nm1128: as always er you know if you want to discuss the essays with me come along [0.2] you know any time or certainly i'll be in my room during [0.2] s-, so-called [0.4] surgery hours [0.4] [laugh] [1.4] right let's get this thing moving [6.0] i'm dealing with the economics of er [0.6] free trade [1.2] areas [0.9] which some of you have done i mean i'll be doing it a little bit more depth than we did on my other course [0.6] but there's obviously quite a bit of overlap on this particular topic [0.5] so i'm looking for you to [0.4] do the lecture rather than me [0.9] er [1.6] so here's the handout [5.6] i assume you've got all sm1129: nm1128: yes [laughter] [0.4] we're doing a little bit more [laughter] i i said you're doing the lecture [laughter] [3.0] but some people haven't [0.8] had the privilege of er [1.0] doing the E-U in developing countries so [1.6] what i'm dealing with is that today we'll deal with the the economics [0.7] of [0.3] customs union and free trade agreements [1.1] and in next week [0.4] we'll deal with article twenty-four [0.4] which is the W-T-O [0.6] er [0.3] article the general agreement on tariffs and trade article [0.7] er which covers authorizes [0.6] er free trade areas and customs union [0.4] because of course [0.6] they [0.2] fundamentally break article one [0.5] er the principle of non-discrimination i mean the whole purpose of a free trade area or a customs union [0.6] is to discriminate [0.2] in favour of the partner countries [0.3] and therefore against the world [0.5] er so which is entirely against the whole [0.5] essence [0.5] of the GAT [0.2] the [0.2] er agreements and the W-T-O [0.5] so article twenty-four permits [0.4] this major break [0.6] er from the principle of non- discrimination [0.5] but i'll deal with that next week [0.6] er 'cause it's a topic which [0.6] er has come to the fore [1.2] particularly given the proliferation of [0.7] er these [0.2] preferential trade agreements as Bhagwati [0.2] prefers to call them [0.9] er [1.5] i mean at the moment i think there's about a hundred-and-six [1.0] preferential trade agreements have been notified [0.7] to the W-T-O [0.4] and not all agreements are notified [0.8] er so [0.2] there's something in n-, [0.2] in excess [0.6] of a hundred-and-six preferential trade agreements [0.7] er and the p-, [0.7] as i say the previous [0.2] past [0.9] ten years or less [1.1] have seen a proliferation of these agreements [0.3] er i mean everybody's signing agreements as if there was no tomorrow [0.6] er [0. 4] which is entirely contrary to all that we were saying [0.5] about the Uruguay round [0.4] and the move towards [0.3] a rules based system for international trade [0.5] and the principle of non-discrimination that underpins [0.4] all of the [0.2] new [0.4] er international economic order [1. 8] so one of the questions really i mean one of the fundamental questions which people are asking themselves today is why [0.3] you know why in a world in which on the one hand [0.4] we strengthened [0.5] the general agreement on tariffs and trade [0.5] and we have the general agreement on trade and services [0.5] and trade related intellectual property rights agreements trade related investment measures [0.6] er [0.3] and so on [0.4] i-, particularly the strengthening of the di-, the [0.4] er dispute settlement [0.4] process [0.6] all of that you know we we emphasized [0.4] really was to underpin the [0.3] spectacular growth of world trade that we've seen [0.7] er so why at this time of all times [0.5] do we see this [0.3] huge increase [0.4] in the number of preferential trade agreements [0.5] which is fundamentally based on mercantilist philosophy isn't it [0.2] i mean the view that [0.5] you know we sign up agreements between ourselves [0.4] er and keep out the rest of the world you know [0.5] we sort of concentrate the gains from trade [0.5] er between us at the expense of or [0.2] partly at the expense of the rest of the world [0.5] so why that's one of the big questions that we'll [0.2] continue to come [0.4] to to come back to [1.2] er [1.0] i don't think anybody knows the answer to that one [0.5] er but we can at least speculate on it [1.7] and of course as Bhagwati puts it as well [0.2] are they are they obstacles [0.7] to the development of a [0.2] non-discriminatory [0.2] free trade world [0.8] or are they simply stepping stones [1.1] which might be the apologist case if you like [0.5] for customs unions and free trade agreement [1.8] stepping stones in the sense that [0.6] er [0.4] you first of all [0.7] er [0.7] free up trade between the partner countries [0.7] and maybe deepen relations between you [0.9] er and having adjusted to that [0.3] you can then go on [0.4] to [0.4] er free trade [0.5] on a [0.2] worldwide basis [0.9] and particularly perhaps for developing countries [0.6] er that might be very attractive [0.2] rather than go suddenly for broke [0.6] you know suddenly [0.7] when your barriers to trade as we've [0. 2] discussed in the past have been very high [0.4] very high tariff and non- tariff barriers [0.7] er [0.3] and you [0.7] you know rapidly take them away over a short period of time expose yourself to world trade [0.5] that's a pretty frightening thought [0.5] er for for any country [0.6] so maybe a regional free trade agreement [0.3] particularly with [0.4] an industrialized country a large industrialized country like United States [0.6] or a regional grouping like the E-U [0.6] that might be a sort of stepping stone [0.3] so you free trade first of all with the [0.2] the big [0.3] industrialized market [0. 5] and you adjust to that [0.5] and then you go in to [0.4] er liberalized trade [0.5] on a on a worldwide basis [0.2] and that's the sort of optimistic view if you like [0.6] of [0.3] er the role of free trade agreements [0.9] er [0.4] in which case they're stepping stones [1.1] to er [0.7] er final free trade [1.1] or are they obstacles in the way that i indicated at the beginning they might be [0.4] 'cause fundamentally [0.2] they're discriminatory [0.7] and the more agreements you have [0.4] the more discrimination we have in the world [0.7] and therefore [0.8] we're running quite contrary [0.9] to the fundamental principle [0.6] of the W-T-O [0.3] principle of non-discrimination [1.0] so [0.2] that's the big debate and we [0.6] there's no answers to that one [0.5] you just have to [0.9] really [0.8] make up your own minds [2.7] so first of all let's go through with the basic economics of it i say my apologies to those who've done this before but it's such an important topic [0.4] it comes up in all sorts of areas [1.3] er so what i'm going to do [0.6] is er put up the diagrams [0.5] and then get those of you particularly well anyone [0.3] but particularly those of you who've done E-U and developing countries course [0.5] er to then explain the diagrams to me [0.6] rather than me do it [1.6] so let's see if we [0.8] when we get this thing focused in this ghastly room that we have [17.0] least it's not as bad as the Palmer building is it where you've got the [0.3] the screen up one end and people are sitting up the other end i mean that is really [0.4] truly awful [1.6] okay [2.8] well the starting point [0.5] on the analysis of [1.5] er preferential trade agreements [1.4] really was by [0.7] put up by Jacob Viner [1.5] er [1.3] who [0.2] pointed out [0.4] that [0.6] er [1.2] preferential trade agreements on the one hand [0.4] freed up trade between the partner countries and therefore the theory of comparative advantage can work [0.6] okay [0.5] but of course it was only partial liberalization [1.1] er it discriminated against the countries [0.9] and so [0.3] it was er Viner [1.6] who [3.0] coined the terms [0.3] trade creation [1.2] and [0.3] the next diagram that we'll do trade diversion [2.8] er have we got [0.3] a spare handout [2.4] oh you do right [1.0] [1.3] sm1130: nm1128: [3.1] okay so trade creation then this is comparative advantage working [0.5] mm [1.0] but of course only between [0.2] the member countries [1.0] mm [2.1] er [1.8] this diagram here [1.1] er this is [0.2] a [0.5] preferential trade agreement [0.6] between [0.3] a developing country [0.8] right [0.2] which is er [0.4] labelled L-B-C here [1.6] and [0.3] the European Union [0.3] E-U [2.8] er [0.4] and we're looking to see what happens in the developing country here [2.1] er the the argument's a general one [0.2] but er [0.4] purposes of [0.3] our interest let's look at the developing country [0.2] side of the equation [1.0] er [0.7] now in this case here [0.7] the European Union [0.9] is the cheapest source of supply [0.8] er [0.6] of the imported goods [0.7] okay the rest of the world [0.6] the dearer source of supply somewhere up here so we can forget about them [0.8] okay [1.2] so we're simply we're importing [0.2] from the E-U [0.7] er which is the cheapest source of supply [0.8] prior to the preferential trade agreement [0.9] there is the [0.2] tariff [0.7] tariff [0.5] is the distance between [1.0] P-star-E-U [0.3] and P- E-U here [0.6] okay [1.0] so that's the [0.5] that's the height of the tariff [2.9] er [0.4] and prior to the preferential trade agreement [0.4] we're importing [0.2] M-O [0.8] from [0.8] the E-U [1.6] tariffs then disappear [1.5] okay [0.8] and [0.3] er [1.4] we then [0.8] er [2.4] expand our imports from the E-U [0.6] upto M-F-T-A [0.9] imports under the [0.5] free trade agreement [2.1] mm [3.5] okay [1.3] first of all first question for you [0.8] er [1.9] how do consumers gain [0.3] from this [2.7] in the di-, in terms of the diagram [0.6] what can you show has been the gain in welfare to consumers [0.4] from signing the free trade agreement [0.6] yeah [0.6] sm1131: can provide them choice [0.9] [0.7] not very good price [0.3] nm1128: right sm1131: goods [0.5] [0.5] nm1128: right sm1131: [0.8] his prices [0.8] and a wider choice of foreign goods [0.9] nm1128: okay so they pay a lower price [0.7] er than before [0.2] mm [0.7] and they've got a wider choice of goods [0.6] there's something else purely analytical terms sm1132: C-N-D [0.5] nm1128: sorry sm1132: C-N-D sm1133: [0.6] nm1128: okay [1.1] so they pay a a lower price [0.2] for the previous level of imports [0.4] M-F-T-A [0.4] er sorry M M-O [0.2] right [0.8] but then also what happens because the price falls [0.5] what else happens [1.1] sm1132: consume more nm1128: they they consume more that's right [0.4] and there's the wider choice which you said [0.3] we'll come back to that one later on [0.6] we're just dealing with a particular product just now so [0.5] they gain in two respects [0.4] they gain [0.4] that [0.3] the previous level of imports they can buy cheaper than before [0.3] mm [0.5] and then because the goods are cheaper [0.8] they move down their demand curve [0.5] okay [1.0] er consuming even more [0.6] mm [0.8] so the gain in the consumer surplus [1.7] is this [0.3] area in here [1.4] someone just define for me what do we mean by [0.2] the gain in the consumer surplus [1.2] it's a technical term in economics what does it mean [3.2] sm1134: does it [0.2] mean how much [0.2] work consumer's doing to pay [1.2] er [0.2] difference of [0.4] how much [0.5] nm1128: that's right [0.4] that's right exactly that's a [0.3] that's a very good definition of it [0.3] okay [0.3] so the consumer surplus [0.5] er is [0. 