4.1.5 Trading Blocs And The World Trade Organisation (WTO)

Question 1

Trading blocs: regional trade agreements and bilateral trade agreements

Answer 1

A regional trading bloc is a group of countries within a geographical region that protect themselves from imports from non-members; they sign an agreement to reduce or eliminate tariffs, quotas and other protectionist barriers among themselves and they are a form of integration.
e.g. NAFTA (North America), the EU, ASEAN (Asia) and MERCOSUR (South America).
- Most regional trade agreements take the form of bilateral agreements, between one single country and another single country. Some agreements are multilateral or plurilateral agreements, between at least three countries.

Question 2

Types of trading blocs

Answer 2

1) Free Trade Areas (FTA)
2) Customs unions
3) Common markets
4) Monetary unions

Question 3

Free Trade Areas (FTA)

Answer 3

Trading bloc where trade barriers are removed between member countries but each member can impose trade restrictions on non-members

Question 4

Custom unions

Answer 4

Where there is free trade between member countries combined with a common external tariff on goods from countries outside the customs union

Question 5

Common markets

Answer 5

Include the free movement of factors of production e.g. labour between member countries

Question 6

Monetary unions

Answer 6

These are two or more countries with a single currency, with an exchange rate that is monitored and controlled by one central bank or several central banks with closely coordinated monetary policy (govt tax and spending) e.g. the EU, West African Economic and Monetary Union

Question 7

Why are monetary unions beneficial?

Answer 7

They mean prices are fixed as all currencies are the same and there are reduced exchange rate costs; it becomes easier for prices to be compared across the union and so MNCs (multinational corporations) are less able to price discriminate

Question 8

Why can monetary unions be bad?

Answer 8

There are financial costs involved with starting the new currency and there would be costs if the union broke up
- there is a loss of policy independence, countries are unable to change the value of their currency and what is good for one country may not be good for another

Question 9

Economic union*

Answer 9

The final step of economic integration
- There will be a common market with coordination of social, fiscal and monetary policy

Question 10

Two main types of benefits of regional trade agreements*

Answer 10

1) Static benefits from the gains of specialisation
2) Dynamic benefits from increased competition and the transfer of resources

Question 11

Free trade

Answer 11

The absence of govt policies restricting the import and export of goods and services i.e. absence of protectionism

Question 12

Costs and Benefits of trading blocs depend on…

Answer 12

Whether they lead to trade creation or trade diversion

Question 13

Trade creation

Answer 13

Occurs within trading blocs and involves the removal of trade barriers which results in increased trade between countries in the same bloc when trade is created by the joining of a trade union. The diagram is the opposite of the tariff diagram, since it removes the tariffs and leads to welfare gain and higher consumer surplus. It is when consumption shifts from a high cost domestic producer to a low cost partner producer , so for example when consumption of wine shifted from domestic producers to efficient French producers when we joined the EU.

Question 14

Advantages of regional trade agreements

Answer 14

• Free trade encourages increased specialisation, increasing output, according to comparative advantage; also helps firms to benefit from
  economies of scale, causing lower prices and costs (dynamic advantage)
• Competition as the removal of barriers means domestic industries face greater competition, encouraging innovation and lower prices, leading to improvements in productive and allocative efficiency (dynamic)
• Employment, the increased trade may create more jobs if it leads to an increase in output
• Consumer utility, there will be increased choice for consumers
• Tariffs cause inefficiencies: removing tariffs creates welfare gain

Question 15

Disadvantages of regional trade agreements

Answer 15

• Trade diversion: countries are no longer able to benefit from trade with countries outside their bloc, distorting world trade and reducing the benefits of specialisation; inefficient producers within the bloc are protected from efficient producers outside the bloc, called trade diversion
• Retaliation: the creation of one regional trading bloc will lead to the creation of others and this can lead to trade disputes
• Gains distributed unequally: developed countries often gain most and developing countries are impacted little
• Product diversity: they may be weak if they cover a very limited range of goods
• They lessen national sovereignty/dependance
• Interdependance
• Trading blocs can be seen as ‘ second best’ solutions in a world with protectionism; economic efficiency would be maximised if there were no barriers to trade

