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    Lecture 6 Trade Agreements

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    Gina Wael
    World leaders have recognized that reducing trade barriers expands global trade. Post-WWII efforts included establishing the World Trade Organization to eliminate tariffs and the IMF to stabilize currencies. At the same time, many countries also pursued regional economic cooperation. The General Agreement on Tariffs and Trade was signed in 1947 by 23 countries to reduce trade barriers and promote the most favored nation principle. This was replaced by the World Trade Organization in 1995 which has stronger enforcement powers. The WTO oversees ongoing negotiations to further liberalize global commerce and resolve trade disputes.

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    Lecture 6 Trade Agreements

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    Gina Wael
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    World leaders have recognized that reducing trade barriers expands global trade. Post-WWII efforts included establishing the World Trade Organization to eliminate tariffs and the IMF to stabilize currencies. At the same time, many countries also pursued regional economic cooperation. The General Agreement on Tariffs and Trade was signed in 1947 by 23 countries to reduce trade barriers and promote the most favored nation principle. This was replaced by the World Trade Organization in 1995 which has stronger enforcement powers. The WTO oversees ongoing negotiations to further liberalize global commerce and resolve trade disputes.

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    World leaders have recognized that reducing trade barriers expands global trade. Post-WWII efforts included establishing the World Trade Organization to eliminate tariffs and the IMF to stabilize currencies. At the same time, many countries also pursued regional economic cooperation. The General Agreement on Tariffs and Trade was signed in 1947 by 23 countries to reduce trade barriers and promote the most favored nation principle. This was replaced by the World Trade Organization in 1995 which has stronger enforcement powers. The WTO oversees ongoing negotiations to further liberalize global commerce and resolve trade disputes.

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    12 views32 pages

    Lecture 6 Trade Agreements

    Uploaded by

    Gina Wael
    World leaders have recognized that reducing trade barriers expands global trade. Post-WWII efforts included establishing the World Trade Organization to eliminate tariffs and the IMF to stabilize currencies. At the same time, many countries also pursued regional economic cooperation. The General Agreement on Tariffs and Trade was signed in 1947 by 23 countries to reduce trade barriers and promote the most favored nation principle. This was replaced by the World Trade Organization in 1995 which has stronger enforcement powers. The WTO oversees ongoing negotiations to further liberalize global commerce and resolve trade disputes.

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    International economics

    th
    6 lecture
    Trade agreements
    Economic Integration
    World leaders have recognized that the reduction or elimination of
    artificial barriers to trade is necessary for expanding world trade. The
    worldwide postwar efforts to expand foreign trade included the elimination
    of tariff barriers through the World Trade Organization and the
    stabilization of currencies through the International Monetary Fund. At the
    same time as these efforts went forward on the international level, many
    countries around the world also pursued economic cooperation at the
    regional level. Regional economic cooperation is based on the premise
    that countries in a region connected by historical, geographical, cultural,
    economic, and political similarities may be able to strike more intensive
    cooperative agreements for mutually beneficial
    • economic advantages.
    From GATT to WTO
    In 1947, 23 countries signed the General Agreement on Tariffs and
    Trade (GATT) in Geneva. To join GATT, countries must adhere to the most
    favored nation (MFN) clause, which requires that if a country grants a
    tariff reduction to one country, it must grant the same concession to all
    other countries. For example, if the USA cuts its tariff from 20 percent to 10
    percent on wool sweaters from Australia, it must grant the same
    concession on wool sweaters from all other countries. The MFN clause
    also applies to quotas and licenses.
    From GATT to WTO
    • GATT members have held many talks since 1947 to expand and promote
    world trade. First, GATT members held periodic meetings from 1947 to
    1952 to cut specific tariffs.
    • Second, the Kennedy Round (1964–7) covered across-the-board tariff
    reductions on industrial products. Perhaps the most important part of the
    Kennedy Round was to reduce trade barriers between the USA and the
    European Economic Community.
    • Third, the Tokyo Round (1973–9) of multilateral trade negotiations
    discussed the reduction of nontariff barriers. The most important part of
    these agreements is a series of detailed codes spelling out permissible
    and non-permissible “good” behavior by governments in almost all
    nontariff measures.
    From GATT to WTO
    • Fourth, the Uruguay Round (1986–93) discussed the expansion of trade
    liberalization to include services, intellectual property rights, and
    agricultural products.
    • The new organization, known as the World Trade Organization (WTO),
    has replaced the GATT since the Uruguay Round accord became
    effective on January 1, 1995. Today, the WTO’s 144 members account
    for more than 97 percent of world trade. The WTO has five major
    functions: (1) administrating its trade agreements; (2) acting as a forum
    for trade negotiations; (3) monitoring national trade policies; (4) offering
    technical assistance and training for developing countries; and (5)
    cooperating with other international organizations. China joined the
    WTO in 2001. China’s WTO membership has further legitimized the idea
    of free trade.
    From GATT to WTO
    The WTO has more power to enforce the rules of international trade
    than the GATT. Under the WTO there is a powerful dispute-resolution
    system, with three-person arbitration panels. Countries may bring
    charges against their trading partners to a WTO panel. WTO members
    cannot veto the panel’s rulings, as was the case under GATT. If an
    offending country fails to comply with panel recommendations, its
    trading partners are guaranteed the right to compensation. As a final
    resort, the trading partners are given the right to impose countervailing
    sanctions against the offending country.
    From GATT to WTO
    • In November 2001, WTO members began to explore a new round of
    talks with the aim of further liberalizing global commerce. Major issues
    include a moratorium on tariffs for electronic commerce, easier access
    to foreign markets for high-tech, banking, and insurance exports,
    elimination of agricultural subsidies, tougher labor standards around the
    world, revision of US antidumping laws, and more time for developing
    countries to liberalize trade.
    Non-Discrimination Principle according to WTO

