Trading blocs is the group of countries that join together in some form of agreement in order to
increase trade between them, and/or to gain economic benefits from cooperation
on some level. This is called economic integration. The level of effect from economic
integration is depends on what stages has the country reached; the higher stage
of economic integration causes larger impact but they may also gain benefits
There are six stages of economic integration, preferential trading areas, free trade areas,
customs unions, common markets, economic and monetary union and the final stage
is the complete economic integration.
For the first stage of economic integration : Preferential Trading Areas. Trading bloc gives preferential access to certain products from certain countries. And, it is usually carried out by reducing, but not eliminating tariffs.
The second stage is Free Trade Areas. It is an agreement made between countries, where the countries agree to trade freely among them, but are able to trade with countries outside of FTA in whatever way they wish. For example, countries A, B, C signed for the free trade area; A, B, C can trade freely. A can trade freely with D if they have good relationship without asking B or C’s permissions.
The third stage is Customs Unions. There is agreement made between countries, where countries agree to trade freely among themselves, agree to adopt common external barriers against any country attempting to import into the customs union. For example countries A, B, C are the custom union, then they will put common external barriers on D which trying to get into their custom union areas.
The fourth stage is Common Market which is customs union with common policies on
product regulation, and free movement of goods, services, capital and labour. These
countries will have harmonization of economic policy, possible single policy.
The fifth stage is Economic and Monetary
Union. It is an advanced stage of common market that is a common market
with a common currency. For example, Eurozone adopt Euro as their currency. The
final stage is Complete Economic Integration
that is the combination of the above stages – the countries would have free
trade areas within its members, and they would have common policies on product
regulation, and free movement of goods, services, capital and labour, harmonization
of economic policy, possible single policy, and the common currency. In the
final stage, individual countries involved would have no control of economic
policy, full monetary union, complete harmonization of fiscal policy.
As the pros and cons will highly depends to a large extent on the degree of integration.
For the first stage(Preferential trading areas), countries could pay less tax in certain products. This decreases the cost of purchasing for imports which leads to higher motivation on investment plus the higher supply of raw materials. However, countries may not gain benefits as countries in the Free Trade Areas, thus comparative advantage will be lower.
For the second stage(Free trade areas), countries gain benefits from free trade. This increase chances for gaining other countries’ comparative advantage. Moreover, individual countries are still independent on their own policy, thus they have high level of control for both economic and
political sovereignties. Assume country A and B form free trade areas, and A has good relationship with country C, thus A put free trade on C. However, if B dislike them and put external barriers on C, then it may breakdown relationship between A and C, caused countries’ conflict.
For the third stage and above, members in the custom unions can gain benefits from free trade, provide more choices to citizens. As they share the common external barriers, this decreases
competition among members, include a greater size of market with the potential
for larger export markets, increased competition with non-members that leads to
greater efficiency, it may stimulus for investment due to larger market size.
However competitiveness of these members may rise when competing with other countries. Other countries may not satisfy with it and assert higher barriers on the members which increases price of product, thus decrease level of consumption and investment, probably leads to
unemployment. Some domestic producers are likely to gain from the larger market
while others may find themselves unable to compete. Moreover, trade negotiation
may be easier in a world made up of a no. of large trading blocs. If members enact
discriminatory policies against non-members, this may damage achievements of
multilateral trading negotiations of WTO. Also, it takes away country’s
political sovereignty while political decisions start to be made by central
body, thus the power of domestic government in the country reduced.
Furthermore, it takes away country’s economic sovereignty while Economic
decisions start to be made by central body , Government and citizen in any
given country may be reluctant to give up the right to make economic decisions.
Moreover, countries may benefits from either trade creation or trade diversion. Trade creation occurs when the entry of a country into a customs union leads to the production of a good or service transferring from a high-cost producer to a low-cost producer. Trade diversion occurs when the entry of a country into a customs union leads to the production of a good
or service transferring from a low-cost producer to a high-cost producer.
In the trade creation case, it is beneficial for countries whose join trading blocs. For example, country A join a common market Z, then the amount of tariff which imposed before is removed. Price lower from P(A)+T to P(A).
Before, country A produced at Q2Q3 now, they produce at Q1Q4. The pink area represents the regained world efficiency as country A is more efficient on producing product X. As price is lower, thus more demand leads to consumer surplus shaded in blue triangle. Trade creation has achieved in country A, benefits private individuals and citizens in country A,
brings cheaper product with higher productivity.
On the other side, trade diversion can harm country who joined into the common market.
Before country A joined Z union, the Q1Q4 are the amount of imports from efficient producer, country B. However, after country A joined union Z, they need to follow union Z to impose tax on country B(while country B isn’t their member). As a result, the tariff causes price increase from P(B) to P(B)+tariff. Now, country B produce at Q2 and the amount of imports to country A is Q2Q3. Q3Q4 will be the loss of consumer surplus(i.e. yellow triangle) which caused by increase in price. Before joining the union Z, Q1Q2 produced by efficient country B, but now, it is produced by inefficient country A(i.e. world welfare loss shaded in grey box). Moreover, inefficient producers in union Z would then produce Q2Q3 which is the misallocation of world’s resources(that is shaded in pink box).
In conclusion, by joining the trading blocs can bring both advantages and
disadvantage to country. Countries need to consider carefully before making decisions
and make sure that it doesn’t conflict with its government objective. For
example, for capitalism countries may want to have independent policies and
economic decisions, but they may consider first or second stage of economic
integration and benefits from free trade areas. For countries who want increase
competitiveness in world market may want to join common market, in order to
share same currency, benefits from free trade and obtain the common policies to
defeat the non-members.