Trade Diversion or trade deviation is a phenomenon in which trade shifts occur from more efficient suppliers to less efficient suppliers, as a result of the introduction of tariffs and tariff preferences in international trade. In a trade diversion situation, a country that should be the main supplier in a particular market can be outperformed by another country which is more expensive but enjoys lower tariffs.
Trade Diversion plays an important role in international trade because it can affect market efficiency and the distribution of resources around the world. By hindering trade that should be more efficient, Trade Diversion can cause economic loss and harm consumers, producers and the countries involved in the trade.
Therefore, in this article, we will discuss more about Trade Diversion and the factors that influence it, case studies on Trade Diversion, its impact on international trade, and ways to overcome this phenomenon so that international trade can run more efficiently and fair.
Trade Diversion Factors
Factors that influence the occurrence of Trade Diversion include differences in tariffs, tariff preferences, and differences in production costs.
1. Tariff Difference
Tariffs are taxes imposed on imported goods that enter a country. If a country decides to provide lower tariffs to certain countries in a trade deal, then that country will have a greater tariff advantage over other countries that are not covered by the agreement. As a result, countries that are supposed to be the main supplier in certain markets may be outperformed by other countries which are more expensive, but enjoy lower tariffs.
2. Tariff Preferences
Tariff preferences are government policies that provide lower tariffs or even tariff-free for products imported from certain countries, as an incentive to increase bilateral trade. However, tariff preferences can cause trade diversion because products that originally come from more efficient and competitive countries are replaced by products from countries with lower tariff preferences.
3. Differences in Production Costs
Differences in production costs between countries can also affect the occurrence of Trade Diversion. If the cost of producing a product is cheaper in country A than in country B, then the product should be imported from country A. However, if country B provides lower tariffs or tariff preferences for the product, then producers in country B become more competitive, and the product is imported from country B even though the cost of production is higher.
In this case, the difference in production costs is not a direct cause of Trade Diversion, but rather a supporting factor for Trade Diversion because countries with higher production costs can produce more expensive products so they cannot compete with other countries that are more efficient, but enjoy lower tariffs or tariff preferences.
Example of Trade Diversion
One example of a case of Trade Diversion occurs in trade between the United States, Canada and Mexico through the North American Free Trade Agreement (NAFTA). When NAFTA was adopted, import tariffs between the three countries were abolished so that trade between them became freer.
However, lower tariffs on products provided by NAFTA make countries outside the agreement less competitive, even though they are actually more efficient at producing certain products. As a result, trade between the United States, Canada, and Mexico increased, but trade with other more efficient and competitive countries decreased.
Another example of trade diversion occurs in the European region, where the European Union (EU) has trade agreements with African, Caribbean and Pacific (AKP) countries. However, the EU also has trade agreements with other non-AKP countries, such as Thailand and India. Because deals with AKPs provide greater tariff preference than deals with non-AKP countries, imports from non-AKP countries become less competitive, and imports from AKP countries increase. As a result, Trade Diversion occurs in EU trade with non-AKP countries.
This case study shows that trade diversion can occur at various levels of trade agreements, and can cause significant economic impacts for the countries involved in the trade.
Impact of Trade Diversion
The occurrence of trade diversion can have a significant economic impact on countries involved in trade. The following are some of the impacts that can occur:
a. Declining Economic Efficiency
The occurrence of Trade Diversion can cause countries that are more efficient in producing certain products to become less competitive. As a result, resources that should be used for the production of more efficient products are instead used for the production of less efficient products. This can lead to a decrease in overall economic efficiency, thereby hampering economic growth and reducing people’s welfare.
b. Consumer Losses
Trade Diversion can also cause consumers to suffer losses. This occurs because products that are supposed to be cheaper and more efficient cannot compete in the market as a result of tariffs or tariff preferences. Conversely, more expensive products from countries that enjoy tariff preferences or lower tariffs become more competitive. This can cause consumers to have to pay more for products that should be cheaper.
c. Producer Losses
Trade Diversion can also cause losses for producers. If producers cannot compete with countries that enjoy tariff preferences or lower tariffs, then their production will decline. As a result, the number of jobs can decrease and producers experience a decrease in income.
d. Investment Uncertainty
The occurrence of Trade Diversion can also create uncertainty for investors. This occurs because investors must consider the possibility of trade policies that may affect their production in the future. As a result, investors may postpone or even cancel their investment plans, thereby affecting economic growth.
So, Trade Diversion can have a significant economic impact for countries involved in trade. Therefore, it is important for countries to consider the impact of the trade policies they implement, so as to promote more efficient and fair trade.
How to Avoid Trade Diversion
To avoid Trade Diversion, countries can take the following actions:
1. Expand Free Trade Agreements
One way to avoid Trade Diversion is to expand free trade agreements between countries. With the existence of broader free trade agreements, countries will have access to larger markets and have more choices in choosing trading partners. This can encourage healthy competition and help promote overall economic efficiency.
2. Reducing Tariff Preferences
Countries can reduce tariff preferences for products from certain countries and apply the same tariffs to all countries. With equal tariffs for all countries, countries will compete fairly, and more efficient countries will win the competition.
3. Strengthen Anti-Dumping Practices
Countries can strengthen anti-dumping practices to protect domestic producers from unfair competition. Anti-dumping practices can help prevent imports of products that are sold at prices below market prices, thereby preventing trade diversion.
4. Increasing Market Openness
Countries can increase their market openness to products from other countries. By increasing market openness, countries will have more choices in choosing trading partners and increase overall economic efficiency.
5. Reducing Non-Tariff Barriers
Countries can reduce non-tariff barriers that can lead to trade diversion, such as over-regulation or different standards for the same product. By reducing non-tariff barriers, countries will facilitate trade between countries and promote overall economic efficiency.
In the world of international trade, Trade Diversion is an important issue to pay attention to. Trade Diversion can have a detrimental effect on countries involved in trade, especially if it occurs in the long term. Therefore, efforts and actions are needed to prevent Trade Diversion from occurring.
Expanding free trade agreements, reducing tariff preferences, strengthening anti-dumping practices, increasing market openness, and reducing non-tariff barriers are some of the ways countries can take to avoid trade diversion. By taking such action, countries can ensure more efficient and fair trade, thereby enhancing economic growth and societal well-being.
In facing the challenges of international trade, cooperation and communication between countries is very important. Countries must work together to create a fair and efficient trading environment, so as to provide maximum benefits for all parties involved. In this way, Trade Diversion can be avoided, and international trade can become the main driver of economic growth and global prosperity.