    • Non-discrimination has two elements


    • Most-favored nation (MFN) applying to border measures
    • Each member must grant treatment to all other members as
    favorable as it extend to any individual member country
    • National Treatment (NT) applying to behind-the-border
    measures
    • Foreign goods within a country should be treated no less
    favorably than domestic good with regard to tax policies and
    other regulations
    Figure 8.1: Non-Discrimination Principle

    © Kenneth A. Reinert, Cambridge University Press 2021


    GATT/WTO rounds of multilateral trade
    negotiations
    Multilateralism versus Regionalism
    • The term multilateralism refers to the GATT/WTO system and the trade negotiations
    that take place within it
    • One of the founding principles of this system is nondiscrimination
    • Involves the most favored nation (MFN) and national treatment (NT) sub-
    principles
    • “Regionalism” refers to a violation of the nondiscrimination principle in which one
    member of a regional trade agreement (RTA) discriminates in its trade policies in
    favor of another member of the RTA and against nonmembers
    • Has been allowed by the GATT/WTO under certain circumstances:
    • Free trade areas (FTAs)
    • Customs unions (CUs)
    • Interim agreements leading to an FTA or CU “within a reasonable length of
    time
    Economic integration
    Economic integration refers to the commercial policy of discriminatively
    reducing or eliminating barriers only among the nations joining together.
    • Preferential trade arrangements
    • Provide lower barriers to trade among participating nations
    than on trade with non-member nations.
    • The loosest form of economic integration.
    • Example: British Commonwealth Preference Scheme,
    established in 1932 between the United Kingdom and
    members of the British Empire
    Steps to economic Integration
    Free trade areas
     Free trade areas
     Removes all barriers to trade among members, but each nation retains its
    own barriers to trade with non-members.
     Examples:
     European Free Trade Association (EFTA), 1960, between United Kingdom, Austria,
    Denmark, Norway, Portugal, Sweden and Switzerland
     North American Free Trade Agreement (NAFTA), 1993, between the United States, Canada
    and Mexico
    Customs union
     Customs union
     Removes all barriers to trade among members and harmonizes
    trade policies toward the rest of the world.
     Examples:
     European Union (EU), or European Common Market, 1957, between West Germany,
    France, Italy, Belgium, the Netherlands, and Luxembourg.
     Zollverein, 1834, between large number of sovereign German states
    Common market
     Common market
     Removes all barriers to trade among members, harmonizes trade
    policies toward the rest of the world, and allows free movement of
    labor and capital among member nations.
     Example:
     European Union (EU) achieved common market status in 1993.
    Economic union
     monetary union, agreement between two or more states creating
    a single currency area. A monetary union involves the irrevocable
    fixation of the exchange rates of the national currencies existing
    before the formation of a monetary union. Historically, monetary
    unions have been formed on the basis of both economic and
    political considerations. A monetary union is accompanied by
    setting up a single monetary policy and establishing a
    single central bank or by making the already existing national
    central banks the integrative units of a common central banking
    system
    Economic union
     Economic union
     Removes all barriers to trade among members, harmonizes trade
    policies towards the rest of the world, allows free movement of labor
    and capital among member nations, and unifies monetary and fiscal
    policies of members.
     Most advanced type of economic integration.
     Examples:
     Benelux, formed after World War II between Belgium, the Netherlands and
    Luxembourg
    Trade-Creating Customs Unions
    • Trade creation occurs when domestic production in a member
    nation is replaced by lower-cost imports from another member
    nation.
    • Leads to increased welfare for members as nations
    specialize in comparative advantages.
    • Leads to increased welfare for non-members as increased
    real income spills over into increased imports from rest of the
    world.
    • In Figure 10.1, removing the tariff increases social welfare, recapturing the
    deadweight losses.
    FIGURE 10-1 A Trade-Creating Customs Union.

    Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.
    FIGURE 10.1. A Trade-Creating
    Customs Union.
    DX and SX represent Nation 2’s domestic demand and supply curves of commodity X.
    At the tariff-inclusive PX =$2 before the formation of the customs union, Nation 2
    consumes 50X (GH),with 20X (GJ) produced in Nation 2 and 30X (JH) imported from
    Nation 1. Nation 2 also collects a tariff revenue of $30 (MJHN). Nation 2 does not
    import commodity X from Nation 3 because of the tariff-inclusive PX > $2. After Nation
    2 forms a customs union with Nation 1 only, Nation 2 consumes 70X (AB), with 10X
    (AC) produce domestically and 60X (CB) imported from Nation 1 at PX = $1. The tariff
    revenue disappears, and area AGJC represents a transfer from domestic producers to
    domestic consumers. This leaves net static gains to Nation 2 as a whole equal to $15,
    given by the sum of the areas of shaded triangles CJM and BHN.
    Trade-Diverting Customs Unions
    • Trade diversion occurs when lower-cost imports from non-members are
    replaced by higher cost imports from members.
    • By itself, trade diversion lowers welfare as it shifts resources away from comparative
    advantages.
    • Trade diverting customs union also results in trade creation. Change in welfare
    depends on relative magnitude of creation and diversion.
    • In Figure 10.2, the shaded triangles represent gains from trade creation. The
    rectangle represents the loss of tariff revenue (that is not compensated with
    consumer surplus gain).
    FIGURE 10-2 A Trade-Diverting Customs Union.
    FIGURE 10.2. A Trade-Diverting
    Customs Union.

    DX and SX represent Nation 2’s domestic demand and supply curves of


    commodity X, while S1 and S3 are the free trade perfectly elastic supply curves
    of commodity X of Nation 1 and Nation 3, respectively. With a
    nondiscriminatory 100 percent tariff, Nation 2 imports 30X (JH) at PX = $2 from
    Nation 1. After forming a customs union with Nation 3 only, Nation 2 imports
    45X (C B) at PX = $1.50 from Nation 3. The welfare gain in Nation 2 from pure
    trade creation is $3.75 (given by the sum of the areas of the two shaded
    triangles). The welfare loss from trade diversion proper is $15 (the area of the
    shaded rectangle). Thus, this trade-diverting customs union leads to a net
    welfare loss of $11.25 for Nation 2.
    Trade-Diverting Customs Unions

    • It was once believed that any movement toward freer trade would increase
    welfare, so formation of a customs union would necessarily result in increased
    welfare for members and non-members.
    • In 1950, Viner showed that formation of a customs union could increase or
    reduce welfare, depending on the circumstances under which it takes place.
    • Difficult to measure gains/losses empirically.
    • Attempts to measure static welfare effects of the EU result in surprisingly small
    gains of 1-2% of GDPs.
    The Theory of the Second Best and Other Static Welfare
    Effects of Customs Unions

    • Theory of the Second Best


    If all conditions required to maximize welfare cannot be satisfied,
    trying to satisfy as many conditions as possible does not
    necessarily or usually lead to the second-best position.
    • Creation of customs unions may not be the second-best choice relative to free trade.
    The Theory of the Second Best and Other Static Welfare
    Effects of Customs Unions

    • Conditions More Likely to Lead to Increased Welfare


    1. Higher pre-union trade barriers of member nations.
    2. Lower customs union’s trade barriers with non-members.
    3. Greater number of nations forming customs union, and the larger their size.
    4. More competitive rather than complementary economies of member
    nations.
    5. Closer geographical proximity of member nations.
    6. Greater pre-union trade and economic relationship among potential
    member nations.
    The Theory of the Second Best and Other Static
    Welfare Effects of Customs Unions

    Other Static Effects of Customs Unions


    1. Administration savings from elimination of customs officers, border patrols,
    and others.
    2. Reduction in demand for imports from and supply of exports to rest of the
    world will likely lead to improvement in collective terms of trade of member
    nations.
    3. By acting as a single unit, customs union will likely have more bargaining
    power than members separately.
    Dynamic Benefits from Customs
    Unions
    Dynamic Benefits of Customs Unions
    1. Increased competition, leading to greater efficiencies and technological
    improvements.
    2. Economies of scale from the enlarged market.
    3. Stimulus of investment to take advantage of enlarged market, and to meet
    increased competition.
    4. Better utilization of community resources as labor and capital move freely
    (assumes common market).
    Thank You

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