Carbaugh10e Ch08

Copyright ©2005, Thomson/South-Western

International Economics

Regional Trading Arrangements

Carbaugh, Chap. 8 2

Regional trade agreements

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

Carbaugh, Chap. 8 3


Reasons for regional trade agreements Economic growth

Larger market creates economies of scale, encourages specialization, attracts foreign investment

Non-economic objectives Helps manage immigration flows, or enhances regional

security, for example

Solidifies domestic economic reforms East European nations have looked to association with

the EU as a way of locking in economic reforms

Carbaugh, Chap. 8 4


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

Carbaugh, Chap. 8 5

Static effects of a customs union


Carbaugh, Chap. 8 6

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

Carbaugh, Chap. 8 7


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) EMU came into full effect in 2002 with the

introduction of a common currency, the euro

Carbaugh, Chap. 8 8


EU Economic & Monetary Union Member nations which met economic criteria by

1999 replaced their national currencies with the euro in 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

Carbaugh, Chap. 8 9


European Union enlargement The EU admitted 10 nations, mostly transition

economies in eastern Europe, to EU membership in 2004

Candidate members had to demonstrate their fitness by achieving: Stability of institutions, and guaranteed democracy,

rule of law, human rights and protection of minorities A functioning market economy which is ready to

compete in the EU market Adherence to the EU’s aims of political, economic and

monetary union

Carbaugh, Chap. 8 10


Other key EU policies Common agricultural policy (CAP)

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



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’s impact so far Trilateral trade increased significantly

Most of the increase in US trade with Mexico and Canada resulted from trade creation, but Canada-Mexico trade increases came mostly from trade diversion

Some US jobs were lost to Mexico, but the numbers were small compared to job creation that came with US growth Larger effects were felt in sectors more

exposed to intra-NAFTA trade



NAFTA’s impact so far (cont’d)

Changes in investment flows were small (in relation to total US foreign investment)

Closer political ties were built among the three nations (especially between the US and Mexico), and they refrained from building new trade barriers even during recession



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) with only limited trade with the West



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

There is an ongoing debate over the best pace for economic reform (including trade and financial liberalization) - “shock therapy” vs. gradualism

Significant structural reform issues remain even in those east European nations which recently joined the EU



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

Carbaugh10e Ch08

Business

Transcript of Carbaugh10e Ch08