AEM Chapter 8

Deflation and the Eurozone

Deflation is a sustained decline in the general level of prices. It occurs when price decreases are so widespread and sustained. falling prices may cause consumers and businesses to postpone purchases in the hope of realizing lower prices in the future. falling prices increase the burden of debt because borrowers are now forced to repay their loans with money that has reduced purchasing power. With the rate of inflation well below the European Central Bank's (ECB) target rate of 2 percent in 2015, policymakers feared that the Eurozone could slip into deflation. This resulted in the ECB's implementation of an expansionary monetary policy to steer inflation back to its target

How many PTA's are there today?

419!

Gains from trade from a fully integrated market in the EU

5.3% GDP which equates to a gain of 875 billion

Common Market

A common market is a group of trading nations that permits (1) the free movement of goods and services among member nations, (2) the initiation of common external trade restrictions against nonmembers, and (3) the free movement of factors of production across national borders within the economic bloc. The common market thus represents a more complete stage of integration than a free trade area or a customs union. Examples: European Community (EC) and European Monetary System (EMS)

Regional Trading Agreement: Free Trade Area

A free trade area is an association of trading nations in which members agree to remove all tariff and nontariff barriers among themselves. Each member maintains its own set of trade restrictions against outsiders. An example of this stage of integration is the North American Free Trade Agreement (NAFTA), which consists of Canada, Mexico, and the United States.

Motivations for Regional Trading Agreements

A motivation of virtually every regional trading arrangement has been the prospect of enhanced economic growth. An expanded regional market can allow economies of large-scale production, foster specialization, enhance learning-by-doing, and attract foreign investment. Regional initiatives can also foster a variety of noneconomic objectives such as managing immigration flows and promoting regional security. Regionalism may enhance and solidify domestic economic reforms. As new regional trading arrangements are formed or existing ones are expanded or deepened, the opportunity cost of remaining outside an arrangement increases.

Optimum Currency Areas

An optimum currency area is a region in which it is economically preferable to have a single official currency rather than multiple official currencies. The United States can be considered an optimal currency area. According to the theory of optimum currency areas, there are gains to be had from sharing a currency across countries' boundaries. These gains include more uniform prices, lower transaction costs, and greater certainty for investors, and enhanced competition. A single monetary policy run by an independent central bank should promote price stability. Need flexibility of prices, wages and labor. Both parties should have similar economies and business cycles

Example: U.S.-Mexico Tomato Dispute

As competition intensified, American tomato growers accused Mexican growers of selling their tomatoes in the United States at prices less than fair value (dumping) and driving American growers out of business. The Americans petitioned for the levying of antidumping tariffs on Mexican tomatoes. The Mexican government contended that Mexican tomatoes were not sold in the United States at prices below fair value: Mexican grown tomatoes were more competitive due to superior technology, good weather, and lower labor costs. To resolve this dispute, an agreement was reached in 1996 in which Mexico's largest growers placed a floor on the price of their tomatoes sold in the United States so they would not undercut American growers. The price floor was later heightened again by US farmers

EU Agricultural Policy

Besides providing free trade in industrial goods among its members, the EU has abolished restrictions on agricultural products traded internally. The common agricultural policy mandated that Members of the European Union agree to maintain identical governmental agricultural policies to support farmers. A substantial element of the common agricultural policy has been the support of prices received by farmers for their produce. Schemes involving deficiency payments, output controls, and direct income payments have been used for this purpose. In addition, the common agricultural policy has supported EU farm prices through a system of variable levies that applies tariffs to agricultural imports entering the EU. Exports of any surplus quantities of EU produce have been assured through the adoption of export subsidies. The common agricultural policy has encouraged inefficient farm production by EU farmers and has restricted food imports from more efficient nonmember producers. Such trade diversion has been a welfare decreasing effect on the EU.

