Preferential Trade Agreements Or Trade blocs Ch. 12

M OTIVATION Thus far: “nondiscriminatory” reduction in tariff rates. WTO’s multi-lateral agreement: if a country offers a reduction in a tariff to one member, it must be offered to all members of the WTO The Most Favored Nation (MFN) clause of the GATT/WTO WTO agreement: countries cannot normally discriminate between their trading partners. Exceptions to MFN 1. Countries can set up a free trade agreement that applies only to goods traded within a group of countries 2. Countries can give developing countries special access to their markets. 3. Countries can raise barriers against products that are considered to be traded unfairly from specific countries.

M OTIVATION What is a Preferential Trading Agreement (PTA)? PTA: trade agreements between countries in which they lower tariffs for each other but not for the rest of the world. GATT allows these agreements provided that: 1. Preferences are 100% 2. There is a timeline for achieving free trade 3. The PTA does not increase protection against the rest of the world. Key point : Regional integration should complement the multilateral trading system and not threaten it.

M OTIVATION History and place of PTAs in GATT/WTO 1940s-1970s 1980s: attitudes changed and countries began to favor PTAs US-Caribbean Basin Initiative US-FTA with Israel Canada-US Free Trade Agreement (CUSFTA) North American Free Trade Agreement (NAFTA) Association of Southeast Asian Nations (ASEAN) Asia-Pacific Economic Cooperation (APEC)

M OTIVATION So how prevalent are PTAs today? Almost 300 PTA were in force by A WTO member is party to 13 PTA’s on average Despite the surge of PTAs in recent years, 16% of global merchandise trade receives preferential treatment! A large number of disputes between PTA members are brought to the WTO dispute settlement system. About 30% of disputes are between WTO members who are parties to the same PTA

M OTIVATION As this happened, questions started to arise: 1. What are the effects of PTAs? Do they increase the volume of trade? Trade Creating vs Trade Diverting 2. Are PTAs compatible with strengthening multilateral trading system? – Are PTAs “building blocks” or “stumbling blocks”?

4 TYPES OF PTA S 1. Free trade area 2. Customs union 3. Common market 4. Economic Union Same Internal barriers xxxX Same External barriers Xxx Free factor mobility xX Common monetary Policy x

T YPE OF PTA: 1. F REE T RADE A REA 1. Free trade area (FTA) Tariffs and other trade barriers among members are removed Each nation maintains its own tariff schedule and other commercial policies with regard to goods coming from nonmember countries. Potential problem: Nonmembers will export their good to the member country in a FTA with the lowest external barrier The importing FTA member country then re-ships to member countries with the higher barrier Ex: NAFTA Ex: China- Iceland free trade agreement (April 15, 2013) Same Internal barriers x Same External barriers Free factor mobility Common monetary Policy

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T YPE OF PTA: 2. C USTOMS U NION 2. Customs union Eliminates barriers to trade in goods between or among its members Adopts a common external tariff that all members of the customs union apply to trade from countries outside the union. The common external tariff must on average be no higher than the pre- union tariff Ex: A ndean Group currently: Bolivia, Venezuela, Colombia, Ecuador The Southern African Customs Union : South Africa, Botswana, Lesotho, Namibia and Swaziland Same Internal barriers x Same External barriers X Free factor mobility Common monetary Policy

F REE TRADE AREA VS. C USTOMS U NION Focus on the difference here because it is most relevant to international trade Key difference is external trade barriers Free Trade area: members may differ in the trade barriers that they impose on non-members; don’t have to have a common external tariff rate on goods from nonmembers Problem: Importers within a FTA will avoid tariffs by importing via a low-tariff member Rules of Origin is meant to deter Customs union: have a common external trade barrier Difficult to get all member countries to agree on external barriers Once established tariff, administration is easy: Goods must pay tariffs when they enter the union – but then they can be freely shipped within the union

T YPE OF PTA: 3. C OMMON M ARKET 3. Common market Eliminates all barriers to trade in goods among the members Adopts a common external tariff. Permits the free movement of goods, services, people, and capital within the market. Example The European Common Market (EEC, 1958) which became the European Community (EC) which became the European Union The Southern Common Market (MERCOSUR): Argentina, Brazil, Paraguay and Uruguay Same Internal barriers x Same External barriers x Free factor mobility x Common monetary Policy

T YPE OF PTA: 4. E CONOMIC U NION 4. Economic Union Eliminates all barriers to trade in goods among the members Adopts a common external tariff Permits the free movement of goods, services, people, and capital within the market Provides for common monetary policy, a common fiscal policy and a common currency for its members. Ex: European Union Not all EU members have adopted the Euro (about 16 of the 27 countries have) Same Internal barriers x Same External barriers x Free factor mobility x Common monetary Policy x