Question

Define the concept of trade creation and trade diversion with respect to regional economic integration. Given that, integration can both create and divert trade, under what circumstances will regional integration be in the best interest of the world economy? b) In what ways could regional trade blocks serve as either a building block or stumbling block (i.e., an obstacle) to those agreements envisioned by multilateral agreements sponsored by the WTO?

Answer 1

Regional economic integration can rage from preferential trade agreements to Economic Unions. And essential part of regional economic integration is reduction in barriers to trade across participating countries.

Trade creation occurs when on account of lowering of tariff, there is increase in trade with countries that now become a part of regional economic integration. It is important for trade creation that direction of trade does not change upon formation of regional economic integration.

Trade diversion occurs when a country starts to trade with a country with higher production costs and terminates trade with a country with lower production cost just becuase the higher production cost country now becomes part of economic bloc.

Economic integration woll be most suitable for global economy when:

1. Size of economic bloc is large and it covers significant part of world economy.

2. The economies participating in economic integration be competitive rather than complementary

3. Economic integration is brought about by including countries which already have large trade among themselves.

4. The tariff with rest of the world are not increased or are reduced.

B: WTO aims at increasing global trade by nudding countries to collectively reduce trade barriers. Regional trade blocks also aim at same but at local level. Regional trading blocks can be building blocks for global trade when:

1. Regional trade agreements cover a large number of economies.

2. They are open to inducting more members

3. They do not dicriminate against non-members

Regional trade blocks can be stumbling blocks if:

1. They resist expansion of regional blocks

2. Countries not part of regional blocks are discriminated against them in trading with members of blocks. This prevents such non-member countries to resist opening up of their economies for global trade.