1. 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

2. 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?)

3. 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

4. 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: mil $15.2tril $30,500
€-zone: 326mil tril ,500
USA: mil tril ,900

6. European Union
Within-region trade grew much more quickly than world trade in the 1960s
Steps to remove remaining barriers ( ) 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

7. 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

8. 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

9. 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

10. Government support for agriculture, 2007
Subsidy

11. 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

12. 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

13. Trade effects of NAFTA: trade creation and trade diversion (thousands of dollars)

14. Major western hemisphere regional trade agreements

15. GDP per capita* for the transition economies, 2007 (in dollars)

16. 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

17. 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

18. The world’s largest corporations, 2008

19. MNE Motives EXPAND Market penetration Preempt competition
Cost advantages
Skirt restrictions/trade barriers
Hedge
Against currency fluctuations
Against market shifts

20. 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

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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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.