The Economics of Preferential Trade Liberalization

Question 1

Unilateral discriminatory liberalization (three theories)

Answer 1

• ‘Smith’s certitude’ by Adam Smith: foreign firms gain (i.e., higher price and more exports) when tariffs against them are eliminated
• ‘Haberler’s spillover’ by Gottfried Haberler: third nations (those excluded from the preferences) must lose
• ‘Viner’s ambiguity’ by Jacob Viner: trade liberalization/customs unions have contradictory effects on welfare due to their trade creation and trade diversion effects

Question 2

Early experience with Customs Union

Answer 2

• Trade creation: 30%; trade diversion 15%
• Static welfare gain: not more than 0.5% of GDP
• lots of intra-industry trade (IIT): two-way trade in similar, sometimes identical, products
• IIT arises because of differentiated goods (demand for variety) and because there are fixed costs to producing each new variety
• IIT between EU countries grew rapidly until the 1970s, then slackened off
• IIT has the policy implication that adjustment costs may be lower, and thus political opposition to trade liberalisation is reduced

Question 3

Analysis of a customs union - European Integration

Answer 3

• European integration involved a sequence of preferential liberalizations but all reciprocal

Question 4

Customs unions versus free trade agreements

Answer 4

• FTA is like a CU but without a common external tariff
• > ‘tariff cheats’ = ‘trade deflection’ -> Rules Of Origin as protection (difficult and expensive to administer)
• CU require political integration while FTAs do not

Question 5

‘Deep’ trade arrangements

Answer 5

• Regional integration initiatives that go beyond mere tariff cutting
• Empirically the trade creation effect is much larger than the trade diversion effect for most industrial goods
• e.g. CETA

Question 6

WTO Rules for FTAs and CUs

Answer 6

• basic principle of the WTO/GATT is non-discrimination in application of tariffs
• Art. 24 permits them, if…
  … substantially all trade must be covered
  … intra-bloc tariffs must go to zero within reasonable period
  … in case of CU, the common external tariff must not on average be higher than the external tariffs of the CU members were before