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Chapter-9

Chapter-9. The Political Economy of Trade Policy. The Welfare Effects of RTAs…. An RTA has two elements and thus two opposite effects: Trade Creation (Trade Liberalization Element): An expansion of in world trade that results from the formation of PTA (….Beneficial)

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Chapter-9

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  1. Chapter-9 The Political Economy of Trade Policy

  2. The Welfare Effects of RTAs… • An RTA has two elements and thus two opposite effects: • Trade Creation (Trade Liberalization Element): • An expansion of in world trade that results from the formation of PTA (….Beneficial) 2. Trade Diversion (Protectionist Element): • A shift in the pattern of trade from low-cost world producer to high-cost RTA member (s)…..(Harmful).

  3. The Welfare Effects of RTAs… Thus, the welfare (economic) impacts economic integration, depend on the net difference between trade creation effects and the trade diversion effects Hands-On-Practice….. Suppose autarky price of X in three countries (A, B, C) is as follows

  4. SA $5.00 PA $2.00 PB $1.50 PC DA N Q M P

  5. The Welfare Effects of RTAs… • With free international trade, from which country should A be importing? • how much would that be…? • A should import from C (the low cost world producer) • MN.

  6. SA DA $5.00 PA $1.50 PC Total Imports from C = MN Total Value of Imports = $1.5 X MN M N

  7. The Welfare Effects of RTAs… Suppose that producers in country A lobby their government so that it imposes a 100% Advalorem tariff on imports (from all countries) into A. 3. What would be the unit prices of imports from C (after tariff)? 4. What would be the unit prices of imports from B (after tariff)?

  8. SA DA $5.00 PA $4.00 PB + Tariff PC + Tariff $3.00 $2.00 PB $1.50 PC N Q M P R S

  9. The Welfare Effects of RTAs… 5. Once the tariffs are in effect, would country A need to change its trade partner? • NO!!! 6. If so, what would be the effect of the import tariff? • A Fall in Imports from C

  10. SA DA $5.00 PA PC + Tariff $3.00 Post tariff Imports From C = RS $1.50 PC Pre-Tariff Imports from C = MN M R S N

  11. The Welfare Effects of RTAs… • Suppose B negotiates with A and forms a Free Trade Area (FTA) ; Eliminates the tariff on imports. 7. What will be the effect of the formation of FTA between A and B?

  12. The Welfare Effects of RTAs… • Two effects… 1..Trade Diversion– A now imports from B; not from C. This would divert trade…(RS)….(from the low cost world producer (C) to the high-cost FTA member (B)).

  13. SA DA $5.00 PA PC + Tariff $3.00 Amount of Trade Diverted $2.00 PB $1.50 PC R S

  14. The Welfare Effects of RTAs… 2. Trade Expansion: • The increase in import resulting from the economic integration that eliminates trade barriers. • With integration imports will be PQ

  15. SA DA $5.00 PA PC + Tariff $3.00 Trade Diverted $2.00 PB Trade Created Q P R S

  16. The Welfare Effects of RTAs… • What is the Economic (Welfare) Effects of Economic Integration? (Is it Beneficial/ Harmful)?

  17. SA DA $5.00 PA PC + Tariff $3.00 c a b d $2.00 PB e $1.50 PC N Q M P R S

  18. The Welfare Effects of RTAs… 8.1. Economic Benefits: • Consumers in A benefit (Price falls from $3.00 to $2.00) • Consumers’ surplus would rise • Area (A + B+ C+ D)

  19. The Welfare Effects of RTAs… 8.2. Economic Losses: • Producers’ Surplus Falls • Area ( A) • Government Revenue Falls • Area (C + E)

  20. The Welfare Effects of RTAs… Net Economic Effects: Effects of Trade creation - Effects of Trade Diversion (A+B+C+D) – (A+ C+E) (A + B + C + D) – (A + C +E) (B + D) – (E)

  21. The Welfare Effects of RTAs… Implication • At best the welfare effects of economic integration is indeterminate (ambiguous). ..That is, there is No Guarantee that economic integration improves living standards. • Some conditions, however, could make the trade creation effects dominate the trade diversion effects • The higher the initial tariffs between member countries • The lower the barriers to trade with non-member countries • The greater the number of the members forming the integration and the higher the flow of goods between them

  22. In class exercise • Consider the following data detailing trade before and after a hypothetical country, Javaland forms an FTA with Macau

  23. In class exercise • How much trade was diverted? • How much trade was created? • Suppose Guam charges $7.00 for this product and Macau charges $8.00. If Javaland’s original tariff was $2 per unit, calculate the welfare gain or loss from forming FTA.

  24. The Welfare Effects of RTAs… Implication • At best the welfare effects of economic integration is indeterminate (ambiguous). ..That is, there is No Guarantee that economic integration improves living standards. ? ? ? ? ? ? ?

  25. Why RTA? • Why would A negotiate economic integration with B, while it can improve welfare more by integrating with C? • Reasons for the formation of trading agreements goes beyond the static gains and losses (Trade creation and trade diversion effects).

  26. Why RTA? • I. Dynamic gains from economic integration • Economies of large scale production • Increased market size; Foreign investment…. • Enhanced competition… • (What keeps a RTA from expanding to include every other country?)

  27. Why RTA? • II. Political (non-economic) reasons • Gesture for good neighborhood, regional security • Long term development goals, safe haven trading arrangements • Regional competition.

