Online Tutorial by AdaTeaches

ECONOMIC
INTEGRATION IN
NORTH AMERICA

Summary

Trade blocs and their economic

consequences
Trade creation and trade diversion
The North American Free Trade
Association and its impacts

Chapter Readings

Gerber ch. 13
Pugel ch.12
Salvatore ch. 7

Article Readings

Burfisher, M.E., Robinson, S. and Thierfelder, K. (2001)

The impact of NAFTA on the United States, Journal of
Economic Perspectives, vol. 15, pp. 125-144.
Klein, L.R. and Salvatore, D. (1995) Welfare effects of the
North American Free Trade Agreement, Journal of Policy
Modeling, vol. 17, pp. 163-176.
Krueger, A.O. (1999) Are preferential trading
arrangements trade-liberalising or protectionist?
Journal of Economic Perspectives, vol. 13, pp. 105124.
Krugman, P. (1993) The uncomfortable truth about NAFTA,
Foreign Affairs, November/December, pp. 13-19.
Rodrik, D. (2000) How far will international economic

Trade blocs and their economic consequences

A trade bloc is a type of

intergovernmental agreement, often part
of a regional intergovernmental
organization, where regional barriers to
trade, (tariffs and non-tariff barriers) are
reduced or eliminated among the
participating states.

Types of Trade Blocs

Preferential trading areas

Free trade areas
Customs unions
Common markets
Economic and monetary unions.

Preferential Trade Area

Preferential Trade Areas (PTAs) exist

when countries within a geographical
region agree to reduce or eliminate tariff
barriers on selected goods imported
from other members of the area. This is
often the first small step towards the
creation of a trading bloc.

Free Trade Area

Free Trade Areas (FTAs) are created when
two or more countries in a region agree to
reduce or eliminate barriers to trade on all
goods coming from other members.
E.g
North American Free Trade Agreement
(NAFTA)
ASEAN Free Trade Area (AFTA)
Pacific Alliance

Customs Union
A customs union involves the removal of
tariff barriers between members, plus the
acceptance of a common (unified) external
tariff against non-members. This means
that members may negotiate as a single
bloc with 3rd parties, such as with other
trading blocs, or with the WTO.

Common Market
A common market is the first significant step towards
full economic integration, and occurs when member
countries trade freely in all economic resources not
just tangible goods. This means that all barriers to
trade in goods, services, capital, and labour are
removed. In addition, as well as removing tariffs, nontariff barriers are also reduced and eliminated. For a
common market to be successful there must also be a
significant level of harmonisation of micro-economic
policies, and common rules regarding monopoly
power and other anti-competitive practices. There
may also be common policies affecting key industries.

Advantages of Trade
Blocs

increased competition that lowers prices

or costs
enhanced ability to achieve scale
economies
attracting more direct investment by
foreign companies
Market efficiency

Disadvantages of Trade
Blocs

Loss of Sovereignty
Increased dependency on participating
members
Retaliation from non-members

Trade creation and trade diversion

The basic three-country model of a trade bloc
shows that:
1. Its economic benefits for the partner
countries and the world depend on its
trade creation, the amount by which it
raises the total volume of world trade.
2. Its economic costs depend on its trade
diversion, the volume of trade it diverts
from lower-cost outside suppliers to
higher-cost partner-country suppliers.

Trade blocs in Developed

Countries
1.

2.

3.

The European Union from 1957 to 1992 was a customs

union, in which member countries remove tariffs and
other barriers to trade among themselves and also adopt
a common set of external tariffs
In 1992 the Single European Act promoted free
movement of workers and capital, so the EU became a
common market. (The act also required removal of many
remaining nontariff barriers to trade among the member
countries.)
As the EU further integrates, including the adoption of the
euro as a common currency by 15 of its members, the
EU is moving toward economic union, in which all
economic policies would be unified.

Trade blocs in Developing

Countries
1.

2.

