In an attempt to address the issue of whether the degree of regional trading arrangements is a pleasing or harmful development, economists have challenged to construct dynamic models that analyze the effects of the world being organized into a dilapidated number of trading blocks. Krugman (1991) developed a model in which the world consisted of a large number of small provinces, every of which specialized in the production of a single, distinct product.
The products of every province entered symmetrically into world demand, with an invariable elasticity of substitution between any two such products. The world was implicit to be organized into a certain number of trading blocs of equal size with internal free trade, but a common exterior tariff on imports from the rest of the world. Each bloc acted non-co-operatively and set its external tariff at whatever level maximized its economic welfare. As Krugman (1993) has argued, there are two main problems with this model.
The first is that it assumes that each of the blocs sets tariffs in a non-co-operative manner, such that the external tariff of each bloc increases as the number of blocs reduces. However, suppose that tariffs are set through negotiation relatively than in a non-co-operative manner. Consolidation into a smaller number of blocs can make negotiated agreements to lower tariffs more probable because the number of players involved is fewer. The second is that it ignores the degree to which countries that are part of the same bloc are ‘natural’ trading partners.
If they are, certainly, natural trading partners (because transportation and communication costs between the countries are low); the risk that consolidation of the world into a smaller number of blocs will lessen global economic welfare is reduced. Krugman’s conclusion is that, while more vigilant modeling is required to take account of these factors, the answer to whether or not regionalism is good or bad must be vague. A linked issue concerns why so many such blocs are being formed.
The answer to this can be found, Krugman argues, in the advantages that regional negotiations have over multilateral negotiations as a way of trade liberalization. The number of participants in regional negotiations is fewer, which reduces the threat of ‘free riding’ and makes agreements easier to reach. “A first can be called the 'preference-dilution effect': because regional integration implies a larger political community, each of the politically important interest groups in member countries will have less influence on the design of common policies.
The second is the 'preference-asymmetry effect': because preferences on specific issues are likely to differ across member countries, the resulting need for compromises may enhance efficiency”. Dr. Patrick Low, Commercial Policy and the Multilateral Trading system, 2006-2007 http://www. sac-hei. ch/wp-content/uploads/2007/06/wto_low_vero. doc) Member Countries' Trade Policies The conception of RTAs may interrupt the formation of rent-seeking interest-groups, as these have to restructure at the regional level, setting up an institutional structure that permits them to agree on a common position.
But, regional trade agreements might also ease the adoption of less liberal policies. Consumer interests can be harder to protect in an RTA than at the national level, whereas producer interests are more expected to be strengthened than weakened (Tumlir, 1983). Every national producer group can face less opposition while seeking price-increasing policies, and may indeed find sustain from other producer groups in other countries that practice their own interests.
The requirement for striking compromises can then result in a less liberal regulatory regime. additionally, it can be in the interest of national politicians to let a regional organization assure national pressure groups as this is less apparent for domestic voters and can be justified as being essential to retain the agreement ( Vaubel, 1986). Much will usually depend on the type of regional integration agreement that is concerned. Two basic types can be illustrious: an FTA, as opposed to a customs union or common market.
Both types entail non-discrimination between the members of the agreement: any benefit decided to member country B by member country A is also obtainable to member country C. The main difference between an FTA and a customs union or common market is that the later have a common external trade policy. Whatever the degree of internal liberalization of trade and competition, execution of a common external trade policy can offer rise to an upward bias in the point of external protection over time, particularly if import-competing industries practice instruments of contingent protection such as anti-dumping actions.
The range for expansion in the use and coverage of AD actions in a customs-union is adequately illustrated by the experience of the EU (Hindley and Messerlin, 1993). Thus, there can be no net increase in external trade barriers at the configuration of a customs union, but there can simply be an upward trend if dependent protection is maintained as an option. In contrast, FTAs have a diverse dynamic, as members in some sense contend in their external trade policies. Both customs unions and members of an FTA can negotiate FTAs with non-member countries.
To the degree that the countries involved do not have FFAs with each other, a hub-and-spoke system possibly will emerge ( Wonnacott, 1991). By permitting bilateral deals regarding sectoral exposure and the obligations imposed by the agreement, vested interests might be created that can prove harder to extricate in future attempts to achieve further liberalization than if the agreement had been practical on a non-discriminatory basis. As summarized by Bhagwati (1993) such groups might argue that the region 'is our market', and that 'our markets are large enough'. (Bhagwati, 1993).