Module 8A: Preferential Trading Agreements

Corresponding chapter in the book: 11

ECON 4321
FA 2025
PREFERENTIAL TRADING AGREEMENTS

There are an increasing number of preferential trade

agreements (PTAs)/ free trade agreements (FTAs)/
regional trade agreements (RTAs)

They differ from multilateral trade agreements because

they only apply to a few countries.

Preferential trade agreements are discriminatory.

Econ 4321: International Trade 2

PREFERENTIAL TRADING AGREEMENTS 2
Multilateral trade agreements such as the General
Agreement on Tariffs and Trade (GATT) / World
Trade Organization (WTO) encourage a
nondiscriminatory reduction in tariffs.
GATT Article 1
Tariff reductions are expected to be made on a
“most favored nation” (MFN) basis.
All exporting countries granted the status are
expected to pay the same tariff rates.

Econ 4321: International Trade 3

PREFERENTIAL TRADING AGREEMENTS 3
However, nations may also establish preferential trade
agreements (PTAs) or free trade agreements (FTAs), or regional
trade agreements (RTAs)
For a range of products, PTA members charge lower tariffs on
each other relative to other countries.
GATT Article 24

GATT/WTO provides an exception to most-favored-nation status

for RTAs as, in general, trade creation is larger than trade
diversion

PTAs/RTAs may create losses for some producers in some

countries outside the agreement.

Econ 4321: International Trade 4

 NAFTA AND OTHER U.S. TRADE AGREEMENTS
Country Status of Agreement Date of Implementation

Israel Implemented 1985

Canada Implemented 1989, 1994
Mexico Implemented 1994
Jordan Implemented 2001
Chile Implemented 2004
Singapore Implemented 2004
Australia Implemented 2004
Bahrain Implemented 2006
Morocco Implemented 2006
Dominican R. – Central
America Free Trade Agr. (CAFTA-DR) -
Costa Rica, El Salvador, Guatemala, Implemented 2005
Honduras, Nicaragua, and the Dominican
Republic.
Panama Implemented 2011
Colombia Implemented 2011
South Korea Implemented 2011
5
USMCA Implemented 2020
THE FREE TRADE AGREEMENTS WITH THE FOLLOWING
COUNTRIES AND BLOCS ARE BEING NEGOTIATED

Free Trade Area of the Americas (all countries on the Western Hemisphere-
[Link]
US - Middle East Free Trade Area (US-MEFTA; incl. most countries in the Middle East)
Transatlantic Free Trade Area (TAFTA; European Union -
[Link]
United States-Thailand Free Trade Agreement
United States-New Zealand Free Trade Agreement
United States-Ghana Free Trade Agreement
United States-Indonesia Free Trade Agreement
United States -Kenya Free Trade Agreement
United States -Kuwait Free Trade Agreement (Expert-level trade talks held in February
2006)
United States -Malaysia Free Trade Agreement (last meeting was in July 2008)
United States -Mauritius Free Trade Agreement

Econ 4321: International Trade 6

 THE FREE TRADE AGREEMENTS WITH THE
FOLLOWING COUNTRIES AND BLOCS ARE BEING
NEGOTIATED:

United States -Mozambique Free Trade Agreement

United States -Taiwan Free Trade Agreement
United States -United Arab Emirates Free Trade
United States -Southern African Customs Union Free Trade Agreement (South Africa,
Botswana, Lesotho, Swaziland, and Namibia)
United States-Ecuador Free Trade Agreement
United States -Qatar Free Trade Agreement
Trans-Pacific Strategic Economic Partnership (Brunei, Chile, Singapore, New Zeeland,
United States, Australia, Peru, Vietnam, Malaysia, Mexico, Canada)

Click on the following link for the updated info.

