International Economics
By Robert J. Carbaugh
9th Edition
Chapter 9:
Regional Trading Arrangements
Carbaugh, Chap. 9
Types of regional trade arrangements
Free trade areas (NAFTA, for example)
Customs unions (Benelux)
Common markets (EU)
Economic/monetary union
Regional trade agreements
Carbaugh, Chap. 9
Effects of regional trade agreements
Static effects
Trade creation effect (consumption effect, production effect)
Trade diversion effect
Dynamic effects
Economies of scale
Greater competition
Investment stimulus
Regional trade agreements
Carbaugh, Chap. 9
Static effects of a customs union
Regional trade agreements
Carbaugh, Chap. 9
The European Union
Created by the Treaty of Rome (1957)
Policy aims included:
Abolition of tariffs, quotas and other restrictions
Common external tariff
Free movement of capital, labor and business
Common policies on transport, agriculture, and competition and business conduct
Coordination of monetary and fiscal policies
Regional trade agreements: case studies
Carbaugh, Chap. 9
The European Union (cont’d)
Lowering of barriers caused within-region trade to grow much more quickly than overall world trade in the 1960s
Steps to remove remaining barriers (1985-92) further increased integration
Maastricht Summit (1991) began process of economic and monetary union (EMU)
EMU came into full effect in 2002 with the introduction of a common currency, the euro
Regional trade agreements: case studies
Carbaugh, Chap. 9
EU Economic & Monetary Union
Member nations which met economic criteria by 1999 replaced their national currencies with the euro in 2002
New European Central Bank created to control monetary and exchange rate policy
“Convergence criteria” required for membership:
Price stability
Low long-term interest rates
Stable exchange rates
Sound public finances
Regional trade agreements: case studies
Carbaugh, Chap. 9
Other key EU policies
Common agricultural policy (CAP)
Support payments to farmers
Variable import levies
Export subsidies
Government procurement policies
All EU businesses can bid for larger contracts in any nation
Regional trade agreements: case studies
Carbaugh, Chap. 9
CAP: variable levies and export subsidies
Regional trade agreements: case studies
Carbaugh, Chap. 9
Opening up government procurement
Regional trade agreements: case studies
Carbaugh, Chap. 9
European Union enlargement
The EU is negotiating with 12 applicant nations, mostly transition economies in eastern Europe, for EU membership by 2004
Candidate members had to demonstrate their fitness by achieving:
Stability of institutions, and guaranteed democracy, rule of law, human rights and protection of minorities
A functioning market economy which is ready to compete in the EU market
Adherence to the EU’s aims of political, economic and monetary union
Regional trade agreements: case studies
Carbaugh, Chap. 9
Costs & benefits of EMU
Europe does not meet all the requirements of a theoretical “optimal currency area”
Advantages of EMU - real but small:
Lower transaction costs
Price comparisons easier
Exchange rate risk eliminated
Stimulates competition
Regional trade agreements: case studies
Carbaugh, Chap. 9
Costs & benefits of EMU (cont'd)
Disadvantages of EMU:
Loss of monetary policy and the exchange rates as economic adjustment tools
Use of fiscal policy for adjustment is also constrained
Adjustment to shocks therefore depends on wage flexibility and labor mobility, which are both low in Europe
Regional trade agreements: case studies
Carbaugh, Chap. 9
North American Free Trade Agmt. (1994)
Gradual and comprehensive elimination of trade barriers among US, Mexico and Canada over 15 years:
Full, phased elimination of import tariffs
Elimination of most NTBs
Protection of intellectual property rights
Dispute settlement procedures
Side agreements on environmental protection and labor law
Regional trade agreements: case studies
Carbaugh, Chap. 9
NAFTA's benefits
Mexico stood to gain the most, with access to large industrial markets and new inward investment flows
Canada maintained its preferences in the US market and hoped for future access to South American markets
US stood to gain from access to the Mexican market and cheap labor and parts, access to reliable oil supplies, and less immigration pressure; but the benefits were modest
Regional trade agreements: case studies
Carbaugh, Chap. 9
Concerns about NAFTA
Main US losers from NAFTA would be import-protected industries competing with Mexican producers, and unskilled workers
US industrial workers also worried about lower pay scale in Mexico and plant relocations
Concerns Mexico would not enforce environmental protection measures
Side agreements on environment and labor law were concluded to address those concerns
Regional trade agreements: case studies
Carbaugh, Chap. 9
NAFTA’s impact so far
Trilateral trade increased significantly
Some US jobs were lost to Mexico, but the numbers were small compared to job creation that came with US growth
Changes in investment flows were small (in relation to total US foreign investment)
Closer political ties were built among the three nations, and they refrained from building new trade barriers even during recession
Regional trade agreements: case studies
Carbaugh, Chap. 9
Special case: economies in transition
Nations of eastern Europe and the former Soviet Union have been making a transition from a non-market (planned) economy to a market economy since the early 1990s - which has been very disruptive
These nations’ planned economies required them to be largely isolated from world trade - instead, set up their own trading bloc, the Council for Mutual Economic Assistance (CMEA) with only limited trade with the West
Regional trade agreements: case studies
Carbaugh, Chap. 9
Economies in transition (cont’d)
Even after the collapse of the central planning system, the nations remained tied together because of historical trade links inside CMEA and their common legacy as non-market economies
There is an ongoing debate over the best pace for economic reform (including trade and financial liberalization) - “shock therapy” vs. gradualism
Regional trade agreements: case studies
Carbaugh, Chap. 9
Economies in transition (cont’d)
Barriers to trade with the West used to make strategies such as countertrade, co-production agreements, joint R&D agreements, and contract manufacturing agreements very common
Gradual elimination of barriers to foreign business in most transition countries has allowed foreign firms to operate in the region more normally in recent years
Regional trade agreements: case studies
Carbaugh, Chap. 9
