International Trade Theories PDF

**Nations trade because they are different and want to take advantage of their differences.** **[Classical theory Limitations:]** - **[simplified models with abstract assumptions;]** - **[statical view on comparative advantages;]** - **[analysis of the supply side of the market only;]** -...

**Nations trade because they are different and want to take advantage of their differences.** **[Classical theory Limitations:]** - **[simplified models with abstract assumptions;]** - **[statical view on comparative advantages;]** - **[analysis of the supply side of the market only;]** - **[failure to identify causes of costs differences;]** - **[failure to explain incomplete specialisation;]** 2. **Classical trade theories** - Common assumptions: - Model 2x2x1 (2 countries, 2 products, 1 factor of production- labour) - Labour theory of value - Constant costs - Perfect competition - Full employment - Free trade - Zero transportation costs - Product price expressed in physical units rather in monetary units - **Theory of absolute advantage** -- introduced **by Smith** and he states that each country should specialise and produce that product for which it has absolute advantage, meaning that each country will produce and export that product which they can produce most efficiently (at lowest costs). According to this theory, international trade is positive sum game because each country benefits from this trade. Besides common assumptions, theory of absolute advantages has following assumptions: **perfect mobility of production factors (labour) within and between countries** and only considers supply **side of the market**. - **We calculate the absolute advantage [comparing production costs for an unit] of the certain product within two countries.** - **aLp \< aLp^f^** - **aLp -- labour costs for production of an unit of the certain product in the domestic country;** - **aLp^f^ -- labour costs for production of an unit of the certain product in the foreign country;** - **Theory of comparative advantages** -- introduced by **Ricardo** and he states that each country should specialise and produce that product for which it has comparative (relative) advantage. Each country will export those products and import those for whose production it has comparative disadvantage. - In this theory international trade is positive sum game because there is equal distribution of gains among countries. - Besides common assumptions, theory of comparative advantages has following assumptions: **perfect mobility of production factors (labour) within** **country but no international mobility, fixed but different technology between** countries, **fixed resources, fixed tastes and** only considers supply side of the market. - ***A country should specialise in production of a product it can produce [more efficiently compared to other products], even if the country has not an absolute advantage in that product.*** - **labour theory of value;** - **constant costs;** - **perfect competition;** - **full employment;** - **free trade;** - **zero transport costs;** - **perfect mobility of labour between industries within a country and no international mobility;** - **fixed but different technology between countries;** - **fixed resources, tastes etc.** **[Basis for trade (Ricardo's trading principle):]** **Basis for trade arises from differences in relative productivity ([comparative costs differences]) between countries.** - **[Smith's trading principle: ]** **differences in absolute productivity** **(costs differences)** - **[Ricardo's trading principle:]** **differences in relative productivity** **(comparative costs differences)** **[How to calculate comparative advantages?]** **Comparative advantages are calculated by [comparing relative unit costs of production] ([comparing ratios of unit costs]).** **[How to calculate comparative advantages? ]** - **comparing ratios of production costs of two different products within each of two countries;** **aLx/aLy : aLx^f^/aLy^f^** **aLx -- time/labour costs for production of an unit of the product x in domestic country;** **aLy -- time/labour costs for production of an unit of the product Y in domestic country;** **aLx^f^ --time/labour costs for production of an unit of the product x in foreign country;** **aLy^f^ -- time/labour costs time/labour costs for production of an unit of the product Y in foreign country;** - **Theory of reciprocal demand** was introduced **by Mill** who states that **each country\'s production and export price depends on recipro**cal **demand which is demand of one country for goods of another country.** In this way, countries **that have lower productivity can reach better terms of trade**. According to this **theory countries trade because they are different and they want to take advantage of their differences**. The only additional assumption for this theory is that it considers demand side of the market. **Theory of Reciprocal Demand:** - **Former theories exclusively analyse supply side of the market as determinant of relative product prices.