[Link]

Econ 4321: International Trade 7

32 –
FREE TRADE AGREEMENTS
30 –
28 –
26 –
24 –
22 –
20 –
18 –
16 –
14 –
12 –
10 –
8–
6–
4–
2–
0–

Goods Services Accessions Cumulative

Econ 4321: International Trade 8

 TRADING AGREEMENTS
Even though free trade agreements are controversial, the
WTO has accepted them as there are both benefits and
costs

The benefits are that the decline in trade barriers would

increase world trade

The costs are that the total benefits are not shared equally
among all nations and there will be some losers
See the article at
[Link]
750X1300140X

Econ 4321: International Trade 9

PREFERENTIAL TRADING AGREEMENTS 4

What are the different types of regional economic

integration?

Econ 4321: International Trade 10

TRADING AGREEMENTS / DEGREES OF
ECONOMIC INTEGRATION
1. In free-trade areas (FTAs), the countries agree to
eliminate tariffs and other non-tariff barriers between each
other
Removes tariffs between member countries, with each
country retaining its tariff structure against outsiders
e.g., US-Israel, the North American Free Trade Agreement
(NAFTA)

To be legal, it must cover “substantially all” trade

This usually means nonagricultural products
It must be completed within a reasonable time
Typically they are phased in over 15 years
It may cover services, portfolio investments, and FDI.

Econ 4321: International Trade 11

TRADING AGREEMENTS / DEGREES OF
ECONOMIC INTEGRATION 2
Each country maintains its own separate national tariff
schedule.

Trade deflection may occur, the diversion of exports to a

country within an FTA that has lower tariffs on a specific
good

This can lead to the establishment of “screwdriver plants”

designed to provide minor assembly work produced in a
foreign country but within an FTA to avoid higher tariffs.

FTA+: An FTA that also harmonizes some beyond-the-

border standards (e.g., environmental standards). -
NAFTA

Econ 4321: International Trade 12

 TRADING AGREEMENTS / DEGREES OF
ECONOMIC INTEGRATION 3
2. A customs union is an agreement between countries to
maintain a free-trade area and to construct and maintain a
common external tariff
e.g., Southern Common Market (Mercosur), The Southern
African Customs Union (SACU), and The European Union
Customs Union (EUCU)

It has a common external tariff where each country

replaces its national tariff schedule with a common tariff
schedule applicable to all member countries.
It takes time for national schedules to harmonize.
Customs unions are broad but may not include trade in
agricultural products, services, and financial flows.
Econ 4321: International Trade 13
 TRADING AGREEMENTS / DEGREES OF
ECONOMIC INTEGRATION 4
All members agree to charge the same tariffs on non-
members
Tariff administration is relatively easy
Goods must pay tariffs when they enter the union
But from then on can be shipped freely between members
A cargo that is unloaded at Rotterdam must pay duties
there
No additional charges if it then goes by truck to Munich
However, members must agree on a common external tariff
Not easy for countries to give up part of their sovereignty
to a supranational entity

Econ 4321: International Trade 14

TRADING AGREEMENTS / DEGREES OF
ECONOMIC INTEGRATION 5
3. A common market is a customs union with the
addition of factor mobility between member countries
Example: European Union
This allows more efficient allocation of capital and
labor
However, large wage differentials may induce a large
amount of migration between countries
Harmonizing regulations among the member
countries can be challenging

