4.1.5 Trading blocs and the World Trade Organisation

• Types of trading blocs

  • Free trade area
  • Customs union
  • Common market
• Free trade area


  Countries agree to trade goods with other members without protectionist barriers
• Free trade areas


  • North American Free Trade Agreement (NAFTA)
  • European Free Trade Association (EFTA)
• Free trade areas


  • Allow members to exploit their comparative advantages, which increases efficiency
• Customs union


  Countries have established a common trade policy with the rest of the world, and have free trade between members
• Common market


  Establishes free trade in goods and services, a common external tariff and allows free movement of capital and labour across borders
• When the EU was established, it was a Common Market
• Monetary union


  Members share the same currency
• Conditions necessary for monetary union success

  • Common central monetary policy
  • Use the same interest rate
  • Member nations required to control government finances (budget deficits cannot exceed 3% of GDP)
  • Gross National Debt has to be below 6% of GDP
  • Inflation has to be below 1.5% of the three lowest inflation countries
  • Average government bond yield has to be below 2% of the yield of the countries with the lowest interest rates (to ensure exchange rate stability)
  • Achieve real convergence (member countries have to respond similarly to external shocks or policy changes)
  • Flexibility in product markets and labour markets to deal with shocks (through geographical and occupational mobility of labour, and wage and price flexibility)
• Optimal currency zone


  Created when countries achieve real convergence
• Costs and benefits of regional trade agreements


  • Trade creation
  • Trade diversion
  • Reduced transaction costs
  • Economies of scale
  • Enhanced competition
  • Migration
• Trade creation


  A country consumes more imports from a low cost producer, and fewer from a high cost producer
• Trade diversion


  Trade shifts to a less efficient producer, as a country might stop importing from a cheaper producer outside a trading bloc to a more expensive one inside the trading bloc
• Protectionist barriers are often imposed on countries who are not members, so trade is diverted from producers outside the bloc to producers within the trading bloc
• The UK trades mainly with the EU, at the expense of former trade links in the Commonwealth
• Reduced transaction costs


  No barriers to trade or no border controls, so it is cheaper and simpler to trade
• Economies of scale


  Firms can take advantage of a larger potential market in which to trade
• Enhanced competition


  Firms become more efficient and there is a better allocation of resources, with possible long-run benefits of dynamic efficiency
• Migration


  The supply of labour is increased, which could help fill labour shortages, but some countries might lose their best workers
• Role of the WTO in trade liberalisation

  • Promotes world trade through reducing trade barriers and policing existing agreements
  • Settles trade disputes
  • Organises trade negotiations
• Every member of the WTO must follow the rules, and those who break the rules face trade sanctions
• The WTO covers the trade in goods, services and intellectual property rights
• As of 2015, there are 161 member states in the WTO
• Possible conflicts between regional trade agreements and the WTO

  • Trading blocs might distort world trade or adversely affect those who do not belong to them
  • Inefficient allocation of resources as a result of policies such as the EU CAP
  • Conflicts between blocs could lead to a rise in protectionism
  • A common external tariff contradicts the WTO's principles
  • Some countries might argue that the WTO is too powerful, or that it ignores the problems of developing countries
  • Setting up a customs union or a free trade area could be seen to violate the WTO's principle of having all trading partners treated equally
• However, trading blocs can complement the trading system and the WTO strives to ensure that non-members can trade freely and easily with the members of a trade bloc