978-0134129945 Chapter 3 Lecture Note Part 1

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CHAPTER 3

THE GLOBAL TRADE ENVIRONMENT

SUMMARY

A. This chapter examines the environment for world trade, focusing on the institutions and

regional cooperation agreements that affect trade patterns.

B. The multilateral World Trade Organization, created in 1995 as the successor to the

General Agreement on Tariffs and Trade, provides a forum for settling disputes among

member nations and tries to set policy for world trade.

C. The world trade environment is also characterized by preferential trade agreements

among smaller numbers of countries on a regional and subregional basis. These

agreements can be conceptualized on a continuum of increasing economic integration.

D. Free trade areas such as the one created by the North American Free Trade

Agreement (NAFTA) represent the lowest level of economic integration.

E. The purpose of a free trade agreement is to eliminate tariffs and quotas. Rules of origin

are used to verify the country from which goods are shipped. A customs union, such as

Mercosur, represents a further degree of integration in the form of common external

tariffs.

F. In a common market such as Central American Integration System (SICA), restrictions

on the movement of labor and capital are eased in an effort to further increase integration.

G. An economic union, such as the European Union (EU), the highest level of economic

integration is achieved by unification of economic policies and institutions.

Harmonization, the coming together of varying standards and regulations, is a key

characteristic of the EU.

H. Other important cooperation arrangements include the Association of Southeast Asian

Nations (ASEAN), the Cooperation Council for the Arab States of the Gulf (GCC). In

Africa, the two main cooperation agreements are the Economic Community of West

African States (ECOWAS) and the South African Development Community (SADC).

LEARNING OBJECTIVES

1 Explain the role of the World Trade Organization in facilitating global trade relations among

nations

2 Compare and contrast the four main categories of preferential trade agreements

3 Explain the trade relationship dynamics among signatories of NAFTA

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4 Identify the four main preferential trade agreements in Latin America and the key members of

each

5 Identify the main preferential trade agreement in the Asia-Pacific region

6 Describe the various forms of economic integration in Europe

7 Describe the activities of the key regional organizations in the Middle East

8 Identify the issues for global marketers wishing to expand in Africa

OVERVIEW

Global trade talks have been taking on a distinctly bicoastal character lately. Looking east and

west across the Pacific Ocean, the United States and several Asian countries are hammering out

the details of a trade framework known as the Trans-Pacific Partnership (TPP).

The goal is an ambitious one: to create a free trade area that will lead to long-term economic

growth.

ANNOTATED LECTURE/OUTLINE

THE WORLD TRADE ORGANZIATION AND GATT

(Learning Objective #1)

The year 2017 marks the 70th anniversary of the General Agreement on Tariffs and Trade

(GATT), a treaty among nations whose governments agree, at least in principle, to promote trade

among members.

The General Agreement on Tariffs and Trade (GATT) was treaty among nations whose

governments agreed to promote trade among members.

GATT was intended to be a multilateral, global initiative which liberalized world trade and

handled 300 disputes over fifty years; however, GATT lacked enforcement power.

The successor to GATT, the World Trade Organization (WTO), born on January 1, 1995,

provides a forum for trade-related negotiations among its 160 members and mediates trade

disputes.

The Dispute Settlement Body (DSB) mediates complaints concerning unfair trade barriers;

during a 60-day consultation period, parties engage in good-faith negotiations (see Table 3 -1).

Failing that, the DSB convenes a panel and acts on the panel’s recommendations; if after due

process, the losing party violates WTO rules, the WTO can impose trade sanctions.

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WTO trade ministers meet annually to work on improving world trade, but politicians in many

countries resist the WTO’s plans to move swiftly in removing trade barriers.

The current round of WTO negotiations began in 2001; the talks collapsed in 2005, and attempts

to revive them in the years since have not been successful. That is one reason why the

Transatlantic Trade and Investment Partnership (TTIP) and the Trans-Pacific Partnership (TPP)

negotiations are moving ahead.

PREFERENTIAL TRADE AGREEMENTS

(Learning Objective #2)

The WTO promotes free trade on a global basis; in addition, countries in each of the world’s

regions are seeking to liberalize trade within their regions.

A preferential trade agreement is a mechanism that confers special treatment on select trading

partners. By favoring certain countries, such agreements frequently discriminate against others.

Free Trade Area

A free trade area (FTA) is formed when two or more countries agree to eliminate tariffs and

other barriers that restrict trade.

A free trade area comes into being when trading partners successfully negotiate a free trade

agreement (also abbreviated FTA), the ultimate goal of which is zero duties on goods that cross

borders between the partners.

Rules of origin are used to discourage the importation of goods into the member country with

the lowest external tariff for transshipment to one or more FTA members with higher external

tariffs.

To date, more than 300 free trade agreements have been negotiated globally.

Customs Unions

A customs union represents the logical evolution of a free trade area.

In addition to eliminating internal barriers to trade, members of a customs union agree to the

establishment of common external tariffs (CETs).