Efforts by developing countries to form

trade blocs failed in the 1960s and
1970s, but they have become more
successful since 1990.
Trade among the MERCOSUR
countries in South America expanded
since the bloc was formed in 1991, but
some of this expanded intrabloc trade is
trade diversion.

The United States role in the global

economy

1.
2.
3.
4.
5.

Shaped by size, wealth, and role as a military

super power
Endowed with
wide range of resources
abundant and fertile farmland
a relatively well educated population
disproportionate share of the worlds top research
universities
Venture capital

The United States role in the global

economy

US is third most
populous
country after
China and India,
and GDP more
than twice
Chinas, the
worlds second
largest economy

Background and Context

As the worlds largest economy anything the

United States does has an impact on the
rest of the world

Given its large economy and population U.S.

trade with the rest of the world has been a
smaller share of its GDP than in most other
developed economies

The Trade-to-GDP Ratio for the World, 1960-2010

The Trade-to-GDP Ratio for the United

States, 1960-2010

Leading U.S. Trade Partners,

1990 and 2010

The Shifting Focus of US Trade

Relations

Throughout most of the post-World War II

period the United States was a strong
supporter of multilateral trade

Three factors have shifted the U.S. focus

towards greater use of bilateral and
plurilateral trade agreements

The United States is still supportive of the

WTO

The Shifting Focus of US Trade

Relations (cont.)

First, multilateral trade negotiations became more

complicated as the GATT and then WTO added
new members

When the GATT was originally signed in 1947 it had

twenty-three members

By the time of the Uruguay Round (19861994)

there were 128 signatories to GATT

Currently there are 155 member countries in the

WTO

The Shifting Focus of US Trade

Relations (cont.)

Second, many quotas have been converted to tariffs

and tariffs in general have fallen dramatically

New multilateral trade negotiations in the Doha

Round focused on more difficult issues
- agricultural support systems,
- intellectual property,
- services trade,
- government procurement, and
- assistance for developing countries.

The Shifting Focus of US Trade

Relations (cont.)

Third, the end of the Cold War removed one of

the pressures that caused the United States to
offer trade concessions to other countries

Free Trade Agreements, Exports, and Imports

in Billions of Dollars, 2010

Demographic and Economic

Characteristics of North America

Income per capita is measured in two ways:

- In U.S. dollars converted from Canadian dollars
Mexican pesos at market exchange rates
- In dollars measured in terms of purchasing
power parity (PPP)

and

The North American market is marked by

numerous difficult policy questions on migration
and environmental and labor standards

Population and GDP for NAFTA Region,

2011

Canada-US Trade Relations

The United States and Canada have the largest

bilateral trade relationship of any two countries in
the world with two-way merchandise goods trade in
2011 of more than $597 billion

Due to a shared border, a common historical

background, and a similar culture

Also the result of three stages of integration: Auto

Pact of 1965, Canada-U.S. Free Trade Agreement
(CUSTA) in 1989, NAFTA agreement in 1994

Auto Pact of 1965

Removed tariffs on cars, trucks, buses,

tires, and automotive parts between the
two countries, greatly benefiting the
large American car makers.

Goals of Auto Pact of 1965

To reduce production costs in Canada

by force of more efficient production of a
smaller range of vehicles and
components.
To lower vehicle prices for consumers.
To increased production creating
thousands of jobs and increasing
wages.

Aftermath of Auto Pact

This transfer of control of Canadian automaking

operations to their US parent corporations
substantially reduced the autonomy of the
Canadian operations
The agreement also prevented Canada pursuing
free trade in automobiles elsewhere internationally.
The Auto Pact was abolished in 2001 after a World
Trade Organization ruling declared it illegal, though
by that time the North American Free Trade
Agreement had effectively superseded it.

