International Economics

Lecture week 11th

Economic Integration: Customs

Unions and Free Trade Areas

Presented by Dr. Nanda R. Nurdianto

Department of Economics
Universitas Pertamina
2022
In this lecture:
◼ Introduction
◼ Trade-Creating Customs Unions
◼ Trade-Diverting Customs Unions
◼ The Theory of the Second Best and Other
Static Welfare Effects of Customs Unions
◼ Dynamic Benefits from Customs Unions
◼ History of Attempts at Economic Integration
◼ Indonesia in FTA
 Learning Goals:
◼ Understand the meaning of trade creation,
trade diversion, and the dynamic benefits of
economic integration
◼ Describe the importance and effects of the
major trading blocks such as European Union
(EU) and NAFTA.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 NAFTA
Population: 445 million
Global Economy Trade Cooperation
JAPAN
GDP: US$15.857 trillion
Population: 127 million
CHINA GDP PPP: US$ 4.29 trillion
EU
Population: 1.330 billion
Population: 491 million
GDP PPP: US$ 6.991 trillion
GDP: US$ 14.38 trillion Japan-Korea-China FTA
FTA Canada – Chile 1997 (under negotiation)
FTA : Chile – Mexico 1999 TPP
FTA : USA – Chile 2004 TTIP
FTA : USA – Singapore 2004
FTA : USA – Australia 2005
Japan-Korea FTA
(under negotiation)
FTA : Mexico – Japan 2005
FTA : Chile – Brunei – NZ – Sing EU
apore 2006 27 countries
TPP: USA-EU 2013 Japan-Mexico EPA
expanding to
(signed agreement)
NAFTA Eastern Europe
U.S.A., EU-MEXICO FT RCEP
Canada, A
Mexico ACP-EU ASEAN-Japan Compreh
Countries in Africa and ensive Economic Partners
expanding to the Caribbean hip (AJCEP)
Latin America (approx. 70 countries)

under negotiation SAPTA Japan’s Bilaterals:

Japan-Mexico Bangladesh, Bhutan, Indi
• Japan-Singapore EPA
a, Maldives,
EPA Nepal, Pakistan, Sri Lanka • Japan-Philippines EPA
(signed agreement) • Japan-Thailand EPA
• Japan-Malaysia EPA
FTAA(by 2005)
AEC
Indonesia, Malaysia, Philippines,
• Japan-Indonesia EPA
MERCOSUR Singapore, Thailand, Brunei, Viet
Argentina, Brazil, nam, Laos, Myanmar, Cambodia
Paraguay, Uruguay

NOTES: as of 7 April 2015 India - ASEAN FTA ASEAN

China - ASEAN FTA
Population: 575.5 million
Notifications FTA & RTA to WTO : 612 Australia-New Zealand-ASEAN FTA GDP: US$ 3.431 billion
Total In force : 406 Korea - ASEAN FTA
4
FTAAP = Future
Sumber: WTO dan sumber lainnya (diolah oleh Kementerian Perdagangan)
Introduction

◼ Economic integration refers to the commercial

policy of discriminatively reducing or
eliminating barriers only among the nations
joining together.
Forms of Economıc Integratıon
◼ The higher levels need more complicated agreements
Economic Market
Integration
(Economic Union)

Common market

Custom Union

CECA, CEPA,
CTEP, EPA

FTA

PTA
Forms of Economic Integration

◼ Preferential trade arrangements (PTA)

◼ Provide lower barriers to trade among
participating nations than on trade with non-
member nations.
◼ The loosest form of economic integration.
◼ Example: British Commonwealth Preference
Scheme, established in 1932 between the United
Kingdom and members of the British Empire.
◼ Indonesia-Pakistan Preferential trade arrangements
(IP-PTA) since 2005
Forms of Economic Integration

◼ Free trade areas (FTA)

◼ Removes all barriers to trade among members,
but each nation retains its own barriers to
trade with non-members.
◼ Examples:
◼ European Free Trade Association (EFTA), 1960, between
United Kingdom, Austria, Denmark, Norway, Portugal,
Sweden and Switzerland
◼ North American Free Trade Agreement (NAFTA), 1993,
between the United States, Canada and Mexico
◼ Latin America Free Trade Association (LAFTA), 1960,
among Latin America countries
◼ ASEAN, 1992
 Forms of Economic Integration: Bilateral Cooperation