Dynamic Effects

Dynamic gains include economies of scale, greater competition, and a stimulus of investment Perhaps the most noticeable result of a customs union is market enlargement. Being able to penetrate freely into domestic markets of other member nations, producers can take advantage of economies of scale that would not have occurred in smaller markets limited by trade restrictions. With freer trade, domestic producers must compete or face the possibility of financial bankruptcy. To survive in expanded and more competitive markets, producers must cut waste, keep prices down, improve quality, and raise productivity. Competitive pressure can also be an effective check against the use of monopoly power and in general a benefit to the nation's consumers. In addition, trade can accelerate the pace of technical advance and boost the level of productivity

EU is not a true union

EU has monetary union but without coordinated fiscal policy; fiscal, budgeting and tax systems, and banking regulations, not integrated. Major differences in fiscal discipline, budget deficits and government debt (e.g. Germany vs. Greece, Italy, Spain, Ireland) Different debt levels, economic conditions and risk perceptions create high interest rate differentials

Jobs lost compared to jobs gained from NAFTA?

Economic Policy Institute (2011) claims ~683,000 U.S. jobs lost due to NAFTA. But - how about jobs gained? Hard to identify since distributed across industries and states U.S. is $124 billion richer each year due to trade growth due to NAFTA • For every job lost due to NAFTA, gains to U.S. economy around $450,000. • U.S. jobs lost offset by jobs gained, with salaries 15%-20% higher • Trade with Mexico supports 14 million U.S. jobs Rise in employment in services and a decline in agriculture and manufacturing

Economic integration

Economic integration is a process of eliminating restrictions on international trade, payments, and factor mobility. Economic integration results in the uniting of two or more national economies in a regional trading arrangement. Can sometimes get confusing by the overlaps of nations participating in a multitude of trade agreements

Convergence Criteria

Economic standards required of all nations in a monetary union; in the instance of the Maastricht Treaty, these standards included price stability, low long-term interest rates, stable exchange rates, and sound public finances.

Greece and the Eurozone

In 2008 Greece was in deep recession, its economy was uncompetitive with northern eurozone members like Germany, and its debt was more than three times as large as previously estimated. International Monetary Fund, agreed on a package that gave Greece 110 billion euros in loans. Events intensified when Greece announced that it could not fulfill its debt payments to the International Monetary Fund. government imposed capital controls that prevented the movement of euros out of Greece and temporarily closed domestic banks. Part of the problem of the eurozone is that it is not a single country and its mechanisms for fiscal transfers across borders are underdeveloped and contentious.

NAFTA and environmental regulations

Investigate abuses in either area. • Impose fines or trade sanctions if countries fail to enforce environmental laws or labor standards • Environmental issues still a source of conflict (e.g. maquiladoras, etc. Another issue: "rules of origin" as they apply to transshipped products made elsewhere (e.g., Central America, Asia)

The beginnings of the EU

In the years immediately after World War II, Western European countries suffered balance-of-payments deficits in response to reconstruction efforts. To shield their firms and workers from external competitive pressures, they initiated an elaborate network of tariff and exchange restrictions, quantitative controls, and state trading. It was against this background of trade liberalization that the European Union, then known as the European Community, was created by the Treaty of Rome in 1957. According to the Treaty of Rome, the EU agreed in principle to follow the path of economic integration and eventually become an economic union. In pursuing this goal, EU members first dismantled tariffs and established a free trade area in 1968. This liberalization of trade was accompanied by a fivefold increase in the value of industrial trade—higher than world trade in general. The success of the free trade area inspired the EU to continue its process of economic integration. In 1970, the EU became a full-fledged customs union when it adopted a common external tariff system for its members.

Customs Union

Like a free trade association, a customs union is an agreement among two or more trading partners to remove all tariff and nontariff trade barriers between themselves. In addition, each member nation imposes identical trade restrictions against nonparticipants. The effect of the common external trade policy is to permit free trade within the customs union, whereas all trade restrictions imposed against outsiders are equalized. A well-known example is Benelux (Belgium, the Netherlands, and Luxembourg), which was formed in 1948 and MERCOSUR