Canada-U.S. Free Trade Agreement

(CUSTA)

eliminate barriers to trade in goods and services

between Canada and the United States
facilitate conditions of fair competition within the freetrade area established by the Agreement
significantly liberalize conditions for investment within
that free-trade area
establish effective procedures for the joint administration
of the Agreement and the resolution of disputes
lay the foundation for further bilateral and multilateral
cooperation to expand and enhance the benefits of the
Agreement.

Effect of CUSTA

Cross-border shopping- where Canadians

would make shopping daytrips to US border
towns to take advantage of tariff-free goods
and a high Canadian dollar, provided a miniboom for these towns.
Concerns that free trade would have negative
effects, not only on the economy (it might
cause of capital flight and job insecurity due
to international outsourcing), but also on the
social and political fabric of the country.

Mexican Economic Reforms

From the 1950s until the onset of the crisis in

1982, Mexican per capita growth averaged 3.3
percent per year in real terms doubling living
standards approximately every generation

Mexicos long growth boom occurred under

import substitution industrialization (ISI)
policies

ISI policies target the development of

manufacturing through support for domestic
industries that produce goods which substitute for
imports.

Mexican Economic Reforms

(cont.)

A major weakness of ISI policies: they

discriminate against exports by raising the
rate of return for domestic market producing
firms

Domestic market producing firms have high

protectionist walls and charge higher prices
while facing little or no competition

Problems emerged in 1981 and in August

1982, the debt crisis began: Mexico
suspended payments of the principal of its
debts

Mexican Economic Reforms

(cont.)

The debt crisis in Mexico was the result of a

series of factors and spread to the rest of Latin
America
-

poor macroeconomic management

accumulation of a large amount of debt
heavy borrowing from foreign banks
weak tax systems
rising world interest rates that made debt service more
expensive

This period came to be known as the Lost

Decade

Mexican Economic Reforms

(cont.)

The solution to the debt crisis required multiple

policy changes

In the 1980s, Mexico privatized many firms that

had been drains on the federal budget
Brought its federal budget under control
Reduced its restrictions on foreign direct
investment
Opened its markets to greater competition

The North American Free Trade

Agreement

NAFTA was ratified in 1993 taking effect

January 1, 1994

Trade flows increased significantly, but had

been growing before implementation partly in
anticipation of an agreement

The first important feature of NAFTA- most

forms of trade barriers came down

Most of the change came on the Mexican side

The North American Free Trade

Agreement (cont.)

Some tariffs and investment restrictions on

cross border investment were eliminated
immediately, but in many cases there was a
variable period of phasing out tariffs and
investment restrictions

A second feature of NAFTA is that it specifies

North American content

Requirements for goods subject to free trade

The North American Free Trade

Agreement (cont.)

A third feature of NAFTA is three separate

dispute resolution mechanisms, depending on
the source of the disagreement

Individual chapters cover disputes related to

dumping and anti-dumping duties; treatment
of foreign investors by national policies, called
investor-state disputes

The North American Free Trade

Agreement (cont.)

Fourth significant feature of the agreement

NAFTA itself did not contain language regarding

labor and environmental standards or concerns

Two side agreements were ratified and

implemented; North American Agreement on
Labor Cooperation and the North American
Agreement on Environmental Cooperation.

Two NAFTA-Specific Issues

Illegal immigration is a contentious issue

in U.S.-Mexico relations
Proponents argue that illegal immigrants

support the U.S. economy by buying goods

and services and help keep prices low by
increasing labor supply
Opponents argue that the U.S. should not

ignore illegal behavior and that the

increased labor from illegal immigration
suppresses wages for legal workers

Two NAFTA-Specific Issues

(cont.)

Attempts at stricter border enforcement

have been largely unsuccessful at
stopping illegal immigration
The border is too long 2,000 miles
The economic incentive that enter the U.S.

is too high
Nearly half of the illegal immigrants entered

legal, but did not return home when their

visas expired

Two NAFTA-Specific Issues

(cont.)

1.
2.
3.