Econ 4321: International Trade 15

TRADING AGREEMENTS / DEGREES OF
ECONOMIC INTEGRATION 6
4. An economic union is an agreement between countries to
maintain an FTA, a common external tariff, free mobility of
capital and labor, and some degree of unification in government
policies and monetary policies
Requires a common currency and the abolition of each
country's central bank, and the creation of a new common
central bank
Each national government must align its national policies on
taxes, antitrust, labor, environmental regulations, and so
forth with other member countries.
Monetary Union: Establishment of a common currency and
completely integrated monetary and exchange rate policy
(EU Area)
Fiscal Union: Establishment of a common fiscal policy
(USA) Econ 4321: International Trade 16
Econ 4321: International Trade Shallow Vs Deep Integration
17
 MOTIVES FOR PTAS
Avoid beggar-thy-neighbor effects
An economic policy through which an individual country tries to solve its
economic problems in ways (for instance, shifting demand away from
imports to domestically produced goods through trade barriers) that make
the economic problems of everyone worse off
Prisoner’s dilemma situation (each country has the incentive to follow
such a policy, and in so doing, every country becomes worse off)
Not very relevant given a multilateral trade agreement such as the
GATT/WTO
Help countries gain credibility.
A government may choose to tie its hands and commit to trade openness
through a PTA
Less exposed to political pressures for protection
PTA relevant in addition to GATT/WTO commitments
The import-competing firms can become exporters
[Link]
18
Econ 4321: International Trade
 MOTIVES FOR PTAS (CONT.)
Additional rationale
Increasing market size enables exploiting economies of
scale
Signaling less uncertainty on future trade policy to
investors
Need to achieve deeper integration
Easier to achieve policy coordination at the regional
than at the multilateral level
The slow pace of multilateral negotiations
Political stability
Econ 4321: International Trade 19
 WELFARE EFFECTS OF PTAS
Welfare depends on the extent of trade creation and
trade diversion
PTAs may lead to more trade between members but
reduce that between a member and a nonmember
Trade is stimulated based on preferential tax
treatment instead of economic efficiency
This may induce countries to import from less
efficient suppliers
Raises the possibility of a reduction in economic
welfare

Econ 4321: International Trade 20

 WELFARE EFFECTS OF PTAS 2
Trade creation (TC) occurs when two countries
mutually eliminate tariffs and nontariff barriers to
trade, thus increasing the trade between the
countries.

This may result in export losses to other countries

and trade diversion (TD) as trade shifts away from
them to member countries.

Trade creation increases world welfare, and trade

diversion decreases world welfare.
World welfare increases only if the trade creation is
larger than the trade diversion.
Econ 4321: International Trade 21
 WELFARE EFFECTS OF PTAS 3
The supply/demand model can be used to show the effect of
lowering trade barriers among members
Assumptions
Three countries - Mexico, the U.S., Japan – Mexico & U.S. for
the customs union
Trade a homogeneous good
Home (Mexico) - a small country; takes international
prices as given
Mexico is a small country relative to Japan and U.S.
U.S. and Japan – large economies
Japan is the most efficient supplier of cars; it is not a union
member.
Home can satisfy its entire demand for the good by
importing from either of them.
Initially, Home (Mexico) has no free trade agreement and
applies the same MFN tariff to both B and C
Econ 4321: International Trade 22
THE STATIC EFFECTS OF A CUSTOMS UNION

Free trade price of cars from Japanese suppliers: P1

Tariff-inclusive price by Japanese suppliers: P3
Free trade price of cars by American suppliers: P2
Tariff-inclusive price by American suppliers: P4
Mexico buys all foreign cars from Japan at P3 before the
free trade agreement.
Mexico buys Q3 of cars from foreign producers, and Q2 are
domestically produced.

Econ 4321: International Trade 23

THE STATIC EFFECTS OF A CUSTOMS UNION 3
Static Welfare Effects of a Customs Union

Econ 4321: International Trade 24

Based on this hypothetical example, Japan is the most efficient supplier of cars at a free-trade
price of P1 and tariff-inclusive price of P3 (where P3 equals P1+tariff). U.S. can supply cars
at a free-trade price of P2 and a tariff-inclusive price of P4 (P4 = P2+tariff). Before the union,
Mexico buys all of its imports from Japan at a price of P3. Consumers in Mexico buy Q
amount of cars, of which Q2 is domestically produced, and Q2 to Q3 is imported from Japan.
After forming the customs union, Mexico removed the tariff on U.S.-produced cars but not on
Japanese cars. The U.S. can now supply cars at price P2, and Japan can supply at price P3.
Mexico now buys all of its imports from the U.S. Increase in consumption for Mexico –area a;
the welfare gain associated with the increase in consumption to Q4. Lower-price imports from
the U.S. replace some of Mexico’s domestic production (Q1 to Q2). The welfare gain
associated with this is area b. The overall trade creation effect is a+b

