Why does trade deflection occur

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Summary Proceedings. IMF Research Bulletin. IMF Research Perspectives. Advanced search Help. Browse Topics Business and Economics. Archived Series. Previous Chapter Next Chapter. Download PDF 1. Abstract Full Text Related Publications. Effects on a Developing Country of Joining a Free Trade Area A developing country joining an FTA can expect to have its present degree of liberalization locked in, with future governments having little ability to influence further change.

Table 1. Effects of Three Kinds of Liberalization. Vinerian Trade Diversion Suppose the LAC has a given tariff of 30 percent on all imports of a particular product to start with. Trade Contraction: Increase of Protection Against Imports from Outside Trade contraction occurs if the level of the external tariff is actually raised as a result of the establishment of the FTA. Extent of Gain from Reciprocity Effect The extent of the gain to the LAC depends not just on the level of existing barriers to its exports in the United States but on what these barriers might have been in the future if no FTA were established.

Multilateral Trade Liberalization and Regionalism In my view, multilateral free trade—or at least substantial worldwide liberalization supported by strong rules—is preferable to regional arrangements. How Regionalism Might Affect Multilateralism Regionalism can be seen as a supplement to multilateralism, as an alternative or as a path toward it.

Multilateralism and Regionalism Compared Consider now the interests of a particular developing country LAC and compare the effects of multilateral liberalization with regional liberalization an FTA with the United States being formed. Note: Copyright: Institute for International Economics, All rights reserved.

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Let us assume that, in order to protect its inefficient farmers equally, the UK imposes differential tariffs on New Zealand and Denmark in order to raise the imported price above its own high cost butter. We will also assume that, with these tariffs in place, a total demand of 30m kg of butter exists in the UK each year, with UK farmers supplying 20m kg the maximum it can produce , and New Zealand and Danish farmers supply 5m kg each.

Once a union is created, members agree to eliminate tariffs between themselves. The effect of this is that, facing lower priced, zero-tariff, imports from members, consumers increase their demand for these goods, and new trade will be created — a process called trade creation.

For example, if Denmark and the UK form a customs union, tariffs on Danish butter must now be reduced, and once they are completely removed, the free market price of p will be highly attractive to UK consumers. UK consumers will now consume more butter in total because average butter prices will have fallen with the removal of tariffs on Danish butter, and total demand for butter rises. For example, total output and consumption might increase to 32m kgs up by 2m , with UK farmers down from 20m to 15m, New Zealand exports collapsing to just 2m, and Denmark increasing its output and sales of butter to the UK to 10m from 5m to 10m.

The additional 2m kgs of butter produced and consumed is the new trade created as a result of the removal of barriers by union members. Furthermore, this will enable a dynamic reaction within Denmark and the UK. Over time, as countries Denmark and the UK become more integrated, increased trade will generate further efficiency gains, such as through the application of economies of scale. Prices may fall even further, relative to those of non-member countries, and the process of trade creation continues.

For example, with increased sales, Denmark can specialise further in butter production, and produce on large scale, bringing prices down even further perhaps nearer to the New Zealand level. Also, the UK can now free up its resources, and move them out of butter production and into goods and services for which the UK has a comparative advantages over Denmark. Hence, over time, trade creation will continue as a positive long-term effect of a customs union.

The major loser in this is the previous trading partner left outside the bloc — less trade now exists between new members and their old trading partners. The process of efficient producers losing out to inefficient ones is generally referred to as trade diversion.

For example, after Denmark and the UK form a customs union, New Zealand, which was the most efficient butter producer, suffers a loss of sales to the UK, from 5m to 2m, with trade diverted from New Zealand to Denmark.

However, there is some debate about the use of the term trade diversion. In its simplest form it means any trade diverted away from efficient global producers as a result of the creation of a customs union.

Kennedy, P. Konings, J. Pierce, J. Journal of International Economics 85 2 — Prusa, T. Tovar, B. Javier Ramos-Real, and E. De Almeida. Evidence from the Electricity Distribution Industry in Brazil.

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