International Markets and European Institutions

PS -A

TR - (C+E +F) MFN

à

+ E + G PTA

à

B + D F + G

–

= 46

So, when is it better to create a preferential trade agreement?

Moving from free trade to preferential trade agreement, if you are a big country and the tariff

is small you may gain by applying a tariff to all countries outside the agreement.

Talking about PTAs, it is important to refer as well to:

Trade creation:

- given by the fact that with PTA, more trade is encouraged; in fact,

compared with the MFN, a more quantity is imported.

Trade diversion

- (or supply’): by creating an agreement with a partner, it is

‘switching

by definition a discrimination against someone else so with the agreement I am

diverting trade with the rest of the world because I buy more from the partner and less

from the rest of the world.

But the decrease in trade with the rest of the world is more than compensated by the increase

in trade with the partner so overall, the trade increases.

Then, to explain what happens in the shift from MFN to PTA we can also refer to:

Smith s certitude:

- (it is shown in the partner’s chart: the trapezium created by the

’

difference between MFN and PTA) it is sure that the partner will gain from the PTA,

thanks to the removal of the tariff.

Harberler s spill-over:

- (it is shown in the rest of the world’s chart: the trapezium created

’

by the difference between MFN and PTA) we can think of it as a negative externality

created by the PTA between the partner and the home country because the rest of the

world, as a consequence of the PTA, will export less and at a lower price (to remain

competitive).

Viner s ambinguity:

- (it is shown in the international market chart) it is the fact that the

’

net welfare effect is not certainly positive nor negative.

EUROPEAN UNION

www.europa.eu

EU see the application of many things we have discussed before: it is a useful case for a better

understanding. EU started as a Preferential Trade Agreement.

First of all, it is important to understand that there is a difference between Institutions and

Trade Agreements:

INSTITUTIONS: TRADE AGREEMENTS:

‘Deardoff’s

- Rules of the game (the game is - Definition according to

international economic, social and Glossary of International Trade’ (a

political interactions) glossary that defines a lot of terms):

Trade Agreement is a negotiated

agreement among two or more

countries to limit or alter their

policies with respect to trade.

Comparing the two definitions, we see that a trade agreement may be seen as an institution but

only in very specific cases: if it deal about policies between countries.

EU nowadays is an institution (a larger set of rules, a larger area compared to a trade

agreement) but was born as a trade agreement. In its history, EU has moved from being a trade

agreement to becoming an institution.

Institutions are needed to allow interactions, but of course by definition sometime they are also

a burden because people face some constraints. The important thing is to set the right balance

between the institution and the organization of the market: too many rules may let people feel

very constrained and can create a sort of reaction. EU is at a very dangerous threshold in this

respect. In this respect we have to understand if the institution is working properly.

EU is covering some area of interaction between firms and consumers living in EU but not all:

there may be a collision between national rules and EU rules, there is a coordination problem

of rules that coexist. Is the institution fulfilling its mandates? Is efficiency improving and

welfare improving?

Keep in mind that rules of the game of economic interactions shape the way in which economic

actors behave. So it is important to know which are the rules of the game in the European

Market, which is one of the biggest in the world.

EU is as well a level of economic integration which is unique since we cannot see it elsewhere:

there is not another institution like EU. But it is improving the situation or not?

EU ORIGINS AND INSTITUTIONS

EU as a Trade Agreement, was created with a very specific political problem in mind: there is

not only economic behind it. Generally speaking, trade agreements are good to facilitate

trade creation between members

transactions. But related to them there is a which is created

when the PTA is made. But what comes before? Economics of politics? Are there economic

reasons which lead to the creation of the agreement that than have implications in politics or is

it the other way round?

It is also the case of the birth of EU: it is very much related to the after war period. At the end of

WWII, EU had very little production capability left and was a deeply divided continent, since

the strongest battles where within it. It was very difficult to cooperate for this reason. But it

was necessary to revive the European economic production and industry and cooperation was

48

fundamental: the idea was to create an economic link between the countries to overcome the

division and avoid another war.