4] er [0.3] i mean let's [0.6] er [0.4] well let's take a price [0.6] er [4.9] er well someone describe to me in terms of the diagram what it means [0.5] if it's under what you mean maybe i'll leave it to you [3.4] it's the difference between what people will be willing to pay and what they actually have to pay [1.4] sm1135: [0.3] nm1128: sorry sm1135: the price that they're willing to pay s-, [0.2] that should be the price P-E-star [0.5] and the that actually pays P-E-U sm1134: P-E-U sm1135: [0.4] nm1128: right [0.6] right [0.3] right okay [1.1] yes about right so [0.3] so the consumer surplus then [0.3] is the increase in the area under the demand curve [0.5] okay [1.0] so [0.3] er [0.2] that's what i-, if you take any particular level of imports imports M-O [0.2] okay [0.7] er they'd be willing to pay [0.3] as you said [0.2] P- [0.2] E-U-star [0.8] but they actually only have to pay that [0.5] okay [0.6] so they gain that about here [0.4] right [0.5] and similarly all the way down the demand curve [0.2] it's only the very last unit [0.6] that's consumed [0.3] all right [0.7] at which the price they have to pay [0.4] is just equal [0.5] at the margin is just equal [0.2] to the price [0.4] er that they'd be willing to pay [0.7] for all the intramarginal units [0.6] they'd be willing to pay a higher price [0.4] but they don't have to [0.6] okay they just have to pay [0.5] price P-E-U okay [0.4] so the area under a demand curve is the consumer surplus [0.5] mm [0.9] and what we're measuring here is the increase in the consumer surplus [0.5] as a consequence [0.4] of [0.4] er [0.3] the abolition of a tariff [1.6] area A-B- C-D [1.1] okay [0.9] we then divide that up [0.3] okay [0.7] er [0.3] i think it [0.2] pretty well speaks for itself [2.3] the loss of tariff revenue of course is by the government [0.3] in the developing country [0.2] mm [0.6] i er [0.2] going back to what we were talking about this morning [0.3] if Morocco [0. 5] er signs a free trade agreement or so in-, er indeed it has signed a free trade agreement with the E-U [0.8] then [0.3] one major impact [0.3] on on on Morocco [0.7] is that previously [0.3] i think something like twenty per cent [0.5] of government revenues in Morocco came from import duties [0.4] most of those were from the E-U about three-quarters of its imports [0.4] come from the E-U [0.7] well [0.7] once the agreement's fully in place [0.4] that source [0. 7] of government revenue will disappear [0.4] mm [0.9] er it's a very important element [0.4] it's a er a c-, a a very important cost [0.7] to [0.2] particularly to developing countries and signing [1.0] free trade agreement with industrialized countries [0.4] so that loss of government revenue [0.4] is the [0.4] is the size of the tariff [1.0] P-star [1.0] against P [0.2] okay so that's the height of the tariff [0.3] multiplied by [0.2] the previous level of imports [0.9] M-O [0.6] mm [0.6] so [0.3] that's the tariff [0.3] it used to be [0.2] applied to imports from the E-U [0.6] that's now disappeared [0.7] so [1.5] the difference between those two prices multiplied by [0.4] the previous level of imports [0. 4] I-E in the area A-B [0.6] is [0.3] the loss of tariff revenue [0.7] by [0.7] er Morocco [0.5] or where it happened to be [5.1] so that element under the demand curve [0.8] the increase in the consumer surplus A-B-C-D [0.4] is made up of two components [0.6] mm [0.8] the first one's a pure transfer [1.2] mm [0. 5] it's a transfer [0.5] from the government [0.2] of Morocco [0.7] to the consumers in Moroco [0.8] mm [1.6] so [0.2] one just cancels out the other [0. 8] all right [0.6] net [0.5] er there's no welfare gain [0.7] in that sense [0. 9] all right there's a gain in consumer surplus [1.4] but that chunk of the consumer surplus in here [0.6] is just [0.2] a decrease in government revenues [0.5] and that's transferred to consumers [0.8] through the lower price [0.4] that they pay for the previous level of imports [0.5] one balances out the other exactly [0.6] er [0.4] zero change in terms of welfare [0.9] unless you like to say that well [0.7] it's better off if [0.5] er consumers gain [0.5] er [0.2] than if governments get their revenues but [0.4] as economists we're we're very neutral in all those things all right [0.5] er so we don't make value judgements [0.5] as to whether governments should consume [0.4] or whether private individuals or firms should consume [1.0] point of view of the economy [0.7] that's simply a a transfer [1.0] er [1.1] no welfare effect at all [0.8] so [0.3] the net welfare effect then [0.5] is [0.3] that the two tri-, the is the is the triangle here [0.7] plus this whatever that shape is [0.4] i've forgotten my methematics somebody tell me [laughter] er [0.3] D in there [0.5] er [0.7] it's those two areas C-plus-D [0.3] is the net [0.2] welfare gain [0. 5] okay so cons-, the gain and the consumer surplus [1.4] minus this transfer element A-B [0.6] so we're left with [0.3] this area in here [1.1] so that's the welfare gain [1.8] unambiguously a welfare gain [0.6] to [0.2] the developing country [1.6] from the [0.4] er [0.6] abolition of the tariffs the free trade agreement [0.9] and that's what Viner called [0.6] trade creation [1. 2] mm [3.0] the consumers [0.6] er [0.7] are able to [0.8] purchase [0.3] er [0. 2] a higher level of imports [0.7] at [0.5] a lower price [4.7] let's look a little bit further now [0.4] er i've sketched in here [0.5] not terribly well but i hope it's clear [0.7] what's going on behind the scenes here [0.6] because this is the demand for imports and the demand for imports [0.5] is a residual demand [0.7] mm [0.9] it's the difference between [0.3] domestic demand [0.3] and domestic supply [0.8] okay [0.2] that's imports [0.9] mm [0.8] 'cause we assume that the good is produced [1.2] within Morocco [0.8] within the developing country [0.5] er as well as imported from the E-U [0.9] we'll come back to that assumption later [0.4] but [0.5] that's the basic assumption [0.4] it's the same product [0.5] produced within the [0.2] er Morocco [0.8] and also imported [0.8] so imports are the difference then between domestic demand [0.9] all right the demand in the developing country [0.3] and supply in the developing country [1.4] mm [1.3] so let's look now at this [0.3] what lies behind this trade creation gain [2.5] what are its two components then [1.9] imports rise [0.2] for two reasons [0.5] what are they there's rise in imports in M-O [0.4] M-F-T-A [0.5] it's for two reasons [0.9] what are they [0.6] sm1132: [0.2] [cough] [0.5] the [0.3] position of tariffs [0.4] which creates obviously a lower price and er [0.7] greater consumption [0.4] nm1128: right [0.5] okay [0.2] so that's the movement down the demand curve here [0.5] okay so the lower price [0.2] we demand more of something [0.2] if it's cheaper [0.2] we buy more of it [0.8] right that's one component [0.4] and the second component [1.8] of the rise in imports [4.3] how about the left hand side [1.4] sm1135: nm1128: right okay specifically what's happening [0.2] the the tariffs taken away [0.3] so [1.6] competition [0.5] sm1132: will destroy the er [1.1] unproductive er [0.2] enterprise nm1128: or the less efficient one sm1132: or the less efficient nm1128: the less efficient ones that's right [0.3] okay [0.3] so we move back down [0.2] the supply curve [0.3] in the developing country [0.3] okay [0.4] so we take away the tariff protection [0.5] okay [0.9] the the marginal producers then [0.5] the ones that could only survive [0.9] under tariff protection [0.6] now simply go under [0.7] yeah sm1136: i have just one question er [0.5] [1.1] [0.7] [0.8] nm1128: o-, sm1136: [0.5] [1.8] [0.7] nm1128: yes i mean you're you're right [0.4] but [0.4] but y-, you're sort of [0.2] jumping the gun as it were you're so you're moving ahead in the in the analysis that is indeed the fear [0.2] okay [0.4] that we we've talked about the infant industry arguments the reasons for protection [0.5] so maybe you shouldn't be signing just yet [0.3] that's right [0.2] that's right [0.4] that's right maybe [0.5] you know [0.8] i mean i i showed a pretty steep curve here [0.4] all right [0.3] which indicated [0.4] that [0.5] they were indeed vulnerable [0.3] right i deliberately drew that supply curve quite steeply [0.5] for precisely the reasons you've given [0.3] okay [0.5] but there's an awful lot of firms [0.7] that need the tariff protection [0.9] because we're dealing with a developing country [0.7] er they're still learning by doing [0.4] er [0.3] things i'll be going onto in a moment on on economies of scale and production [0.4] you know [0.2] they they just entered the manufacturing sector fairly recently [0.3] they're still feeling their way they're still learning skills [0.6] and they're still [0.2] moving down their long run average cost curve and so forth [0.5] er [0.6] and is suddenly bang the protection's taken away [0.3] and [0.2] they go [0.2] straight down the supply curve here [0.3] right [0.3] yeah [0.6] but we'll come onto that in a a moment that's a good point [0.7] er [0.3] so [1.4] er [0.3] i've got a situation here then where [0.4] er the increase in imports is due to two forces [0.6] the first one is the movement down the demand curve for the product in the developing country [0.8] something's cheaper you buy more of it [0.9] the second element [0.6] is [0.4] that the [0.2] doing away with the tariff protection [0.5] does away with the less efficient producers [0.7] mm [0.8] they may be infant industries [0.5] too bad the infant never grows up all right [0.4] er [0.9] er [0.4] and that's the second reason then why imports rise [0. 7] mm [3.6] er [2.7] right let's explore that a little bit further now [1.3] er [1.0] given that theory [1.9] suppose you had [0.6] er let's go back to last term now [0.5] okay [0.6] where we talked about [0.5] the possibilities of a free trade agreement [0.7] er [1.1] well certainly er on on the other course i talked about [0.5] er [0.4] a free trade agreement between the E-U [0.6] and say sub-Saharan African countries [0.4] mm [1.3] er so we're talking here about countries [0.2] particularly [0.5] er low levels of income low levels of industrialization [0.2] and the rest [2.4] given the analysis that we've got there [1.2] do you think the trade creation [0.2] i i'm lost to the fact that the E-U as i say is [0.2] [cough] [0. 4] er [0.6] you know planning to sign free trade agreements with [0.2] various regional groupings of these countries [0.6] er no later than two-thousand-and- eight [0.5] mm [0.2] two-thousand-and six two-thousand-and-eight [1.3] er [0.7] given then a free trade agreement between the E-U [0.2] and sub-Saharan African countries [1.2] do you think the trade creation effects would be large or small [6.5] sm1135: nm1128: right [0.6] sm1135: nm1128: so it i-, w-, so so trade creation would be [0.5] large or small [1.5] sm1135: large [1.6] sm1132: small nm1128: ah [0.5] [laugh] right [laughter] [0.2] you're saying small [laughter] [0.4] sm1132: 'cause i think [0.3] what they were saying that that result [0.6] result packed in in [0.5] small trade creation [0.3] nm1128: because [0.6] sm1132: well because the sort of fact you got a less developed country er nm1128: mm sm1132: which [0.4] is [0.3] sm1136: [1.3] sm1132: products [0.2] will [0.5] what was [0.6] manufacturing [0.2] er everything else from the whole production [0.5] will not be able to compete er [0.5] against the E-U [2.3] E-U of their countries producers [0.2] nm1128: well if if it couldn't compete against it okay [0.6] all right [0.9] then [0.2] following what we've just said just now sm1132: right yeah nm1128: [0.4] okay there's going to be a big surge in imports sm1132: mm nm1128: that's going to wipe out the local industry [0.6] okay sm1132: but then again we did mention earlier first term [0.6] that er [1.1] it's not just that tariffs nm1128: well all that yes sm1132: not sure whether they're er [0.2] will be removed or not nm1128: it will oh yes i mean because [0.2] all all the non-tariff barriers will be reduced as well as the tariffs or at least most of the non-tariff barriers [0.4] all the import quotas import licensing [0.5] everything else has to go in a free trade agreement i mean it is [0.3] free trade [0.3] all right [0.5] right we can [0.5] i mean we can't actually look at the details you have to [0.9] say well it's not quite as simple as that but [0.4] let's just keep it at that for the moment [0.2] because that's more or less what it is [0.5] but what i'm getting at here though is [0.2] say we're talking about Chad or Mali [0.3] right [0.4] some very very poor countries [0.7] er you know sm1136: yeah sorry nm1128: the industry that they've got sm1136: this is this is what i thought er nm1128: right [0.3] sm1136: what it is about [0.3] is [0.4] whether the [1.4] what the E-U c-, could export [0.2] whether it is suitable [0.3] for the er [0.5] er [0.3] African mark-, er market [0.4] for Mali for example [0.3] i mean the Mali [0.2] er consumer [0.8] does he really want er [0.6] a car or does he really want nm1128: well he probably wants it [laughter] sm1136: well he wants a car yeah he wants a car but can he pay for it nm1128: yes [0.2] yes sm1136: so that that's that's what i was going to [0.3] nm1128: right [0.2] sm1136: yeah [0.3] nm1128: okay sm1136: so nm1128: and in terms of local production then what's what's what sort of [0.7] goods are going to be produced [0.7] you know manufactured goods right sm1132: [0.6] nm1128: right [0.6] so a lot of the local industry will be producing for the domestic market [0.2] okay [0. 