Regional trade arrangements: EU, NAFTA Economic integration  economies of scale Basis for enlargement

1. Multilateral trade arrangements [GATT  WTO]Nondiscrimination: bilateral liberalization extended to all members.  “Most favored nation”BUT Complex negotiations: 150+ nations at the table • Regional trade arrangements: EU, NAFTA • Economic integration  economies of scale • Basis for enlargement • As integration proceeds, costs of staying out increase • As labor deploys to competitive sectors, benefits (and • political support) spreads. • BUT trade diversion vis a visnon-members

2. Regional trade agreements Types of regional trade arrangements • Free trade areas (NAFTA, for example) • Customs unions (Benelux, CACM) • Common markets (MERCOSUR,EEC) • Economic union (EU) • Economic and monetary union (USA, EMU?)

3. Effects of regional trade agreements • Static effects • Trade creation effect • consumption effect … buy more from your partner • production effect … less inefficient domestic production • Trade diversion effect • … buy less from efficient, low cost producers not in the club…e.g., UK vis a visAustralia • Dynamic effects • Economies of scale • Greater competition • Investment stimulus

4. European Union / European Monetary Union Created by the Treaty of Rome (1957) Original Members: Belgium,France,Germany, Italy,Luxembourg,Netherlands Joiners,’73: Denmark,Ireland,UK Joiners,’80s: Greece, Portugal, Spain…smoke & mirrors Joiners,’95: Austria,Finland,Sweden Joiners, ‘00s: Transition economies: Slovenia, Poland, Czech Republic, Slovakia, Hungary, Estonia, Latvia, Lithuania, Bulgaria, Romania + Cyprus, Malta Total Population, GDP, GDP per capita (PPP, 2008) EU: 500mil $15.2tril $30,500 €-zone: 326mil 10.6 tril 32,500 USA: 306mil 14.3 tril 46,900

6. European Union • Within-region trade grew much more quickly than world trade in the 1960s • Steps to remove remaining barriers (1985-92) further increased integration • 1987 Delors Report • Four Freedoms: goods, services, labor, capital • Maastricht Summit (1991) • Laid out process of economic and monetary union (EMU) • German unification  September 1992 currency crisis • Italy, Spain “devalue” • UK, Sweden drop out

7. EMU: Economic & Monetary Union (1999) • National currencies replaced with the euro, 2002 • European Central Bank created to control monetary and exchange rate policy • “Convergence criteria” required for membership: • Price stability … 3.2% inflation • Low long-term interest rates … 7.7% • Stable exchange rates • Sound public finances • Deficit/GDP … 3% • Debt/GDP … 60% Who will bail out Greece? Moral Hazard and PIIGS Contagion “Candidate countries see the convergence criteria as a small price to pay for the exchange rate stability and low interest rates that come with full entry into the monetary union.” Carbaugh, p. 282

8. Benefits of EMU • Lower transaction costs • Price comparisons easier • Exchange rate risk eliminated • Stimulates competition Costs of EMU • Europe is not an "optimal currency area" • Loss of monetary policy and the exchange rates as economic adjustment tools • Response to Asymmetric shocks • Use of fiscal policy for adjustment is constrained • Need wage flexibility and labor mobility • both are low in Europe

9. Other key EU policies • Common agricultural policy (CAP) • Support payments to farmers  surpluses • Export subsidies  devastates LDC agriculture • Variable import levies: when world price down, EU tariff up  stable prices within EU • Germans supported French farmers • Now support Polish/Hungarian/Baltic farmers • Government procurement policies • All EU businesses can bid for large contracts in any nation

10. Government support for agriculture, 2007 Subsidy

11. US-Canada Free Trade Agreement (1989) North American Free Trade Agreement (1994) • US, Mexico, Canada • Gradual and comprehensive elimination of trade barriers over 15 years: • Full, phased elimination of import tariffs • Elimination of most NTBs • Protection of intellectual property rights • Dispute settlement procedures • Side agreements on environmental protection and labor law

12. Concerns about NAFTA • Main US losers from NAFTA: import-protected industries competing with Mexican producers, and unskilled workers • Trade diversion from low-cost Asian producers • US industrial workers worried about lower pay in Mexico and plant relocations • Concerns Mexico won’t enforce environmental protection measures • Concern now shifted to China and India

13. Trade effects of NAFTA: trade creation and trade diversion (thousands of dollars)

14. Major western hemisphere regional trade agreements

15. GDP per capita* for the transition economies, 2007 (in dollars)

16. Factor Flows: Increased Productivity  Increased Profit Productivity depends on: Factor scarcity COOPERATING factors (including more of the same factor) Agglomeration economies Interactions … Exchange of information Institutional quality Rule of law Protection of property rights Country risks

17. Operating Abroad • Export from home base • License / franchise foreign providers • Foreign Direct Investment (FDI) • Multinational enterprises (MNEs) • Joint ventures • What’s the nationality? • EXXON — Burger King • Toyota — Baskin—Robbins • Ikea • Aldi/Trader Joe

18. The world’s largest corporations, 2008

19. MNE Motives • EXPAND • Market penetration • Preempt competition • Cost advantages • Skirt restrictions/trade barriers • Hedge • Against currency fluctuations • Against market shifts

20. Country Risk Analysis • political risk: government stability, corruption, domestic conflict, religious & ethnic tensions • financial risk: debt to GDP ratio, loan defaults exchange rate stability • economic risk: growth of GDP, per capita GDP, inflation rate

21. Direct investment position of the United States on an historical cost basis, 2007*

22. Flavors of MNEs • Vertical integration • Backward: secure inputs to core business • Forward: secure market position of final good • Horizontal integration • Create and service overlapping demand for core products • Conglomeration • Add international dimension to business portfolio

23. The Joint Venture Alternative • Combine skills • Share costs • Share risks • Gain local acceptance/leverage • Joint venture with foreign government • Forestall protection • Forestall competition Encounter Coordination Problems

24. FDI and Its Discontents Host discontents • MNEs purchase existing businesses  No new jobs • Foreign bosses • Loss of sovereignty • Gimmicks like transfer pricing  tax avoidance Source discontents • [Short-term?] job loss • Technology transfer • Lose competitive edge • Create own gravediggers • Loss of sovereignty • MNE end runs

25. Labor Immigration Push or Pull? Wage Convergence Winners – Losers Long-run impacts • The division of labor is limited by the extent of the market Profits  Investment  Jobs

26. Labor Mobility - Migration • U.S. immigration - initially more Western Europeans – recently more Mexican and Asian • Immigration Act of 1924 – limited overall flow & Immigration to US • established specific quota from each country based on previous emigration patterns • quota formula modified in 1965

27. Effects of Migration • labor migration equalizes wages • increase in output and welfare in the U.S. • decrease in output and welfare in Mexico • net gain in world output due to higher VMP in U.S.