FREE TRADE AGREEMENTS

TRADE, TRADE AGREEMENTS, & IMMIGRATION

1. Simple Trade Model
2. Logic behind trading blocs
3. Trade Organizations & U.S. Trade Agreements
4. Trade Agreements and Labor
5. Labor Standards
6. Immigration
WHY NATIONS TRADE?
Differences in factor endowments
 Countries differ in endowments in natural resources, infrastructure, capital availability, human capital
accumulation

Benefits from economies of scale

 By specializing, countries can produce on a large scale
SIMPLE TRADE MODEL
Assumptions:
2 good world: e.g., food and clothes
2 types of inputs – capital and labor
Regions differ in their endowments of each
Both capital and labor are of fixed quantity and immobile
Constant returns to scale
Consumers in both countries have same taste

Can combine capital and labor to produce some mix of food and clothes: result is a
production possibilities function.
 COMPARATIVE ADVANTAGE

Regions (countries) differ in the quantity/quality of inputs

Costs of producing one good expressed in opportunity costs or foregone production:
- I.e., The cost of producing one unit of A means foregoing the production of x units of B

Country X is said to have a comparative advantage in producing Good A if the

foregone output of Good B is lower than the foregone output of Good B in Country
Y.
Note: No $$ Discussed
 TRADE AS MUTUALLY BENEFICIAL

Notion is that countries differ in the relative costs of production.

Free trade does not lead to all production being shifted to the lowest cost location
 PREDICTIONS OF SIMPLE MODEL
(HECKSCHER-OHLIN HYPOTHESIS)

1. Countries will export goods in which they have a comparative advantage and
import those in which they do not.
2. Free trade leads to specialization of production according to comparative
advantage
3. Maximized Consumer Welfare (lower product prices)
IMPLEMENTING FREE TRADE Introduction to Trading Blocs
TRADING BLOCS

Definition: Preferential trading agreements

Members of bloc favored over non-members
Expected Advantages to trading blocs
Creation of new markets for producers
Lower priced goods/services for consumer
Promote political stability & economic prosperity
Much of world divided into regional trading blocs
4 TYPES OF TRADING BLOCS

1. Trade Preference Association: Members lower govt. barriers on goods from other
members only (e.g., Preferred nation designation).
2. Free Trade Area: Members eliminate barriers against other members but
maintain individual barriers against goods from non-members (e.g., NAFTA).
3. Customs Union: Members eliminate govt. barriers against members imports and
establish common tariffs against non-members (e.g, EC, Mercosur).
4. Common Market: Barriers to all transactions removed between members, incl.
transfers of labor, capital, & services. Common barriers against non-members
(e.g., EU).
THEORETICAL PROS & CONS OF TRADING BLOCS: ADVANTAGE

Trade Creation: Members import goods they previously did not

import
Efficiency enhancing: Specializing production according to
comparative advantage
Lower product prices for consumers in bloc
Efficiency enhancing
Economies of Scale
Larger markets allow producers to enjoy economies of scale ->
lower production costs
Efficiency enhancing
THEORETICAL PROS & CONS OF TRADING BLOCS: DISADVANTAGE

Trade Diversion:
Members now import goods from other members that
were previously imported from outside of bloc
Assumed that switch is from more efficiently produced to
less efficiently produced goods
Not efficiency enhancing
FEATURES OF TRADING BLOCS
One or more small countries linked to larger country (or bloc
itself)
Small countries often trying to make internal reform
Ultimate goal of deeper integration
Degree of liberalization relatively modest
Smaller countries usually making greater concessions
EMPIRICAL RESULTS ON TRADE CREATION

Trade creation more likely to occur the:

Higher pre-bloc tariffs & trade barriers
More member countries
More competitive the countries prior to forming bloc
Closer the countries geographically
WHY PUSH FOR BLOCKS IF BENEFITS MIXED

Product of political process where beneficiaries represented

Way to reduce political conflicts
Way for developing countries to reduce dependence on
developed countries
Ideological commitment
INDIAN TRADE AGREEMENTS
SAARC-SAFTA
Formed in 1991, MERCOSUR is a sub-regional trading
community in Latin America, and comprises of Argentina, Brazil,
Paraguay, and Uruguay.
ASEAN-India FTA
BIMSTEC FTA