5] and [0.3] these goods will be pretty basic consumer goods right fundamentally selling in terms of price [0.3] okay they're cheap [0.5] they use local materials local labour [0.5] er [0.4] but not exactly state of the art [0. 4] they're not beautifully designed coloured [0.3] whatever [0.2] right [0.6] but [0.2] they're basic essentials of life [0.3] in that country [1.3] er [0.7] they're [0.4] you might call them non-tradeable goods [0.4] a lot of them [0.5] mm [0.8] er they are purely produced for the domestic market [0.9] they might have a regional market but that's [0.3] tha-, that's another story [0.2] all right [0.3] they're certainly not goods [0.3] that compete [0.3] with the sort of goods which you'd import from the E-U [0.5] what sort of goods are you going importing from the E-U [0.6] if you're Chad Mali [1.3] et cetera [1.1] Uganda [2.0] what what sort of goods are you going to be importing from the E-U [1.6] capital goods investment goods [0.2] intermediate products okay [0.9] not produced in the local economy on the whole [0.4] that's the key point [0.3] okay [0.5] so the key word i'm getting round to then [0.5] is that [0.2] one of the important aspects of the trade creation effect [0.7] is the degree of substitutability [1.2] between [0. 6] domestic production [0.7] and imported goods [0.7] okay [1.2] in other words my supply curve that i've got here [1.0] okay [1.5] er [2.3] and i've drawn that quite steeply [0.8] indicating that the degree of substitutability [0.3] is quite small [1.3] mm [1.0] most of the goods you import from the E-U [0.6] are not produced in the domestic economy [1.3] so if you like the trade displacing effect on domestic production [0.5] is also going to be [0.3] quite small [1.1] now it depends on the economy [0.5] right i've talked about Chad or Mali [0.5] if we're talking about Cote d'Ivoire [0.5] er Zimbabwe [0.5] Kenya [0.9] er [0.2] well [1.3] there's going to be a greater degree [0.4] of [0.4] er overlap [0.4] if you like [0.6] between [0.9] some domestic production anyway [0.8] and [0.3] imports from the E-U [0.4] mm [0.8] so if er the price of [0.3] of goods fall [0.5] imported from the E-U [0.7] er [0.5] then [0.2] that's going to [0.5] squeeze out [0.4] er less efficient [0.4] less desirable goods [0.3] produced by some [0.4] or er d-, domestic producers [0.5] in er in the country [0.3] they could only survive [0.5] behind high tariff protection [0.4] but you still got a lot of other production [0.6] which is simply doesn't compete [0.6] er with imports from the E-U [3.5] that's important because this theory was developed by Viner [0.8] in the context particularly of explaining [0.5] er the common market [0. 4] all right we're going back now to the nineteen-fifties [0.6] mm [0.5] if you're [0.4] talking about a free trade agreement a customs union [0.8] i'll give you the difference between those later on [0.9] er [0.4] between [0.4] industrialized countries in Europe between France and Germany and Italy [0.4] right [0.8] then the degree of substitutability [0.9] between imports and domestic production is going to be very high [0.3] mm [1.0] so the trade creation effect on that side is potentially very powerful [0.6] mm [0.8] er but going to be going to be a wide range of goods which are [0.3] produced for the domestic economy [0.3] which you could just as well import from France or Germany or Italy [0.2] mm [1.0] and so [0.5] er the trade creation effect would be very powerful [0.7] er [0.2] in an industrialized country but between an industrialized and a developing country [0.3] we would expect it to be very much less [2.2] but when you come to look at the empirical estimation [0.4] of [0.5] er the effects [0.3] when you when you read the literature [0.3] on on this such as it is [1.8] er you will see no discussion at all or very little discussion [0.5] about this particular point [1.8] er nobody asked that question [0.9] about [0.7] er [0.6] is the degree of substitutability between imports and domestic production [0.2] high or low [0.9] in particular what value does it have what is the elasticity of substitution [0.8] absolutely no one knows [0.3] mm [0.3] if anybody finds a reference which tells you what [0. 2] that figure is [0.3] even for one [0.3] one developing country [0.5] i'd be very grateful [0.6] mm seriously grateful because [0.6] part of my job is to try and [0.2] measure these blasted things all right [0.4] i've never found [0. 5] a source [0.3] which is actually [0.4] empirically measured the elasticity of substitution [0.6] for imports from an industrialized country [0.2] and domestic production [1.8] everybody just assumes a number [1.4] most of the of the literature on that is for industrialized countries [0.3] not for developing countries and it's a very important difference [1.0] the other element is the extent to which the decrease in price for the increased comsumption [0.3] all right [0.6] er and er that [1.3] well again is an empirical [0.5] fact i mean [0.3] it just depends if we're talking again about very poor countries [0.3] mm [0.4] with very low levels of income [0.9] er [0.6] again the sort of comsumer goods which the E-U produces [0.4] are not going to have a very big market there [0.3] the the the rich elite [0.4] will be able to buy their Mercedes or whatever [0.6] er but er [0.2] they probably buy them anyway whether the tariff was there or not [0.5] and indeed because they're rich elites they're probably not paying their tariff anyway [0.3] they're finding some way round it [0.6] so er [0.3] i don't think we need worry about that side of things [0.6] what it will do however [0.3] is make investment goods and intermediate goods [0.3] cheaper [1.2] mm [0.2] than they were before [1.0] mm [3.2] what effect do you think that would have on the economy [1.7] sm1136: nm1128: well [0.2] certainly the short term effect will be a rise in imports [0. 2] we've just shown that [0.3] sm1136: yes nm1128: okay [1.0] we haven't looked at the export side of this yet [0.3] that might also rise it depends what went before sm1136: nm1128: but but but but but let's but let's leave the balance of trade aside for the moment we're still quite a way from looking at that [0.5] let's just look solely at the effect [0.4] of [0.2] doing away with the tariff [0.6] and moving [0.4] down the demand curve [0.5] and this case the demand for investment goods and intermediate products [0.9] what effect's that going to have on the economy [1.2] sm1135: [0.2] nm1128: sorry i'm not i [0.2] i don't want to look at the export side at the moment okay i'm just looking at [0.4] you know [0.6] if if if investment goods and intermediate goods are cheaper [0.6] what effect's it going to have [0.7] sf1137: well it should somehow get an increased investment in the country [1.2] nm1128: that's it [0.3] that's that's what we're looking for [0.2] okay [0.6] so investment goods intermediate goods that you need in production [0.3] all right [0.5] both those factors you can buy capital goods cheaper [0.5] and the costs of production are lower [0.3] all right [0.4] than they were before [0.4] and given the height of the tariffs and non-tariff barriers [0.5] okay [0.5] er that er e-, existed before [0.4] er [0.6] that fall is going to be quite substantial [1.0] er so that could be a powerful boost [0.3] to investment in the economy [0.9] remember one of the puzzles in many developing countries is that [0.6] we have [0.3] a basis for saving and investment [1.1] which very often doesn't occur [0.4] we can look at countries with similar income distributions and similar levels of per capita income [0.5] but widely different saving and investment rates [0.7] all right [0.3] and we're always puzzled why [0.4] and one of the reasons for that [0.5] is the price of capital [0.4] okay [0.6] if the price of capital falls [0.9] in terms of interest rates but also in terms of price of capital goods [0.4] intermediate goods need in production [0.5] then that could stimulate a a rise in production [1.0] and [0.2] just to briefly [0.3] deal with your point [0.5] er [0.6] the balance of payments might deteriorate [0.3] okay [0.2] as we import these goods [0.4] then production rises [0.5] all right [0. 3] and production [0.2] both of exports [0.5] and of import substitutes [0.5] to the extent that they exist [0.8] er [0.4] could then [0.4] move the balance of payments the other way [0.9] mm [0.7] so it's a [0.2] it's an empirical question [0.5] sm1136: [0.9] nm1128: yes i mean the-, there's a problem of financing it all [0.4] that's right which we haven't discussed here we've just said imports rise [0.6] the you know what you're saying to me is where does the foreign exchange come to buy it all right [laughter] and we just call that oh that's an adjustment problem you know [laughter] er [0.2] but of course it's more than that you're absolutely right [0.5] er [0.2] so [0.2] if this is going to work in a developing country and it's a very [0.2] very useful point [0.6] er [0.2] probably with the the developing country needs aid [0.7] all right [0.7] er [0. 3] the government will need aid [0.3] because its [0.4] i-, its revenues have fallen [0.5] quite substantially [0.5] okay [0.4] and it needs to change its structure of taxation [0.5] from heavy dependence on import duties [0.4] towards indirect taxes value added tax or something like that [0.6] that's going to take time expertise [0.5] et cetera [0.3] right so they'll need [0.4] aid and technical assistance [0.3] to bridge them over that [0.5] particular adjustment problem [0.8] also we've got a rise in imports with nothing happening on the export side [0. 