Preferential Trade Agreements

Preferential Trade Agreements

These give preferential access to certain products from certain countries by reducing or eliminating tariffs, or by other agreements relating to trade.

Basically they involve agreements to improve trade liberalisation between countries. There are two types:

Bilateral agreements: these are between two countries.

Multilateral agreements: these are between more than two countries.

Bilateral agreements tend to be easier to implement, however, multilateral agreements tend to be beneficial to more people.

Trading Blocs

Advantages of trading blocs

  • Free trade within the bloc

  • Easier to access other markets

  • Firms can expand to make use of economies of scale

  • Growth in exports will create jobs

  • Firms inside the bloc are protected from cheaper goods being offered outside of it

  • Trade creation

Disadvantages of trading blocs

  • Reduce beneficial effects of free trade, like specialisation and exploitation of comparative advantage

  • Inefficiencies – fail to make use of more efficient firms outside of the bloc

  • Trade diversion

  • The common external tariff may lead others to retaliate.

Trade creation and diversion

Trade creation is where trading blocs result in high cost domestic products being replaced by low cost and more efficient imports. This is believed to be beneficial as cheaper supplies from abroad allows for lower prices that benefit consumers.

As a result of trade agreements, trade may be diverted from a more efficient exporter to a less efficient one, rather than creating new trade. This is usually due to the common external tariff that the countries in the trading bloc may agree to. Therefore, trading blocs may not always be best at promoting free trade.

Advantages of a monetary union

  • Transparency – investors and tourists can more easily compare the international prices of goods.

  • Lower transaction costs – single currency so no need to change currency

  • Certainty – price changes are more predictable so producers can plan ahead and are more willing to invest

  • Jobs – the export sector is likely to expand

Disadvantages of a monetary union

  • Loss of economic sovereignty – individual countries cannot set their own interest rates, which is particularly bad when the economies of countries within the union are very diverse (like Germany compared to Greece in the EU)

  • The countries involved may vary greatly in their language, politics and culture, which may make it very hard to unify them

  • Inefficiencies may bread as firms within the union are favoured over more efficient firms outside the union.