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Exam Summary of Economic integration.

 the concept of international cooperation is linked almost automatically to the English word "aid“, later to “development aid” since it was provided for solving such problems as sanitary conditions, illiteracy, development of minimum infrastructure..

The idea of cooperation began to develop on the international scene as an aid or transfer of resources — by way of grants — from more developed countries to less developed nations.

At present, the concept of international cooperation has evolved to acquire a more general meaning.

International Cooperation Is a series of actions that attempt to coordinate policies or join efforts to achieve common objectives in the international sphere

Properties of International Cooperation

1.       In raising the issue of coordination and the need to join efforts, the concept of cooperation is distinguished from a traditional notion of "aid". Thus, resources involved in it may be in form of loans or grants.

 Cooperation should not to be understood as

 a unidirectional process, in which a country or a group of countries — donors — provide support for another countries — recipients.

Rather, it is a "two-way process," in which both types of countries —donors and recipients— agree to cooperate to solve a given problem and, in so doing, satisfy objectives that each of them has set out to achieve beforehand. In this respect, cooperation always generates "mutual benefits"

2.       . The term "mutual benefits" does not necessarily involve obtaining economic benefits since it may also involve certain political objectives.

3.       . The definition clearly places the concept of cooperation in the international sphere, reaffirming the idea that it is always part of the foreign policies of governments.

Elements of International Cooperation

1.       Globalization, marked by the unification of world markets, that intensifies the breadth and scope of the links and interconnections between states and societies

2.       . Liberalization of world trade, which results in a growing interdependence of national economies, giving rise — at the same time — to strong pressures on the domestic economic systems by demanding the accelerated growth of technological development, personnel retraining and the modernization of production

3.        The growing ideological convergence among leading countries in the international political system

International Economic Cooperation: Is a component of international cooperation that seeks to generate the conditions needed to facilitate the processes of trade and financial integration in the international arena by implementing actions with the purpose of obtaining indirect economic benefits in the medium and long term

Phenomena and Processes Related to International Economic Cooperation

Properties of International Economic Cooperation

1.       Economic benefits: Although the traditional definition of cooperation continues to be valid, the emphasis on the prospective goals changes since these are straightforwardly economic and are linked to exchange processes connected to trade or capital flows.

2.       Emphasis on the relationship between partners, which cooperate to obtain mutual benefits

3.       Inclusion of the private sector: since such type of cooperation may occur between companies, firms, households, etc

4.       The changing role of the state: The state adopts a leading role insofar as economic cooperation is essential to ensure top quality achievements by fostering the technological and productive development of a given country

5.       Actions or activities intended to secure indirect short and medium term economic goals: Actions or activities in terms of economic cooperation focus on generating conditions to facilitate trade and enhance competitive skills in world markets.

Week 2.

1. Economic integration can be defined as: ü

 an economic arrangement between different regions marked by the reduction or elimination of trade barriers and the coordination of monetary and fiscal policies;

 ü trade unification between different states by the partial or full abolishing of customs tariffs on trade taking place within the borders of each state;

 ü the elimination of tariff and nontariff barriers to the flow of goods, services, and factors of production between a group of nations, or different parts of the same nation;

ü the collaboration of two or more countries to limit or eliminate trade restrictions and encourage political and economic cooperation. It allows global markets to function more steadily with less government intervention, giving countries a chance to make the greatest use of their resources.

Economic Cooperation involves joint infrastructure projects.

Economic Integration focuses on trade and factors of production movement.

Countries collaborate to attain a common goal in terms of trade, economic and political. Examples are: EU, African Union , Nafta ETC.

Characteristics of Economic Integration

1. Economic integration is geographical.

2. Economic integration has enabled countries to focus on issues that are relevant to their stage of development as well as encourage trade between neighbors.

3. Integration expands markets and input sources, better allocating resources across the region and accelerating economic growth.

4. Economic integration is one-way countries achieve national interests—only in concert with others.

5. Economic integration plays a critical role in promoting peace and security as the opportunity cost of interdependence reduces the likelihood of war.

