Trade diversion

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Trade diversion is an economic term related to international economics in which trade is diverted from a more efficient exporter towards a less efficient one by the formation of a free trade agreement or a customs union. Total cost of good becomes cheaper when trading within the agreement because of the low tariff. This is as compared to trading with countries outside the agreement with lower cost goods but higher tariff. The related term Trade creation is when the formation of a trade agreement between countries decreases the price of the goods for more consumers, and therefore increases overall trade. In this case the more efficient producer with the agreement increases trade. [1]

Contents

The terms were used by 'old' Chicago School economist Jacob Viner in his 1950 paper The Customs Union Issue. [2]

Notable uses

An early use of the terms was by Jacob Viner in his 1950 paper The Customs Union Issue. [1] [3] Later in same decade Richard Lipsey noted that not only the location of production but also the location of consumption of goods would be effected by trade agreements. [4]

Béla Balassa discussed the concepts in relation to the European Common Market in his paper 1967 Trade Creation and Trade Diversion in the European Common Market. [5]

In 2013, Paul Oslington's Contextual History, Practitioner History, and Classic Status: Reading Jacob Viner's The Customs Union Issue reviewed revisited Viner's original paper. [3]

Occurrence

When a country applies the same tariff to all nations, it will always import from the most efficient producer, since the more efficient nation will provide the goods at a lower price. With the establishment of a bilateral or regional free trade agreement, that may not be the case. If the agreement is signed with a less-efficient nation, it may well be that their products become cheaper in the importing market than those from the more-efficient nation, since there are taxes for only one of them. Consequently, after the establishment of the agreement, the importing country would acquire products from a higher-cost producer, instead of the low-cost producer from which it was importing until then. In other words, this would cause a trade diversion. [6]

Term

The term was coined by Jacob Viner in The Customs Union Issue in 1950. [7] In its literal meaning the term was however incomplete, as it failed to capture all welfare effects of discriminatory tariff liberalization, and it was not useful when it came to non-tariff barriers. Economists have however dealt with this incompleteness in two ways. Either they stretched the original meaning to cover all welfare effects, or they introduced new terms like trade expansion or internal versus external trade creation.[ citation needed ]

Viner's article became and still is the foundation of the theory of international economic integration. It considered only two states comparing their trade flows with the rest of the world after they abolish customs tariffs on inner border of their union. Following the fact that economic unions most often include more than 2 states, attempts have been made to increase the number of the states (3+world), but not so successfully, as they did not have as clear conclusions as Viner's.[ citation needed ]

Opposite to economically efficient trade creation effect, the trade diversion flow is cost-inefficient compared with the rest of the world. Balance between trade creation and trade diversion effects due to the creation of economic union makes the union either economically efficient (positive balance) or inefficient (negative balance). It is based on the fact that unification of states usually applies mergers of more than 1 sector in economy (even European Coal and Steel Union, which had 2 sectors only) leading to the creation of either trade creation or diversion effects. [6]

Positive effects of trade diversion include increase of trade between unified states, increase of employment in manufacturing states inside the union consequently leading to increase of respective taxes and welfare.

Downside

Diverted trade may hurt the non-member nation economically and politically, and create a strained relationship between the two nations. The decreased output of the good or service traded from one nation with a high comparative advantage to a nation of lower comparative advantage works against creating more efficiency and therefore against more overall surplus. It is widely believed by economists that trade diversion is harmful to consumers. The dynamics of trade diversion was described by Ravshanbek Dalimov in 2009. He used similarity of trade flows to the flux of gas or liquid stimulated by the pressure difference, while the flows of trade flows are stimulated by the price difference. [8] This allowed use of Navier-Stokes equations for the interregional dynamics of trade flows. [6]

See also

Related Research Articles

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A customs union is generally defined as a type of trade bloc which is composed of a free trade area with a common external tariff.

<span class="mw-page-title-main">Free trade area</span> Regional trade agreement

A free trade area is the region encompassing a trade bloc whose member countries have signed a free trade agreement (FTA). Such agreements involve cooperation between at least two countries to reduce trade barriers, import quotas and tariffs, and to increase trade of goods and services with each other. If natural persons are also free to move between the countries, in addition to a free trade agreement, it would also be considered an open border. It can be considered the second stage of economic integration.

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<span class="mw-page-title-main">Free trade</span> Absence of government restriction on international trade

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<span class="mw-page-title-main">ASEAN Free Trade Area</span> Free trade area of the Association of South East Asian Nations

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<span class="mw-page-title-main">Non-tariff barriers to trade</span> Type of trade barriers

Non-tariff barriers to trade are trade barriers that restrict imports or exports of goods or services through mechanisms other than the simple imposition of tariffs.

