International Economics
By Robert J. Carbaugh
8th Edition
Chapter 9:
Regional Trading Arrangements
Copyright ©2002, South-Western College Publishing
Regional trade agreements
Types of regional trade arrangements
 Free trade areas (NAFTA, for example)
 Customs unions (Benelux)
 Common markets (EU)
 Economic/monetary union
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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
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Regional trade agreements
Static effects of a customs union
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Regional trade agreements: case studies
The European Union
 Created by the Treaty of Rome (1957)
 Policy aims included:
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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
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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 (198592) further increased integration
 Maastricht Summit (1991) began process of
economic and monetary union (EMU)
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Regional trade agreements: case studies
EU Economic & Monetary Union (1999)
 Member nations will replace national currencies
with the euro by 2002
 New European Central Bank created to control
monetary and exchange rate policy
 “Convergence criteria” required for membership:
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Price stability
Low long-term interest rates
Stable exchange rates
Sound public finances
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Regional trade agreements: case studies
Other key EU policies
 Common agricultural policy
 Support payments to farmers
 Variable import levies
 Export subsidies
 Government procurement policies
 All EU businesses can bid for larger contracts
in any nation
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Regional trade agreements: case studies
CAP: variable levies and export subsidies
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Regional trade agreements: case studies
Opening up government procurement
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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:
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Lower transaction costs
Price comparisons easier
Exchange rate risk eliminated
Stimulates competition
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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. 9
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Regional trade agreements: case studies
US-Canada Free Trade Agmt. (1989)
 Elimination of all tariffs and most NTBs over
ten years
 Binational tribunal created to hear trade
disputes
 Canada, in particular, is expected to benefit
from economies of scale
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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:
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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
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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
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Regional trade agreements: case studies
Concerns about NAFTA
 Main US losers from NAFTA would be importprotected 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
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Regional trade agreements: case studies
NAFTA after five years
 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
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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)
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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
 Financing limitations have hampered an
increase in trade: transition nations have
generally not been able to increase exports to
match imports and must borrow the difference
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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
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