Success factors for economic integration:

“permanency" in its evolution: a gradual expansion and over time a higher degree of economic/political unification.

the ability for sharing joint revenues (customs duties, licensing etc.) between member states.

 a process for adopting decisions both economically and politically.

 a will to make concessions between developed and developing states of the union.

Obstacles to achieving integration:

1.       Reluctance to surrender political sovereignty: The argument here is that the greater the degree of economic integration, the greater the loss of national, political sovereignty.

2.       Reluctance to surrender economic sovereignty:

       'One size fits all' interest rate policy - full monetary integration involving the use of a single currency would mean that individual nation states would lose the power to set their own interest rates (these would be set by the central bank of the monetary union). Countries would then have to accept, what has become known as, a 'one size fits all policy', which may not suit all members. For example, Ireland and Britain had a de facto monetary union since 1826 until 1978 but were clearly independent states, with different foreign policies.

 Structural/regional imbalances within countries – as the degree of integration increases, the freedom of individual countries to offer selective assistance to particular regions within the country and to particular industries, would get less and less

3 Development gap between countries.

The pros of creating economic integration include the following:

1. Trade creation. Integration creates more opportunities for countries to trade with one another by removing the barriers to trade and investment.

2. Employment opportunities. By removing restrictions on labor movement, economic integration can help expand job opportunities.

 3. Consensus and cooperation. Member nations may find it easier to agree with smaller numbers of countries. Regional understanding and similarities may also facilitate closer political cooperation.

The cons involved in creating integration include the following:

1. Trade diversion. Member countries may trade more with each other than with nonmember nations. This may mean increased trade with a less efficient or more expensive producer because it is in a member country. In this sense, weaker companies can be protected inadvertently with the bloc agreement acting as a trade barrier. In essence, integration has formed new trade barriers with countries outside of the trading bloc.

2. Employment shifts and reductions. Countries may move production to cheaper labor markets in member countries. Similarly, workers may move to gain access to better jobs and wages.

3. Loss of national sovereignty. With each new round of discussions and agreements within a regional bloc, nations may find that they have to give up more of their political and economic rights. For example, the economic crisis in Greece is threatening not only the EU in general but also other member nations.

2.       Levels (Stages) of Economic Integration.

Free trade= Reduction of tariffs between members: USMCA, MERCOSUR, ASIAN (Partial)

Custom Union: Common External Tariffs.

Common Market: free Movement of Capitals and services. Different national regulation.

Economic Union: No barrier for internal trade, free movement of labor, harmonized tax rate, common monetary and fiscal policy. EU partial.

Pollical union: common government.

FREE TRADE AGREEMENT

 The first level of economic integration is the establishment of free trade agreements (FTAs) either preferential trade agreements (PTAs) or Free Trade Area

North American Free Trade Agreement (NAFTA) (United States, Canada, Mexico);

Closer Economic Relations (CER) (Australia, New Zealand)

Tariffs (a tax imposed on imported goods) between member countries are significantly reduced, and some are abolished altogether.

 Each member country keeps its tariffs regarding third countries, including its economic policy.

The general goal of free trade agreements is to develop economies of scale and comparative advantages, promoting economic efficiency.

These agreements can be limited to a few sectors or can encompass all aspects of international trade.

CUSTOMS UNION

is built on a free trade area - Andean Pact (Bolivia, Colombia, Ecuador, Peru) is created when a group of countries removes all restrictions on mutual trade and also adopts a common system of external tariffs and quotas with respect to trade with third countries; movements of capital and labor remain restricted.