Question 16

Trade creation

Answer 16

When trade is created by the joining of a trade union.
- The diagram is the opposite of the tariff diagram, since it removes the tariffs and leads to welfare gain and higher consumer surplus.
- It is when consumption shifts from a high cost domestic producer to a low cost partner producer e.g. when consumption of wine shifted from domestic producers to efficient French producers when we joined the EU

Question 17

Trade diversion

Answer 17

Occurs because members of the same trading bloc now buy less goods from countries outside of the bloc
- where consumption shifts from a lower cost producer outside the trading bloc to a higher cost producer within it
- e.g. the UK switching from buying New Zealand butter, which is the cheapest, to European butter when they joined the EU:
— Before, there would have been the same tariff on both New Zealand and European butter so New Zealand butter would have been bought since it is produced more efficiently and therefore is cheaper.
— However, joining the EU meant that the tariff on EU butter was removed and so this became cheaper and consumption was switched to the higher cost EU butter. This reduces world-wide efficiency as countries are not buying from the most cost-effective supplier and therefore not fully utilising comparative advantage.
— For the UK, there will be both gains and losses.

Question 18

World Trade Organisation (WTO) context

Answer 18

The World Trade Organisation was set up in 1995 to replace the GATT, which had
aimed to reduce protectionism.
It has two main aims: to bring about trade liberalisation and to ensure countries act according to the trade agreements they have signed.

Question 19

Role of the WTO in trade liberalisation

Answer 19

• If a country fails to follow its agreements, a country or group can file a complaint and the WTO will attempt to solve the issue through negotiations but the complaint can go to a panel of experts and countries must agree to their rulings. If they reject the ruling, the country which wins the ruling has the legal right to impose trade sanctions against the exports of the losing country. E.g. Boeing being allowed to impose tariffs on Airbus for illegal subsidies in Europe in 2018.
• They hold a series of talks called ‘rounds’, the most recent of these is the Doha Round in 2001 which aims to cut protectionism on agricultural goods, reduce tariffs on manufacturing goods, increase access to markets in services, tighten intellectual property rights and give the WTO more power to settle disputes.
  Eval: One problem is that for any agreement to take place, all countries must agree to it and so any country is able to veto an agreement. This veto may also be politically motivated, for example retaliation against the US for something unrelated.

Question 20

Possible conflicts between regional trade agreements and the WTO

Answer 20

• Regional trade agreements contradict WTO’s principles as a common external tariff on trade outside the trading bloc introduces protectionism. Customs unions and free trade areas can be seen as violating the WTO’s principle since not all trading partners are treated equally.
  Eval: However, they can complement the trading system and the WTO strives to ensure non-members can trade freely and easily with members of a trade bloc.
• Some might argue the WTO is too powerful or that it ignores the developing countries, as developed countries do not trade freely with developing countries.
• The protectionist approach of the USA and China currently provides a threat to the WTO system

Question 21

Trade creation and diversion

Answer 21

The costs and benefits of trading blocs will depend on whether they lead to trade creation or trade diversion. Trade creation is when a country moves from buying goods from a high cost to a lower cost country, whilst trade diversion is when they go from low cost to a higher cost.

Question 22

Trading blocs more likely to lead to trade diversion vs creation

Answer 22

• When it has a very high external tariff as this will push countries to buy from within the bloc or if there is a relatively small cost difference between goods purchased within and outside the block.
• The higher the tariffs imposed by a country before joining the market, the more likely it is that trade creation rather than diversion will take place.

Question 23

Joining FTA (Free Trade Area) leading to more trade creation vs diversion

Answer 23

• If joining a FTA leads to more trade creation than diversion, it is welfare improving.
• If it leads to more diversion than creation, the FTA is reducing welfare.