CU Theory Flashcards
How can non-members of FTA’s bypass tariff
By exporting to the country with lowest external tariff. And then can move good around the FTA free.
Hence why rules of origin exist
Non-preferential vs preferential rules of origin
B) which one should only have one origin
Non preferential is used to determine country of origin for general purposes, like quotas or labelling purposes.
Preferential rules of origin are part of PTAs to identify whether product is tariffed or not.
B) under non-preferential , a good SHOULD only have one country of origin, but since rules of origin are unharmonised, the same product may have different origins. Thus WTO objective to make common)
How else to stop outsiders bypassing tariffs
CU - common external barrier
What must the common external tariff be set to
B) main issue of CU
On average no higher than ex ante tariff
B) hard to get members to agree on the CET
Viner: 2 effects associated with the CU/FTA:
Trade creation - replace domestic production with more efficient partner (good)
Trade diversion - replaces foreign efficient production with a less efficient partner (bad)
Model build:
Country A is small. Upward sloping supply
Partner B is large. Perfectly elastic supply (horizontal)
Perfectly elastic world (non-partner supply)
B is not the most efficient supplier
A sets the tariff, and forms CU/FTA with B.
Draw before CU diagram pg 8
Before CU, tariffs applied to both B and world.
World is more efficient and so Pw<Pb, and so Pw(1+t) is also < Pb(1+t) so country A imports from world.
After CU diagram
B) assess welfare gains
Now B is in CU, no tariffs
So now import from B instead of Pw(1+t)
B)
CS rises abcd since price falls from Pw(1+t) to B
PS loss a since domestic producers produce less compared to pre-CU and at a lower price
Loss of gov revenue (c+e) as now import from partner B
Net welfare effect (b+d-c)
Where is trade creation on diagram
B) where is trade diversion
b+d
b is production gain (domestic producers are replaced by more efficient partner production)
d is consumption gain (total consumption increased and price falls)
B)
Trade diversion is e (trade moves from more efficient foreign producers to partner)
What if partner B is the most efficient producer
Before CU
After CU pg18
Before CU, A would already be importing from B!
As Pb<Pw and so import at Pb(1+t) as < Pw(1+t)
After CU
Still import from B, but now pay the tariff free price Pb. So less domestic production, and more imports. No trade has been diverted, so only trade creation!
What if CU is LEAST efficient producer (Pb is still higher than Pw(1+t))
Pg 20
A will still import from world at Pw(1+t), so CU has no effect
Key to remember that no change at all on trade patterns (won’t reduce domestic production and extend total consumption) because Pw is still tariffed so no change!
