Regional Trading Arrangements

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International Economics
Chapter 5

• Regional Trading Arrangements

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Chapter 5 Regional Trading Arrangements

• 5.1 Types of Regional Trading Arrangements
• 5.2 Effects of Customs Union
• 5.3 Practice of Regional Integration

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5.1 Types of Regional Trading Arrangements

• Free Trade Area
• The most common scheme is referred to as a free
  trade area (FTA), in which all members of the
  group remove tariffs on each others product,
  while at the same time each member retains its
  independence in establishing trading policies
  with nonmembers.
• North American Free Trade Agreement (NAFTA)

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5.1 Types of Regional Trading Arrangements

• Customs Union
• Like a free trade association, a customs union
  (CU) is an agreement among two or more trading
  partners to remove all tariff and nontariff trade
  barriers among themselves.
• Belgium, the Netherlands, and Luxembourg (BENELUX)

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5.1 Types of Regional Trading Arrangements

• Common Market
• A common market is a group of trading nations
  that permits the free movement of goods and
  services among member nations, the initiation of
  common external trade restrictions against
  nonmembers, and the free movement of factors of
  production across national borders within the
  economic bloc.
• The Treaties of Rome in 1957 established a common
  market within the European Community (EC).

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5.1 Types of Regional Trading Arrangements

• Economic Union
• Beyond these stages, economic integration could
  evolve to the stage of economic union, which
  includes all features of a common market but also
  implies the unification of economic institutions
  and the coordination of economic policy
  throughout all member nations.
• The Treaties of Rome in 1957 established a common
  market within the European Community (EC).

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5.1 Types of Regional Trading Arrangements
Some Regional Trading Arrangements in the World
Economy
Organizations Included Nations
Association of Southeast Asian Nations (ASEAN) Brunei, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam
Economic Community of West African States (ECOWAS) Benin, Burkina Faso, Cape Verde, Cote dIvoire, Gambia, Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Mauritania, Niger, Nigeria, Senegal, Sierra Leone, Togo
European Union (EU) Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, the United Kingdom
Latin American Integration Association (LAIA) Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru, Uruguay, Venezuela
North American Free Trade Agreement (NAFTA) Canada, Mexico, the United States
South African Customs Union (SACU) Botswana, Lesotho, Namibia, South Africa, Swaziland
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Chapter 5 Regional Trading Arrangements

• 5.1 Types of Regional Trading Arrangements
• 5.2 Effects of Customs Union
• 5.3 Practice of Regional Integration

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5.2 Effects of Customs Union

• Static Effects
• Country A, B, and C.
• Assuming that A is the world high-cost producer
  of beer, and that initially A protects its
  producer with an ad valorem tariff of 100 percent
  against all foreign producers.
• Suppose that, in autarky, beer would cost 5 per
  bottle in A, and B would be willing to export
  beer to A for 2 per bottle, while C, the
  low-cost world producer, is willing to export
  beer at a price of 1.5 per bottle.

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5.2 Effects of Customs Union
Static Effects of Customs Union
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5.2 Effects of Customs Union

• Now, recall that we have assumed that A has a 100
  percent tariff in place. The effect of this
  tariff is to double the price of imported beer.
  Thus, the price of beer imported from C rises to
  3 per bottle.
• Suppose that A were to negotiate a CU with
  Country B. Under such an arrangement, goods
  coming to A from Country B would not be charged a
  tariff. The tariff would remain on any goods
  coming from Country C. Then, consumers in A could
  buy beer from B at a price of 2. If they were to
  buy from C instead, the price would be 3.

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5.2 Effects of Customs Union

• As this example shows, the formation of a CU can
  have two effects on international trade.
• First, there is the shift in the source of trade
  from C, the lowest-cost world producer, to B, the
  lowest-cost CU member nation. This shift in the
  source of trade is known as trade diversion.
• The second effect of the formation of the CU is
  that trade expands for Country A. Imports rise
  from EF to GH. This comes about because consumers
  are able to pay a lower price for imports. The
  expansion of trade that results from CU formation
  is known as trade creation.