** - **J. S. Mill left labour theory of value and indroduced [demand side] of the market.** - **Export price will be determinated by reciprocal demand intensity** - **Reciprocalcal demand is demand of each of two countries for export product of the other one.** - 3. **Neoclassical trade theories**: - Common assumptions: - Abandonment of labour theory of value (2/3 factors of production) - Costs expressed in monetary units - Both constant and variable costs - Complete and incomplete specialisation - Transportation costs (not in H-O theory) **[Differences]: What is different in neoclassical theories?** - **two- or multi-factors models;** - **abandonment of labour theory of value;** - **costs expressed in money terms instead in physical product units;** - **both constant and variable (changeable) costs;** - **both complet and incomplet specialisation;** - **transportation costs;** - **Opportunity costs theory** was introduced by **Haberler.** - Other assumptions: **2x2x3, increasing costs, existence of marginal costs.** Haberler stated that a country **has a comparative advantage if it can produce an additional unit at lower opportunity costs expressed in terms of other product**, which means that country will specialise and produce those products for which it **has lower marginal costs.** A country will export the goods in which it has a lower opportunity cost of production and **import goods in which it has a higher opportunity cost of relative to another country. Terms of trade between two products are equal to the relation of their marginal costs. Production of one product can be increased only at the expense of production of another product,** indicating that terms-of-trade are equal to the relation of the substitution costs. With the opportunity costs theory, a country **gains from trade by either completely specializing or partially specializing.** Partial specialization -- a country meets its needs in some product partly from domestic production and partly from imports. - **G. Haberler introduced a new element in his analysis -- [the principle of marginal costs.] (The price is equal to the marginal production costs i.e. equal to amount to be paid for all factors required for production of an additional product unit.)** **Opportunity costs can be illustrated by production possibilities schedule (PPF); the slope of PPF is equal to opportunity costs;** - - **PPF indicates the maximum amount of any two products an economy can produce, assuming that all resources are used in their most efficient manner (full employment).** - **Marginal rate of transformation: MRT = MC~s~/MC~t~** - **The slope of PPF provides a measure of the MRT, which indicates the amount of one product that must be "sacrificed" in order an additional unit of another product to be produced.** - **Terms-of-trade betwen two products are equal to the relation of their marginal costs.** - **Production of one product can be increased only at the expenses of production of another product, indicating that terms-of-trade are equal to the relation of the substitution costs:** - **P~s~/P~t~ = MC~s~/MC~t~ = Δt/Δs** - **P = MC = AC** - **Terms-of-trade between two products are equal to the relation of their marginal costs and to the relation of their average costs.** - **PPF is a straight line and identical to the price line.** - **Amount of some product to be "sacrificed" in order to produce a new unit of another product is always the same.** - - **Heckscher -- Ohlin theroy** (H-O theory; general-equilibrium theory, factor-endowment theory,theory of factor proportions) states that there **are 2 key determinants of comparative advantages:** - Differences **in relative factor endowment**: by physical units of factors (supply side elements) and by factor prices (both supply and demand side elements) - Differences in **relative factor intensity**: a product **is capital intensive if the ratio of capital to labour is bigger than ratio in production of another product** - 2 x 2 (two countries, two comodities) - Perfect competition both in commodity market and factor market - Free trade - Homogenous products - Identical tastes and preferences (identical demand conditions) - Constant average costs - Perfect mobility of labour within countries, no international mobility - Given and fixed technology - Zero transportation costs - Two-factor model and different factor intensity of products - Identical production functions for the same product in different countries - Identical technology in different countries **[Price definition:]** **A country is relatively capital abundant if its ratio of interest rate (price of capital) to wage (price of labour) is [lower] than that ratio in another country.