Trade Creation and Trade Diversion
A major effect of regional trade liberalization is to alter the pattern of
production and trade as countries reallocate their resources toward the
production of goods in which they have a comparative advantage.
Economists divide the effects on trade into two categories: trade creation
and trade diversion.
Trade creation occurs when producers in one member country find that
they can export products to another member country that previously were
produced there because of tariff protection. For example, when the North
American Free Trade Agreement (NAFTA) eliminated most cross-border
tariffs among Mexico, Canada, and the United States, some U.S. firms
found that they could undersell their Canadian competitors in some
product lines, and some Canadian firms found that they could undersell
their U.S. competitors in other product lines. As a result, specialization
occurred, and new international trade developed among the three
countries.
Trade creation represents efficient specialization according to comparative advantage.Trade diversion occurs when exporters in one member country replace
more efficient foreign exporters as suppliers to another member country.
For example, trade diversion occurs when U.S. firms find that they can
undersell competitors from the rest of the world in the Canadian market,