1. Economics of European integration Lecture 5: EU trade policy
Thomas Blondiau (Center for Economic Studies, KU Leuven)
Louvain Institute for Ireland in Europe, January 2012

2. EU Trade Policy: outline
International framework
Benefits of free trade
EU as a trading partner
EU external trade policy
Preferential trade liberalization (revisited)

3. EU Trade Policy
Common Commercial Policy - Article 113 of the Treaty of Rome:
Community tariff regime
Common trade agreement with third countries (trade in goods, service and intellectual property)

4. International framework
GATT (1948)
WTO (1995) functions:
Regulations for conduct of international trade
Settlements of disputes
Negotiations to liberalize world trade
Latest negotiations rounds:
: Uruguay round
2001-?: Doha round

5. International framework: WTO principles
Non-discrimination
Reciprocity
Binding and enforceable commitments
Transparency
Safety valves (for specific circumstances)

6. WTO organizational structure
Council for trade in goods (GATT)
Council for trade related aspects of intellectual property rights (TRIPS)
Council for trade in services (GATS)
Trade negotiations committee (TNC): Uruguay round, Doha round, etc.
Decision-making: practice of consensus
Dispute settlement body
Including Appellate Body, arbitrators, etc.

7. International framework: Road to WTO
Progress in international trade talks was made during a successive set of ‘trade rounds’
Initially, trade rounds were aimed at reducing trade barriers through lower tariffs
Uruguay round ( ) was more ambitious:
Significantly reduce agricultural subsidies (led by ‘Cairns group’: Australia, Brazil, Canada, Indonesia, New-Zealand)
Liberalize framework for foreign investment (TRIM)
Liberalize trade in services (GATS)
Obtain wider protection and recognition of patents/copyrights (TRIPS)
Obtain further reduction in tariffs (GATT)

8. International framework: Road to WTO
Doha round ( …): Goal is to improve market access
Talks have stalled since 2008
Issues:
Continued protectionism and export subsidies for agriculture in developed world (US, EU, Japan)
Singapore issues difficult to digest (US, G20 developing countries)
Trade facilitation (more efficiency in customs clearing)
Public procurement (current GPA scheme is voluntary under WTO)
Trade & investment
Trade & competition (more uniformity in ‘market rules’)
Additional issues:
Related to TRIPS and access to patented medicines in developing countries (innovation incentives vs. public health)
Special and differential treatment
Implementation issues (related to Singapore issues)

9. International framework: Doha Round
Copenhagen consensus evaluated the Doha round as the second best investment for global welfare, after provision of vitamin supplements to malnourished children
Evaluation based on economic cost-benefit analysis

10. Benefits of free trade: theory
Technological differences; comparative advantage (Ricardo)
Difference in endowments (Heckscher-Ohlin)
Economies of scale
Economies of scale and product varieties (Krugman, New Trade Theory; intra-industry trade)

11. Comparative advantage: example
In two hours, France could produce 6 kg of bread and 4 liters of wine
Assume trade becomes possible at 6 kg of bread for 6 liters of wine
France produces 12 kg of bread, and trades 6 kg of bread for 6 liters of wine. They end up with 6 kg of bread and 6 liters of wine
Similar reasoning for Italy; both countries better off with trade
Lower wages in Italy
Relative world price is between relative autarky prices
Technology
France
Italy
Bread (kg produced in a man-hour) 6 1
Wine (liters produced in a man-hour) 4 2

12. Heckscher-Ohlin
A country will export the commodity whose production is intensive of the factor in which the country is relatively abundant
Assume same technology in both countries

13. Heckscher-Ohlin
Assume the production of bread is capital intensive and the production of wine is labor intensive
Assume France has a relative abundance of capital and Italy has a relative abundance of labor
This shows up in the production possibility frontiers

14. Heckscher-Ohlin graphically

15. Heckscher-Ohlin graphically
Indifference curves shows combinations of wine and bread consumption that give the same level of satisfaction
Assume same preferences in both countries (so same indifference curves)
Higher indifference curve means higher level of satisfaction (higher utility level)

16. Heckscher-Ohlin graphically

17. Heckscher-Ohlin graphically
Relative price is
the price of wine / the price of bread
Slope of the blue lines in the next figure

