Amity Business School

Amity Business School

MBA 2013, 3rd Semester
INTERNATIONAL ECONOMICS AND POLICY

Amanpreet Kang
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References
1. International Economics, Francis Cherunilam (4th Edition), Mc Graw Hill 2. International Economics, BO Sodersten and Geoffrey Reed (3rd Edition), Macmillan 3. International Economics, Paul Krugman and Maurice Obstfeld (6th Edition), Pearson Education 4. Economics, Samuelson & Nordhaus (18th Edition), Tata Mc Graw Hill

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Economic Integration

The process of removing trade impediments between 2 countries leads to economic integration. Co-operation and co-ordination. Trade impediments??? Global integration
GATT, WTO NTBs, GATS and TRIPS

Regional integration
Proliferation in agreements since 1980s First RTA 300+ registered RTAs India and regional integration (several agreements, refer www.commerce.nic.in)
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Economic Integration
MFN Principle Promotes non-discrimination RTAs are exception to MFN principle Preferential trading areas allowed if: Trade barriers are removed substantially on all trade The agreement on the whole does not result in more restrictive trade barriers to outsiders than those existed before

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Economic Integration
Trade Bloc, PTA, RTA, RIA preferential trade agreement (PTA) between a subset of countries, designed to significantly reduce or remove trade barriers within member countries. Natural trade bloc Characteristics
it implies a reduction or elimination of barriers to trade, and this trade liberalization is discriminatory Preferential market access is motive in some

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Economic Integration
Trade Bloc, PTA, RTA, RIA preferential trade agreement (PTA) between a subset of countries, designed to significantly reduce or remove trade barriers within member countries. Natural trade bloc Characteristics
it implies a reduction or elimination of barriers to trade, and this trade liberalization is discriminatory

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Economic Integration
The first waves, 1930s, leading to a fragmentation of the world into trade blocs. Old/ first regionalism, regional initiatives of developing countries in the 1950s and 1960s. Objective of import-substitution industrialization Rationale was that developing countries could reap the benefit from economies of scale by opening up their trade preferentially among themselves, hence reducing the cost of their individual import-substitution strategy while the trade bloc became more self-sufficient. New/ second regionalism, (the North-South trade blocs)
NAFTA
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Reasons for formation of Trade Blocs

Reasons for formation include: 1) Easy to integrate and cooperate Few participants, easy to negotiate Politically easy to pursue vs. multilateral trade Easy exchange of concessions Easy enforcement of concessions Enforcement at lower costs Length and difficulty of negotiations during the Uruguay round of GATT lead to these agreements becoming attractive 2) Adherence to reforms by partners

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Reasons for formation of Trade Blocs

2) Adherence to reforms by partners Deeper and faster trade liberalization and hence integration Larger number of issues can be addressed and faster Can address elements beyond standard policy concerns 3) Proximity Natural trading partners Gravity model (geographic distance, transport costs, trade barriers) Domino effect (Exert pressures for inclusion on non member countries to reduce the cost of being left out)

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Reasons for formation of Trade Blocs

(4) Non-economic objectives Trade blocs also serve to pursue non-economic objectives, or objectives beyond the immediate economic concerns of a PTA, such as: political stability, democratic development or security issues (either domestic security, or as a response to thirdcountry security threats, or security threats between partner countries).

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Types of Trade Blocs

Some of the popular types of trade blocs include: (1) (2) (3) (4) (5) (6) Preferential Trade Agreement (PTA) Free Trade Area (FTA) Customs Union Common Market Economic Union Monetary Union

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Free Trade Area Customs Union Common Market Economic Union Economic Integration

Free Trade among members Free Trade among members Free Trade among members Free Trade among members Free Trade among members Common External Commercial Policy Common External Commercial Policy Common External Commercial Policy Common External Commercial Policy Free factor mobility within the trade bloc Free factor mobility within the trade bloc Free factor mobility within the trade bloc Harmonized economic policies Harmonized Supernationa l organisation economic structure policies
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Types of Trade Blocs

(1) Preferential Trade Agreement (PTA) A preferential trade agreement is perhaps the weakest form of economic integration. In a PTA countries would offer tariff reductions, though perhaps not eliminations, to a set of partner countries in some product categories. Higher tariffs, perhaps non-discriminatory tariffs, would remain in all remaining product categories. This type of trade agreement is not allowed among WTO members who are obligated to grant most-favored nation status to all other WTO members. In 1998 the US proposed legislation to eliminate tariffs on imports from the nations in sub-Sahara Africa. This action represents a unilateral preferential trade agreement since tariffs would be reduced in one direction but not the other.

