International Economics Tenth Edition CHAPTER T E N 10 International Economics Tenth Edition Economic Integration: Customs Unions and Free Trade Areas Dominick Salvatore John Wiley & Sons, Inc. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The World Trade Organization (WTO) General Agreement on Tariffs and Trade (GATT) A multilateral agreement whose purpose was the "substantial reduction of tariffs and other trade barriers and the elimination of preferences, on a reciprocal and mutually advantageous basis." Signed by 23 nations in 1947 and took effect in 1948. There were eight rounds of multilateral negotiations, focusing mostly on tariff rate cuts, except the last round (Uruguay Round) Lasted until 1994 and was replaced by the World Trade Organization (WTO) on January 1, 1995. The original GATT text (GATT 1947) is still in effect under the WTO framework, subject to the modifications of GATT 1994. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

The World Trade Organization (WTO) The Uruguay Round GATT’s eighth round of negotiations, with 123 countries participating. Began in September 1986 with completion scheduled for December 1990. Disagreements between United States and European Union, on reducing agricultural subsidies, delayed conclusion for three years. Concluded with the signature by 123 nations in Marrakesh on April 14, 1994. Agreement took effect in July, 1995. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

The World Trade Organization (WTO) Aims of the Uruguay Round: Establish rules for monitoring protectionism and reversing the trend. Bring services, agriculture and foreign investments into negotiations. Negotiate international rules for protection of intellectual property rights. Ensure more timely decision and compliance with GATT rulings on dispute settlements. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

The World Trade Organization (WTO) A Major Provision of Uruguay Accord: World Trade Organization (WTO) Established the WTO in place of the GATT Secretariat, with authority in industrial and agricultural products and services. Trade disputes to be settled by vote of two-thirds or three-quarters of nations rather than unanimously. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

The World Trade Organization (WTO) Doha Round Launched in November, 2001, in Doha, Qatar. Agenda included: Further liberalization of production and trade in agriculture, industrial products, and services. Further tightening of antidumping regulations, investment and competition policies. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

The World Trade Organization (WTO) Doha Round Developing nations reluctant to make concessions because of feeling that Uruguay Round failed to deliver on promises. Developing nations insisted on making Doha Round a true “development round”. Intended to conclude by end of 2004, all but collapsed in 2006 over disagreements over agricultural subsidies between developed and developing nations. As of beginning of 2015, still not concluded. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Rising Regionalism In the period 1948-1994, the GATT received 124 notifications of RTAs (relating to trade in goods), and since the creation of the WTO in 1995, over 400 additional arrangements covering trade in goods or services have been notified. Source: WTO Secretariat (https://www.wto.org/english/tratop_e/region_e/regfac_e.htm)

Learning Goals: Understand the meaning of trade creation, trade diversion, and the dynamic benefits of economic integration Describe the importance and effects of the major trading blocks such as European Union (EU), NAFTA, and TPP. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Introduction Economic integration refers to the commercial policy of discriminatively reducing or eliminating barriers only among the nations joining together. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Preferential trade arrangements Introduction Preferential trade arrangements Provide lower barriers to trade among participating nations than on trade with non-member nations. The loosest form of economic integration. Example: British Commonwealth Preference Scheme, established in 1932 between the United Kingdom and members of the British Empire. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Introduction Free trade areas Removes all barriers to trade among members, but each nation retains its own barriers to trade with non-members. Examples: European Free Trade Association (EFTA), 1960, between United Kingdom, Austria, Denmark, Norway, Portugal, Sweden and Switzerland North American Free Trade Agreement (NAFTA), 1993, between the United States, Canada and Mexico Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Introduction Customs union Removes all barriers to trade among members and harmonizes trade policies toward the rest of the world. Examples: European Union (EU), or European Common Market, 1957, between West Germany, France, Italy, Belgium, the Netherlands, and Luxembourg. Zollverein, 1834, between large number of sovereign German states Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Introduction Common market Removes all barriers to trade among members, harmonizes trade policies toward the rest of the world, and allows free movement of labor and capital among member nations. Example: European Union (EU) achieved common market status in 1993. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Introduction Economic union Removes all barriers to trade among members, harmonizes trade policies towards the rest of the world, allows free movement of labor and capital among member nations, and unifies monetary and fiscal policies of members. Most advanced type of economic integration. Examples: Benelux, formed after World War II between Belgium, the Netherlands and Luxembourg Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Static Effects of Economic Integration Trade creation effects vs. trade diversion effects. Administration savings from elimination of customs officers, border patrols, and others. Reduction in demand for imports from rest of the world will likely lead to improvement in collective terms of trade of member nations. By acting as a single unit, customs union will likely have more bargaining power than members separately. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Trade-Creating Customs Unions Trade creation occurs when domestic production in a member nation is replaced by lower-cost imports from another member nation. Leads to increased welfare for members as nations specialize in comparative advantages. Leads to increased welfare for non-members as increased real income spills over into increased imports from rest of the world. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Trade-Diverting Customs Unions Trade diversion occurs when lower-cost imports from non-members are replaced by higher cost imports from members. By itself, trade diversion lowers welfare as it shifts resources away from comparative advantages. Trade diverting customs union also results in trade creation. Change in welfare depends on relative magnitude of creation and diversion. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