<span class="mw-page-title-main">Australia–United States Free Trade Agreement</span> Preferential trade agreement

The Australia – United States Free Trade Agreement (AUSFTA) is a preferential trade agreement between Australia and the United States modelled on the North American Free Trade Agreement (NAFTA). The AUSFTA was signed on 18 May 2004 and came into effect on 1 January 2005.

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<span class="mw-page-title-main">European Union–Turkey Customs Union</span> Customs union between Turkey and European Union

The European Union–Turkey Customs Union is a trade agreement between the European Union (EU) and Turkey. The agreement came into effect on 31 December 1995, following a 6 March 1995 Decision of the European Community–Turkey Association Council to implement a customs union between the two parties. Goods may travel between the two entities without any customs restrictions. The Customs Union does not cover essential economic areas such as agriculture, services or public procurement.

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<span class="mw-page-title-main">Trade creation</span> Economic effect of customs unions

Trade creation is an economic term related to international economics in which trade flows are redirected due to the formation of a free trade area or a customs union. The issue was firstly brought into discussion by Jacob Viner (1950), together with the trade diversion effect.

A common external tariff(CET) must be introduced when a group of countries forms a customs union. The same customs duties, import quotas, preferences or other non-tariff barriers to trade apply to all goods entering the area, regardless of which country within the area they are entering. It is designed to end re-exportation; but it may also inhibit imports from countries outside the customs union and thereby diminish consumer choice and support protectionism of industries based within the customs union. The common external tariff is a mild form of economic union but may lead to further types of economic integration. In addition to having the same customs duties, the countries may have other common trade policies, such as having the same quotas, preferences or other non-tariff trade regulations apply to all goods entering the area, regardless of which country, within the area, they are entering.

<span class="mw-page-title-main">Economic integration</span> Unification of policies between states

Economic integration is the unification of economic policies between different states, through the partial or full abolition of tariff and non-tariff restrictions on trade.

A free-trade agreement (FTA) or treaty is an agreement according to international law to form a free-trade area between the cooperating states. There are two types of trade agreements: bilateral and multilateral. Bilateral trade agreements occur when two countries agree to loosen trade restrictions between the two of them, generally to expand business opportunities. Multilateral trade agreements are agreements among three or more countries, and are the most difficult to negotiate and agree.

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Economic integration involves at least two countries to abolish customs tariffs on inner border between the states. This causes a number of effects, while the phenomenon itself has specific properties for its successful development.

<span class="mw-page-title-main">Commercial policy</span>

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Australian governments, both those of the colonies after the introduction of responsible government in the 1850s and the national government since federation in 1901, have had the power to fix and change tariff rates. This power resides in the respective legislatures, with tariffs, being a tax law, is required to originate in the lower house of the legislature.

References

  1. 1 2 "Trade creation". Economics Online. Retrieved 9 December 2017.
  2. ↑ Viner, Jacob (2014). The customs union issue. Oslington, Paul. Oxford University Press, USA. ISBN   978-1306290920. OCLC   867818657.
  3. 1 2 Oslington, Paul (2013). "Contextual History, Practitioner History, and Classic Status: Reading Jacob Viner's The Customs Union Issue". Journal of the History of Economic Thought. 35 (4): 491–515. doi:10.1017/S1053837213000308. S2CID   154530653.
  4. ↑ Lipsey, Richard G. (1957). "The Theory of Customs Unions: Trade Diversion and Welfare". Economica. 24 (93): 40–46. doi:10.2307/2551626. JSTOR   2551626.
  5. ↑ Balassa, Bela (1967). "Trade Creation and Trade Diversion in the European Common Market". The Economic Journal. 77 (305): 1–21. doi:10.2307/2229344. JSTOR   2229344.
  6. 1 2 3 Preferential Trade Agreement Policies for Development. The World Bank. Jean-Pierre Chauffour and Jean-Christophe Maur, Editors. (2011) 536 pag. ISBN   9780821386439
  7. ↑ Viner, Jacob (1950). The Customs Union Issue. Studies in the administration of international law and organisation. Vol. 10. London: Stevens. OCLC   470257202.
  8. ↑ Ravshanbek Dalimov. Dynamics of international economic integration: Non-linear analysis. (2010) 276 pag. ISBN   3838380975, ISBN   978-3838380971
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