What is a Trading Bloc?

Trading blocs are usually groups of countries in specific regions that manage and promote trade activities. Trading blocs lead to trade liberalisation (the freeing of trade from protectionist measures) and trade creation between members, since they are treated favourably in comparison to non-members.

The World Trade Organisation (WTO) permits the existence of trading blocs, provided that they result in lower protection against outside countries than existed before the creation of the trading bloc .

The most significant trading blocs currently are:

European Union (EU) – a customs union, a single market and now with a single currency

European Free Trade Area (EFTA)

North American Free Trade Agreement (NAFTA) between the USA, Canada and Mexico

Mercosur - a customs union between Brazil, Argentina, Uruguay, Paraguay and Venezuela

Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA)

Common Market of Eastern and Southern Africa (COMESA)

South Asian Free Trade Area (SAFTA) created in 2006 with countries such as India and Pakistan

Pacific Alliance – 2013 – a regional trade agreement between Chile, Colombia, Mexico and Peru

Trading Blocs and Trade Creation

Trade creation is the movement from a higher cost source of output to a lower cost source of supply as a result of joining a trade agreement.

Trade creation occurs when a country enters a free trade area / agreement or becomes involved in a customs union in which there is free trade between members but also a common external tariff.

Trading Blocs and Trade Diversion

Trade diversion is a switch from a lower-cost foreign source/supplier outside of a customs union towards a higher-cost supplier located inside the customs union.

Trade diversion is a feature of a country deciding to join a customs union i.e. an area where there is free trade within the customs union but also a common external tariff.

When a country joins a customs union it might initially be trading freely with a low cost supplier in a 3rd party nation.

Once inside a customs union, the country must now adopt a common external tariff which will then increase the cost of importing from the 3rd party nation.

These higher prices might affect consumers directly e.g. higher prices for food.

Or they might affect consumers indirectly because producers now have to pay more for their imports from the 3rd party.