63404 Preferential Trade Agreement Policies for Development A HANDBOOK Editors Jean-Pierre Chau our • Jean-Christophe Maur PREFERENTIAL TRADE AGREEMENT POLICIES FOR DEVELOPMENT PREFERENTIAL TRADE AGREEMENT POLICIES FOR DEVELOPMENT A HANDBOOK Jean-Pierre Chauffour and Jean-Christophe Maur, Editors © 2011 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved 1 2 3 4 :: 14 13 12 11 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denomina- tions, and other information shown on any map in this work do not imply any judgement on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permis- sion may be a violation of applicable law. The International Bank for Reconstruction and Development / The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; telephone: 978-750-8400; fax: 978-750- 4470; Internet: www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. ISBN: 978-0-8213-8643-9 eISBN: 978-0-8213-8644-6 DOI: 10.1596/978-0-8213-8643-9 Library of Congress Cataloging-in-Publication Data. Preferential trade agreement policies for development : a handbook / Jean-Pierre Chauffour, Jean-Christophe Maur, editors. p. cm. Includes bibliographical references and index. ISBN 978-0-8213-8643-9 — ISBN 978-0-8213-8644-6 (electronic) 1. Developing countries—Commercial policy. 2. Developing countries—Foreign economic relations. 3. Tariff preferences—Developing countries. 4. Free trade—Developing countries. 5. Economic development—Developing coun- tries. I. Chauffour, Jean-Pierre. II. Maur, Jean-Christophe. III. World Bank. HF1413.P69 2011 382'.9091724—dc22 2011014920 Cover illustration: Barrie Maguire, NewsArt.com Cover design: Drew Fasick CONTENTS Foreword xi Acknowledgments xiii About the Editors and Contributors xv Abbreviations xvii Overview 1 Jean-Pierre Chauffour and Jean-Christophe Maur 1 Beyond Market Access 17 Jean-Pierre Chauffour and Jean-Christophe Maur 2 Landscape 37 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard 3 Economics 69 Richard Baldwin 4 North-South Preferential Trade Agreements 95 Bernard Hoekman 5 Customs Unions 111 Soamiely Andriamananjara 6 Preferential Trade Agreements and Multilateral Liberalization 121 Richard Baldwin and Caroline Freund 7 Agriculture 143 Tim Josling 8 Preferential Rules of Origin 161 Paul Brenton 9 Trade Remedy Provisions 179 Thomas J. Prusa 10 Product Standards 197 Jean-Christophe Maur and Ben Shepherd v vi Contents 11 TBT and SPS Measures, in Practice 217 Andrew L. Stoler 12 Services 235 Aaditya Mattoo and Pierre Sauvé 13 Labor Mobility 275 Sherry Stephenson and Gary Hufbauer 14 Investment 307 Sébastien Miroudot 15 Trade Facilitation 327 Jean-Christophe Maur 16 Competition Policy 347 Kamala Dawar and Peter Holmes 17 Government Procurement 367 Kamala Dawar and Simon J. Evenett 18 Intellectual Property Rights 387 Carsten Fink 19 Environment 407 Anuradha R. V. 20 Labor Rights 427 Kimberly Ann Elliott 21 Human Rights 443 Susan Ariel Aaronson 22 Dispute Settlement 467 Amelia Porges Index 503 Boxes 2.1 Typology of Preferential Trade Agreements 38 6.1 Is Bilateralism Bad? 123 7.1 The WTO Agreement on Agriculture 146 9.1 Antidumping Template 186 9.2 Countervailing Duties Template 186 9.3 Global Safeguards Template 186 9.4 Bilateral Safeguards Template 187 10.1 What Are Meta-Standards? 198 10.2 Proliferation and Growing Importance of Product Standards 198 10.3 Do Voluntary Standards Have Cost Effects, Too? 201 10.4 Inventory Methods versus Direct Measures of Restrictiveness 203 10.5 Facilitating Market Access: Harmonization, Equivalence, and Mutual Recognition 204 Contents vii 10.6 Trade Effects of Harmonization: Empirical Evidence 205 10.7 Trade Effects of Mutual Recognition: Empirical Evidence 207 10.8 How Small ASEAN Countries Manage to Access Certification and Accreditation Services 209 10.9 The Codex Alimentarius and Preferential Trade Agreements 213 11.1 WTO Standards and Guidelines on TBT and SPS Measures 218 11.2 Success Story: Orchids to Australia 224 11.3 Impact of SPS Measures in the China-New Zealand PTA 226 11.4 WTO Assessment of TBT Implementation Costs 230 11.5 Using the PTA’s Living Agreement Institutions for Capacity Building: An Example 230 11.6 Dispute Settlement of TBT and SPS Measures in the WTO and within the Andean Community 231 12.1 WTO+ and WTO-Extra Provisions in U.S. and EU PTAs 241 12.2 Harmonization and Mutual Recognition in Services: Promise and Pitfalls 248 12.3 PTAs and Digital Trade 259 12.4 Tourism Liberalization in the EU–CARIFORUM EPA 260 12.5 Cultural Cooperation and Aid for Trade in the EU–CARIFORUM EPA 263 13.1 Labor Mobility in Statistical Terms 277 13.2 Quantitative Estimates of Overall Gains from Greater Labor Mobility 279 14.1 Rules on Investment at the WTO 308 15.1 Definition and Scope of Trade Facilitation in Selected PTAs 328 15.2 Trade Facilitation and the WTO 329 15.3 The Trans-Kalahari Corridor 330 15.4 Mercosur’s Transit and Cross-Border Transport Agreement 339 16.1 Competition Policy and International Cooperation 356 17.1 Persistence of Discrimination: Procurement Practices and the Global Economic Crisis 369 17.2 Three International Government Procurement Instruments 372 17.3 Examples of Flexible Provisions in Government Procurement PTAs 375 18.1 Patent-Registration Linkage and Test Data Protection: The Case of Chile 394 19.1 Considerations for Developing Countries in Negotiating PTAs 412 20.1 Sweatshop Scandal Insurance for Brand-Name Buyers 429 20.2 Labor Rights and the WTO 430 20.3 NAFTA as a Tool for Promoting Rights of Mexican Migrants in the United States 438 20.4 Responding to a Sweatshop Scandal through Capacity Building and Monitoring 439 21.1 Transparency, Due Process, and Democracy Spillovers from the WTO 448 22.1 The Protocol of Olivos 482 Figures 1.1 Most Favored Nation (MFN) Tariff Rates, Weighted Mean, All Products 20 2.1 Total PTA Notifications Received by the World Trade Organization, by Year, 1949–2009 40 2.2 All PTAs Notified to the GATT/WTO, by Year of Entry into Force, 1949–2009 40 2.3 PTAs Notified to the GATT/WTO and in Force, by Year of Entry into Force, 1959–2009 41 2.4 PTAs Notified to the GATT (Pre-1995) and the WTO (Post-1995), by Legal Provision 41 2.5 Evolution of Notified PTAs in Force, by Type of Partner, 1958–2009 43 2.6 Number of PTAs under Negotiation and Signed, by Type of Partner, as of February 2010 43 2.7 Bilateral versus Plurilateral PTAs Notified to the GATT/WTO 44 2.8 Cross-Regional and Intraregional PTAs Notified to the GATT/WTO 44 2.9 PTAs, by Region and by Year of Entry into Force, 2000–09 45 2.10 PTAs in Force and under Negotiation, by Region 46 2.11 PTAs in Force and under Negotiation by Selected Countries and Groupings, as of February 2010 46 2.12 Issues Covered in Regional Trade Agreements, 1989–2009 47 2.13 Participation in Notified PTAs as of February 2010 (Goods) 49 2.14 Participation in Notified EIAs as of February 2010 (Services) 50 2.15 Network of Plurilateral Groupings in Europe and Central Asia 51 2.16 Network of Plurilateral Groupings in the Americas and the Caribbean 52 2.17 Network of Plurilateral Groupings in South Asia, East Asia, and the Pacific 53 2.18 Network of Plurilateral Groupings in Africa and the Middle East 54 viii Contents 2.19 Evolution of the Share of Intra-PTA Imports in Total Imports, 1970–2008 58 2.20 Evolution of the Share of Intraregional Trade in Gross Domestic Product, 1970–2008 60 2.21 Most Favored Nation Applied Tariffs, Trade-Weighted Average of All PTA Members Selected Periods 62 2.22 Proportion of Tariff-Free Imports as a Share of Total Imports, All Goods, Selected PTAs and Periods 62 2.23 Percentage Changes in Trade from Entry into Force of a Preferential Trade Agreement to 2008, Based on Gravity Model Estimates 63 3.1 Trade Pattern for a Simple Preferential Trade Association 70 3.2 Trading Equilibriums in a Preferential Trade Association 71 3.3 Ambiguous Net Welfare Effects 72 3.4 Effects of Preferential Frictional Barrier Liberalization on Prices and Imports 73 3.5 Welfare Effects of Preferential TBT Liberalization: Viner’s Ambiguity Vanishes 73 3.6 Competition (COMP) and Break-Even (BE) Curves 74 3.7 Prices, Output, and Equilibrium Firm Size in a Closed Economy 75 3.8 Prices, Output, and Equilibrium Firm Size with Integration 77 3.9 Welfare Effects of Complete Liberalization 78 3.10 Demand-Linked Circular Causality 79 3.11 Input-Cost-Linked Circular Causality 80 3.12 Locational Equilibrium Diagram 81 3.13 Locational Equilibrium Diagram with Trade Liberalization 82 3.14 Trade Arrangements and Industrialization 82 3.15 Location of Japanese Auto and Electrical Machinery Plants in East Asia, 1975–2004 85 3A.1 Johnson’s Diagram, Small Home and Partner Countries 87 3A.2 The Small PTA Diagram: A Simple Case 88 3B.1 Monopoly Profit Maximization 90 3B.2 Duopolist as Monopolist on Residual Demand: Example of a Nonequilibrium 91 3B.3 Duopoly and