3] s-, in the in the short term [0.3] which may be several years [0.8] er [0.5] that's got to be paid for [0.4] or alternatively there's a balance of payments crisis [0.3] currency devalued you get inflation [0.3] all sorts of nasty effects could arise [0.3] so again [0.9] we're saying that you need financial assistance [0.4] foreign exchange needs to come in [0.6] in order to [0.4] enable a country to buy these investment goods [0.5] and er and these intermediate goods [0.3] er [0.4] then its production can expand [0.6] er [0.4] as production expands [0.5] er and tradeable goods supply of tradeable goods rises [0.7] so you don't need the aid [1.2] that's the theory [3.1] okay well we can squeeze quite a bit out of that diagram [0.5] er [0.3] and it is important that you understand the mechanics okay [0.3] too often [0.6] i think the the the textbooks simply [0.2] throw that up [0.4] there's A B C and D that's the consumer surplus you know blah blah blah on to the next thing on to trade diversion [0.2] mm [0.5] think of what's going on [0.6] because if you if you think of what's going on [0.4] behind the scenes here [0.6] then you can say [0.8] is the trade creation effect going to be large [0.2] or going to be small [0.9] and [0.3] what are the adjustment problems for the country [0.4] in terms of the government revenues [0.5] and in terms of [0.4] dealing with the rise in imports [0.6] whenever we just said [0.5] exports haven't increased [2.8] any [0.2] questions on that before we go on to the next one and trade diversion [2.2] er happy [2.1] okay [0.2] right [0.5] well [0.7] that's the welfare gain [0.2] okay [1.2] er remember in this view of things [0.3] the fact that you wipe out a bit of local industry [0.7] er certainly means they're inefficient producers [0.3] all right [0.3] er which you know [0.3] er shouldn't be there in the first place because they're only there under protection [0.5] they go away [0.5] that releases resources [0.4] which can be more productively used in the rest of the economy [0.5] all right that's the assumption behind it [0.5] but they may just be infants that are ready to grow up [0.7] sm1135: can we add [0.3] [0.6] nm1128: no [0.5] because [0.7] that's just going to effect that distance up here [0.7] okay [0.9] er if what you're saying is [0.2] i mean i haven't actually marked that in because we got enough rubbish on this diagram [0.4] that's the [0.2] tariff inclusive price if there was such a price for the rest of the world in fact we're not importing from the rest of the world at all [0. 6] so [0.3] er i'm not [0.3] i'm not concerned with that [0.2] no [0.8] er [0. 5] but you're ju-, you're w-, what you're saying is that [0.5] er instead of being up here the rest of the world [0.3] tariff inclusive price would be up here somewhere [0.4] just above that [0.7] but that's irrelevant to the argument [0.2] that doesn't affect the magnitude [0.5] of our [0.5] squares and triangles and rectangles and [0.2] things underneath [0.5] mm [0.5] sm1135: nm1128: see sm1135: [1.0] nm1128: i think [0.8] what it wa-, what's con-, confusing you here is [0.2] on this simple diagram [0.7] er we import [0.7] only from the E-U [0.8] we're not importing anything from the rest of the world [0.9] okay [0.3] i mean i think what you're thinking in [0.2] the back of your mind is in reality we import from both [0.7] right [0.7] er but to simplify the analysis [0.6] because the E-U is the cheapest source of supply in the world [0.3] we only import from the from the E-U [0.6] there's no imports from the rest of the world [0.6] so we don't need complicate the picture but [0.7] that er i see your point [0.2] yes in reality we do it [4.5] okay [1.2] let's look at the other side of things nm1128: okay nm1128: now [0.5] er again [0.3] let's go through the mechanics of this [0.5] mm [1.3] er [1.7] whoops [3.1] this thing [2.1] it's [1.4] difficult when it's this close to the screen [6.6] can read that [0.6] okay in this case it's the reverse situation to the one we had before [0.8] so [0.4] here the E-U is not the cheapest source of supply in the rest of the world [0.7] on the contrary [0. 3] the tariff inclusive price [0.3] P-E-U [0.3] one-plus-T [0.7] er is higher [0.5] than the price for the rest of the world the rest of the world now is the cheapest the U-S Japan [0.5] et cetera [0.4] are a cheaper source of supply [0. 7] mm [1.3] er [0.4] so [0.5] er [1.7] at that tariff inclusive price for the rest of the world [1.1] Morocco [0.2] is importing [0.2] M-zero [0.8] mm [1.7] er [1.4] now that the tariff is taken away [1.4] from imports from the E-U [0.3] but not from the rest of the world [1.4] mm [1.4] the picture totally reverses [0.6] okay [1.6] because the rest of the world has to pay a tariff [0.7] but the E-U doesn't [0.9] okay [1.8] we now import [0.4] we switch [0.7] our sources of imports [0.2] from the rest of the world [0.3] to the E-U [0.3] the E-U now becomes [0.5] the cheapest source of supply [0.5] mm [0.5] not because it's the most efficient [1.5] but because the E-U [0.2] doesn't have to pay a tariff [0. 7] imports from the E-U don't have to pay a tariff [0.6] whereas those from the rest of the world do [2.0] so we're discriminating [0.3] against [0.5] the rest of the world [1.0] in favour of the E-U [0.9] hence we switch our imports [0.9] totally [1.7] away from the rest of the world [0.3] to the E-U [0.8] even though the E-U is not the most efficient source of supply in the world [0.9] right [0.5] it's because [0.6] either they're dearer they're less efficient [0. 2] less well designed [1.1] but nevertheless they don't have to pay a tariff [1. 3] the rest of the world does [0.7] and so they capture the market [1.3] well that's a welfare loss [0.7] mm [1.3] er [1.6] in its simplest terms a welfare loss because [0.3] there must be something wrong with E-U goods all right otherwise we'd be importing from them in the first place right [0.6] we've talked in terms of price here [0.7] but remember [0.3] that we've got the price and non-price characteristics of products [0.5] and maybe they're just less well designed investment goods and intermediate goods they're less efficient [0.7] they're not state of the art the latest technology that you get from the U-S or Japan [0.8] er [0.9] nevertheless you import from the E-U [1.6] okay [0.5] yeah the analysis is exactly the same as before [0.5] er the gain in the consumer surplus is the area under the demand curve okay [0.4] which is er [0.8] A-plus-C [1.1] okay [0.9] that is that wedge in there [1.4] er [1.9] slightly different of course because the loss of tariff revenue [0.7] is the difference between the rest of the world's price [3.1] er a world prices and the tariff that's the height of the tariff sorry [0.4] that's the height of the tariff in here [0.7] okay [2.4] so we were getting this tariff revenue [1.1] from the rest of the world [0.5] plus this area up in here [0.6] so [0.2] the tariff revenue from the rest of the world before [0.4] was A-plus- B [0.8] okay that's the height of the tariff multiplied by the level of imports [0.9] okay [0.6] well we're losing that tariff revenue [2.2] er [0.5] part of that [0.3] loss of tariff revenue [0.3] is going to who [0.4] where's B going to [3.8] sm1135: [1.1] nm1128: in [2.2] where [0.3] which producers are we talking about you're right sm1135: E-U the E-U nm1128: in the E-U [0.2] that's right [0.5] so [0.2] B [0.7] is a loss of tariff revenue [0.5] being handed to E-U producers [0.7] okay [0.7] because they are [0.3] at a higher price [0.5] than the price for the rest of the world [0.7] okay [0.9] so there's a [0.5] a a transfer [0.3] that's a welfare loss to Morocco [0.8] it's a transfer of tariff revenue [0.9] which was being previously being collected from the rest of the world [0.4] now going to [0.3] Philips or wherever it happens to be the [0.3] immediate [0.2] right [0.6] er [2.6] to er [0.2] either [0.5] boost their profits or [0.5] because they are [0.2] higher cost source of supply whatever it is [0.5] that's a transfer to the E-U [0.6] from the government of Morocco [1.5] er [4.6] so we've got the gain and the consumer surplus [0.6] okay the area under the demand curve [0.3] right [0.3] we've got the loss of tariff revenue [0.4] right [0.4] remember that neutral [0.5] so the net effect [0.4] is [0.2] C [1.1] okay [0.3] that's the [0.2] so the gain and the the the net welfare effect [0.7] to to Morocco in terms of the gain in consumer surplus [0. 7] they're paying a lower price [0.4] of increased quantities of imports [0.5] is C [0.3] the triangle [0.7] mm [1.6] minus [0.4] the loss of tariff revenue [0.6] which has been transferred [0.4] to the E-U producers [0.7] okay as we've just said [2.1] so [0.7] the net welfare effect on Morocco [0.5] is [0.2] the gain and the consumer surplus [0.9] right minus [0.3] the loss of tariff revenue [0.2] transferred to E-U producers [3.4] purely [1.5] as a matter of geometry if you like [0.7] all right [0.5] the rectangle B [0.5] is going to be bigger [0.5] than [0.5] the triangle C [0.6] mm [1.6] unless unless [0.2] what [1.8] sm1135: nm1128: yes back to your point i think you were making earlier that's right [laugh] [0.2] okay [0.3] unless go on spell it out [0.9] sm1135: unless the the difference [0.3] er margin between [0.3] the er the rest of the world and the E-U [0.3] nm1128: mm sm1135: is is smaller nm1128: yes [0.2] okay [0.3] right so [0.2] the rest of the world was just a fraction cheaper than the E-U [0.4] okay [0.5] then that rectangle's going to be a very small area [0.3] right [0.5] and so it is technically possible [0.5] that that could be a very tiny rectangle [0.5] compared to the triangle C [0.5] in which case there would be [0.2] also welfare gain [0.5] but none of the textbooks say that [1.1] okay [0.7] er you won't find that in a textbook for the simple reason i think [0.4] that it's most unlikely to occur [0.2] but it's technically possible [2.0] so that's trade diversion that's a welfare loss then [0.7] it's a welfare loss because [2.2] you're transferring government revenue [0.3] from Morocco to the E-U [0.7] and transferring income [1.0] from Morocco [0.4] to the E-U straightforwardly [0.6] right [0.3] it's [0.2] it's like A going in the reverse direction [1.6] er and secondly [0.5] er [1.0] we weren't buying fr-, anything from the E-U before [0.7] presumably because it was a crummy source of supply [0.5] okay [0.5] er you know it was it was dearer it was less efficient it was yesterday's technology it was poor design [0.2] nobody wanted the blasted thing [0.3] okay [0.7] now suddenly [0.5] er you're not buying from the rest of the world you're buying only from the E-U [0.5] solely [0.2] solely because [0.3] of the preferential trade agreement [0.9] solely because [1.1] the E-U no longer has to pay tariffs [0.5] but the rest of the world still has to [0.6] okay [0.3] that's a distortion [0.7] in the market [0.8] it's a distortion [0.3] which is welfare reducing [0.5] for Morocco [1.1] it it's welfare reducing for the world as a whole of course as well [0.6] 'cause they there's a loss of production [0. 6] so [0.2] at a global level there's a loss of welfare [1.4] borne by whoever it was that was exporting to Morocco before [0.2] U-S [0.2] Japan et cetera [0. 2] to the other developing countries [1.3] so at a global level it's a loss of welfare [0.5] and it's a loss of welfare [0.3] to Morocco itself [5.1] i emphasized the the the impact on developing countries partly 'cause that's what we're interested in [0.9] but also because again you'll read in the literature [0.9] again in mostly in the development literature i have to say [0.9] that [0.2] you needn't worry about trade diversion [0.5] 'cause that's only a global loss of welfare [0.2] okay [0. 3] that the costs of trade diversion are borne [0.5] by the rest of the world [0.3] all right [0.5] that's nonsense [0.2] okay that's complete and utter nonsense [0.3] for the reasons that we've given [0.7] mm [0.7] from the straightforward transfer of of government revenue to the E-U [0.5] and you're buying [0.2] a less efficient [0.3] product than you were before [0.8] mm [0.5] sm1135: in this case it should be better for the devloping countries nm1128: well [0.2] that that's [laughter] sm1135: [0.8] nm1128: yes i mean that's what Bhagwati [0.2] so so so why do you sign the wretched agreements all right [laughter] [0.4] er [0.5] the point i-, i mean to be a-, a-, again [0.2] be impartial on this one okay because Bhagwati [0.3] hates preferential trade agreements [0.4] so let's be neutral about all this [1. 