customs_union_and_common_market_theory - The Economics of...

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Unformatted text preview: The Economics of Customs Unions and Common Markets Unions Prof. Dr. Aad van Mourik Cologne Business School PRINCIPAL TYPES OF TRADE MEASURES MEASURES TARIFFS (specific, ad valorem) s QUOTA s • • s free import licences or auctioned includes VERs, OMAs, etc. TARIFF QUOTAS s Voluntary export (price) restraints s Customs procedures PRINCIPAL TYPES OF TRADE MEASURES - cont. MEASURES Domestic content requirements s Subsidies (export and production) s Anti-dumping & countervailing Anti-dumping measures measures s Government procurement policies s Technical and administrative Technical regulations regulations s WELFARE EFFECTS OF FREE TRADE: IMPORTS IMPORTS p a b c A B q d CS: +b+d PS: ­b Net: +d + pa pw WELFARE EFFECTS OF TARIFFS p CS: ­a­b­c­d PS:+a + TR:+c Net: ­b­d a bc d q Pw+t pw A B WELFARE EFFECTS OF QUOTA WELFARE Are equivalent to tariff if quota licenses Are are sold in efficient auction are s Are worse than tariff is quota licenses Are given away for free, foreign producers capture quota rent (VERs) capture s STAGES OF ECONOMIC INTEGRATION INTEGRATION Free trade area (FTA) s Customs union (CU) s Common Market (CM) s Economic Union (EU) s Monetary union (MU) s Economic and monetary union (EMU) s THE (EC) CUSTOMS UNION THE Elimination of tariffs (Art. 12-17) and Elimination quotas (Art. 30/34) plus all measures having equivalent effect (neg. integration) integration) + s Imposition of a common commercial Imposition policy (pos. int.) policy s EC EXPERIENCE WITH TRADE LIBERALIZATION LIBERALIZATION NTBs remained important until recently NTBs (e.g., internal taxation, technical standards, public procurement, national quotas) quotas) s White Paper/Single Eur. Act: elimination White of remaining barriers to trade of s ECONOMIC EFFECTS OF CUSTOMS UNIONS CUSTOMS s s Static welfare effects: trade creation vs trade diversion trade Dynamic welfare effects: • productivity effects • economies of scale • learning effects • more competition • terms of trade effects • increased technical progress • factor price equalization Customs union theory Customs s s s s Pre-1950 view was that customs unions implied Pre-1950 a move towards free trade and were therefore welfare-improving welfare-improving Jacob Viner (1950) showed that customs unions Jacob have contradictory effects on welfare due to their trade creation and trade diversion effects trade trade Lipsey (1957) extended this analysis to include Lipsey consumption effects consumption customs union theory addresses the trade and customs welfare effects on both members and the rest of the world of a change from national tariff protection to a customs union protection TRADE CREATION/DIVERSION TRADE A Tariff Tariff Production costs 50 Production Price in A before CU 50 Price Price in A after CU with B 50 Price Price in A after CU with C 50 Price B C 100%100% 20 35 40 70 20 70 40 35 Trade Creating CUs P CS = +a+b+c+d+e+f+g+h PS = -a-e TR = -c-g NET = +(b+f) + (d+h) bcd fgh Q Pb+t a Pc e Pb A BC D Trade Diverting CUs P CS = +a+b+c+d PS = -a TR = -c-g NET =+(b+d) - g a bcd g Q Pb+t Pc Pb ABC D INCIDENCE OF EFFECTS INCIDENCE production structure: complementary production vs. substitutive vs. s size of the union s level of initial tariffs s Initial cost differences s transportation and transaction costs s flexibility/adaptability of the CU flexibility/adaptability members (institutional structures) members s The Kemp-Wan theorem The s Argument so far is that a CU may not lead to Argument an overall welfare improvement for Union members. Also, trade diversion hurts ROW exporters. However, if we allow the possibility of costless redistribution between partners, then it is possible to prove that a CU need never harm any country. This argument is any known as the Kemp-Wan theorem (1976). It depends on the CET being a variable and being set at the appropriate level. being Early experience with the CU: Early trade creation/diversion & intra-industry trade s s s s s s Trade creation: 30%; trade diversion 15% Static welfare gain: not more than 0.5% of GDP Furthermore: lots of intra-industry trade (IIT): two-way Furthermore: trade in similar, sometimes identical, products trade IIT arises because of differentiated goods (demand for IIT variety) and because there are fixed costs to producing each new variety each IIT between EU countries grew rapidly until the 1970s, IIT then slackened off then IIT has the policy implication that adjustment costs may IIT be lower, and thus political opposition to trade liberalisation is reduced liberalisation CU theory under imperfect competition competition Critique of traditional theory • traditional theories based on assumption of perfect competition • welfare effects are a consequence of cost differences between welfare countries. countries. • size of the market that results from integration is not directly size important important Real world characterised by: • iimperfect competition in industrial markets because of the mperfect existence of economies of scale and product differentiation existence • demand and hence the size of the market are of central importance demand and affect welfare