1. 1 3001IBA Lecture Notes 5/Week 5 Topic 3.2 Economic Integration/Regionalism/ The WTO Text: Carbaugh R J (2013), International Economics, 14th Edition Regional Trading Arrangements 1

2. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 2 Learning Objectives 1.Discuss Economic Integration – the types of regional agreements 2.Discuss and analyse the Static economic effects of economic integration: oTrade creation and welfare oTrade diversion and welfare 3.Discuss the Dynamic economic effects of regional integration 4.Give a Brief overall assessment of the effects of economic integration 5.Provide a Case Study of the European Union 6.Briefly discuss the WTO

3. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 3 Types of Regional Trading Arrangements Economic integration Process of eliminating restrictions on international trade, payments, and factor mobility Results in the uniting of two or more national economies in a regional trading arrangement Motivations for regional trading arrangements Prospect of enhanced economic growth Economies of large-scale production & attract foreign investment Foster a variety of noneconomic objectives Managing immigration flows Promoting regional security Enhance & solidify domestic economic reforms © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 3

4. 4 Types of Regional Trading Arrangements Free-trade area Association of trading nations Members agree to remove all tariff and nontariff barriers among themselves Each member maintains its own set of trade restrictions against outsiders North American Free Trade Agreement (NAFTA) Canada, Mexico, and the United States © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 4

5. 5 Types of Regional Trading Arrangements Free-trade area (continued) Association of trading nations Agreement among members to remove trade barriers among members while retaining independence in forming trade policies with nonmembers. Examples: multilateral - N(orth) A(merican) F(ree) T(rade) A(greement) Canada, Mexico, and the United States; bilateral – recent Australia-US FTA. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 5

6. 6 Types of Regional Trading Arrangements Customs union Agreement among two or more trading partners To remove all tariff and nontariff trade barriers between themselves Each member nation imposes identical trade restrictions against nonparticipants Example: Benelux Belgium, the Netherlands, and Luxembourg – formed 1947; absorbed into ECM 1958 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 6

7. 7 Types of Regional Trading Arrangements Common market Group of trading nations Customs union plus agreement that permits (1) free trade among members; (2) common external trade restrictions; and (3) free movement of factors of production Example: E(uropean) C(ommon) M(arket) before it evolved to the next type of arrangement © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 7

8. 8 Types of Regional Trading Arrangements Economic union Common market agreement plus: unification of main economic institutions and coordination of economic policy between members. Early example: Belgium and Luxembourg 1920s National, social, taxation, and fiscal policies are harmonized and administered by a supranational institution Requires an agreement to transfer economic sovereignty to a supranational authority © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 8

9. 9 Types of Regional Trading Arrangements Monetary union Ultimate degree of economic union So is economic union plus: Unification of national monetary policies Acceptance of a common currency administered by a supranational monetary authority Examples: United States, E(uropean) U(nion) So all of above Types include trade liberalization for 2 or more countries. Question: What is APEC, & which above type does it represent? (www.apec.org) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 9

10. 10 Effects of a Regional Trading Arrangement Static effects of economic integration On productive efficiency And consumer welfare Trade creation takes place when there is a shift in product origin from a higher-resource-cost domestic producer to a lower- resource-cost member country producer. The shift represents movement towards the free trade allocation. Trade diversion takes place when there is a shift in product origin from a lower-resource-cost nonmember producer to a higher- resource-cost member country producer. The shift represents movement away from the free trade allocation. Dynamic effects of economic integration Relate to long-term rates of growth © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 10

11. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 11 Effects of a Regional Trading Arrangement Static effects Trade-creation effect Welfare gain Some domestic production of one customs-union member Replaced by another member’s lower-cost imports Consumption effect Production effect Trade-diversion effect Welfare loss Imports from a low-cost supplier outside the union Are replaced by purchases from a higher-cost supplier within the union © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 11

12. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 12 Effects of a Regional Trading Arrangement Trade creation and welfare Consider a Customs Union (as defined previously), CU Assume: (1)Three countries L(uxembourg), US & G(ermany). (2). No transportation costs (3).Single good, produced in Countries US, G, and L. SU.S. is the world price (faced by L, a price taker, (small country). Under current trade arrangements (without a CU), L imposes tariffs on imported grain – US is L’s lower cost supplier at SU.S. + tariff, (since G’s supply price is SG + tariff) Now L joins a CU with Country G, so it removes its tariff on G’s grain exports (- which is now, at price SG, the lower-resource-cost member). Since U.S. is a non-member of the CU, the price of its grain exports to L is still SU.S. + tariff. Welfare effects for trade creation (see diagram FIGURE 8.1) There is Consumer surplus gain, a loss of producer surplus, and a loss of tariff revenue Adding all of these, the welfare gains = a + b which is positive

13. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 13 Effects of a Regional Trading Arrangement Trade diversion and welfare Again, Consider a Customs Union (as defined previously) Assume same countries and product (grain) as previously. Under current trade arrangements (without a CU), L imposes a tariff only on imported grain from G – so US is L’s lower cost supplier at SU.S. (the world free trade price), since G’s supply price is SG + tariff. Now L joins a CU with Country G, so it removes its tariff on imported grain from G (- which is now, at price SG, the lower- resource-cost member). Since U.S. is a non-member of the CU, L imposes a tariff on imports of grain from the U.S. so the price of its grain exports to L is now SU.S. + tariff.

14. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 14 Effects of a Regional Trading Arrangement Welfare effects for trade diversion (see diagram FIGURE 8.1 page 267, Text 14 th edition) There is Consumer surplus gain, a loss of producer surplus, and a loss of tariff revenue from G’s imports, as well as a further loss from the tariff now imposed on U.S. grain imports. Adding all of these, the welfare gain/loss = a + b - c which may be positive or negative – if negative it is trade diversion. The closer is the CU partner (Country G) price SG to the low-cost world (Country U.S.) price SU.S., (i.e. the smaller is c,) the more likely that the impact of integration is positive for Country L.

15. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 15 The formation of a customs union leads to a welfare-increasing trade creation effect and a welfare- decreasing trade diversion effect. The overall effect of the customs union on the welfare of its members, as well as on the world as a whole, depends on the relative strength of these two opposing forces. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 15 Static welfare effects of a customs union FIGURE 8.1

16. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 16 Effects of a Regional Trading Arrangement Dynamic effects Greater competition – increased number of producers makes collusion less likely and forces firms to become more efficient Economies of scale – access to a larger market allows producers to become more efficient through greater specialization, better equipment, and usage of by-products Stimulus of investment – because of increased rate of return and ability to spread R&D costs trade makes greater levels of investment more likely Dynamic benefits from increased factor mobility among the members – both labour and capital can move more freely from areas of surplus to areas of scarcity – higher factor incomes and increased economic efficiency.

17. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 17 Brief Overall Assessment of Regional Integration Likely positive net effects: The higher pre-customs union tariffs and the lower the common external tariff The more elastic supply and demand are in member countries The greater the numbers of participating members and the larger the group size The greater the ease in shifting from a higher cost domestic source to a lower cost member source, and the more preunion per-unit cost differences between sources (and the greater the scope for economies of scale and higher foreign investment and technology – dynamic effects). The lower are the transport costs between members – geographic proximity. Possible negatives: The distribution of benefits among member countries is unknown. Product suitability and choice for the integration arrangements. Historical trade connections are often lacking for small potential member countries.

18. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 18 Brief Overall Assessment of Regional Integration Possible negatives cont.: Increasing emphasis on regional integration (-e.g. appears to be deepening in the Asia-Pacific area – APEC -) may provide stumbling blocks to a multilateral trading system and trade liberalisation as embodied in the W(orld) T(rade) O(rganisation), given the discrimination from within the regional groups: In particular: trade barriers may be reduced for a relatively small group of member countries; the regional group may further raise trade barriers to outside non-members: economies of scale may not be obtained – relatively small markets; the group members may concentrate on regional trade negotiations instead of participating globally: domestic economic policies can be more difficult due to loss of control, and lessened sovereignty and independence, for the members. Question: Any example(s) of difficulties, failed economic integration?

19. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 19 European Union: 1960 - 1985 oTreaty of Rome – 1957 – established European Community – precursor to EU o EU members removed tariffs in 1968 leading to fivefold increase in trade o EU adopted common external tariffs in 1970 making it a customs union o trade creation: machinery, transportation equipment, chemicals & raw materials o trade diversion: agricultural commodities and raw materials o trade creation exceeded trade diversion o EU saw increases in economies of scale, competition, investment o 1985 EU eliminated nontariff barriers resulting in creation of European common market European Union & Maastricht o1991 Maastricht Treaty established monetary union and euro as common currency by 2002

20. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 20 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. o advantages: eliminated exchange rate risk reduced currency conversion costs insulation from monetary disturbance & speculation o disadvantages: loss of individual monetary authority transition to common currency could lead to speculative attacks

21. TRADE CONFLICTS © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 21 World Trade Organization Does WTO Reduce National Sovereignty? Yes – because of WTO disputes settlement No – because findings of a WTO dispute- settlement panel cannot force the United States to change its laws Retaliatory tariffs for WTO enforcement? Small country impose retaliatory tariffs Relatively more costly to initiate No favorable movements in its terms of trade © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 21

22. TRADE CONFLICTS © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 22 World Trade Organization Trade liberalization - harms the environment? “Race to the bottom” in environmental standards Social preferences Trade liberalization - improves the environment? Trade stimulates economic growth Key factors in societies’ demand for a cleaner environment Tougher environmental laws Trade and growth Development and dissemination of environmentally friendly production techniques © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 22

23. TRADE CONFLICTS The WTO January 1, 1995, GATT transformed into WTO WTO 153 nations, 97% of world trade International organization, headquartered in Geneva, Switzerland Multilateral trading system Trade in services, intellectual property, and investment Administers a unified package of agreements to which all members are committed © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 23

24. TRADE CONFLICTS The WTO (cont.) WTO Reverses policies of protection in certain “sensitive” areas Settling trade disputes Is not a government Individual nations - free to set their own appropriate levels of environment, labor, health, and safety protections Various councils and committees © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use 24