EC1111 Lecture 2 Why Trade Agreements? Why do trade agreements exist . Because there are barriers to trade (that generate profit opportunities) (making one group better off at the expense of another) o However, it pays off to lower barriers - it increases welfare gains. . Apart from the theory of comparative advantage, there are potential profits from free trade. o Comparative Advantage creates opportunities for specialization and development If this is true, why does free trade not occur more in the world? · The government has a stake: swayed by lobbies, it does not always encourage free trade - e.g., farmers in EU and USA are very influential · Infant industry argument - discourage imports in order to protect infant domestic industries · Redistribution issues - how do we redistribute the gains from trade? Usually, we satisfy some and frustrate others Free trade = Some winners and few losers. Have to redistribute the welfare gains to those who have missed out. This is usually done via tax. E.g. may tax corporations and redistribute to consumers. Interest groups and protection - Political Economy arguments · Those who most benefit from trade (consumers) are poorly organised (e.g. chaning yourself to a tree wont do much) . Those who lose from free trade (producers-industrialists and farmers) are efficiently organised and lobby harder for protection o They also have more resources Preferential Trade Agreements A bilateral trade is the exchange of goods between two nations promoting trade and investment. The two countries will reduce or eliminate tariffs, import quotas, export restraints, and other trade barriers to encourage trade and investment. A unilateral trade agreement is a commerce treaty that a nation imposes without regard to others. It benefits that one country only. It is unilateral because other nations have no choice in the matter. It is not open to negotiation.
Preferential trade agreements (PTA's) of different degrees: · Free trade agreement: groups of countries reduce or eliminate barriers to imports within the group. Each country sets its own tariffs vis-à -vis non-members (e.g. the EU, Switzerland and Norway) · Customs unions: In addition to the previous case, countries co-ordinate to set a common external tariff to imports from the rest of the world. (already a free trade agreement) . Common market: Free movement of resources in addition to merchandises and services (both goods and services can move, e.g. labour) Problem: With too many small groups, there is a Coordination Failure at the global stage. The WTO wants there to be as few preferential trade agreements as possible including as many countries as possible. It is better to have a few large trading blocs than many small ones. The EU is good because it includes 28 countries. Two waves of preferential trade agreements: First: . Treaty of Rome 19ffi7 -> Subsequently lead to EU . West Indies Federation (19ffi8-1962) -> CARIFTA (196ffi-1972) -> CARICOM (1972 - present) . Andean Pact (196ffi-1996) -> Andean Community of Nations (1996-present) o Non-US participation Second: (larger and more powerful)