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Students Zone - Answers to End of Chapter Questions

CHAPTER 4: ECONOMIC INTEGRATION

1. Assume that Austria, Hungary and Turkey all produce refrigerators and the domestic price per refrigerator in Austria is £600, in Hungary £500, and in Turkey £360.

a) Suppose Austria imposes a 100% tariff on refrigerators. What are the trading options open for Austria?

b) If Austria then formed a CU with Hungary with a common external tariff of 100% how would Austria's options change?

c) How would you describe the situation in (b)?

d) If the tariff rate in Austria in (a) were 50 per cent instead of 100 per cent how different would your answers to (a), (b), and(c) be?

Turkey is in a CU arrangement with Germany but not with Iran. Why would such a CU be better economically for Turkey?

3. Using the example in Table 5.2 explain the likely impact of trade creation and trade diversion on the French, German and Japanese businesses.

4. Which business sectors of which economies would have lost out most by UK’s membership of the EC in 1973?

Answer

It was always felt that Commonwealth countries were most likely to lose out by the UK joining the EC. In particular it was suggested that Australia and New Zealand – who had a substantial part their trade with the UK – would suffer. The agricultural sector in particular was seen as being the worst hit as these had a substantial part of their exports going to the UK.

5 . How would you account for the relatively poor economic performance in Western Europe in the 1970s and 1980s? In what ways might the revival of European integration help this performance?

Answer

There are lots of reasons for the growth – too many to go into here. But relevant to this particular chapter would be the concept of Eurosclerosis – is the name given to the weak growth of the EU in the 1970s/80s. Much of the blame for this was placed on the European Social Model which protected labour markets and reduced flexibility especially when compared to the US more market based model (and the faster growth in the US in the period). It has been suggested that the greater integration – single currency and enlargement – has counter the Eurosclerosis by opening up markets and increasing the labour market but others are less optimistic (see The Economist (2003) “A Franco German Beauty Contest”, 16th October)

6 . Do you think US businesses would view NAFTA as a success? Would Canadian and Mexican businesses think likewise? Why or why not?

Answer

Generally NAFTA has made it much easier to do business by removing tariffs from internal trade.

US business view – US firms have gained through lower labour costs and greater funds for new technology. It has also released US labour to train for higher skilled jobs. One of the fears was a loss of jobs from the US to Mexico but Hufbauer and Schott have pointed out that between 1994 and 2000 the US gained more than 2m jobs a year. Manufacturing jobs did fall but other areas more than made up for the fall. Also they suggest that most of the new jobs have been at higher than average wages (in The Economist 2004a).

There were also fears from the environmentalists that if production moved to Mexico with its lower environmental standards and enforcement, then US firms could do more damage to environment. There has been no conclusive evidence of this, although it is often said that if you go over the border just breathing the area proves it! (The Economist 2004a). However on positive side, what there has been is increased cooperation in this area and the environmental laws have been improved.

Canadian View – Canadian businesses have seen trade within the region expand dramatically; in 1990 US exports to Mexico and Canada represented approximately 25 percent of its trade, now it is more like 33 per cent.

Furthermore Canadian unemployment fell over the period but its main fear was that its social welfare model (with generous minimum wage for example) would be threatened. However despite some reductions in public spending, this has not happened (The Economist 2004a).

Mexican View - It is difficult to disentangle the effect of NAFTA from the effect of the Tequila crisis of 1994-5. The effect was a collapse of the financial system and the government was forced to bail out the weakened banks at huge cost. The system has still not recovered and the lower level of credit and financial services have affected the domestic economy considerably. On the positive side, Mexico has recovered from the crises more quickly than the previous crisis in 1982 and 1986. Also Mexico was less affected by the recent Brazilian and Argentinean crises that it probably would have been pre-NAFTA.

As to Mexican trade, this has increased, especially with the US with which it has had a trade surplus throughout its NAFTA membership. Data - US exports to Mexico doubled between 1993-2001 to $91bn but also imports from Mexico have tripled to $131bn. Given that US trade outside NAFTA has also grown strongly, it suggests most of this switch has been in the form of trade creation rather than diversion (Husted and Melvin 2004)

FDI has also increased and jobs in the export businesses have tended to pay more than in the rest of the (The Economist 2004a)

Mexico also still has problems with poor education, bureaucracy, poor infrastructure, lack of credit, corruption and weak tax base, which have perhaps stopped Mexico from gaining as much as it could have from NAFTA (The Economist 2004a)

7. If Asian businesses were asked which has had the most effect on your business, ASEAN or APEC, which do you think they would choose and why?

ASEAN is smaller but is a closer-knit economic community. It is also closer to a free trade area than APEC. It members are mainly Asian and geographically close therefore the scope for trading is greater.

But APEC is obviously much larger and gives greater scope for trade and investment opportunities. It is also a very useful pressure group and has potential for future growth.

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