18. Heckscher-Ohlin graphically

19. Heckscher-Ohlin graphically
For trade to occur, relative world price must be between relative autarky prices:
Rel. p(France) > Rel. world price > Rel. p(Italy)
World price is slope of green line in next figure

20. Heckscher-Ohlin graphically

21. Heckscher-Ohlin graphically
Because of trade, both countries end up on a higher indifference curve and are therefore better off
Both countries specialize
Points outside of production possibility frontier become possible

22. Benefits of protection
Protect specific groups in society
Diversify production (uncertainty)
Strategic independence (e.g. food, energy)
Protect employment
Protect infant industry
Strategic argument (terms-of-trade)
Avoid (social) dumping

23. EXPORTS
IMPORTS

24. Pattern of Trade EU25 (2003)
EXPORTS
IMPORTS

25. Differences among Member States, imports 2003

26. Composition exports and imports

27. What with whom?

28. Institutions Trade policy is an exclusive competency of EU.
Customs Union requires COORDINATION.
Trade in goods:
Commission has responsibility for negotiating, Council of Ministers sets “Directives for Negotiation.”
Karel De Gucht (Trade Commissioner).
Council accepts/rejects final deal by Qualified Majority Vote.
Commission in charge of surveillance and enforcement of 3rd nation commitments to EU.
Trade disputes with US, China, etc.
European Parliament has no explicit powers. It’s only informed.

29. QUALIFIED MAJORITY VOTE
Each member state has a fixed number of votes roughly determined by its population, but progressively weighted in favour of smaller countries.
To pass a vote by QMV, all three of the following conditions must apply:
the proposal must be supported by 255 votes from a total of about 74% of the votes;
the proposal must be backed by a majority of member states;
the countries supporting the proposal must represent at least 62% of the total EU population.

30. Treaty of Rome only gave Commission power over trade in goods.
Treaty of Nice (& Amsterdam) extended Commission’s authority to some aspects of services trade and intellectual property rights.
It made QMV the rule in Council on such matters.

31. Contingent Protection (anti-dumping&anti-subsidy)
WTO allows members to raise tariffs to (does not violate WTO):
1. Counter ‘unfair’ trade practices, e.g.
Antidumping (often)
Anti-subsidy
2. Provide temporary protection “safeguards.”
(Iron, steel, consumer electronics, chemicals)
The various WTO articles on these require a procedure; in EU the Commission is in charge of these procedures, but the final decision is subject to QMV approval of the Council.
Tariffs and preferably price undertaking (avoid complaints on EU’s protection).
Trade-off between consumer welfare and producer welfare.

32. Distributional consequences: Home

33. EU External Trade Policy
Complex
Has preferential trade agreements with all but nine of the WTO’s 148 members.
Each free trade agreement can contain hundreds of pages of exceptions and technical rules.
Has general agreement on trade, but also has separate sectoral agreement
See for updating details.

34. EU External Trade Policy
EU has special deals with 139 nations; often more than one per partner.

35. EU External Trade Policy
European-Mediterranean area:
1. West, Central and Eastern Europe = Single market in industrial goods; EU + EFTA (but not agricultural food)
2. Euro-Med10 Association Agreements:
Morocco, Algeria, Tunisia, Egypt, Israel, the Palestinian Authority, Lebanon, Jordon, Syria and Turkey.
Bilateral duty-free trade in industrial goods
Asymmetric:
Asymmetric dependence (e.g. 70% of Morocco’s exports to EU, but <1% of EU to Morocco)
EU cuts its tariffs faster, Med 10 promise to eliminate their tariffs on EU industrial goods by 2010

36. EU External Trade Policy
European-Mediterranean area:
Turkey uses EU’s common external tariff for industrial imports
EFTA nations sign similar agreements with Med-10

37. EU External Trade Policy
Former Soviet republics & Western Balkans
1. Partnership and Cooperation Agreements (PCAs).
Generalised System of Preference - GSP plus.
Russia, Ukraine, Georgia, Belarus, Armenia, Azerbaijan, Kazakhstan, Kyrgyzstan, Moldova and Uzbekistan.
2. Stabilisation and Association Agreements (SAAs).
Former Yugoslavian states.
Croatia has started membership; others likely to follow.
These are all GSP (Generalized System of Preference), a WTO rule allows rich nations to charge lower tariffs on imports from poor nations. (Asymmetric)

38. Preferential arrangements with former colonies
Colonial preferences conflicted with Common External Tariff.
EU made exception for these nations to avoid imposing new tariffs; signed “unilateral PTAs”
Yaoundé Convention and Arusha Agreement
When UK joined 1974 extended to many Commonwealth nations.
“ACP nations” (Africa, Caribbean & Pacific); the new agreement = Lomé Convention.
Duty-free but subject to quota for sensitive items (sugar, banana, etc.).
These didn’t help the ACP nations to industrialize.
When Lomé Convention renewed in 2000, the EU and the ACP nations agreed to modernise the deal.
Cotonou Agreement; eventually reciprocal free trade.

