Transcript The European Union (EU)

Chapter-9
The Political Economy of Trade
Policy
The Welfare Effects of RTAs…
An RTA has two elements and thus two opposite effects:
1. 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).
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
as follows
(A, B, C) is
SA
$5.00
PA
$2.00
PB
$1.50
PC
DA
M
P
Q
N
The Welfare Effects of RTAs…
1.
2.
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.
DA
SA
$5.00
PA
$1.50
PC
Total Imports from C = MN
Total Value of Imports = $1.5 X MN
M
N
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.
4.
What would be the unit prices of imports from C (after tariff)?
What would be the unit prices of imports from B (after tariff)?
SA
DA
$5.00
PA
$4.00
PB + Tariff
PC + Tariff
$3.00
$2.00
PB
$1.50
PC
M P
R
S
Q
N
The Welfare Effects of RTAs…
5.
6.
Once the tariffs are in effect, would country A need to
change its trade partner?
NO!!!
If so, what would be the effect of the import tariff?
A Fall in Imports from C
SA
DA
$5.00
PA
PC + Tariff
$3.00
Post tariff Imports
$1.50
PC
From C = RS
Pre-Tariff Imports from C = MN
M
R
S
N
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?
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)).
SA
DA
$5.00
PA
$3.00
PC + Tariff
$2.00
PB
$1.50
Amount of Trade
Diverted
R
PC
S
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
DA
SA
$5.00
PA
PC + Tariff
$3.00
$2.00
PB
Trade Diverted
Trade Created
P
R
S
Q
The Welfare Effects of RTAs…
What is the Economic (Welfare) Effects of Economic
Integration? (Is it Beneficial/ Harmful)?
SA
DA
$5.00
PA
PC + Tariff
$3.00
$2.00
a
b
c
d
PB
e
$1.50
M P
R
PC
S
Q
N
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)
The Welfare Effects of RTAs…
8.2. Economic Losses:
Producers’ Surplus Falls
• Area ( A)
Government Revenue Falls
• Area (C + E)
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)
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
In class exercise
Consider the following data detailing trade before and after a
hypothetical country, Javaland forms an FTA with Macau
Imports of
Javaland from
Guam
Imports of
Javaland from
Macau
Before
FTA
After
FTA
100 Million
0 units
0
280 Million
In class exercise
1. How much trade was diverted?
2. How much trade was created?
3. 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.
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.
???????
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).
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?)
Why RTA?
II. Political (non-economic) reasons
• Gesture for good neighborhood, regional security
• Long term development goals, safe haven trading
arrangements
• Regional competition.
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)
Some Examples of RTA …
The European
Union (EU)
The North American
Free Trade Agreement
(NAFTA)
The European Union (EU)
European Union: Members and Applicants, 2001
Sweden
Finland
Estonia
Members
Latvia
Lithuania
Denmark
Applicants
Ireland United
KingdomNetherlands
Poland
Germany
Belgium
Czech Rep.
Luxembourg
Slovakia
France
Austria Hungary
Slovenia
Romania
Bulgaria
Italy
Portugal
Spain
Turkey
Greece
Malta
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
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
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)
The European Union (EU)
1992 (Maastricht Treaty) Agreed to establish an
Economic Union and Common Currency
1999- European Monetary Union (EMU), 2002Coomon 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)
Intra-Group Trade as Percent of Total Merchandise
Trade, 2000
Percent
70
EU
60
50
40
30
20
10
0
Intra-Group Exports as Percent of
Total Exports
Intra-Group Imports as Percent of
Total Imports
The North American Free Trade Agreement (NAFTA)
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
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)
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?
The North American Free Trade Agreement (NAFTA)
1. Expected to provide each member nation better
access to the other’s markets, technology, labor
and expertise.
2. Significant Differences…..
Size of the Economy; Average Earnings (Wages);
Labor Productivity; Efficiency of the Productive
Sectors.
The North American Free Trade Agreement (NAFTA)
Significant differences in Average Hourly Earnings
(Wages)
Year
1985
1987
1993
1995
1997
2000
USA
13.01
13.52
17.20
17.20
17.74
19.86
CAN
10.94
12.04
16.05
16.03
16.68
15.65
Hourly Manufacturing wages in US Dollars
Source: BLS (http://www.bls.gov/bls/newsrels.htm)
MEX
1.59
1.04
2.40
1.51
1.53
2.09
The North American Free Trade Agreement (NAFTA)
3. 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?
Intra-Group Trade as Percent of Total Merchandise
Trade, 2000
Percent
70
EU
60
NAFTA
Intra-Group Exports as Percent of
Total Exports
Intra-Group Imports as Percent of
Total Imports
50
40
ASEAN
30
MERCOSUR
20
10
0
The North American Free Trade Agreement (NAFTA)
Effects….
Trade Flow (1994-1998)
Creation
(‘000$)
Diversion
(‘000$)
US imports from Canada
689,997
384,189
US imports from Mexico
284,774
50,138
38,444
25,212
3,321
163,943
50,036
27,651
902
27,099
Canadian imports from US
Canadian imports from Mexico
Mexican imports from USA
Mexican imports from Canada
Source: Karemera & Ohah (1998)
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…)
The North American Free Trade Agreement (NAFTA)
Effects….
Industry
# of Job Losses
% to Total
Job Losses
Apparel
73,568
28.3
Electronics
33,684
13.0
Transportation Equipment
17,090
6.6
Fabricated Metals
15,372
5.9
Textiles
14,150
5.5
Non-Electrical Machinery
11,747
4.5
Lumber
9,826
3.8
Scientific Instruments
9,433
3.6
Paper Products
8,982
3.5
Rubber
7,722
3.0
Leather
7,521
2.9
Other Manufacturing
35,171
13.5
Non-Manufacturing
15,352
5.9
Source: Congressional Research Review (2000)
The North American Free Trade Agreement (NAFTA)
Potential Winners and Losers
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
LOSERS
Labor Intensive, Lower wage, import
competing US businesses could lose
from reduced protections ( tariffs) on
competing imports
MERCOSUR
Formed
in businesses
1991
US
Domestic
that use imports
as components
in theArgentina,
production Paraguay,
process
Includes Brazil,
and US
Uruguay.
workers in import competing
save on production costs
businesses
1994: became a customs union with average
CET of(because
14%. of firms
relocation to Low cost area)
Intra-MERCOSUR
trade requirements
increased 400% in first 4 years.
Adherence
to workers’ rights
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
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
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.