Chapter 9
Preferential Trading Arrangements
Summary and Review of Basic Concepts
In a preferential trading arrangement, participants agree to reduce or eliminate barriers to the movement of goods between member countries but retain trade barriers against nonmember countries. Such agreements are inherently discriminatory, in contrast to the principle of uniform treatment stressed by the WTO.
A free trade area is a preferential trading arrangement in which each member reserves the right to decide what trade policy it will have regarding nonmember countries. The North American Free Trade Agreement (NAFTA) between the United States, Canada, and Mexico is a free trade area.
In a customs union, members agree to harmonize their trade policies against nonmember countries. The European Union (EU) is a customs union.
Preferential trading arrangements may or may not promote world efficiency.
Inefficiencies arise when members are induced to shift the source of their imports from the lowest cost world producer to a higher cost producer from a member country. This is known as trade diversion.
Preferential agreements are more likely to be welfare promoting if they lead to an increase in the overall volume of trade and cause high cost producers in some member countries to be displaced by lower cost producers from other member countries. This is known as trade creation.
Another important source of efficiency gains involves economies of scale that may be exploited more fully when a larger market is created within the preferential trading area,
For most of the past 50 years, the policies of the Mexican government discouraged economic integration with the rest of the world. Subsidies and import barriers were used to promote self-sufficiency in manufacturing. Heavy restrictions were placed on foreign investment in Mexico. The government also took on an important role in directing the economy through widespread ownership and control of Mexican companies.
In response to massive inefficiencies in Mexican business and attendant problems with inflation and public debt, the government in the mid 1980s, under the leadership of President de la Madrid, took steps to liberalize the Mexican economy. Efficiency in domestic business was to be developed by promoting competition rather than restricting it. Trade barriers were reduced, regulations were eased, and businesses previously owned by the government were privatized. These reforms were continued by President Salinas who initiated the process leading to the North American Free Trade Agreement.
Despite some political opposition, NAFTA came into effect in 1994. Political opposition in the United States came mostly from those who felt that U.S. workers would not be able to compete with lower paid Mexican workers. Other opponents included environmentalists who feared that with NAFTA, U. S. firms would relocate to Mexico in order to escape environmental regulation.
Economic analysis suggests that neither fear is likely to materialize in a significant fashion. The agreement may bring hardship to certain sectors (labor-intensive manufacturing) and to certain labor groups (low-skill workers). Dislocation effects are not likely to be large in the short run. Mexico currently supplies only 2-3% of U.S. imports. Dislocation may become more severe over time, however, as resources are reallocated within Mexico toward export industries and as inflows of foreign capital and technology bolster the productive resources of the country. And, since environmental regulations add only a small fraction to the costs of production, and NAFTA should encourage Mexico to specialize in producing low pollution goods such as agricultural products.
To date, NAFTA has had only a small effect on the U.S. economy. It has not created major job losses in U.S. manufacturing. Although manufacturing wages are significantly higher in the United States than in Mexico, so too is the productivity of U.S. labor (see Chapter 3). Mexican labor productivity suffers from poor training, a shortage of managers, inadequate infrastructure, scarce capital and an unreliable legal system.
The EU is the world's largest customs union. The ultimate goal of the EU is to eliminate all barriers to the movement of goods, labor, and capital within the union. It also hopes to establish a single European currency.
The EU government consists of four main institutions: The European Commission initiates policy and ensures that EU law is applied by member states. The Council of the EU deliberates particularly important or controversial policy issues and also helps to oversee the execution of EU policy. The European Court of Justice decides the legality of Council or Commission acts. The European Parliament is the legislative body of the EU and acts as the chief representative of the people.
The 1987 Single European Act was important in the process of European economic integration. It called for a harmonization of technical standards and a deregulation of transportation and financial services. As of early 1997, roughly 90 percent of the directives set out in the act had been enacted.
At a conference in Maastricht, Belgium in 1991, EU members agreed to form a monetary union with a single currency by the end of the century. Members would have to cede sovereignty over monetary policy to a single EU central bank and closely coordinate their fiscal policies. Despite doubts due to currency crises prevalent when the text went to press, the monetary union began by the targeted date, January 1, 1999.
At the end of World War II, the United States was a leading proponent of multilateral trade liberalization and fought against a GATT amendment that would permit regional trading agreements. Beginning in the 1980s, the United States changed its position and negotiated regional agreements with Israel, Canada and Mexico. Some observers are concerned that increased emphasis on regional agreements will undermine WTO.