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Regionalism In Trading Arrangements Notes

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Countries do not normally have incentive to move towards free trade

Why does protection occur?
o Internal political reasons and differences in opinion of LDC's and MDC's o Interest groups - depends on political structure o Agriculture
 Important voters
 Self sufficiency o Infant industry argument BUT Latin America vs E Asia
 Ineffective industry o LDC's can't compete well on the global market so formed a coalition - 'Enabling Clause'
 MDC's did not agree with liberalisation of agriculture

Following financial crisis, protection hasn't increased as much as expected - move towards freer trade

Regionalism obsolete due to globalism? - MNC's etc. o But always a lobby for 'British farming' etc. 'International Economics' Krugman & Obstfeld (pg 242-3)

Free trade area - each country's goods can be shipped to the other without tariffs, but countries set tariffs against the outside world independently

Customs union - countries must agree on tariff rates

Free trade area versus customs union o FTA 'is politically straightforward but an administrative headache, while [a customs union] is just the opposite' o Customs union
 Goods must pay tariffs when they cross the border of the union and can then be shipped freely - easy administration
 BUT 'countries are, in effect, ceding part of their sovereignty to a supranational entity, the EU' o NAFTA
 Goods from Mexico to USA do not have to pay tariffs, but what stops firms producing in, say Bangladesh, from shipping to Mexico and then to the USA without paying their tariffs.

Goods from Mexico to USA still have a customs inspection and can only pass through without a tariff if they are certified as being manufactured in Mexico

But when does the good become manufactured in Mexico? What if it outsources from other countries?
o So FTA like NAFTA impose an 'administrative headache' concerning an elaborate set of 'rules of origin'

'At first it might seem that preferential tariff reductions are also good, if not as good as reducing tariffs all around.' o 'Perhaps surprisingly, this conclusion is too optimistic.'
 E.g. US is a low cost producer of wheat ($4 per bushel), France is a medium cost producer ($6 per bushel), Britain is a high cost producer ($8 per bushel)

Both Britain and France maintain tariffs against all wheat imports o If they form a customs union, British tariff against French but not US wheat will be abolished. Is this good or bad for Britain?
 If Britain's initial tariff was high enough to exclude wheat imports from either France or the US (e.g. tariff of $5 ->

costs $9 to import US wheat and $11 to import French wheat, so British consumers buy $8 British wheat instead)

When the French tariff is eliminated, imports from France will replace British production

This is a gain from Britain's point of view, as it now only needs to produce $6 worth of export goods to pay for a bushel of French wheat
 If the initial tariff was lower at $3, so that before joining a customs union Britain imported wheat from the US at $7 rather than producing its own, a customs union will mean that consumers buy French wheat at $6 rather than US at

BUT US wheat is really cheaper than French wheat, as the $3 tax on US wheat returns to Britain in the form of government revenue.

So Britain will have to devote more resources to exports to pay for its wheat imports and will be worse off.
 Britain gains if the formation of a customs union creates trade (French wheat replacing domestic production), but loses if the trade within the customs union simply replaces trade with countries outside the union (trade diversion). 'World trade and payments' Caves, Frankel & Jones (Ch. 14)

Monopoly and the gains from trade o 'ability of international competition to limit distortions caused by monopolies in a nation's product markets.' o Monopoly and import competition
 'the tariff is the mother of trusts'

'domestic producers who had worked out collusive agreements among themselves could not raise prices and exploit consumers without help from tariffs, which kept import competition away.'

Figure 14.1
 Point C1 shows production and consumption in a closed economy with competitive clothing and food industries
 If food industry is monopolised, it restricts its output to say FM or F'M causing too many factors of production to be shifted into clothing industry (relative prices distorted to PM or P'M)
 If economy now opened to trade, monopoly faces competition from cheaper imports with a world market price shown by PT
 It chooses output FT (the same output that a competitive food industry would choose) o This could mean contracting output from F' M because of cost disadvantage against foreign producers of food

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