Trade Creation And Trade Diversion
Economics notes
Trade Creation And Trade Diversion
➡️ Trade creation occurs when a free trade agreement (FTA) between two countries leads to an increase in the volume of trade between them. This is usually due to the removal of tariffs and other trade barriers, which makes it easier and cheaper for firms to trade with each other.
➡️ Trade diversion occurs when a free trade agreement (FTA) between two countries leads to a decrease in the volume of trade between other countries. This is usually due to the preferential access that the two countries in the FTA have to each other's markets, which makes it more attractive for firms to trade with each other than with other countries.
➡️ Overall, trade creation and trade diversion can both have positive and negative effects on the global economy. On the one hand, they can lead to increased efficiency and lower prices for consumers. On the other hand, they can lead to a decrease in competition and a decrease in the welfare of countries that are not part of the FTA.
What is trade creation and how does it differ from trade diversion?
Trade creation refers to the increase in economic welfare that results from the creation of new trade flows between countries. This occurs when a trade agreement or policy leads to the substitution of higher-cost domestic production with lower-cost imports from a partner country. On the other hand, trade diversion occurs when a trade agreement or policy leads to the substitution of lower-cost imports from non-partner countries with higher-cost imports from a partner country. This can result in a decrease in economic welfare.
What are the benefits and drawbacks of trade creation and trade diversion?
The benefits of trade creation include increased economic efficiency, lower prices for consumers, and increased competition. Trade diversion, however, can lead to higher prices for consumers, reduced competition, and a loss of economic efficiency. Additionally, trade diversion can lead to political tensions between countries that are excluded from the trade agreement or policy.
How can policymakers ensure that trade agreements and policies result in trade creation rather than trade diversion?
Policymakers can ensure that trade agreements and policies result in trade creation by negotiating agreements that are based on the principles of free trade and that eliminate barriers to trade. This can include reducing tariffs, quotas, and other trade barriers. Additionally, policymakers can ensure that trade agreements and policies are designed to promote competition and economic efficiency, rather than protecting domestic industries. Finally, policymakers can work to ensure that trade agreements and policies are transparent and inclusive, and that they take into account the interests of all stakeholders, including consumers, workers, and businesses.