Oligopoly: Expectation-Consistent Outputs 91 6.1 Net Welfare Effects, Preferential Trade Agreement to Global Free Trade 125 6.2 Relationship between MFN Tariffs and Home Welfare 125 6.3 Juggernaut Logic 127 6.4 Juggernaut Building Block Logic 128 6.5 Imported MFN Liberalization 131 6.6 An Economic Theory of the GATT 132 8.1 Restrictiveness (R-Index) of Rules of Origin in Free Trade Agreements 171 9.1 Hub-and-Spoke and Cross-Regional Arrangement of PTAs 188 9.2 Intra-PTA Antidumping Filings, Sample of 74 PTAs 194 10.1 Elements of a Standards Infrastructure 200 12.1 Services-Related PTAs as a Share of Total PTA Notifications to the WTO, 2010 236 12.2 Services-Related PTAs Notified to the WTO, by Country Group 236 12.3 Sectoral Coverage of PTAs and of GATS Offers and Schedules, Selected Countries 257 12.4 GATS+ Advances in East Asian PTAs with Services Provisions, by Sector 261 12.5 GATS+ Advances in East Asian PTAs with Services Provisions, by Mode 262 12A.1 GATS and EU–CARIFORUM Commitments Compared: Barbados 266 12A.2 GATS and EU–CARIFORUM Commitments Compared: Dominican Republic 267 12A.3 GATS and EU–CARIFORUM Commitments Compared: Jamaica 268 12A.4 GATS and EU–CARIFORUM Commitments Compared: Trinidad and Tobago 269 13.1 Theoretical Gains from Liberalization of Mode 4 278 13.2 Theoretical Effect on Developed Countries of Liberalization of Mode 4 279 13.3 Theoretical Effect on Developing Countries of Liberalization of Mode 4 279 13A.1 Provisions on Mode 4 in PTAs between the United States and Developing Countries 300 13A.2 Provisions on Mode 4 in PTAs between Canada and Developing Countries 301 13A.3 Provisions on Mode 4 in PTAs between the European Union (EU) and Developing Countries 302 13A.4 Provisions on Mode 4 in PTAs between Japan and Developing Countries 302 13A.5 Provisions on Mode 4 in PTAs between Australia and New Zealand and Developing Countries 303 13A.6 Provisions on Mode 4 in PTAs between Developed and Developing Countries 304 14.1 Total Number of PTAs and Number with Investment Provisions, 1970–2009 308 17.1 PTAs Containing Government Procurement Provisions, 2009 371 Contents ix Tables 1.1 Types and Scope of Regulatory Objectives in Selected Areas Covered by Trade Liberalization Agreements 29 2.1 Deep Commitments in Selected EU and U.S. PTAs, by Type of Provision 48 2.2 Correlation between Intra-PTA and Total Export Growth Rates, 1970–2008 61 2.3 Estimation Results of the Gravity Model of the Average Trade between Two Partners, Selected PTAs 61 2A.1 Membership of Selected Plurilateral Preferential Trade Agreements 64 3.1 ASEAN Tariffs on Engines and Automobiles, Most Favored Nation (MFN) Tariffs and Common Effective Preference Tariffs (CEPTs), 2008 84 3.2 Intraindustry Trade as a Share of Internal and External Trade of PTAs 86 4.1 European Union (EU) Instruments and EU and National Objectives 106 5.1 Selected Customs Unions, in Force and Planned 112 7.1 Summary of Provisions Affecting Agriculture in NAFTA, U.S.–Chile, U.S.–Australia, and CAFTA Agreements 156 8.1 Summary of Methods for Determining Origin 164 9.1 Trade-Contingent Initiations and Measures in PTAs, 1995–2007 181 9.2 Contingent Protection Rules in Selected PTAs 182 9.3 Characteristics of PTAs 184 9.4 Summary of Contingent Protection Rules in PTAs 185 9.5 Cross-Tabulation of Contingent Protection Rules, by Hub 189 9.6 Antidumping Template for Selected PTA Hubs 189 9.7 Countervailing Duties Template for Selected PTA Hubs 190 9.8 Global Safeguards Template for Selected PTA Hubs 191 9.9 Bilateral Safeguards Template for Selected PTA Hubs 192 9.10 Characteristics of PTAs That Have Disallowed Trade Remedies 193 9.11 Antidumping Activity, by PTA Status 194 10.1 Prevalence of Harmonization and Mutual Recognition in Preferential Trade Agreements 207 10.2 Content of Preferential Trade Agreements Relating to Provisions on Standards 208 11.1 Comparison of Main Features Relating to TBT and SPS Measures, 11 PTAs 219 12.1 Key Disciplines in PTAs That Cover Services 244 12.2 Negotiating Approaches in Services Trade 253 12.3 Key Features of PTAs That Cover Services 255 12.4 Average Percentage of Subsectors Subject to Market Access Commitments on Mode 3, Selected Country Groupings 258 12.5 GATS Commitments, GATS DDA Offers, and “Best� PTA Commitments for All Members Reviewed, Selected Sectors 258 12A.1 Preferential Trade Agreements (PTAs) That Include Provisions on Trade in Services 264 12A.2 Classification of Preferential Trade Agreements (PTAs) Featuring Services Provisions by Country Group 265 13.1 Bilateral Labor Agreements with Developing-Country Partners: Government Programs for Temporary Workers 288 13A.1 Quantitative Estimates of Gains from Increased Labor Mobility 292 13A.2 Agreements between the United States and Developing Countries 293 13A.3 Agreements between Canada and Developing Countries 294 13A.4 Agreements between the European Union and Developing Countries 295 13A.5 Agreements between Japan and Developing Countries 296 13A.6 Agreements between Australia and New Zealand and Developing Countries 297 14A.1 Overview of Recent PTAs Covering Investment 322 14A.2 Selected Empirical Studies on the Impact of Bilateral Investment Measures 324 15.1 Functions of Selected Corridors 338 16.1 Cartel Overcharges and Deterrent Effect, Vitamin Industry, 1990s 354 16.2 Models of Regional Competition Regimes 357 18.1 U.S. Free Trade Agreement (FTA) Landscape 390 18.2 Principal TRIPS+ Provisions in U.S. Free Trade Agreements (FTAs) Ratified between 2001 and 2006 392 18.3 European Union (EU) Preferential Trade Agreements (PTAs) and Economic Partnership Agreements (EPAs) 398 20.1 Sanctions Authorized for Labor Violations in U.S. Preferential Trade Agreements 436 21.1 Examples of Human Rights Embedded in PTAs: Demandeurs and Position of Provisions in Agreement 445 x Contents 21.2 The Universal Declaration on Human Rights and Its Two Covenants 446 21.3 Examples of Avenues and Actions at the WTO Related to Human Rights, 2005–10 447 21.4 Human Rights in Preferential Trade Agreements: Comparing EFTA, the EU, the United States, and Canada 449 21.5 Examples of Human Rights Embedded in Preferential Trade Agreements 450 FOREWORD Regional integration is increasingly recognized as a key avenue for promoting economic growth and reducing poverty. Preferential trade agreements (PTAs) have become a central instrument of regional integration in all parts of the world. Beyond market access and the progressive elimination of barriers at the border, PTAs are increasingly being used to address a host of behind-the-border issues, also known as “deep integration� issues, in order to promote cooperation in the areas of investment, trade facilitation, competition policy, and government procurement, as well as wider social issues related to the regulation of the environment and the protection of labor and human rights. While the multilateral route to trade integration remains the first-best option, the stalling of the Doha Round of nego- tiations has led to a temporary impasse. Countries—developed and developing alike—have turned to the regional or bilat- eral route. With close to 300 PTAs notified to the World Trade Organization, regionalism has become a reality on the ground. Many countries are members of multiple PTAs, and the pace of negotiations on new agreements is accelerating. While it has been known for a long time that the traditional preferential market access elements of PTAs are likely to be suboptimal from a welfare perspective, as compared to multilateral or even unilateral liberalization, and that third parties often suffer from these arrangements, policy makers around the world expect these costs to be dwarfed by the deep inte- gration benefits of modern PTAs. The purpose of this handbook on preferential trade agreement policies for development is to explore the various ways in which policy makers and trade negotiators in the developing world can limit the costs and maximize the benefits of their regional integration efforts. Today’s modern PTAs are shaping a broad and comprehensive reform agenda that developing countries can adopt and implement with full ownership and mutual accountability. Preferential market access is no longer the predominant motive. Increasingly important is the use of PTAs to promote competitiveness, upgrade production stan- dards, liberalize services, modernize regulatory regimes, promote labor mobility, protect intellectual property, improve governance, and foster transparency and the rule of law; and, in time, to help build common regional values and norms for a more peaceful and prosperous world. Open regionalism as a complement to a freer and more transparent, rules-based multilateral trading system has been promoted by the World Bank for many years. Regional integration continues to play a positive transformational role in Europe, North