1. 1 Lectures 23-28: Trade Policy and Integration What: instruments of trade policy How: effects of trade policy Why: arguments against free trade New: economic integration

2. 2 Fall 2007 NU-FAST Zahid Siddique Economic Integration (EI) Another dimension of trade policy is creation of economic integration by regional trade agreements (RTA) –discriminative commercial policy to reduce or eliminate trade barriers only among member nations The degree of RTA varies around different ranges –Preferential trade arrangements: lower trade barriers among participating nations than on non-members (e.g. British Commonwealth Preference Scheme) loosest form of EI –Free-trade area: no internal barriers, but separate trade policy against others (e.g. EFTA and NAFTA) –Custom union: common external trade policy, apart from internal removal of barriers (e.g. EU)

3. 3 Fall 2007 NU-FAST Zahid Siddique Economic Integration (EI) –Common market: free mobility of inputs among member nations (e.g. EU went close to it) –Economic union: harmonization and co-ordination of fiscal and monetary policies among member states Duty-free zones or free-economic zones is another recent developmentallowing duty-free raw-materials and intermediate products to attract investment Companies need to adjust organizational structure and operation to take advantage of regional trade groups –knowledge of regional economic groups is helpful for international expansion

4. 4 Fall 2007 NU-FAST Zahid Siddique Where to look for economic integration? Many factors determine where to form EI –Geographical proximity distances that goods need to travel is short –Cultural background similar consumer taste and common history are helpful to bring countries closer to each other –Political harmony domestic and international harmony in interests are key to co-ordination at economic level –Economic structure Co-movement in economic variables, development levels of economies, monetary systems and nature of business structure are important to form economic- bloc

5. 5 Fall 2007 NU-FAST Zahid Siddique Static effects of EI: Trade creation Static effects means shifting of resources from inefficient to efficient companies as trade barriers falls Trade creation: expansion in trade due to shifting of production to more efficient producers for CA reasons –high-cost domestic production is replaced by low-cost imports from union members Consider country As domestic market as before 0 DdDd SdSd PSPS Sugar P d 1 e SbSb PbPb Assume that price in B is P b while in C is P c (P c > P b ) 100% tariff on both means –after-tariff price in B lower than that of in C A imports from B SdSd DdDd M bu ScSc PcPc S b1 P b +T S c1 P c +T

6. 6 Fall 2007 NU-FAST Zahid Siddique Static effects of EI: Trade creation Now assume A forms custom union with B All barriers on B removed, but retained on C –Bs imports now further cheaper [P b < (P b +T)] –imports in A increase; i.e. more trade created After integration –government losses its revenue of [T × M] 0 DdDd SdSd PSPS Sugar P d 1 e SbSb PbPb –consumers have more goods to consume –lower prices at home –increased competition; hence efficiency –larger export-possibility for other member firms SdSd DdDd M bu ScSc PcPc S1S1 D1D1 M au S b1 P b +T S c1 P c +T

7. 7 Fall 2007 NU-FAST Zahid Siddique Static effects of EI: Trade diversion Trade diversion: shifting of trade to producers within groups at the expanse of efficiency –low cost imports from outside are replaced by higher cost imports from union members Consider As domestic market, along with B and C, again –with A importing from B at after-tariff price Assume that now A forms custom union with C 0 DdDd SdSd PSPS Sugar P d 1 e SbSb PbPb Cs imports cheaper [P c < (P b +T)] than those of B Trade diverts to C (inefficient producers) due to discriminative policy Net effect on member countries welfare depends upon magnitude of trade diversion and creation SdSd DdDd M ba ScSc PcPc S b1 P b +T S2S2 D2D2

8. 8 Fall 2007 NU-FAST Zahid Siddique Dynamic effects of EI Dynamic effects means benefits gained over time due to: –Increased competition producers are forced to be more efficient stimulus to develop and utilize better technology –Economies of Scalefall in average cost due to expansion in production scale larger market creates opportunities for cheaper expansion in production –Stimulus to investment enlarged markets and competition leads to larger opportunities for investment outsiders try to set up production within unions to benefit from trade-policy (called tariff-factories)

9. 9 Fall 2007 NU-FAST Zahid Siddique Assignment 4 Study Budget 2007-08 and Economic Survey of Pakistan and outline features of Pakistans trade policy Last date of submission –November 07, 2007