INTERNATIONAL ECONOMICS

E.  Regional Trading Arrangements

• Multilateral liberalization

- Trade liberalization extended to all WTO members

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• Regional trading arrangements

- Trade barriers reduced only for a small group of partner nations

- Complements multilateral trading system

- Self-reinforcing process - becomes attractive for nonmembers to join and receive benefits

- Little incentive to sign multilateral agreements

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1.  Types of regional trading arrangements

a.  Free-trade area

• All barriers removed among members

• Each member has own trade restrictions against outsiders

Ex. - NAFTA

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b.  Customs union

• All barriers removed among members

• All members have identical barriers against outsiders

Ex. - Benelux (Belgium, Netherlands, Luxembourg)

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c.  Common market

• Free movement of goods and services between members

• Common external barriers against outsiders

• Free movement of factors of production between members

Ex. - European Union

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d.  Economic union

• Supranational body determines harmonized national, social, taxation, and fiscal policy

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e.  Monetary union

• Harmonized monetary policy and common currency

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2.  Reasons for regionalism

• Allows economies of large-scale production

- May not gain much more from global market

• Allows specialization

- Workers move out of import-competing industries and into exporting industries based on comparative advantage

• Attracts foreign investment

• Achieves noneconomic objectives

- Manages immigration flows

- Promotes regional security

• May enhance domestic economic reforms

• Smaller nations may seek relations with larger nations when future access is uncertain ("safe-haven" trading arrangements)

• May want to establish strong regional linkages as opposed to weak multilateral ones

- Can achieve deeper economic integration among members than multilateral accords

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3.  Effects of regional trading arrangements

a.  Static effects

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b.  Dynamic effects

• Expanded market => economies of scale

• More competition => greater efficiency

• Stimulates investment in new technology due to higher returns

• Accelerate pace of technological advance

• Boost productivity

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3.  European Union (EU)

a.  Timeline

• 1957 - Treaty of Rome forms European Community (Belgium, France, Italy, Luxembourg, Netherlands, West Germany) => trade liberalization

• 1968 - free-trade area

• 1970 - customs union

• 1985 - detailed program announced for becoming a common market

• 1992 - elimination of nontariff barriers

• 1992 - Maastricht Treaty signed, pledged to move towards monetary union

• 2002 - European Monetary Union (EMU) formed, euro the single currency

• 2004 - new EU constitution

• 2005 - French and Dutch voters reject EU constitution

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b.  European Monetary Union

• European Central Bank located in Frankfurt

• Responsible for monetary and exchange policies

(1)  Economic convergence

• Alignment of economic and monetary policies before joining EMU

(a) Price stability - inflation no more than 1.5 percent above average inflation of three lowest countries

(b) Low long-term interest rates - long-term interest rates no more than 2 percent above average interest rate in those countries

(c) Stable exchange rates - exchange rate kept with target bands, no devaluations for two years prior to joining monetary union

(d) Sound public finances - deficit should be no more than 3 percent of GDP, debt should be no more than 60 percent of GDP

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(2)  Optimal currency area

• Region where it is economically preferable to have a single currency

(a)  Advantages of a common currency

- Risks of exchange rate fluctuations eliminated within area

- Costs of currency conversion reduced

- Economies insulated from monetary disturbances and speculation

- Price stability

- Political pressure for trade protection reduced

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(b)  Disadvantages

- No independent monetary policy to deal with macroeconomic shocks

- Can't change the exchange rate to deal with problems

- Individual country can't use inflation to reduce public debt in real terms

- Could lead to speculative attacks during conversion to single currency

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(c)  Most likely to succeed when:

- Countries have similar business cycles and economic structures

- Monetary policy should affect countries the same way

- No cultural, legal, or linguistic barriers to labor mobility

- Wage and price flexibility

- System to stabilize transfers

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(d)  Reaction to shocks

- Mobility of labor - must be willing and able to move freely to other countries

- Flexible prices and wages - must adjust in response to problems

- Automatic mechanism to transfer fiscal resources to adversely affected countries

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(e)  Problems in Europe

- Inability of individual countries to use monetary and exchange rate policies to deal with economic problems

- Difficulty reducing budget deficits

- Wages inflexible and labor mobility is limited in Europe

- Regulations on labor employment make labor market rigid

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4.  North American Free Trade Agreement (NAFTA)

• Reduce barriers between U.S., Canada, and Mexico

a.  Benefits and costs

(1)  Canada

• Benefits - maintain preferences in U.S. market, access to Mexican market

• Costs - worries about threat to social welfare system

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(2)  Mexico

• Benefits - increase production, increased investment

• Costs - agriculture hurt by U.S. competition

• Not as much economic development as some had hoped due to other problems

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(3)  United States

• Benefits

- Expanded trade opportunities

- Reduced prices

- Increased competition

- Economies of scale

- Reliable source of oil

- Less illegal immigration

- Enhanced political stability in Mexico

• Winners - higher-skill, higher-tech businesses and workers, businesses that relocate to Mexico, businesses that use lower cost inputs, consumers

• Losers - labor-intensive import-competing businesses, workers of businesses that close or relocate

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b.  NAFTA as an optimum currency area

• Should there be a common currency?

• Large degree of economic integration

• Canadian and U.S. economies similar, big difference with Mexico

• Problems with Mexican economy - low income, high inflation and interest rates, volatile peso, high external debt, balance of payments deficits, weak financial markets

• Common currency would stabilize financial markets, reduce inflation and interest rates

• Not much benefit for Canada

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5.  Other regional groupings

• Free Trade Area of the Americas (FTAA)

• Central American Free Trade Agreement (CAFTA)

• Southern Cone Common Market (MERCOSUR)

• Asia-Pacific Economic Cooperation (APEC)

• Association of Southeast Asian Nations (ASEAN)

• Trans Pacific Partnership