The unprecedented wave of migration

appears to be ending for three main reasons
the border has become harder and more
dangerous to cross
the political and economic environment of
the United States is more difficult
the demography of Mexico is changing
reducing the number of potential migrants

Two NAFTA-Specific Issues

(cont.)

A second issue in the NAFTA region is

the rise in drug violence in Mexico

This issue has far more than trade

implications since it concerns law
enforcement, medicine, public health,
economic well-being, civil liberties, and
other areas

New and Old Agreements

The United States has put in place a series

of unilateral agreements providing market
access without demanding reciprocation,
called preferential agreements

This type of agreement is enacted to support

the development efforts of a set of countries,
or for a specific political reason

The Impact of NAFTA on U.S.Mexico Trade

Trade flows between U.S. and Mexico have risen

The growth in trade between all three NAFTA

partners indicates increased specialization,
economies of scale, and efficiency

The exact impact of NAFTA is hard to assess

Bilateral trade has expanded already since 1989

thanks to Mexicos economic reforms

Mexicos 19941995 peso crisis and recession caused
U.S. exports to decline momentarily to Mexico

Key Trade Initiatives of the United

States

Labor and Environmental

Standards

In nearly all the trade agreements since NFATA,

North American Agreement on Labor
Cooperation and North American Agreement
on Environmental Cooperation have served as
frameworks for labor and environmental clauses

Both of these agreements operate on the principle

countries should enforce their own laws and not
be used as tools for attracting trade or investment

Labor and Environmental

Standards (cont.)

Enforcement relies on consultations with

parties levying a complaint
Agreements attempt to create public
awareness of non-compliance without setting
specific standards or encroaching on the
sovereignty of national governments
General recognition of labor rights is set forth in
the International Labour Organizations
(ILO) Declaration on Fundamental
Principles and Rights at Work

Two NAFTA-Specific Issues

(cont.)

These four basic rights are built into conventions

drafted by the ILO that countries are encouraged
to sign
1. Freedom of association and the effective
recognition of the right to collective bargaining
2. The elimination of all forms of forced or
compulsory labor
3. The effective abolition of child labor
4. The elimination of discrimination with respect to
employment and occupation

Two NAFTA-Specific Issues

(cont.)

The environmental side agreement of NAFTA

established a framework for incorporating
environmental clauses into subsequent free
trade agreements
In many respects, it is parallel to the labor
clause motivated by similar concerns that low
environmental standards not be used to gain
competitive advantages

Two NAFTA-Specific Issues

(cont.)

Critics of the labor and environmental clauses

come in two forms

Some economists think that trade agreements

should not be about labor and the environment so
these clauses do not belong in trade agreements

Another set of economists argue the clauses are

meaningless because there is no real
enforcement mechanism

Investor-State Relations

The United States has forty bilateral investment

treaties (BIT) with countries across the globe

These agreements set out the rules governing crossborder investment and dispute resolution

Emphasizes national treatment of foreign investors

eliminating distinctions between national and foreign
investors

Eliminate the use of most performance requirements

for foreign investment

Job Loss Due to Trade

There are a quite a few estimates of the job

gains or losses caused by NAFTA and other
trade agreements

Within five years of NAFTAs implementation,

the estimates ranged from a net loss of
98,000 a year to a net gain of 42,000 a year

The politics of trade makes the discussion of

job impacts necessary

Job Loss Due to Trade

(cont.)

The ability of an economy to generate jobs is

determined by factors that do not include
trade

Far more important than NAFTA or any other

agreement are the business cycle,
demography, and labor market policies

Quiz
GDP per capita can be measured using market
exchange rates or purchasing power parity. If one
is interested in learning about living standards in
Mexico, as compared with the U.S. it is best to
compare
a. GDP per capita using market exchange rates.
b. GDP per capita using purchasing power parity.
c. GDP per capita using either purchasing power parity or

market exchange rates. They both give the same answer.

d. GDP per capita using purchasing power parity multiplied
by market exchange rates.