NAFTA's Benefits and Costs for Mexico and Canada

MEXICO: Rising investment spending in Mexico has helped increase wage incomes and employment, national output, and foreign exchange earnings; it also has facilitated the transfer of technology.Mexican producers of rice, beef, pork, and poultry claim they have been devastated by U.S. competition in the Mexican market resulting from NAFTA. They claim they cannot compete against U.S. imports where easy credit, better transportation, better technology, and major subsidies give U.S. farmers an unfair advantage. Although it has succeeded in stimulating increased trade and foreign investment, NAFTA alone has not been enough to modernize Mexico or guarantee prosperity. Need better education and infrastructure- something NAFTA can't provide! CANADA: threaten Canada's social welfare model, either by causing certain practices and policies (such as universal health care or a generous minimum wage) to be considered as uncompetitive or by imposing downward pressure on the country's base of personal and corporate taxes, thus starving government programs of resources. Canada's benefits from NAFTA have been mostly in the form of safeguards

NAFTA's Benefits and Costs for the United States

NAFTA proponents maintain that the agreement has benefited the U.S. economy overall by expanding trade opportunities, reducing prices, increasing competition, and enhancing the ability of U.S. firms to attain economies of large-scale production. American companies, particularly larger ones, have realized better access to cheaper labor and parts. The United States has benefited from a more reliable source of petroleum, less illegal Mexican immigration, and enhanced Mexican political stability as a result of the nation's increasing wealth. On the business side, the losers have been industries such as citrus growing and sugar that rely on trade barriers to limit imports of low-priced Mexican goods. Other losers are unskilled workers, such as those in the apparel industry, whose jobs are most vulnerable to competition from low-paid workers abroad. American labor unions have been especially concerned that Mexico's low wage scale encourages U.S. companies to locate in Mexico, resulting in job losses in the United States.

Maastricht Treaty

Signed in 1991, this agreement set 2002 as the date for completing the process of replacing the EU countries' central banks with a European Central Bank and replacing their national currencies with a single European currency.

Export Subsidies

The EU has also used a system of export subsidies to ensure that any surplus agricultural output will be sold overseas. The high price supports of the common agricultural policy have given EU farmers the incentive to increase production, often in surplus quantities. But the world price of agricultural commodities has generally been below the EU price. The EU pays its producers export subsidies so they can sell surplus produce abroad at the low price but still receive the higher, international support price. By encouraging exports, the government will reduce the domestic supply and eliminate the need for the government to purchase the excess.

Beginning of NAFTA

The establishment of NAFTA was expected to provide each member nation better access to the others' markets, technology, labor, and expertise. In many respects, there were remarkable fits between the nations: The United States would benefit from Mexico's pool of cheap and increasingly skilled labor, while Mexico would benefit from U.S. investment and expertise. Negotiating the free trade agreement was difficult because it required meshing two large advanced industrial economies (United States and Canada) with that of a sizable developing nation (Mexico). The huge living standard gap between Mexico, with its lower wage scale, and the United States and Canada was a politically sensitive issue. One of the main concerns about NAFTA was whether Canada and the United States as developed countries had much to gain from trade liberalization with Mexico. Unstated goals of Nafta: compete with EU, MERSOCUR and minimize illegal immigration from Mexico.

Economic Costs and Benefits of a Common Currency: The European Monetary Union

The euro helps lower the costs of goods and services, facilitates a comparison of prices within the EU, and promotes more uniform prices. Disadvantages: Absence of individual domestic monetary policy to counter macroeconomic shocks. Inability of an individual country to use inflation to reduce public debt in real terms. The transition from individual currencies to a single currency could lead to speculative attacks.

Is the European Union Really a Common Market?

The original concept of the EU was a common market based on uniform regulations. By producing for a single market throughout Europe, firms could attain production runs large enough to realize substantial economies of scale. Instead, persistent national differences have burdened firms with extra costs that stifle plant expansion and job creation.Persistent regulatory differences between markets have adversely affected business expansion plans throughout Europe

Monetary Union

The unification of national monetary policies and the acceptance of a common currency administered by a supranational monetary authority. The United States serves as an example of a monetary union. Fifty states are linked together in a complete monetary union with a common currency