Higher price Static Welfare Effects of

supplier (U.S.) a Customs Union
replaces
imports from
lower price
supplier (Japan)
Welfare loss of c

As long as a+b > c,

there is an increase
in world welfare
25
Econ 4321: International Trade
THE STATIC EFFECTS OF A CUSTOMS UNION 4
Mexico removes tariffs on U.S. cars only.
The price for U.S. cars is now lower than that of Japanese
cars, and Mexico buys all cars from the U.S.
The movement to freer trade under a customs union affects
world welfare in two opposing ways.
First, trade creation increases world welfare
Mexico purchases more cars, Q4
Q1-Q4 imported from the U.S.
Increase in consumption for Mexico –area a; the welfare gain
associated with the rise in consumption to Q4
Lower-price imports from the U.S. replace some of Mexico’s
domestic production (Q1 to Q2). The welfare gain associated
with this is area b.
The overall trade creation effect is a+b

Econ 4321: International Trade 26

THE STATIC EFFECTS OF A CUSTOMS UNION 5

Decrease in Welfare -Trade Diversion

Higher-price supplier (US) replaces imports from the
lower-price supplier (Japan)
Welfare loss of c

As long as a+b > c, there is an increase in world

welfare.

Econ 4321: International Trade 27

 THE STATIC EFFECTS OF A CUSTOMS
UNION 6
In this example, trade creation increases world
welfare in triangles a and b
But trade diversion occurs in box c
If the area of (a + b) is greater than the area of c, world
welfare will increase.
If the area of c is greater than the area (a + b), world
welfare will decrease.

Econ 4321: International Trade 28

 MULTILATERALISM VERSUS REGIONAL
TRADE AGREEMENTS

Trade liberalization is a contentious matter.

Outside the EU, until the 1980s, most trade liberalization
had been through MTNs.
Since then, PTAs have become more common.
The benefits and costs of PTAs are difficult to calculate
This has led to some reservations about the spread of PTAs
Others believe the benefits outweigh the costs

Econ 4321: International Trade 29

MULTILATERALISM VERSUS REGIONAL
TRADE AGREEMENTS 2

Theoretically, MTNs are non-discriminatory as there

is only trade creation and no trade diversion.
A PTA is inherently discriminatory as member
countries are treated differently than nonmember
countries.
As PTAs spread, world trade becomes more
complicated
The world trading system could revert back to a
system where each country has different tariffs for
each product for specific countries

Econ 4321: International Trade 30

 MULTILATERALISM VERSUS REGIONAL
TRADE AGREEMENTS 3

The increased amount of trade diversion potentially

reduces world welfare
As countries spend more time on PTAs, they will
spend less time on WTO matters
This makes obtaining multilateral agreements more
difficult
However, PTAs are legal under WTO rules, and trade
creation generally exceeds trade diversion
Their popularity may be because governments prefer
them

Econ 4321: International Trade 31

MULTILATERALISM VERSUS REGIONAL
TRADE AGREEMENTS 4

In some cases, governments want to pursue more

profound levels of integration than is possible with
multinational agreements
The adjustment costs for domestic industries may be
lower with RTAs than with MTNs
Some economists see RTAs as substitutes for MTNs
Some see them as compliments
There is little or no support for abandoning the
process.

Econ 4321: International Trade 32

 WELFARE EFFECTS OF NAFTA
Trade creation and diversion
Difficult to determine
In the case of NAFTA
Slowly phased-in tariff preferences
Rise of the maquiladoras (the name for
manufacturing operations in a free trade zone)
Factories import material and equipment on a tariff-
free and duty-free basis for assembly, processing, or
manufacturing purposes
They then export these assembled, processed,
and/or manufactured products to the country of
origin where the material and equipment came from
Econ 4321: International Trade 33
WELFARE EFFECTS OF PTAS (CONT.)

