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Trade creation and diversion effects for International Business Mcom sem 2 Delhi University


Trade creation and diversion effects for International Business Mcom sem 2 Delhi University

Trade creation and diversion effects for International Business MCOM sem 2 Delhi University:- we will provide complete details of Trade creation and diversion effects for International Business MCOM sem 2 Delhi University in this article.

Trade creation and diversion effects for International Business MCOM sem 2 Delhi University:-Trade creation

Trade creation is an economic term related to international economics in which trade flows are redirected due to the formation of a free trade area or a customs union. The issue was firstly brought into discussion by Jacob Viner (1950), together with the trade diversion effect.

In the former case after the formation of economic union, the cost of the goods considered is decreased, leading to an increase of efficiency of economic integration. Hence, trade creation’s essence is in elimination of customs tariffs on inner border of unifying states (usually already trading with each other), causing further decrease of price of the goods, while there may be a case of new trade flow creation of the goods between the states decided to economically integrate.

The opposite takes place in case of trade diversion, when the trade flow is diverted from actually cost-efficient partner state to less efficient one – but which became a member of economic union and made its goods cheaper within a union, but higher compared to the rest of the world. In practice, both trade creation and diversion effects take place due to formation of economic union. Efficiency of economic integration of specific union right now is assessed as a final outcome between trade creation and diversion effects: it is cost-effective in case of prevailing of the trade creation effects, and vice versa.

Trade creation and diversion effects for International Business Mcom sem 2 Delhi University:-Occurrence of Trade Creation

When a customs union is formed, the member nations establish a free trade area amongst themselves and a common external tariff on non-member nations. As a result, the member nations establish greater trading ties between themselves now that protectionist barriers such as tariffs, import quotas, non-tariff barriers and subsidies have been eliminated. The result is an increase in trade among member nations in the good or service of each nation’s comparative advantage. In other words, increase in trade causes greater revenues, (more profitable).

Trade creation and diversion effects for International Business Mcom sem 2 Delhi University:-Downside of Trade Creation

The creation of trade is important to the nation entering the customs union in that increased specialization may hurt other industries. Arguments for protectionism, such as the infant industry argument, national defense, outsourcing, and issues with health and safety regulations are brought to mind. However, customs unions are typically formed with friendly nations, eliminating the national defense argument.

Trade creation takes place when domestic consumers in countries import more goods and services as import prices fall due to a removal of import tariffs and import quotas; production will shift to a lower cost producer.

Trade creation and diversion effects for International Business Mcom sem 2 Delhi University:-Trade Creation and Trade Diversion

Trade Creation and Trade Diversion

Trade Creation (definition): refers to the situation where higher cost products (imported or domestically produced) are replaced by lower cost imports.

Trade Diversion (definition): refers to the situation where lower cost imports are replaced by higher cost imports from a member after the formation of the bloc.

Trade creation involves the removal of tariffs and its benefits include getting rid of the disadvantages that comes with tariffs: reducing price, increasing consumption, increasing imports, decreasing domestic production and increasing allocative efficiency.

Trade diversion also includes the removal of tariff. This is why it has a trade-creating effect. However, because trade diversion includes shifting from a lower cost producer (country A + tariff) to a higher cost producer (Country B without tariff), trade diversion also comes with some costs.

Trade diversion

Trade diversion is an economic term related to international economics in which trade is diverted from a more efficient exporter towards a less efficient one by the formation of a free trade agreement or a customs union.

Occurrence

When a country applies the same tariff to all nations, it will always import from the most efficient producer, since the more efficient nation will provide the goods at a lower price. With the establishment of a bilateral or regional free trade agreement, that may not be the case. If the agreement is signed with a less-efficient nation, it may well be that their products become cheaper in the importing market than those from the more-efficient nation, since there are taxes for only one of them. Consequently, after the establishment of the agreement, the importing country would acquire products from a higher-cost producer, instead of the low-cost producer from which it was importing until then. In other words, this would cause a trade diversion.

Term

The term was coined by Jacob Viner in The Customs Union Issue in 1950. In its literal meaning the term was however incomplete, as it failed to capture all welfare effects of discriminatory tariff liberalization, and it was not useful when it came to non-tariff barriers. Economists have however dealt with this incompleteness in two ways. Either they stretched the original meaning to cover all welfare effects, or they introduced new terms like trade expansion or internal versus external trade creation.

Viner’s article became and still is the foundation of the theory of international economic integration. It considered only two states comparing their trade flows with the rest of the world after they abolish customs tariffs on inner border of their union. Following the fact that economic unions most often include more than 2 states, attempts have been made to increase the number of the states (3+world), but not so successfully, as they did not have as clear conclusions as Viner’s.

Opposite to economically efficient trade creation effect, the trade diversion flow is cost-inefficient compared with the rest of the world. Balance between trade creation and trade diversion effects due to the creation of economic union makes the union either economically efficient (positive balance) or inefficient (negative balance). It is based on the fact that unification of states usually applies mergers of more than 1 sector in economy (even European Coal and Steel Union, which had 2 sectors only) leading to the creation of either trade creation or diversion effects.

Positive effects of trade diversion include increase of trade between unified states, increase of employment in manufacturing states inside the union consequently leading to increase of respective taxes and welfare.

Trade creation and diversion effects for International Business Mcom sem 2 Delhi University

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