Trading Blocs

A trading bloc is a group of countries that have mutually agreed to reduce and progressively eliminate barriers to trade (for example tariffs) and the movement of factors of production among the members of the bloc and may or may not have common trade barriers against non-member countries.

Examples of trading blocs: the Asia-Pacific Economic Cooperation (APEC) and the Association of Southeast Asian Nations (ASEAN).

Types of Trading Blocs

Free Trade Area (FTA)

In FTA, all barriers to the flow of goods and services among the members have been removed. Each member within the FTA retains its trade policies against non-members.

An example of an FTA is the United States-Mexico-Canada Agreement (USMCA).

Customs Union

The Customs Union is an improvement of the FTA. It allows the free flow of goods and services among the members and has a common trade policy against non-members. An example of a customs union is Belgium, the Netherlands, and Luxemburg (Benelux) of 1947.

Common Markets

Common markets incorporate all features of the customs union and also allow the free movement of factors of production among its members. Examples include the East African Common Market and The Southern Cone Common Market (MERCOSUR) of Argentina, Brazil, Paraguay, and Uruguay.

Economic Union

The economic union has a higher economic integration level than the common market. It includes all features of the common market and additionally incorporates common economic institutions and coordination of economic policies among members.

If the members of the economic union agree to have a common currency, then it is also called the monetary union. An example of an economic union (also a monetary union) is the European Union (EU).

Regional Integration

We can view regional integration as a move towards freer trade, where members get preferential treatment as compared to non-members. Members eliminate or reduce trade barriers against each other, resulting in a more efficient resource allocation.

Regional integration is on the rise because eliminating trade and investment barriers among a small group of countries is easier, quicker, and politically less contentious than multilateral trade negotiations under the World Trade Organization.

Note: The World Trade Organization (WTO) is a negotiation forum that deals with global trade rules between nations and helps member countries settle their trade disputes.

Trade creation and trade diversion are the two static effects directly resulting from the creation of the customs union.

Trade creation: This is when regional integration results in member countries replacing higher-cost domestic production with lower-cost imports from other members.

Trade diversion: This is when member countries replace lower-cost imports from non-member countries with higher-cost imports from member countries. The higher-cost imports from member countries will be cheaper because of the elimination of trade barriers (tariffs on imports) between member countries.

The net welfare to a country is positive if trade creation is larger than trade diversion.

Advantages of Trading Blocs

• Improved specialization based on comparative advantage: Trading blocs allow member countries to focus on producing goods where they have a cost advantage, leading to efficient resource utilization.
• Reduction in monopoly power due to foreign competition: With more players in the market, monopolistic power diminishes, leading to competitive prices and enhanced product quality.
• Economies of scale from larger market size: larger markets provided by trading blocs enable firms to produce on a larger scale, leading to reduced costs per unit.
• Learning by doing: As countries trade and produce more, they gain experience and expertise, resulting in improved production methods and efficiencies.
• Technology transfer: Trading blocs facilitate the sharing of technology between member nations, leading to modernization and improved production capacities.
• Knowledge spillovers: Ideas and innovations are easily shared within a trading bloc, promoting creativity and fostering innovation.
• Greater foreign investment: Member countries often see an influx of foreign investment due to the attractive and larger market provided by the bloc.
• Better quality intermediate inputs at world prices: Trading blocs often provide access to high-quality raw materials and intermediate goods at competitive global prices.
• Higher interdependence among members of the regional trading bloc results in reduced potential conflicts: As countries trade more with each other, their economies become intertwined, making conflicts less likely due to mutual economic interests.

Disadvantages of the Trading Blocs

• Potential Harm to Low-skilled Workers: There can be negative impacts on low-skilled workers, especially if there’s an influx of low-skilled labor-intensive imports from other member countries.
• Adjustment Costs: As import competition might cause inefficient firms to shut down, workers in these firms may become temporarily unemployed until they find new opportunities.
• Long-term Employment Losses: Workers displaced due to regional integration might face enduring wage losses if they don’t secure jobs that pay as much as their previous ones or if they remain unemployed for extended periods.
• Concerns Over National Sovereignty: There are apprehensions about national sovereignty, especially when countries of varying sizes and economic strengths are part of the same trading bloc. This can create power imbalances and challenges in decision-making.

Challenges to Greater Integration

• Cultural and Historical Barriers: Cultural differences, along with historical considerations such as wars and conflicts, can interfere with the social and political processes required for deeper integration.
• Restrictions on Independent Economic and Social Policies: A significant degree of economic integration can restrict member countries from pursuing their economic and social policies independently. With free trade, as well as the mobility of labor and capital, policies aimed at controlling relative prices or quantities within a country can be countered. Moreover, in a monetary union, countries can’t control monetary policy, and currency devaluation or revaluation isn’t an option to address persistent imbalances. When such imbalances occur, they can lead to crises that have repercussions for other countries, as seen in the Greek fiscal crisis in 2010.

Investment Implications

From an investment perspective, regional integration offers new opportunities for trade and investment. However, differences in culture, tastes, and competitive conditions that exist within member countries may limit the potential benefits of investments within a trading bloc. Problems faced by individual members within a trade bloc may also rapidly spread to other members within the bloc.

Question

If Columbia and Ecuador have free trade between themselves and a common policy excluding non-members from this free trade, then they are a part of a:

1. Customs union.
2. Free trade area.
3. Common market.

Solution

The correct answer is A.

Customs unions allow free movement of goods and services and also form a mutual policy against non-members.

B is incorrect. A free trade area is a grouping of countries where trade barriers are abolished.

C is incorrect. A common market is a free trade area with relatively free movement of capital and services.