Trade Blocks

Section 4.3

What is a trade block?

A group of countries that try to get the benefits of free trade by forming a free trade area or a custom union with other countries with similar interests.

In This Lesson We Will Talk About

Free

trade areas Custom unions Common markets Examples Advantages of trade blocks Disadvantages of trade blocks

Free Trade Area (FTA)

A group of countries who agree to eliminate trade barriers between members, while retaining independent tariff systems with non-members.
e.g NAFTA, COMESA, ASEAN Some sectors may remain exempt from free trade provisions (agriculture)

Custom Union
A Group of two or more independent countries who agree to abolish trade barriers (tariffs and quotas) between members, while adopting a common external tariff with non-members.

Common Market
A

fully integrated market area allowing free trade for members as well as labor and capital mobility. A common market may also adopt a common currency (e.g. Euro). Economic Convergence
Member countries usually have a set of common economic targets e.g. Fiscal deficit should remain under 3% of GDP for all EU members

Examples of Trade Blocks

EU

Austria, Finland, Greece, Luxembourg, Spain, Belgium, France, Ireland, Netherlands, Sweden, Denmark, Germany, Italy, Portugal, United Kingdom, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia
NAFTA

US, Canada, Mexico

ASEAN

Indonesia, Malaysia, Brunei, Philippines, Singapore, Thailand, Cambodia, Laos, Myanmar, Vietnam
MERCOSUR

Argentina, Brazil, Uruguay, Paraguay

Advantages of Trade Blocks

Increased

market size Trade creation Specialization results in a more efficient allocation of resources Exploitation of economies of scale Specialization results in large scale production, which in turn results in cost reductions when economies of scale are present.

Advantages of Trade Blocks

Increased

competition results in lower prices, which benefit consumers Greater choices Improvement in quality due to the exposure to more competition More rapid spread of technology among members Prevent wars due to the creation of common interests

Advantages in the Context of a Global Economy

Members

of trade blocks may be able to negotiate better trade terms with the rest of the world than as individual nations Trade blocks may result in greater labor mobility and hence help reduce unemployment in member nations

Advantages in the Context of a Global Economy

Trade

block membership may encourage FDI

FDI: Investment owned and operated by a foreign country. e.g. a multinational corporation builds a plant in the country
Trade

blocks may provide greater currency stability

Disadvantages of Trade Blocks

Resources

may flow to the more efficient larger countries to the detriment of smaller members It may encourage mergers and takeovers leading to greater oligopolistic collusion

Disadvantages of Trade Blocks

Costs

of economic convergence may be very high for some trading nations

Adopting a deflationary policy to keep inflation low (to meet target) may come at the expense of growth

Disadvantages in the Context of a Global Economy

Tensions

may arise between trading blocks on the one hand and global institutions such as the WTO on the other.
The WTO aims at abolishing tariffs and NTBs between all member countries and requires members to treat all other members on most favored nation (MFN) basis.

World Trade Organization

Role of WTO: Abolish trade barriers (both tariff and NTB) between countries No preferential treatment is allowed; treat all other countries on most favored nation (MFN) basis Settle trade disputes

The End