even where production and cost conditions are completely uniform for all the countries .... completely CU theory under imperfect competition competition ... thus additional gains to a CU because of: s increased competition leading to greater technical efficiency increased (“cold shower” effect) (“cold s changes in efficiency as economies of scale are utilised s increased competition between firms erodes market power s the existence of more product varieties These gains are grouped under the heading of dynamic gains These dynamic from market integration in contrast to the static gains which static arise from resource reallocation within countries arise Integration and X-inefficiency Integration Price and marginal cost A MC1 MC2 P1 B C SG DUK1 DUK O q1 q2 q3 q4 Quantity Economies of scale Economies s s s s Economies of scale in production for a firm imply that average costs fall Economies as output is increased. This is shown by a fall in the long-run average cost curve of the firm (decreasing costs). Scale economies may be associated with the size of plant (engineering Scale economies, or the length of the production run), or with the size of the firm, reducing per unit R&D and marketing expenditure which are now spread over a larger output volume. Such economies are known as internal economies of scale. internal External economies of scale are associated with the expansion of an industry which lead to the cost curves of firms within the industry falling as total output is increased. They may be due to the development of specialised services or improvement of marketing facilities resulting from the expansion of industry output. from Internal economies of scale imply imperfect competition and economic Internal integration will have pro-competitive effects as segmented markets are brought together. External economies of scale do not imply any change in market structure and lie behind the next slide. change Customs unions and economies of scale of Trade creation effect Cost reduction effect PA ACA Consumption effect PU PW XA PB ACB DA X'A XB X'B DB DAB Home country Partner country Integration and monopoly power Integration s s In imperfect competition firms exercise In market power to the extent that price exceeds marginal cost marginal By increasing the size of the market, By economic integration reduces the extent of monopoly pricing practices. Prices fall, and consumer welfare increases by more than producer surplus falls, as shown on the next overhead. overhead. Integration and monopoly power Integration Price and marginal cost A MC1 MC2 P1 SG DUK MRUK O q1 q2 q3 Quantity Pro-competitive effects of larger market size market s The following diagram brings together the three welfareimproving effects of integration under imperfect competition: • cost reductions due to internal scale economies • greater variety • reduction in market power illustrated by the reduction in the reduction price markup over marginal costs price In addition, further cost reductions may arise due to the ‘cold In shower’ effect of greater competition. shower’ A customs union with monopolistic competition monopolistic p1 B competition ensures price equals average cost, i.e. zero profit cost reduction effect p1 p2 p3 ac mc optimal level of production q1 B E ac mc C mr D1 q1 mr q2 D1 D3 D2 Individual country equilibrium Customs union equilibrium THE COMMON MARKET THE Free movements of labour + s Free movements of capital s  Welfare effects: free movement free increases welfare (GNP) increases Wage formation in nonWage integrated markets Wages Da F E Wages Sa Db S H Sb Workers Workers Country A Country B Wage convergence in integrated markets markets Wages Da F E 1 J K 2 L Sa + Sb/exc R 3 H Workers P 4 U S 5 T Wages Sa Db Db + Da/exc Sb Workers Country A Country B Welfare effects of integrating labour markets labour Category Workers Employers Country A B B to A A B Gains * HRPU UPTS JEFL * Losses JEFK * * * HRPS Interest equalisation in a common capital market common A Gain to P equal to increase in GDP less cost of paying H for the cost of using K*K0 capital B C ru rh M Gain to H from investing K*K0 capital in P rather than investing it at home rp ru D G N Oh K* K0 Op Factor mobility and the spatial concentration of economic activity concentration The 'cumulative causation' thesis. With capital not flowing to the weaker regions and labour flowing to the higher productivity ones, weaker regions lose their best labour and will have little local investment, thus leading to 'unbalanced growth'. r Q K M H Oh C B G F D E Op Krugman's unbalanced growth hypothesis - L Little evidence that removal of barriers to factor market integration in the EU has to date led to steady income divergence. How open is the EU labour market? market? s s Treaty of Rome provisions • Art 48 and 49 defined freedom of movement for workers • Art 52-58 established freedom of establishment • supporting provisions (maintenance of social security rights, supporting right to use employment services, right to training) right Barriers to labour mobility • Little evidence of much labour mobility to date • Exclusion of public service jobs • Need to provide information on vacancies • Transferability of social security payments • Mutual recognition of