** **PK~A~/PL~A~ \< PK~B~/PL~B~** **r~A~/w~A~ \< r~B~/w~B~** In the **Heckscher-Ohlin (H-O) theory**, a product is considered **labor-intensive** if its production requires a relatively higher proportion of labor compared to capital when compared to another product **[H-O-S Theorem:] (Thesis on factor-price equalization)** **International trade will bring about equalization in the relative and absolute returns to homogenous factors across nations** 4. Model of a Two-Factor Economy: ================================= The model of a two-factor economy was first introduced **by Frank William Taussig.** Taussig says that there are two production factors: labor and capital. This idea (two or more production factors) was prevalent in neoclassical theories of trade. This model assumes that an economy can produce goods with two inputs that are limited in supply. Each good that is produced uses more of one input than the other (i.e. labor-intensive, capital-intensive goods). **Two-Factor Economy in the Heckscher-Ohlin Theory:** An economy can produce two goods: A and B. The production of these goods requires two inputs that are in limited supply: labor and land. - A product is capital-intensive if the ratio of capital to labor in its production is bigger than that ratio in production of another product. **(K/L)~x~\> (K/L)~y~** This model concludes that a capital-abundant country will export capital-intensive products and a labor-abundant country exports labor-intensive products. 5. Empirical Evidence of the H-O Model ====================================== Heckscher and Ohlin considered the Factor-Price Equalization theorem an econometric success because the large volume of international trade in the late 19th and 20th centuries coincided with the convergence of commodity and factor prices worldwide. Modern econometric estimates have shown the model to perform poorly. **The Leontief Paradox:** In 1954, an econometric test by Leontief of the H-O model found that the United States, **despite having a relative abundance of capital, tended to export labor-intensive goods and import capital-intensive goods. This problem became known as the Leontied paradox.** - **increasing trade between similar countries (similar in terms of factor endowment);** - **increasing trade in similar products (similar in terms of factor intensity) between countries;** **KRAJ DRUGE LEKCIJE** **6. Technological Theories** Technological theories are one of moden theories which state that there is continous moving of PPF due to increas in factor supply and more efficient use of factors. It also states that there are different technologies between countries and that technlogical trade is the new reason to trade. According to these theories there are following technological innovation types: - Improvement in production process of some product - Improvement in product characteristics - Introduction of a new product 1. **Theory on economic growth** and trade was introduced by Rybczyski (I think) and it states that if there is growth in potential output PPF will shift outwards. This theory analyses three types of effects: a. Effect of growth in factor supply b. effect of technological change on economic growth c. Effects of economic growth on international trade d. **[Balanced growth] -- growth in supply of all factors at the same rate; PPF moves symmetrically i.e. evenly in all directions.** e. **[Imbalanced growth (Biased growth)] -- growth in supply of only one factor or faster growth in supply of one factor compared to the growth of the other one; PPF shifts out as well but asymmetrically.** f. g. **[Export-biased growth] -- growth biased toward the good a country exports; PPF expands disproportionately; tends to worsen a growing country's terms-of-trade to the benefit of the rest of the world.** h. **[Import-biased growth] -- growth biased toward the good of a country imports, tends to improve a growing country's terms-of-trade at the rest of the world's expense.** i. **[Immiserizing growth]** - **neutral growth (trade and output grow at the same rate);** - **protrade growth (faster growth of trade);** - **antitrade growth (faster growth of output).** 2. **Technological gap theory** was introduced by Posner and it proposes that changes in international trade are directed by the relative technological sophistication of countries. In this theory international trade is based on differences in technological changes over time among countries where some countries progress faster, which creates technological gap allowing a temporary monopoly in world market. Technological inovations create dynamic comparative advantages which means that comparative adnvatages can be changed over time due to technological changes or diffusion of technology. Inovation increases trade between industrailized countries. 3. **[Basic assumption: ]** 4. **International trade can be based on differences in technological changes over time among countries because of a time lag in transfer of technology.** 5. **Innovation creates [a technological gap] which provides for a temporary monopoly in the world market.** 6. 