2] er there's the the [0.3] the [1.7] the [0.4] the the static [0.3] welfare effects [1.0] of [0.3] the preferential trade agreement [0.6] are there for the net effect between the positive trade creation [0.7] on the one hand [0.7] and the trade diversion effect on the other [0.3] okay [0.5] and if trade creation our previous diagram is greater [0.3] than trade diversion [0.8] then [0.2] Morocco gains [0.6] from the preferential trade agreement [0.6] okay so [0.2] it's [0. 3] as always it's plusses and minuses [0.4] okay we call swings and roundabouts [0.6] er [0.4] it's er [0.2] there's a gain the trade creation gain [0.2] the welfare gain on the one hand [1.0] and the trade diversion the welfare loss on the other and it's the net effect of the two [0.9] mm [1.9] so the change in welfare if you like [0.5] is trade creation [0.2] minus trade diversion [0.7] okay [4.5] let's look at the magnitudes of trade diversion again [0.5] our E-U Morocco agreement [0.8] mm [0.8] is it going to be big or small let's gask the same question as we did before and we said it's the net effect [3.0] what do you think [2.6] or [0.4] sub-Saharan Africa sm1135: nm1128: sorry [0.3] sm1135: nm1128: er is trade diversion going to be big or small [0.3] when you've got an African country on the one hand [0.3] and the E-U on the other [5.9] what would you expect it to be [1.5] same logic as we used before [0.4] sm1136: [0.8] nm1128: sorry [0.2] sm1136: [2.0] nm1128: yeah [0.2] you're right sm1136: nm1128: okay give yourself time ss: [2.2] nm1128: so substitutability [0.8] between [1.5] sm1133: [0.5] nm1128: sorry [0.2] sm1133: nm1128: yes okay [0.2] they're the ones that are in competition with each other [0.5] okay [0.9] so one of the key things is [0.5] what sort of goods is Morocco or Mali or Chad importing [0.7] from the E-U and the rest of the world [0.9] do you think there'd be [0.5] same goods or different goods [2.1] rough-, probably speaking [2.7] sm1132: should be the same [0.4] nm1128: yeah okay we s-, we said it would be investment goods and intermediate products [0.6] which largely weren't produced in the domestic economy it's a bit of a simplification that but it's not [0.4] wildly different from the truth [0.8] okay [0.6] and whether they're produced in the E-U [0.3] right whether they're produced in Germany or France or Italy [0.4] or Japan [0.4] or [0.2] er the United States [0.4] or Taiwan all right or or Singapore [0.3] okay [0.8] it's purely a matter of [0.6] price and technology and all the rest of it [0.3] okay it's going to be a similar sort of mix of goods [0.5] produced there [0.9] so what's that going to tell you about the elasticity of substitution [0. 6] be precise now [0.9] er between [0.9] imports from the E-U [0.3] and the rest of the world [1.0] sm1136: nm1128: yeah it's going to be very high sm1136: very high [0.4] nm1128: yeah [1.3] therefore the trade diversion effect will be [1.1] sm1132: high [0.2] nm1128: high [0.9] that's the key point [0.6] okay [1.5] so we would expect the magnitude of the [0.4] trade diversion effect [0.7] where the agreement is [1. 0] between [0.4] an industrialized and developing country we would expect trade diversion to be large [1.4] because the sort of goods you import from the E-U will be a similar sort of mix of goods [0.4] to the ones that you import [0.4] from other industrialized countries [0.2] okay [0.5] no big surprise about that [2.4] so the elasticity of substitution then [0.9] that's the [0.2] it will will be high [0.2] that's the key parameter [1.1] which will determine the magnitude of the trade diversion effect [1.0] mm [2.1] now surprise surprise [0.5] nobody's been able to measure that one either [laughter] er [0.3] i'm not sure why [0.6] er you can look at there's a book [0. 4] everybody uses by Leamer and Stern which came out in the seventies [0.4] on elasticities and international trade [0.5] and everybody [0.3] says well [0.2] they say the figure's three [0.5] so [0.2] i'm going to use three [0.3] er [0. 4] and that's the figure that they've had to use you know [0.6] people talk about the the elasticity of subsitution [0.3] as being three [0.4] for the purposes of measuring the trade diversion effect [2.0] do you think that would be a a sensible figure to use that we're talking about a free trade agreement between an industrialized and developing country [1.7] given what we've just said [3.5] you're shaking [0.3] no i mean [0.8] you expect it to be what [0.5] slightly more lot more [2.7] sm1136: nm1128: yeah a lot more [0.3] mm a lot more okay [0.7] again the estimates that we work with [0.6] are estimates produced [0.3] for trade between industrialized countries [0.7] mm [0.6] which is still possibly the relevant one to use mm [1.6] er [0.2] but given the structure of imports [1. 4] er being heavily concentrated in investment goods and intermediate goods for a developing country [0.8] i would imagine that the elasticity of substitution [0.6] for this sort of trade agreement [0.3] would be higher [0.4] than the elasticity of substitution for an agreement [0.3] say between Britain and France [0.2] but [0.3] you know we could debate about that [1.7] debate about that [0.8] anyway [1.6] so [0.2] going back to this then [0.8] trade creation [0.6] what conclusion did we draw about that magnitude [2.3] sm1136: low [0.3] nm1128: fairly low we wouldn't expect it to be very great [0.2] right [0.4] but the differences in levels of income in structures of production [0.7] et cetera [0.8] okay between the E-U [0.4] and the developing country [0.8] and trade diversion [1.7] high [1.2] so [0.2] without doing any numbers at all [0.2] all right [0.6] simply looking at the at the determinants [0.7] of [0.8] trade creation and trade diversion [0.8] we're going to say [0.3] that [0.6] trade diversion will be greater [0.5] than [0.2] trade creation [0.7] okay [0.9] in which case [0.6] welfare will decline [1.4] and it's going to be g-, [0.2] going to take an awful lot of persuading [1.5] to er [0.9] tell us otherwise [0. 6] the only question then [0.4] is how big [0.6] [laughter] [0.4] er [0.2] you know [0.4] er [0.9] how big is the loss of welfare going to be [3.4] okay everybody happy with the static [0.3] Vinerian model [2.8] yes [0.4] sm1136: sign this [0.2] nm1128: yes well that's [laughter] that's exactly the thing i was just going to say [laughter] i obviously led into it quite well [0.5] er why do they sign it [0.3] mm [0.6] er why why do you sign it [0.3] and really the lest of the of of the lecture and probably b-, [0.2] a bit of next week [0.3] going to be trying to [0.5] explore why that's what economists have done ever since [0.5] sm1136: [1.5] nm1128: yes i mean we-, the-, the-, there's various er things we'll be through that's right [0.3] where it's the sort of long runs so people say that's a static effect [0.5] okay that's the once and for all effect [0.4] but there's other beneficial gains to investment and blah blah blah and we'll be [0.3] doing that that's right [0.5] but [0.2] that's the starting point okay [0.3] why sign it [0.7] i've given you a th-, [0.4] a third diagram there [1.0] which er [0.3] is taken from Bhagwati 'cause i think it's a useful one [1.2] er it's a variation on [0.3] the [0.6] er [1.1] on [0.3] on the model [2.5] because one of the magnitudes of this [0.2] er effect [0.9] is going to [0.2] er is going to depend also on the share [0.9] of the E-U in the total imports [0.3] of the developing country [0.8] mm [0.5] that's clearly going to be very important [1. 1] but haven't said anything about that we've just talked about the magnitude of the tariff change [1.9] but clearly the magnitude [0.3] of the trade creation effect [0.6] will be larger [1.5] the larger the share of the E-U in total imports of the developing country [0.6] mm [3.0] and [0.5] conversely the trade diversion effect [0.3] okay [0.7] er will be [0.5] er smaller [0.9] the smaller the share of imports from the rest of the world [0.6] other things we need [1.2] in the E-U a caveat [6.3] so [0.6] we've implicitly i think [0.2] er [0.5] in our previous models assumed that the share of the E-U was quite significant [0.5] that's why you're signing the agreement [0.5] okay you're [0.4] basically it's the developing country [0. 5] signing [0.5] a free trade agreement with its major trading partner [0.8] mm [0.3] and that's the usual pattern [1.2] what we're looking at here is the case where the opposite's true [1.4] where the developing country is signing [0.2] a free trade agreement [0.7] with an industrialized country that's a minor [0.4] trading partner [1.1] an example [0.3] would be the Caribbean countries [0.4] signing a free trade agreement with the E-U [0.9] okay Caribbean countries fundamentally their trade [0.6] is with the U-S Canada [0.3] and other Latin American countries [0.6] and the E-U account for a very small proportion maybe ten per cent [0.2] at most [0.8] of total imports [2.0] nevertheless the Caribbean [0.5] is heading on the route of signing [0.3] a free trade agreement with the E-U [0.4] round about two-thousand-and-six two-thousand-and-eight i mean it's terribly complicated [0.2] er [0.5] political dynamite all round [0.4] for obvious reasons [0.5] the U-S are not exactly going to be jumping for joy [0.6] er and [laugh] [0.3] the Caribbean can't er [0.5] can't really er afford to upset the U-S so [0.3] not quite sure but [0.6] if they want to [0.5] preserve their [0.2] preferential access for their exports of sugar [0.3] and for bananas [0.4] which are terribly important to these countries [0.5] they'll have to sign a free trade agreement [0.2] that's the that's the big dilemma they're faced with [0.3] sm1136: [0.6] nm1128: sorry the banana war again yes [0.2] no yes there'll be another one [laughter] [1.1] so this is an agreement then between [0.2] er the Caribbean countries and the E-U [0.4] with the E-U [0.2] counting a maybe only a small proportion [0.4] of imports [0.9] well as i put here [0.9] er [2.0] it's a question of price-takers and price-makers all right that we talked about last term [0.6] er [0.9] here [0.5] fundamentally [0.4] prices are set by the U-S [0. 2] okay that's the big source of supply [0.6] okay [0.7] and E-U producers [0. 2] simply [0.4] er [0.6] sell [0.6] er in [0.2] in the market at the price set by the U-S suppliers okay they have they're such a small proportion of the market [0.5] that they have no influence on price [0.7] okay [0.6] common sense assumption [0.6] okay [0.7] let me see what [0.3] what happens in this case [1. 3] well again we've got [0.2] free [0.4] er [0.4] w-, er er free trade [0.4] imports from [0.5] er the E-U [0.7] er here [0.4] and imports from the rest of the world call that United States [0.2] okay [0.7] but the difference in this case [0.7] is that because the U-S [0.3] is the major source of supply it's the price-maker [0.8] perfectly elastic supply [0.5] okay [2.9] the Caribbean however is a distant market [0.8] er [0.3] for E-U producers [0.8] substantial transport costs [1.0] only a small proportion of their export's going there [0. 5] so transport costs would be a significant proportion of total cost [0.6] so the supply curve will be anything but [0.2] perfectly elastic [0.8] er [0.2] it'll be fairly steep [0.9] re-, reflecting the fact that they [0.4] command only a small proportion of the market [0.8] price is set [0.2] here [1.2] so [1. 3] the U-S sets the price [0.3] in the Caribbean market [0.5] the E-U [0.4] suppliers provide [0.3] m-, move up their supply curve [0.7] until they hit point B [0.7] okay [0.8] and [0.5] er at that point [0.4] which is set by [0.6] the U-S [0.8] er [0.2] price [0.2] plus the tariff [0.8] okay [0.6] er [0. 