International Economics I
(Econ 2081)
CHAPTER FIVE
INTERNATIONAL TRADE
INSTITUTIONS
Habtemariam
A. 1
Introduction
Since World War II, advanced
nations have significantly lowered
their trade restrictions. Such
trade liberalization has stemmed
from two approaches.
◦ Reciprocal reduction of trade barriers
on non discriminatory basis.
◦ Regional trading arrangements.
Under this system, member
countries agree to impose lower
barriers to trade within the group
than with non-group.Habtemariam A. 2
5.1.General Agreement on
Tariffs and Trade (GATT)
Bilateral negotiations helped countries to
reduce their average level of tariffs.
Multinational negotiations started
immediately after the II world War.
It was imagined that International Trade
Organization (ITO) would be established
along with the IMF and the World Bank.
GATT signed in 1947 by 23 countries
GATT was crafted as an agreement among
contracting parties (member nations) to
decrease trade barriers and to place all
nations on an equal footing in trading
relationships.
Habtemariam A. 3
The GATT objectives
To carry on trade on the principle of
non-discrimination, reciprocity and
transparency.
To grant protection of domestic
industry through tariff only.
To liberate tariff and non-tariff
measures through multilateral
negotiation.
To provide a set of rules (codes of
conduct) that would inhibit
countries from taking unilateral
Habtemariam A. 4
GATT was based on several principles
Reciprocity-if a country negotiates a
tariff deduction of, say 5%, and it is
agreed upon, then the country has
also to make the same amount of
tariff deduction on certain commodity
it imports from the other country.
The principle of non-discrimination
would imply that tariff cuts once
negotiated are extended to all
countries exporting the same good.
Habtemariam A. 5
Most Favored Nation (MFN) - Normal trade
relations
National treatment. Which means, an agreement
between nations to apply tariffs to each other at
rates as low as those applied to any other nation.
Exceptions to the GATT principles
a) Balance of payment problems- quantitative
restriction on imports during sever BoP problem.
b) Regional groupings-it allows the establishment of
free trade areas and customs union.
c) Tariff preferences – tariff preferences, which were
in operation before the signing were allowed to
continue.
Problems of the GATT system
◦ coordination problems free riders
◦ weakness in the settlement of trade disputes
Habtemariam A. 6
5.2. World Trade Organization
(WTO)
In 1995, GATT was transformed in
to WTO.
◦ Embodies the main provisions of
GATT
◦ Improve GATT’s process for resolving
trade dispute
◦ It is a membership organization,
which is responsible for governing
the conduct of trade relations among
its members.
Habtemariam A. 7
Objectives of WTO
Achieving over all sustainable
development.
Ensuring that the developing
countries may get a share in the
growth of international trade.
Settling trade disputes .
To develop a more viable and
durable multilateral trading system.
Coordinating policies in the field of
trade, environment and economic
development, etc.
Habtemariam A. 8
Differences between WTO and
GATT
The WTO is a full – fledged
international organization.
The WTO has a far wider scope
than the old GATT.
The WTO also administers a unified
package of agreements to which all
members are committed
Moreover, WTO reverses policies of
protection in certain “Sensitive”
areas (for example, agriculture and
textiles) that were more or less
tolerated in the old GATT.
Habtemariam A. 9
Main methods in which the WTO system
works
More open- lowering trade barriers.
Predictable and transparent-trade barriers
should not be raised arbitrarily.
More competitive-discouraging ‘unfair’
practices, such as export subsidies and
dumping products at below cost to gain
market share.
More beneficial for less developed countries-
giving them more time to adjust, greater
flexibility and special privileges.
Protect the environment-the WTO’s
agreements permit members to take measures
to protect not only the environment but also
public health, animal health and plant health.
Habtemariam A. 10
Trade negotiations-the WTO agreements
cover goods, services and intellectual
property
Implementation and monitoring-WTO
agreements require governments to
make their trade policies transparent by
notifying the WTO about laws in force
and measures adopted.
Dispute settlement-countries bring
disputes to the WTO if they think their
rights under the agreements are being
infringed.
Habtemariam A. 11
Building trade capacity-WTO
agreements contain special provision
for developing countries.