COMMON MARKET

European Community (EC) before January 1994 (Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, United Kingdom);

Common Market of the South (Mercosur or Mercosul: Mercado Comun del Sur / Mercado Comum do Su) (Argentina, Brazil, Paraguay, and Uruguay)

- removes all barriers to the mobility of factors of production (people, capital) and other resources within the area;

requires significant policy harmonization (places more severe limitations on member countries’ ability to pursue independent economic policies): free movement of labour necessitates agreement on worker qualifications and certifications; a broad convergence of fiscal and monetary policies due to the increased economic interdependence within the region and the effect that one member country’s policies can have on other member countries

Advantage is the expected gains in economic efficiency: mobility of labour and capital can more easily respond to economic signals within the common market, resulting in a more efficient allocation of resources

ECONOMIC UNION

Is the deepest form of economic integration European Union (EU) from January 1999

all tariffs are removed for trade between member countries, creating a uniform market;

free movements of labor, enabling workers in a member country to move and work in another member country;

coordinated common monetary and fiscal policies as well as labour market, regional development, transportation and industrial policies.

common currency - European Monetary Unit (called the 'Euro');

 harmonization of tax rates;

 supranational institutions regulate commerce within the union to ensure uniform application of the rules

POLITICAL UNION (sometimes it is called TOTAL INTEGRATION)

EU has some elements. The ultimate aim is a United States of Europe.

 European parliament, directly elected by citizens of EU countries. Council of Ministers: government ministers for each EU country. Court of Justice: the official interpreter of EU law. Constitution of the EU: France and the Netherland rejected in 2005

Basic Elements of the level of economic integration.

Free Trade Agreement (FTA) = Zero terrif btw members countries and reduced non-tarrif barrier

Custom Union: FTA+ Common external Tariff

Common Market: CU+ free movement of capital and labor, some policy harmonization.

Economic Union: CM+ Common Economic Policies

Political Union: EU+ the executive, legislative and judiciary

Week 3

1.       The Meaning of Regionalism

The term “region” derives from the Latin word regio, which since the Roman period had different meanings, connoting “direction”, “position, state”, “border, line”, “part of the world”, “country”, “region, district, area”.

Region refers to…..

Geographical approach: regions are areas that are broadly divided by physical characteristics, human impact characteristics, and the interaction of man and environment;

Historical approach: the regions as “way of life” (landscapes, ways of life and human practices);

Philosophical approach: region is looked upon as a special world with its own mentality, outlook, traditions, etc.

 Functional approach: regions are regarded as the operational structures of its activities;

Administrative approach: region as an administrative area, division, or district; subject of a federation;

International politics approach: in this case the “region” can be defined as “international region”, “euroregion”, “transnational region” or “trans-border” region, e.g. Tyrol Euroregion (Italy, Austria).

 “Mixed” approach is an attempt to mix several characteristics of the “region” in its definition: historical, geographical, social and cultural, etc.

The Meaning of Regionalism

Regionalism is the expression of a common sense of identity and purpose combined with the creation and implementation of institutions that express a particular identity and shape collective action within a geographical region.

Regionalism is actions by governments to liberalize or facilitate trade on a regional basis, sometimes through free trade areas or customs unions. (World Trade Organization).

Regionalism refers to three distinct elements:

a) movements demanding territorial autonomy within unitary states (‘bottom-up’ regionalism);

b) the organization of the central state on a regional basis for the delivery of its policies including regional development policies (‘top-down’ regionalism);

c) political decentralization and regional autonomy (a response to the first)

Historical Development of Regionalism

 *Catalonia is an autonomous community of Spain, designated as a nationality by its Statute of Autonomy. It has Parliament, language, police, educational system.

*Catalonia receives 58 % of the proceeds of a number of other taxes, including on alcohol and fuel, raised there.

*Catalonia, with about 16 % of Spain’s population of 47 million, complains about the redistribution of tax revenues.

*Each year, it pays about 10 billion euros (8.85 billion pounds) more in taxes to Madrid than it gets back, or around 5 % of regional economic output, according to Spanish Treasury data.

An independence referendum was held on 1 October 2017 in the Spanish autonomous community of Catalonia, passed by the Parliament of Catalonia as the Law on the Referendum on Self-determination of Catalonia.

