to common
problems: what drives
economic, social and
environmental change.
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 18
International Trade Liberalization: Regional Approach
Free trade among small number of nations; while maintaining some barriers with rest of the world
These are called preferential trading arrangements
International Economics
Hannele Wallenius
Stages of Economic Integration
6 Economic Integration - 6.1 Institutions Of International Finance 19
No Internal Common Factor and Common Common
Trade Barriers External Tariff Asset Mobility Currency Economic
Policy
Free Trade Are X
Customs Union X X
Single Market X X X
Monetary Union X X X X
Economic Union X X X X X
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 20
EU Trade Agreements
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 21
Examples of Regional Trade Agreements (RTAs):
The number of RTAs from around 70 in 1990 to over 300 today.
The European Union (EU) – a customs union, a single market and now with a single currency
The European Free Trade Area (EFTA)
The North American Free Trade Agreement (NAFTA) – created in 1994
Mercosur - a customs union between Brazil, Argentina, Uruguay, Paraguay, and Venezuela
Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA)
Common Market of Eastern and Southern Africa (COMESA)
South Asian Free Trade Area (SAFTA) created in January 2006 and containing countries such as India and Pakistan
In addition, United States has free trade agreements in force with 20 countries
International Economics
Hannele Wallenius
Mega-regionalism:
Trans-Pacific Partnership (TPP) and the Trans-Atlantic Trade and Investment Partnership (TTIP)
The United States is negotiating a regional FTA, the Trans-Pacific Partnership, with Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam
USA and EU launched negotiations on the Transatlantic Trade and Investment Partnership in June 2013
6 Economic Integration - 6.1 Institutions Of International Finance 22
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 23
The Road to EU in a Nut Shell EEC formed in 1957 as CU among six
countries: France, West Germany, Italy, Netherlands, Belgium and Luxemburg (signed the Treaties of Rome)*
*Already in 1951, the same six countries formed the European Coal and Steel Community, which begins to unite European countries
The signing of the Treaties of Rome
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 24
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 25
Will preferential arrangements foster free trade?
Some concerns among economists that regional trade agreements may make it more difficult, rather than easier, to achieve the ultimate objective of global free trade
The regional approach to trade liberalization could lead to the formation of large "trade blocs" which trade freely among members but choke off trade with the rest of the world
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 26
Will preferential arrangements foster free trade! continued
For this reason some economists have argued that the multilateral approach (MFN)1 to trade liberalization, represented by the trade liberalization agreements in successive WTO rounds, is more likely to achieve global free trade than the regional or preferential approach
1Most Favored Nations
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 27
Will preferential arrangements foster free trade? continued
Preferential trade arrangements are often supported because they represent a movement in the direction of free trade
If free trade is economically the most efficient policy, it would seem to follow that any movement towards free trade should be beneficial in terms of economic efficiency
It turns out that this conclusion can be wrong!
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 28
Will preferential arrangements foster free trade? continued
Even if free trade is most efficient, it is not true that a step in that direction necessarily raises economic efficiency
Whether a preferential trade arrangement raises a country's welfare and economic efficiency depends on the extent to which the arrangement causes trade diversion versus trade creation
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 29
Trade Creation and Trade Diversion: Regional Integration and Welfare
The overall welfare effects of economic integration are ambiguous and require case-by-case judgment
Reason: integration is both a policy of protection and a move toward free trade
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 30
The effect of the protectionist element of integration is called trade diversion
and
the effect of the trade liberalization element is called trade creation
The free-trade area's overall effect on welfare is determined by comparing the trade-creation and trade-diversion effects
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 31
If trade creation dominates, the formation of a free-trade area will enhance welfare...
Sdom
Ddom
SNM + t
SM
SNM
SM + t
QX
PX
e
C
H
G
J
P0
P1
Q0 Q2Q1Q3
Figure 1
ba dc
PD
2.Trade increases from Q0 - Q1 to Q2 - Q3, if a free trade area is formed with country M, causing a welfare gain c + d.
3.Trade diversion, however, causes an efficiency loss e (lost tariff revenue).
1.Let’s assume that a country has originally imposed a tariff t on all imports of X. Imports then being Q0 – Q1.
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 32
Figure 1: Welfare Effects of Economic Integration: Formation of a Free-Trade Area in Good X. SM denotes the supply of good X by member countries and SNM the supply by nonmember countries
Formation of a free-trade area causes a move from point C to point H in consumption. Trade increases as imports rise from Q0 - Q1 to Q2 - Q3, causing a welfare gain c + d
Trade also is diverted from nonmember countries toward member countries, causing an efficiency loss represented by the area of rectangle e
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 33
The net gain for the domestic country depends which is larger (c + d) or e!
Note that if member countries are the low-cost producers of the traded good, there will be no trade diversion effect and integration will unambiguously increase welfare
Note also that if tariff is low enough to make the tariff-inclusive price of nonmember imports lower than the price of member imports, the free-trade area will have no trade-creating or trade-diverting effects since no trade with member countries will occur
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 34
Why would a country create a
FTA with a country A if it could improve its
welfare more by forming one with
country B?
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 35
Why would a country create a FTA...1. To answer that we need to go beyond
calculation of static gains and losses (i.e. trade creation and trade diversion) to dynamic gains: there may be economies of scale in
production in various goodso market size expands for the
manufacturers in these two countries…
why not include country B as well?maybe the economies of scale have
already been fully exploited...
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 36
Why would a country create a FTA … continued
2. Preferential trading arrangements are some times formed for political (noneconomic) reasons
for instance, EU was formed because the European political leaders wanted to integrate their economies so completely that temptations to go on war would be diminished substantially
International Economics
Hannele Wallenius
6 Economic Integration - 6.2 Customs Unions And Free Trade Areas 37
Economists obtain estimates of the overall impact of integration by calculating the effects corresponding to areas a, b, c, d, and e (in our figure) for each major good traded
In the case of EU, most analysts agree that trade creation outweighs trade diversion; estimates suggest the EU's trade-creating effect has been about four times that of its trade-diverting impact
How efficient is EU in terms of trade creation?
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 38
Arguments Against Regionalism
Bhagwati views the formation of regional trade arrangements (RTAs) as undermining the WTO
Regionalism is harmful because it encourages trade diversion
Arguments Against and For of Regional Trade Agreements
International Economics
Hannele Wallenius
6 Economic Integration - 6.1 Institutions Of International Finance 39
Arguments Favoring Regionalism
Paul Krugman argues that trade diversion from FTAs is low because trading blocs are “natural” trading areas
Due to proximity and similarity of cultures and standards of living, regional trade agreements stimulate trade that would have occurred even in the absence of an agreement
International Economics
Hannele Wallenius
In-Class Exercise 3
Draw a mind map of economic integration
6 Economic Integration - 6.1 Institutions Of International Finance 40