◼ Comprehensive Economic Cooperation Agreement (CECA)

◼ an agreement between Malaysia and India to strengthen bilateral trade

◼ Comprehensive Economic Partnership Agreement (CEPA)

◼ a free trade agreement between India and South Korea → recognize the
difference of level of development between developing and developed
countries, increasing invistment and cooperation building for priority
industries
◼ Economic Partnership Agreements (EPA)
◼ a scheme to create a free trade area (FTA) between the European Union
and the African, Caribbean and Pacific Group of States (ACP)
◼ Comprehensive Trade and Economic Partnership (CTEP)
◼ an agreement between Indonesia and Iran to strengthen bilateral trade
→ having similiar level of development, to deepening cooperation via
opening market access, economy cooperation/capacity building and
promoting investment and trade facilities
Forms of Economic Integration

◼ Customs union
◼ Removes all barriers to trade among members
and harmonizes trade policies toward the rest
of the world.
◼ Examples:
◼ European Union (EU), or European Common
Market, 1957, between West Germany, France,
Italy, Belgium, the Netherlands, and
Luxembourg.
◼ Zollverein, 1834, between large number of
sovereign German states
Forms of Economic Integration

◼ Common market
◼ Removes all barriers to trade among members,
harmonizes trade policies toward the rest of
the world, and allows free movement of labor
and capital among member nations.
◼ Example:
◼ European Union (EU) achieved common market
status in 1993 → EU policy is in general promulgated
by EU directives which are implemented in the EU
regulations → Institutions of EU: European Council,
European Commission, Council of the EU, European
Parliament, Court of Justice, European Central Bank &
European Court of Auditors.
Forms of Economic Integration
◼ Economic union
◼ Removes all barriers to trade
among members, harmonizes
trade policies towards the rest of
the world, allows free movement
of labor and capital among
member nations, and unifies
monetary and fiscal policies of
members → politic-economic
union
◼ Most advanced type of economic
integration.
◼ Examples:
◼ Benelux, formed after World
War II between Belgium, the
Netherlands and Luxembourg
 Forms of Economic Integration: another form
◼ Duty free zones (free economic zones)
◼ Areas established to attract foreign investments by allowing
raw materials and intermediate products duty free.
◼ The term is used to designate areas in which companies are
taxed very lightly or not at all to encourage economic
activity
◼ The WTO Agreement on Subsidies and Countervailing
Measures (SCM) has content on the conditions and benefits
of free zones
◼ Some are called free ports which have historically been
endowed with favorable customs regulations
◼ Example: Brazil:Free Economic Zone of Manaus, China: Hong
Kong, Pearl River Delta, Germany: Hamburg, etc.
Trade-Creating Customs Unions

◼ Trade creation occurs when domestic

production in a member nation is replaced by
lower-cost imports from another member
nation.
◼ Leads to increased welfare for members as
nations specialize in comparative advantages.
◼ Leads to increased welfare for non-members as
increased real income spills over into
increased imports from rest of the world.
◼ http://www.economicsonline.co.uk/Global_ec
onomics/Trade_creation.html
Trade-Diverting Customs Unions

◼ Trade diversion occurs when lower-cost

imports from non-members are replaced by
higher cost imports from members.
◼ By itself, trade diversion lowers welfare as it
shifts resources away from comparative
advantages.
◼ Trade diverting customs union also results in
trade creation. Change in welfare depends on
relative magnitude of creation and diversion.
The Theory of the Second Best and Other
Static Welfare Effects of Customs Unions

◼ It was once believed that any movement toward

freer trade would increase welfare, so formation
of a customs union would necessarily result in
increased welfare for members and non-
members.
◼ In 1950, Viner showed that formation of a
customs union could increase or reduce welfare,
depending on the circumstances under which it
takes place.
The Theory of the Second Best and Other
Static Welfare Effects of Customs Unions

◼ Theory of the Second Best

If all conditions required to maximize welfare
cannot be satisfied, trying to satisfy as many
conditions as possible does not necessarily or
usually lead to the second-best position.
The Theory of the Second Best and Other
Static Welfare Effects of Customs Unions