FIGURE 10-2 A Trade-Diverting Customs Union. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Other Static Effects of Customs Unions Administration savings from elimination of customs officers, border patrols, and others. Reduction in demand for imports from and supply of exports to rest of the world will likely lead to improvement in collective terms of trade of member nations. By acting as a single unit, customs union will likely have more bargaining power than members separately. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Dynamic Benefits from Customs Unions Dynamic Benefits of Customs Unions Increased competition, leading to greater efficiencies and technological improvements. Economies of scale from the enlarged market. Stimulus of investment to take advantage of enlarged market, and to meet increased competition. Better utilization of community resources as labor and capital move freely (assumes common market). Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Major Trading Blocks EU (European Union) NAFTA (North American Free Trade Agreement) ASEAN (Association of South East Asian Nations) MERCOSUR (Mercado Comun del Condo Sur, South Common Markets) TPP (Trans-Pacific Partnership) RCEP (Regional Closer Economic Partnership)? TTIP (Transatlantic Trade and Investment Partnership)? Source: WTO Secretariat (https://www.wto.org/english/tratop_e/region_e/regfac_e.htm)

History of Attempts at Economic Integration The European Union (EU) 1958 – established common external tariff (Customs Union) 1968 – Achieved free trade in industrial goods within EU, and common price for agricultural goods 1970 – Reduced restrictions on movement of labor and capital 1993 – Removed all remaining restrictions on flow of goods, services and resources, becoming largest trade bloc in the world1999 (Common Market) Began to use the common currency, Euro among 19 members out of 28 EU member states (Monetary Union) Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

History of Attempts at Economic Integration The European Free Trade Association (EFTA) 1960 – formed by “outer seven” nations: United Kingdom, Austria, Denmark, Norway, Portugal, Sweden and Switzerland 1967 – Achieved free trade in industrial goods 1991 – Membership evolved to include Austria, Finland, Iceland, Liechtenstein, Norway, Sweden, and Switzerland 1994 – Joined EU to form European Economic Area (EEA) Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

History of Attempts at Economic Integration The North American Free Trade Agreement (NAFTA) 1994 – formed by United States, Canada and Mexico, to eventually lead to free trade in goods and services over entire North American area. Also phased out many other barriers to trade and reduced barriers to cross-border investments among the three member nations. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Attempts at Economic Integration in Developing Countries The Southern Common Market (Mercosur) Argentina, Paraguay, Brazil, and Uruguay in 1991, and Venezuela (2012). Associate members are Bolivia and Chile (1996), Peru (2003), Columbia, Ecuador, and Venezuela (2004). It is now a customs union. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Attempts at Economic Integration in Developing Countries Association of South East Asian Nations (ASEAN) Brunei, Darussalam, Cambodia, Indonesia, Laos, Malaysia, the Philippines, Singapore, Thailand, Vietnam Primarily a political association, but began in 1977 to move toward a common market ASEAN Free Trade Area (AFTA) agreement was signed in 1992. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Major Trading Blocks Trans-Pacific Partnership (TPP) 12 countries among 21 APEC members. Largest trading block in terms of GDP (40% of world GDP). US, Japan, Australia, New Zealand, Canada, Mexico, Malaysia, Vietnam, Singapore, Brunei, Chile, and Peru. http://www.economist.com/news/finance-economics/21671151-tpp-now-faces- hard-road-passage-national-legislatures-twelve-countries-strike-ambitious - Numura’s view on TPP: http://nomuraconnects.com/?gclid=COH8stPbu8gCFUosvQodUxYEFQ#spotlight Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Note: Countries in red are those with which Korea has signed an FTA. Hong Kong, PNG, Russia, Chinese Taipei Canada Mexico U.S. Brunei Malaysia Singapore Vietnam Australia Japan, NZ Indonesia Philippines Thailand Cambodia Laos Myanmar India China, Korea Chile Peru APEC (FTAAP) RCEP TPP NAFTA ASEAN Note: Countries in red are those with which Korea has signed an FTA.