F. Sanna-Randaccio LECTURE 44-45 :

INTERNATIONAL ECONOMIC INTEGRATION

Multilateral Agreements (incorporating the MFN clause, i.e non-discriminatory agreements) and Preferential Trading Agreements

Degrees of International Economic Integration

The Effects of a Custom Union (static benefits)

•Trade Creation •Trade Diversion

Other benefits from a Custom Union (dynamic benefits)

Political arguments for a Custom Union(strategic considerations)

Regionalism versus Multilateralism

The reduction of tariffs and NTBs may take place through multilateral agreements which imply non-discriminatory reduction due to the application of the “most-favoured-nation” clause (MFN).

There is also the possibility of preferential trading agreements, that is trade liberalization among a restricted group of countries.

Thus a subset of countries may decide to adopt a more advanced form of economic integration.

International trading cooperation may take different forms (in order of increasing degree of integration): A PREFERENTIAL TRADING AGREEMENTS: Reduction of tariffs and other import restrictions among the participating countries but at the same time full independence for each country with regard to setting commercial policy versus third (i.e. non- member) countries

A FREE –TRADE AREA (FTA): Abolition of tariffs and other NTBs on imports among member states, while preserving full freedom as to commercial policy versus the rest of the world.

A CUSTOM UNION (CU): FTA + Common tariff level on imports from non-member countries (common commercial policy). Common External Tariff.

COMMON MARKET (CM): CU+ free movement of production factors.

ECONOMIC UNION:

CM + common economic policies. Different degrees of Economic Union.

NAFTA, MERCOSUR, ASEAN. FTAA

EU

THE EFFECTS OF A CUSTOM UNION

Preferential tariff reduction leads to the removal of only some of thedistorsions (tariffs among member states are abolished while those onthird countries are still operating). Therefore the CU is not necessarilywelfare improving. It is not possible to prove general propositions. Insome circumstances a country entering a CU may benefit from it, inothers it may be impoverished by it.

We thus should examine case by case the effects of a CU. They are highlycontext dependent. These effects are classified as:

Trade Creation

Trade Diversion

Trade Creation (e.g. Europe post WWII from autarky to CU)

Country 2 (Germany) Country 1 (France)

Trade Diversion (with pre-existent trade)

We have trade creation when a commodity which was produced by acountry in the domestic market due to the tariff, due to the elimination oftariffs within the CU, is now imported from another member state whichis most efficient in this production.

In such a case the Custom Union leads to trade creation and a betterallocation of resources.

We have trade diversion when, due to tariff elimination within theUnion, a partner country start importing from another member of the CUinstead than from a country not participating to the CU. The latter is notany more competitive as it is discriminated by the tariff still applied onimports from it.

In such a case the Custom Union leads to trade diversion and a worseallocation of resources.

Formation of a CU leads to a welfare loss for a participating country iftrade flows within the CU substitute pre-existing trade flows withcountries remaining outside.

The custom union is more likely to be beneficial:

• The more competitive the member countries

• The higher the initial tariffs among the countries entering the CU

• The lower the common external tariff

• The wider the union

--The increase in the market size allows to better exploit economies of scale.

--Competition increases.

--The bargaining power in international trade negotiations and in international commercial policy disputes increases.

Political arguments for a CU

The case of Common European Market (MEC) in 1957

Dynamic benefits from a Custom Union:

REGIONALISM e MULTILATERALISM

Panagariya (2000): the proliferation of regional agreements leads

to a result that Bhagwati has labelled as a tariff “spaghetti bowl”

where a country applies on the same good a great variety of tariffs

depending on the country of origin of the imported good.

…Ironically processes initially meant to lead to trade liberalisation

end up in reproducing the chaotic situation existing in the 1930’s

due to protectionism and the limited application of the MFN clause.

• International economic relations are becoming increasingly complex due to the growing economic interdependence among countries and to the remarkable changes taking place in the structure of economic power at the world level (the emergence of China and other BRICS).

•The separation between national economic policy measures and commercial policies is now more blurred.

•Numerous cases of Prisoner’s Dilemmas.

•Importance to introduce mechanism constraining governments freedom to adopt protectionists measures.

•Thus….. greater necessity of multilateral rules but increasing difficulty to reach the necessary consensus