Theorie und Politik der Europäischen Integration Prof. Dr. Herbert Brücker Lecture 5 Preferential Trade Liberalisation Theory and Politics of European.

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1 Theorie und Politik der Europäischen Integration Prof. Dr. Herbert Brücker Lecture 5 Preferential Trade Liberalisation Theory and Politics of European Integration

2 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Last Lecture The Microeconomics of Trade and Tariffs ·Basic Tools ·Demand and Supply ·Import Demand Curve ·Export Supply Curve ·Welfare Analysis ·The Gains from Trade ·Welfare Analysis of MFN Tariffs ·Why WTO

3 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Today's Lecture - Overview Preferential Trade Liberalisation Terminology ·preferential trade liberalization ·discriminatory trade liberalization ·regionalism Three underlying questions: 1.Does preferential trade liberalisation harm welfare in (i) participating or (ii) RoW countries? Theory Empiry (brief) 2.Up to now (historically) has the world trading system suffered because of regionalism? 3.Will (future) regionalism damage the global trading system?

4 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Today's Reading Preferential Trade Liberalisation ·Baldwin & Wyplosz (2006) “The Economics of European Integration”, McGraw-Hill, Ch 5. Further reading ·Baldwin, R. E.. (1997) The Causes of Regionalism, The World Economy, Vol. 20 (Issue 7), pp. 865-888. ·Laird,S. (1999), Regional Trade Agreements: Dangerous Liaisons? The World Economy, Vol 22 (Issue 9), pp. 1179-1200. ·Lamy, P. (2002), Stepping Stones or Stumbling Blocks? The EU's Approach Towards the Problem of Multilateralism vs Regionalism in Trade Policy, The World Economy, Vol 25 (Issue 10), pp. 1399- 1413.

5 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Three country setting

6 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Three country setting Regionalism is: home and partner drop tariff on each other’s exports Maintain tariff vis-à-vis RoW

7 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Does preferential trade liberalisation harm welfare in (i) participating countries or (ii) RoW? Welfare impact for members (home and partner) Welfare impact for Non- members (ROW-third countries) In theory In practice (empirical evidence)

8 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Viner’s ambiguity: the intuition Jacob Viner (1950) distinguishes two effects of discriminatory trade liberalization: Trade Creation … trade more with the partner country after tariff removal ·Involves that you buy more from partner firm which produces at lower marginal costs that home firms Trade Diversion … trade less with the ROW after tariff removal ·Involves that you buy more from partner firms and less from RoW firms, albeit RoW firms produce at lower marginal costs than partner firms Therefore, overall welfare effect ambiguous These terms are widely used/understood! Slight imprecision because price effects appear to be ignored

9 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation The PTA Diagram Studying European integrations – e.g. EEC’s customs union – which were discriminatory, i.e. preferential requires: at least three countries ·at least two integrating nations ·at least one excluded nation. ability to track domestic and international consequences of liberalization Need MD-MS diagram to allow for two sources of imports. We use for pedagogic reasons no imperfect competition and no increasing return (NICNIR) framework

10 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation The NICNIR framework No imperfect competition Prices equal marginal costs, no profits No increasing returns to scale Doubling all inputs yields double output, i.e. no fixed costs of production (e.g. marketing, set-up costs for machinery etc.) Monumentally unrealistic, but simplifies analysis Next lecture we introduce increasing returns to scale and imperfect competition framework

11 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation The PTA Diagram: Free Trade Equilibrium Domestic price Home imports MD P FT RoW Exports Partner Exports XS P XS R MS M=X P +X R PartnerHomeRoW Border price Border price 2 1 XPXP XRXR

12 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation The PTA Diagram: MFN Tariff Equilibrium Domestic price Home imports MD P FT RoW Exports Partner Exports XS P XS R MS MS MFN P’P’ M’M=X P +X R PartnerHom e RoW Border price T P ’ -T 2 1 X’ R X’PX’P XPXP XRXR

13 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Discriminatory, Unilateral Liberalization To build up to analysis of real-world policy changes (e.g. customs union): Consider Home removes tariff (T) on imports only from Partner 1 st step is to construct the new MS curve The liberalization shifts up MS (as with MFN liberalization) but not as far since only on half of imports ·Shifts up MS to half way between MS (free trade) and MS (MFN Tariff), but More complex, kinked MS curve with PTA

14 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Discriminatory, Unilateral Liberalization Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Partner Home RoW Border price Border price MS PTA 1 PaPa P’P’ T T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” p*

15 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Domestic Price and Border Price Changes Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Border price MS PTA P’P’ T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” P ’ -T P” What happens when Home removes T but only on imports from Partner, i.e. in case of preferential trade liberalization?