7. **Product life cycle theory** was introduced by Vernon and it\'s based on both, demand and supply side of the market. It focuses on product and role of technological innovation rather than on country, and states that each product goes through three phases during its life cycle: i. new product phase- where country needs highly skilled labour and R&D. In this phase devaloped countries (innovator country) are exporters. ii. Product-growth phase- in which product reaches scale economy which means its average costs decrease in long term based on increase of output. In this phase imitators of products appear. iii. Product maturity phase- where product is standardised andproduction moves to countries with lower income which have cheaper labour. In this phase devaloped (innovator) countries are importers. In last two phases there is lack of innovation and emphasis is on factor endowments. When a life cycle goes towards its end explanation of comparative advantages becomes closer to H-O theory. Assumptions: - Different technologies between countries - Technology changes over time - Capital moves among countries - Focus on a product - Limited usibility (only for technology intensive products) - Analysis both supply and demand side of the market - Dynamic comparative advantages **[Linders Theory]** This theory states that devaloped countries trade more among each other than with devaloping countries and that they trade in similar products. He differs bases for trade in primary and secondary (industrial) products, where trade for primary products is supply- side based and depends on differences in relative factor endowment. Trade for secondary products is based on demand-side where basis for trade depends upon similarities in consumer\'s preferences and incomes. Therefore the more similar demand structure between countries is, the bigger their mutural trade will be. This is also one of the first theories on intra-trade where Linder states that same products can be traded in both directions- imported and exported at the same time. In this theory Linder indicates types of countries that will trade but not their trade directions or patterns. According to this theory domestic demand determines both exports and imports commodity structure. **7. Theory of Economy of Scale** This theory was introduced by Krugman. It is based on economies of scale which states that average costs of product will decrease in long term based on increase of output. Krugman states there are 2 different economies of scale:. Economies of scale can be classified into two main types: Internal -- arising from within the company; and External -- arising from extraneous factors such as industry size - Internal economy of scale- which states that average costs of a product depend on a size of an individual company but not necessarily on that of the industry, so each company will specialyze in production of one or few variations of a product. Such company where internal exonomy of scale is large can monopolise an industry therefore internal economy of scale creates imperfect competition in industry. - External economies of scale- states that average costs of a product depend on size of the industry but not necessarily on the size of company, therefore single companies need not to be large, but they cooperate within the industry creating perfect competition (if there is a lot of small companies) therefore country can dominate at world market. **8.Theory of Comparative Advantages of nations(M. Porter)** This theory was introduced by Porter and it emphasis on productivity as the key determinent of international competitivenes where he puts focus on industry or single company. This theory comines thesis and characteristics form both-conventional and new theories. It analyses micro and macro view of competitiveness and international trade, also it combines elements of supply-side and demand-side of the market. Porter explained this theory throught „diamond of nation advantages" which illustrates 4basic interconnected groups of determination of competitive advantages and 2 additional variables. 4 basic interconnnected groups: - factor conditions - demand conditions - related and supporting industries - firm structure, strategy and rivalry 2 additional variables: - Chance - government **9. Inter- and Intra-Industry Trade** ***Interindustry*(**manufactures for food) trade reflects comparative advantage. The pattern of interindustry trade is that Home, the capital-abundant country, is a net exporter of capital-intensive manufactures and a net importer of labor-intensive food. So comparative advantage continues to be a major part of the trade story. ***Intraindustry***trade (manufactures for manufactures) does *not* reflect comparative advantage. Even if the countries had the same overall capital-labor ratio, their firms would continue to produce differentiated products and the demand of consumers for products made abroad would continue to generate intraindustry trade. It is economies of scale that