qualifications Shares of foreign nationals in EU member state labour forces member Country Belgium Denmark Germany Greece Spain France Ireland Italy Luxembourg Netherlands Portugal United Kingdom Austria Finland Sweden EU Source: El-Agraa Other EU 1990 5.2 0.5 2.8 0.2 0.1 3.0 2.1 na 31.5 1.4 1.4 1.6 2.0 1995 5.4 0.8 2.8 0.2 0.3 2.5 2.4 0.1 36.2 1.7 1.7 1.6 1.1 0.2 2.0 1.7 1990 0.2 1.5 5.7 0.5 0.1 3.5 0.5 Na 1.9 2.3 2.3 1.8 2.8 Non-EU 1995 2.5 1.1 6.2 1.5 0.5 3.7 0.6 0.4 2.8 2.2 2.2 2.0 8.5 0.5 2.1 2.9 Treatment of non-EU nationals Treatment s s Internal labour mobility implies common rules on Internal immigration and asylum-seekers immigration Steps towards a joint EU migration and asylum policy • Schengen Agreements I and II (1985 and 1990) – intergovernmental agreement signed by only some EU intergovernmental members; common visa policy restricted to short-term visitors members; • Dublin Convention (1990) – rules governing treatment of asylum seekers • Maastricht Treaty (1992) – the third pillar gave EU some rights to define a common the immigration policy immigration s In spite of these developments, the EU has no explicit In collective labour immigration policy. Current debate has few economic perspectives. few The Internal Market: Internal The costs of non-Europe The costs s s s s Customs-related costs put a charge on companies equal to Customs-related a major portion of their profits on intra-EU trade; around 25% in many sectors. 25% Industries in areas like motor manufacturing and Industries telecommunications losing billions because of inefficiencies imposed by divergent product standards or protectionist government procurement protectionist Smaller companies to a significant extent debarred from Smaller trans-border business activity by administrative costs and trans border regulatory hassles. regulatory A bewildering array of price differences between MS. bewildering Prices of some financial services can vary by 50% from one state to another. state The 1992 process The s s Limitations of the original Rome Treaty The importance of EC Court of Justice The decisions decisions • Cassis de Dijon (1979) • The German beer purity case (1987) s s The 1985 Cockfield White Paper • distinguished physical, technical and fiscal barriers The 1986 Single European Act • defined the internal market • iintroduced qualified majority voting on single ntroduced market issues, with few exceptions. market Principal types of barriers in goods markets goods s Physical frontiers • eliminating frontiers implied either eliminating policies eliminating (MCAs) or moving checks elsewhere (plant health, statistics) (MCAs) s s s Technical standards • mutual recognition replaced harmonisation of standards Public procurement • tiny share of cross-border purchases; rules on tendering Fiscal differences • original concern was with indirect tax differences because of original the role of frontier checks in policing trade the • more recent ‘level playing field’ concerns (corporate profits more tax) tax) Service market integration Service s s s The specificity of services trade liberalisation Basic elements contained in the Rome Treaty - Art. Basic 52 on right of establishment and Art. 59 on freedom to provide services across borders But original Treaty provisions heavily qualified • special regimes for transport, financial services, telecomms special and post and s Role of the Court of Justice in developing mutual Role recognition principle also in services - home country not host country control not Case study: a European financial area financial s s s The key role of regulation in financial services The markets markets The 'old' integration strategy The 1985 White Paper 'new approach' • agreed set of minimum harmonised regulations • mutual recognition of the regulatory arrangements of other mutual member states member • regulation based on home country control - single passport regulation home s s s The Second Banking Directive, 1989 Capital Liberalisation Directive, 1988 Consequences of EC-1992 for financial services Quantifying the effects of the SEM SEM s A more economically meaningful list of trade more barriers barriers • • • • • Tariffs Tariffs Quantitative restrictions Quantitative Cost-increasing barriers Cost-increasing Market-entry restrictions Market-entry Market-distorting subsidies s Benefits are two main kinds • ‘comparative advantage’ benefits due to changes in relative comparative prices when barriers are removed prices • market integration benefits due to reduction in monopoly market rents, X-inefficiency and reaping of scale economies rents, Three methodologies to derive empirical estimates empirical s Microeconomic approaches • welfare analysis welfare • reduction in price divergence s Macroeconomic approach The microeconomic welfare approach begins The with the standard trade creation/trade diversion diagram adapted to take account of invisible trade barriers invisible s Stages in the microeconomic Stages welfare analysis of SEM effects welfare Studies - business surveys - barrier studies - sector studies Tariff equivalent of market barriers Supply/demand models of 65 sectors (Davenport & Cawley) Stage 1 and Stage 2 effects Economies of scale (Schwalbach) Set of indirect to direct effect