Example of Quebec

Quebec is the largest province by area and the second largest by population in Canada.

 Quebec's official language is French.

The Canadian parliament voted in 2006 to recognize Quebec as a “nation”. üQuebec, has its own delegations in the Unites States, Latin America, Asia, Europe and Africa. Quebec is also a member of its own right in some international organizations, including UNESCO.

Early Regionalism

Pre-modern exchange systems were often based on symbolic kinship bonds and also contained an important element of diplomacy and the creation of trust between isolated communities. Often geographical and environmental obstacles prevented more organized interaction. In order to further regionalize, the potential region must, necessarily, experience increasing interaction and more frequent contact between human communities.

Migratory patterns were particularly important for the creation of new ethnicities, social and cultural structures and spaces (informal regions).

 The formal and political organization of cross-community interactions can be seen in a rich variety of geographically confined empires, kingdoms, alliances, pacts, unions, and confederations between assorted political units.

Old Regionalism

The first regional movements (e.g. Catalonia, Flanders or Brittany) are found in Europe in the late XIX century, directed largely against the centralizing and uniform nation state. They were often conservative in orientation, supported by traditional social classes and religious groups and opposing social change imposed by modernity. Such types of movement can be seen as responses to the consolidation of the nation state, the closing of borders, the creation of national markets and efforts at cultural and social homogenization, which had an uneven impact on various sectors and territories

Regional policies were state policies intended to ensure even development across the national territory. They consisted of subsidies and tax incentives, together with infrastructure provision, to encourage the relocation of investment to lagging regions. They followed a triple logic:

 1) Economically, they were intended to maximize national production by mobilizing resources in regions of under-employment.

 2) Socially they represented the spatial extension of the principle of social solidarity and the welfare state by reducing regional inequalities.

 3) Politically, they secured support for the state and for ruling parties in under-developed or declining areas.

The emergence of regionalism in the developing world was closely linked to colonialism/anti-colonialism and the quest to facilitate economic development in the newly independent nation-states in Latin America, Africa and to some extent also in Asia.

New Regionalism

The fall of the Berlin Wall together with the Single European Act resulted in a new dynamic process of European integration. This was also the start of what has often been referred to as ‘new regionalism’ on a global scale.The new regionalism referred to a number of new trends and developments, such as the increase in the number of regional trade agreements, an externally oriented and less protectionist type of regionalism, and the increasing importance of a range of business and civil society actors in regionalization.

 Beyond the New Regionalism Something has happened with the nature of regionalism itself since around the turn of the millennium or the mid-2000s. This fact, as well as signs of its increasing diversity, is evidenced by the rich set of new (partly overlapping, partly competing) concepts and labels, such as “posthegemonic regionalism”, “differentiated integration”, “regional worlds”, “networking region”, “beyond regionalism”.

Regionalism has become a structural component of today’s global politics. It is even claimed that today’s world order is a regional world order. The fundamental point is not that regionalism necessarily dominates global politics in all respects, but rather that “regions are now everywhere across the globe and are increasingly fundamental to the functioning of all aspects of world affairs from trade to conflict management, and can even be said to now constitute world order.

Regionalism is most widespread in Europe, where regional trade agreements (nearly 60 per cent of them are concluded by European countries) are an essential element of the European Union’s external relations.

Old Regionalism Theory

The old regionalism theory was based on the concepts of trade creation (the point is in elimination of tariffs on inner border of unifying states (usually already trading with each other), causing further decrease of price of the goods, while there may be a case of new trade flow creation between the states decided to economically integrate) and trade diversion (when the trade flow is diverted from actually cost-efficient partner state to less efficient one – but which became a member of economic union and made its goods cheaper within a union, but higher compared to the rest of the world. In practice, both trade creation and diversion effects take place due to formation of economic union) but the theory can give no definitive answer as to which effect will predominate.

