Trade Agreement Preferential Trade Agreement (PTA) Custom Union Economic Analysis of PTA/CU

The Stage of Economic Integration Stage 1 Preferential Trade Agreement Stage 2 Free Trade Area, Monetary Union Stage 3 Custom Union, Common Market Stage 4 Economic Union, Customs and Monetary Union Stage 5 Economic and Monetary Union (Fiscal Union) Stage 6 Complete Economic Integration

Preferential Trade Agreement (PTA) PTA or discriminatory trade agreement or regional trade liberalization PTA is a trading bloc which gives preferential access to certain products from the participating countries. This is done by reducing tariffs, but not by abolishing them completely. A PTA can be established through a trade pact. It is the first stage of economic integration. The line between a PTA and a Free trade area (FTA) may be blurred, as almost any PTA has a main goal of becoming a FTA in accordance with the General Agreement on Tariffs and Trade.

Preferential Trade Agreement (PTA) PTA Free Trade Area Custom Union

Free Trade Area (FTA) FTA is a trade bloc whose member countries have signed an agreement to eliminate internal barriers to trade but to maintain existing barriers against nonmember countries It can be considered the second stage of economic integration. Countries choose this kind of economic integration if their economical structures are complementary. If their economical structures are competitive, they are more likely to form a customs union.

Custom Union (CU) CU is a type of trade bloc which is an agreement among several countries to eliminate internal barriers to trade and to erect common barriers against nonmember countries The participant countries set up common external trade policy, but in some cases they use different import quotas Common competition policy is also helpful to avoid competition deficiency. Purposes for establishing a customs union normally include increasing economic efficiency and establishing closer political and cultural ties between the member countries. It is the third stage of economic integration.

Economic Analysis CASE I There are three countries A, B and C: A:-the world high-cost producer of rice and at autarky A protects its producers with an ad valorem tariff of 100% - at the autarky, the price of rice in A is $5.00/kg B :willing to export to A at $2.00/kg C:-the world low-cost producer, willing to export to A at $1.50/kg If free trade is allowed, what will happen?

Free Trade A SBSB In free trade, A will import rice from the low-cost producer—country C, importing IJ kilos IJ SCSC SASA DADA P rice Q rice IMPORT

With tariff A SBSB With tariff, A still imports rice from the low-cost producer— country C, but with less amount of import (EF kilos) and collect tariff revenue (klmn) IJ SCSC SASA DADA P rice Q rice S C + tariff S B + tariff FE tariff revenue k lm n

Economic Analysis CASE II Suppose A and B create FTA between them so goods coming to A from country B will not be charged a tariff What is the effect?

Economic Analysis CASE II The formation of an FTA between A and B will create: a) Trade diversion There is a shift of importer from the world low-cost producer (country C) to the lowest-cost member (country B) → remember country C is still charged by A with 100% tariff while B is not → trade diversion is viewed as welfare reducing for the world

With PTA A SBSB IJ SCSC SASA DADA P rice Q rice S C + tariff3.00 FEGH With PTA, A imports rice from country B, adding the amount of import (GH kilos) but collects no tariff revenue

Economic Analysis CASE II The formation of an FTA between A and B will create: b) Trade creation The trade expands in country A, imports rise from EF to GH → trade creation is viewed as good, since high-cost producer (A) can obtain greater extent of benefit from international trade

With PTA A SBSB IJ SCSC SASA DADA P rice Q rice S C + tariff3.00 FEGH With PTA, A imports rice from country B, adding the amount of import (GH kilos) but collects no tariff revenue a c bd g fe

Economic Analysis CASE II The formation of an FTA between A and B will create: The welfare effects on country A of FTA between countries A and B Change in CS+$ a+$ b+$ c+$ d Change in PS- $ a Change in gov’ revenue - $ c Change in welfare+$ b+$ d- $ c

Economic Analysis CASE II Why would A ever form an FTA with B if it could improve its welfare more by forming one with C? a) If there are economies of scales in production in various goods. Then when A and B form an FTA, the size of the market expands for the manufacturers in these two countries. The economies of scales are presumed to be fully exploited within the narrower FTA

Economic Analysis CASE II Why would A ever form an FTA with B if it could improve its welfare more by forming one with C? b) FTA is formed for political reasons The formation of EU can be viewed as an attempt by European political leaders to integrate their economies so completely that the temptations to go war would diminish substantially