North-South Trade. Is the EU's trade policy position fostering economic development?

Academic Paper 2018 12 Pages

Business economics - Economic Policy


Table of contents

1. Introduction

2. Comparative Advantage Theory and Trade

3. Trade Policy in Developing Countries

4. EU Trade Policy
4.1. EU Instruments

5. Conclusion

6. Bibliography

1. Introduction

The European Union (EU) has a fundamental international role in trade. In a global trade, as it is today, the aim for the Union is to adapt rapidly to world changes. (European Commission, 2018) The EU is interested in having well performing partners, to have a feedback effect and to link trade with foreign policy, in order to ensure security especially in the neighbourhood.

The EU market is very open, 70 % of the imported goods enter the EU at reduced tariffs or even free. (European Commission, 2018) In fact, the EU, unlike other economies, did not close its market in answer to the crisis, on the contrary, it negotiated in recent times other FTA with South Korea and Singapore. (European Commission, 2018)

The aim of this paper is to understand whether the EU's trade policy position is fostering economic development. According to International Monetary Fund's World Economic Outlook Report, on April 2015 the Developing Countries in the world are 151, this number emphasises the importance of the topic.

The first part gives an overview on the trade theories, in particular the comparative advantage theory. The main analysis of this paper is concentrated on the trade policies used in the Developing Countries (DC) and the EU trade policy and its instruments and their effects. Before getting to the conclusion this paper will highlight the main critics and problems of the EU trade policy.

2. Comparative Advantage Theory and Trade

The gains of international trade can be multiple, and comparative advantage is the theory, which can help us to understand better how. Agents who involve themselves in international trade, invest their resources usually where they have low opportunity cost, concentrating much on the production of goods where they have more difficulties would only represent a waste of resources. Once the country is able to produce that good at a lower price than the competitors that country will have a comparative advantage over the others. The countries who have comparative advantage on one or more products join international negotiations. The benefit is more productivity; the countries will specialise in the production of different goods, and all countries will benefit from this specialisation. (Krugman et al., 2015) Ricardo's model claims that international trade is due to the difference in labour productivity, it is used to explain why countries engage in international trade. If countries are better in the production of some specific goods by engaging in free trade, they will improve their economy by exporting more those goods for which they have comparative advantage, and importing other goods. In this way the countries become more competitive. (Krugman et al., 2015)

If on one side there is the positive effects of trade, scholars agree that increased trade has economic growth as effect, , on the other side liberalisation has winner and losers, some theorists argue that we can always compensate the losers, but we don’t do it. This is the main reason why policy makers have to concentrate more on fair income distribution.

Nevertheless, the EU is performing very well in the trade sector. According to the European Commission the key for the EU's success is its common policy (rather than negotiating with 28 different countries). Secondly the EU has several primates: it has half a billion of consumers ready to pay more than the rest of the world, it is the largest single market and has quite transparent rules, the legal framework of investment is secured (unlike many other countries in the world) and its market is open to DC. (European Commission, 2018) Moreover, the Commission argues that the EU's success is closely linked to the success of its trading partners and sustainable development plays a fundamental role. (European Commission, 2018)

3. Trade Policy in Developing Countries

The aim of this paper is to better understand which role EU has in the economic development of DC. This section is dedicated to the study of the past economic policies adopted by the DC.

For two decades after the Second World War the most used strategy for DC was the import-substituting industrialization, the so-called infant industry argument supported this strategy. The idea behind the infant industry argument is that new industries are not able to compete with well-established firms of the rest of the world and for this reason, governments use quotas or tariffs to protect those industries at the beginning. (Krugman et al., 2015) Scholars agree that this argument has actually validity only in two cases of market failure: appropriability (when firms in a new industry generate social benefits for which they are not compensated) and imperfect capital markets (growth of new industries will be restricted). (Krugman et al., 2015)

The general idea behind these protectionist policies, was that economic growth is characterized by improvements of domestic production, rather than increased exports. One of the extreme cases of import substituting was India in the early 70s. Scholars and economists agree that in reality this strategy did not work, it resulted in a complete defeat, and the negative effects outbalanced the positive. (Krugman et al., 2015) Critics of the import-substitute claim that it increases unemployment and income inequality.

