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© Baldwin&Wyplosz The Economics of European Integration 1 Chapter 5: Essential Economics of Preferential Liberalisation + Chapter 1: Domino Effect.

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Presentation on theme: "© Baldwin&Wyplosz The Economics of European Integration 1 Chapter 5: Essential Economics of Preferential Liberalisation + Chapter 1: Domino Effect."— Presentation transcript:

1 © Baldwin&Wyplosz The Economics of European Integration 1 Chapter 5: Essential Economics of Preferential Liberalisation + Chapter 1: Domino Effect

2 © Baldwin&Wyplosz The Economics of European Integration 2 The PTA Diagram Studying European integrations – e.g. EECs customs union – which were discriminatory, i.e. preferential requires: –at least three countries at least two integrating nations at least one excluded nation. –Ability to track domestic and international consequences of liberalisation Must MD-MS diagram to allow for two sources of imports.

3 © Baldwin&Wyplosz The Economics of European Integration 3 The PTA Diagram: Free trade eqm Domestic price Home imports MD P FT RoW Exports Partner Exports XS P XS R MS M=X P +X R PartnerHomeRoW Border price 2 1 XPXP XRXR

4 © Baldwin&Wyplosz The Economics of European Integration 4 The PTA Diagram: MFN tariff eqm Domestic price Home imports MD P FT RoW Exports Partner Exports XS P XS R MS MS MFN P MM=X P +X R PartnerHomeRoW Border price T P -T 2 1 XRXR X P XPXP XRXR

5 © Baldwin&Wyplosz The Economics of European Integration 5 Discriminatory, unilateral liberalization To build up to analysis of real-world policy changes (e.g. customs union): –Consider Home removes T on imports only from Partner 1 st step is to construct the new MS curve –The liberalisation shifts up MS (as with MFN liberalisation) but not as far since only on half of imports Shifts up MS to half way between MS (free trade) and MS (MFN T), but –More complex, kinked MS curve with PTA

6 © Baldwin&Wyplosz The Economics of European Integration 6 Discriminatory, unilateral liberalization Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Partner Home RoW Border price MS PTA 1 PaPa P T T P P P -T XRXR XRXR XPXP XPXP M p*

7 © Baldwin&Wyplosz The Economics of European Integration 7 domestic price & border price changes domestic price falls to P from P Partner-based firms see border price rise, P-T to P RoW firms see border price fall from P-T to P-T. Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P

8 © Baldwin&Wyplosz The Economics of European Integration 8 Quantity changes: supply switching RoW exports fall Partner exports rise more than RoW exports fall, so domestic imports rise Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P

9 © Baldwin&Wyplosz The Economics of European Integration 9 Impact of customs union formation

10 © Baldwin&Wyplosz The Economics of European Integration 10 Welfare effects Homes net change = A+B-C Partners net change = +D RoWs net change = -E Domestic price Home imports MD RoW Exports Partner Exports XS P XS R M Partner Home RoW Border price P P XRXR XPXP XPXP M C B A X R XRXR P -T P E D

11 © Baldwin&Wyplosz The Economics of European Integration 11 Customs Union vs FTA FTA like CU but no Common External Tariff –Opens door to tariff cheats, goods from RoW destined for Home market enter via Partner if Partner has lower external tariff, called trade deflection –Solution is rules of origin meant to establish where a good was made. Problems: Difficult and expensive to administer, especially as world get more integrated Rules often become vehicle for disguised protection Despite the origin-problem in FTAs, almost all preferential trade arrangements in world are FTAs. –CUs require some political integration Must agree on CET and how to change it, including anti-dumping duties, etc.

12 © Baldwin&Wyplosz The Economics of European Integration 12 WTO Rules A basic principle of the WTO/GATT is non- discrimination in application of tariffs FTAs and CUs violate this principle Article 24 permits FTAs and CUs subject to conditions: –Substantially all trade must be covered Cannot pick and choose products –Intra-bloc tariffs must go to zero within reasonable period –If CU, the CET must not on average be higher than the external tariffs of the CU members were before In EECs CU this meant France and Italy lowered their tariffs, Benelux nations raised theirs (German tariffs were about at the average anyway)

13 , two non-overlapping circles E GR IR L FIN IS EFTA-7 EEC-6 West European Trade Arrangements in 1960s: The EFTA-7 and the EEC-6 form two non-overlapping circles. N S P CH A UK I D F B L NL DK

14 Evolution to Two Concentric Circles Preferential liberalisation in EEC and EFTA proceeded (EECs customs union and EFTAs FTA completed by 1968) –Discriminatory effects emerge, leading to new political pressures for EFTAs to join EEC Trade diversion creates force for inclusion As EEC enlarges, force for inclusion strengthens –When UK decides to apply for EEC (1961), 3 other EFTAns also change their minds –De Gaulles non (twice)

15 Evolution to Two Concentric Circles Preferential liberalisation in EEC and EFTA proceeded (EECs customs union and EFTAs FTA completed by 1968) –Discriminatory effects emerge, leading to new political pressures for EFTAs to join EEC Trade diversion creates force for inclusion As EEC enlarges, force for inclusion strengthens –When UK decides to apply for EEC (1961), 3 other EFTAns also change their minds –De Gaulles non (twice)

16 Evolution to Two Concentric Circles First enlargement, 1973 UK, Denmark, Ireland & Norway admitted (Norwegians say no in referendum) Enlargement of EEC reinforces force for inclusion on remaining EFTAs –Remaining EFTAs sign FTA agreements with EEC-9 –Why werent the FTAs signed before? Domino-like affect of lowering barriers 1 st within EEC6 enlargement EEC-EFTA FTAs

17 Domino effect, part II Deeper integration in EC-12 strengthened the force for inclusion in remaining EFTAns End of Cold War loosened EFTAns resistance to EC membership Result of force for inclusion –EEA – initiative to extend single market to EFTAs –Membership applications by all EFTAns except Iceland Concentric circles, but both deeper

18 Fourth enlargement 1994, Austria, Finland, Norway and Sweden admitted (Norwegians again vote no). Cyprus Malta

19 Communisms creeping failure and spectacular collapse By the 1980s, Western European system clearly superior due to the creeping failure of planned economies Up to 1980s, Soviets thwarted reform efforts (economic & military pressure) Changes in USSR due to inadequacy economic system –timid pro-market reforms (perestroika) –openness (glasnost)

20 Velvet revolutions in CEECs –June 1989 Polish labour movement Solidarity forced free parliamentary elections & communists lost Moscow accepted new Polish government. –Moscows hands-off approach to the Polish election triggered a chain of events. Reformist in Hungarian communist party pressed for democracy & Hungary opened its border with Austria, 1000s East Germans moved to West Germany via Hungary and Austria. Mass protests in East Germany; Wall falls 9 th November 1989 End of 1989: democracy in Poland, Hungary, Czechoslovakia and East Germany (unification in 1990).

21 USSR collapses 1990, Estonia, Latvia and Lithuania – declared their independence from the USSR End of 1991, the Soviet Union itself breaks up Cold War ends without a shot Military division of Europe ended

22 EU reacts The European Union reacted swiftly to this geopolitical earthquake by providing emergency aid and loans to the fledgling democracies. Signing of Europe Agreements with newly free nations in Central and Eastern Europe –These are free trade agreements with promises of deeper integration and some aid


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