Multilateral trade arrangements [GATT  WTO]
Nondiscrimination: bilateral liberalization extended to all
members.  “Most favored nation”
BUT Complex negotiations: 150+ nations at the table
Regional trade arrangements: EU, NAFTA
Economic integration  economies of scale
Basis for enlargement
• As integration proceeds, costs of staying out increase
•
As labor deploys to competitive sectors, benefits (and
political support) spreads.
BUT trade diversion vis a vis non-members
Regional trade agreements
Types of regional trade arrangements
 Free trade areas (NAFTA, for example)
 Customs unions (Benelux, CACM)
 Common markets (MERCOSUR,EEC)
 Economic union (EU)
 Economic and monetary union (USA, EMU?)
Effects of regional trade agreements
 Static effects
 Trade creation effect
 consumption effect … buy more from your partner
 production effect … less inefficient domestic
production
 Trade diversion effect
 … buy less from efficient, low cost producers not in
the club…e.g., UK vis a vis Australia
 Dynamic effects
 Economies of scale
 Greater competition
 Investment stimulus
European Union / European Monetary Union
Created by the Treaty of Rome (1957)
Original Members: Belgium,France,Germany,
Italy,Luxembourg,Netherlands
Joiners,’73: Denmark,Ireland,UK
Joiners,’80s: Greece, Portugal, Spain…smoke & mirrors
Joiners,’95: Austria,Finland,Sweden
Joiners, ‘00s: Transition economies: Slovenia, Poland, Czech
Republic, Slovakia, Hungary, Estonia, Latvia, Lithuania,
Bulgaria, Romania + Cyprus, Malta
Total Population, GDP, GDP per capita (PPP, 2008)
EU:
500mil
$15.2tril
$30,500
€-zone: 326mil
10.6 tril
32,500
USA:
306mil
14.3 tril
46,900
European Union
 Within-region trade grew much more quickly than world
trade in the 1960s
 Steps to remove remaining barriers (1985-92) further
increased integration
 1987 Delors Report
 Four Freedoms: goods, services, labor, capital
 Maastricht Summit (1991)
 Laid out process of economic and monetary union
(EMU)
 German unification  September 1992 currency crisis
 Italy, Spain “devalue”
 UK, Sweden drop out
EMU: Economic & Monetary Union (1999)
 National currencies replaced with the euro, 2002
 European Central Bank created to control
monetary and exchange rate policy
 “Convergence criteria” required for membership:




Price stability … 3.2% inflation
Low long-term interest rates … 7.7%
Stable exchange rates “Candidate countries see the convergence
Sound public finances criteria as a small price to pay for the
 Deficit/GDP … 3%
 Debt/GDP … 60%
exchange rate stability and low interest rates
that come with full entry into the monetary
union.”
Carbaugh, p. 282
Who will bail out Greece?
Moral Hazard and PIIGS
Contagion
Benefits of EMU
 Lower transaction costs
 Price comparisons easier
 Exchange rate risk eliminated
 Stimulates competition
Costs of EMU
Europe is not an "optimal currency area"
•Loss of monetary policy and the exchange rates
as economic adjustment tools
Response to Asymmetric shocks
•Use of fiscal policy for adjustment is constrained
•Need wage flexibility and labor mobility
•both are low in Europe
Other key EU policies
 Common agricultural policy (CAP)
 Support payments to farmers  surpluses
 Export subsidies  devastates LDC agriculture
 Variable import levies: when world price down,
EU tariff up  stable prices within EU
 Germans supported French farmers
 Now support Polish/Hungarian/Baltic farmers
 Government procurement policies
 All EU businesses can bid for large contracts in any
nation
Government support for agriculture, 2007
Subsidy
10
US-Canada Free Trade Agreement (1989)
North American Free Trade Agreement (1994)
 US, Mexico, Canada
 Gradual and comprehensive elimination of
trade barriers 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
Concerns about NAFTA
 Main US losers from NAFTA: import-protected
industries competing with Mexican producers, and
unskilled workers
 Trade diversion from low-cost Asian producers
 US industrial workers worried about lower pay in
Mexico and plant relocations
 Concerns Mexico won’t enforce environmental
protection measures
 Concern now shifted to China and India
Trade effects of NAFTA: trade creation and
trade diversion (thousands of dollars)
Major western hemisphere regional trade
agreements
GDP per capita* for the transition economies,
2007 (in dollars)
Factor Flows:
Increased Productivity  Increased Profit
Productivity depends on:
•Factor scarcity
•COOPERATING factors
(including more of the same factor)
•Agglomeration economies
Interactions … Exchange of information
•Institutional quality
• Rule of law
• Protection of property rights
• Country risks
Operating Abroad
 Export from home base
 License / franchise foreign providers
 Foreign Direct Investment (FDI)
 Multinational enterprises (MNEs)
 Joint ventures
 What’s the nationality?


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
EXXON
Toyota
Ikea
Aldi/Trader Joe
— Burger King
— Baskin—Robbins
The world’s largest corporations, 2008
MNE Motives
 EXPAND
 Market penetration
 Preempt competition
 Cost advantages
 Skirt restrictions/trade barriers
 Hedge
 Against currency fluctuations
 Against market shifts
Country Risk Analysis
o political risk: government stability, corruption,
domestic conflict, religious & ethnic tensions
o financial risk:
debt to GDP ratio,
loan defaults
exchange rate
stability
o economic risk:
growth of GDP,
per capita GDP,
inflation rate
Direct investment position of the United States
on an historical cost basis, 2007*
21
Flavors of MNEs
 Vertical integration
 Backward: secure inputs to core business
 Forward: secure market position of final good
 Horizontal integration
 Create and service overlapping demand for core
products
 Conglomeration
 Add international dimension to business portfolio
The Joint Venture Alternative




Combine skills
Share costs
Share risks
Gain local acceptance/leverage
 Joint venture with foreign government
 Forestall protection
 Forestall competition
Encounter Coordination Problems
FDI and Its Discontents
Host discontents
 MNEs purchase existing businesses  No new
jobs
 Foreign bosses
 Loss of sovereignty
 Gimmicks like transfer pricing  tax avoidance
Source discontents
 [Short-term?] job loss
 Technology transfer
 Lose competitive edge
 Create own gravediggers
 Loss of sovereignty
 MNE end runs
Labor Immigration
Push or Pull?
Wage Convergence
Winners – Losers
Long-run impacts
 The division of labor is limited by the extent of
the market
Profits  Investment  Jobs
Labor Mobility - Migration
o U.S. immigration - initially more Western
Europeans – recently more Mexican and Asian
o Immigration Act of 1924 – limited overall flow &
Immigration to US
established
specific quota
from each
country based
on previous
emigration
patterns
o quota formula
modified in
1965
Effects of Migration
o
o
o
o
labor migration equalizes wages
increase in output and welfare in the U.S.
decrease in output and welfare in Mexico
net gain in world output due to higher VMP in U.S.