Ch12_Trade Blocs

Ch12_Trade Blocs - TRADE BLOCS &TRADE BLOCKS 1...

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Unformatted text preview: TRADE BLOCS &TRADE BLOCKS 1 Agenda • Trade blocs Free trade areas Customs unions Common markets Economic unions • Trade creation, Trade diversion • Trade blocks Trade embargoes • NAFTA • The E.U. 4 Main Types of Economic Integration • Free trade area Eliminates tariffs within the area only Each country retains its own policy towards nonmembers (EFTA, NAFTA) • Customs union Adds a common external policy to the free trade area (EEC, MERCOSUR) 6 •1 Main Types of Economic Integration • Common market Factors of production (labor and capital) can flow freely within a customs union (EU in the 1990s) • Economic union Common determination of fiscal and monetary policies in a common market EU may be on the way to becoming economic union Political union? How does economic union work without political union? 7 Figure 12.1 – Types of Economic Blocs 8 The Effects of a Trade Bloc • Trade creation (benefit) Home-country consumers switch from highcost domestic suppliers to lower cost suppliers in a partner country 9 •2 The Effects of a Trade Bloc • Trade diversion (cost) Home-country consumers switch from lowcost suppliers outside the union to higher-cost suppliers in a partner country This can happen easily if the countries increase their protection against nonmembers after the union if there was relatively high protection in the first place 10 Who Are the Trade Blocs? • The EU (27 countries) • The remaining EFTA (1960): Iceland, Norway, Liechtenstein, Switzerland • Preferential trade agreements between the EU and 20 other countries • NAFTA (3 countries) • Trade agreements between Mexico and the EU, EFTA, Japan, Chile, Israel EU and South Korea 11 Who Are the Trade Blocs? (cnt) cnt) • Free-trade agreement between the U.S. & Australia (05), Bahrain (04), CAFTA-DR (05) Chile (04), Israel (85), Jordan (01), Morocco (04), Oman (04), Singapore (03), SACU (03) CAFTA: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Dominican Republic SACU: Botswana, Lesotho, Namibia, South Africa, Swaziland To ratify: South Korea (07) Intended: Malaysia TPAs: Colombia, Panama, Peru 12 •3 Who Are the Trade Blocs? (cnt) cnt) • Mercosur(l) (since 1991): Argentina, Brazil, Paraguay, Uruguay, Venezuela (2006) Bolivia, Chile, Colombia, Ecuador, Peru have associate member status (2005) • Switzerland & Norway’s trade agreements with the EU • Turkey’s trade agreements with the EU, EFTA, and 6 other countries 13 A New Entity: UNASUL • The UNASUR(L) is the integration of the MERCOSUL and Andean Community of Nations South American Community of Nations; treaty signed 5/2008 They are trying to implement a model very similar to the EU system. The attempt is to create a bloc between all the South American nations. So far, they have had a successful start http://en.wikipedia.org/wiki/Union_of_South_American_Natio ns#Overview 14 Who Are the Trade Blocs? (concl) concl) • AFTA; ASEAN Free Trade Agreement ASEAN formed in 1992 AFTA members (1995): Brunei, Indonesia, Malaysia, Philippines, Singapore, Thailand Vietnam(95), Laos, Myanmar(97), Cambodia(99) 15 •4 Equilibrium with Tariffs Small open economy SCanada Tariff revenue from foreign imports PAutarky PTariff PWorld DCanada QDomestic QTariff QTotal Remaining gains from free trade after imposing the tariff Losses from imposing the tariff 16 Trade Diversion vs. Trade Creation • The story (U.K.): £1,000 tariff on all foreign cars Assumes all supply functions are flat UK buys cars from Japan Lowest cost producer Joins EEC: No tariff for EEC goods Same tariff to the RoW UK now buys cars from Germany Even though the low-cost producer is still Japan 17 Trade Diversion versus Trade Creation: UK Market for Imported Compact Cars Net Gain b - c b<c b>c de 18 •5 Trade Diversion vs. Trade Creation • What are the gains and losses to the UK from this customs union? Consumer gain: a + b Tariff revenue loss: a + c Net: b – c • This can be a gain or a loss • c is also the loss from trade diversion No tariff but not buying from the low-cost producer 19 Trade Diversion vs. Trade Creation • Trade creation happens because the UK buys more cars Lower prices • Trade diversion happens because UK imports switch from Japan to Germany 20 Trade Diversion vs. Trade Creation • What are the costs: Trade creation costs: b = Trade diversion costs: c = Net loss = 21 •6 Trade Diversion vs. Trade Creation • What are the costs: Trade creation costs: b = (15-10)*500/2 = £1.25 million Trade diversion costs: c = 10*500 = £5.00 million Net loss = £3.75 million 22 Pure Trade Creation • If Germany was the low cost producer, then the U.K. would have been buying German cars with the tariff before joining the EEC would continue to buy German cars after joining the EEC would buy more cars because of the lower price No trade diversion Same as removing a tariff 23 Trade Creation vs. Trade Diversion • If all supplies were elastic (upward-sloping), then Trade diversion may improve the terms of trade for the bloc partners Similar to the large-country case with tariffs 24 •7 Equilibrium in a Customs Union SCanada PCan PUS PRoW a d b e f c g h DCanada QCan QCan QWorld QUS Net gains from creating the custom union Net losses from trade diversion 25 Gains and Losses From a Trade Bloc • Difference between the production costs of foreign producers inside and outside the trade bloc The gains are higher when the differences in production costs between foreign producers are small • The elasticity of demand The gains are larger when the elasticity of demand is large 26 Other Possible Gains • Increased competition may reduce prices Reduce monopoly in each tariff-protected economy • Increased competition may lower the costs of production Innovation, reduce inefficiencies • Lower costs from scale economies Larger markets • Better opportunities for business investment 27 •8 Embargoes: Trade Blocks • The story: Before the embargo, the black-hat guys face an import supply of Sn + Se, the combined supply from the white-hat guys (Se) and the neutrals (Sn) Price is P0 (equilibrium is at E) The white-hats impose an embargo Supply is now only Sn Price is P1 (equilibrium is at F) White-hat guys see a price drop in their exports 30 Effects of an Embargo on Exports Exports Import demand 31 Failed Embargoes • Why would an embargo fail economically It could backfire Export supply of the white-hats is not very elastic Price depends on the exports Elastic demand in embargo target In the book’s diagram, a is large, b + c are small It could be close to irrelevant Close and plentiful substitutes Highly elastic supply from neutrals Maybe elastic demand in embargo target In the book’s diagram, b + c are small 33 •9 Summary • Trade blocs can be: free trade areas, customs unions, common markets, economic unions • Trade blocs generally both create and divert trade Gains are not guaranteed • Trade blocks (embargoes) can fail for economic as well as political reasons 34 NAFTA • North American Free Trade Agreement Canada, Mexico, U.S. Ratified in 1994 • Why? • Did it work? Economist Article, “Free Trade on Trial” 36 THE END 38 •10 European Economic Integration 39 •11 ...
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