16 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Domestic Price and Border Price Changes Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Border price MS PTA P’P’ T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” P ’ -T P” domestic price falls from P’ to P”

17 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Domestic Price and Border Price Changes Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Border price MS PTA P’P’ T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” P ’ -T P” domestic price falls from P’ to P” Partner-based firms see border price rise, from P’-T to P”

18 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Domestic Price and Border Price Changes Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Border price MS PTA P’P’ T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” P ’ -T P” domestic price falls to P’ from P” Partner-based firms see border price rise, P’-T to P” RoW firms see border price fall from P’-T to P”-T.

19 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Quantity Changes: Supply Switching Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Border price MS PTA P’P’ T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” P ’ -T P”

20 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Quantity Changes: Supply Switching Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Border price MS PTA P’P’ T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” P ’ -T P” RoW exports fall

21 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Quantity Changes: Supply Switching Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Border price MS PTA P’P’ T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” P ’ -T P” RoW exports fall Partner exports rise more than RoW exports fall,

22 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Quantity Changes: Supply Switching Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M’ Border price MS PTA P’P’ T P” P ’ -T P ” -T X R” X R’ X P’ X P” M”M” P ’ -T P” RoW exports fall Partner exports rise more than RoW exports fall, so domestic imports rise

23 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects Domestic price Home imports MD RoW Exports Partner Exports XS P XS R M’ Partner Home RoW Border price P’P’ P” X R’ X P’ X P” M”M” C B A XR”XR” X R” P ’ -T P ” -T P ’ -T P ” -T P” E D

24 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects Domestic price Home imports MD RoW Exports Partner Exports XS P XS R M’ Partner Home RoW Border price P’P’ P” X R’ X P’ X P” M”M” C B A XR”XR” X R” P ’ -T P ” -T P ’ -T P ” -T P” E D Home’s net change = A+B-C

25 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects Domestic price Home imports MD RoW Exports Partner Exports XS P XS R M’ Partner Home RoW Border price P’P’ P” X R’ X P’ X P” M”M” C B A XR”XR” X R” P ’ -T P ” -T P ’ -T P ” -T P” E D Home’s net change = A+B-C Partner’s net change = +D

26 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects Domestic price Home imports MD RoW Exports Partner Exports XS P XS R M’ Partner Home RoW Border price P’P’ P” X R’ X P’ X P” M”M” C B A XR”XR” X R” P ’ -T P ” -T P ’ -T P ” -T P” E D Home’s net change = A+B-C Partner’s net change = +D RoW’s net change = -E

27 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Analysis of a Customs Union FTA vs Customs Unions Given symmetry 3-nation set up, FTA between Home and Partner is automatically a customs union ·Home-Partner CU has Common External Tariff (CET) equal to T in the real world, things are more complicated Analysis is simply a matter of recombining results from the unilateral preferential case In market for good 1, analysis is identical In market for good 2, Home plays the role of Partner In market for good 2, Partner plays role of Home Market for good 3 is not affected by preferential liberalization

28 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Recall three country setting in Customs Union

29 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects of a Customs Union euros imports MD euros Exports XS M’ A D 2 D 1 C 1 B C2C2 XP”XP”XP’XP’XR”XR”XP’XP’ P’-T P” P’ P”-T

30 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects of a Customs Union euros imports MD euros Exports XS M’ A D 2 D 1 C 1 B C2C2 XP”XP”XP’XP’XR”XR”XP’XP’ P’-T P” P’ P”-T In market for good 1 Home change = A+B-C1-C2

31 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects of a Customs Union euros imports MD euros Exports XS M’ A D 2 D 1 C 1 B C2C2 XP”XP”XP’XP’XR”XR”XP’XP’ P’-T P” P’ P”-T In market for good 1 Home change = A+B-C1-C2 In market for good 2 Home change = +D1+D2

32 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects of a Customs Union euros imports MD euros Exports XS M’ A D 2 D 1 C 1 B C2C2 XP”XP”XP’XP’XR”XR”XP’XP’ P’-T P” P’ P”-T In market for good 1 Home change = A+B-C1-C2 In market for good 2 Home change = +D1+D2 Net Home impact =A+B+D2-C2

33 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects of a Customs Union euros imports MD euros Exports XS M’ A D 2 D 1 C 1 B C2C2 XP”XP”XP’XP’XR”XR”XP’XP’ P’-T P” P’ P”-T In market for good 1 Home change = A+B-C1-C2 In market for good 2 Home change = +D1+D2 Net Home impact =A+B+D2-C2 Assumption: D1=C1!