Clausing (2001)
Canada - United States Free Trade Agreement
Substantial trade creation effects
Little evidence of trade diversion

Econ 4321: International Trade 34

EMPIRICAL FINDINGS ON TRADE CREATION
AND TRADE DIVERSION

Econ 4321: International Trade 35

EMPIRICAL FINDINGS ON TRADE CREATION
AND TRADE DIVERSION 2

Econ 4321: International Trade 36

EMPIRICAL FINDINGS ON TRADE CREATION
AND TRADE DIVERSION 3

Econ 4321: International Trade 37

EMPIRICAL FINDINGS ON TRADE CREATION
AND TRADE DIVERSION 4

Econ 4321: International Trade 38

EMPIRICAL FINDINGS ON TRADE CREATION
AND TRADE DIVERSION 5

Econ 4321: International Trade 39

DO COUNTRIES WHICH ANYWAY TRADE MORE FORM
PTAS? (CONT.) MAGEE (2003)

Econ 4321: International Trade 40

NAFTA AND OTHER U.S. TRADE AGREEMENTS 2
Up through the early 1980s, the U.S. was focused on
reducing trade barriers through multilateral trade
negotiations (MTNs)

The policy started to change in the 1970s with the GSP

(The U.S. Generalized System of Preferences) and the
Caribbean Basin Initiative in 1981
[Link]
development/preference-programs/generalized-
system-preference-gsp

The U.S. was moving away from a pure multilateral

approach to reducing trade barriers because of the
slow pace and lack of progress in agricultural products.
Econ 4321: International Trade 41
NAFTA AND OTHER U.S. TRADE AGREEMENTS 3
The first agreement was the U.S.-Israel FTA.
This served as the template for all subsequent RTAs
Covered trade in all goods, including agriculture
Covered virtually all trade in service
Liberalized capital flows, including FDI
Phased in over ten years to give each economy time
to adjust
Not all subsequent RTAs have been identical to this,
but the main features have been retained

Econ 4321: International Trade 42

 NAFTA
NAFTA
NAFTA has created a great deal of debate over the past
several years
It is a very straightforward trade agreement
Essentially it establishes a free trade area between the
US, Canada, and Mexico.

Econ 4321: International Trade 43

 NAFTA 2
In 1989 the U.S. and Canada signed a free-trade
agreement that phased tariff reductions over ten years.
Covered trade in goods and services, investment,
and eliminate national preference on most
government contracts
Freed U.S. and Canada from the few remaining
restrictions on trade
In 1992 this was broadened to include Mexico

Econ 4321: International Trade 44

 NAFTA 3

• In 1992 this was broadened to include Mexico.

Tariff reductions were phased in over 15 years.
The agreement covers all merchandise trade, services,
investment, and intellectual property rights.
Trade disputes are to be adjudicated by a member
panel
The agreement calls for each country to enforce its own
labor and environmental laws

Econ 4321: International Trade 45

 NAFTA 4
The agreement gives Canada unrestricted access to a
larger market allowing its firms to grow larger
Trade with Mexico has long run appeal to the U.S. and
Canada
The Mexican economy is growing much faster than the
U.S. or Canada
Mexican tariffs were much higher before the trade
agreement
Mexico has seen NAFTA as a way to advance export-led
growth

Econ 4321: International Trade 46

 NAFTA 5
It does not require Mexico, the US (and Canada) to adopt a
common external tariff on imports from non-members –
NOT a Custom Union.
A shirt made by Mexican workers can be brought into the
United States freely.
Suppose that the US maintains high tariffs on shirts
imported from non-members.
Say Mexico does not impose similar tariffs.
What would prevent a non-member from shipping a shirt
to Mexico and then putting it on a truck bound for Chicago?

Econ 4321: International Trade 47

 NAFTA 6
Goods shipped from Mexico to the US pass through
a customs inspection
They can enter the US duty-free only if they have
documents proving that they are, in fact, Mexican
goods
Not transshipped imports from non-members
What is a Mexican shirt?
Not a shirt that comes from Bangladesh but has buttons
sewn by Mexicans
But one who says everything except the buttons was
made in Mexico

Econ 4321: International Trade 48

 OTHER U.S. TRADE AGREEMENTS
Other U.S Trade Agreements
Many of the U.S. trade agreements are with other
Western Hemisphere countries.
This is mainly because of the failure of the Free Trade
Area of the Americas (FTAA)
In late 1994, 34 governments agreed to pursue an FTA
for the entire hemisphere.
Progress has been relatively slow, mainly because many
South American governments are concerned about
protectionism and agricultural subsidies in the U.S.