◼ Conditions More Likely to Lead to Increased

Welfare
1. Higher pre-union trade barriers of member
nations.
2. Lower customs union’s trade barriers with
non-members.
3. Greater number of nations forming customs
union, and the larger their size.
The Theory of the Second Best and Other
Static Welfare Effects of Customs Unions

◼ Conditions More Likely to Lead to Increased

Welfare
4. More competitive rather than complementary
economies of member nations.
5. Closer geographical proximity of member
nations.
6. Greater pre-union trade and economic
relationship among potential member nations.
The Theory of the Second Best and Other
Static Welfare Effects of Customs Unions

◼ Other Static Effects of Customs Unions

1. Administration savings from elimination of
customs officers, border patrols, and others.
2. Reduction in demand for imports from and
supply of exports to rest of the world will
likely lead to improvement in collective terms
of trade of member nations.
3. By acting as a single unit, customs union will
likely have more bargaining power than
members separately.
Dynamic Benefits from Customs Unions

◼ Dynamic Benefits of Customs Unions

1. Increased competition, leading to greater
efficiencies and technological improvements.
2. Economies of scale from the enlarged market.
3. Stimulus of investment to take advantage of
enlarged market, and to meet increased
competition.
4. Better utilization of community resources as labor
and capital move freely (assumes common
market).
History of Attempts at Economic Integration

◼ The European Union (EU)

◼ 1958 – established common external tariff
◼ 1968 – Achieved free trade in industrial goods
within EU, and common price for agricultural
goods
◼ 1970 – Reduced restrictions on movement of
labor and capital
◼ 1993 – Removed all remaining restrictions on
flow of goods, services and resources, becoming
largest trade bloc in the world
History of Attempts at Economic Integration

◼ The European Free Trade Association (EFTA)

◼ 1960 – formed by “outer seven” nations: United
Kingdom, Austria, Denmark, Norway, Portugal,
Sweden and Switzerland
◼ 1967 – Achieved free trade in industrial goods
◼ 1991 – Membership evolved to include Austria,
Finland, Iceland, Liechtenstein, Norway, Sweden,
and Switzerland
◼ 1994 – Joined EU to form European Economic
Area (EEA)
History of Attempts at Economic Integration

◼ The North American Free Trade Agreement

(NAFTA)
◼ 1994 – formed by United States, Canada and
Mexico, to eventually lead to free trade in
goods and services over entire North
American area.
◼ Also phased out many other barriers to trade and
reduced barriers to cross-border investments
among the three member nations.
 Indonesia in FTA
◼ Indonesia is a member of Association of Southeast Asian
Nations (ASEAN) which nowadays has develop ASEAN Free
Trade Area (AFTA) policy in pursue of lowering intra-regional
tariff between the members through Common Effective
Preferential Tariff (CEPT) Scheme. The tariff requires the
members to set the tariff between 0-5%.

◼ More than 99% products in CEPT Inclusion List (IL) of ASEAN-

6, consisting of Countries such as Brunei Darussalam,
Indonesia, Malaysia, Philippines, Singapore and Thailand have
already implemented 0-5% tariffs, while in other countries such
as Cambodia, Laos, Myanmar and Vietnam, the tariff is in the
stage of development.

Salvatore: International Economics, 10th Edition © 2009 John Wiley & Sons, Inc.
 Indonesia in FTA
◼ Currently, Indonesia has not only developed free market policy
between ASEAN country members but also develop the cooperation
with other Countries such as:
• ASEAN-Australia-New Zealand,
• ASEAN-China,
• ASEAN-Korea,
• ASEAN-India
• Indonesia-Japan (IJ-EPA),
• And other bilateral cooperation

Source: https://djpen.kemendag.go.id/app_frontend/contents/53-indonesia-in-fta

Salvatore: International Economics, 10th Edition © 2009 John Wiley & Sons, Inc.
Salvatore: International Economics, 10th Edition © 2009 John Wiley & Sons, Inc.
INDIVIDUAL TASK
◼ Choose between pro and con of trade/economic
integration!
◼ Identify at least 3 reasons for pro or con from
the trade integration!
◼ Notes: Everyone is not allowed to do the same
homework results. Every plagiarism will
automatically zero point and absent annul
◼ Submit it through e-learning, due on Friday, 3
June 2022 at 16.00 WIB.
THE END