34 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects of a Customs Union euros imports MD euros Exports XS M’ A D 2 D 1 C 1 B C2C2 XP”XP”XP’XP’XR”XR”XP’XP’ P’-T P” P’ P”-T In market for good 1 Home change = A+B-C1-C2 In market for good 2 Home change =+D1+D2 Net Home impact =A+B+D2-C2 (since C1=D1) Partner impact identical

35 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Welfare Effects of a Customs Union euros imports MD euros Exports XS M’ A D 2 D 1 C 1 B C2C2 XP”XP”XP’XP’XR”XR”XP’XP’ P’-T P” P’ P”-T In market for good 1 Home change = A+B-C1-C2 In market for good 2 Home change =+D1+D2 Net Home impact =A+B+D2-C2 (since C1=D1) Partner impact identical But: RoW loses!

36 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Frictional Barrier Preferential Trade Liberalisation euros imports MD euros Exports XS M’ A D F XP”XP”XP’XP’XR”XR”XP’XP’ P’-T P” P’ P”-T In market for good 1 Home change = A+F In market for good 2 Home change = +D Net Home impact =A+F+D unambiguously positive Partner gains same RoW loses

37 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Q1: Do existing regionalism constructions harm welfare in the participating or RoW countries? Welfare impact for members (home and partner) Welfare impact for Non- members (ROW-third countries) In theoryPositive except for very unusual case, inelastic demand for ROW product Negative In any event In practice (empirical evidence)

38 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation EU Customs Union: Empirical Effects

39 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation EU Customs Union: Empirical Effects Q: can we see any import displacements? (as suggested by previous figure)

40 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Q1: Do existing regionalism constructions harm welfare in the participating or RoW countries? Welfare impact for members (home and partner) Welfare impact for Non- members (ROW-third countries) In theoryPositive except for very unusual case, inelastic demand for ROW product Negative In any event In practice (empirical evidence) PositiveNeutral or not determined Noise from global trade volume growth

41 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Q2: Up to now (historically) has the world trading system suffered because of regionalism? Put different: Has Regionalism hindered GATT/WTO progress? GATT/ WTO do work and proceeded (yet have no benchmark) Some areas that appear not to succeed multilateral are also difficult regional: food in WTO vs. CAP Historically could look as if Regionalism triggers Multilateralism: ·Regionalism of EEC (CU) → ·Hurts USA (ROW) → ·Forces USA to push for global (multilateralism) liberalisation

42 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Q3: Will (future) regionalism damage the global trading system? Two schools: Larry Summers: NO, no negative empirical consequences observable Jagdish Bhagwati: YES, risk inter-block trade wars; with regional agreement in place partners have less need for global agreement To answer Q3 properly, need to know what are the causes of regionalism in the first place. Two possible explanations: It is hard to work in GATT/WTO framework, therefore countries prefer easier regional PTAs Once the USA had switched to Regionalism, all other want to do the same in their neighbourhood (i.e. Multilateralism has failed) Baldwin says both wrong.. True explanation is “domino theory of regionalism”

43 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Some empirical facts on regionalism Even though plenty of regional FTA’a (more than 100) only two serious: North America (NAFTA) and Europe (EU/EEA) Distinguish Deep and Shallow integration ·Deep also addressing frictional trade barriers (examples: EU, EEA) ·Shallow only FTA or CU, i.e. rent creating trade barriers are removed (examples: the rest) Historic accounts of the timing and motivation ·Find frequent theme: knock-on effect (domino effect) –NAFTA triggered further Latin America Regional Liberalisation –EEC triggered EFTA

44 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Causes of Regionalism – traditional views (e.g. Krugman 1993) i.Large number of participants at Multilateral liberalisation makes it political harder, difficult ii.Modern (i.e. frictional) trade barriers are harder to negotiate/monitor about, at multilateral level can only deal with tariffs and quotas iii.Frustrations with GATT, and no longer single dominant player (USA) makes the system (compromises) more difficult

45 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Causes of Regionalism – traditional views (e.g. Krugman 1993) i.Large number of participants at Multilateral liberalisation makes it political harder, difficult Reply: Only see the successful regional PTAs, never the failed ones … regional is politically as hard to negotiate as multilateral ii.Modern (i.e. frictional) trade barriers are harder to negotiate/monitor about, at multilateral level can only deal with tariffs and quotas Reply: contradicted by the facts, most regionalism also only addresses tariffs and quotas, EU is the big exception – not the rule iii.Frustration with GATT and no longer single dominant player (USA) makes the system (compromises) more difficult Reply: history shoes that e.g. USA constantly aimed at North American FTA (since 1948) but only got CUSFTA in 1989,

46 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Causes of Regionalism – The Domino Theory The central message: Trade and investment diversion (experienced by non-participating) causes pressures for inclusion.

