What Are the Benefits of Trade Bloc Agreements?

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When countries form a trading bloc, they team up to benefit each others' economies. Trading blocs are groups of countries that give each other better trade deals than they do the rest of the world. The deal can range from lower tariffs to something as complex as the European Union (EU), in which the member countries function as a single common market.

TL;DR (Too Long; Didn't Read)

Trade blocs encourage manufacturers in different countries to compete with each other and increase efficiency, which translates to lower prices for consumers. But there are downsides too.

Trade and Tariffs

The idea of imposing a tariff on goods that cross national borders goes back centuries. Tariffs come in different varieties: import duties charge a tax on goods from other countries, for instance, while export duties levy a tax on things shipped out of the country.

Tariffs serve two primary purposes. One is to raise revenue for the government by collecting a tax on cross-border shipments. The other is to protect the nation's domestic industries, as taxing imports can make them expensive enough that consumers will buy domestic to save money.

Some tariffs do both. One of the first laws passed by the United States Congress was the Tariff Act of 1789, which protected American industry but also raised a lot of money for the federal government.

The Hanseatic League

Trading blocs go back before the name was coined. The Hanseatic League was one of the first European examples, a trade federation of German towns and cities that formed sometime prior to 1241 C.E. Along with members offering each other freer trade, the League's combined economic power enabled it to secure favorable trading privileges in other parts of Europe.

Unlike modern trading blocs, the Hanseatic League was a powerful military force. Violence was a constant threat to long-distance trade; one of the advantages of trade blocs was that the merchants' private armies helped protect each other. In the 14th century, the League fought a nine-year war with Denmark to win trading privileges in Scandinavia.

That kind of power inevitably attracted opposition. Other nations began closing their borders to Hanseatic trade to protect their own merchants and protest the League's military interventions. The League's power vanished in the 17th century, though it didn't disband until 1862.

Modern Trading Blocs

After World War II, tariffs declined around the world, but they didn't disappear completely. That gives nations an incentive to form various trade blocs such as the European Union (EU) or the North American Free Trade Agreement (NAFTA) between the United States, Canada and Mexico. Trading blocs come in several varieties:

  • Preferential trade areas agree to reduce or eliminate tariffs on selected goods traded between countries.

  • A free trade area such as NAFTA eliminates or reduces trade barriers on all goods.

  • A customs union combines free trade between members with tariff barriers against nations outside the union.

  • Members of a common market such as the European Union drop all trade barriers, including non-tariff ones. Common-market members try to harmonize their economic policies, industrial policies and regulations until they operate almost like a single economy. The euro, for example, has replaced national currencies in 19 EU states. 

Non-tariff barriers can include regulations on safety, health, food, monopoly power and intellectual property rights. The EU and the United States have different regulations and laws on many of these issues, forcing businesses to adapt to two sets of standards.

Benefits of Trading Blocs

Modern trading blocs don't wage war on non-members like the Hanseatic League, but they're still controversial. Critics of blocs say free trade should be a worldwide thing, and favoring specific countries distorts the natural flow of goods around the world. The counter-argument is that the benefits of trading blocs for member nations are too good to pass up.

  • When trade barriers drop, manufacturers in different countries compete with each other directly. That forces them to become increasingly efficient in order to keep or grow their market share.

  • It's a good deal for consumers because foreign products become more widely available, at cheaper prices.

  • Competition reduces prices, giving consumers better buys for their money. As prices go down, consumers can buy more, which boosts the economy.

  • Different countries have different strengths, such as an educated workforce, access to raw materials or lots of farmland. Partners in a trade bloc can specialize in what they do best, knowing they can sell their output to other nations.

  • Specialization enables big companies to develop economies of scale, which makes them more efficient.

  • The growth in trade and sales can lead to a growth in jobs. 

Economists debate whether these results actually come true in practice, rather than just in theory. One study found that trade agreements don't actually reduce costs, but the quality of the goods for sale goes up.

Trade Blocs: The Negative Effects

Along with the advantages of trade blocs, economists say they have multiple harmful effects. Many of them stem from the way other countries are shut out of the benefits members of the trade bloc enjoy. Countries outside NAFTA, for instance, are at a disadvantage selling to the U.S. compared to Mexico or Canada.

  • Inefficient companies or industries within the trading bloc have protection against competitors in other nations. That reduces the pressure on them to become more efficient and productive.

  • Trade blocs may retaliate against each other by raising tariffs or imposing regulatory roadblocks on imports.

  • Trade blocs are great for major corporations that have the resources to adapt to an international playing field. Small companies may find themselves crushed by lower-priced goods coming in from out of the country.

  • If native industries can't compete with foreign ones, they go under, leaving lots of people jobless.

  • Regional trade blocs cut into global economic growth by promoting one region over the rest.

  • A trade bloc such as the EU adds another layer of government and regulation. Member countries lose some of their power to regulate or deregulate because they have to comply with the trade bloc's rules. 

  • Countries that subsidize their business sector have an unfair advantage over businesses in a free market. Free-trade advocates say there are other legal steps countries can take that aren't as trade-disruptive as tariffs. 

The Effects of NAFTA

In 1994, the North American Free Trade Agreement created a trade bloc that encompassed the entire North American continent. Canada, Mexico and the U.S. hoped to gain the advantages of trade blocs: free trade in agriculture and automobile manufacturing, protection of intellectual property, better labor and environmental safeguards and setting up a mechanism to resolve economic disputes.

NAFTA was intensely controversial when the first President Bush began negotiations in 1991. Supporters said it would boost the economies of all three nations. Critics said Mexico, where wages are much lower than the United States or Canada, would siphon off millions of jobs with a "giant sucking sound".

More than two decades later, economists still debate whether NAFTA proves the benefits of trading blocs or made things worse.

NAFTA 20 Years Later

Regional trade increased sharply under NAFTA, from under $300 billion to $1.1 trillion in 2016. However, it's hard to say how much that is due to the benefits of trading blocs and how much is due to other economic developments. Further complicating the picture is that while the overall economy may have done better, specific industries, such as automobiles, took a huge hit.

Imports from Mexico cost 600,000 U.S. jobs over two decades. Workers without a college degree were particularly hard-hit because of the competition from low-wage labor in Mexico. NAFTA advocates say it created 200,000 jobs that pay 15% to 20% more than the jobs that were lost in the trading bloc.

At the time of writing, the three partners have agreed to a revised NAFTA to fix some of the perceived problems.

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About the Author

Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com