• A larger regional market offers opportunities for economies of scale, stimulates competition and provides incentives for investment. Achieving economies of scale is very important for firms in small countries, and especially in developing countries. Economies of scale may occur through product specialization enabling firms in two countries to specialize in particular product lines instead of producing the full product line.

New Regionalism Theory

The new regionalism is determined by the structural changes in the global economy of the 1990s brought about by globalization. Following successive rounds of trade liberalization in the GATT/WTO, FDI has become much more important in the global economy; investment flows are now growing faster than trade flows. Firms have an incentive to switch from trade to FDI when trading costs (transport costs and government regulatory barriers) are high and investment costs (including communications costs) are rapidly declining.

• Multilateral trade liberalization fosters global trade but it increases transport costs relative to regional trade. At the same time, the dramatic fall in communications costs is driving the shift from exporting to FDI. So, regional integration that fosters investment creation is preferable to further multilateral trade liberalization. Since the size of the market is crucial in attracting FDI, small countries compete to attract foreign investment by ‘‘regionalizing’’ their market. Small countries may be willing to pay a premium for this by undertaking considerable economic reforms. By linking up with a large country, small countries gain credibility in the eyes of foreign investors based on the belief that the large country will play the role of hegemon in the club and will enforce the rules.

“Regionalization 1.0”: internationalization of the “region”

Regionalization 1.0 corresponds to the phenomenon of the “international region,” which is a number of states, which are united by some common characteristics and problems

Features of International Regions

the elements that make up the international region are nation statethe geographical factor plays a leading role

the common historical, cultural, economic and political ties

the presence of regional problems that required the joint participation of all interested states

the international region should be regarded as a subsystem, a complex element of the international system, but located between the global and local levels of the system

The “international region”, gradually began to evolve, gaining a global dimension under the influence of objective trends: Trans nationalization, which is a process that largely determined the new state of the world political system as a “transnational environment of global interaction” and provided the system with such characteristics as multilevel Ness and interdependence; Democratization of the world political practice meaning the formation of a multi-lateral approach (the interaction between state and non-state actors) to decision-making at the international level, the expansion of participation in the formation of world politics and global governance.

Theory of Liberal Economics

Economic liberalism is a political and economic ideology based on strong support for a market economy based on individual lines and private property in the means of production.

 Economic liberalism is based on the principles of personal liberty, private property, and limited government interference.

21st century is complex in character and it is consisting of “trade-investment service” nexus. That’s why, the barriers in front of the international trade are not the traditional customs barriers, but also barriers behind the borders like competition policy, intellectual property, investment rules etc.

üThe most common theoretical explanations are:

Ø “Slow multilateralism”, i.e. the assertion that regionalism is spreading because multilateral talks are progressing so slowly (Paul Krugman, Jagdish Bhagwati). Multilateralism is in crisis. Power competition is increasing, globalization is slowing, and the West finds itself with no choice but to return to realism and realpolitik.

Ø The global spread of democracy, and the quest for geopolitical stability (Edward Mansfield).

 Ø The bandwagon effect, which argues that nations sign FTA since they see other nations signing them (Jagdish Bhagwati).

Ø The domino theory of regionalism produces what looks like a bandwagon effect but identifies the precise political economy links producing it (Richard Baldwin)

The idea of domino effect: Forming a preferential/free trade area, or deepening an existing one, produces trade and investment diversion. This diversion generates new political economy forces in nonparticipating nations. The pressure increases with the size of the trade bloc, yet bloc size depends upon how many nations join.

“The General Theory of Second Best” was formalized by Richard Lipsey and Kelvin Lancaster in 1956.

The solution of a model is referred to as an equilibrium. An equilibrium is described by explaining the conditions or relationships that must be satisfied in order for the equilibrium to be realized. These are called the equilibrium conditions. In economic models, these conditions arise from the maximizing behavior of producers and consumers. Thus the solution is also called an optimum.