39. Regional groups, ACP nations
West Africa
Central Africa
East South Africa
Southern Africa
Caribbean
Pacific
Benin
Burkina Faso
Caper Verde Cote d’Ivoire
Gambia Ghana Guinea
Guinea Biss.
Liberia
Mali
Mauritania
Niger
Nigeria
Senegal
Sierra Leona
Togo
Cameroon
Chad
Congo
Equat. Guinea
Gabon
Sao Tome e Principe
Burundi
Comoros Congo (Rep Dem)
Djibouti
Eritrea
Ethiopia
Kenya
Malawi
Mauritius
Madagascar
Rwanda
Seychelles
Sudan
Uganda
Zambia
Zimbabwe
Angola
Botswana
Lesotho
Mozambique
Namibia
Swaziland
Tanzania
Antigua
Bahamas
Barbados
Belize
Dominica
Domin Rep
Grenada
Guyana
Haiti
Jamaica
Sta Lucia
St Vincent
St Ch and Nevis
Surinam
Trinidad and Tobago
Cook Is
Fed Micron
Fiji
Kiribati
Marshall Isl
Nauru
Niue
Palau
Papua NG
Samoa
Solomon Is
Tonga
Tuvalu
Vanuatu

40. Preferences for poor nations: GSP
1971 GATT provision.
EU grants GSP-generalised system of tariff preferences- to almost all poor nations.
1. General GSP (to all developing countries).
2. “Super-GSP” more generous on market access :‘Everything but Arms’ for least developed nations.
On paper, EBA grants zero-tariff access to all goods, except arms and munitions.
Goods in which these nations are most competitive are in fact excluded from the deal.
Tariffs on bananas, rice and sugar – products where these poor nations could easily expand their EU sales – are to come down only in the future.
Moreover, even though all tariffs on these items should be gone by 2009, the exports quantities are limited by bilateral quotas.

41. Non-regional free trade agreements
Mexico, Chile, and South Africa.
Mercosur (Argentina, Brazil, Paraguay & Uruguay)
Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates)
India and ASEAN (Indonesia, Malaysia, Philippines, Thailand, Singapore, Vietnam, Cambodia, Burma & Laos).

42. Non-preferential trade
Only affects 9 nations
But represents 1/3 of EU imports (US, Japan, etc.)
Thus CET still matters
Also important to evaluate how much of an edge a country obtains by awarding duty-free GSP or FTA treatment
Average Common Ext. Tariff 6.5%
Average industrial goods 4.1%
Average on agricultural imports 16.5%
with huge variation

43. EU Common external tariff
Agricultural products have much higher tariff than others!

44. EU common external tariff
May explain why EU is ready to provide duty-free treatment for many industrial goods to certain countries
Very little impact on EU market
In areas where zero tariffs may matter, EU is much more reluctant for signing FTA
Industrial goods coming from USA, Japan
Agricultural goods

45. Current facts…
“Traditionally, there has been a divide between northern liberal countries, such as Britain and Sweden, and protectionist founder members, such as France and Italy”. The Economist Dec 2006
USA and EU blaming each other for failure in trade negotiations.
“What they're saying is that for every dollar that they strip out of their trade-distorting farm subsidies they want to be given a dollar's worth of market access in developing country markets," Commissioner Mandelson said. "That is not acceptable to developing countries and it's a principle that I on Europe's behalf certainly couldn't sign up to either." US trade representative Susan Schwab insisted the US remained "fully committed to multilateral trading system”.

46. Some remarks on poverty
World Trade policies are fundamental to diminish poverty and inequality.
Poverty is the main cause of violence
Disparities in trade policies increase the gap among countries.
Globalization and technology progress make more difficult the migration control. Restrictive policies are not the solution… eliminating miserable conditions from certain areas in the world is.
But how to really help poor countries to develop?