America, East Asia, and Latin America, and the same forces are poised to deepen integration in the Middle East and North Africa, South Asia, and Sub-Saharan Africa. In the course of wide-ranging consultations on the World Bank’s upcoming international trade strategy, regional integration and cross-border trade cooperation emerged as one of the four main themes. I hope that this handbook—the collective effort of some of the world’s most renowned trade economists—enhances the understanding of various institutional arrangements and their possible development implications, thereby helping realize the promise of open regionalism and trade for poverty reduction. Mahmoud Mohieldin Managing Director World Bank Group xi ACKNOWLEDGMENTS This handbook is the product of a rich and fruitful collaboration among an outstanding set of distinguished individuals— economists, lawyers, and professional practitioners from around the world on the challenges and opportunities of preferential trade agreements (PTAs) for developing countries. This collaboration was made possible by the support of the Multi- Donor Trust Fund for Trade and Development (MDTF-TD) financed by contributions from the governments of Finland, Norway, Sweden, and the United Kingdom. The editors would like to extend their special thanks to the 26 authors who contributed to this volume for the quality of their research, their professional insights, and their patience in dealing with our multiple requests from the initial concep- tual stages, first drafts, lectures, and final assembly of the material. Without their unique knowledge and expertise, the preparation of this handbook would simply not have been possible. This book is the result of the close cooperation of two World Bank vice presidencies: Otaviano Canuto, vice president of the Poverty Reduction and Economic Management (PREM) Network, and Sanjay Pradhan, vice president of the World Bank Institute (WBI). Strong support from the Development Economics and Africa vice presidencies must also be acknowledged, in particular through substantive contributions to chapters of this book and insightful comments. The World Bank project on preferential trade agreements was originally the brain child of Uri Dadush, director of the World Bank International Trade Department, who in the Global Economic Prospects 2005: Trade, Regionalism, and Develop- ment (Washington, DC: World Bank, 2005) rightfully identified regionalism as an increasingly complex yet potentially pro- ductive avenue for promoting trade, economic integration, and development. When Bernard Hoekman took over the direction of the department, he not only provided the overall intellectual guidance for this project but also magnified its reach and helped us assemble the best possible crew of advisers and reviewers. Among them, we are particularly grateful to Richard Baldwin, Clem Boonekamp, Olivier Cattaneo, Jaime de Melo, Antoni Estevadeordal, Carsten Fink, Caroline Freund, Daria Goldstein, Mona Haddad, Gary Hufbauer, Nuno Limão, Patrick Low, Richard Newfarmer, Marcelo Olarreaga, and Sherry Stephenson for their overall guidance and support in various phases of this project. This endeavor was complemented by a World Bank Institute initiative, under the lead of Roumeen Islam, manager of the Poverty Reduction team, to bring focus and an entirely new program of activities on regional integration. This initiative turned out to be instrumental in the conception of this handbook. Notwithstanding fierce competing work priorities, Mona Haddad, sector manager (PREM), and Raj Nallari, manager (WBI), provided constant support without which the realization of this large project would not have been feasible. The editors would also like to acknowledge the contributions of many reviewers of individual chapters: Susan Aaronson, Rolf Adlung, Julia Almeida Salles, Bruce Blonigen, Olivier Cadot, Steve Charnovitz, Meredith Crowley, Jaime de Melo, Daria Goldstein, Lee-Ann Jackson, Steven Jaffee, Michael Jensen, Muthukumara Mani, Toni Matsudaira, Gerard McLinden, Roberta Piermartini, Daniel Sokol, and Jon Strand. Other colleagues at the World Bank have volunteered to share their knowledge and enthusiasm and provided invaluable advice and recommendations throughout the process, including Jean- François Arvis, Aaditya Mattoo, Maurice Schiff, Ravindra Yatawara, and Gianni Zanini. A special appreciation goes naturally to our experienced team of peer reviewers, who shared their international expert- ise and helped improve both the scope and focus of the entire manuscript: Ndiame Diop, Antoni Estevadeordal, and Richard Newfarmer. A book cannot exist without an effective production team. This book benefited from the impeccable professionalism of the World Bank’s Office of the Publisher. Stephen McGroarty and Mark Ingebretsen managed the publication process in xiii xiv Acknowledgments the smoothest possible way. Nancy Levine did an outstanding job at copyediting the entire volume. She deserves most of the credit for ensuring the readability of the technical parts of the book, and for making it, if not a page turner, an accessi- ble tool for experts. We would also like to thank the dedicated and professional support provided by the administrative team in the International Trade Department and WBI, including Cynthia Abidin-Saurman, Anita Chen, Nene Mane, Rebecca Martin, Anita Nyajur, Vasumathi Rollakanty, and Amelia Yuson. Special thanks also to Charumathi Rama Rao, who provided support on the financial management aspects of the project, and to Stacey Chow, who effectively coordinates the International Trade Department’s publication program. The editors would also like to thank the participants in the conference on the European and Asian approaches to Deep Integration co-hosted by the Centre for the Analysis of Regional Integration at Sussex (CARIS) at Sussex University on September 14–15, 2009; in particular, Michael Gasiorek, Peter Holmes, Jim Rollo, Zhen Khun Wang, and Alan Winters for useful and constructive feedback on early drafts of the chapters. Our thanks also go to the participants to the 2009–10 WBI courses on PTA and Development in Washington, DC, Dakar, and Arusha, and particularly to those who have contributed to their success: Raymond Boumbouya, Caiphas Chekwoti, Göte Hansson, Peter Kiuluku, Tharcisse Ntilivamunda, and Ina Hoxha Zaloshnja. A particular thought goes to the late Dipo Busari and his family. We owe a lot to the excellence of instructors and speakers who contributed to the courses: Richard Baldwin, Paul Brenton, Nora Dihel, Kimberley Elliott, Simon Evenett, Carsten Fink, Caroline Freund, Larry Hinkle, Bernard Hoekman, Peter Holmes, Gary Hufbauer, Oliver Jammes, Tim Josling, Charles Kunaka, Thea Lee, Javier Lopez, Aadittya Mattoo, Bonard Mawpe, Mary Mbithi, Abdoulaye Ndiaye, Ibrahima Bouna Niang, Tom Prusa, Andrew Roberts, Sebastian Sáez, Pierre Sauvé, Ben Shepherd, Yolanda Strachan, David Tarr, and Gianni Zanini. These thanks should not associate in any way our collaborators and partners in the production of this book to any remaining errors and shortcomings, which remain solely those of the editors. ABOUT THE EDITORS AND CONTRIBUTORS The Editors Jean-Pierre Chauffour is lead economist in the World Bank’s International Trade Department, Poverty Reduction and Economic Management (PREM) network, where he works on regionalism, competitiveness, and trade policy issues. Prior to joining the Bank in 2007, he spent 15 years at the International Monetary Fund (IMF) where he held various positions, including mission chief in the African Department and representative to the World Trade Organization (WTO) and United Nations (UN) in Geneva. Mr. Chauffour has extensive economic policy experience and has worked in many areas of the developing world, most extensively in Africa, the Middle East, and Eastern Europe. He holds master’s degrees in economics and in money, banking, and finance from the Panthéon-Sorbonne University in Paris, France. He is the author of The Power of Freedom: Uniting Human Rights and Development (Washington, DC: Cato Institute, 2009). Jean-Christophe Maur is senior economist in the growth and competitiveness practice of the World Bank Institute and a fellow with the Group d’Economie Mondiale at the Institut d’Etudes Politiques de Paris. His current areas of work cover regional integration issues, services liberalization, and contributing to the World Bank’s Development Debates platform. Mr. Maur joined the World Bank in 2008 from the U.K. Department of International Development, where he participated in U.K. trade negotiations in trade facilitation and goods market access. He was also tasked to manage the multilateral trade assistance cooperation with the World Bank and contributed to create the multi-donor trust fund for trade and develop- ment. His research