A standard perfectly competitive model includes the following equilibrium conditions:

 (1) the output price is equal to the marginal cost for each firm in an industry,

 (2) the ratio of prices between any two goods is equal to each consumer’s marginal rate of substitution between the two goods,

 (3) the long-run profit of each firm is equal to zero,

(4) supply of all goods is equal to demand for all goods. – In a general equilibrium model with many consumers, firms, industries, and markets, there will be numerous equilibrium conditions that must be satisfied simultaneously.

 Today’s regional economic integrations are considered as second-best theory, while the first one reminds a utopia.

Traditional theories of economic integration, which explain the possible benefits of integration and are often referred to as static analysis or as “old regionalism.”

 Research of trade integration and the explanation of theoretical issues related to preferential trade agreements are based on Jacob Viner’s pioneering work The Customs Union Issue in 1950.

 Viner’s study is the first one to define specific criteria for the distinction of the pros and cons of economic integration. His static analysis of economic integration distinguishes the now well-known effects of trade creation and trade diversion.

Viner claims that trade creation increases a country’s welfare while trade diversion reduces it.

 What Viner’s theory practically means is that countries would be motivated to participate in integration if it would possibly bring more benefits than costs, or, in other words – when integration leads to more trade creation than trade diversion.

The New Economic Integration Theories

Hungarian economist Béla Balassa was one of the first researchers that introduce the concept of the dynamic effects of economic integration, which adds a new dimension to the research in this area

 B. Balassa introduces a new instrument to analyse the effects of economic integration on welfare – dynamic effects analysis – as a better means of explaining the reasons and economic rationale behind the creation of economic integration. Balassa defines the main dynamic effects of integration

A main thesis in international economics is that free trade on competitive markets enables production and consumption efficiency globally as well as in every single country.

Bela Balassa published The Theory of Economic Integration in 1961.

 His book was defining the economic integration as a process that begins at the stage of free trade area, then reaches a customs union and the absolute integration with economic and monetary union in the single market.

 Today, the theory can clearly be seen as a practice experienced by European Union.

 Bela Balassa defined that as economic integration increases, the barriers of trade between markets diminish.

Balassa believed that supranational common markets, with their free movement of economic factors across national borders, naturally generate demand for further integration, not only economically (via monetary unions)

The New Economic Integration Theories

There is no reliable method for quantitative assessment of dynamic effects. üDynamic analysis of the effects of economic integration comes from the characteristics of today’s free economy.The dynamic effects of economic integration can be summarized as follows:

 • increase of investment expenditure,

• sustainable increase of demand,

• consolidation of production and increase of its specialization,

• improvement of the organization and management of production and production technology,

 • rationalization of territorial distribution and utilization of resources,

• increase of production efficiency, creation of economic growth

1.       Protectionism VS. Free Trade

Protectionism is a policy of protecting domestic industries against foreign competition by means of tariff (import tariffs) and non-tariff (subsidies, quotas, embargo) instruments

By 1913 customs duties were low throughout the Western world, and import quotas were hardly ever used. It was the damage and dislocation caused by World War I that inspired a continual raising of customs barriers in Europe in the 1920s. During the Great Depression of the 1930s, record levels of unemployment engendered an epidemic of protectionist measures. World trade shrank drastically as a result.

Instruments of Protectionism

1.       Tariffs measures involve customs duties.

A customs duty is a tariff or a kind of indirect tax which is realized on goods of international trade (on the importation (mostly) or exportation of goods).

 It is usually calculated as a percentage on the value of the goods but meat, fish, tea, certain textile products and certain firearms attract rates of duty calculated either as a percentage of the value or as cents per unit (for example, per kilogram or meter).

 High import duties make foreign goods noncompetitive in home market and used for protection the national manufacturers of similar goods

Customs duties are classified into three types:

ad valorem duty, specific duty and compound duty:

1. Ad Valorem Duty is assessed as percentage of the import value of goods.

 2. Specific Duty is assessed on the basis of some units of measurements, such as quantity (e.g. $5 per dozen) or weight, either net weight or gross weight (e.g. $20 per kilogram net).

