Trade Blocs and Trade Blocks
F Economic bloc: A group of countries who act together
for a common purpose, united by treaty or agreement
F Types of economic blocs - for trade purposes
» Good news - Trading opportunities enhanced within bloc
» Bad news - Trading opportunities discouraged outside bloc
» Are you enhancing trade with good, low cost partners?
F Theory of Customs Unions
» Trade creation and trade diversion effects
F Examples of economic blocs: EU, NAFTA, others
F Trade Blocks
» Trade embargoes as political or economic policy
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 1
Types of Economic Blocs (1 of 2)
(1) Preferential Trading Club
» British Commonwealth Preference System
» Most Favored Nation (MFN) principle - A trade concession
granted to any foreign nation must be granted to all foreign
nations with MFN status
u Encourages non-discrimination
u GATT has granted dozens of exceptions (EU, NAFTA, …)
(2) Free-Trade Area
» Free trade within the area, but separate national trade
policies with outsiders (⇒ need for customs inspectors)
» Examples:
u European Free Trade Area (EFTA, 1960)
u Latin American Free Trade Area (LAFTA, 1960, deceased 1969)
u Association of South East Asian Nations (ASEAN, 1976)
u North American Free Trade Area (NAFTA, 1994)
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 2
1
Types of Economic Blocs (2 of 2)
(3) Customs Union
» Free trade within the area, and common national trade
policies with outsiders (⇒ no need for customs inspectors)
» Examples:
u European Economic Community (till 1992)
(4) Common Market
» Free movement of all factors of production
» Examples:
u European Economic Community (after 1992, “Single Market”)
(5) Economic Union
» All economic policies (monetary, fiscal, welfare) shared by
all member countries
» Examples:
u Belgium and Luxembourg (1921) u U.S.A. u Not yet EU
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 3
Trade Discrimination - Good or Bad?
F Trade discrimination
» Granting more favorable trade relations to some partners
than to other
F Good or bad?
» Adding trade barriers generally bad as in analysis of tariffs
» Relaxing trade barriers intuitively good, except what if you
eliminate barriers vis-à-vis a country that is a high cost
producer?
u Trade creation effect: Lower barriers create trade, and gains
from trade
u Trade diversion effect: Lower barriers with some (not all)
countries may tilt (divert) trade toward high cost producers (⇒
loss from trade)
» ⇒ pick your marriage partner carefully
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 4
2
Customs Unions and Welfare (1 of 2)
F Consider countries A, B & C
F Country A has upward sloping
supply and imports from either
B or C, with tariff T
F Before Customs Union
Price
DA
SA
SB + T
SC + T
A
B
D E
F
C
SB
G
SC
H
» A’s imports from C are Q3 - Q2
» Welfare loss (from tariff) = lost
consumer surplus - tariff rev
» {A+B+C+D+E+F+G+H} - {B+F}
= {A+D+E} + {C+G+H}
Q1
Q2
Q3
Q4
Q
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 5
Customs Unions and Welfare (2 of 2)
F After Custom Union of A & B
» A’s imports from B are Q4 - Q1
» Welfare loss = lost consumer
surplus
» {D+E+F+G+H}
Price
DA
SA
SB + T
SC + T
A
B
D E
F
Q1
Q2
Prof. Levich
C
SB
G
Q3
H
Q4
SC
Q
F Did customs union of A&B improve
welfare? Yes, if
{D+E+F+G+H} < {A+D+E} + {C+G+H}
or if
F < A + C
F F: Trade diversion effect
F A+C: Trade creation effect
C45.0001, Economics of IB
Chapter 11, p. 6
3
Customs Unions - General Lessons
F Welfare gain when
» Trade creation effect > Trade diversion effect
F Welfare gains from customs union favored by
» Greater difference between home and partner country
supply (cost) curves (partner was subject to high tariff)
» Smaller difference between partner country and world-wide
supply curves (partner almost as efficient as the world)
» Larger import elasticity of demand for imports
F Caveats
» Customs union effects all goods, may be trade creation
gains on some goods, but trade divergence losses on others
F Other benefits
» Welfare gain a flow, take NPV
» Static vs. dynamic effects (scale economies, other incentives)
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 7
Examples of European Economic Blocs
F Outline of European economic integration
»
»
»
»
»
»
»
»
1950-52: European Coal and Steel Community (6)
1958: Treaty of Rome, European Economic Community (6)
1960: European Free Trade Association - EFTA (7)
1970s: EEC expands, trade barriers reduced, U.K.
Commonwealth preferences removed
1978: EEC becomes European Community (EC)
1981 Greece, 1986 Portugal and Spain join EC
1987: “Single European Act” to eliminate all barriers
(including non-tariff barriers) to movements of goods, labor
and capital by 1992. “Single passport” for labor and capital.
1992: Single European Act achieved
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 8
4
Gains from European Integration
F Three sources of European gains
» Trade creation in manufactured goods (net +)
» Trade diversion from Common Agricultural Policy (-)
u Britain loses access to low cost food suppliers through
Commonwealth Preference System in exchange for higher cost
European suppliers
» Dynamic gains from scale economies, stimulating
productivity improvements, and increased competition
u Probably a (+), but hard to estimate with accuracy.
u Cecchini Report (1988) estimated gains ~ 5.3% of EU GDP
– Gains from removal of non-tariff trade barriers 0.20%
– Gains from removal of production barriers
2.20%
– Economies of scale
1.65%
– Intensified competition
1.25%
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 9
Examples of American Economic Blocs
F Canada - U.S. Free-Trade Area
» Canada/US auto agreement in place since 1965
» Full Canada/US FTA in place 1/1/89, with 10 year phase in
» Canada already US largest trade partner, barriers not great
F North American Free Trade Area - NAFTA (1994)
» Free trade in goods and capital among US/Mexico/Canada
» Harmonization of safety and environmental standards (why?)