interests cover regional trade integration and public goods, trade facilitation, standards, and intellectual property rights. He holds a doctorate in economics from Institut d’Etudes Politiques de Paris, and is a graduate of the ESSEC Business School. He was also a visiting fellow at Harvard University. The Contributors Susan Ariel Aaronson, associate research professor of international affairs, George Washington University, Washington, DC, and research fellow, World Trade Institute, Bern. Rohini Acharya, chief of regional trade agreements section, World Trade Organization, Geneva. Soamiely Andriamananjara, senior economist, Growth and Competitiveness Practice, World Bank Institute, Washington, DC. Richard Baldwin, professor of international economics, Graduate Institute of International and Development Studies, Geneva. Paul Brenton, lead economist (Trade and Regional Integration), Poverty Reduction and Economic Management, Africa Region, World Bank, London. Jo-Ann Crawford, counselor, World Trade Organization, Geneva. Kamala Dawar, Graduate Institute of International and Development Studies, Geneva. Kimberly Ann Elliott, senior fellow, Center for Global Development, Washington, DC. xv xvi About the Editors and Contributors Simon Evenett, professor of international trade and economic development, University of St. Gallen, Switzerland. Carsten Fink, chief economist, World Intellectual Property Organization, Geneva. Caroline Freund, chief economist, Middle East and North Africa Region, World Bank, Washington, DC. Bernard Hoekman, sector director, International Trade Department, World Bank, Washington, DC. Peter Holmes, Jean Monnet Reader in the Economics of European Integration, University of Sussex, Brighton, U.K. Gary Hufbauer, Reginald Jones Senior Fellow, Peterson Institute for International Economics, Washington, DC. Tim Josling, professor emeritus, Food Research Institute, Stanford University, Stanford, California. Maryla Maliszewska, economist, Development Prospects Group, World Bank, Washington, DC. Aaditya Mattoo, research manager, Trade and International Integration, World Bank, Washington, DC. Sébastien Miroudot, trade policy analyst, Organisation for Economic Co-operation and Development (OECD), Paris. Amelia Porges, principal, Law Offices of Amelia Porges PLLC, Arlington, Virginia. Thomas Prusa, professor of economics, Rutgers University, Brunswick, New Jersey. Anuradha R.V., partner, Clarus Law Associates, New Delhi. Christelle Renard, RTA database administrator, World Trade Organization, Geneva. Pierre Sauvé, deputy managing director and director of studies, World Trade Institute, University of Bern. Ben Shepherd, principal, Developing Trade Consultants Ltd., New York City. Sherry Stephenson, head, institutional relations, Organization of American States, Washington, DC. Andrew Stoler, executive director, Institute for International Trade, University of Adelaide, Australia. ABBREVIATIONS AB Appellate Body (WTO) ACP African, Caribbean, and Pacific (States) ACWL Advisory Centre on WTO Law ADR alternative dispute resolution AFAS ASEAN Framework Agreement on Services AFTA ASEAN Free Trade Area AGOA African Growth and Opportunity Act (U.S.) ANZCERTA Australia–New Zealand Closer Economic Relations Trade Agreement ANZGPA Australia and New Zealand Government Procurement Agreement APEC Asia-Pacific Economic Cooperation APTA Asia-Pacific Trade Agreement ASEAN Association of Southeast Asian Nations ATIGA ASEAN Trade in Goods Agreement ATJ Andean Tribunal of Justice AUSFTA Australia–U.S. Free Trade Agreement BIT bilateral investment treaty BLA bilateral labor agreement BTA bilateral trade agreement CACJ Central American Court of Justice CACM Central American Common Market CAFTA Central America Free Trade Agreement CAFTA–DR Dominican Republic–CAFTA CAN Comunidad Andina (Andean Community) CAP Common Agricultural Policy (EU) CARICOM Caribbean Community CARIFORUM Caribbean Forum of African, Caribbean, and Pacific (ACP) States CEC Council for Economic Cooperation (NAFTA); Commission of the European Communities CEFTA Central European Free Trade Agreement CEMAC Economic and Monetary Community of Central Africa (Communauté Économique et Monétaire de l’Afrique Centrale) CEPA Closer Economic Partnership Agreement (China) CEPAL/ECLAC Comisión Económica para América Latina/Economic Commission for Latin America and the Caribbean CEPT common effective preference tariff CET common external tariff CIF cost, insurance, and freight CIS Commonwealth of Independent States COMESA Common Market for Eastern and Southern Africa CTC change of tariff classification xvii xviii Abbreviations CUSFTA Canada–U.S. Free Trade Agreement CVD countervailing duties DDA Doha Development Agenda DSB Dispute Settlement Body (WTO) DSM Dispute Settlement Mechanism (WTO) DSU Dispute Settlement Understanding (WTO) DTT double-taxation treaty EAC East African Community; environmental affairs council EBA Everything But Arms (EU) ECJ European Court of Justice ECLAC/CEPAL Economic Commission for Latin America and the Caribbean/ Comisión Económica para América Latina ECO Economic Cooperation Organization ECOWAS Economic Community of West African States EDI electronic data interchange EEA European Economic Area EEC European Economic Community (for historical references) EFTA European Free Trade Association EGS environmental goods and services EIA economic integration agreement; environmental impact assessment ENP European Neighborhood Policy EPA economic partnership agreement ESM emergency safeguard mechanism EU European Union FAO Food and Agriculture Organization (of the United Nations) FDI foreign direct investment FOB free on board FTA free trade agreement; free trade area FTAA Free Trade Area of the Americas FTC Free Trade Commission (NAFTA) GAFTA Greater Arab Free Trade Agreement GATS General Agreement on Trade in Services GATT General Agreement on Tariffs and Trade GCC Gulf Cooperation Council GDP gross domestic product GI geographical indication GNP gross national product GPA Government Procurement Agreement (WTO) GSP generalized system of preferences HS Harmonized System ICCPR International Covenant on Civil and Political Rights ICESCR International Covenant on Economic, Social and Cultural Rights ICN International Competition Network ICSID International Centre for the Settlement of Investment Disputes ICT information and communication technology ICTSD International Center for Trade and Sustainable Development IMF International Monetary Fund IPR intellectual property right ISO International Organization for Standardization IT information technology ITO International Trade Organization Abbreviations xix LAIA/ALADI Latin American Integration Association/Asociación Latinoamericana de Integración Mercosur Southern Cone Common Market (Mercado Común del Sur) MFA Multifibre Arrangement MFN most favored nation MLAT mutual legal assistance treaty MNC multinational corporation MNE multinational enterprise MRA mutual recognition agreement MTN multilateral trade negotiation NAAEC North American Agreement on Environmental Cooperation (side agreement to NAFTA) NAALC North American Agreement on Labor Cooperation (side agreement to NAFTA) NACEC North American Commission for Environmental Cooperation NAFTA North American Free Trade Agreement NGO nongovernmental organization NTM nontariff measure OAS Organization of American States OCT Overseas Countries and Territories OECD Organisation for Economic Co-operation and Development OSBP one-stop border post PAFTA Pan-Arab Free Trade Area PICTA Pacific Island Countries Trade Agreement PRTR pollutant release and transfer registry PTA preferential trade agreement REIO regional economic integration organization ROO rule of origin RoW Rest of the World RTA regional trade agreement; reciprocal preferential agreement SAARC South Asian Association for Regional Cooperation SACU Southern African Customs Union SAD single administrative document SADC Southern African Development Community SAFTA South Asian Free Trade Area; Singapore–Australia Free Trade Agreement SAR special administrative region SIA sustainability impact assessment SME small and medium-size enterprise SPARTECA South Pacific Regional Trade and Economic Co-operation Agreement SPS sanitary and phytosanitary TBT technical barriers to trade TDCA Trade, Development, and Cooperation Agreement (EU–South Africa) TEC Treaty establishing the European Community TFAP trade facilitation action plan TIFA trade and investment framework agreement TPA Trade Promotion Act of 2002 (U.S.) TPR Tribunal Permanente de Revisión (Mercosur) TPRM Trade Policy Review Mechanism (WTO) TPSEP Trans-Pacific Strategic Economic Partnership TRIMS Trade-Related Investment Measures TRIPS Trade-Related Aspects of Intellectual Property Rights TRQ tariff-rate quota TWP temporary worker program UDHR Universal