CHAPTER 10 Regional Trading Arrangements

2 Types of regional trading arrangements Free-Trade Area — all members of the group remove tariffs on each other’s products, while at the same time each member retains its independence in establishing trading policies with nonmembers. (e.g. NAFTA — the North American Free Trade Area)

3 Types of regional trading arrangements Free-Trade Area  Rules of origin — the stipulation by a country that for a product to qualify as an authentic domestically manufactured product, the product must be manufactured predominantly from locally supplied, as opposed to imported, components.

4 Types of regional trading arrangements Customs Union — all tariffs are removed between members and the group adopts a common external commercial policy toward nonmembers. Furthermore, the group acts as one body in the negotiation of all trade agreements with nonmembers. The customs union is a step closer toward economic integration than the FTA. (e.g. EEC —the European Economic Community )

5 Types of regional trading arrangements Common Market — all tariffs are removed between members, a common external trade policy is adopted for nonmembers, and all barriers to factor movements among the member countries are removed. (e.g. EC — the European Community)

6 Types of regional trading arrangements Economic Union — the most comprehensive of the four forms of economic integration is an economic union. It includes all features of a common market but also implies the unification of economic institutions and the coordination of economic policy throughout all member countries. The EU is on a path toward full unity.

7 Impetus for regionalism An expanded regional market can allow economies of large-scale production, foster specialization and learning-by-doing, and attract foreign investment. Smaller nations may seek safe-haven trading arrangements with larger nations when future access to the larger nations’ markets appears uncertain. As new regional trading arrangements are formed, or existing ones are expanded or deepened, the opportunity cost of remaining outside an arrangement increases.

8 Effects of regional trade arrangements Static effects –Trade creation effect (consumption effect, production effect) –Trade diversion effect Dynamic effects –Economies of scale –Greater competition –Investment stimulus

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10 Effects of regional trade arrangements — static effects

11 Effects of regional trade arrangements — static effects Trade creation — economic integration leads to a shift in product origin from a domestic producer whose resource costs are higher to a member producer whose resource costs are lower. This shift represents a movement in the direction of the free-trade allocation of resources and thus is presumably beneficial for welfare. Trade creation causes the national gain shown as area b.

12 Effects of regional trade arrangements — static effects Trade diversion — there is a shift in product origin from a nonmember producer whose resource costs are lower to a member country producer whose resource costs are higher. This shift represents a movement away from the free-trade allocation of resources and could reduce welfare. Trade diversion causes the national loss shown as area c.

13 Conditions of making for greater gains from a customs union The lower the partner costs relative to the outside-world costs, the greater the gains. The more elastic the import demand, the greater the gains.

14 Questions What is the difference between a free- trade area and a customs union? Why are rules of origin needed for a free-trade area?

15 Questions Suppose that the U.S.A currently imports 1.0 million pairs of shoes from China at $20 each. With a 50% tariff, the consumer price in the U.S.A is $30. The price of shoes in Mexico is $25. Suppose that as a result of NAFTA, the U.S.A imports 1.2 million pairs of shoes from Mexico and none from China. What are the gains and losses to U.S. consumers, U.S. producers, the U.S. government, and the world as a whole?