47 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Causes of Regionalism – The Domino Theory The central message: Trade and investment diversion (experienced by non-participating) causes pressures for inclusion. (effects visible in PTA diagram) ·Notice the larger a block becomes the more costly to stay outside –Pro- and anti-membership forces becomes skewed as the PTA grows –Outsider firms lose as PTA forms … now outsider firms may switch for lobbying pro-tariff towards pro-membership of the PTA ·If entry is impossible (say: political reasons), than incentive to form own “outsider”-FTA Within this theory Regionalism is NOT necessarily bad

48 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Domino Evidence – regionalism follows trade interests

49 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation A different view on risks involved A different view on the risks involved (Laird, 1997)

50 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation From basic theory such as PTA diagram we know … The gain for home and partner for joining the PTA rises ·If the tariff reduction is larger ·The more the two countries initially trade with each other ·The larger the PTA block is The cost from excluding some (RWO) countries – trade diversion – means less to home and partner ·If trade with ROW is small anyway ·If there exist efficient intra-PTA substitutes for ROW products Part of this will be more true for neighbouring countries … hence a force towards Regional Trade Agreements

51 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation But, degree of Integration in RTAs may differ Common internal tariff Zero internal tariff Common external tariff Zero Frictional T. costs Common Currency MFN (WTO) +---- FTA (EFTA) ++--- Customs Union (EEC) +++-- Single Market (EU1992) ++++- Economic Union (EU2000) +++++ RTAs

52 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Customs Union vs. FTA FTA are like CU but have no Common External Tariff: opens door to ‘tariff cheats’, trade deflection: ·goods from RoW destined for home market enter via Partner if Partner has lower external tariff

53 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Trade deflection in a FTA FTA Partner FTA tariff: 0% External Tariff: 10% Home FTA tariff: 0% External tariff: 20% Trade deflection ? Compared to CU ? ROW Tariff: 15%

54 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Trade deflection in CU? CU ROW Tariff:15% Partner FTA tariff: 0% External Tariff: 15% Home FTA tariff: 0% External tariff: 15% Can there be trade deflection in CU ?

55 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Rules of Origin (ROO) The solution to trade deflection is ‘rules of origin’ (ROO) ROO try to establish where a good was made: ·problems: difficult and expensive to administer, especially as world get more integrated ·rules often become vehicle for disguised protection. So this looks as if CU is the better form of RTA compared to FTA, since ROO are costly

56 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Rules of Origin in FTA FTA Partner FTA tariff: 0% External Tariff: 10% Home FTA tariff: 0% External tariff: 20% ROO: home examines all imports zero tariff applies here zero tariff does NOT apply here ROW Tariff: 15%

57 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Rules of Origin issue FTA’s need ROOs for their customs adminstration various ways to administer ROOs … Test if the tariff heading a a product has changed from entry to exit Degree of the value added created in “Partner” Production process requirement (e.g. excluding pure assembly) Resulting problems ROOs within one FTA can vary by type, across products, sectors, partners … thus ample opportunity for hidden protectionism

58 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation CU vs. FTA Despite this origin-problem in FTAs, almost all preferential trade arrangements existing today are FTAs WHY? CU’s require some political integration: Members must agree on Common External Tariff and how to change it ·This includes anti-dumping duties, etc. FTA allows members to participate in Multilateral Liberalization at their own pace, while CU forces command stand for its members

59 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation How are CU and FTAs placed into WTO Rules? A basic principle of the WTO/GATT is non-discrimination in application of tariffs FTAs and CUs violate this principle Article 24 permits FTAs and CUs subject to conditions: Substantially all trade must be covered ·Cannot pick and choose products Intra-bloc tariffs must go to zero within reasonable period If CU, the CET must not on average be higher than the external tariffs of the CU members were before ·In EEC’s CU this meant France and Italy lowered their tariffs, Benelux nations raised theirs (German tariffs were about at the average anyway)

60 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | herbert.bruecker@uni-bamberg.de | www.uni-bamberg.de/sowi/bruecker Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation NEXT LECTURE Recall: No Lecture November 26! December 3 Trade III: Benefitting from a larger Market: Market Size and Scale Effects Reading: Baldwin & Wyplosz (2006) “The Economics of European Integration”, McGraw-Hill, Ch 6.