  28. Some Examples of RTA … • Two waves of economic integration: • 1960s • Most were modeled after European Community. • Attempts among developing countries met only with partial success. • Some African and Latin American plans failed. • Mid-1980s • European Union (EU) • North American Free Trade Agreement (NAFTA) • Association of South East Asian Nations (ASEAN) • Southern Common Market (MERCOSUR)

  29. Some Examples of RTA … • The North American Free Trade Agreement (NAFTA) • The European Union (EU)

  30. The European Union (EU)

  31. European Union: Members and Applicants, 2001 Sweden Finland Estonia Members Latvia Lithuania Denmark Applicants Ireland United Kingdom Poland Netherlands Germany Belgium Czech Rep. Luxembourg Slovakia Austria Hungary France Romania Slovenia Bulgaria Italy Portugal Spain Turkey Greece Malta

  32. The European Union (EU) • (1951): European Coal and Steel Community- (ECSC) _____________________________________ • Belgium, France, Italy, Luxembourg, The Netherlands, and West Germany) • Eliminate Tariff and Quotas between members and expand free trade

  33. The European Union (EU) • (1957): European Economic Community (EEC) __________________________________ • Rome Treaty---Agreement to reduce tariff and non-tariff trade barriers between members and institute common external tariff. • Gradual elimination of tariffs and quotas, expand trade flow

  34. The European Union (EU) • (1967): ECSC and EEC merged; European Union (EU) formed ___________________________________ • U.K., Ireland, Denmark (1973); Greece (1981); Spain and Portugal (1986); Austria, Finland, Sweden (1995). • About a dozen other countries on the waiting list (Expanding beyond W. Europe)

  35. The European Union (EU) • 1992 (Maastricht Treaty) Agreed to establish an Economic Union and Common Currency • 1999- European Monetary Union (EMU), 2002-Coomon Currency (Euro)—Less-UK, Sweden • Today EU is more than a free trade area/ custom union—Is almost an Economic Union • The benefits (trade creation effects) appear to outweigh the costs (trade diversion effects). Why? • Number of members and significance of trade between members (see graph)

  36. Intra-Group Trade as Percent of Total Merchandise Trade, 2000 70 Intra-Group Exports as Percent of Total Exports Percent EU Intra-Group Imports as Percent of Total Imports 60 50 40 30 20 10 0

  37. The North American Free Trade Agreement (NAFTA)

  38. The North American Free Trade Agreement (NAFTA) • What is NAFTA? • A free trade area (with few added touches) between the U.S., Canada, and Mexico. • Started on January 1, 1989– as Free Trade Agreement between the U.S. and Canada

  39. The North American Free Trade Agreement (NAFTA) • 1992, Canada and the U.S. agreed to expand the free trade area to include Mexico • 1993- the U.S. congress approved the agreement, NAFTA went into effect in 1994. • Tariff Reductions to be phased out in 15 years (2010)

  40. The North American Free Trade Agreement (NAFTA) • Additional issues relate to Labor & environmental standards • Each country is to enforce its labor and Environmental Laws • What is special about NAFTA?

  41. The North American Free Trade Agreement (NAFTA) • Expected to provide each member nation better access to the other’s markets, technology, labor and expertise. • Significant Differences….. • Size of the Economy;Average Earnings (Wages); Labor Productivity;Efficiency of the Productive Sectors.

  42. The North American Free Trade Agreement (NAFTA) Significant differences in Average Hourly Earnings (Wages)

  43. The North American Free Trade Agreement (NAFTA) • NAFTA is also a FTA between developed and developing country? • Is there a benefit in forming FTA between developed and developing country? • Who stands to gain from NAFTA? Who losses? Which sector? • What is/was the economic impact of NAFTA on the economy’s member countries?

  44. Intra-Group Trade as Percent of Total Merchandise Trade, 2000 70 Intra-Group Exports as Percent of Total Exports Percent EU NAFTA Intra-Group Imports as Percent of Total Imports 60 50 40 ASEAN 30 MERCOSUR 20 10 0

  45. The North American Free Trade Agreement (NAFTA) Effects….

  46. The North American Free Trade Agreement (NAFTA) • Trade Creation and Diversion effects differ across countries • Negative static effects of NAFTA on the U.S. economy have been relatively small; Reason: • the U.S. merchandise exports to, and imports from, Mexico accounts a very small proportion of the U.S. GDP • Total job losses in USA due to increased plant relocations into Canada and Mexico (1994-1999) = 259, 618 (See Next table…)

  47. The North American Free Trade Agreement (NAFTA) Effects….

  48. WINNERS High-Skill, High-tech US businesses that benefit from reduced barriers Labor intensive US businesses that relocate to Mexico benefit from lower production costs US Domestic businesses that use imports as components in the production process save on production costs Adherence to workers’ rights requirements in Mexico could raise Mexican Labor costs, making US exports more competitive Consequently, less pressure on US workers in import competing business to give up their wages or the protection of their rights LOSERS Labor Intensive, Lower wage, import competing US businesses could lose from reduced protections ( tariffs) on competing imports US workers in import competing businesses (because of firms relocation to Low cost area) Some US firms who may be wanting to relocate to Mexico to save labor costs may lose because of adherence to worker-rights in Mexico The North American Free Trade Agreement (NAFTA) Potential Winners and Losers • MERCOSUR • Formed in 1991 • Includes Brazil, Argentina, Paraguay, and Uruguay. • 1994: became a customs union with average CET of 14%. • Intra-MERCOSUR trade increased 400% in first 4 years.

  49. Other RTAs • MERCOSUR • Formed in 1991 • Includes Brazil, Argentina, Paraguay, and Uruguay. • 1994: became a customs union with average CET of 14%. • Intra-MERCOSUR trade increased 400% in first 4 years.

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