Declaration of Human Rights xx Abbreviations UNCITRAL United Nations Commission on International Trade Law UNCTAD United Nations Conference on Trade and Development USITC U.S. International Trade Commission USTR United States Trade Representative VER voluntary export restraint WAEMU/UEMOA West African Economic and Monetary Union/Union Économique et Monétaire Ouest-Africaine WCO World Customs Organization WIPO World Intellectual Property Organization WTO World Trade Organization Overview Jean-Pierre Chauffour and Jean-Christophe Maur Preferential trade agreements (PTAs) have become a cor- improvements in productivity brought about by the trans- nerstone of the international trade system. The surge in fer of improved technology, learning by doing, and their number and scope is fast reshaping the architecture of increased competition. Bilateral or regional integration can the world trading system and the trading environment of be an important engine of trade competitiveness, both for developing countries. The integration of these diverse small, very poor, landlocked countries and for less region- agreements into a multilateral framework that facilitates ally integrated or diversified middle-income countries. the expansion of trade is likely to be one of the main chal- At the same time, the multitude of PTAs is becoming lenges facing the world trading system in the coming years. cumbersome to manage for many developing countries. Hundreds of preferential agreements—free trade agree- As agreements proliferate, countries become members of ments and customs unions that involve reciprocal tariff several different agreements. The average African country, reductions—are currently in force, including close to 300 for instance, belongs to four different agreements, and the that had been notified to the World Trade Organization average Latin America country belongs to seven. This (WTO) as of end-2010. Such a proliferation of regional creates what has been referred to as a “spaghetti bowl� of and bilateral PTAs, together with the sluggishness of Doha overlapping arrangements, often with different tariff Round negotiations toward a new multilateral trade agree- schedules, different exclusions of particular sectors or ment, pose serious challenges to the promotion of a more products, different periods of implementation, different open, transparent, rules-based multilateral trading system. rules of origin, different customs procedures, and so on. Although PTAs may promote development, they necessar- The proliferation of bilateral and regional PTAs may ily discriminate against nonmembers and can therefore undermine progress toward a more open, transparent, and lead to trade diversion in a way that hurts both member rules-based multilateral trading system. countries and excluded countries. At the same time, PTAs This Handbook offers an introduction to the complex create larger and more competitive markets and benefit world of modern PTAs. It follows in the steps of earlier, producers and consumers through economies of scale and seminal World Bank publications on the economics and lower prices, among other effects. Beyond market access practice of PTAs, notably New Dimensions in Regional Inte- motives, PTAs are increasingly used as engines of change in gration (De Melo and Panagariya 1996), Trade Blocs (World many developing countries, to promote, implement, and Bank 2000), and Regional Integration and Development lock in reforms in a wide range of policy areas such as (Schiff and Winters 2003). Supplementing these earlier investment regimes, competition rules, and government publications, this volume aims at taking its audience procurement. beyond the traditional market access paradigm to consider In many developing countries, regional integration has more broadly and systematically the numerous regulatory become a key means of promoting economic growth and policy dimensions that are contained in modern PTAs. In fighting poverty. In fact, no low-income country has man- particular, it offers a framework for understanding a num- aged to grow and sustainably reduce poverty without ber of behind-the-border policies typically covered in global or regional trade integration. In the short term, PTAs, including labor mobility, investment, trade facilita- regional trade contributes to growth by expanding markets tion, competition, and government procurement, as well as for goods and services. In the medium to long term, other societal and more normative policies related to intel- regional integration contributes to growth through lectual property, environment, labor rights, and human 1 2 Jean-Pierre Chauffour and Jean-Christophe Maur rights. These latter are increasingly among the policies tions of these links for development, rather than to assess driven by powerful trading blocs as they strive to influence the individual merits of given PTA initiatives. developing countries and the evolution of the global trad- The remainder of this overview offers a brief survey of ing system. the contents of the Handbook to help readers navigate The Handbook is also inspired by the numerous among the topics and to put the various parts in perspective. requests received by the World Bank from developing countries or groups of developing countries worldwide for A Road Map of the Handbook advice on PTAs, including those currently being negoti- ated, as an aid in understanding the obligations and the This volume consists of 22 mostly original and unpub- possible economic and development implications of vari- lished chapters written by renowned international trade ous provisions. In light of these requests, and in view of the academics and experts. They originate from the course on growing but fragmented knowledge on PTAs, the Hand- preferential trade agreements designed by the World Bank book seeks to provide a first point of entry into the issues, Institute and from the regional integration work of the to inform the policy debate in this area, and to help trade World Bank’s International Trade Department. policy makers, researchers, and practitioners, among Chapter 1 highlights the main theme and raison d’être others, better understand and navigate the world of PTAs. of the Handbook: that modern PTAs are essentially preoc- In particular, the book has been written with a view to cupied by a wide range of behind-the-border and deep informing policy makers and trade negotiators in devel- integration issues that represent considerable opportuni- oping countries about the economic and development ties and challenges for low-income countries, beyond the implications of different approaches to the most impor- benefits of market access. Chapter 2 maps the landscape of tant sectoral provisions in PTAs. The ultimate objective of regionalism, chapter 3 presents the economic theory of the Handbook is to help developing countries use PTAs PTAs, and chapter 4 describes the characteristics of poten- proactively, as instruments to bolster their trade competi- tially development-friendly PTAs. Chapter 5 examines the tiveness and leverage the global economy to promote specificities of customs unions, one of the most advanced growth and poverty reduction. forms of PTA. Chapter 6 discusses the tension between The content of the Handbook is largely nontechnical regionalism and multilateralism. Next, chapters 7 through and has been written to be accessible for a large audience 17 survey current practice in the main policy areas typically of policy makers, general academics, and other stake- covered in PTAs: agriculture policy, rules of origin, product holders who are not necessarily economists or legal spe- standards, technical barriers, trade remedies, services, labor cialists. It is designed to be used for both graduate and mobility, and deep integration areas related to investment, undergraduate teaching in economics, international rela- trade facilitation, competition policy, and government tions, political science, and law, but it may also be of spe- procurement. Chapters 18 through 21 review a number of cial interest to informed readers who may not have more normative issues that are increasingly incorporated detailed knowledge of all aspects of PTAs. One of its key into PTAs—intellectual property, environment, labor objectives is to offer an entry point to specialized areas rights, and human rights. Chapter 22 closes the volume covered in PTAs. For this reason, each chapter can be with a discussion of the cross-cutting issue of dispute read independently, as a guide to the most salient issues settlement in PTAs. arising in PTAs today. Given the rapidly evolving nature From a methodological standpoint, each policy area of many issues discussed in the Handbook, the volume is has been researched with a set of generic questions in to be regarded as a window into the issues