lecture 3

• Preferential trade agreements eliminate tariffs on import and export for only 1 group of trading partners
• Preferential liberalisation is at the heart of European Integration since the introduction of the Customs Union and the Single market
• Discriminatory effects of preferential trade agreements play a central role in the political economy of European Integration, through domino effects
• The 2 main assumptions for analyzing preferential trade agreements are that there is perfect competition, and no increasing returns to scale
• Preferential (discriminatory) liberalisation in its simplest form is unilateral trade liberalisation
• Unilateral trade liberalisation is when 1 nation removes its tariff on imports from only 1 trading partner
• 3 basic elements of preferential liberalisation:

  • Foreign firms gain when tariffs against them are removed
  • Countries excluded from liberalisation lose
  • Preferential liberalisation may harm the home nation
• In a customs union, a country is both 'home' and the 'partner' to each other
• Assuming symmetry between values and tariffs on imports and exports, discriminatory liberalisation by both the home and partner means both countries receive the welfare change from both imports and exports
• The welfare change from entering a customs union is still ambiguous
• Going from a unilateral to a bilateral preferential liberalisation results in a bigger impact on the rest of the world and can cause domino effects
• A free trade agreement is like a customs union but without a common external tariff
• A free trade agreement allows for trade deflection- goods from Rest of the World (RoW) are imported to the home market via a partner country with a lower import tariff
• 'Rules of origin' are used to try and reduce the risk of trade deflection and establish where a good was made
• Rules of origin are expensive and difficult to enforce, especially as the world gets more integrated because parts are imported from one country, then assembled in another
• When parts and the final assembled product are assembled in different places, to say a product is from a specific country, a certain proportion of its value has to have been made within the country
• Most preferential trade agreements are Free Trade Agreements because Customs unions require political integration, and it's difficult to find groups that all fully agree with each other
• Since the 1986 Single European Acts, most economic integration in Europe has involved the removal of frictional barriers to trade
• Frictional barriers are shown as tariffs where the tariff revenue is thrown away, so removal of the frictional barrier removes ambiguity over the impact on the home country, and is always beneficial, as there is no loss of tax revenue
• Reciprocal preferential frictional barrier liberalisation reduces the domestic and border price, and partners receive higher prices, and Rest of the World (RoW) receive lower prices
• When frictional barriers are preferentially liberalised, home imports and partner exports rise, while RoW exports fall. Supply switching continues
• Removal of frictional barriers can have negatives, as reduced regulation can make products less safe
• Removal of frictional barriers is hard to do, because it is hard to establish the best regulations
• EU external trade liberalisation focuses on Single Market reforms over tariffs
• Deep Trade Agreements are regional integration initiatives that go beyond tariff cutting
• Introduction of the Euro is an example of deep trade, as it allows countries to trade within the Eurozone using a single currency instead of multiple currencies