keep each country from producing the full range of products for itself; thus economies of scale can be an independent source of international trade. The pattern of intraindustry trade itself is unpredictable. All we know is that the countries will producedifferent products. The relative importance of intraindustry and interindustry trade depends onsimilar countries are. If Home and Foreign are similar in their capital-labor ratios, thenthere will be little interindustry trade, and intraindustry trade, based ultimately on economies of scale, will be dominant. On the other hand, if the capital-labor ratios are very different, so that, for example, Foreign specializes completely in food production, there will be no intraindustry trade based on economies of scale. All trade will be based on comparative advantage. **[Inter-industry trade is international trade in products belonging to different industries.]** **[Intra-industry trade is international trade in products within the same industry.]** **[Passive foreign trade policy] includes restrictions on import and export flows.** **[Active foreign trade policy] includes instruments of export promotion.** **[Main goals of passive trade policy -- TO PROTECT]:** - **protection of domestic producers;** - **protection of domestic consumers (industries or citizens);** - **protection of balance-of-payments (rational spending of foreign currencies);** - **increasing budget revenues;** **[Main goals of active trade policy -- TO PROMOTE]:** **promotion of production, employment and export** - **Instruments of foreign trade policy are measures that the governments of national economies establish in order to regulate, limit or encourage trade flows with foreign countries.** - **Instruments can have a negative effect on foreign trade (trade restriction) or a positive effect (trade promotion).** - **There are different classifications of foreign trade policy instruments.** - **[economic measures] (customs duties, quantitative restrictions, etc.)** - **[\"political\" measures] -- these measures have no economic reason, but are economic means to achieve political goals abroad:** - **customs measures -- tariffs for retaliation, customs wars; prohibition measures -- boycott, embargo, economic blockade;** **boycott -- ban on importing from a certain economy; embargo -- ban on exporting to a certain economy; economic blockade -- prohibition of both export and import in relations with a certain economy** **Other type of classification of instruments:** - **instruments affecting price of goods** **(examples: tariffs, import taxes\...)** - **Instruments affecting quantity of goods** **(examples: quotas, licences\...)** **10. TARIFFS: DEFINITION, TYPES AND EFFECTS** - **Differential tariffs leads to a different treatment of goods originated from different countries; they have political character.** - **Tariff preference/Preferential tariff -- a lower (or zero) tariff on a product from one country than is applied to imports from most countries.** - **Tariff for retorsion -- a tariff imposed for a purpose to force other country to release.** - **Dumping -- when export price is \"unfairly low,\" defined as either below the home market price (normal value) or below cost.** - **Anti-dumping tariff -- a tariff levied on dumped imports.** - **Countervailing tariff -- a tariff levied against imports that are subsidized by the exporting country\'s government, designed to countervail the effect of the subsidy.** Definition: a tariff is a tax levied on a product when it crosses national boundaries. It is a trade restriction. Types: Tariffs by type of trade flow: Import tariffs Export tariffs Transit tariffs Tariffs by main function Protective tariffs Revenue tariffs Tariffs by trade relations Autonomous (maximal) tariffs Conventional (minimal) tariffs Tariffs by way of determination Ad valorem tariffs Specific tariffs Compound tariffs Tariffs by country of origin Unitary tariffs Differential tariffs Tariffs for equalizing Anti- dumping Countervailing tariffs Effects of tariffs: Effect on import Effect on domestic production Effect on domestic consumption Tariffs can decrease domestic production or divert domestic consumption Revenue effect Redistributive effect Effect on employment Effect on balance- of- payments Decrease in import and outflow of foreign currencies **[Effect on import:]** **Tariff reduces import indirectly -- through its impact on product price.** **tariff → increase in import price → decrease in import demand → decrease in import** **[Effect on prices:]** **Tariff can raise prices of imported goods for amount of the tariff, less than the amount of the tariff, more than the amount of the tariff (so called "tariff pyramid").