Outreach-The WTO maintains regular
dialogue with non-governmental
organizations, parliamentarians, other
international organizations, the media
and the general public.
Trade Rounds-These methods are used to
improve the trade system through different
Trade Rounds(negotiations).
Habtemariam A. 12
Name Start Duration Countries Subjects covered Achievements
Signing of GATT, 45,000 tariff concessions affecting
Geneva April 1947 7 months 23 Tariffs
$10 billion of trade
Annecy April 1949 5 months 13 Tariffs Countries exchanged some 5,000 tariff concessions
September Countries exchanged some 8,700 tariff concessions,
Torquay 8 months 38 Tariffs
1950 cutting the 1948 tariff levels by 25%
Tariffs, admission of
Geneva II January 1956 5 months 26 $2.5 billion in tariff reductions
Japan
September
Dillon 11 months 26 Tariffs Tariff concessions worth $4.9 billion of world trade
1960
Kennedy May 1964 37 months 62 Tariffs, Anti-dumping Tariff concessions worth $40 billion of world trade
Tariffs, non-tariff
September Tariff reductions worth more than $300 billion dollars
Tokyo 74 months 102 measures, "framework"
1973 achieved
agreements
Tariffs, non-tariff
The round led to the creation of WTO, and extended
measures, rules,
the range of trade negotiations, leading to major
services, intellectual
September reductions in tariffs (about 40%) and agricultural
Uruguay 87 months 123 property, dispute
1986 subsidies, an agreement to allow full access
settlement, textiles,
for textiles and clothing from developing countries,
agriculture, creation of
and an extension of intellectual property rights.
WTO, etc
Tariffs, non-tariff
measures, agriculture,
labor standards,
November environment, The round has not yet concluded. Bali Package
Doha ? 159
2001 competition, signed on the 7th December 2013.
investment,
transparency, patents
etc
Habtemariam A. 13
Intellectual Property Rights and
WTO
Article 2 of WIPO defines
intellectual property as:
◦ "Intellectual property" shall include
the rights relating to: literary, artistic
and scientific works; performances of
performing artists, phonograms, and
broadcasts; inventions in all fields of
human endeavor; scientific
discoveries; etc.
The economic rationale for
protection of IP stems from
‘market failure’. Habtemariam A. 14
‘Market failure’ is inability of the market
to deliver certain goods (Public goods)
Such kinds of goods are characterized
as
◦ non-rival
◦ non-excludable
◦ original costs of production are high
Benefits from an IP regime include
increased innovation and technology
transfer.
Disadvantage - create monopolies and
restricts access to technology for
imitators.
Habtemariam A. 15
The WTO Agreement on Trade-
Related Aspects of Intellectual
Property Rights (TRIPs
Agreement) is the Uruguay Round
agreement covering the
protection and enforcement of
intellectual property rights.
TRIPS covers patents, copyrights,
trademarks, geographical
indicators, industrial designs,
layout designs of integrated
circuits, and undisclosed
information. Habtemariam A. 16
TRIPS was expected to facilitate
the transfer of technology to
developing countries
Technology transfer takes place
in three ways; international trade,
foreign direct investment and
licensing of technologies and
trademarks to unaffiliated firms,
subsidiaries and joint ventures.
Evidence that technology flow
has accelerated in consequence
of the protection extended by
17
TRIPS is mixed. Habtemariam A.
UN Conference on Trade and
Development (UNCTAD)
The UNCTAD was established in 1964,
following the growing dissatisfaction
with the operation of such
international institutions as the IMF
and GATT.
These institutions failed to address
the development and trade problems
of LDCs.
The UNCTAD is a permanent organ of
the UN General Assembly with its
head quarter at Geneva.
Habtemariam A. 18
Functions of UNCTAD
The UNCATD is expected to perform the
following functions as laid down by the
UN General Assembly.
1. To promote international trade between
countries with different socioeconomic
systems, especially for accelerating the
economic development of LDCs.
2. To formulate principles and policies of
international trade and related problems
of economic development.
3. To make proposals for putting the said
principles and polices into effect.
Habtemariam A. 19
4. To review and facilitate the
coordination of activities of other
institutions within the UN system
in the field of international trade
and related problems.