European Community of Coal and Steel was a trade agreement, signed in 1952: countries in EU

decide to cooperate in the production of steel and coal that at the time were absolutely crucial

also from a military and strategically point of view (you would never make a war with the

supplier of your weapons). In this way the war was much more unlikely. Moreover, it was a tool

to keep Germany under control which was the economic power of Europe before the war and

it was the country that started the war: Germany had to be taken under control.

To sum up, tiding economic production inside Europe had the main goal of reducing the risk of

a new war.

With new production techniques, production of steel (and not only) need economies of scale:

you need to produce a lot and individual countries did not have enough large markets to do it.

So to make economic production much more efficient, forces had to be joined. At the same time,

it would have increase cooperation and reduce the risk of war.

The experiment worked well: a community in production and market of this goods was created

Treaty of Rome European Economic

and in 1957 the countries signed the forming the

Community. Nowadays, this treaty is still the main governing Europe: it is basically the rules of

the game and it is to a large extend a trade agreement.

But at the beginning the rules of the game were:

- Free trade (t=0 among members) among members

- Common external trade policy ‘custom union’.

Nowadays the agreement with this rules is a

Countries needed to have an agreement on how to behave with the rest of the world.

The first loss of national sovereignty was made to help economic. In fact, at the beginning the

members were: France, Italy, Germany, Belgium, Netherland and Luxemburg. UK was invited

to join but they said no because they do not want to loose the national sovereignty because at

the time they had very strong tights with colonies and they wanted to have their own trade

policies and rules since they had a very high influence.

There is another area of policies which had to be common: if you really want to have a free

internal market in Europe, if in each country the rules of how a market work are different it is

impossible to have it because every time you cross the border the rules change. It was especially

relevant in agriculture, which had a larger production in the 50s and was considered strategic:

it is crucial to feed the population to allow a country to survive.

Moreover, at the time, people were massively migrating from the countryside to the cities: there

was also the risk that this trend of moving would have occurred too fast creating social

problems and the risk of lowering agricultural production. At the time, every country were

heavily subsidizing agricultural goods and controlling prices to be sure agricultural good was

enough and farmers would have want to be farmers. The problem is that having a free trade

area implies have levelled prices across markets but if you have a system of controlled prices

and subsidies, this is impossible: either a free market or government intervention in

agriculture. So they decided that also agricultural policies had to be common so the rules of the

game are:

- Free trade (t=0 among members) among members.

- Common external trade policy.

- Common agricultural policies.

But the rules of agricultural policies were decided all together and to make it fit all the countries,

it is needed to average out and find compromises between the willing and the decisions of the

countries. To do so, it is easy if the countries are similar: if countries are very different a

compromise is barely impossible. 49

Another reason why UK did not want to join is an agricultural reason: it had no interest in

spending money to subsidize agriculture.

European economy, as a result, boomed, thanks to economies of scale and so on: it grew at a

very high speed and it became the largest market in the world. Countries outside the agreement

worsen their situation and their access to the market: it is discriminatory and for example, UK

situation, even if they did not change anything worsen. They found difficult to sell goods

because the preferential access that member had to the market made competition very though

for all the external countries, those who are not members. A very sharp industrial declined

happened in UK, colonies were less strong, the influence on the world became weaker and then

they realized it was not a good idea to say no so they went to EU and ask to participate but EU

said no and they had to wait for five years: in 1973 UK, Ireland and Denmark joined. These

countries were economically different from the others and especially Ireland was a very poor

country at the time. The rules of the game for Ireland at the beginning was to open up the

market as anyone else, and there was a high risk of crush: economic disparity among EU

countries started with this first enlargement. And EU have to find a way to deal with this

situation.

THE EU SINGLE MARKET AND INDUSTIRAL POLICIES

During the 70s, the world economy was hit by a severe crisis. In 1973 the fixed exchange rate

system collapsed and there was the first oil shock: energy became very expensive so the

production was difficult because of the high costs. Governments tried to find a way to react:

economic response at national level in integrated market is not effective so once you have

created economic ties, it is difficult to have different responses. But what happened is that there

was not so much cooperation and every country tried to save itself.

During the 80s they wanted to relaunch the integration programme moving further to a true

common market. According to some economists, in fact, EU economy was hit much more

severely by the crisis because of the fragmentation. So the idea was to move to a truly fully

single market

integrated to be able to exploit bette