Trade Agreements, Trading Blocs and Globalisation
Countries can integrate their trade through agreements of increasing depth, from a free trade area and a customs union to a common (single) market and, deepest of all, a monetary union with a shared currency.
Before you start
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Method
- Identify and define the type of trade agreement or bloc described in the question, placing it on the ladder of economic integration from free trade area to monetary union.
- Explain trade creation: a bloc member switches from buying a good from a less efficient domestic producer to a more efficient partner within the bloc, raising overall efficiency and welfare.
- Explain trade diversion: a bloc member switches from buying a good from a more efficient producer outside the bloc to a less efficient producer inside the bloc, purely because of the common external tariff, reducing overall global efficiency.
- State that the net welfare effect of joining a bloc depends on whether trade creation or trade diversion dominates.
- Explain the drivers of globalisation: multilateral trade liberalisation (e.g. through the WTO), falling transport and communication costs, the spread of multinational corporations, and the growth of global supply chains.
- Identify winners from globalisation (consumers, through lower prices and more choice; export industries; workers in newly industrialising economies; shareholders of multinational firms) and losers (import-competing domestic industries and their workers, particularly lower-skilled workers in developed economies facing competition from lower-wage economies, and the environment, from increased trade-related transport and production).
- Evaluate by considering whether the gains and losses are evenly distributed within and between countries, whether short-run structural unemployment among displaced workers is offset by economy-wide gains over time, and whether deeper trade integration increases a country's vulnerability to economic shocks originating elsewhere.
Worked example
Before joining a customs union, Country X imports a good from the cheapest available world supplier at a world price of 20 pounds per unit. After joining the union, Country X must apply the union's common external tariff of 15% to any imports from outside the union, but can trade tariff-free with union partner Country Y, which produces the good at 21 pounds per unit. Determine which supplier Country X will now buy from, and state whether this represents trade creation or trade diversion.
- Calculate the tariff-inclusive price from the original (non-member) world supplier: 20 x 1.15 = 23 pounds per unit.
- Compare this with the tariff-free price from union partner Country Y: 21 pounds per unit.
- Since 21 pounds is lower than 23 pounds, Country X will now buy from Country Y within the union.
- Compare Country Y's price (21 pounds) with the original world price before any tariff (20 pounds): Country Y is actually less efficient (more expensive) than the original world supplier.
- Conclude: this is trade diversion, since Country X has switched from a more efficient world producer to a less efficient union partner purely because of the tariff structure created by joining the union, reducing global efficiency even though it increases trade within the bloc.
Practice questions
Try each question, then tap to reveal the answer.
Q1Define a customs union.Show answer
Answer: A group of countries that removes tariffs on trade between its members and applies a common external tariff on trade with non-members.
Q2How does a free trade area differ from a customs union?Show answer
Answer: In a free trade area, members remove tariffs between themselves but each sets its own tariffs on non-members; a customs union adds a common external tariff applied by all members.
Q3Define trade creation.Show answer
Answer: When joining a trading bloc causes a member to switch from a less efficient domestic producer to a more efficient producer within the bloc, raising overall efficiency.
Q4Define trade diversion.Show answer
Answer: When joining a trading bloc causes a member to switch from a more efficient producer outside the bloc to a less efficient producer inside the bloc, because of the common external tariff.
Q5What is the main role of the World Trade Organization (WTO)?Show answer
Answer: To set and enforce multilateral rules for international trade and to provide a forum for settling trade disputes between member countries.
Q6Give one example of a group of workers who might lose out from globalisation in a developed economy.Show answer
Answer: Lower-skilled workers in an import-competing industry that faces new competition from lower-wage economies.
Q7Explain in one sentence why deeper trade integration can increase a country's vulnerability to shocks.Show answer
Answer: Because a more open, interconnected economy is more exposed to a recession, financial crisis, or supply disruption originating in a trading partner or supplier country.
Exam-style questions
Written in the style of a A Level Economics exam paper, with a full mark scheme.
Distinguish between trade creation and trade diversion, using an example of each.
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Evaluate the extent to which globalisation benefits a developed economy such as the UK.
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See real A Level Economics past-paper questions, with official mark schemes →
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