Trade Creation

Definition

Trade creation refers to the increase in trade that occurs when a trade agreement, such as a free trade agreement or customs union, reduces or eliminates tariffs and other trade barriers between member countries. This leads to the expansion of trade between the participating nations as consumers and producers shift to take advantage of the new, lower-cost trading opportunities.

5 Must Know Facts For Your Next Test

1. Trade creation leads to an increase in overall trade volume and economic welfare for the member countries of a trade agreement.
2. The removal of tariffs and other trade barriers between member countries allows consumers to access lower-priced goods, while producers can take advantage of expanded export markets.
3. Trade creation is often seen as a positive outcome of regional trade agreements, as it promotes specialization and the efficient allocation of resources.
4. The magnitude of trade creation depends on factors such as the size of the tariff reductions, the substitutability of goods between member and non-member countries, and the competitiveness of the industries involved.
5. Governments may enact trade policies, such as free trade agreements or customs unions, to promote trade creation and the associated economic benefits.

Review Questions

• Explain how trade creation occurs within the context of a free trade agreement or customs union.
  • When a free trade agreement or customs union is established, the elimination or reduction of tariffs and other trade barriers between member countries leads to an increase in trade. Consumers in member countries can now access lower-priced goods from other member countries, while producers can expand their export markets. This shift in consumption and production patterns results in an overall increase in trade volume and economic welfare for the participating nations, a phenomenon known as trade creation.
• Describe the relationship between trade creation and the efficient allocation of resources.
  • Trade creation promotes the efficient allocation of resources by allowing countries to specialize in the production of goods and services in which they have a comparative advantage. When tariffs and other trade barriers are reduced or eliminated, consumers and producers can shift their activities to take advantage of the new, lower-cost trading opportunities. This leads to an increase in overall trade and a more efficient distribution of resources across the member countries, as each nation focuses on producing the goods and services it can produce most effectively.
• Evaluate the role of government trade policies, such as free trade agreements and customs unions, in facilitating trade creation.
  • Governments play a key role in enacting trade policies that can promote trade creation. By establishing free trade agreements or customs unions, governments can eliminate or reduce tariffs and other trade barriers between member countries, enabling consumers and producers to take advantage of the new, lower-cost trading opportunities. This shift in consumption and production patterns leads to an increase in overall trade volume and economic welfare for the participating nations, a desirable outcome known as trade creation. Governments may pursue these trade policies to boost economic growth, increase consumer choice, and foster specialization and the efficient allocation of resources across member countries.

Related terms

Trade Diversion:

The shift in trade away from more efficient non-member producers towards less efficient member producers due to the preferential tariff rates established by a trade agreement.

Customs Union: An economic arrangement where member countries eliminate tariffs on trade between themselves and adopt a common external tariff on imports from non-member countries.

Free Trade Agreement (FTA): An agreement between two or more countries to eliminate or reduce tariffs, quotas, and other barriers to the free flow of goods and services between them.