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Types of Trade Blocs

(2) Free Trade Area (FTA) A free trade area occurs when a group of countries agree to eliminate tariffs between themselves, but maintain their own external tariff on imports from the rest of the world. The North American Free Trade Area is an example of a FTA. When the NAFTA is fully implemented, tariffs of automobile imports between the US and Mexico will be zero. However, Mexico may continue to set a different tariff than the US on auto imports from non-NAFTA countries. Because of the different external tariffs, FTAs generally develop elaborate "rules of origin". These rules are designed to prevent goods from being imported into the FTA member country with the lowest tariff and then transshipped to the country with higher tariffs.
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Types of Trade Blocs

(3) Customs Union A customs union occurs when a group of countries agree to eliminate tariffs between themselves and set a common external tariff on imports from the rest of the world. The European Union represents such an arrangement. A customs union avoids the problem of developing complicated rules of origin, but introduces the problem of policy coordination. With a customs union, all member countries must be able to agree on tariff rates across many different import industries.

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Types of Trade Blocs

(4) Common Market A common market establishes free trade in goods and services, sets common external tariffs among members and also allows for the free mobility of capital and labor across countries. The European Union was established as a common market by the Treaty of Rome in 1957, although it took a long time for the transition to take place. Today, EU citizens have a common passport, can work in any EU member country and can invest throughout the union without restriction.

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Types of Trade Blocs

(5) Economic Union An economic union typically will maintain free trade in goods and services, set common external tariffs among members, allow the free mobility of capital and labor, and will also relegate some fiscal spending responsibilities to a supra-national agency. The European Union's Common Agriculture Policy (CAP) is an example of a type of fiscal coordination indicative of an economic union.

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Types of Trade Blocs

(6) Monetary Union Monetary union establishes a common currency among a group of countries. This involves the formation of a central monetary authority which will determine monetary policy for the entire group. The Maastricht treaty signed by EU members in 1991 proposed the implementation of a single European currency (the Euro) by 1999. The degree of monetary union that will arise remains uncertain in 1998. United States as economic and monetary union - Each US state has its own government which sets policies and laws for its own residents. However, each state cedes control, to some extent, over foreign policy, agricultural policy, welfare policy, and monetary policy to the federal government. Goods, services, labor and capital can all move freely, without restrictions among the US states and the Nations sets a common external trade policy.
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Integration Theory
Combination of free trade and protection Types of economic integration Characteristics of member countries that lead to successful integration Effects of economic integration on international trade & location Effects of economic integration on growth and development

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Integration Theory
Theory of Customs Union Customs union would mean substitution of single customs territory for two or more customs territories so that: Duties and other regulations of commerce are eliminated with respect to substantially all trade between the constituent territories of the union Substantially the same duties and regulations of commerce are applied by each of the members of the union to the trade and territories not included in the union

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Integration Theory
Theory of Customs Union Effects of Customs Union Static Effects primary, involve reallocation of resources among existing industries, material, technology, etc. Trade creation and trade diversion Production effect Consumption effect Dynamic Effects - consequential Competition, scale economies, external economies, technological change, investment risk and uncertainty reduction

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Basic Tariff Analysis

Deriving Homes Import Demand Curve
Price, P S Price, P A 2 1 MD

PA P2

D S1 S2 D2 D1 Quantity, Q D2 S2

D1 S1

Quantity, Q
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Basic Tariff Analysis

Deriving Foreigns Export Supply Curve
Price, P P2 P1 S* Price, P XS

P*A D* D*2 D*1 S*1 S*2 Quantity, Q S*1 D*1 S*2 D*2 Quantity, Q
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Basic Tariff Analysis

World Equilibrium
Price, P XS

1 PW

MD

QW

Quantity, Q
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Effects of a Tariff
Home Home market market Price, P S Price, P XS 2 t P*T 3 MD D Quantity, Q QT QW Quantity, Q D* Quantity, Q
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World World market market

Foreign market Foreign market Price, P S*

PT PW

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Trade Diversion

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Trade Creation

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Benefits of Trade Blocs

It was earlier thought that trade blocs always lead to welfare because of significant reduction of trade barriers. They are a mix of free trade and protectionism Hence benefits of the trade bloc will be determined by: Respective strength of trade creation and diversion principle of second best In a world where there are more than one distortions of free trade, elimination of one of the distortions does not necessarily improve welfare

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Determinants of Success of RIA

Nature of economies that have formed the trade bloc Proximity of the members Size of trade bloc Size of members Extent of trade barriers Intra regional trade Share in global trade
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