🔄 Trade Creation and Trade Diversion
Trade creation.
Trade diversion.
Example: Country A joins a customs union with Country B.
Trade creation: A previously produced steel domestically at $100/tonne. B produces at $80. After the FTA, A imports from B — cheaper, more efficient → welfare gain.
Trade diversion: Before the union, A imported cheap rice from Country C (non-member) at $50. After the union, the CET makes C's rice cost $70. A now imports from B at $60 — but B is less efficient than C. The cheapest source is blocked → welfare loss.
✅ Advantages of Economic Integration
- Trade creation — improved resource allocation as production shifts to lower-cost producers.
- Larger market access — firms benefit from economies of scale and lower average costs.
- Greater competition — forces firms to become efficient, innovate, and lower prices.
- Increased FDI — larger markets attract foreign investment (e.g. car factories in EU to access 450m consumers).
- Political cooperation — economic ties reduce the likelihood of conflict between members.
- Stronger bargaining power — a bloc can negotiate better terms in WTO and bilateral deals than individual countries.
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❌ Disadvantages of Economic Integration
- Trade diversion — imports may shift from efficient non-members to less efficient members.
- Loss of sovereignty — members surrender control over trade policy (and possibly monetary policy in a monetary union).
- Unequal distribution of benefits — larger, richer members may benefit more than smaller ones.
- Structural unemployment — industries exposed to competition from partners may close, causing job losses in specific sectors.
- Regulatory burden — harmonising rules across countries is complex and costly.
- One-size-fits-all monetary policy — in a monetary union, one interest rate may not suit all economies (e.g. Greece vs Germany in the Eurozone crisis).
IB essay structure: For and against integration → evaluate → 'It depends on...' whether trade creation outweighs trade diversion, whether the bloc is between similar or dissimilar economies, and the depth of integration.