REGIONAL TRADE

ARRANGEMENTS
Module 6
Regional Integration vs.
Multilateralism
• WTO-Major purpose is to promote trade liberalization through
worldwide agreements
• Regional Agreements rose sharply in the last 30 years; easier to
negotiate trade deals with fewer nations.
• Regional trade agreement: Trade barriers reduced for smaller group of
partner nations; discrimination against rest of the world
• WTO trade agreement: Trade liberalization by any one nation is
extended to all WTO members (159) on a non-discriminatory basis.
• Members of regional agreements may not be very interested in
worldwide liberalization.
Regional Integration vs. Multilateralism
(cont’d)
• Regional agreements could help, rather than hinder, global
agreements, if structured on basis of openness & inclusiveness
• They achieve deeper economic interdependence among members
• Greater commonality of interests
• Simpler negotiating process
• As market area grows, non-members want to join to enjoy member benefits
• Partial adjustment of workers
• Benefits workers and industries
• Promotes political support for trade liberalization
Types of Regional Trading
Arrangements
• Economic Integration
• Process of eliminating restrictions on int’l trade, payments & factor mobility
• Uniting 2 or more countries in a regional trading arrangement
• Free Trade Area (FTA)
• Members agree to remove tariff & non-tariff barriers among themselves
• Members maintain their own trade restrictions against outsiders (ex. NAFTA)
• Customs Union
• Same as FTA, but members impose same trade restrictions against non-
members (ex. BENELUX, formed in 1948)
• Free trade within union
• All restrictions against outsiders are equalized
Types of Regional Trading Arrangements
(Cont’d)
• Common Market
• Allows free movement of goods & services among members; common trade
restrictions against non-members; free movement of production factors among
member nations.
• More complete stage of integration than FTA or Customs Union (EU got status in 1992)
• Economic Union
• National, social, taxation, and fiscal policies harmonized and administered by
supranational institution.
• Requires agreement to transfer economic sovereignty to a supranational authority
• Monetary Union
• Unification of national monetary policies, and acceptance of common currency,
administered by a supranational monetary authority (ex. Canada, US)
Why Regional Trade Arrangements?
• Economies of scale
• Specialization in certain products or services w/out fear of
competition
• Managing immigration flows & regional security
• Accessing a large regional market that could be challenging (NAFTA)
• Bypassing or avoiding barrier policies from neighbouring countries
• Not wanting to be left out of an agreement between other
neighbouring countries
Effects of Regional Trading
• Static Effects – on productive efficiency & consumer welfare
• Trade Creation Effect: World Welfare Increasing
• Occurs when a domestic production of one customs union member is replaced by
another member’s lower cost imports. The welfare of the member countries is increased
because it leads to increased production specialization.
• Trade Diversion Effect: World Welfare Decreasing
• Occurs when imports from a low-cost supplier outside the union are replaced by
purchases from a higher cost supplier within the union
• Static analysis concludes that formation of customs union will increase the
welfare of its members, as well as the rest of the world, if the positive trade
creation effect more than offsets the negative trade diversion effect
• Competitive economies are probably union members
• Larger # of members in a union = more opportunities for competitive members
Effects of Regional Trading (cont’d)
• Dynamic Effects – relates to a member’s long run growth rates
• May more than offset unfavourable static effects
• Include economies of scale, greater competition, stimulus of investment
• Results of customs union: Market enlargement-union markets are larger
than individual countries
• Leads to production savings due to economies of scale
• Efficiencies attributable to greater specialization
• Use of most efficient equipment
• More complete use of byproducts
• More competition, less monopoly
• Higher productivity
• All above lead to a consistently higher rate of growth
EUROPEAN UNION
• Treaty of Rome in 1957 created the European Community; 6 members
only.
• Objective was Economic Integration, leading to Economic Union
• Grew over the years to include 28 members by 2013. Named
European Union.
• 1968: Dismantled tariffs & became a Free Trade Area
• 1970: Became a Customs Union, when it adopted common external
tariff system for its members
• Analysis: Trade creation exceeded trade diversion by 2-15%.
• Additional competition & investments + Economies of scale.
EUROPEAN UNION (cont’d)
• After forming a customs union, there was little growth towards
becoming a common market.
• 1985: Removed last non-tariff barriers to becoming a common market
• Border controls & customs red tape
• Divergent standards & technical regulations
• Conflicting business laws
• Protectionist procurement policies of governments
• Became European Common Market; 2nd trade bloc in the world
• 2002: Became Monetary Union, with European Central Bank & Euro
EUROPEAN UNION (cont’d)
• Convergence came to align economies of member countries
• Price stability: Inflation can’t be more than 1.5% over average of lowest 3
inflation rates
• Low long-term interest rates: No more than 2% above average rate in 3
lowest countries
• Stable exchange rates: Within target band of union; no devaluation in 2 years
prior to joining union
• Sound public finances: Budget deficit <3% of GDP; gov’t debt <60% of GDP
• Eurozone (18 countries) have Euro as official currency
• Euro: 2nd largest reserve currency & 2nd most traded after USD
Agricultural Policy
• Common agricultural policy to replace individual nations’ policies
• Includes deficiency payments, output controls & direct income payments
• Variable levies on external imports
• Export subsidies
• Because of different efficiency levels between members, common policy is
supporting inefficient farm production
• Restricted more efficient imports from non-member countries
• Leads to trade diversion and reduction in welfare due to high price support
• Variable Levies: Determined daily; = difference between lowest overseas
price and the support price.
• EU producers insulated from lower external prices
• EU consumers protected from rising prices
Agricultural Policy (cont’d)
• Variable levies – more restrictive than fixed levies
• Discourages foreign producers from absorbing part of tariff
• Upper limit applied to variables levies
• Export Subsidies – to encourage exporting surplus production
• Government gives farmers the difference between the international price and
the local “support” price
• Equal to government buying surplus products from the farmers at the local
support price, and selling it overseas at a lower price.
• Export subsidies lead to disgruntled foreign farmers, accusing Europeans of
too much protectionism.
Is EU really a Common Market?
• Although the EU has been working hard to homogenize its systems,
there are still lots of differences between the different requirements
of its member states
• Different cultures, local requirements, etc. affect producers and their
economies of scale; producers fight legal battles w/local governments
• Battles between the European Commission and individual governments
• So, The Common Market remains “uncommon”!
EMU: Cost & benefits of a common currency
(EURO)
• European Central Bank (ECB)
• Located in Frankfurt, Germany
• Responsible for monetary policy & exchange rate policies
• Controls supply of euro’s
• Sets short term euro interest rate
• Maintains permanently fixed exchange rates for member countries
• E.g. prices in different American states
Optimum Currency Area
• Optimum currency area: Region in which it is economically preferable to have a
single official currency rather than multiple official currencies
• Advantages/gains of adopting a common currency
• The risks associated with exchange fluctuations are eliminated within a common currency area
• Costs of currency conversion are lessened
• The economies are insulated from monetary disturbances and speculation
• Political pressures for trade protection are reduced.
• More uniform prices; Greater certainty for investors; Enhanced competition; Promotion of price stability

