regional trading arrangements

International EconomicsBy Robert J. Carbaugh

8th Edition

Chapter 9:

Regional Trading Arrangements

Regional trade agreements

Types of regional trade arrangements

• Free trade areas (NAFTA, for example)

• Customs unions (Benelux)

• Common markets (EU)

• Economic/monetary union

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

Static effects of a customs unionRegional trade agreements

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


The European Union (cont’d)

• Lowering of barriers caused within-region trade to grow much more quickly than overall world trade in the 1960s

• Steps to remove remaining barriers (1985-92) further increased integration

• Maastricht Summit (1991) began process of economic and monetary union (EMU)


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


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

CAP: variable levies and export subsidies


Opening up government procurement



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


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


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


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


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


Concerns about NAFTA

• Main US losers from NAFTA would be import-protected 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


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


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)


Economies in transition (cont’d)

• 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


Economies in transition (cont’d)

• 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

regional trading arrangements

Economy & Finance

trade disputescanada

region trade

overall world trade

case studiesopening

case studiescap

loss of monetary policy

process of economic

labor mobility