Issues such as immigration and environmental and labor

standards create more tensions in the NAFTA than in other
trade blocs. These tensions are more likely to arise in the
NAFTA
a. Because there is more geographical distance between the U.S.,

Canada and Mexico, than there is between members in other trade

blocs.
b. Because there is more variation in GDP per capita between the U.S.,
Canada and Mexico, than there is between members in other trade
blocs.
c. Because there is more variation in the degree of democracy between
the U.S., Canada and Mexico, than there is between members in
other trade blocs.
d. Because the NAFTA is more recently created than other trade blocs.

The U.S. Canada Auto Pact

a. Is an important part of the Canada-U.S.
b.
c.
d.
e.

Trade Agreement (CUSTA).

Allows for free trade in automobiles.
Allows for free trade in auto parts.
Both A and B.
Both B and C.

Many Canadians were concerned about the CanadaU.S. Trade Agreement (CUSTA) because they worried
that it would
a. Lead to U.S. news and media overwhelming Canadian culture,

and that it would force Canada to abandon some of its social

programs.
b. Cause fiscal problems as Canada lost its ability to collect tariffs
on its imports from the U.S.
c. Not liberalize enough to help the U.S. and Canada remain
competitive against the rise of imports from developing countries.
d. All of the above.

Between 1960 and 2008 U.S.

manufacturing experienced.
a. A decline in value-added and a small

decrease in employment.
b. An increase in value-added and a small
decrease in employment.
c. A decline in value-added and a huge
decrease in employment.
d. A small increase in value-added and a large
increase in employment.

In the 1980s Mexico made policy changes that

made it more profitable to for firms to export. As
firms took advantage of these new opportunities
a. More firms moved close to the U.S.-Mexico Border.
b. More firms consolidated and expanded their operations

around the capital, Mexico City.

c. Income per capita in Mexican cities near the U.S.
border grew more rapidly than elsewhere in Mexico.
d. Income per capita in Mexican cities near the U.S.
border fell behind income growth elsewhere in Mexico.
e. Both A and C.
f. Both B and D.

Trade agreements such as the NAFTA force

governments to consider the effects on jobs,
a. Since the NAFTA has caused a fall in

manufacturing wages in all member countries.

b. Trade agreements raise these issues politically,
even though jobs are more tightly connected to
national labor market, fiscal and monetary policies.
c. Since the NAFTA has caused increased
unemployment in all member countries.
d. All of the above.

In 2005 the United States ratified the Dominican

RepublicCentral American Free Trade Agreement
(DR-CAFTA), with the Dominican Republic and
five Central American countries: The most likely
future impacts of this agreement are
a. A large decrease in U.S. per capita income.
b. Gains for U.S. agriculture producers who have increased

market opportunities in Central America.

c. Gains for banks, insurance companies and
telecommunications firms in Central America who will be
able to enter the U.S. market.
d. All of the above.

In Free trade areas Rules of Origin

a. Set rules about the migration of workers. They create

production efficiencies since for migration by workers in the

free trade area provides a stable work force.
b. Define which goods qualify for free trade treatment. They
create inefficiencies since accounting for rules or origin is
complex and requires a lot or resources.
c. Set rules about the migration of workers. They create
inefficiencies since they provide preferences for migration by
workers in the free trade area.
d. Define which goods qualify for free trade treatment. They
create production efficiencies since they help firms to focus
input sourcing in the free trade area.

It is argued that the U.S. could ease migration

issues with Mexico by focusing on policies that
increase Mexican economic growth. The rationale
behind this idea is that
a. The Mexican Peso would be more stable if Mexico had more

rapid growth.
b. Fewer individuals will seek to migrate if they had higher and
more certain incomes in Mexico.
c. Economic growth would provide resources to the Mexican
government, which could be used to enforce their workplace
rules and labor standards.
d. All of the above.