Static Effects of Regional Trading Agreements: Trade Creation Effect

Trade creation occurs when a domestic production of one customs union member is replaced by another member's lower cost imports. The welfare of the member countries is increased by trade creation because it leads to increased production specialization according to the principle of comparative advantage. The trade creation effect consists of a consumption effect and a production effect. The formation of the customs union also yields a production effect resulting in a more efficient use of world resources. Eliminating the tariff barrier against Germany means that Luxembourg's producers must now compete against lower cost, more efficient German producers. Inefficient domestic producers drop out of the market, resulting in a decline in home output of three bushels. The reduction in the cost of obtaining this output equals triangle a in the figure. This triangle represents the favorable production effect. The overall trade creation effect is given by the sum of triangles a + b. Two outside agains represent POSITIVE

Trade Diversion Effect

Trade diversion occurs when imports from a low-cost supplier outside the union are replaced by purchases from a higher cost supplier within the union. This diversion suggests that world production is reorganized less efficiently. success of a customs union depends on the factors contributing to trade creation and diversion

BREXIT

U.K. voted 51.9% to 48.1% to leave the EU on June 23, 2016 Terms of exit must be agreed to by 27 other nations, some of whom may hold referenda; could take many years "Hard" Brexit vs. "soft" Brexit - access to EU market, allowing free movement of people, etc. Effects so far: British £ down ~15% since June 2016, and inflation up (2.3%), but - growth rate ~1.8% in 2016, and unemployment at 11-year low (4.8%). Future effects?

Example: U.S.-Mexico Trucking Dispute

U.S. government introduced 22 additional safety requirements that Mexican trucks would have to meet if they eventually received authority to travel throughout the United States. This measure went beyond the requirements that were applied to U.S. and Canadian trucks operating in the United States. Mexico responded by protesting the trucking restrictions to a NAFTA arbitration panel that ruled that the United States was in violation of its NAFTA obligations. The result was an agreement in 2007 that established a pilot program that allowed a limited number of Mexican cargo trucks to travel throughout the United States under rigid safety regulations.Mexico retaliated by releasing a list of 99 U.S. products that would face tariffs of 10 to 45 percent. A deal was agreed on. Under the deal, Mexico agreed to end its tariffs applied to U.S. goods, and in return, its trucks were allowed to travel throughout the United States. Stringent regulations were placed on Mexican trucks and drivers entering the United States.

Variable Levy

Under a variable levy system, the levy is determined daily and equals the difference between the lowest price on the world market and the support price. The variable import levy tends to be more restrictive than a fixed tariff. It discourages foreign producers from absorbing part of the tariff and cutting prices to maintain export sales. Cutting prices only triggers higher variable levies. For the same reason, variable levies discourage foreign producers from subsidizing their exports in order to penetrate domestic markets.

Regional Trading Agreement

Under this system, member nations agree to impose lower barriers to trade within the group than to trade with nonmember nations. Each member nation continues to determine its domestic policies, but the trade policy of each includes preferential treatment for group members. It's discriminatory to other nations not in the agreement but it is allowed under Article 24

Economic Union

Where national, social, taxation, and fiscal policies are harmonized and administered by a supranational institution. The ultimate degree of economic union would be the unification of national monetary policies and the acceptance of a common currency administered by a supranational monetary authority. The economic union would thus include the dimension of a monetary union. Example: EU

US winners and losers when NAFTA enacted with Mexico

Winners: Higher skill, higher tech businesses and their workers benefit from free trade. Labor-intensive businesses that relocate to Mexico benefit by reducing production costs.Domestic businesses that use imports as components in the production process save on production costs.Consumers in the United States benefit from less expensive products because of increased competition with free trade. Losers: Labor-intensive, lower wage, import-competing businesses lose from reduced tariffs on competing imports. Workers in import-competing businesses lose if their businesses close or relocate.

Eurozone's Problems and Challenges

some countries (such as Greece) did not appear to fulfill these standards when they were accepted into the monetary union. These standards were sometimes ignored once countries became members of the monetary union. integration of differing economies into a monetary union without a way to adjust these economies. An important monetary policy challenge for the EMU is the ability of the European Central Bank to focus on price stability over the long term. Some are concerned that over time, monetary policy may become too expansionary given the large number of countries voting on monetary policy and the fact that strong anti-inflationary actions are not well ingrained in countries like Greece, Portugal, Spain, Italy, and Cyprus. Labor market flexibility is an important structural issue.