Trade Blocs and Trade Blocks

Trade Blocs and Trade Blocks Economic bloc: A group of countries who act together for a common purpose, united by treaty or agreement 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? Theory of Customs Unions» Trade creation and trade diversion effects Examples of economic blocs: EU, NAFTA, others 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 Encourages non-discrimination 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: European Free Trade Area (EFTA, 1960) Latin American Free Trade Area (LAFTA, 1960, deceased 1969) Association of South East Asian Nations (ASEAN, 1976) 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: European Economic Community (till 1992) (4) Common Market» Free movement of all factors of production» Examples: European Economic Community (after 1992, Single Market ) (5) Economic Union» All economic policies (monetary, fiscal, welfare) shared by all member countries» Examples: Belgium and Luxembourg (1921) U.S.A. Not yet EU Prof. Levich C45.0001, Economics of IB Chapter 11, p. 3 Trade Discrimination - Good or Bad? Trade discrimination» Granting more favorable trade relations to some partners than to other 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? Trade creation effect: Lower barriers create trade, and gains from trade 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) Price DA SA Consider countries A, B & C Country A has upward sloping supply and imports from either B or C, with tariff T Before Customs Union D A E B F C G H SB + T SC + T SB SC» A s imports from C are Q 3 - Q 2» 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) After Custom Union of A & B Price DA SA SB + T SC + T A B C SB D E F G H SC Q1 Q2 Q3 Q4 Q» A s imports from B are Q 4 - Q 1» Welfare loss = lost consumer surplus» {D+E+F+G+H} 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: Trade diversion effect A+C: Trade creation effect Prof. Levich C45.0001, Economics of IB Chapter 11, p. 6 3

Customs Unions - General Lessons Welfare gain when» Trade creation effect > Trade diversion effect 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 Caveats» Customs union effects all goods, may be trade creation gains on some goods, but trade divergence losses on others 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 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 Three sources of European gains» Trade creation in manufactured goods (net +)» Trade diversion from Common Agricultural Policy (-) 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 Probably a (+), but hard to estimate with accuracy. 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 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 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 Largest gains for Mexico, then Canada, then US 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 Mexico In U.S. In Canada In the 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 rate 0.7 0.2 0.4-0.1 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 9.3 0.2 0.5-0.0 Lindert/Pugel, Fig. 11.3 Prof. Levich C45.0001, Economics of IB Chapter 11, p. 11 Estimated Impact of NAFTA on U.S. (1 of 3) 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. 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% 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) On Mexican Economy» Faster recovery time after Mexico financial crisis (Dec 1994) vs. Mexico debt crisis (Feb 1982) Recovery of US exports to Mexico Return of Mexico to capital markets 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) 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,... 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 Latin American Free Trade Area (LAFTA)» Started in 1960 with Mexico + South America» Disbanded in 1969, splitting into smaller groups Central American Common Market (1960)» Disbanded in 1970s Association of South East Asian Nations (ASEAN)» Started in 1976, up and down experiences Mercosur - common market of the south» 1991 by Argentina, Brazil, Paraguay, Uruguay 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 Denial of trading opportunities used as politicaleconomic weapon Types of trade blocks» Sanctions - General term for restrictions of some sort Ban on textiles, sneakers & soccer balls made with child labor» Embargoes & boycotts - complete ban on trade» NOT Trade War tariff, retaliation, further retaliation, etc. 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 Small country can be heavily trade dependent (low elasticity)» Relative costs: low to large country, high on small country 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 Trade blocs remove trade barriers among countries» Encouraging trade may be good, but weigh cost / benefits» Marriage partner matters: Trade creation > trade diversion 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 Regional trade bloc successes» EU and NAFTA - largest gains go to smallest countries Trade block mixed success» South Africa - Yes; many others - No; politics matters Prof. Levich C45.0001, Economics of IB Chapter 11, p. 18 9