2] then [0.4] that determines [0.3] imports from the E-U [0.3] O-Q-one [0.8] okay [1.2] and then the rest of imports come from the U-S [1.0] now let's take the tariff away from [0.5] er [0.2] imports [1.0] from the E-U [0.2] but not from the U-S [1.0] okay [0.5] free trade agreement with E-U [0.5] mm [1.2] er [0.5] in that case then [2.1] we show the effect of that by an output movement [0.5] of the E-U supply curve [0.9] okay [0.8] er [0.9] in which case imports [0.5] from the E-U expand from Q-one [0.4] out to Q-two [1.3] okay [2.0] the important thing to note [0.8] is that [0.3] nothing happens [1.1] to [0.2] the internal price levels [0.5] in the Caribbean [0.8] 'cause they're set by U-S suppliers [0.6] so it's U-S supply [0.3] plus the tariff [0.6] so it's the tariff inclusive U-S price [0.9] which sets the domestic price level in the Caribbean [0.6] mm [1.2] what the [0.5] E-U exporters do is simply maximize profits [0.9] with price is set by the U-S suppliers [1.6] so [1.0] imports from the U-S expand from Q-one out to Q-two [0.3] mm [1.0] er [0.4] there's a loss of tariff revenue to the Caribbean governments [0.7] of A- [1.1] C- [0.3] G-E [0.3] okay that area in there where they previously collected the tariff [0.7] now [0. 4] that's being lost [0.8] and guess who's getting it [1.1] su1138: [0.9] nm1128: no the E-U [0.3] okay [0.4] that got to be the U-S are still paying the tariffs excuse me [0.7] er [1.1] the but but the [0.3] E-U suppliers aren't paying the tariff [0.3] mm [0.6] nothing's happened to the domestic price level 'cause they're price-takers [0.6] okay [0.3] so that loss of tariff revenue [0. 3] goes straight into the pockets [0.3] of the E-U [0.2] exporters [0.9] very nicely thank you [0.4] mm [1.1] er [1.1] and that's it [1.4] there is no gain for the consumers [0.7] because nothing happens to the price [1.6] er [0.4] the [0.3] internal price level of the Caribbean doesn't fall [0.7] because [0.5] the E-U [0.6] er previously was accounting for maybe ten per cent of imports [0. 3] now goes up to fifteen per cent of imports [0.7] but it's not going to affect price [0.3] okay [2.9] you still get eighty-five per cent of [0.4] of imports coming from the U-S [0.3] that's what determines the internal price level in the Caribbean [1.7] so the price-makers [0.6] of the U-S exporters [1. 5] the E-U exporters are price-takers [1.0] mm [0.6] they can't influence price they're too small to do so [1.2] so they simply clean up [0.7] in terms of the of not having [0.4] having to pay the tariff [0.8] they previously had to [0.3] they simply [0.3] boost their profits [0.8] er no gain in consumer surplus [0.6] straightforward deterioration in the terms of trade from the Caribbean against [0.3] the E-U [0. 8] er straightforward transfer of government revenue [0.4] from the Caribbean governments and [0.3] people [0.9] to the E-U [0.2] producers [0.8] full stop [0.3] end of story [2.6] that's the price [0.3] of continuing to get access [0. 5] for your exports of sugar and bananas [3.1] and you can measure it [0.3] [laughter] [2.4] get to make the right assumptions [1.7] when i [0.3] i [0.3] actually went through this one when we because er as you know there's er all the [0.6] er will be up to about two-thousand-and-six two-thousand-and-eight [0. 5] the trade negotiations [0.4] er [0.2] going on [0.5] er [0.2] with the commission [1.6] er [0.3] over there that will be starting quite soon [0.4] and i went through that analysis er with the [0.3] and the with people over the the within the the commission [0.5] er there was a [laughter] [0.4] it wasn't favourably received [laughter] [0.6] er [0.4] people were unhappy with the idea that the price wouldn't change [0.5] er [0.3] but that's the reality i mean it's an empirical question [0.2] okay [0.7] but if you account for only ten or fifteen per cent of the market [0.4] and the Caribbean group [0.2] very helpfully [0.3] told me well actually that was a bit high [0.4] it's about seven or eight per cent actually you know in many countries [0.6] then you're a price-taker you don't influence price [0.4] and that's what the whole analysis [0.2] hinges on [0.7] er [1.2] so that's er by way of er a variation of a theme yeah sm1132: one question [0.4] the role of the U-S company in that last model [0.3] nm1128: yes [1.4] is to get very upset you know sm1132: [1.2] as a price-ma as a price-maker i mean [0.5] how [0.3] i mean how how will the U-S respond [0.9] nm1128: well they get very upset [laughter] [0.2] yes i mean er [0.2] it's obviously it's it's crowding out [0.3] er imports from the U-S [0.7] that's right [0.6] yeah [0.2] that's it sm1132: so [0.7] is there anything the U the U-S [0.8] will do in that situation nm1128: yes i mean that's the that's the big issue that's the dilemma which the Caribbean countries are faced with [0.4] sm1132: how nm1128: because at the at the [0.2] currently [0.4] they have [0.5] er [0.3] under the Caribbean Basin Initiative [0.6] they have preferential access to the U-S market [0.7] principally for clothing [0.2] i mean that's the key one for them really [0.7] er [1.0] you know [0.7] i can't imagine the U-S standing by and continuing to allow them that preferential access [0.6] while their exporters are saying but we're losing market share [1.3] sm1132: so isn't the isn't rea-, [1.3] to the er [0.8] Caribbean countries in this example [0.7] are better off sticking with the price-maker [0.9] than rather nm1128: and [0.2] but then if they don't sign the free trade agreement they lose their exports of sugar and and bananas [0.5] and that cause large scale unemployment in Jamaica and in the [0.6] er [0.2] you know the er [0.3] er Windward Islands [0.3] sm1132: but then again if if if that happens then the U-S [0.4] might retaliate [0.2] say well [0.4] you know nm1128: yeah sm1132: to import from nm1128: yeah [0.4] sm1132: Indonesia or somewhere else nm1128: and then the [0.3] so [0.3] so the guys in the in the in in the sugar and banana plantations [0.5] do all right but the guys in the clothing industry are unemployed sm1136: nm1128: [laughter] [0.2] yeah that's the dilemma they've got [1.2] sm1136: nm1128: right sm1136: [0.6] nm1128: yeah [0.4] sm1136: nm1128: mm sm1136: [0.2] nm1128: well [0.2] that is well th-, yes that is exactly what the Caribbean and and and CARICOM in particular the Caribbean community [0.4] which is a free trade agreement in fact it's it's moving over to a customs union [0.6] there [0. 3] and they're physically signing i mean some of those hundred-and-six agreements i mentioned [0.4] were between CARICOM [0.7] er and various Latin American countries 'cause they see that as being their future sm1136: nm1128: yes sm1136: nm1128: yeah [0.3] yeah that's right that's right so er better off [0.2] building up your trade with Latin America [0.4] yes [0.2] i mean [0.2] i a-, again it's an example of of [0.4] the patterns of trade not being determined so much by [0.4] purely economic considerations [0.4] as by a colonial heritage [0. 9] er that's why their export in sugar and bananas to Europe [0.6] er [0.3] in a free trade situation [0.7] they may or may not be doing so probably wouldn't [0. 8] er free trade probably sugar will be coming from India or from Brazil or somewhere like that [0.5] where a a very low cost producer well it's from Australia [0.2] are a very low cost producer [0.5] not from the Caribbean i mean that's a reflection [0.4] of the fact that were British colonies [0.7] er i'm not saying that market [1.8] er but and that's created a dilemma [0.9] and similarly with clothing you see the clothing industry [0.3] in Jamaica which is a quite an important source of employment for them that live there [0.9] is principally because of the [0.4] Caribbean Basin Initiative it's because of preferences in the U-S market [0.4] without those preferences [0.4] again in a free trade situation [0.4] the clothing would come from Asia [0.5] not from Jamaica [1.0] i mean Jamaica then says well what the heck are we going to produce [0.5] but [0.5] but [0.2] you've got the answer i mean the answer is that it'll be other things which of course we don't know about [0.4] because they don't exist [0.7] but [0.4] er the obvious trade pattern would be towards Latin American countries [0.3] that have a different resource base a different level of income [0.6] a different stage of technology [0.4] so the two economies are complementary to each other [0.4] and that's the future for these countries' problems [1.6] but that gets us away from [0.8] here anyway that's just er a variation on the [0.7] on the i mean th-, th-, the the previous models assume [0.6] that the [0.5] partner country in the trade agreement was a price-maker [0.3] okay [0.4] this is a case where [0.3] the partner country's a price-taker [0.6] with the rest of the world [0.3] determining the price [0.3] and that alters the analysis [3.3] okay so [0.2] why sign the damn thing [laughter] you know [laughter] er [1.9] and that's er as i say that's the question which everybody has er [0.7] you know [0.2] really [0.2] teased their brains about [1.7] er [2.8] you have to look to the so- called dynamic [1.0] arguments okay [0.5] i don't like the term dynamic because we've nicked it off [0.2] thermodynamics or [0.2] physics or something like that [0.6] er [0.2] growth enhancing [0.2] i think is more accurate [0.3] okay [0.8] er [0.2] phrase so it's a growth enhancing [0.5] effects of a free trade agreement [0.3] what might they be [1.2] 'cause remember [0.3] trade creation and trade diversion [0.3] are once and for all [0.3] static effects [0.4] okay [0.3] they just have a once and for all impact [0.4] and that's it [0.3] okay [1.0] fundamentally what we're talking about here [0.2] is accelerating the growth of these countries [0.6] okay [0.4] it's a continuous process [0.8] so [1.0] okay [0.2] trade diversion might be greater than [0.5] trade creation [0.8] all right [0.7] but that's just a once and for all cost if you like [0.5] mm [0.9] er [1.1] is there something about the free trade agreements that [0.5] has a continuous effect [0.3] on [0.7] increasing output year by year [0.4] more rapidly [0.5] than would otherwise have occurred [0.4] if you hadn't signed the free trade agreement [0.9] and those who favour free trade agreements say those are the really important things [0.3] those growth enhancing effects [0.3] they're the really important ones [0.5] but they're difficult to measure [0.9] rather fortunate that perhaps but [0.6] er [0.3] the other ones are difficult to measure anyway [1.0] so the first one then [0.2] obvious one [0.4] is [0.2] er [0.2] economies of scale [0.8] okay [1.5] basically the argument is a simple one [1.8] er [1.1] the developing country [1. 6] has access to a wider market [0.9] so [0.3] previously if you imagine producers [0.3] simply selling [0.5] in the home market [1.0] the home market's small [0.5] 'cause you're a small country small size of population [0.6] and you've got a low level of [0.5] per capita G-N-P [0.8] so [0.4] er [0.2] the effect of that [0.4] is er [1.3] er [0.7] to mean that [3. 5] if that's the [0.4] long run average cost curve [4.1] er [0.8] then [1.0] you know [0.2] it [0.6] you're probably this is [0.8] cost [0.8] output [4.0] your small size of the domestic market [5.7] producing a P-A just producing [0. 4] er a production for the [0.3] for the for the home market [0.8] er [0.9] means that you're operating at quite high [0.3] average cost of production [1. 