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2. WTO and trading blocs We have shown that free trade allows specialisation according to comparative advantage, leading to an increase in output and greater welfare for (potentially) all countries. Can call this static efficiency Free trade also leads to increased competition and so dynamic efficiency Tariffs, quotas and other import restrictions lower welfare These restrictions can make sense in the case of infant industries (but do not always), can be applied against countries which dump, and might be used to protect strategic industries But how do countries reduce restrictions, how is world trade governed By the formation of trading blocs and with the intervention of the World Trading Organisation (WTO)

3. WTO and trading blocs – a very brief history A response to the depression of the 1930s was for countries to protect their own industries against imports Particularly since WW2 countries realised protection had been self- defeating Formation of GATT (General Agreement on Tariffs and Trade) of 23 countries under which countries could not increase tariffs and quotas This did not lead to a reduction, so GATT (which became the WTO in 1995) organised a series of negotiations, called rounds, for countries to agree to reduce tariffs and quotas. Several rounds (see later – we’re on the ninth) At the same time, and partly because of the difficulty in reaching agreement in the rounds, some countries agreed with each other particular trade liberalisation measures, leading to trading blocs and many bilateral agreements

4. Trading blocs A trading bloc is a group of countries that sign an agreement to reduce tariffs, quotas and other barriers between each other The creation of a trading bloc can be seen as the first step in economic integration (like with the EU). The order is: Preferential trading areas Members sign up to a preferential trading agreement under which they agree to reduce barriers on a range of goods Free trade areas Members agree to eliminate all barriers between each other Each country negotiates independently the barriers it has with countries outside the bloc Quick research – which are the main free trade areas

6. Trading blocs Customs Union Free trade area plus a common external tariff This means the trading bloc negotiates all tariffs and quotas with countries outside the bloc rather than individual countries For example, the UK cannot negotiate trade agreements with China. These negotiations are conducted by the EU Common market Customs union plus mobility of factors of production, most importantly labour Common product laws and standards

7. After Common Market This is where the EU has headed: Economic Union Monetary union- a single currency Countries do not have independent monetary policy, eg ECB conducts monetary policy for the EU This requires ever closer fiscal policy, and so leads to Fiscal union – central body organises the bulk of decisions on taxes and spending A bit like the UK, where overall decisions are taken in Westminster ….Political Union

8. Advantages and disadvantages of trading blocs Free trade is the best solution, ie free trade between all countries rather then just some The creation of trading blocs leads to both positives and negatives Trade creation from free trade within the trading bloc, ie a welfare gain for countries within the bloc Trade creation These gains are the normal ones from reducing tariffs, with the increase in trade as a result of production moving to a lower cost supplier. In this this case it means from within the trading bloc Bigger market Economies of scale Jobs

9. Gains from trade creation S domestic D domestic P tariff P world = EU A B D Q S1 with tariff Q D1 with tariff Higher Imports C Eliminate tariffs, consumer surplus increased by A + B + C + D Producer surplus decreased by A, and government tax revenue falls by C Total welfare gain = B + D Imports have increased = trade is created Q S2 FTA Q D2 FTA S EU (France) S EU (France) + tariff

10. Trade diversion – loss in welfare If countries outside the newly created trading bloc (eg FTA) were the lowest cost producers (had a comparative advantage) then trade may be diverted This is because a country within the FTA may now be a cheaper supplier with no tariffs than the previous world supplier with tariffs Trade is therefore created within the FTA, but is also diverted from the lowest cost supplier For example, if a tariff exists on all imports of lamb, and New Zealand is the lowest cost producer, then UK will import from New Zealand. But once the free trade area is created there is no tariff on eg French lamb so it may be cheaper for consumers, even though France may be higher cost producers – loss to world efficiency/welfare as UK chooses French lamb

11. Trade creation and diversion (UK) S domestic D domestic P w+tariff P FTA A B D Q S1 with tariff Q D1 with tariff C Q S2 FTA Q D2 FTA S world (NZ) S world + tariff (NZ) S FTA (France) E P W Starting point is where all countries have tariffs on all imports. Analyse impact on the UK Cheapest world supplier was not EU but say New Zealand, represented by S world + tariff so price is P w + tariff Creation of FTA, we now buy at P FTA from eg France, so consumer surplus increases by A+B+C+D Producer surplus falls by A, and we lose C + E in revenue from the tariff So welfare gain is B + D - E, so if E is greater than B + D there is an overall loss in welfare The loss in revenue will be greater the greater the original difference in prices between France and NZ