covered by mind. How do provisions in a given policy area compare PTAs, not as a definitive appraisal. across selected relevant PTAs and (when applicable) with Although the global evolution of preferentialism WTO rules? What are the legal and economic implications betrays the influence of particular countries and integra- of different formulations? Are there particular economic tion initiatives, the Handbook purposely chooses not to development benefits or costs associated with different discuss as stand-alone issues important bilateral or pluri- approaches? To what extent are third parties being dis- lateral initiatives led by large economies such as the criminated against, and are PTA provisions conducive to European Union (EU) and the United States. Rather, it open regionalism? How binding are the provisions in the refers throughout to specific relevant examples. The focus short term and the longer term? What dispute settlement is chiefly to promote understanding, from an analytical mechanisms would be used in case of disagreements, and perspective, of the links between sectoral issues in deep how? Are there particular approaches (e.g., hard law ver- integration and preferential liberalization and the implica- sus soft law) that can be advocated or that should be Overview 3 avoided? What are the implications of the provisions for characterized by low external barriers to trade, liberalized building up institutions and for technical assistance services markets, nonrestrictive rules of origins for services needs? To what extent do the provisions help deliver as well as for goods, a focus on reducing transaction costs regional public goods or tackle market failures that are at borders, and transparency and the availability of due regional in nature? process. Another answer to complexity, and one not sufficiently considered, according to the authors, by developing coun- Beyond Market Access tries, is selectivity. Liberalization is a complex matter, not Beyond market access, PTAs have become potential only from a capacity standpoint, but also politically. Over- instruments of choice for many developing countries for loading the negotiating agenda (which will later become promoting wide-ranging reforms and promoting owner- the implementing agenda) creates a distraction from what ship, mutual accountability, and results. In chapter 1, Jean- may be achievable and where gains may be the most Pierre Chauffour and Jean-Christophe Maur discuss important. Agreements bloated by too many issues may why, for many low-income countries, PTAs are increas- lose significance and fail to achieve much. ingly the core of a credible development strategy for Finally, the dynamics of North-South, South-South, and accelerating economic growth and reducing poverty. North-North PTAs differ considerably. Asymmetric agree- Choosing meaningful issues, with the right partner, with ments make cooperation less easy and may provide less adequate technical assistance, and employing a cooperative scope for transnational public goods and mutual recogni- approach, may bring about substantial progress toward lib- tion but may open greater prospects for lock-in and for eralization and can serve as a positive signal or trigger for access to imported regulatory regimes, when needed. Mar- more challenging areas. To be sure, the maintenance of ket access considerations will dominate for the small part- high border barriers toward third parties entails discrimi- ner, whereas the larger partner will seek, beyond that, to nation and costs, and traditional PTAs clearly represent an diffuse its regulatory norms, including values norms, and inferior solution compared with multilateral liberalization. to trigger competitive liberalization effects in partner But market access is no longer the only or even the main countries. item on the agenda of negotiators, especially those of developing countries, since deep integration really involves Landscape the contemplation of a domestic reform strategy. In this respect, prioritization of core objectives should be a central Today’s multilateral trading system is characterized by a consideration of negotiators. criss-crossing web of ever more complex PTAs. In chapter 2, From a theoretical standpoint, the economic paradigm Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, of traditional or shallow PTAs does not necessarily apply to and Christelle Renard survey the landscape of PTAs and deep and comprehensive PTAs. Concepts such as mercan- note that recent developments and trends can be summed tilist reciprocal liberalization, trade creation and diversion, up in a number of stylized facts: or a textual approach toward the design of PTAs may still underpin the reasoning of many policy makers, but they • PTAs have become ubiquitous, and participation in are often not valid, or only partially explanatory, for deep PTAs is becoming more diverse, spreading to most geo- integration liberalization. Discrimination is still an issue in graphic regions, especially East Asia and the Pacific. deep PTAs, but it may not be the pervasive problem it is in North-South preferential partnerships are on the rise, as a goods-only PTAs, especially if the principle of open access number of developing countries elect to forgo unilateral to any regulatory treatment is respected. programs such as the generalized system of preferences More worrying than discrimination, perhaps, in view of (GSP) in favor of reciprocal agreements. Cross-regional the desirable objective of multilateral liberalization, is the agreements are also expanding, in an attempt to keep on inherent complexity created by overlapping and conflicting a level playing field with other countries that are also regulatory regimes in the myriad of PTAs. This concern is gaining preferences. already clearly identified, and the call for multilateralizing • There is some consolidation of PTA networks as bilateral regionalism already voiced, in the WTO. Complexity relationships are replaced by plurilateral PTAs among the requires that some core principles should be followed. The same partners. This is the case, for instance, in Latin key to making PTAs complementary to a nondiscrimina- America. Agreements between regional blocs—for exam- tory multilateral system and supportive of development is ple, between the European Free Trade Association (EFTA) to strive for open regionalism in the shape of agreements and the Southern African Customs Union (SACU)—are 4 Jean-Pierre Chauffour and Jean-Christophe Maur also on the increase. In Asia, countries long resistant within the PTA to ensure welfare gains for all. The poten- to preferential trade liberalization are catching up, tial negative effect of PTAs on third countries could be with the emergence of plurilateral PTAs that coexist addressed by lowering PTA external tariffs to leave the alongside bilateral PTAs involving the same sets of third countries’ trade levels unchanged. Even though this is partners. rarely how PTAs operate in practice, they are, in theory, not • The structural configuration of PTAs is changing, necessarily bad for world welfare, from a static perspective. with bilateral PTAs becoming increasingly the norm. There is more to the economics of PTAs than the mere Such PTAs can be concluded more rapidly, and they mechanistic static effects. PTAs can generate complex confirm a shift away from using PTAs as a means of dynamic gains that operate by changing the rate at which forging traditional regional partnerships among geo- new factors of production, mainly capital, are accumu- graphically proximate countries and toward using lated. Signers of regional trade deals have long emphasized them to negotiate strategic, bilateral market access, the importance of the dynamic, or growth, effect of PTAs, often among countries in different regions. Indeed, which may sensibly alter the economic benefits of prefer- cross-regional PTAs account for two-thirds of those ential liberalization. One of the mainstay justifications for currently under negotiation. PTAs is the belief that uniting small economies will make • The regulatory scope of PTAs is rapidly becoming regional firms more efficient and more competitive by broader and deeper. On issues that fall under the cur- allowing them access to a bigger market. Indeed, in the rent mandate of the WTO, some countries have elected presence of imperfect competition and economies of scale, to take on bilateral commitments that exceed those they the size of the market matters. Preferential liberalization have accepted at the multilateral level—that are and defragmentation of national markets lead immediately “WTO+.