5] you then sign a free trade agreement gives you access to this huge E-U market [0.7] i don't know how many million people there are i've forgotten how many there are in the E-U sm1132: two-hundred-and-forty something like that nm1128: right sm1136: three-hundred-and nm1128: yeah sm1136: [0.5] nm1128: yeah three-hundred-and-fifty-million people okay [0.3] and instead of your population of [0.4] twelve-million [laughter] er [0.5] so [0.2] you don't need too many of that three-hundred-and-fifty-million people to buy your goods [0.5] to be able to move somewhere out here [0.6] okay [1.3] er so [0.4] you may er having [0.8] free access [0.6] unrestricted access to this huge market [0.6] enables you to increase exports [0.7] expand productions way above the constraint [0.5] of the [0.6] er domestic market [0.6] and you move down your long run average cost curve [0.7] okay [0.8] and that makes you even more competitive of course [1.2] than you were before [0.6] and so exports expand even more [0.3] so you get a [0.2] a virtuous process [0.8] if you're moving down [0.4] if you expand your exports [0.4] you're moving down the long run average cost curve [0.5] because you're more efficient than you were before producing a [0.3] lower average cost than before [0.3] you sell more output [0.3] and so you go on [0.9] moving down [0. 4] the average cost curves in that way [1.4] sm1132: i'm sorry just er [0.3] one point [0.3] is the assumption here that er [0.7] we have free er [0.4] trade agreement just between [0.7] the developing countries and [0.2] for example the E-U [1.0] er but what what if we say well [0.5] got er [0.2] free trade nm1128: mm sm1132: [0.3] you know w-, with the whole world [0.3] then obviously [0.6] do we have still economies of scale then [0.6] that is the question [0.2] nm1128: well then it gets complicated for the reasons that you've [0.2] indicated because everybody else has got a free trade agreement [0.2] all right [0.6] er so you've just got free trade i mean ultimately then you've just got world free trade [1.3] in which case comparative advantage should work on a on a world basis [0.2] all right [0.5] and [1.0] provided you've got a comparative advantage in this product [1.0] the same argument should hold [0.8] mm [1.6] i mean [0.4] the only difference is that this might hold for a product in which you don't have a comparative advantage [0.5] on a worldwide level [0.5] all right [0.4] but you do in terms of trade with E-U [0.5] so if you just had a an agreement between Morocco and E-U [0.3] nothing else in the world [0.8] all right [0.2] Morocco can move down its long run average cost curve say for clothing [0.4] it's an important industry in Morocco [0.6] okay [1.4] mm [0.7] er because it doesn't have to compete with Asia and the rest [0.5] but if the E- U signs agreements up with all the Asian countries and Eastern Europe and everybody else [0.2] okay [0.4] then that might not hold [0.3] you had to have a comparative advantage at a world level [1.3] so er [0.4] i mean in a sense you see what what i'm saying is that [0.6] er [0.2] a preferential trade agreement can create a false comparative advantage [0.8] mm [1.1] because [0.2] you have free access to the E-U [0.6] but the rest of the world doesn't [0.4] okay [0.8] then you're more competitive but it's a false [0.4] comparative advantage [0.9] mm [0.5] and as more agreements are signed [0.5] you might well find that you've committed yourself to produce clothing [0.8] but then [0.2] you're left high and dry because you're a high cost producer [0.8] just that the Caribbean countries [0. 6] er [0.2] had a false comparative advantage in selling bananas in the U-K market [0.6] or sugar cane in the U-K market [0.6] only because they have preferential access [0.2] to to to Britain [0.7] but Australia [0.6] Brazil [0. 7] er Ecuador in the case of bananas and so on [0.5] er didn't [0.3] mm [0.6] so it created a false comparative adavantage they built up these industries [0. 7] and now [0.4] when we've got free trade virtually on those products [0.6] er they can't survive without preferences [1.1] sm1132: so basically [0.4] as the [0.3] for example the European Union er signs more and more trade agreements nm1128: yes sm1132: which it's which is in the process of doing so now nm1128: yes that's right sm1132: with the [0.5] Caribbean with Eastern Europe and [0.2] other countries [0.5] er nm1128: that's right [0.6] sm1132: and so so basically that preferential [0.7] er lose nm1128: margin sm1132: er it loses it's er significance nm1128: absolutely [0.2] absolutely [0.2] that's right [0.3] that's right [0.8] er yes [0.2] i mean it's er [0.8] yes i mean it [0.2] whi-, which of course [0. 5] er [0.3] those who say [0.3] therefore free trade agreements are stepping stones [0.6] to multilateral trade liberalization might [0.3] exa-, you know say well that's exactly what i'm saying [0.4] mm [0.8] that they're just stepping stones [0.2] to world free trade [0.8] i shall point out at the end it's not quite as simple as that [0.7] 'cause the agreements differ [0.2] in their content [0.5] and that creates barriers to trade [0.8] but that's getting a-, that's jumping the gun a bit [1.2] but that's right we're talking as if it was the only agreement in the world [0.4] mm [0.7] er [0.7] obviously if it isn't [0.3] then that [0.6] that reduces the gains [0.4] to Morocco [0.3] or wherever it happens to be [0.7] but then we move over more to [0.6] just global or multilateral trade liberalization getting closer to that [0.7] perhaps [2.5] okay so the first dynamic gain might be economies of scale you move down your long run average cost curve [0.9] the second one the familiar one to us from any trade liberalization [0.6] er greater competition [0.6] mm [1.1] to the extent [0.2] that imports [1.0] compete with domestic production we're back to that argument again [0.6] the elasticity of substitution between domestic production [0.3] and imports [0.6] if that's small [0.4] then [0.7] that argument's not terribly important [1.4] er [1.2] but it's still going to e- , [0.2] exist [0.5] a wider choice of goods [0.4] okay previously you'd all sorts of barriers to trade [0.8] i mean [0.6] many developing countries in the past anyway [0.7] simply prohibited a whole range of imported goods [0.4] so as to conserve foreign exchange [0.4] for so-called essentials [0.5] mm [0.7] er [0.3] free trade [0.5] widens choice [0.3] that's a a welfare gain in itself [2.0] increase in foreign direct investment [0.2] people particularly emphasize this gain here [1.1] and [0.6] er [1.7] the two terms here investment creation [0.4] and investment deflection [1.9] er [9.7] investment creation somebody tell me about that [2.3] sm1135: er [0.7] it's like sm1135: the share of the market [1.8] [1.8] nm1128: right [0.2] okay [0.5] so we've got two [0.2] forces working just like the trade aspect [0.5] okay [1.1] first of all let's again go back to our agreement between E-U and Morocco [0.4] mm [0.8] now er er previously we had barriers to trade between the two countries [0.7] er [0.8] let let's assume that was the case [1.0] er [0.2] now we've a situation where there's no barriers to trade at all [1.8] a producer of say clothing in France [1.3] where labour costs are high [0.8] mm [1.2] can now close down that factory [0.8] relocate it in Morocco [0.3] where labour costs are much lower [1.9] er and then export [0.5] er the output back into France again [1.6] so that the [0.8] er the manufact-, the the the clothing manufacturer [0.5] can now serve the domestic market in France [0.4] much more cheaply than they could before [0.9] er [0.2] as a result of the preferential trade agreement [1.0] mm [1.2] so [0.4] er that's one gain from the free trade agreement [1.2] yeah sm1135: so the [0.3] [cough] there would be in er inves-, investment diversion from the [1.7] nm1128: in the sense of [0.3] sm1135: in the sense of [0.2] maybe er [0.6] an investor will move er [0.5] and then the export [0.2] nm1128: yes that was the case i was i was i was going though just now sm1136: [0.6] nm1128: well it's i-, er er it's normally called in-, [0.2] in-, [0.2] investment deflection [0.3] that one sm1136: nm1128: okay [0.7] er but it's it's a bit i mean it depends which as you say which wh-, which standpoint you view it from [0.8] er but if you're viewing it from the E-U point of view [0.4] it's investment deflection [0.8] okay [1.5] er [0.6] in the case of the [0.6] er say [0.2] the United States [0.2] okay [0.6] that was [0.3] previously [1.2] selling goods in the [0.2] you know that that was exporting goods [0.3] to Morocco [0.3] mm [1.0] but now a trade diversion against it [0.6] okay [0.9] it may wish to retain its market share [0.4] in Morocco [0.9] okay [0.3] in which case it replaces its exports [0.4] by investment [0.5] in [0.4] a plant [0.5] which will [0.3] produce [0.2] the goods previously exported [0.5] and that's called investment creation [0.8] right it's called [0.3] i-, it's the creation of investment because investment [0.4] is taking the place [0.4] of exports [0.4] as a way of servicing the market [6.1] so [0.3] yeah [0.3] sf1137: [0.6] nm1128: yes previously i mean let's say they were selling say agricultural machinery to Morocco [0.5] and they were exporting that from the U-S to Morocco [0.9] now because [0.5] of [0.2] o-, of trade diversion [1.0] the-, the-, they they've lost the market [0.7] the market was big enough [1.1] then they might say we want to retain our market share [0.5] by jumping [0.2] the tariff wall [0.6] in in Morocco if there's still place for it [0.6] and setting up an assembly plant for [0.5] the combine harvesters the tractors [0.3] in in Morocco [0.4] and in s-, and and and [0.2] and continuing [0.7] to retain its market share [1.6] sf1137: nm1128: right sf1137: nm1128: i-, [0.6] i-, [0.4] i-, [1.1] investment deflection [0.3] yeah sf1137: invest deflection nm1128: yeah investment deflection is France [0.8] er [0.5] closing down a factory in France [0.4] and setting up a clothing factory in Morocco [0.7] it's deflecting investment [0.4] from investment in the home country [0.3] to [0.2] investment [0.5] in in Morocco [1.4] sf1137: other word for deflection [0.3] nm1128: these are the [0.3] technical terms that are used in the literature [0. 2] sm1135: de-investment nm1128: sorry [0.2] sm1135: de-investment [1.4] nm1128: yes i mean i-, [0.2] it's ca-, it's called deflection [0.6] because [0. 4] it's simply in-, in-, investment taking place in a different geographical location [0.6] mm [0.6] but the total amount of investment hasn't increased [0. 7] all right [0.4] it's just been deflected [0.3] to a different geographical location [0.4] hence the word deflection [1.0] [laughter] [0.3] not a not that [0.6] i mean if you can imagine sort of investment flowing [0.3] in into France [0.4] over the years [0.5] then the preferential trade agreement's signed [0.6] and it's closed off there and it's deflected off down towards Morocco [0.5] okay [1.4] that's [0.3] whereas the other case is creation of investment that didn't exist before [0.5] okay [0.3] you're not closing anything down in the United States necessarily [0.3] i mean they'll probably sell the factory somewhere else [0.7] what you're doing is [0.5] in-, instead of servicing the market through exports [1.0] you now service it through investment [0.2] in a production facility [0.7] so it's i-, it's creation of investment [0.3] that didn't exist before [0.9] sf1137: but it is the U-S would have to look what to do with nm1128: yes but we don't ask that question [0.2] that's right [laughter] [1.3] 'cause that's the rest of the world [0.5] and the rest of the world's very big [0.6] all right [0.8] er and Morocco's very small [0.4] so we needn't bother about that question that's all we're saying [4.3] so [0.5] er [0.4] whoops [3. 