5. To be available as a center for
harmonize trade related
development policies of
governments and regional
economic groupings.
Habtemariam A. 20
Objectives of UNCTAD
1. Trade in primary commodities:
to stabilize the prices of the
commodities.
to increase the prices of these
goods to compensate for the past
worsening in the terms of trade of the
LDCs.
2. trade of Manufactured goods
to enjoy tariff reductions or
exemptions from custom duties.
Habtemariam A. 21
3. Development Financing
UNCTAD tried to solve the
problems of LDCs related to their
BoP deficits and debt issues.
However it didn’t succeed.
4. Economic cooperation among
LDCs
the conference emphasized the
need for promotional cooperation
and self reliance among the LDCs.
Habtemariam A. 22
Technological transfer
• it was pointed out that better
research facilities, training
programs and establishment of
local and regional centers for
technological transfer.
Habtemariam A. 23
North-South Dialogue and New
International Economic Order (NIEO)
The year 1974 marked the official
launching of the so called North-South
Dialogue-the dialogue between the DCs
(representing North and the LDCs
(representing South).
It was thought that the old international
economic order was some what wicked,
immoral and unjust particularly to LDCs
and NIEO was felt necessary in order to
create a healthy and resilient world
economy free from international tensions,
monetary chaos and economic stagnation
and ideology.
Habtemariam A. 24
NIOE’S Objectives
Reduction in Global income
disparities between the rich and the
poor countries of the world;
Restricting the international
monetary system so that it response
to the needs of the poor countries;
Handling the primary commodities
issue and promoting LDCs
industrialization through commodity
processing and other methods;
Habtemariam A. 25
Common code of conduct of multinational
cooperation, foreign investment and
capital flows, transfer of technology,
international aid, and other flows from the
rich to the poor countries; and
Reduce dependence and increased
collective self reliance among LDCs.
The NIEO, basically, aims at redressing
the existing imbalances between the DCs
and LDCs insofar as they related to trade
and payment relationships between the
rich and the poor countries of the world.
Habtemariam A. 26
5.3. Regional Trading Arrangements:
The Theory of Customs Union
Since the mid- 1950s, the term
economic integration has
attracted a wide attention and
has got acceptance.
Economic integration is a process
of eliminating restrictions on
international trade, payments
and factor mobility.
Habtemariam A. 27
Economic Integration: Theory and Practice
• The growth of trade among
countries.
• Integration encourages rational
division of labor among a group of
countries and increases market
size
• Provides opportunities for a
coordinated industrial strategy to
exploit economies of scale
• Trade creation
• Trade diversion
Habtemariam A. 28
Regional trading blocs and the
globalization of trade
◦NAFTA
◦MERCOSUR
◦SADC
◦ASEAN
◦Local conditions matter
◦Still not fully answered: Do blocs
promote growth or retard the
progress of globalization?
Habtemariam A. 29
5.3.1. Forms of Regional Trading
Arrangements
Habtemariam A. 30
5.3.2. Rationale for REI
Enhanced economic growth
◦ Allow economies of large scale
production,
◦ Foster specialization and learning- by
–doing, and
◦ Attract foreign investment
Non economic objectives, such as
◦ Managing immigration flows
◦ Promoting regional security.
Habtemariam A. 31
5.3.3. The Theory of Custom
Union
Custom union-refers to a group of
two or more countries form an
association or a union, and the
members agree:
-Introduce free trade among the
members, but
-Imposes a common external
tariff against non-member
countries.
Habtemariam A. 32
Preferential Trading Union
Two or more countries can form a
trading union or a club and
reduce tariff on imports of each
other and maintain their
individual tariffs against the out
side world.
Ex. Common Wealth member
countries.
Habtemariam A. 33
Free trade Union or
Association
When two or more countries come
together and abolish all tariff duties
on their mutual trade in all goods and
services but retain their individual
tariffs against the rest of the world.
Example: The European Free Trade
Area, which consists of, Austria,
Denmark, Norway, Portugal,
Switzerland and UK.
LAFTA-Latin American Free Trade
Association.