** **[Effect on domestic production:]** **tariff → increase in price of imported goods → increase in demand for domestic substitute → increase in domestic production (if there are unemployed capacities)** **[Effect on domestic consumption (deflationary effect):]** - **decreasing of domestic consumption** - **diverting of domestic consumption** **[Protective effect:]** - **in short run -- positive, because of increase in domestic production; in long run -- negative, because of isolation of domestic producers from foreign competition;** - **it depends on elasticity of foreign export supply:** - **in case of perfectly inelastic foreign supply, there is no protective effect at all;** - **in case of perfectly elastic foreign supply, protective effect becomes prohibitive and import stops;** **[Effect on terms-of-trade:]** - **net terms-of trade:** **Px/Pm** - **effect on terms-of-trade depends on price elasticity of foreign supply:** - **in case of an elastic foreign supply, a tariff does not improve terms-of-trade;** - **in case of an inelastic foreign supply, a tariff improves terms-of-trade, but eliminates protective effect, effect on domestic consumption and redistributive effect;** - **optimal tariff;** 11. Costs and Benefits of Tariffs ================================= Tariff's increase the cost of imports, leading to a decline in consumer surplus. Maybe in the long run consumers benefit from the protection of domestic industries if these industries use the tariffs to improve Domestic Producers, who produce the good, will benefit from the introduction of tarrifs. This is because it makes their domestic production relatively more attractive compared to the imports. In the long run, domestic firms may not make the necessary improvements that they would have done without tariffs Also the introduction of tariffs usually leads to retaliation. Therefore, some exporting firms will lose out and sell less exports. Costs and benefits of tariffs depend on the size of the nation, therefore we have: **A small country case:** When a nation is "small", it has no effect on the foreign (world) price of a good, because its demand of the good is an insignificant part of the world demand.(price taker) Therefore price will not fall, but will remain the same, while price in the domestic market is going to rise. - Import tariff in a small nation redistributes income from domestic producers of the commodity. This leads to inefficiencies of a tariff - A small nation always loses from the imposition of the import tariff. **A large country case:** A large nation can change world prices and its terms of trade. We say that large nation is a price maker. - A tariff rises the price of a good in the importing country, making its consumer surplus decrease and making it producer surplus increase. - Government revenue will increase. If the terms of trade gain exceeds the efficiency loss, then national welfare will increase under a tariff, at the expense of foreign countries. 12. Non-Tariff Barriers to Trade ================================ A form of restrictive trade where barriers to trade are set up and take form other than a tariff. Non-tariff barriers include: quotas, import licenses, embargoes, sanctions and other restrictions and are frequently used by large and developed economies. The most common instruments of direct regulation of imports (and sometimes export) are licenses and quotas. Almost all industrialized countries apply these non-tariff methods.  **Import licenses** -- he license system requires that a state (through specially authorized office) issues permits for foreign trade transactions of import and export commodities included in the lists of licensed merchandises. **Quotas** -- is a limitation in value or in physical terms, imposed on import and export of certain goods for certain period of time. **Embargo** -is a specific type of quotas prohibiting trade. As well as quotas embargoes may be imposed on imports or exports of particular goods. 13\. Free Trade: Arguments Pro et Contra Free trade can be: **open economy -- an economy with high level of trade liberalisation;** **closed economy -- an economy with numerous and very high trade barriers;** **in today's world, practically all nations impose some restrictions on flows of goods and services;** Pro: - Increase total production, efficiency and productivity(reduce barriers leads to trade creation) - Increased specialization - Increased competition - Economies of Scale - Encourage research and development - Potentially increase consumption, investment and GDP Cons: - Infant industry argument - No revenue for government - Protection against dumping - Environmental costs - Help the balance of payments **14. Theory of Economic Integration** **International economic integration is a process or a stage of institutional integrating of countries, based on reciprocity, mostly at regional level, through liberalization of trade and/or liberalization of factor movement.** **It is a process of eliminating restrictions on international trade, payments and factor mobility.** **Author: The pioneer work in the field was the „Theory of Customs Union" by Jacob Viner.