Chapter 9
Preferential Trade Arrangements
This chapter focuses on regional trade agreements. It begins with a treatment of the standard approach to
measuring the gains or losses from membership in a preferential trade arrangement. It then turns to an
in-depth discussion of the history and institutional details of NAFTA and the EU. The chapter closes with
a brief examination of the question of whether regionalism is a complement to or substitute for multilateral
trade liberalization.
Clearly, the subject material of this chapter is highly germane to a variety of ongoing real world issues. In
late 1994 and early 1995, many newspapers and news magazines published evaluations of the first year of
the NAFTA agreement. The Mexican devaluation of the peso in December 1994 and the subsequent
◼ Chapter Outline
Introduction
Preferential Trade Arrangements: Economic Analysis
North American Free Trade Agreement
Global Insights 9.1: Details of the NAFTA
Other U.S. Free Trade Area Agreements
European Union
The EU Government
The Single Market Initiative
Regionalism vs. Multilateralism
Global Insights 9.2: Other Preferential Trade Arrangements
Summary
Exercises
Chapter 9 Preferential Trade Arrangements 41
◼ Suggested Answers for the End-of-Chapter Exercises
1. What is the difference between free trade areas and customs unions? Provide examples of each.
Both types of arrangements eliminate barriers between the member countries. In a FTA, countries are
free to maintain their own individual barriers to other countries. In a CU, the members also agree to
erect a common barrier to nonmember countries.
2. Comment on the observation that the sign of a successful customs union is that world trade expands
after it is formed.
Suppose two countries, A and B, forming the customs union had the same external barriers (tariff)
3. Discuss the pros and cons of multilateral trade liberalization under the principle of unconditional
MFN status versus the formation of regional trade arrangements.
There is no disputing the desirability of nondiscrimination in trade policy. Uniformity in tariffs and
other trade policy measures promotes efficiency in world trading patterns. With their premise of
4. Why was the formation of NAFTA so controversial in the United States, but much less so in Canada?
5. Why was the formation of NAFTA so controversial in the United States, while the formation of the
Canada-U.S. FTA was little noticed by most Americans?
The main opposition to the formation of NAFTA came from those who feared that lowering barriers
to trade with Mexico would cause U.S. wages to fall and U.S. capital to relocate to Mexico to take
6. What conditions are likely to lead to a trade-diverting customs union? To a trade-creating customs
union?
There are a variety of factors that will lead to trade diversion following the formation of a CU. The
greater the number of countries in the agreement, the smaller the likelihood of significant trade
7. Why is trade diversion considered harmful and trade creation considered beneficial?
Trade diversion is considered bad because the discriminatory policies of the preferential trade
8. Consider the following data detailing the situation for Guatland before and after it forms a FTA with
Mexland:
Pre-FTA
Imports from Eurland: 100 million units
Imports from Mexland: 0 units
Post-FTA
Imports from Eurland: 0
Imports from Mexland: 270 million units
How much trade was diverted by this agreement? How much trade was created? Suppose that
Chapter 9 Preferential Trade Arrangements 43
Using Figure 9.1 to illustrate, Guatland’s gain or loss from the agreement is given by the amount