4.2 Trading blocs and restrictions on trade

Question 1

What are the benefits of free trade?

Why may developing countries face issues with free trade?

Answer 1

• Higher standard of living with comparative advantage
• Lower prices
• More choice
• Economies of scale - lower LRAC, lower prices higher profits

Developing countries:

• Infant industries can’t compete
• TNCs use monopsony power to hold down prices for commodities - hard to raise incomes
• Developing economies dependent on primary produce - volatile and so may see fall in terms of trade

Question 2

What are the negatives of free trade?

Answer 2

• Free trade does not mean fair trade - rich countries force lower prices for commodities if they have monopsony power
• Trade imbalance - less competitive countries run deficits whilst others run surplus
• Dumping of surplus of goods sold off cheaply and putting local businesses out of business e.g. China
• Unemployment of local markets
• Contagion - dependence on fortune of other countries
• Fail to develop in sectors don’t specialize in
• Sunset industries can fail fast as they are undercut by other countries
• TNCs set up where there are little regulations so imports may be dangerous or unethical
• Insecure to shocks e.g. natural disaster if specialize in primary industry

Question 3

What are trade blocs and what are the 4 types?

Answer 3

• Trade blocs are groups of countries with formal agreements to eliminate trade barriers between themselves. The WTO permits trade blocs, provided they result in lower import protection against other countries that existed. Some include:
• USMCA (US Mexico Canada Agreement)
• EU

They may be bi-lateral meaning that the bloc is between two economies or groups of economies promoting trade in goods and services and flows of oreign investment e.g. ASEAN, EU-Japan

1. Free trade areas - no import tariffs or quotas on products from one country entering another and members can set their own barriers against countries outside the bloc. Example may be African Continental Free Trade Area which is new with 55 nations - intra Africa trade grew to 19% of Africa’s trade
2. Customs union - abolish tariffs and quotas and adopt common external measures on countries not in the member. Example may be the EU. The revenues of tariffs are then combined for all member states and the members as a bloc discuss trade unions
3. Common market - no barriers to trade or movement of factors between members - common barriers against countries outside the area. Involve deeper integration, free movement of capital, goods and services and labor. Examples may be Switzerland who is outside of the EU but members of the EU single market.
4. Monetary unions - no barriers to trade between members, common barriers against countries outside the area however all have a single unit of currency - also a customs union EU.

Question 4

What are the 4 freedoms the EU is built on?

Answer 4

• Free trade in goods - sell products anywhere in EU
• Mobility of labour - live study work anywhere in EU
• Free movement of capital - financial capital flow freely between states
• Free trade in services - pensions, telecoms, advertising

Question 5

What are the advantages of joining a trading bloc?

Answer 5

• Trade creation leads to growth
• More efficient use of resources from free movement of capital and labour
• Growth of industry within bloc
• Infrastructure
• EoFS
• Wider competition - innovation and efficiency
• Lower prices and more choice

Question 6

What are the costs of joining a trading bloc?

Answer 6

• Non members lose out
• Loss of sovereignity - accept the rules
• Hurts national industries especially emerging ones undercut
• Interdependence issues
• Negative externalities - exploit lower regulations

Question 7

Why may a country join a bloc?

Answer 7

• Promote trade and growth
• Efficient use of resources
• Protection of industry
• Infrastructural development
• better political relations

Question 8

What is the value chain and what causes a change in the chain?

Answer 8

The value chain is the steps required to bring a product from conception to distribution through design, raw materials, manufacturing and marketing. The value added is the difference between the cost of inputs and the price obtained from selling it.

Changes to patterns:

• Comparative advantage e.g. India IT growth
• Industrialisation and development status - BRICS
• Changes in incomes
• Tastes and preferences
• Changes to exchange rates (relative)
• Free trade areas and blocs or trade barriers

Question 9

What are the possible advantages of joining the EU?