** **Time Framework: This theory is relativley new; at the beginning it was only a part of international trade theory. The development of the modern theory of economic integration was after World War 2. Jacob Viner\'s work was of 1950.** **Classification: International economic integration is a process or a stage of institutional integrating of countries, mostly at regional level, by liberalization of trade and/or liberalization of factor movement.It is a process of eliminating restrictions on international trade, payments and factor mobility.** **[Elements of the definition:]** - **process or stage (dynamic chategory)** - **institutional integrating** - **regional level (dominant)** - **liberalization of trade and other flows** **Integration by subjects: Functional Integrations (subjects: TNCs), Institutional Integrations (subjects: countries)** **Integration by Sectoral scope: Sectoral integration, Total integration** **Integrations by level of development of members: Integrations among developed countries, Integrations among developing countries, Integrations among developed and developing countries** **Integrations by symmetry of obligations: Symmetrical integrations, Asymmetrical integrations** - **trading aspect -- merchandise exchange (dominant aspect);** - **non-trading aspects -- monetary arrangement, fical aspect, labour moving, capital moving, technology transfer;** **Motives for economic integration:** - **political motives ("hidden" motives)** - **economic motives ("visible" motives)** **[Stages:]** - **(preferential trading agreement)** - **free trade area (FTA)** - **customs union (CU)** - **common market (CM)** - **economic union (partial or total)** **Free Trade Area (FTA)** **[Characteristics:]** - **free movement of goods (elimination of all trade barriers);** - **individual customs tarrifs;** - **rules of origin;** **[Examples:] EFTA, LAIA** **Customs Union (CU)** **[Characteristics:]** - **+common customs tariff;** **[Examples:] Benelux, MERCOSUR** **Common Market (CM)** **[Characteristics:]** - **+free factor movement (free movement of labour and capital);** **[Example:] CARICOM** **Partial/Total Economic Union** **[Characteristics:]** - **+harmonized fiscal, monetary, industrial and other economic policies;** **[Example:] European Union (to some extent)** **Stage of Integration** **No trade restrictions in INTRA-regional trade** **Common external tariffs** **Free movement of labour and capital** **Harmonized monetary and fiscal policies** --------------------------- --------------------------------------------------- ----------------------------- ----------------------------------------- --------------------------------------------- **Free Trade Area (FTA)** **-** **-** **-** **Customs Union (CU)** **-** **-** **Common Market (CM)** **-** **Economic Union** For Mexicans to move and work legally and without barriers in the USA, **NAFTA** (North American Free Trade Agreement) would need to evolve into an **economic union**. ### Explanation of the Stages: 1. **Free Trade Zone (FTZ)**: Removes tariffs and trade barriers between member countries for goods and services but does not allow free movement of labor or capital. (*This was NAFTA\'s level.*) 2. **Customs Union**: Adds a common external tariff for non-member countries but still does not allow free labor movement. 3. **Economic Union**: Allows for the free movement of goods, services, capital, and labor across member countries, in addition to harmonized economic policies. - Example: The European Union (EU) allows workers to move freely between member states. 4. **Foreign Trade Zone**: This is not a stage of integration but rather a designated area where goods can be imported, stored, or manufactured with reduced regulations and taxes. Thus, for Mexicans to work legally and freely in the U.S., NAFTA would need to transform into an **economic union**. The agreement between Bosnia and Herzegovina (BiH) and Croatia in March 1994, with characteristics such as the exchange of goods without trade restrictions, a protocol of origin, and separate customs tariffs, corresponds to a **free trade area**. ### Explanation: 1. **Free Trade Area**: - Trade in goods occurs without restrictions like tariffs or quotas between member countries. - Each country retains its own customs tariffs for non-members. - The protocol of origin ensures that only goods originating within the member countries benefit from tariff elimination. - This matches the agreement\'s characteristics. 2. **Customs Union**: - Includes a free trade area but adds a common external tariff for non-member countries. - Since BiH and Croatia had separate customs tariffs, this was **not** a customs union. 3. **Common Market**: - Builds on a customs union and adds free movement of labor, capital, and services. - The agreement does not indicate these features, so it is **not** a common market. 4. **None of the above**: - This option doesn\'t apply because the agreement fits the definition of a **free trade area**. ### Conclusion: The agreement was a **free trade area**.