The completion of a trade bloc involves the removal of all remaining regulatory and administrative barriers to trade and to the free movement of labour and capital. Such barriers can be physical i.e. border checks which are carried out on the flow of goods and the movement of people between countries. This not only facilitates the movements of goods between member countries, but also for non-member countries, as they only have to meet one set of requirements and can ship goods to all countries in the EU. For example, the EU has common tariff, custom and commercial policies towards all third or foreign countries, which has increased the bargaining power of the EU, since it now represents around 390 million customers and thousands of businesses. The free movement of people exists in the EU, as there is now a common European passport for all EU citizens, however airports and other entry points into the EU will still require passports for people outside the Union.
There are also technical barriers, which are the different rules and regulations imposed by countries on goods and services for reasons such as safety, health and environment protection. Removing these means there is complete freedom of capital movements for financial institutions. Fiscal barriers are the different tax rates applied to goods and services in member countries. One result of a high indirect tax is to discourage consumption, including imports of the taxed product. Eliminating these fiscal barriers will create harmony in the structure and rates of indirect taxation. This will reduce the need for border controls and remove the price distortions, which adversely affects resource allocation.
It is suggested that comparative advantage, which can take place more easily in a trade bloc, shows that free trade between countries is more likely to increase world production. Comparative advantage is where a country is able to produce a good more cheaply relative to other goods produced domestically than another country. A trade bloc aims to eliminate restrictions on trading barriers, facilitating trade nationally and furthermore on a global level, hence increasing world production, as countries are able to specialise more in the fields in which they produce more efficiently.
- Comment on the benefits and disadvantages of trade blocs to member and non-member countries (60 marks)
It must not be forgotten that there are also long-term political and social benefits to trade blocs. Member countries understand that they have become part of a union with other countries and therefore make greater efforts to co-operate with each other. Business contacts will give rise to a learning, understanding and appreciation of other cultures of trading partners. There then are economic benefits in existence. The theory of comparative advantage, which exists when a country is able to produce a good more cheaply relative to other goods produced domestically than another country, shows that free trade between countries is likely to increase total world production. When a small number of countries form a free trade area or common market, there will be both gainers and losers.
Specialisation is increased in the free trade area. A larger market allows countries to allocate their resources in producing goods or services, of which they can produce well, rather than producing them inefficiently when other countries can provide them at lower prices (comparative advantage). For example, in NAFTA, it is clear that in the foreseeable future that Mexico will become the home of assembly industries that use low-cost labour. Such industries include computer parts, automotive and textiles. Mexico will then specialise in manufacturing goods, which will therefore become extremely productive. A drawback to the free trade agreement is interdependency. As countries become more specialised, they become more dependent on their trading partners, meaning that each country will loose some control over its economy. Decisions of foreign countries can then greatly affect decisions in the domestic country. For example, is essential foods are not grown in the domestic economy, or political conflicts take place, or a strike in the manufacturing sector of a company, which is based in another country will surely have an effect other sectors of the firm, which are set in another country. Trade blocs also provide the free movement of knowledge. Companies in the free trade area can set up subsidiaries in other member countries, where existing technology may be of use. It also allows businesses to create arrangements where companies can sell its knowledge easily to other businesses. For example, a US pharmaceutical company can now sell and produce medicines in Mexico and Canada, allowing consumers in those countries to benefit from the US medical discoveries. Lower economically developing countries (LEDCs) that are members of trade blocs are likely to benefit from capital investments from more economically developed countries (MEDCs), which set up factories and plants in LEDCs, in the hope of taking advantage of cheaper labour.
The existence of trade blocs between countries increases competition. The elimination of tariffs (taxes on imported goods), quotas (a physical limit on the quantity of goods imported) and other such restrictions allows companies, who were once restrained from business, to compete on equal footing with national companies. Domestic industries will therefore face greater competition than before from firms in other member countries. Increased competition will encourage innovation, reduce costs of production and reduce prices, for firms will be price takers of the market, as the market becomes more perfectly competitive. Although there is likely to be greater competition in the short run, competition is likely to reduce in the long run, as the theory of perfect competition predicts that competition will drive the least efficient competitors out of the market. In the USA, for example, NAFTA, has helped in keeping the prices of textiles, lumber and some agricultural goods low. However, this does not prove true for all free trade blocs, as the EU and MESCOSUR have created higher tariffs and other restrictions to goods and services from external countries of the bloc, especially in regards to agricultural goods, which have kept food prices artificially high. However, increased competition may force some industries to downsize or shutdown. Trade blocs give rise to trade creation, which takes place when a country moves from buying in a high cost country to a low cost country. Many people will then find themselves out of work and may find it difficult to find jobs in that line of work, if they were previously in specialised jobs.
The costs of production tend to decline for companies of member countries, as they take advantage of lower costs of labour, cheaper natural resources and easier access to services of greater quality and specialised knowledge. For example, Dell Computer Corporation, which is based in Texas, USA, is able to make use of lower costs of labour from Mexico to assemble many of its monitors. U.S. software and computer companies are helping to make many more Mexican companies more efficient. The companies in the free trade area will also be able to benefit from economies of scale, where the long run average cost of a company will fall, bringing benefits to the consumers, as prices are likely to fall. These economies of scale could be purchasing, marketing, financial, managerial and technical economies of scale, and if these can be achieved by national companies, they can then carve a market for themselves in the free trade area. Then the customer base has increased from on a national level to the trade bloc level, where there are many other customers in member countries. For instance, companies in the UK have increased their customer base from 59 million in the UK to 300 million in the European Union. Also with a larger consumer base, there is equally an increase in the producer base, so that consumers can benefit from a greater variety of goods and services available to them. These economies of scale will be achieved over a period of time as companies expand internally or merge with other foreign companies. The size of potential gains will be greater, the more homogenous the tastes of consumers in the market. Therefore, the firm of a member country will benefit through greater productive efficiency (achieved when costs of production are at a minimum) and the consumers within the trade bloc will benefit from lower prices for goods and services.
A union of countries where tariffs, quotas and other restrictions are eliminated means that an international firm needs only to meet one set of requirements for one country, then it can freely move its goods around the trade bloc. For example, a Japanese firm will pay the tariff to import its goods into France and then it can ship its goods around the EU freely. However, the tariffs increase costs for the Japanese firm, meaning the price of its good may be more expensive in comparison to a homogenous product produced in the EU, and may cause consumers in the EU to buy domestically produced goods rather than the Japanese good.
One will then over time be able to see an increase in employment and income. A larger market will give rise to expansions in companies and demand labour at all levels in the company, from manufacturing to distribution. Taking NAFTA as an example, manufacturing and assembly plants will be set up in Mexico, creating job opportunities for Mexicans, and increasing consumption of goods or services for the US or Canadian firm, seeking low-cost labour. The increased income of Mexican workers has increased the consumption of US and Canadian goods and services. This increases employment of high-paying jobs in Canada and the USA. In Mexico, Canada and the USA, income will have risen and in the long run so will economic growth and the standard of living.