Visit [Link]
agreements
for a full list

Econ 4321: International Trade 49

THE U.S.-MEXICO-CANADA AGREEMENT
(USMCA)
For details about USMCA, visit :
[Link]
agreements/united-states-mexico-canada-
agreement

Visit [Link]
trade-agreements
for a full list of agreements

Econ 4321: International Trade 50

 U.S. TRADE AGREEMENTS
The U.S. uses FTAs to enhance economic development
in selected countries that wish to pursue a more
export-oriented strategy.

The U.S. helps countries develop and gain access to

potentially fast-growing markets.

Since trade barriers are usually much higher in

developing countries than in developed countries,
developing countries are the ones who sacrifice
protection.

The use of RTAs allows the U.S. to move at a faster pace

than with the MTN process.
Econ 4321: International Trade 51
RULES OF ORIGIN IN INTERNATIONAL
TRADE
Determining what country actually produced goods is
known as the rules of origin
a) Required for statistical reports on trade flows
b) Necessary to enforce health, sanitary, and technical
regulations and maintain public safety
c) Higher tariffs can be imposed on countries not members
of the WTO
d) Necessary to administer antidumping and countervailing
duties
e) Needed to ensure quotas are respected
f) Required to enforce trade sanctions
g) Needed to restrict the amount of trade deflection resulting
from PTAs

Econ 4321: International Trade 52

RULES OF ORIGIN IN INTERNATIONAL
TRADE 2
Trade deflection results when a good is moved through a
country that receives reduced tariffs to qualify for duty-
free treatment

Rules of origin are costly for firms, and when compliance

costs exceed the value of the tariff, rules of origin
become a nontariff barrier to trade.

Using rules of origin as a disguised/hidden form of

protectionism is increasing.

Econ 4321: International Trade 53

 RULES OF ORIGIN IN INTERNATIONAL
TRADE 3

FTAs require an elaborate set of “rules of origin.”

These determine whether a good is eligible to cross the
border without paying a tariff
FTAs impose a significant burden on paperwork
Rules of origin may prove to be a significant obstacle to
trade
Reduces transparency

Econ 4321: International Trade 54

 RULES OF ORIGIN IN INTERNATIONAL
TRADE 4
NAFTA
About 200 pages of the agreement’s text are devoted to
rules of origin
Stricter rules than those in the US-Canada FTA
Automobiles must have 62.5% North American content to
receive duty-free treatment.
US-Can FTA requires 50%

Econ 4321: International Trade 55

 RULES OF ORIGIN IN INTERNATIONAL
TRADE 5

US-Can FTA: textile and apparel goods had to be made from

North American fabric to be eligible
NAFTA requires the yarn from which the fabric is also
woven to have North American content
Rules of origin can distort trade
Exporters may try to raise the North American content
artificially.

Econ 4321: International Trade 56

 RULES OF ORIGIN IN INTERNATIONAL
TRADE 6
Goods that satisfy rules of origin requirements
“Originating goods”
Originating goods
Wholly obtained (or produced) goods
e.g., Minerals, agricultural products, seafood
Result of a “substantial transformation.”
e.g., Goods containing components that originate in
other countries
NAFTA - Origin of the Good
[Link]
procedures/rules-origin/meets-annex
Econ 4321: International Trade 57
 THE U.S.-MEXICO-CANADA AGREEMENT
(USMCA) 2

“Rules of origin" for cars made and sold in the U.S.,

Mexico, and Canada
Requires that 75% of automotive components be
produced within the three-nation bloc for firms to sell
duty-free
It was 62.5% under the NAFTA rules
See
[Link]
agreements/united-states-mexico-canada-
agreement/agreement-between

Econ 4321: International Trade 58

The European Union

Econ 4321: International Trade 59

 THE EUROPEAN UNION

In 1957 the European Coal and Steel Community

(ECSC) signed the Treaty of Rome.
Provided for the elimination of tariffs and non-tariff
barriers to trade between member countries and the
institution of a common external tariff
Treaty established the European Economic
Community (EEC) as a customs union.
It has continually enlarged itself to cover more and
more of Europe.