By the late 80s, this strategy was openly recognized as a failure and was soon abandoned. (Krugman et al., 2015) The main problem and effect of these protectionist instruments is that the consumer is the looser; in fact, the prices of the products increased, because the market is not open for imports and liberalization again. Protectionism usually leads a block in the economy; you may create jobs in manufacturing but the country will not do export.

Why is it so difficult for DC to develop? Krugman mentions some of the difficulties of the DC which have a role in the lack of success of these strategies: lack of skilled labour, and lack of entrepreneurs and managerial competence. (Krugman et al., 2015) The more general problem of DC is the coordination failure, bad infrastructure, investors are not attracted there, no revenues. Another reason why FTA and customs union in Africa are not working is that there is a general lack of trust towards the neighbour countries (risk of war), dictatorships, countries do not want to be dependent on their neighbours, and this situation is not attractive for investors.

4. EU Trade Policy

The beginning of the EU trade policy goes back to the Treaty of Rome. The establishment of the Customs Union and the Common Agricultural Policy (CAP) are the first steps for a liberalized trade between the Member States (MS). (Woolcock, 2010: 382) In the 1980s during the period of the General Agreement on Tariffs and Trade (GATT) the main international actors are the EU and the United States of America. The EU's influence is such that scholars agree that it had an influential role in the creation of the World Trade Organization (WTO). (Woolcock, 2010) The situation is gradually changing. The raise of developing economies like Brazil, China or India changes the international context in which the EU and USA were leading, starting from the 1990s some scholars define the trade system as multi-polar, the influential actors are increasing in number. For this reasons the EU changes its policy in 2006, the aim for the EU is now to have a multi-level approach, by negotiating bilateral Free Trade Agreements (FTA) for example. (Woolcock, 2010)

The relations with DC were affected by the strategic changes of the EU. Global Europe was introduced in 2006, the EU priorities on the agenda are to find new key partners[1]and to make proposals for “new generation of carefully selected and prioritised FTAs”. (European Commission, 2006) Since the new strategy has been adopted, the EU includes, in the negotiation of agreements with DC, topics like environment, labour rights, and sustainable development. (EU commission, 2018)

It is worth mentioning that, the problem of trade policy in this field is that external action, aid, development and trade policy are all interrelated. There is no clear distribution of competence and separation of topics, because this would be very difficult, and at the same time, this trans-sectoral feature could represent an obstacle for good efficiency.

4.1. EU instruments

In the past, the EU has been using mainly autonomous non-reciprocal[2]preferential agreements, also known as generalized system of preferences (GSP) and special preferential schemes for DC, which were considered to have a particular relevance in the eyes of the EU. The most important schemes are under the Lomé Convention with the African Caribbean and Pacific countries (ACP) and the southern and eastern neighbourhood countries of the EU. (El-Agraa, 2011: 403)

It is important to understand what exactly the GPS achieved in the past to better understand the EU strategy today. Between 1971 (first year of GPS) and 1995 this system covered all manufactured products but it was making a difference between sensitive and none, sensitive products were characterized by quotas, in 1995 these have been replaced with tariffs. (El-Agraa, 2011: 404) In reality, there has been no notable change in the DC exports, in fact, this system is considered an exception for the rules of WTO and creates uncertainties for eventual investors and the concessions on sensitive products were not enough. (El-Agraa, 2011: 405) An important change in the second half of the 1990s is the decision of the EU to remove quotas and duties on all products coming from LDC[3]and at the same time, the strategic changes are beginning and the EU starts to negotiate reciprocal FTA. (El-Agraa, 2011: 403)

Another important change in the mid of the 90s is the approach towards the neighbouring countries in the Mediterranean and Middle East. The first policy introduced by the EU was in 1973, the so-called Global Mediterranean Policy, which lasted until 1993. The trade preferences have been introduced in this framework coved by bilateral cooperation agreements. (El-Agraa, 2011) In the 90s the situation changed, trade preferences have been expanded and aid increased. In this period Spain pushed for a new policy, the so called Barcelona Process introduced in 1995, which mainly extends important cooperation in the following fields: politics and security, economy and finance; society and culture. Under the cooperation in economy, the goal is to reach Free Trade Zone by 2010, and to sign Association Agreements with the majority of countries by 2006. (El-Agraa, 2011: 407)