47. Aid policy Instruments: Trade preferences Development aid
Humanitarian aid

48. Aid policy

49. EU-US trade and investment
Disputes over issues as varied as bananas, beef, trade legislation and subsidies to aircrafts.
EU and US are the most important world traders. EU share in goods trade is 22.8% and 27.3% in services. US shares are 19.1% and 20.2% respectively.
Each other’s largest trading partner: US accounts for 17.7% (24.2%) of EU15 total imports (exports) of goods. While EU accounts for 24.2% of total US trade of goods.

50. A lot of press attention
Trade disputes EU - USA
A lot of press attention
But most disputes only touched a minimal % of trade
Agriculture: USA objected to EU variable levies, domestic support and export subsidies

51. Preferential trade liberalization
Early literature (Viner, 1953) focused on static effects of integration on welfare:
Trade creation
Trade diversion

52. Trade creation
Benefit of liberalization: domestic production is replaced by cheaper imports from a partner country

53. Trade diversion
Negative effect of preferential liberalization: more expensive imports from a partner country replace low-cost imports from suppliers in third country

54. Implications for the Global Trading System
Questions:
Can PTA expansion lead to global free trade?
Do PTAs make multilateral liberalization less likely?
Do PTAs lead to a rise in trade barriers against non-members?
What kind of trade regimes are we likely to have with criss-crossing PTAs (Spaghetti-Bowl Phenomenon)?
WTO-illegal policies in PTAs?

55. Can PTA Expansion Lead to Global Free Trade?
Baldwin’s “Domino Theory of Regionalism”
Economic incentives for outside countries to seek entry into an existing PTA
Unless there are sufficiently strong non-economic factors that counter these incentives, as the PTA expands, eventually all countries want to enter the PTA
Limitations of Baldwin’s analysis
Trade barriers are seen as transport costs, thus the tariff revenue aspect is not taken into account
Assumption that “insiders” have no incentive to block the entry

56. Do PTAs Make Multilateral Liberalization Less Likely?
Building or stumbling blocks? (Bhagwati)
Building blocks?
Multilateral negotiations will move more rapidly if the number of negotiators is reduced to a handful of blocs
However, if blocs take the form of FTAs, there is no effect on the number of participants
One voice in EU or too occupied with internal problems?
PTAs may serve as a bargaining threat

57. Do PTAs Make Multilateral Liberalization Less Likely? - ctd.
Stumbling blocks?
PTAs are mostly between developed and developing countries
Such PTAs are associated in public mind (in developed countries) with large inflows of L-intensive goods and reduced wages for the unskilled
This can energize and unify protectionist lobbies, generating obstacles against multilateral liberalization
Multilateral negotiations, by contrast, involve both developed and developing countries and draw less attention of protectionist lobbies

58. Do PTAs Lead to a Rise in Trade Barriers against Non-Members?
1. Tariff-revenue objective:
If a country is dependent on tariffs for revenue purposes (e.g. Africa), it may be forced to raise the external tariff to maintain the fiscal balance
The more the country imports from the FTA partner, the larger the loss of revenue, the greater possibility of an increase in the external tariff and greater the trade diversion

59. Do PTAs Lead to a Rise in Trade Barriers against Non-Members? - ctd.
2. Political economy:
when producers play the central role in determining trade policies, liberalization through FTA is likely to be replaced by increased protection against outside countries
Considerable empirical evidence of increases in outside tariffs following the implementation of PTAs

60. The Spaghetti-Bowl Phenomenon
To avoid trade deflection, FTA agreements usually include rules of origin
Criss-crossing FTAs leads to a “Spaghetti Bowl” whereby tariffs vary according to origin of the product
See Fig. 3:
Each FTA has its own rules of origin which vary across products and transition phase
For a given product, there are several different tariff rates depending on what origin is assigned to it

61. Spaghetti Bowl

62. WTO-illegal policies in PTAs
PTAs can undermine the global trading system by introducing arrangements measures which are WTO inconsistent
Example:
Anti-Dumping provisions in the EU Czech association agreement
trade-balancing requirement within Mercosur (an Argentine company operating in Brazil must export as much Brazilian goods to Argentina as it imports)
These practices are not widespread