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5.2 Effects of Customs Union

• Let us calculate the welfare impact on Nation A
  of the creation of a CU between A and B.
• If A forms a CU with Country B, consumers in As
  benefit. The price they pay fall from 3 to 2.
  Consumer surplus rises by abcd. Producer
  surplus falls by a, while tariff revenue falls by
  ce. Netting out these changes in surpluses
  yields a welfare impact on A of (bd)-e.
• Because of the trade diversion, A no longer
  trades with Country C. The impact of this is for
  tariff revenues to fall. Part of this loss of
  tariff revenues, c, accrues to domestic residents
  in the form of lower prices. The remaining loss
  of tariff revenues, Area e, measures the amount
  of the effect of trade diversion.

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5.2 Effects of Customs Union

• Consumers in A pay a lower price to purchase the
  good, and hence, trade expands. The benefits of
  international trade are the familiar triangles
  equal in value to bd.
• The lengths of the bases of the two triangles sum
  to equal the amount that trade has increased
  because of the CU. Thus, the sum of these two
  triangles represents the gain to A from trade
  creation. Thus, Areas bd measure the amount of
  the effect of trade creation.

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5.2 Effects of Customs Union

• What about the other nations?
• B gains on the export side from this arrangement.
  It obtains export markets in A that it had
  previously been unable to penetrate. On the other
  hand, if A is a higher-cost producer than C, then
  when B lowers its tariffs on goods from A, it
  faces ambiguous welfare prospects. Meanwhile,
  Country C loses because its producers have lost
  markets.
• Clearly, since the effect on A and B is ambiguous
  and C loses, the worldwide welfare effect of the
  formation of CU or other preferential trading
  relationships is anything but certain.

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5.2 Effects of Customs Union

• In general, A would eliminate its tariff with
  respect to Country C. The price of beer would
  fall to 1.5, and imports from C would expand to
  IJ.
• The increase in imports represents pure trade
  creation. That is, in this example, trade
  diversion would be zero, since, both before and
  after the agreement, A trades with C.
• For A, the welfare gains of the formation of a CU
  relative to tariff are bfgdhi.
• Country C gain as well, because its exports rise.
  B neither gains nor loses in this case, because
  its trade has not been affected.

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5.2 Effects of Customs Union
The Welfare Effects of a CU on Country A
Items Welfare Changes (Area) Welfare Changes (Area) Welfare Changes (Area) Welfare Changes (Area) Welfare Changes (Area)
Change in consumer surplus a b c d
Change in producer surplus -a -c
Change in government revenue -e
Net welfare change (for Country A) b d -e
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5.2 Effects of Customs Union

• Dynamic effects
• when a CU is formed and trade barriers among
  member nations are eliminated, producers in each
  nation become more efficient to meet the
  competition of other producers within the union.
• A second possible benefit from the formation of a
  CU is that economies of scale are likely to
  result from the enlarged market.
• Another possible benefit is the stimulus to
  investment to take advantage of the enlarged
  market and to meet the increased competition.
• These dynamic gains resulting from the formation
  of a CU are presumed to be much greater than the
  static gains discussed above and to be very
  significant.

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Chapter 5 Regional Trading Arrangements

• 5.1 Types of Regional Trading Arrangements
• 5.2 Effects of Customs Union
• 5.3 Practice of Regional Integration

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5.3 Practice of Regional Integration

• European Union
• In the 1950s, Western Europe began to dismantle
  its trade barriers in response to successful
  tariff negotiations under the auspices of the
  General Agreement on Tariffs and Trade (GATT).
• the European Union (EU), first known as the
  European Community, was created by the Treaty of
  Rome in 1957.
• The EU initially consisted of six nations
  Belgium, France, Italy, Luxembourg, the United
  Kingdom and Ireland, and then Denmark had joined
  the trade bloc.
• Greece became the tenth member in 1981, and the
  entry of Spain and Portugal in 1987 raised the
  membership to 12 nations. In 1995, Austria,
  Finland, and Sweden were admitted into the EU.

