McGraw-Hill/Irwin © 2012 The McGraw-Hill Companies, All Rights Reserved Chapter 12: Trade Blocs and Trade Blocks

This chapter examines two types of trade barriers that are intended to discriminate between foreign countries. 1.A trade bloc has lower or no barriers for trade between its members, while they maintain higher barriers for trade with outside countries. 2.A trade embargo or trade block places extra barriers against trade with a specific foreign country, usually because of a broader policy disagreement.

Copyright  2012 by The McGraw-Hill Companies, Inc. All rights reserved Figure 12.1 Types of Economic Blocs

WTO rules Trade blocs We usually analyze trade blocs by comparing them to countries maintaining barriers against all other countries. WTO rules generally call for equal trade barriers against all other countries (at least those that are also members of the WTO)—the most- favored-nation principle. But the WTO rules also have a few exceptions, including an exception for a trade bloc that achieves substantially free trade among its members.

The European Union Most estimates are that the EU gains from its internal free trade in manufactures, because trade creation has been larger than trade diversion, and because there are probably also dynamic gains, although these are harder to measure. Additional gains came as the move to a truly common market in 1992 removed nontariff barriers and freed resource movements. However, the EU also incurs substantial losses from its highly protectionist common agricultural policy.

Copyright  2012 by The McGraw-Hill Companies, Inc. All rights reserved Exports Plus Imports as a Percentage of GDP Figure 12.2 Trade Diversion versus Trade Creation in Joining a Trade Bloc: UK Market for Imported Compact Cars

For decades efforts to form functioning trade blocs among developing countries failed. Success is now more likely, as many developing countries have shifted toward outward-oriented and market-oriented government policies. MERCOSUR (the Southern Common Market) began in 1991 and has been reasonably successful in freeing internal trade and establishing common external tariffs. Yet, there are some fears that it has also led to substantial trade diversion.

A trade embargo is economic warfare. It hurts both the target country and the country imposing the trade block, and it creates opportunities for other countries that are not taking part in the embargo. An embargo can fail to force the target country to change its policy for at least two reasons. First, the target country’s national decision makers may decide that they can and must endure their losses, even if these losses are large—political failure of an embargo. Second, the embargo may simply fail to inflict much loss on the target country—economic failure of an embargo.

Copyright  2012 by The McGraw-Hill Companies, Inc. All rights reserved Figure 12.3 Effects of an Embargo on Exports to Iraq

Copyright  2012 by The McGraw-Hill Companies, Inc. All rights reserved Figure 2.2 The Market for Motorbikes: Demand and Supply Figure 12.4 Two Kinds of Economically Unsuccessful Embargoes