Some of the customs unions discussed in this chapter are the Andean Community, the Central

American Integration System (SICA), Mercosur, and CARICOM.

Common Market

A common market is the next level of economic integration.

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In addition to the removal of internal barriers to trade and the establishment of common external

tariffs, the common market allows for free movement of factors of production, including labor

and capital.

Economic Union

An economic union builds upon the elimination of the internal tariff barriers, the establishment

of common external barriers, and the free flow of factors. It seeks to coordinate and harmonize

economic and social policies within the union to facilitate the free flow of capital, labor, goods,

and services from country to country.

The full evolution of an economic union would involve the creation of a unified central bank, the

use of a single currency, and common policies on agriculture, social services and welfare,

regional development, transport, taxation, competition, and mergers.

A true economic union requires extensive political unity, which makes it similar to a nation. The

further integration of nations that were members of fully developed economic unions would be

the formation of a central government that would bring together independent political states into

a single political framework.

The European Union is approaching its target of completing most of the steps required to become

a full economic union.

NORTH AMERICA

(Learning Objective #3)

North America, which includes Canada, the United States, and Mexico, comprises a distinctive

regional market.

The U.S. has more industry leaders than any other nation, dominating the computer, software,

aerospace, entertainment, medical equipment, and jet engine industry sectors.

The U.S.-Canada Free Trade Area (CFTA) came into existence in 1989, resulting in over $650

billion per year trade between the two countries.

Canada is the number one trading partner of the U.S.; China is second, and Mexico ranks third.

American companies have more invested in Canada than in any other country.

The North American Free Trade Agreement (NAFTA) became effective in 1994; the result is

a free trade area with a combined population of 470 million and a total GNP of almost $20

trillion (see Figure 3-3).

The governments of all three nations pledge to promote economic growth through tariff

elimination and expanded trade and investment. At present, however, there are no common

external tariffs nor have restrictions on labor and other factor movements been eliminated.

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Illegal immigration from Mexico remains a contentious issue.

NAFTA allows for discretionary protectionism (e.g., California avocado growers won protection,

allowing Mexican avocados into the U.S. during the winter only in the northeast at a quota).

LATIN AMERICA: SICA, Andean Community,

Mercosur, and CARICOM

(Learning Objective #4)

Latin America includes the Caribbean and Central and South America; the market is sizeable, has

a huge resource base, and Latin America has begun economic transformation.

Balanced budgets are a priority, and privatization is underway. Free markets, open economies,

and deregulation are replacing past policies; tariffs are now reduced to 10 to 20 percent.

The Secretariat for Central American Economic Integration, headquartered in Guatemala City,

helps to coordinate the progress toward a true Central American common market. Common rules

of origin were also adopted, allowing for more free movement of goods among SICA countries.

SICA countries agreed to conform to a CET of 5 to 20 percent for most goods by the mid-1990s;

many tariffs had previously exceeded 100 percent. Starting in 2000, import duties converged to a

range of 0 to 15 percent.

Implementation of the Central American Free Trade Agreement with the United States created a

free trade area known as DR-CAFTA that includes five SICA members (El Salvador, Honduras,

Guatemala, Nicaragua, and Costa Rica; Panama is excluded) plus the Dominican Republic.

Implementation has been slow, but some changes have already taken effect.

Companies in Central America operated in the “shadow economy,” with many commercial

transactions going unreported. Government tax revenues should increase as companies join the

formal economy to take advantage of CAFTA’s benefits.

One of the most exciting projects in the region is the enlargement of the Panama Canal. A new

generation of mega-sized cargo freighters will be able to pass through the Canal. Port

improvements are also underway on the east coast of the United States as Miami and other cities

get ready to handle more and bigger ships (see Exhibit 3-4).

Andean Community

The Andean Community was formed in 1969 to accelerate development of member states

through economic and social integration. (Figure 3-5).

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The member countries of the Andean Community are:

Bolivia

Colombia

Ecuador

Peru

Members lowered tariffs on intra-group trade and decided what products each country should

produce. Foreign goods and companies were kept out as much as possible.

Common external tariffs have been established, marking the transition to a true customs union.

Competing ideologies help explain why intraregional trade is not yielding more benefits; Peru

and Colombia are pursuing growth via capitalism, whereas the governments in Ecuador and

Bolivia have socialist leanings. Venezuela is currently in the process of becoming a full member

of Mercosur.

Common Market of the South (Mercosur)

March 2016 marked the 25th anniversary of the signing of the Asunción Treaty.

The treaty signified the agreement by the governments of (see Figure 3 -5):

Argentina

Brazil

Paraguay

Uruguay

to form the Common Market of the South (Mercosur)

Internal tariffs were eliminated, and common external tariffs of up to 20 percent were

established; in theory goods, services, and factors of production will move freely.

Until this goal is achieved, Mercosur will operate as a customs union.

