1. Regional Trade Agreements
Chapter 8
Copyright © 2009 South-Western, a division of Cengage Learning. All rights reserved.

2. Regional Integration vs Multilateralism
regional trade blocs could be a complement to multilateralism by setting a precedent which other nations will follow
can lead to deeper integration
however regional agreements are also discriminatory in that some nations are treated differently than others
decreases incentives for nations to pursue multilateral agreements
trade bloc members may not gain additional economies of scale through multilateralism

3. Types of Regional Agreements
free-trade area – agreement to remove trade barriers among members
example: NAFTA
customs union – agreement to remove trade barriers among members and impose uniform trade restrictions against non-members
example: Benelux
common market – agreement that permits (1) free trade among members; (2) common external trade restrictions; and (3) free movement of factors of production
example: EU

4. Types of Regional Agreements (cont.)
economic union – common market agreement with :
common national, taxation, fiscal, and social policies among members
transfers of sovereignty to a supranational authority
example: Belgium and Luxembourg 1920s
monetary union – economic union with additional characteristic of common monetary policy and common currency
example: United States

5. Static Effects of Trade Arrangements
With Tariff:
(before customs union)
red triangle = consumer surplus
green triangle = producer surplus
black rectangle = tariff revenue
a + b = deadweight loss

6. Static Effects of Trade Arrangements
With Customs Union:
agreement with Germany will lower the price to SG
trade-creation effect:
welfare losses now part of consumer surplus
a = production effect
b = consumption effect
trade-diversion effect:
area c
lost benefits from lower cost suppliers

7. Dynamic Effects of Trade Arrangements
economies of scale – access to a larger market allows producers to become more efficient through greater specialization, better equipment, and usage of by-products
greater competition – increased number of producers makes collusion less likely and forces firms to become more efficient
stimulus of investment – because of increased rate of return and ability to spread R&D costs trade makes greater levels of investment more likely

8. European Union
Treaty of Rome – 1957 – established European Community – precursor to EU
1957: Belgium, France, Italy, Luxembourg, Netherlands & West Germany
1973: United Kingdom, Ireland & Denmark
1981: Greece
1987: Spain & Portugal
1995: Austria, Finland & Sweden
2004: Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia & Slovenia
2007: Bulgaria & Romania

9. European Union:
EU members removed tariffs in 1968 leading to fivefold increase in trade
EU adopted common external tariffs in making it a customs union
trade creation: machinery, transportation equipment, chemicals & raw materials
trade diversion: agricultural commodities and raw materials
trade creation exceeded trade diversion
EU saw increases in economies of scale, competition & investment
1985 EU eliminated nontariff barriers resulting in creation of European common market

10. European Union & Maastricht
1991 Maastricht Treaty established monetary union and euro as common currency by 2002
convergence criteria:
inflation ≤ 1.5% above average inflation of three countries with lowest inflation
long term interest rates ≤ 2.0% above average of same three countries
exchange rate within target bands of monetary union for 2 years
budget deficit ≤ 3.0% of GDP
government debt ≤ 60.0% of GDP

11. EU Agricultural Policy - Variable Levies
no restriction on agriculture traded internally
EU policy based in part on variable levies
adjusted to maintain desired price levels
more restrictive than an import quota in that foreign producers cannot cut prices and absorb tariff cost to maintain export sales

12. EU Agricultural Policy - Subsidies
export subsidies also used to maintain higher prices of EU - common policy
EU producers sell for low price but receive higher price
EU purchases any surplus
surplus then sold on world market for lower price

13. Government Procurement Policies
government purchases previously limited primarily to domestic producers
1992 EU required bidding process from EU firms
benefits:
governments purchase from lower cost producers
increased competition
remaining firms produce with economies of scale

14. European Monetary Union
A common currency also implied the need for a single European Central Bank responsible for all monetary and exchange rate policies of the EMU.
advantages:
eliminated exchange rate risk
reduced currency conversion costs
insulation from monetary disturbance & speculation
disadvantages:
loss of individual monetary authority
transition to common currency could lead to speculative attacks

15. Optimum Currency Areas
definition – region in which it is economically preferable to have a single official currency
success of common currency area:
similar business cycles
similar economic structures
single monetary policy affecting all members in same manner
absence of legal or cultural barriers that would limit labor mobility
wage flexibility
stabilizing transfer system
EU concerns based on rigid wages and limited labor mobility tied to cultural factors

16. North American Free Trade Agreement
free trade area for U.S., Canada & Mexico but not a customs union
issues:
U.S. & Canada represented developed economies while Mexico was a developing economy
Mexico’s authoritarian political system
substantial difference in standard of living between Mexico and Canada & U.S.
decision: integrate Mexico to stimulate development or allow problems in that nation to continue to spill over borders

17. Benefits to Mexico
substantial benefits for Mexico because it integrated with much larger economies
increase in production of goods in which it has comparative advantage
gains at the expense of other low-wage nations
increases in agricultural goods and labor intensive goods
agriculture represents small portion of GDP but supports roughly 25% of the population

18. Benefits & Concerns for Canada
maintain status in international trade
free trade preference in U.S. market
equal access to Mexico’s market
inclusion in future free trade area with Central & South America
economies of scale associated with increased output levels
Possible Cost: closer integration with U.S. as potential threat to Canada’s social welfare system

19. Economies of Scale from NAFTA
access to additional markets increases demand
Canadian producers can sell more autos
increased consumer surplus due to lower price
no worse for producers since costs have dropped

20. Benefits & Costs to the U.S.
expanded trade
increased competition and lower prices
enhanced economies of scale
decrease in illegal immigration
improved political stability in Mexico
Costs:
U.S. industries competing with imports
impact on unskilled workers domestically
potential for environmental consequences
limited benefits due to relative size of these economies

21. Labor Cost Compared to Productivity
Would NAFTA cause many U.S. companies to relocate to Mexico due to lower wages?
Productivity is a major factor in determining cost per unit of output.
Based on higher productivity, U.S. workers can still receive higher wages.

22. NAFTA as Optimum Currency Area?
measures of economic integration: Canada & Mexico are the U.S. largest trading partners
Canada & U.S.: advanced industrial economies with similar per capita incomes, inflation rates and interest rates
Mexico: lower average per capita income, higher inflation rate, higher interest rates, and volatile exchange rate
Mexico adopting U.S. dollar:
pro: price & interest rate stability
con: loss of independent monetary policy

23. Free Trade Area of the Americas
1994 proposal calling for agreement among 34 nations in North and South America
potential to become largest trading bloc in the world with 850 million consumers and $14 trillion in combined income
progressive Latin American trade policies:
reduced governmental management
conventional macroeconomic policies to promote growth and stability
failure of import substitution model
challenges:
other free trade agreements
subsidies on agricultural goods

24. Transition Economies
nations making the transition from centrally planned to market economy
countries opting for greater political & economic freedom have seen improved performance and income