� In addition, some countries are undertaking to more competition because more firms are present in the “WTO-extra� commitments in PTAs on issues that lie market. This, in turn, results in industrial restructuring outside the current WTO mandate. and upgrading because firms need to grow to cover their • For a number of plurilateral PTAs, intra-PTA imports as costs in the more competitive environment, and the least a share of total imports have increased, and both intra- efficient firms exit the market. In the end, the region is left PTA exports and total exports have grown. PTA partners with a more efficient industrial structure, with fewer, big- in selected plurilateral PTAs seem to trade more inter- ger, more efficient firms competing more effectively with nally than would be expected in the absence of a PTA, each other. and the impact on extra-PTA exports and imports is A further dynamic effect from preferential liberaliza- largely positive. tion may stem from the location decisions of firms in the PTA—a source of potential distributional impact within the preference zone. Firms may benefit from the existence Economics of positive externalities (or agglomeration forces) associ- The theoretical effect of PTAs depends on the efficiency ated with being located close to where markets and other with which economic resources are allocated within and producers are. However, there are also negative externali- among countries as a result of partial trade liberalization, ties (or dispersion forces) linked with geographic concen- as opposed to full and multilateral liberalization. Chapter 3, tration, such as higher cost for land or labor. The balance by Richard Baldwin, provides a comprehensive review of of agglomeration and dispersion forces is altered with the theoretical economic foundation of PTAs. PTAs gener- preferential liberalization, but in a complex way. In theory, ate a number of static effects that lead to a one-time reallo- lowering trade costs reduces dispersion forces but also cation of resources. The first effect is that exporters from a diminishes agglomeration forces. The alteration of the country that is enjoying lower (preferential) tariffs will balance has implications that are potentially important— benefit from the improved market access. A second, oppo- but are indeterminate in theory and case-specific—for site, effect is that countries left outside the preferential the location decisions of firms. Members of a PTA are trade area will lose out as their trade with PTA members is thus likely to benefit unequally from these complex displaced by trade between members. A third, and largely dynamic gains. uncertain, static effect is that PTAs may divert trade and enable producers from within the PTA to displace other, North-South PTAs more efficient producers that had been able to serve the market when all faced the same tariff regime. Diversion Issues related to the distributional effects of PTAs among concerns can be addressed through lump-sum transfers their members are of particular concern in the context of Overview 5 agreements between developed and developing countries. that help implement PTA disciplines and enhance their In chapter 4, Bernard Hoekman discusses the key develop- credibility. But deep and comprehensive PTAs between ment policy challenges associated with North-South PTAs developed and developing countries also bring new risks. and offers a number of rules of thumb and approaches for The proposed norms will not necessarily benefit the devel- making these PTAs development friendly. North-South oping countries if the provisions limit policy freedom in PTAs should strive to remove barriers to trade in the devel- inappropriate ways or lead to the allocation of resources to oped country for the products that the developing country activities that yield few immediate benefits or are complex produces; to lower trade barriers in the developing country and costly to implement. partner or partners that raise the prices of goods and serv- ices consumed by firms and households; to promote more Customs Unions general liberalization based on the most favored nation (MFN) principle, as this best serves global development A customs union (CU) is a trade agreement whereby coun- prospects; to support the adoption of complementary tries preferentially grant tariff-free market access to imports measures and actions that allow the potential benefits of from each other and agree to apply a common external tar- trade opportunities to be realized; and to create mecha- iff (CET) to imports from the rest of the world. It is one of nisms through which the private sector can be regularly the most advanced forms of PTA and generally requires informed of progress with implementation of the PTA and considerable coordination among members. In chapter 5, can provide feedback to authorities. Soamiely Andriamananjara observes that CUs have recently Achieving these objectives requires that changes be become less popular than simple free trade agreements made in the way North-South PTAs are usually designed. (FTAs). This trend reflects the nature of the current wave of If the goal is development, a first overarching objective regionalism, which is characterized by smaller cross- should be far-reaching liberalization. This can be achieved regional deals, flexibility, selectivity, and, most important, through a redesign of the approach to PTAs: high-income speed. Recent FTAs tend to be more pragmatic than their countries should liberalize in all sectors (not just “substan- precursors and to focus more on strategic commercial mar- tially all�), on a preferential basis, with liberal and simple ket access and less on geographic considerations or political rules of origin. Developing-country signatories should ambitions. By contrast, CUs are usually set up by a relatively reduce their tariffs and apply negotiated trade policy com- large number of geographically contiguous countries and mitments on an MFN (nondiscriminatory) basis. involve a certain loss of policy-making autonomy. A second necessary change is to build in significant pol- When a country joins a CU, it agrees to relinquish some icy flexibility, as well as stronger accountability mecha- of its national sovereignty over the formulation and imple- nisms. The goal should be to use PTAs as a tool for helping mentation of trade policy. The implication is that a CU developing-country governments pursue priority national member considers the loss of some autonomy to be more regulatory policy objectives, rather than have these objec- than offset by the economic benefits of securing access to a tives dictated by the trade partners. Economic cooperation larger and more harmonized regional market and of based on institutions that help identify good practices enhancing the depth and effectiveness of the ongoing would be a desirable and risk-free way forward. An regional integration process. Some regional groupings con- important corollary is that governments should be held sider the establishment of a CU a prerequisite or a neces- accountable for performance and outcomes. This requires sary step toward the future establishment of some deeper mechanisms that generate the necessary information—an form of economic integration, such as a common market. area in which the private sector has an important role Other groups regard a CU as a useful way of pooling coun- to play. tries’ market power, coordinating their trade policies, and A third plank of a development-focused approach is combining their negotiating powers to deal advantageously expanded development assistance. Such aid should not be with the rest of the world. limited to the issues that are covered by an agreement, and The establishment of a CU involves reaching consensus it should be aimed at improving trade-related regulation on three other important issues not relevant to PTAs. First, and its implementation, as well, including services inputs, members need to agree on a CET. The economic impact of both public (government services such as customs and the CU will be closely related to the degree of discrimina- trade facilitation) and private (transport, distribution, tion it entails, which depends on the selected tariff level. A finance, etc.). The extension of the PTA agenda to regulatory higher CET entails more trade diversion and greater net issues can be beneficial to developing countries, especially if welfare loss (although different economic agents will be accompanied by financial transfers and technical assistance affected differently). Whether CUs lead to higher external 6 Jean-Pierre Chauffour and Jean-Christophe Maur tariffs remains an open question. A number of arguments trading partners’ incentives for further liberalization. A key seem to suggest that CUs engender more protectionist question about the proliferation of PTAs, beyond their pressures than PTAs, but this is an empirical question to direct welfare impact for the countries signing them, there- which the existing literature