CUSTOMS UNIONS - CUSTOMS UNIONS 1 Free Trade 2 Customs...

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Unformatted text preview: CUSTOMS UNIONS 1. Free Trade 2. Customs Unions Defined 3. Customs Unions Analysed 4. Jacob Viner and The Customs Union Issue The (1950) 5. Trade Creation (TC) (TC) 6. Trade Diversion (TD) 7. Consumption Effect 8. Imperfect Competition 9. Economies of Scale 10. Dynamics: Cumulative Causation 1. Free Trade “The argument for free trade is based squarely on the textbook theory of comparative advantage. Put simply, the argument is that unfettered competitive markets will allocate scarce resources to their most efficient uses.” Under competitive conditions, free trade maximizes economic welfare pareto optimal. This does not justify the emphasis on free trade as: does not justify the emphasis on free trade as: Pareto efficiency may not be enough, growth and development are not pareto efficient, and in the long run we may all benefit from other policies. Just because free trade is pareto efficient does not mean that there are not other policies which are also pareto efficient. efficient. Second Best Theory of the second best if, for some reason we cannot obtain all the conditions which would result in an efficient outcome, then there is no point in trying to achieve the others, as that may not improve welfare. Free Trade The assumptions underlying the idea that free trade is efficient are unachievable. Theory assumes perfect competition, no externalities or spillovers, spillovers, abstracts from the problems of uncertainty and assumes full employment of all resources. The predictions of the theory of free trade have not been born out. The theory is based on static maximization at a point of time. Customs Unions Analysed 2. Customs Unions Defined A CU comprises two or more countries which agree to: 1. abolish tariffs and quantitative restrictions on trade trade between themselves; 2. adopt a uniform system of tariffs on imports from non-members countries; this is known as nonthe Common External Tariff (CET) 3. share the revenue from the CET in a prepredetermined way. Originally most economist thought CUs always improved welfare because: free trade maximises welfare, and the imposition of tariffs reduces welfare; the creation of a CU involves the CU elimination of tariffs and is therefore a movement towards free trade; and thus the creation of a CU increases welfare, even though it might not maximise it. 1 4. Jacob Viner and The Customs Union The Issue (1950 In The Customs Union Issue, Jacob Viner showed that The the above analysis was not generally correct, for reasons related to the theory of the second best. CU formation would increase trade between the member countries but whether or not this was member countries but whether or not this was desirable desirable depended on the source of increased trade. Viner identified two possible cases: trade creation and trade trade trade diversion. “In a world of trade protection, a reduction of some trade protection or the introduction of a customs union , both of which constituted steps on the road to free trade by removing some barriers, would not necessarily improve efficiency. 5. Trade Creation (TC) (TC) TC involves a shift in domestic consumption from a high cost domestic source to a lower cost partner source, as a result of the abolition tariffs on intra-union trade. In intraViner's words: Viner "There will be commodities which one of the members of the CU will now newly import from the other but which it formerly did not import at all because the price of the protected domestic product was lower than the price at any foreign source plus the duty." 6. Trade Diversion (TD) 7. Consumption Effect TD involves a shift in domestic consumption from a low cost world source to a higher cost partner source, as a result of the elimination of tariffs on imports from the partner. In Viner's words: words: "There will be other commodities which one of the members of the CU will now newly import from the other whereas before the CU it imported them from a third country, because that was the cheapest possible source of supply even after payment of duty." 8. Imperfect Competition 9. Economies of Scale The importance of imperfect competition is underlined by the extent of intra-industry trade intra(IIT) in similar products which we observe within the EU rather than the classical interinterindustry exchange of different products. Intradiff raindustry trade (IIT) two-way trade in similar, twosometimes identical, products. IIT arises because of differentiated goods (demand for variety). With imperfect competition, demand and size of markets becomes important, importance of economies of scale. The removal of tariffs on imports from the partner country may lead to a fall in prices paid by the home consumer, and, if demand responds to price, to a rise in quantity consumed. Scale economies associated with the size of plant (engineering 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 dit output volume internal economies of scale. External economies of scale the expansion of an industry the cost curves of firms within the industry as total output 2 10. Dynamics: Cumulative Causation The story so far is comparative static, comparing two equilibrium points, one before and one after the CU. CU consumption and production practices across Europe; product varieties, competition amongst firms with CU . Cumulative causation was first used by the Swedish economist Gunnar Myrdal in 1957 to convey the idea economist, Gunnar Myrdal in 1957, to convey the idea of of reinforcing processes by which the patterns of uneven development between regions, between countries and between economic and social phenomena may be perpetuated and even accentuated. In other words, change becomes progressive and propagates itself in a cumulative way. Cumulative Cumulative Causation “Change becomes progressive and propagates itself in a cumulative way” In this case, expansion of market leads to its own dynamics, which perpetuates growth and development. 3 ...
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