Question

what is the main difference between trade creation and trade diversion, and did NAFTA served as a trade creation to mexico or trade diversion? discuss

Answer 1

Trade creation is something n which trade flows increase due to the formation of a free trade area or a customs union in which you exchange goods and services with other and trade diversions is something that trade is diverted from a more efficient exporter towards a less efficient one by the formation of a free trade.

Trade creation and diversion are important direct effects of the formation of a customs union. Trade creation will mean that consumption shifts from a high-cost producer to a low-cost producer and trade therefore expands. Trade diversion on the other hand means that trade shifts from a lower cost producer outside the union to a higher cost producer inside the union. This will not benefit consumers within the union as they are not getting access to cheaper international goods.

Trade creation occurs if there is increased trade among the three countries as a result of the lower trade barriers allowing cheaper goods (no tariffs) and making it easier for services to be provided (no jumping through hoops to get a work permit). Which is generally regarded as a good thing. Products from member countries will suddenly become much cheaper. Perhaps cheaper even than the Chinese whose goods are still being charged tariffs at the border.

Trade creation and diversion do not capture the totality of costs versus benefits of economic integration. There are other consequences of abolishing barriers, such as creating larger markets and therefore economies of scale, as well as greater competition that are not accounted for in the theory.

NAFTA has been trade creating in Mexico rather than trade diverting.