A significant group of DC, the African Caribbean Pacific countries (ACP) have colonial and historical links to the EU. (Holland, 2004) The agreements with ACP countries after 2003 fall under the Cotonou Agreement, these are mainly FTA (or economic partnership agreements EPA). It is here worth mentioning that these kind of arrangements are a consequence of the agreements under the Lomé Convention, which did not show the expected results. (El-Agraa, 2011) ACP countries were even more marginalized, the ACP exports reduced enormously, and critics claim that preferences were not applied to the majority of the products. In fact, only 34 to 45 % of the products from the ACP countries were eligible for preferences. (El-Agraa, 2011: 406) Actually, the main risk of liberalization today under the FTA is the marginalization of some groups of countries. (El-Agraa, 2011: 407) The majority of ACP countries has today signed EPA with the EU. (European Commission, 2018)

Other negotiations on FTA started in the mid-90s[4], today the EU has negotiated a large number of FTA, some are already in place, like with South-Korea and Azerbaijan, others are pending (Japan, Singapore), other are now being negotiated (India, Thailad, GCC) but the majority of the FTA and EPA are partially in place (South Africa, SADC, ESA, SADC). (European Commission, 2018)

Scholars agree that FTA increases trade and economic growth, a good example is the case of South Korea. A study commissioned by the European Commission delivered very good results about the FTA between EU and South Korea. About 99 % of the tariffs have been eliminated, the EU has increased its exports from 23 billion euro of 2009 to an average of about 45 billion euro seven years after, the EU trade balance changed from a deficit of 10 billion euro to 7 billion. (European Union, 2017:7) In comparison with other countries in Asia like Japan, Taiwan or Malaysia, Korea is performing very well since 2005, trade in services has improved as well, exports of services from Korea to EU increased by 35 % since 2011. (European Union, 2017:12) The effect of FTA on foreign direct investments is that they have been stimulated, the stock of foreign direct investments (FDI) has reached 50 billion euro in 2015. (European Union, 2017)

Apart from trade, aid has an important role in development, although, El-Agraa, together with other scholars, affirm that Official Development Assistance (ODA) is not a very efficient instrument. The EU development cooperation policy relies on following principles, the so-called four C: complementary, coordination, coherence and consistency. (El-Agraa, 2011) After the establishment of the Millennium Development Goals (MDG) the EU adapted its policies to those targets, which were renewed in 2005 with the European Consensus. (El-Agraa, 2011: 415)

An major source of ODA is not only the EU Budget, but also the European Development Fund (EDF), which is managed by the Commission on behalf of the MS. The main problem is that ODA is not an exclusive competence of the EU but trade is ruled at supranational level, this is often criticized, since MS could prefer some DC to a greater extent than others. Other criticisms are the slow disbursement of resources, the fact that EU puts much more attention to the process rather than the outcome and that it has a strong bureaucratic approach, and the decision-making process is strongly centralized. (El-Agraa, 2011: 418)

According to El-Agraa the EU moved from an initial strategy of autonomous preference-based and regionally discriminatory regional trade agreements to a more horizontal and differentiated policy, which now concentrates on reciprocity. (El-Agraa, 2011: 409) El-Agraa claims that the most important consequence of FTA is the unilateral removal of trade barriers on EU exports; this is why he criticises the FTA to be an asymmetric liberalization process. In this case, the consequence may be also that many small and medium size businesses are forced to close and unemployment may rise. The main problem highlighted by El-Agraa is that DC mainly have a comparative advantage on agricultural products, but there are still barriers against those. (El-Agraa, 2011) Some scholars also argue that FTAs will only favour the European exports. Moreover, El-Agraa adds the fact that the reduction of tariffs revenues may be a problem the governments of DC have to face.


[1]ESEAN, Korea and Mercosur are identified as potential partners. (European Commission, 2006)

[2]Non-reciprocal means that DCs are not asked to apply the same conditions.

[3]According to the United Nations, the Least Developing Countries are the ones who exhibit the lowest indicators of socioeconomic development, with the lowest Human Development Index in comparison to the rest of the countries. (UNDESA)

[4]Seven negotiations with countries of Mercosur. (El-Agraa, 2011)


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Title: North-South Trade. Is the EU's trade policy position fostering economic development?