3. Compound Duty is assessed as a combination of the specific duty and ad valorem duty

2. Quotas are limits as to how much of a product can be imported or exported to or from a country.

3. License is a permission to import/export specific type of goods during the time defined by authorities.

4. Product standards are regulatory standards in the areas of food preparation, intellectual property enforcement, or materials production, e.g. health and safety standards, environmental standards.

5. Exchange control: the government could limit the amount of foreign currency accessible to paying for imports

6. Voluntary export restraint (VER) is a self-imposed trade restriction where the government of a country limits the amount of a certain good or category of goods that are allowed to be exported to a different country.

 7. Government Subsidies.

 8. Administrative obstacles, e.g. bureaucracy.

Case for Protectionism

          1. Patriotism. Nationalistic feeling or patriotism requires that people of a country should buy products of their domestic industries rather than foreign products.

2. Employment Argument. It is believed that imports of goods from abroad reduce domestic employment.

3. Infant Industry Argument. Protection of infant industries.

4. Anti-dumping Argument. Foreign producers compete unfairly by dumping the goods in another country.

5. Correcting Balance of Payments. The deficit in balance of payments can be reduced by ensuring rapid growth in exports of a country.

Free Trade: International trade that takes place without barriers is called free trade.

Free trade is the policy of minimal state interference in foreign trade, developing on the basis of free market forces of demand and supply.

 It can also be understood as the free market idea applied to international trade. Attributes of free trade:

1) Trade of goods without any trade barriers

2) Trade in services without trade barriers.

3) The absence of "trade-distorting" policies (such as taxes, subsidies, regulations, or laws) that give some firms, households, or factors of production an advantage over others.

4) Unregulated access to markets.

5) Unregulated access to market information.

6) Trade agreements which encourage free trade

Case for Free Trade

1.       Gains in Output and Well-being from Specialization in the production of those goods in which it is relatively more efficient and therefore export a part of them and in exchange gets those goods from other countries in production of which they are comparatively more efficient.

2.       Gains from Economies of Scale enables the trading countries to benefit from the economies of scale. If a country does not trade with others, its firms will produce goods to meet the domestic demand for a product.

3.       Consumers have access goods and services at lower prices and in greater varieties —gains that come from not only foreign‐made items, but also from similar domestic items that are now forced to compete with imports on price or quality

4.       Promotes Competition and Prevents Monopoly

2. The Customs Union: Theoretical Background

Customs unions are by definition discriminatory. They mean an eliminating of tariffs within the union and an establishing of a joint outer tariff wall. They combine free trade with protection.

In tariff theory, there are two types of discrimination:

1) the commodity discrimination is one where different tariff rates are applied to different commodities

2) the country discrimination is one where different tariff rates are applied to the same commodity according to its country of origin.

The customs union theory deals with problems raised by the country discrimination.

The Customs Union: Theoretical Background

 The theory has been limited mainly to the effects of customs union on welfare gains and losses, which may arise from a number of different sources:

1. The specialization of production according to comparative advantage, which is the basis of the classical case for gains from trade.

 2. Economies of scale.

3. Changes in the terms of trade.

4. Forced changes in efficiency due to increased foreign competition.

5. A change in the rate of economic growth.

The Customs Union: Theoretical Background

 The conclusion of the earliest customs union theory may be summarized as follows:

 In the beginning customs unions have been viewed favorably. The reasoning was free trade maximizes world welfare; a customs union reduces tariffs and is therefore a movement towards free trade; a customs union will, therefore, increase world welfare even if it does not lead to a world welfare maximization.

Week 6

1.       Trade Creation and Trade Diversion

The probability of having trade creation is higher than trade diversion.

The higher the elasticity of demand and supply of a country which wants to take part in a customs union, the greater the trade creation. The higher the previous tariff among countries, which establish the union, the higher will be the trade creation.

 When the union is between two rival economies, the trade creation and benefit is superior.

The trade diversion will be lower when the external tariff imposed to third countries by the new customs union is low.