multipliers (Smith and Venables) Stage 3 effects + Competition effects (Smith and Venables Stage 4 effects Variant I Integrated Stage 3 and 4 effects Variant II Estimates of the benefits of removing barriers to the SEM removing ECU (billion) (a) (b) Barrier removal effects Stage 1: Barriers affecting trade (frontier controls, QRs and costincreasing barriers) Stage 2: Barriers affecting production (market entry barriers) Market integration effects Stage 3: Barriers preventing the reaping of economies of scale Stage 4: Barriers which allow X-inefficiency and monopoly rents to exist Total benefits Source: Emerson p. 203 % of EU GDP (a) (b) 0.2 0.3 8 9 57 71 2.0 2.4 60 46 171 61 46 187 2.0 1.6 5.8 2.1 1.6 6.4 Price convergence approach Price s s Based on thesis that prices in the Union will converge Based with the process of market integration with two hypotheses about the extent to which prices two would converge: would • manufactured goods above the Community average price manufactured were assumed to converge to that average. Other goods and services - prices above the average for the prices in the lowest two price countries were assumed to decrease by half their deviation from that average. • prices of other goods and services were assumed to prices converge to the average of prices in the two lowest price countries. countries. s Results suggest economic gains will amount to some Results 82 to 142 billion ECU for the 9 MS, or between 2.8 and 4.8% of GDP. Macroeconomic methodology used to quantify SEM effects used s s estimates of shocks derived from consultants’ studies estimates on abolition of frontier controls, opening up of public procurement, liberalisation of financial services, and ‘supply effects’ (covering technical and regulatory obstacles removal, economies of scale and competition) competition) shocks then fed into OECD macro model to simulate shocks secondary effects (due to multiplier processes, price competitiveness effects) and, in particular, the easing of various macroeconomic constraints (improvement in budgetary and external deficits, reduction in inflationary dangers, etc.) inflationary Macroeconomic benefits of creating the SEM creating GDP (%) Without accompanying measures With accompanying measures Public finance External position Disinflation Prices (%) Employment (millions) 1.8 5.7 4.4 5.0 External balance (% of GDP) 1.0 -0.5 0.0 -0.2 4.5 7.5 6.5 7.0 -6.1 -4.3 -4.9 -4.5 Source: Cecchini Report, Emerson et al. p. 208 Summary and review of Cecchini Report studies Report s s s s Hugely complex economic analysis, 24 reports in all Criticised for over-optimistic assessment of likely Criticised impact, because assumes full implementation of SEM regime regime Criticised for under-optimistic assessment because Criticised additional positive factors (such as dynamic effects from the stimulus to investment and a higher long-run rate of growth) are ignored. rate What, in hindsight, were the effects? 1996 What, Commission Review of the SEM attempted to answer this question. this 1996 Commission Review of the Single Market (1) Single s Novel features • asked businesses what they thought of the Single Market • considered locational effects in addition to the allocation considered effects dealt with by Cecchini effects s The state of opinion • savings from abolition of frontiers partially offset by setting savings up new VAT administration system up • many enterprises still had difficulties with technical standard many requirements requirements • very little intra-EU growth in public procurement business 1996 Commission Review of the Single Market (2) Single s Accumulation effects • relatively short time horizon to evaluate welfare effects. Also relatively lots of noise due to extraordinary other events lots • Estimated boost of between 1.1 and 1.5% of GDP due to Estimated SEM, generating some 300,000 to 900,000 exra jobs. SEM, s Locational effects • evidence of convergence helped at least in part by the SEM • no convincing correlation between the nature of trade no creation (intra-industry or inter-industry) and convergence performance. performance. • Draws negative conclusion that integration process as such Draws is not harmful to successful development, for those countries that have the appropriate conditions for sustained growth in the first place the Summary and conclusions Summary s s s s With the removal of border barriers to trade, the With importance of beyond-the-barrier barriers increased. Such barriers arise from the role of the state in a mixed economy and are almost inevitably discriminatory against outsiders. against Two approaches possible to eliminate these barriers - reregulation at the EU level or mutual recognition. To regulation avoid the ‘race to the bottom’ effect, the EU legislates for minimum standards minimum The single market experience teaches the distinction The between enacting legislation and seeing changes on the ground ground Path-breaking economic quantification of effects ...
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This note was uploaded on 03/23/2010 for the course ECON D0M09A taught by Professor Vanmourik during the Winter '10 term at Katholieke Universiteit Leuven.

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