Econ 4321: International Trade 60

 THE EUROPEAN UNION 2

In 1960 countries not in the EEC formed European

Free Trade Association (EFTA)
Provided for free trade in non-agricultural production
among members and free trade in these products
between itself and EEC
In 1967, EEC and ECSC merged into European
Communities (EC)
The growth of the EU has come mostly from countries
leaving the EFTA

Econ 4321: International Trade 61

 THE EUROPEAN UNION 3
Chronological Development of the European Union
European Coal and Steel Community
Belgium, France, Lux, the Netherlands, Italy, Germany ECSC 1951

European Atomic Energy Community EURATOM 1957

European Economic Community

Treaty of Rome provided elimination of tariffs and nontariff
barriers and the institution of a common external tariff EEC 1957
Received GATT waiver under the Lome Convention

European Free Trade Area

Most European countries not included in the EEC provided
EFTA 1960
for free trade in nonagricultural products

Common Agriculture Policy CAP 1962

European Community
Combined EEC, ECSC, and EURATOM EC 1967

Added The UK, Ireland, and Denmark

1973

62
Econ 4321: International Trade
 THE EUROPEAN UNION 4
Chronological Development of the European Union

Added Greece 1981

Added Spain and Portugal 1986
Added East Germany 1990
1993
European Union EU

Added Finland, Austria and Sweden 1995

European 1999
Monetary EMU
Union
EU
Added Cyprus, Estonia, Czech Rep, Hungary, Latvia, 2004
Lithuania, Malta, Poland, Slovakia and Slovenia

Added Bulgaria and Romania 2007

Econ 4321: International Trade 63

 THE EUROPEAN UNION 5

A customs union only requires a common external tariff

and eliminates most trade barriers between member
countries.
From the beginning, the EU has had a Common
Agricultural Policy (CAP)
Agreement between EU members to subsidize their
agricultural sectors in a similar manner
If subsidy schemes vary, free trade in agriculture
becomes problematic

Econ 4321: International Trade 64

 THE EUROPEAN UNION 6

Under the CAP, each country provides revenue to the EU,

which in turn pays subsidies to the farmers
The CAP guarantees prices for all farm commodities
within the EU
The EU purchases what is not sold on the open market
Farmers are protected from international competition by
a variable levy (tariff)

Econ 4321: International Trade 65

 THE EUROPEAN UNION 7

Support prices are generous, which has created a

chronic oversupply problem.
Further, surplus agricultural commodities are
sometimes dumped on world markets.
This has created constant trade friction between the
EU, the U.S., and other more efficient agricultural
producers.
Controversies over the CAP continue and delay the
Uruguay Round and have created problems for the
Doha Round.

Econ 4321: International Trade 66

 THE EUROPEAN UNION 8

In 1985 the EU started working to determine the steps

necessary to create a barrier-free internal market.
In 1992 the Maastricht Treaty laid out plans for a
new European currency (the Euro)
Euro replaced 12 separate national currencies in
January 2002
Barriers to the movement of labor and capital were
also removed

Econ 4321: International Trade 67

 THE EUROPEAN UNION 9
The future of the EU is uncertain.
The common currency is only one of the
characteristics of an economic union
It still needs a common fiscal policy, common levels of
business taxation, common labor laws, and
commonality in other regulations that distort
economic activity
There are still areas of significant disagreement

Econ 4321: International Trade 68

 SOURCES

Krugman and Obstfeld

Sawyer and Sprinkle
Feenstra and Taylor

Econ 4321: International Trade 69