Trade Bloc

What It Means

A trade bloc is a group of nations that has reached a set of special agreements regarding their economic relationships with each other. The agreements generally focus on the relaxation or elimination of trade barriers, which are laws that limit the amount of business done across two countries’ borders. The most common types of trade barriers are tariffs (taxes on imports) and quotas (limits on the quantities of various imports).

Trade blocs can take different forms. The most enduring and successful trade bloc, as of the early twenty-first century, was the one binding 27 European countries under the European Union (EU). The EU, whose roots lay in attempts to reunify Europe after World War II, was more than just a trade agreement. It brought about wide-ranging economic, political, and social organization among its member countries, including the establishment of a common currency and many other unifying features usually imposed only by national governments. The United States, Canada, and Mexico established another of the world’s most significant trading blocs with the North American Free Trade Agreement (NAFTA) in 1992. Though NAFTA, by reducing most trade barriers between these three countries, had important and controversial economic consequences, it was not intended to erase national economic boundaries to the degree that the EU did, nor did it actively promote the elimination of social and political boundaries.

The creation of trade blocs generally results in benefits to consumers, as high-quality goods and services can be produced at lower prices than they could with trade barriers in place. Effective trade blocs also tend to create stable political relations between countries and to increase total employment and income levels in all participating countries, at least over the long term.

These benefits come at a cost, however. Inevitably some industries and companies eliminate large numbers of jobs in one member country in order to take advantage of cheaper labor in another member country. This can cause great pain to workers and communities. Likewise, trade blocs, by increasing the freedom of companies motivated only by profit, often threaten poorer member countries’ traditional ways of life and the environment.

When Did It Begin

One of the earliest examples of what we now call a trade bloc was the Zollverein (German for “customs union”) enacted by most parts of the German Confederation, a group of nineteenth-century kingdoms consisting of the present-day countries of Germany, Austria, the Czech Republic, Luxembourg, and parts of other surrounding nations. The Zollverein eliminated trade barriers between member territories while raising tariffs that applied to countries outside the union, as many trade blocs do today.

Today’s most significant trade bloc, the EU, began life as an attempt to resolve the differences between European nations after World War II. In 1951 France, West Germany, Belgium, the Netherlands, Italy, and Luxembourg entered into a trade agreement establishing the European Coal and Steel Community (ECSC). This union eliminated trade barriers that applied to these essential economic materials, and it served as the basis for future expansions of the trade bloc, which was, for much of the late twentieth century, known as the European Community (EC). The more comprehensive unification plan embodied by the EU was officially enacted in 1993.

NAFTA was modeled on the EC, which had played a key role in helping European countries recover from World War II and rebuild their economies. The United States and Canada entered into a trade agreement in 1988, and NAFTA brought Mexico into the trade bloc in 1992. The reduction of trade barriers under NAFTA went into effect in 1994.

More Detailed Information

A belief in the beneficial effects of free trade is the foundation for trade blocs such as the EU and NAFTA. The early economists Adam Smith (1723–90) and David Ricardo (1772–1823) were the first thinkers to outline the case for free trade convincingly, and the arguments in favor of free trade have changed little since that time. Essentially, free trade proponents argue that tariffs, quotas, and other trade barriers decrease economic efficiency and overall wealth in all affected countries.

When, for example, banana growers in Ecuador can supply better bananas at a lower price than banana growers in the United States, the United States should allow Ecuadorian bananas to be sold without restraint. Instead of growing bananas, U.S. farmers will concentrate on those crops more suited to the soil and climate of their region. Ecuador has what economists call an “absolute advantage” over the United States when it comes to banana production.

But even when U.S. businesses can produce a particular good as well and as cheaply as businesses in another country, it may be in the nation’s interest to allow foreign companies to assume both the benefits and the burden of supplying that good to U.S. consumers. Perhaps, for instance, U.S. companies and Japanese companies are both capable of delivering high-quality, low-cost steak knives to U.S. consumers. At the same time, however, U.S. companies might be much more capable than Japanese companies of delivering high-quality, low-cost butter knives to U.S. consumers. In this case, U.S. companies would be better off allowing Japanese steak-knife companies to dominate the consumer market, because the United States could ultimately create more wealth by focusing on butter-knife production. In this situation, economists would say that the United States has a “comparative advantage” in butter-knife production.

Despite the widespread acceptance among economists of the doctrines of absolute advantage and comparative advantage, most nations have only selectively pursued policies of free international trade. If a U.S. policy of free international trade led to the collapse of the American steak-knife industry, for example, the spectacle of thousands of out-of-work steak-knife manufacturers would be hard to justify using economic theories. Towns and regions can become economically depressed for decades when a key industry ceases to operate there. Another reason that free trade has only gradually become acceptable to national governments is that large, powerful industries often have a great deal of influence on politicians. Many trade barriers are kept in place for this reason.

Regional trade blocs represent a compromise between totally free trade and total protectionism of a country’s industries. In the case of the EU, moreover, economic cooperation has allowed for the accumulation of world power. EU countries trade freely with one another, allowing each country to concentrate on what it does best, but the EU as a whole generally taxes imports from non-EU countries at high levels to protect European industries. The result is the creation of a single, powerful economy. Though individual European countries cannot begin to compete economically with the much larger United States, the EU as a whole rivals and by some measures outperforms the U.S. economy.

Recent Trends

Since NAFTA took effect in 1994, the industrial landscape of the United States has changed significantly. Many companies in the automotive and clothing industries, for example, have moved their manufacturing facilities to Mexico, where workers can be paid much less than in the United States. This has resulted in a large-scale loss of American jobs at the same time that it has allowed those companies to increase their profits. While other parts of the U.S. economy have boomed since the mid-1990s, towns that have lost large automobile or textile factories have largely failed to prosper. Economists can outline theories about why the United States as a whole is better off because of NAFTA, but it is difficult to prove that economic gains in other parts of the economy were caused by, or can make up for, the painful losses in the auto or clothing industries.

The economic unification of European countries was less controversial at the turn of the millennium than the union between the United States, Canada, and Mexico. With decades of successful cooperation behind them, many EU countries in 1999 adopted a common currency, the euro, and ceased using individual national currencies. EU membership is seen as very desirable economically, and the number of member states has grown dramatically. In 2004 alone, the EU accepted ten new member countries. By 2007, the number of member countries stood at 27.

Political unity has proven more complicated, however. In 2004 the heads of EU member governments drafted a constitution establishing a common framework of laws for all member countries, but in 2005 the citizens of both France and the Netherlands voted against adopting it, preventing the legal document from going into effect.