Answer 9

• Import tariff free access to market of 500 million - since single market encouraged cross border trade
• Easy access to foreign investment from inside/outside EU - encourages inward investment to poorer countries
• Access to structural funds - available to poorer EU nations
• Access to EU capital markets
• Intense competition benefits from efficiency
• Integration with trading partners
• Eliminates transaction cost of currency
• Easier to compare prices under one currency
• Eliminates currency fluctuations - Euro stable so easier to borrow

Question 10

What are the possible costs of joining the eurozone?

Answer 10

• One off transition cost of issuing new currency
• Many economies but one central bank - economies of different sizes so policies and interest have varying impacts
• Loss of exchange rate flexibility -uncompetitive industries see fall in value of currency, lower price of exports

Question 11

What is the optimum currency area theory?

Answer 11

There are six criteria necessary for a successful currency union:

• Countries highly integrated - trade is with fellow members
• Flexible labour markets to cope with shocks - flexible in wages, workers with adaptable skills, high geographical mobility and employment contracts
• Capital mobility - price and wage flexiblity across regions - supply and demand is automatically distributed
• Risk sharing system e.g. automatic fiscal transfer to redistribute to poorer areas more affected during difficult economic times
• Rate of interest changes broadly similar effect in different countries
• Participant countries have similar business cycles

Question 12

What are the cost and benefits of regional trade agreements?

Answer 12

-Trade creation effects - trade deal that lowers tariffs between them so consumers can source imports from a lower cost country leading to lower prices and rise in real income.

However, expanding trade agreements may be a threat to globalisation - regionalisation has been created e.g. East Asia and European Union and some of the poorest countries cannot negotiate favourable tariff or quota free access to many of the markets.

Question 13

What is the role of the WTO?

Answer 13

• Overtook GATT in 1995
• Liberalises trade, settles trade disputes and removes barriers to trade
• 162 members
• Monitors establishment of trading blocks and arbitrates disputes

Most favoured nation - no member can offer better terms to another member than others - all tariffs same for members

National treatment - imported and domestic goods and services should be treated equally

Roles:
Global rules, assurance and stability. Secure supplies, choice of products, components, raw materials and services

Conductor role:
-Ensures rules are followed with rounds of negotations - however take long to be negotiated

Tribunal - settles disputes between members

Monitor - reviews trade policies to ensure fairness

Training - provides support, mainly to developing countries

Question 14

Why is there conflict between the WTO and trade blocs?

Answer 14

Trade blocs engage in free trade with members but exclude non members which is against the WTO aims and only support the WTO aim to an extent

However trade blocs are arguably helping WTo aims as they are more effective than the WTo in general

Question 15

What are some criticisms of the WTO?

Answer 15

• Developed countries seek free trade on industry but protectionism on farm subsidies so they can compete with low cost developing countries, and so they subsidise and protect primary industries in HICs and so primary producers in LICs lose out
• Developing countries seek liberalisation of trade of agriculture as they are competitive and dependent
• Rich countries exploit poor ones by stoppping protectionist measures
• Exports western values at expense of local culture and values
• Non democratic - HICs get higher say in agreements
• Creates poverty and can inhibit development

Question 16

What are the main reasons for protectionism?

Answer 16

• Protect infant industry
• Slow decline of old sectors to limit structural unemployment
• Diversify economy too dependent on a product
• Raise tax revenues
• Improve trade balance and preserve jobs
• Prevent import dumping and unfair trade - excess output sold in another country at price below cost of production
• Protect strategic industries e.g. need a degree of foodstuffs

Question 17

What is dumping?

Answer 17

• Firms sell exports at below costs or below normal prices in home market - form of predatory pricing or discrimination.
• Recent example is steel industry declining less and sold for less than worth

Question 18

What are anti-dumping tariffs?

Answer 18

Tariffs allowed under WTO rules to prevent dumping. May include:

• Ad valorem duty
• Specific duty e.g. fixed value
• variable duty - minimum import price where duty is not paid.

