Below are the benefits and costs of foreign trade.
World Trade Organization The World Trade Organization (WTO) promotes free trade between all of its member countries. The WTO provides a forum for free trade negotiations by conducting rounds, a series of negotiations designed to lead to major free trade agreements. The WTO also settles trade disputes between member countries and sets trade rules.
The WTO has two principles behind its agreements. The first is the ‘most favoured nation principle’, any WTO member who reduces a tariff on another member’s goods must reduce the tariff for all other members. The second is ‘national treatment’, member countries must treat their own goods and imports from other member countries the same, they cannot discriminate.
Let’s say the US and Germany are two member countries of the WTO and Germany puts up a tariff on cars imported from the US. The US can appeal to the WTO who should then either make Germany remove the tariff or let the US put up a tariff against cars imported from Germany to cause an equal amount of damage as the original German tariff.
The WTO’s powers, however, are fairly weak. The WTO can only influence the trade actions of member countries. Also, fines may be more effective but the WTO are not allowed to fine members. Moreover, the WTO may favour rich countries over LDCs. Rich countries may be treated differently than LDCs, for example, many rich countries have tariffs against imports from LDCs.
Trading Blocs A trading bloc is a group of countries that allow free trade within their bloc but may impose tariffs on countries outside the bloc. There are three types of trading blocs:
1) Free Trade Area.
A free trade area is one in which all trade barriers are removed between member countries. Each member can impose its own restrictions on goods from outside the free trade area.
A free trade area exists between the US, Canada and Mexico, this is called the North Atlantic Free Trade Agreement (NAFTA). Another free trade area exists between Brunei, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam, this is called the Association of South East Asian Nations (ASEAN).
2) Customs Union.
A customs union is where there is free trade within the trading bloc and a common external tariff on goods coming from outside the bloc.
3) Monetary Union.
A monetary union is a customs union with a common currency between members. A central bank must control the single currency, monetary and exchange rate policy for all members. An example is the European Monetary Union (EMU).
Conflict Between the WTO and Trading Blocs The WTO promotes free trade and will be happy with the free trade that exists within a trading bloc because this leads to trade creation, that is, the production of goods moves from high cost countries to low cost countries. But, the WTO will be unhappy with the tariffs and quotas that trading blocs impose on countries outside the bloc because this leads to trade diversion, that is, the production of goods moves from low cost countries outside the bloc to high cost countries within the bloc.