Discuss whether the formation of regional trading groups, such as ASEAN and NAFTA, is desirable

Members of trading blocs may benefit from the free trade within the group. Removing trade restrictions can raise output and employment, lower prices and increase choice and so result in higher living standards. Trade creation may occur with trading blocs promoting greater specialisation and trade. The diagram below shows that if before membership a country had imposed a tariff on another member, the removal of the tariff will lower prices and lead to a net welfare gain. Domestic output was initially a, domestic consumption was b and imports ab. After the removal of the tariff, consumption rises to c, domestic output falls to d and imports increase to dc.

Producer surplus falls by 1 and there is a loss of tariff revenue of 3. Consumer surplus, however, increases by 1, 2, 3 and 4 and so there is a net gain of 2 and 4.

Trade diversion, however, may also occur with membership diverting trade from countries outside the trading bloc that produce at a lower cost to higher cost member countries. This can lead to a net welfare loss. The next diagram shows that the imposition of a tariff on the non-member country will result in trade switching to a member country. There is an increase in consumer surplus of 1, 2, 3 and 4 but there is a loss of producer surplus of 1 again but now tariff revenue falls by 3 and 5. If this extra loss of tariff revenue, 5, is greater than the gain of 2 and 4, there will be a net loss.

Trading blocs seek to promote competition between member countries’ firms and this may encourage them to become more efficient which will increase their ability to sell within and outside the trading bloc. Members can also gain from the strong bargaining power that a trading bloc may possess.

Countries outside the trading bloc may benefit from it growing if such growth results in it buying more imports. Being outside the bloc, however, they may find it difficult to sell their products to members of the bloc and so take advantage of its growing prospects. Being outside a trading bloc may also weaken a country’s bargaining power in international trade negotiations.