» Pemex allowed to remain nationalized (why?)
» Estimates of NAFTA’s impact
u Largest gains for Mexico, then Canada, then US
u Distribution of gains: low-skilled manufacturing favors Mexico,
trade diversion from Asia, higher skilled and services favor US
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 10
5
Estimated Impact of NAFTA in % Changes
(Brown, Deardorff, and Stern, 1992)
In
In U.S. In
In the
Mexico
Canada R.O.W.
Effects of removing trade barriers within NAFTA, with no
effects of capital flows
Real national income 1.6
0.1
0.7
-0.0
Real average wage
0.7
0.2
0.4
-0.1
rate
Effects of removing trade barriers within NAFTA, with
induced capital flows into Mexico
Real national income 5.0
0.3
0.7
-0.0
Real average wage
rate
Prof. Levich
9.3
0.2
0.5
-0.0
Lindert/Pugel, Fig. 11.3
C45.0001, Economics of IB
Chapter 11, p. 11
Estimated Impact of NAFTA on U.S. (1 of 3)
F On Trade in North America
» 1/3 of US trade w/Mex & Can, growing at 44% (r/t 33% ROW)
» Exports to Mex & Can support 2.3 million US jobs, ↑ 311,000
» Exports to Mex ~ to Japan, even though Mex(GDP) ~1/12 of J.
F On Trade Barriers
» 1993 Average Mex. tariff (on US) 10%, in 1996 ~2.9%
» 1993 Average U.S. tariff (on Mex) 2.1%, in 1996 ~0.65%
F On U.S. Economy
» Challenge - estimate impact of NAFTA, controlling for other
factors, + Uruguay Round tariffs reductions were scheduled
» Small positive impacts on U.S. net exports, income,
investment, and jobs supported by exports
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 12
6
Estimated Impact of NAFTA on U.S. (2 of 3)
F On Mexican Economy
» Faster recovery time after Mexico financial crisis (Dec 1994)
vs. Mexico debt crisis (Feb 1982)
u Recovery of US exports to Mexico
u Return of Mexico to capital markets
F On Key Sectors
» US suppliers have dominant share (75.5%, up from 69.3%) in
Mexico imports. Reflects drop in Mexico tariffs vs. U.S.
» Larger in some sectors (electronic goods, transport equip.)
» In textiles, % US imports from Mexico ↑, from Asia ↓
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 13
Estimated Impact of NAFTA on U.S. (3 of 3)
F On Labor Protection
» North American Agreement on Labor Cooperation
» Legal process for enforcement of national labor laws
» Cooperation of various labor issues - occupational safety,
child labor, gender issues, ...
F On the Environment
» 2,000 mile border with Mexico
» NAFTA includes environmental safeguards, has led to
greater cooperation on environmental issues and monitoring
» Issues cover - infrastructure projects, movement of
hazardous wastes, wildlife, banning certain pesticides
Source: U.S. Trade Representative’s Report on NAFTA, 1997.
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 14
7
Other Trade Bloc Examples
F Latin American Free Trade Area (LAFTA)
» Started in 1960 with Mexico + South America
» Disbanded in 1969, splitting into smaller groups
F Central American Common Market (1960)
» Disbanded in 1970s
F Association of South East Asian Nations (ASEAN)
» Started in 1976, up and down experiences
F Mercosur - common market of the south
» 1991 by Argentina, Brazil, Paraguay, Uruguay
F Why trade blocs have often failed
» Lack of commitment to opening trade
» To get scale economies, must concentrate production, but
where?
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 15
Trade Blocks
F Denial of trading opportunities used as politicaleconomic weapon
F Types of trade blocks
» Sanctions - General term for restrictions of some sort
u Ban on textiles, sneakers & soccer balls made with child labor
» Embargoes & boycotts - complete ban on trade
» NOT “Trade War” ⇒ tariff, retaliation, further retaliation, etc.
F Long history of use
» US boycott of British goods in 1760s to protest Stamp Act
» Used by US (and others) against many countries over last
50 years - Cuba, Nicaragua, Serbia, South Africa, North
Korea, others
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 16
8
Trade Blocks - Success or Failure?
» Size: large countries impose sanctions on small countries
u Small country can be heavily trade dependent (low elasticity)
» Relative costs: low to large country, high on small country
u Large country retains trade with other non-sanction countries
» Scope: sanctions on more goods puts larger cost on small
country
» Friends: more effective when large country enlists others to
cooperate, less effective if target maintains trade with others
» Timing: extreme, sudden sanctions more effective; more
time allows more time to adjust
» Politics: dictatorship may retain power even when economic
costs are high
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 17
Blocs and Blocks - Summary
F Trade blocs remove trade barriers among countries
» Encouraging trade may be good, but weigh cost / benefits
» Marriage partner matters: Trade creation > trade diversion
F Policy concern about regional trade blocs
»
»
»
»
May promote costly trade diversion
May leave tariffs between blocs
However, regional cooperation often easier than multilateral
Still a role for multilateral trade policy making
F Regional trade bloc successes
» EU and NAFTA - largest gains go to smallest countries
F Trade block mixed success
» South Africa - Yes; many others - No; politics matters
Prof. Levich
C45.0001, Economics of IB
Chapter 11, p. 18
9