Habtemariam A. 34
Common Market
isformed when two or more
countries form a Custom Union
and, in addition, allow free and
unrestricted movements of all
factors of production between the
member countries.
EX. The former European
Economic Community (EEC).
Habtemariam A. 35
Economic Union
The highest stage of economic
integration is reached when countries
form a economic union and harmonize
and unify their fiscal, monetary,
exchange rate, industrial and socio-
economic polices.
It moves towards the establishment of a
common currency, and a banking system.
Ex. European Union (EU).
NB- Political Union is the highest stage of
any integration between countries.
Habtemariam A. 36
The static effects of custom union
Assume a world composed of
three countries: Luxembourg,
Germany and U.S.
Suppose that Luxembourg and
Germany decide to form a
customs union.
The formation of customs union
leads to a welfare- increasing
trade- creation effect and a
welfare-decreasing trade-
diversion effect. 37
Habtemariam A.
Trade Creation and Trade Diversion
Effects of A Free Trade Area
Trade Diversion—a shift in the
pattern
of trade from low-cost world
producers
to higher-cost FTA members;
welfare-reducing effect.
Trade Creation—an expansion in
world trade resulting from
formation of a FTA; welfare-
increasing effect.
Habtemariam A. 38
Illustration
Static Welfare Effects of a customs Union
Price ($) SL
3.75 SG+tariff
3.50 SU.S+tariff
a b C d
3.25 SG
e
3.00 SU.S
DL
1 4 7 17 20 23 Grain (bushels)
Habtemariam A. 39
The trade creation effect consists
of a consumption effect and a
production effect.
◦ Consumption effect (efficiency in
consumption) .
The welfare gain associated with this
increase in consumption equals area of
triangle d.
◦ Production effect - customs union
results in a more efficient use of
world resources.
The welfare gain associated with
production equals area of triangle b.
◦ The overall trade- creation effect is
given by the sum of triangles
Habtemariam A.
b + d. 40
Trade diversion occurs when imports
from a low cost supplier outside the
union (U.S) are replaced by
purchases from a higher cost
supplier within the union (Germany).
◦ Area e is the welfare loss to Luxembourg
and the world as a whole.
Customs union will increase the
welfare of its members, as well as
the rest of the world, if the positive
trade- creation effect more than
offsets the negative trade- diversion
effect.
Habtemariam A. 41
The success of a customs union depends on
the factors contributing to trade creation and
diversion.
◦ Pre union competitiveness
-Nations whose pre union economies are
quite competitive are likely to benefit from
trade creation because the formation of
the union offers greater opportunity for
specialization in production.
◦ Size and number of nations in the union
-the larger the size and the greater the
number of nations in the union, the greater
the gains are likely to be, because there is
a greater possibility that the world’s low
cost producers will be union members.
Habtemariam A. 42
Common external tariff
The scope for trade diversion is
smaller when the customs union’s
common external tariff is lower
rather than higher. Because a lower
tariff allows greater trade to take
place with non member nations,
there will be less replacement of
cheaper imports from non-member
nations by relatively high-cost
imports from partner nations.
Habtemariam A. 43
Dynamic Effects of Trade
Arrangements
Economies of scale – access to a larger
market allows producers to become
more efficient through greater
specialization, better equipment, and
usage of by-products.
Greater competition – increased number
of producers makes collusion less likely
and forces firms to become more
efficient.
Stimulus of investment – because of
increased rate of return and ability to
spread R&D costs trade makes greater
levels of investment more likely.
Habtemariam A. 44
Practical Evidences
The European Union has achieved significant economies
of scale in such products as steel, automobiles, foot
wear, and copper refining.
the European refrigerator industry provides an example
of dynamic effects of integration. Prior to the formation
of European Union, each of the major European nations
that produced refrigerators (Germany, Italy, and France)
supported a small number of manufactures that
produced primarily for the domestic market. These
manufactures had production runs of fewer than
100,000 units per year, a level too low to permit the
adoption of automated equipment. Short production
runs translated in to high per- unit cost.
The formation of European Union resulted in the
opening of European markets and paved the way for the
adoption of large-scale production methods, including
automated press lines and spot Habtemariam
welding.A. 45
-----End of Chapter Five -----
Habtemariam A. 46