Argentina provides a case study in how a country can emerge from an economic crisis as a

stronger global competitor. Argentina’s economy minister responded to the financial crisis of

2001–2002 by implementing emergency measures that included a 29 percent currency

devaluation for exports and capital transactions.

Argentina was allowed to break from the CET and raise duties on consumer goods. The crisis

had a silver lining: virtually overnight, Argentina’s wine exports to the United States were worth

four times more when dollar revenues were converted into pesos.

The currency devaluation also made Argentine vineyard property cheaper for foreign buyers.

Low prices for land, inexpensive labor, and ideal growing conditions for the Malbec grape have

combined to make Argentina’s wine industry a major player in world markets.

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The trade agreement landscape in the region continues to evolve. In 1996, Chile became an

associate member of Mercosur. Policymakers opted against full membership because Chile

already had lower external tariffs than the rest of Mercosur; ironically, full membership would

have required raising them. (In other words, Chile participates in the free trade area aspect of

Mercosur, not the customs union.) Chile’s export-driven success makes it a role model for the

rest of Latin America as well as Central and Eastern Europe.

In 2004, Mercosur signed a cooperation agreement with the Andean Community; as a result,

Bolivia, Colombia, Ecuador, and Peru have become associate members. The EU is Mercosur’s

number one trading partner; Mercosur is negotiating an agreement with the EU to establish a free

trade area. Germany and France are opposed to such an agreement on the grounds that low-cost

agricultural exports from South America will harm farmers in Europe.

Venezuela began the process of joining Mercosur in 2006, the same year that it withdrew from

the Andean Community. For several years, Venezuela reaped the rewards of booming demand

and high prices for oil; oil revenues account for 75 percent of its exports.

Emerging Markets Briefing Book

Brazil

As the data in Figure 3-5 clearly show, Brazil is an economic powerhouse in South America.

Brazil has the largest geographical territory and the largest population in the region. It has

emerged on the world stage as a strong exporter. Rapid economic growth has given

policymakers, including President Dilma Rousseff, a greater presence on the global stage and

more clout at global trade talks.

One symbol of Brazil’s new role in the global economy is Embraer, a jet aircraft manufacturer

(see Exhibit 3-4), Embraer has also established a $50 million joint venture with China Aviation

Industry Corporation. Brazil’s agricultural sector is also a leading exporter. Brazil is the world’s

number-one exporter of beef, coffee, orange juice (check the label on your orange juice carton),

and sugar. Annual coffee bean production totals 40 million 60-kilo bags—one-third of the world

total. JBS is the world’s largest meat processor. Brazil is rapidly gaining a reputation as a

producer of sugar-based ethanol, which can serve as a sustainable substitute for expensive

gasoline.

Moving forward, Brazil faces a number of other challenges. Steady appreciation of Brazil’s

currency, the real, may require exporters to raise prices. Embraer faces tough competition from

Canada’s Bombardier.

The country’s infrastructure remains woefully underdeveloped; significant investment is required

to improve highways, railroads, and ports. Businesspeople speak of “the Brazil cost,” a phrase

that refers to delays related to excessive red tape. Trade with China is presenting both

opportunities and threats. In 2009, China surpassed the United States as Brazil’s top trading

partner. China’s explosive economic growth has created great demand for soybeans, iron ore, and

other Brazilian commodity exports. However, Brazilian manufacturers in light-industry sectors

such as toys, eyeglasses, and footwear are facing increased competition from low-priced Chinese

imports.

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Caribbean Community and Common Market (CARICOM)

CARICOM was formed in 1973 with the following member states:

Antigua and Barbuda

Bahamas

Barbados

Belize

Dominica

Grenada

Guyana

Haiti

Jamaica

Montserrat

St. Kitts and Nevis

St. Lucia

St. Vincent and the Grenadines

Suriname

Trinidad and Tobago

The population of the entire 15-member CARICOM is about 17 million (see Figure 3-6).

To date, CARICOM’s main objective has been to achieve a deepening of economic integration

by means of a Caribbean common market. However, CARICOM was largely stagnant during its

first two decades of existence.

In 1998, leaders agreed to move quickly to establish an economic union with a common

currency. A recent study of the issue has suggested, however, that the limited extent of intra-

regional trade would limit the potential gains from lower transaction costs.

English-speaking CARICOM members are concerned with defending their privileged position

with the U.S.

As of 2000, the Caribbean Basin Trade Partnership Act exempts textile and apparel exports from

the Caribbean to the U.S. from duties and tariffs (Figure 3-6).

Current Trade-Related Issues

One of the biggest trade-related issues in the Western Hemisphere is the Free Trade Area of the

Americas. Many Latin American countries—Brazil in particular—are frustrated by Washington’s

tendency to dictate trade terms that will benefit special interests in the United States.

As a result, Brazil and its Mercosur partners are advocating a slower, three-stage approach to

negotiations with the United States.

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First Stage – discussions on business facilitation issues such as standardized customs

forms and industry deregulation

Second Stage – dispute settlement and rule of origin

Third Stage – tariffs

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