Copyright ©2004, South-Western College Publishing International Economics By Robert J. Carbaugh 9th Edition Chapter 8: Regional Trading Arrangements

Carbaugh, Chap. 9 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. 9 3 Regional trade agreements 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. 9 4 Static effects of a customs union Regional trade agreements

Carbaugh, Chap. 9 5 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. 9 6 Regional trade agreements: case studies 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 ( ) 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. 9 7 Regional trade agreements: case studies 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. 9 8 Regional trade agreements: case studies 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

Carbaugh, Chap. 9 9 CAP: variable levies and export subsidies Regional trade agreements: case studies

Carbaugh, Chap Opening up government procurement Regional trade agreements: case studies

Carbaugh, Chap Regional trade agreements: case studies European Union enlargement  The EU is negotiating with 12 applicant nations, mostly transition economies in eastern Europe, for EU membership by 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 Regional trade agreements: case studies 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

Carbaugh, Chap Regional trade agreements: case studies 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

Carbaugh, Chap Regional trade agreements: case studies 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

Carbaugh, Chap Regional trade agreements: case studies 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

Carbaugh, Chap Regional trade agreements: case studies 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

Carbaugh, Chap Regional trade agreements: case studies NAFTA’s impact so far  Trilateral trade increased significantly  Some US jobs were lost to Mexico, but the numbers were small compared to job creation that came with US growth  Changes in investment flows were small (in relation to total US foreign investment)  Closer political ties were built among the three nations, and they refrained from building new trade barriers even during recession

Carbaugh, Chap Regional trade agreements: case studies 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

Carbaugh, Chap Regional trade agreements: case studies 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

Carbaugh, Chap Regional trade agreements: case studies 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