Trade Creation & Trade Diversion;

Theory of Second Best;

Economic Integration: Formats & Models

BITS Pilani, K K Birla Goa Campus

Focus Areas:
Economic Integration
notion & concepts
Economic Integration
Models
Do Integration Creates or
Diverts Trade
Theory of Second Best
BITS Pilani, K K Birla Goa Campus

Economic Integration Models

PTA - is a trading bloc that gives preferential
access to certain products from the participating
countries.

Preferential

Trade
Agreements PTAs

This is done by reducing tariffs but not by

abolishing them completely.
A PTA can be established through a trade pact.
It is the first stage of economic integration.
These tariff preferences have created numerous
departures from the normal trade relations.
Regional trading bloc formation can both create
and divert trade.
BITS Pilani, K K Birla Goa Campus

PTA Cases

More than 23 forms of

PTAs are identified.

India Afghanistan (2003)

India Mauritius
India Nepal (2009)
India Chile (2007)
India MERCOSUR (2009)
ASEAN PR China (2005)
Laos Thailand (1991)

Among the 119 countries.

Account for 82% of world
trade (Fieleke 1992).
The use of PTAs to
achieve both domestic
and international trade
policy objectives clearly is
increasing.
BITS Pilani, K K Birla Goa Campus

 FTA is an economic integration process encompassing a

trade bloc whose member countries have signed a freetrade agreement.
Generally among neighbouring countries. However, it can
also be extra regional too.

Free Trade Area

or
FTAs

Free trade agreements eliminate tariffs, import quotas,

and preferences on most (if not all) goods and services
traded between the member countries.
If people are also free to move between the countries, in
addition to FTA, it would also be considered an open
border.
It can be considered the second stage of economic
integration. Countries choose this kind of economic
integration if their economic structures are
complementary.
BITS Pilani, K K Birla Goa Campus

ASEA

ASEAN FTAs

EU FTAs

China FTAs

India FTAs
BITS Pilani, K K Birla Goa Campus

NAFTA;
EFTA;
GAFTA;
CAFTA;
MERCOSUR

EFTA
European Free Trade Area.
Formed in 1960
by UK; Austria; Denmark;
Norway; Portugal; Sweden &
Switzerland.
GAFTA
Greater Arab Free Trade
Area.
Formed in 1997
14 countries
BITS Pilani, K K Birla Goa Campus

 A customs union is a type of trade bloc which is

composed of a free trade area with a common external
tariff.

Customs
Union

The participant countries set up common external trade

policy, but in some cases they use different import
quotas.
Purposes for establishing a customs union normally
include increasing economic efficiency and establishing
closer political and cultural ties between the member
countries.
It is the 3rd stage of economic integration.
Customs unions are established through trade pacts.
BITS Pilani, K K Birla Goa Campus

February 26, 2014, 2:54 pm

Russia, India to set up
FTA with Customs Union

South Africa ,Lesotho,

Swaziland, Botswana &
Namibia has formed the
Southern African Customs
Union (SACU) with a
common custom tariff policy.

Russian Deputy Prime Minister Dmitry Rogozin met

Indian Prime Minister Manmohan Singh in New
Delhi on Wednesday 26 February 2014 [MEA]

BITS Pilani, K K Birla Goa Campus

 An economic union is a type of trade bloc which is

composed of a common market with a customs union.

Economic
Union

The participant countries have both common policies on

product regulation, freedom of movement of goods,
services and the factors of production (capital & labour) and
a common external trade policy.
When an economic union involves unifying currency it
becomes a Economic and monetary union.
Purposes for establishing an economic union normally
include increasing economic efficiency and establishing
closer political and cultural ties between the member
countries.
Economic union is established through trade pact.
BITS Pilani, K K Birla Goa Campus

Cases-

Every Economic and monetary union has

also an Economic Union

Benelux Countries

Single market of the European Union

Belgium; Netherlands;
Luxemburg
formed Economic
Unions soon after 2nd
World War

CARICOM Single Market and Economy of

the Caribbean Community
Union State of Russia and Belarus
Monaco - European Union
USA formation

EU goes further by harmonizing or even unifying monetary & fiscal policies of

member states. This is the most advanced economic integration process.
BITS Pilani, K K Birla Goa Campus

Common Market

Common Market

Group formed by countries within a geographical

area to promote duty free trade and free
movement of labor and capital among its
members.
European community (as a legal entity within the
framework of European Union) is the best known
example.
EU became a Common Market in 1993
Common markets impose common external tariff
(CET) on imports from non-member countries.
BITS Pilani, K K Birla Goa Campus

Economic Integration:
Theoretical
Formulations

Is a solution and
problem too!

BITS Pilani, K K Birla Goa Campus

Case of ASEAN

ASEAN

BITS Pilani, K K Birla Goa Campus

Notions & Possibilities!

East Asian Community EAC
ASEAN 10 Member Grouping
ASEAN + 3
ASEAN + 6
ASEAN CEPA
TPR
Regional Structural, Political & Strategic

Issues: Implications?

BITS Pilani, K K Birla Goa Campus

Notion of East Asian Community!

Geography, Contiguity, Economic

Growth Trajectory proposes
feasibility of EAC & Beyond

Financial
Joints/ India
Absent
BITS Pilani, K K Birla Goa Campus

ASEAN + 3
ASEAN + 3 =
ASEAN + China
+ Japan +
South Korea

BITS Pilani, K K Birla Goa Campus

ASEAN + 6 =
16 Member
ASEAN + China +
Japan + South
Korea
+
India + Australia
+ New Zealand
= CEPA or RCEP
BITS Pilani, K K Birla Goa Campus

TPR

ASEAN + 3

ASEAN + 6
Potential future members
Announced interest in joining

Currently in negotiations
BITS Pilani, K K Birla Goa Campus

Regional Economic Integration

What it Means?
Japan has more
than 09 Bilateral/
Multilateral FTAs
in the region

Korea has more

than 07 Bilateral/
Multilateral FTAs
in the region

Noodle
bowl Effect
Singapore has
Japan has more
!
more than 14

Bilateral/
Multilateral FTAs
in the region

than 09 Bilateral/
Multilateral FTAs
in the region
BITS Pilani, K K Birla Goa Campus

Thailand more
than 08 FTAs
in the region
China more than
08 FTAs in the
region

166 by
June 2009
(ADB).

Philippines more
than 05 FTAs in
the region

Net effect is a
Noodle bowl
Effect !

Bhagwati, Greenaway, and Panagariya (1998) and Panagariya (2000) surveyed the
theoretical economics literature on FTAs and the spaghetti bowl, which pre-dates
the rise of Asian FTAs and the noodle bowl.
BITS Pilani, K K Birla Goa Campus

Trade Creation
& Customs
Union-

J. Viner
J. Meade
& H.G Johnson

J. Viner pioneered the development of the theory of

Customs Union in 1950.
Focused on the production effect of Trade Creation &
ignored consumption aspect.
In 1955, J. Meade extended the Customs Union Theory
to analyze the consumption effect also
H.G Johnson developed it further and added both the
production and consumption triangle to obtain total
Welfare Gain of a Customs Union.
Lipsey & Lancaster 1956, further extended it to Theory
of 2nd Best
BITS Pilani, K K Birla Goa Campus