7] the the the first case [0.2] er we-, well i mentioned here anyway the the the investment deflection [0.2] can be quite important i i [0.2] didn't pick clothing by accident [0.6] er [0.2] 'cause it's the one in which you very often see this [0.4] er [1.3] where [0.4] er [0.6] particularly the the labour intensive stages [0.3] of the production process [0.6] could often be [0.2] relocated [0.8] from [0.3] the industrialized country [0.2] to the developing country [0.4] that's what the U-S is doing in Jamaica [0.2] talked about the Caribbean Basin Initiative agreement [0.7] er [0.2] this is what France indeed has done in Morocco all right [0.5] and that is what Egypt is hoping will happen [0.4] er if it signs a free trade agreement [0.4] er with the E-U [0.4] that there'll be this outward processing [0.8] er will take place on quite a large scale [1.0] whether that's beneficial or not for the country is another question [0.2] we talked about that under on direct investment [0.6] but that would be a clear case of investment deflection mm [0.5] investment creation would be the U-S [0.3] coming in to Egypt [0.4] because [0.5] they er they're they're losing their market [0.3] and it's a big market for the U-S [0.4] yeah sm1132: just one question [0.5] say you're a policy maker in Morocco or in [0. 3] the Caribbean [0.8] and er [0.6] you've done your analysis you've looked at the gains you have [0.8] and of free trade agreements well i've got on one side er [0.7] er [0.3] trade creation [0.6] the other hand i've got [0.6] trade diversion [0.3] but i also have dynamic er [0.6] dynamic gains along with that nm1128: right sm1132: [0.5] er i mean [0.5] you have nothing to measure you have [laughter] nm1128: no that's right sm1132: you know [0.3] how do you how do you decide this case and it's very difficult nm1128: yeah sm1132: it's a very difficult choice nm1128: er sm1132: [0.5] to make [0.3] nm1128: yeah i mean you just have to in the end you have to trust your judgement [0.7] er [0.5] all you can do however is analyse the situation [0.3] okay [0.2] and what this does is provide you with a framework of saying [1.6] are these things going to be important [0.2] okay let's go back to the Morocco case [0.3] all right [1.1] er Morocco actually had [0.3] already had preferences with the E-U [0.4] okay [1.0] so [0.4] at the stimulating an effects on its exports [0.2] were zero [1.2] okay [0.6] because they already had preferential access under a bilateral agreement [0.5] so Morocco could say [1.1] forget that [0.5] economies of scale [0.4] okay [0.7] because we've [0.2] we [0.3] we reaped those in the past [0.2] all right [0.3] er er and we're not being given any more preferences [0.8] greater competition [0.7] er [0.7] well [0.9] the goods that we import from E-U [1.0] compete to a limited extent with domestic production but not a lot [1.0] so that's not going to be great [1.1] wider choice of goods [0.4] similar sort of argument [0.7] er maybe a little bit more than we did before [0.6] because we had but we're already dismantling barriers to trade anyway [0.3] you know [0. 9] er so that's not going to be great [0.3] increased foreign direct investment [0.6] er [1.0] well [0.7] what's changed you know [0.3] er [0.6] the only thing that's changed that may be important [0.4] is [0.4] that [0.2] my tariffs on importing goods setting up a production facility in Morocco [0.6] er [0.6] the er er i-, i-, er it's certainly i-, [0.2] it's more profitable to set up a production facility in Morocco than it was before [0.7] if a French [0.5] er clothing manufacturer was setting up a factory [0.3] in Morocco [0.4] all the machinery [0.4] and the intermediate goods would have to pay duty [0.7] previously [0.6] er [0.2] but [0.4] er they [0.2] they no longer have to do so [0.9] er [0.6] but the duties usually are not terribly high on these products [0.2] in developing countries it's consumer goods that carry the very high tariffs [0.8] i mean it may be tariffs of [0.4] you know ten per cent or so so it might make a difference [0. 6] er but not a [0.3] a dramatic amount [0.9] and am i going to get investment from the rest of the world [1.6] i'm a tiny little market [0.2] right [0.7] if this is Brazil that's signing an agreement [0.5] okay [0.5] then sure [0.2] i mean as soon as as [0.2] er as the Mercasor agreement was signed [0.2] American investment poured in [0.7] er to retain market share [0.2] very big market [0. 7] Brazil er b-, t-, er er er er Morocco [0.5] what's its population did we say [1.1] sm1133: nm1128: sorry [1.4] sm1133: [0.3] nm1128: is it as much as that sm1132: i don't think it's that much sm1133: sm1132: it's even less than that nm1128: mm yes [0.2] it's pretty small sm1133: nm1128: and and Tunisia's what about twelve-million [0.5] sm1135: [0.3] nm1128: yeah [1.6] yeah [0.2] yeah [0.5] so we've we've got a small [0.2] er a small market [0.2] so [0.2] thi-, this is the way you'd go through it [0.4] yeah sm1135: [0.8] nm1128: right sm1135: [0.7] nm1128: yes if you sm1135: nm1128: mm sm1135: the er access to er [0.5] Moroccan or Egyptian market nm1128: mm sm1135: [1.2] nm1128: that's right [0.9] so y-, but you you have to i mean going through the point y-, y-, d-, you already had preferential access before [0.5] so you ask the question how much has it increased [0.5] all right sm1135: yeah potential nm1128: yeah [0.6] now one key thing though is that [0.6] you you may have had preferences before but they were unilateral preferences [0.5] a free trade agreement [0.4] is [0.3] a a binding agreement [0.2] mm a legally binding agreement [0.2] of indefinite duration [0.9] and that might give the investors [0.2] greater confidence [0.4] than they had under the previous thing [0.6] so that might be a big plus [0.3] and these are the questions i mean what this does is provide a framework [0.4] for asking a whole series of questions [0.9] that's i can forget about that one that's not going to be terribly big [0.3] that's going to be small [0.7] this one might be big it might not [0.2] we have to look at that more carefully [0.4] and that's what it does [0.4] and then at the end of the day [0.4] you make a judgement [2.9] but the big question too is all of these things i've mentioned here [0.3] you could get from unilateral trade liberalization [0.5] at least a lot of it anyway [0.4] mm [1.0] er i mean you wouldn't nes-, i mean you wouldn't get the so much the investment creation investment deflection effects that wouldn't tell us very much [0.7] but the other ones economies of scale greater competition [0.5] wider choice of goods [0.7] er [1.0] we'd all [0.4] i would all get if i simply lowered my barriers to trade with the world as a whole [1.1] and there'd be no trade diversion cost [0.9] mm [5.7] so again we come back and think why the hell did we sign the agreement right [0.8] er [0. 6] okay [0.2] there might be this [0.2] er investment creation investment deflection effects to the extent that they're important [1.0] er [0.2] as i say [0.4] i would [0.7] think fundamentally that depends how big an economy you are [0.6] mm [0.9] if you're a small economy i wouldn't expect it to be terribly great [0.7] may be wrong [0.8] er Mauritius might be an example where it was quite substantial [0. 5] mm [0.7] er where [0.4] you know it's it's the [0.2] third largest exporter of woollen clothes in the world [0.6] and it's a tiny little island [0.8] and that's [0.2] largely because of preferences [0.5] so [0.7] yeah we got to be careful with that one [0.4] i-, i-, it could be important [1.1] er [1.6] but er [0.9] so so maybe that's important but [0.2] in terms of stimulating foreign direct investment because [0.3] duties on imports of capital goods and intermediate goods have come down [0.4] well [0.2] liberalize to the world as a whole [0.4] mm [0.5] so investors can then buy [0.8] capital goods and intermediate goods at world prices [1.1] mm not simply [0.5] er at whatever price [0.3] the E-U exporter [0.2] sells them to you [1.2] so we still got [0. 8] really we still haven't really answered the question [1.1] why sign the agreement [0.5] we've got the gains from trade [1.0] but why not just get those [0.4] on a non-discriminatory basis through unilateral trade liberalization [0.5] why do it in a in a discriminatory way [1.0] we've still got that puzzle [1.4] well [0.9] er [0.6] next week i'll go through some new thinking [0.5] and er [0.2] to explain [0.6] why some of the what those gains might be [0.8] i've hinted at one of them already [0.8] that is in an uncertain world [1.1] binding yourself in to a free trade agreement [0.4] provides you with a bit more certainty [1.3] so if i engage in unilateral trade liberalization [0.7] and it's or [0.2] maybe with other countries [0.6] er negotiate reciprocal tariff reductions in the W-T-O [0.9] er there's always the danger [0.5] of going back to the nineteen-thirties [0.4] all right there's always [0.2] the W-T-O [0.4] has been weakened [0.2] by the Seattle [0.7] er situation that we've talked about before okay [0.5] maybe it's not quite such a strong organization that we thought it was [0.6] okay [0.5] maybe if there was serious unemployment in the industrialized countries [0.4] the whole agreement would just be torn up [0.6] and we'd be back to the [0.5] er er discrimination and [0.5] er barriers to trade of the nineteen-thirties [0.2] you know that's not improbable [1.6] but if i lock myself in to the E-U or to United States through a free trade agreement [0. 6] maybe that gives me a bit more certainty [0.8] okay it's a i-, it's a [0.2] it's a legally binding agreement [0.8] you'd build up institutional arrangements which link you in with the other country [0.7] so when push comes to shove [0.4] all right [0.5] if we if we did have a bit of a recession in the u-, in the E-U or [0.2] or United States [0.5] they'll discriminate against other people [0.9] er [0.2] not against me at least not in the first instance [0.8] all right [0.7] so [0.2] bit more certainty then perhaps [0.4] yeah sm1132: nm1128: well it [0.6] yeah i mean in the case of Eastern European [0.2] agreements [0.2] it's heavily political [0.3] all right you're trying to reinforce [0.4] the overthrow of communism [0.4] er democratic governments as long as they're not communist governments [0.4] er and so on [0.7] that's right [0.2] so i mean that was a heavy political element in that one [0.5] that was the top of the of the agenda [0.6] and the E-U was willing to pay quite a high price [0. 5] to maintain that [1.3] with the other dev-, o-, other developing countries [0.6] not really willing to pay a price [0.4] and that in a sense is part of the of of also of the puzzle [0.6] the developing countries in effect i mean from what we've said [0.4] have to pay quite a high price [0.8] upfront right at the beginning [0.6] for these agreements [0.6] okay that's the welfare loss [0.5] there's the rising unemployment as industries close down that are competing with imports from the E-U [0.4] there's the loss of government revenue [0.5] you know there's a lot of upfront costs [0.3] for the developing country [1.1] from the agreement [0.8] really not much cost [0.6] for the industrialized country [0.5] mm [1.0] so why do they sign [0. 6] why do developing countries sign these agreements with industrialized countries [0.7] hinted at one of them [0.4] and that's that's increased certainty i think that figures quite prominently [0.8] but there's other [0.3] aspects as well [0.3] that we'll talk about next week [0.5] to do with [0.4] timing consistency problems signalling [0.4] all sorts of other things that we [0.4] talk about [2.7] any final points [2.1] okay [0.5] well i'll carry on doing the theory and then we'll [0.9] talk a bit more about actual agreements next week [0.7] and then we'll get on to talk about article twenty-four [0.4] and er [0.2] how it [0.3] i-, its weaknesses [0.6] and how [0.2] it needs to be reformed [0.5] hopefully in a [0.2] Seattle type row whatever it's going to be called [0.4] [laugh] [1.5] thank you