• Disadvantages/risks of adopting a common currency

• Could entail costs, esp. if interest rate changes affect different countries differently
• Absence of individual domestic monetary policy to counter macroeconomic shocks.
• Inability of an individual country to use inflation to reduce public debt in real terms.
• The transition from individual currencies to a single currency could lead to speculative attacks
Optimum Currency Area (cont’d)
• Workers in affected area must be willing & able to move to other areas
• Country must be able to adjust prices & wages in response to economic
disturbances
• Some automatic mechanism to transfer fiscal resources to affected country
• For best chance of success for a currency area
• Countries should have similar business cycles and economic structures
• Monetary policy should affect all member countries in similar manner
• No legal, cultural or linguistic barriers to labour mobility
• Wage flexibility
• System of stabilizing transfers
Eurozone problems & challenges
• Some countries didn’t meet economic parameters before joining
• Standards ignored once countries became members
• Integrating different economies w/out ways to adjust them
• No real labour mobility and price/wages adjustments
• Some economies (Germany) were more productive than others
• Will Eurozone survive?
• It is not strong enough to withstand a real crisis (recession of 2008; Greece almost failing in 2011,
etc.)
• No mechanisms in place to prop up economies; this leads to always having to “bail out” countries
in financial trouble.
• Without enforcing mechanism to control economies, budgets, deficits in member countries,
Eurozone will always be in a precarious position
• Load is always falling on the strong economies (Germany) to help out poorer members
NAFTA
• Started as FTA between Canada & US in 1989
• Turned into a 3-country agreement to include Mexico in 1994
• Political system, repressed economy and resulting poverty in Mexico
couldn’t be contained forever; This resulted in 1 of 2 options:
• Help Mexico develop into an integrated North America
• Watch things get worse, and spill over the border into the US
• NAFTA supposed to provide members access to the others’ markets
• Cheap skilled labour in Mexico
• Investment & technology in US
NAFTA (cont’d)
• Mexico’s benefits from NAFTA
• Replaced low wage labour countries like Korea and Taiwan
• Investments in Mexico increased employment & wages, foreign exchange earnings, and transfer of
technology.
• Costs
• Farmers had to compete with poultry, meat, pork products from the US
• Canada’s benefits
• Equal access to Mexican market; no loss to trade preferences in the US; maintenance of status in int’l
trade.
• Costs
• Close integration with US; fear of losing social welfare (universal health care; generous minimum
wages); fear of US imposing downward pressure on tax levels.
• NAFTA unable to fix most of Mexico’s problems: corruption, lower education, inadequate
infrastructure, etc.
NAFTA-Benefits & Costs for US
• Benefits
• Expanded trade opportunities
• Reduced prices
• Increased competition
• Ability of US firms to use economies of scale
• Access to cheaper skilled labour
• More reliable source of oil
• Reduced Mexican illegal immigration
NAFTA-Benefits & Costs for US
(cont’d)
• Costs
• Citrus growing & sugar industries lost competitiveness
• Increased unemployment of unskilled labour (although the expected US
companies exodus to Mexico didn’t happen in a large scale because of higher
(4.6x) productivity of US labour)
• Possible closure of more environmentally-friendly industries in US
Major Western Hemisphere Regional Trade
Agreements
Agreement Members Year effective

Central American Free Trade Agreement (CAFTA) Costs Rica, El Salvador, Guatemala, Honduras, Nicaragua, Dominican Republic, 2005
United States

North American Free Trade Agreement (NAFTA) Canada, Mexico, USA 1994

Southern Cone Common Market (MERCOSUR) Argentina, Brazil, Paraguay, Uruguay 1991

Caribbean Community and Common Market Antigua, Bahamas, Barbados, Barbuda, Belize, Dominica, Grenada, Guyana, 1973
Haiti, Jamaica, Montserrat, St. Kitts, Nevis, St. Lucia, St. Vincent, Surinam,
Trinidad, and Tobago

Andean Community Bolivia, Colombia, Ecuador, Peru, Venezuela 1969

Central American Common Market Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua 1961