Trade Integration - Customs Union (L2, L3, L4)

Question 1

What is a CU?

Answer 1

A form of regional integration which has free trade + CET

Question 2

what is the main point of trade theory?

Answer 2

Free trade maximises world production

Question 3

Arguments FOR free trade?

Answer 3

1. bigger market, more competition, lower prices
2. imports are cheaper

Question 4

Arguments AGAINST free trade (argument for tariffs)

Answer 4

1. Tariffs increase share of home market - creating domestic employment
2. Tariffs generate gov. revenue

Question 5

Is a CU beneficial for members?

Answer 5

Depends on if trade is new trade or diverted trade.

Question 6

Jacob Viner’s modelling assumptions

Answer 6

1. World of 3 countries (home/partner/rest of world)
2. One good (price of product is FIXED)
3. Given supply price, unaffected by quantity
4. Given demand level, unaffected by supply
5. Switching to lower cost source is better, higher cost source is worse

Question 7

Why trade creation IS BENEFICIAL

Answer 7

1. Production switched to lower cost source
2. Consumers get lower prices
3. No loss of revenue to the government

Question 8

CAVEATS of trade creation?

Answer 8

1. Nobody will want to buy home produce
2. Workers + machines assumed to be flexible and easily switched between sectors
3. Adjustment costs (losses for firms/workers) from moving sectors are ignored in theory.

Question 9

What is the general condition for countries’ costs in CU?

Answer 9

C(h) > C(f) > C(r)

Question 10

Effects that in theory, CU should have on trade of member countries?

Answer 10

1. increased trade
2. increased specialisation
3. more output + income due to specialisation

Question 11

Actual effect of CU on trade of member countries?

Answer 11

1. Rapid trade growth (+15% to member countries compared with +8.5% to non member countries)
2. De-specialisation (home country gives up production of imported good + become de-specialised, workers cannot transfer their skills)

Question 12

But how can we tell if trade grew fast due to CU or if it was a mere coincidence?

Answer 12

We have to construct an argument, then a counter-factual argument where we extrapolate the trend forwards.

Question 13

Facts about CU + trade growth relationship?

Answer 13

• 19-26% of Increased EU trade was due to tariff cuts in 1960-2000s

HOWEVER, main factor (70%) was due to rising incomes

Question 14

What was the effect of entry into EU to UK?

Answer 14

1973 uk joins EU.

1. UK trade w EU had increased significantly due to trade creation
2. Trade with the rest of world had also increased & external TC as previously the UK had held a higher tariff rate for external countries but adopted a lower tariff rate

Question 15

What were the main worries about forming the EUCU?

Answer 15

People had worried that a CU formation meant large job losses and widespread factory closures.

This is because the home country would need to give up production on certain imported goods, which reduces home production + producer surplus. Leads to laid off workers + lower employment.

Real life labour isn’t as substitutable as in theory.

Question 16

What is a safeguard clause?

Answer 16

if a country has been hurt by trade agreement, e.g., many factories close, they can temporary impose restrictions/trade barriers to limit trade competition to protect own workers/producers

Question 17

However, little problems arose from the formation of the EU. WHY?

Answer 17

1. It was a golden age of fast economic growth and a long transition period, which meant little unemployment
   - nearly 5% growth rate in 1950-1973
2. Intra-industry specialisation - instead of having many firms shut down due to import competition, some firms began to specialise not across industries but within industries (Intra-industry specialization means companies in the same industry focus on making specific, different products rather than a wide range. It helps them become more efficient and competitive within their industry.)
3. Other trade barriers STILL existed (NTBs) hence, need for single market programme.

Question 18

What is inter-industry trade?

Answer 18

Exchanging one type of good for a different type of good. e.g, clothes -> wine

Question 19

What was anticipated of specialiastion pre-1958?

Answer 19

That certain countries would dominate the european market in their best industries, e.g., germany would specialise in car market and sell their cars everywhere, making it hard for any other country to compete

Question 20

What actually happened to trade post CU?

Answer 20

Countries, e.g., France and Germany became more similar from 1958-1963, instead of less different.

Question 21

What index do we use in intra industry trade?

Answer 21

GI index.

0% - different
100% - identical

Question 22

What is intra-industry trade?

Answer 22

Where exports = imports in the same industry/sector.

Question 23

Why would you export and import the same product?

Answer 23

DIFFERENTIATED + BRANDED GOODS.

Many products have branding and are produced in several varieties (e.g., luxury handbags) which gives consumer more choice.

Question 24

Draw me the IIT economies of scale model example

Question 25

Why is AC downward sloping?

Answer 25

The more quantity you produce, the more you can spread the fixed costs over a larger output. so AC decreases + slopes down assuming MC is constant.

Question 26

Why does v2 disappear in the diagram?

Answer 26

As you import more varieties, some domestic varieties will disappear.

Question 27

So what does Intra Industry trade to do choices/prices?

Answer 27

Consumers get more choice and lower prices

Question 28

What happens if we have inter-industry trade vs intra-industry trade?

Answer 28

If inter, we have lots of job losses due to sector readjustment issues.

If intra, some workers do still get laid off due to some domestic firms shutting down - but as they are in the same sector, they can easily find another job.