Quiz 12: Trade Blocs and Trade Blocks

Business

No. The most favored nation principle states that any trade policy concession given by a country to any foreign country must be given to all other foreign countries having MFN status. WTO rules state that all WTO members are entitled to MFN status, but there are some exceptions. A trade bloc is one exception. Countries in a trade bloc treat imports from other member countries more favorably than imports from outside countries.

In a free trade area the member countries permit free trade among themselves but each maintains its own set of tariffs and nontariff barriers to imports from outside countries. Rules of origin are necessary to prevent outside countries from sending their exports into a low-barrier member country and then shipping these products on to a high-barrier member country, to circumvent the high barriers in this second member country. Rules of origin can be protectionist in two ways.  First, they can make it harder for firms in one member country to export to other member countries (contravening "free trade" between the member countries).  Second, they act like area-wide local content requirements. If a high local content is required, then it can force firms to use materials and components produced within the free trade area (rather than importing these items from outside the area).

That standard estimates are that Mexico has probably gained from NAFTA, as trade creation is likely to have been larger than trade diversion, and Mexican firms also gain from better access to selling to the large U.S. market. In Mexico, the gains are largest for those sectors tied to exports and for those resources (including less-skilled labor) that are relatively abundant in Mexico. The standard estimates are that the United States and Canada also probably have gained, with gains to those export sectors that can increase their sales to Mexico and to resources that are relatively abundant in these countries, including skilled labor. (There is also some research that suggests that trade diversion has been larger than the standard estimates, so that the net gains from trade creation and trade diversion for the member countries are close to zero.)  Outside countries are hurt by trade diversion.