Regional trade arrangements: EU, NAFTA 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

Types of regional trade arrangements 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 Sound public finances Deficit/GDP … 3% Debt/GDP … 60% Who will bail out Greece? Moral Hazard and PIIGS Contagion “Candidate countries see the convergence criteria as a small price to pay for the exchange rate stability and low interest rates that come with full entry into the monetary union.” Carbaugh, p. 282

Benefits of EMU Stimulates competition Costs 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

Gradual and comprehensive elimination of trade barriers over 15 years: 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

License / franchise foreign providers Foreign Direct Investment (FDI) Operating Abroad Export from home base License / franchise foreign providers Foreign Direct Investment (FDI) Multinational enterprises (MNEs) Joint ventures What’s the nationality? EXXON — Burger King Toyota — Baskin—Robbins Ikea Aldi/Trader Joe

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 political risk: government stability, corruption, domestic conflict, religious & ethnic tensions financial risk: debt to GDP ratio, loan defaults exchange rate stability economic risk: growth of GDP, per capita GDP, inflation rate

Direct investment position of the United States on an historical cost basis, 2007*

Horizontal integration 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 MNE end runs

Profits  Investment  Jobs 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 U.S. immigration - initially more Western Europeans – recently more Mexican and Asian Immigration Act of 1924 – limited overall flow & established specific quota from each country based on previous emigration patterns quota formula modified in 1965 Immigration to US

Effects of Migration 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.