12. World Trade OrganisationWorld Trade Organisation – some background See earlier Set up in 1995 by the signatories to the Uruguay Round (1986-1994) as the successor to the General Agreement on Tariffs and Trade (GATT) Based on comparative advantage and the mutual benefit of free trade 161 member countries now, including China and Russia By the end of the Tokyo Round (1979) the average tariff on goods had fallen to 4.7%. Under 4% now Uruguay Round (the 8 th round) focussed on agriculture and services eliminating non-tariff barriers for agricultural products, such as quotas in favour of tariffs which are means to be more transparent Ninth round of trade negotiations (and second under WTO) started in Doha, Qatar in 2001 and is ongoing (zzzzzz). Focus on developing countries and on agriculture, and on tightening intellectual property rights Problem for WTO is that the agreement at the end of a round needs to be signed by all members

13. Key roles of the WTO WTO promotes free trade, and describes its main functions as Administering WTO trade agreements Forum for trade negotiations Key basis is the various rounds of negotiations Handling trade disputes Countries can file a complaint to the WTO, which will help settle the dispute through talks, or with a ruling Monitoring national trade policies Technical assistance and training for developing countries

14. With reference to Extract 1, explain the role of the World Trade Organisation (WTO) (5)

15. WTO important principles of trading Non-discrimination Most favoured nation. Under the WTO agreements, countries cannot normally discriminate between their trading partners. Grant someone a special favour (such as a lower customs duty rate for one of their products) and you have to do the same for all other WTO members. However, there is a get-out with bilateral free trade agreements and some other exceptions National treatment Imported and locally-produced goods should be treated equally — at least after the foreign goods have entered the market. The same should apply to foreign and domestic services, and to foreign and local trademarks, copyrights and patents

16. WTO important principles of trading Binding and transparency Binding means when countries open markets they agree not to raise tariffs and set a maximum tariff on a good or service All agricultural products are now bound Tariffs are transparent Provides market security and predictability for traders/investors/firms Reciprocity Watch video

17. Key Areas of Regulation Agriculture, Textiles & Services Agriculture still highly protected No quotas now, and tariffs are all bound, but there is a lot of other support for farming across developed and developing nations. CAP is a fine example Textiles used to be a focus area, with competition from poorer countries leading to job losses in the developed world, but trade restrictions virtually eliminated and now treated as any other product US particularly worried about abuse of patents etc in developing countries - undercutting and stealing intellectual property – WTO attempting to address this in the current round

18. Potential conflicts between WTO and trading blocs If the WTO cannot produce multilateral trade agreements because all countries need to agree any trade deal in a round, then countries will and have resorted to concluding their own bilateral trade agreements, typically Regional Trade Agreements (RTAs) Free world trade from multilateral trade agreements is superior in terms of welfare gains than RTAs Multilateral is all trade creation, whilst RTA is trade creation and trade diversion Barriers continue to exist between members and non-members of a bloc Weaker countries may be excluded from larger markets because of barriers Trading bloc rules may prevent individual members from pursuing potential benefits of trade with non-members If trade becomes concentrated in these zones, WTO may become obsolete or powerless

19. WTO as a positive force Increased living standards due to increased output from specialisation, enabled by freer trade (consider North Korea not participating in world trade) Trade leads to greater equality between developing and developed countries – increased wages, etc – World Bank says trade benefits poor as much as rich Trade increases competition, leading to dynamic efficiency as firms compete to improve products and to lower costs Trade removes protection of large domestic companies which have to face competition from lower cost alternatives

20. Criticism of WTO Rich countries exploit developing countries by paying workers low wages and employing in poor conditions But this is not under the WTO control. The WTO encourages free trade Barriers are lowered by developing countries whilst developed world still maintains barriers in agriculture Free trade has meant the price of the basic products produced in developing countries falls, whilst price of advanced products from developed countries rise Free trade means local cultures are replaced with Coca Cola, Starbucks and McDonalds WTO rules do not allow countries to set environmental restrictions on imported goods, so the environment is being plundered Perhaps these are criticisms of free trade rather than the WTO, where we abide by the market mechanism. Perhaps also of technology/globalisation as well

21. Exam question Explain what a trading bloc is (with example of FTA, Customs Union etc) Impacts include Trade creation – based on comparative advantage – which leads to Faster economic growth - explain Lower inflation - explain More competition and so innovation/dynamic efficiency etc Benefits of labour mobility if a common market But trade diversion Could lower welfare even in a bloc Hurts countries outside the bloc Does still depend on whether the WTO can bring down tariffs generally and between blocs Is it richer countries within blocs? What about inequality?