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5.3 Practice of Regional Integration

• Members of the EU first dismantled tariffs and
  established a free-trade area by 1968. In 1970,
  the EU became a full-fledged customs union when
  it adopted a common external tariff system for
  its members. On January 1, 1993, the EU removed
  all remaining restrictions on the free flow of
  goods, services, and resources among its members,
  thus becoming a single unified market.
• The formation of the EU significantly expanded
  trade in industrial goods with nonmembers. This
  was due to
• The rapid growth of the EU, which increased its
  demand for imports of industrial products from
  outside the union.
• The reduction to very low levels of the average
  tariff on imports of industrial products as a
  result of the Kennedy and Tokyo Rounds of GATT.

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5.3 Practice of Regional Integration

• At the Lome Convention in 1975, the EU eliminated
  most trade barriers on imports from 46 developing
  nations in Africa, the Caribbean, and the Pacific
  region that were former colonies of EU nations.
• Quotas and tariffs on developing nations exports
  are now scheduled to be gradually reduced as a
  result of the Uruguay Round of GATT completed in
  December 1993.
• In February 2000, Lome IV expired and was
  replaced by a new agreement has the same general
  purpose as the Lome Convention and is to remain
  in force for 20 years, subject to revisions every
  five years.

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5.3 Practice of Regional Integration

• Other highlights in the operation of the EU are
  as follows
• Member nations have adopted a common value-added
  tax system, under which a tax is levied on the
  value added to the product at each stage of its
  production and passed on to consumers.
• The Commission (the executive body of the EU
  headquartered in Brussels) proposes laws,
  monitors compliance with treaties, and
  administers common policies such as antitrust
  policies.
• The Council of Ministers (whose members represent
  their own national governments) makes final
  decisions but only on the recommendation of the
  Commission.
• Plans have also been drawn for harmonization of
  monetary and fiscal policies, and eventual full
  political union.

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5.3 Practice of Regional Integration

• North American Free Trade Agreement
• The United States discussed for a free-trade
  agreement with Canada, which became effective in
  1989. This paved the way for Mexico, Canada, and
  the United States to form the North American Free
  Trade Agreement (NAFTA) that went into effect in
  1994.
• The establishment of NAFTA was expected to
  provide each member nation better access to the
  others markets, technology, labor and expertise.
  
• The United States would benefit from Mexicos
  pool of cheap and increasingly skilled labor,
  while Mexico would benefit from the U.S.
  investment and expertise.
• NAFTA eliminates tariffs among the three member
  nations over a 15-year period and at the same
  time substantially reduces nontariff barriers.

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5.3 Practice of Regional Integration

• In the case of automobiles, Mexican tariffs were
  immediately reduced from 20 to 10 percent and
  were scheduled to decline to zero over the next
  10 year.
• In the textile and apparel industry, trade
  barriers were eliminated on 20 percent of
  U.S.-Mexican trade and barriers on an additional
  60 percent are to be removed over a 6-year
  period.
• With respect to foreign investment and financial
  services in general, all barriers to the movement
  of capital were immediately dropped.
• NAFTA was the first regional agreement among
  nations with such diverse income levels

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5.3 Practice of Regional Integration

• Association of Southeast Asian Nations
• The Association of Southeast Asian Nations
  (ASEAN) now comprises 10 members Brunei,
  Indonesia, Malaysia, Philippines, Singapore,
  Thailand, Vietnam, Laos, Myanmar and Cambodia.
• In 1992, ASEAN signed ASEAN Free Trade Area
  (AFTA) agreement supporting local manufacturing
  in all members.
• The primary goals of AFTA seek to
• Increase ASEAN's competitive edge as a
  production base in the world market through the
  elimination of tariffs and non-tariff barriers
  within ASEAN.
• Attract more foreign direct investment to ASEAN.

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5.3 Practice of Regional Integration

• ASEAN Plus Three is a forum that functions as a
  coordinator of cooperation between ASEAN and the
  three East Asian nations of China, Japan, and
  South Korea.
• The ASEANChina Free Trade Area (ACFTA) is a free
  trade area among the ten members of ASEAN and
  China. The initial framework agreement was signed
  in 2002 with the intent on establishing a free
  trade area among the eleven nations by 2010.
• The free trade area came into effect on 1 January
  2010. ACFTA is the largest free trade area in
  terms of population and the third largest in
  terms of nominal GDP. By July 2010, ASEAN had
  become Chinas third largest trade partner and
  China had been ASEANs largest trade partner.