Question 19

What is the impact of a tariff?

Answer 19

Effects:

• Reduces consumption/demand as higher prices
• Incentivises expansion of domestic output
• less importer
• Tax revenues rise
• Domestic profits rise
• Foreign revenues fall
• Consumer surplus falls
• Welfare falls
• Price of imports rise
• Quantity of imports fall
• Increased global share of market

Question 20

How is a tariff illustrated?

Answer 20

Imagine Supply/Demand for domestic supply of steel.

World supply of steel is at a much lower cost at a perfectly elastic level, with excess demand.

When the tariff is added, the world supply price is forced upwards.

This creates two triangles of societal loss as there is a contraction in domestic demand as consumers have to pay a higher price and so their consumer surplus falls

There is an extension in domestic supply as they are able to supply at a higher price than before. This increases consumer surplus and revenues as the quantity and price has increased - still excess demand.

The tax revenue is the rectangle in between the societal losses and the difference between the Qs and Qd at each level shows the quantity of imports.

Question 21

What are import quotas?

Answer 21

Limits to total quantity of a product suppplied to a market, restricting supply of an imported product.

-This adds supply to domestic supply, shifting supply to the right.

• Total global supply is still below at a lower price.
• This reduces global supply and raises prices so fewer imports are consumed, but domestic producers are protected as market share is generated

Question 22

What is the impact of an import quota?

Answer 22

• Reduce supply so raises prices so fewer imports consumed
• Domestic producers increase supply and share of market
• Increase domestic output as more profitable
• Decreases domestic demand as prices rise
• Reduces import volumes
• No effect on tax revenues
• Producer revenues increase for domestic, fall for foreign producers
• Welfare falls

Consumers face higher price in market due to limit on import products and less competition

Government: improved external balance from reduction in imports and expansion of GDP from increased domestic production

Question 23

What is a domestic subsidy?

Answer 23

-Financial support to artificially reduce costs of production and shift domestic supply outwards indicated by the subsequent decrease in prices

Question 24

What is the impact of a domestic subsidy?

Answer 24

• Draws in domestic suppliers into the industry as they gain from the subsidy - get the world price + a subsidy payment and higher revenues lift profits and higher share prices
• Assuming it doesn’t change world prices consumers see no difference
• Government may benefit as effective non tariff barrier to reduce volume of imports
• Allows domestic suppliers to compete within foreign competition
• Non tariff barrier

May be opportunity cost as costs government more

Question 25

What are administrative regulations? What are the effects?

Answer 25

Non tariff barriers which make them more expensive to produe or sell:

• Patents and copyright
• Technical barriers - labeling, regulations
• Environmental or pollution control
• Documentation about place of origin or ingredients

Effects:

• Higher production costs so non tariff barrier
• Domestic firms may receive help in meeting regulations
• May arise as necessity and not intended as barrier to trade e.g. safety of products
• Costs money to impose and police.

Question 26

What are other methods of non tariff barriers?

Answer 26

• Domestic subsidies
• Favouring local producers for contracts or state spending
• Financial protectionism - priority to domestic firms
• Hidden protectionism - indirectly discriminates against foreign firms
• Managed export rates using currency market

Question 27

What are the arguments against protectionism?

Answer 27

• Resource misallocation
• Dangers of price war and retaliation
• More corruption as if more tax revenue goes to corrupt governments then more corruption fueled
• Higher domestic prices
• Increased input costs
• Barriers to entry for markets
• Market distortions
• Regressive effect on income inequality
• Distorts competitive advantage
• Zombie firms kept in business
• Used as political weapons.

Question 28

What is the impact of a tariff on consumer and producer surplus?

Answer 28

Domestic producers: benefit as protected from lower prices imports and so higher producer surplus

Foreign producers: producer surplus lost, tariff creates barrier to trade and squeezes demand

Consumers: higher prices so loss of consumer surplus