has not been able to provide fore relates to their systemic effects on the world trading an unequivocal answer. system. Are PTAs—leaving aside the objective of mutually Second, members need to decide where and how to col- beneficial multilateral reduction of trade barriers—a force lect CET duties: at the initial port of entry into the CU, or for good or for bad? This question raises the more general at the final import destination. Collecting import duties at question of the interaction between PTAs and the multilat- the first port of entry could facilitate freer movement of eral trade system. Do PTAs influence multilateral liberal- goods within the CU and minimize intra-CU border con- ization, or is it the other way round? Or do they influence trols, but it requires the appropriate institutional capacity each other? to administer the revenues and, most important, a high A traditional view among economists is that PTAs form level of trust among members. Most existing CUs allocate a stumbling block in the path to freer multilateral trade. revenues according to the final destination principle, First, market access preferences granted in PTAs create which requires sophisticated administrative measures for incentives to resist multilateral liberalization, which would identifying the end destination of each shipment entering erode these preferences by reducing external MFN tariffs. the union. Second, market access preferences are used as bargaining Third, members have to decide which mechanism to use chips by preference-granting nations against nontrade for managing CET revenues. In some cases, the CU allo- concessions. Third, countries tend to choose to pursue lib- cates (a fraction of) these revenues to a joint fund to eralization with trade partners in areas that are less likely to finance regional development initiatives. Pooling customs affect politically sensitive sectors, while still offering liber- revenues presupposes a high level of coordinating capacity alization gains. Moving toward further liberalization may and a certain degree of trust among members and is more mean undertaking much more politically difficult liberal- likely to be sustainable when tariff revenues do not consti- ization that will affect the sensitive sectors. tute an important part of government revenue for individ- At the other end of the spectrum of economic analysis ual members. In other cases, customs revenues are treated are theories supporting the idea that PTAs could be as the property of individual members and are allocated building blocks for overall freer trade. Liberalization either according to the final destination or in line with an would beget liberalization in reciprocal negotiations, agreed sharing formula. generating a virtuous circle, as exporters are transformed The collection and allocation of customs revenues in a from bystanders in the tariff debate to antiprotectionists CU setting is clearly an area in which harmonization of motivated by the prospect of market access. The initial border management (e.g., customs procedures), coopera- reciprocal tariff cuts in PTAs may start a liberalization tion, and modernization, along with capacity building, juggernaut rolling. could be critical. So far, there is little systematic empirical evidence that regionalism is overwhelmingly bad for the multilateral trade system, as some had feared. Analyses tend to show PTAs and Multilateral Liberalization complementarity between PTA and multilateral tariff lib- In chapter 6, Richard Baldwin and Caroline Freund discuss eralization. Most empirical studies find trade creation the relative merits of preferential liberalization and the cir- effects in PTAs, with trade diversion as the exception. cumstances under which PTAs are more likely to serve as According to the natural trading partner hypothesis, coun- building blocks for greater multilateral trade liberalization tries tend to engage in PTAs with only those partners that than to pose stumbling blocks. On the positive side, PTAs can offer positive welfare gains. Among the selection crite- have offered a popular way for countries to liberalize their ria for such natural partners are geography and lower trade trade policies and gain market access. Countries are often costs, large economic size, and economic complementari- unwilling to liberalize on their own because they count on ties (e.g., factor endowments and difference in economics tariffs to raise tax revenues and, at times, protect domestic size). The complementarity effect is stronger in sectors in sectors. Reciprocal liberalization in the context of PTAs which trade bloc partners are more important suppliers, makes liberalization easier because the increased market which is precisely where trade discrimination would be access may counter the political-economy forces opposing more disrupting. liberalization. PTAs do, however, generate trade diversion There is, however, also evidence of PTAs’ acting as stum- and trade preference rents and these distortions alter the bling blocks. The United States and the European Union Overview 7 liberalized less during the Uruguay Round of multilateral public goods. In the case of regional PTAs, the treatment of trade negotiations in sectors in which preferences were these issues will determine the extent to which the expan- granted. sion of intrabloc markets can lead to scale economies and the rationalization of production and investment. In the case of bilateral PTAs among countries that are not in Agriculture the same region, there is less potential for economies of Turning to the key chapters of PTAs, a first consideration is scale and productivity gains, but PTAs could still offer a often to decide whether to include agriculture as part of the way to secure market access for agricultural exports and negotiations and PTA commitments. In chapter 7, Tim to benefit from (at least temporary) advantages over Josling discusses the challenges and opportunities associ- excluded competitors. ated with the incorporation of agriculture into PTAs. The challenges have to do with the additional competition Rules of Origin faced by domestic agriculture from regional partners that may be lower-cost producers or that, in the case of bilateral At the heart of the preferential regime of PTAs are the rules agreements with developed countries, may have signifi- of origin (ROOs) that determine the eligibility of products cantly better marketing and trade infrastructure. The pol- to receive preferential access. In chapter 8, Paul Brenton icy dilemma is whether to subject domestic agriculture to reviews the rationale and practice of rules of origin in further competition in the hope that the farm sector will PTAs. The justification for preferential rules of origin is respond by undertaking structural and technological to prevent trade deflection or simple transshipment, change and becoming competitive regionally and, eventu- whereby products from nonparticipating countries are ally, globally. Given adequate safeguards—in particular, to redirected through a free-trade partner to avoid the pay- avoid import surges—the better strategy would be to ment of customs duties. These rules, however, can be attempt to develop a competitive agricultural sector, but manipulated to achieve other objectives, such as protecting the political economy does not always allow it. domestic producers of intermediate goods. Restrictive As with other PTA chapters, the opportunities from rules of order that go beyond what is necessary to prevent incorporating agriculture in PTAs go far beyond the gains trade deflection could raise the economic costs of supplying from trade creation. They include collective action on the markets of preferential partners and the administrative research, market development, and health and safety regu- costs of proving conformity with the rules. These costs will lations, as well as cooperation on trade policy and on constrain market access relative to what is promised on approaches to development agencies and donors. Where paper in the trade agreement. The rules of origin are there- these arrangements have worked well, regional markets fore a key element determining the magnitude and distri- have been established, health and safety regulations have bution of the economic benefits that accrue from PTAs. been harmonized or made more compatible, and trade has There is no simple and standard set of rules of order developed through investment, as firms have realized the that can be identified as performing the task of preventing potential of closer market integration. By contrast, when trade deflection. Three main criteria are used to establish PTAs opt to exclude some or all agricultural sectors from whether a product imported from a partner that contains the pressures and opportunities that come with freer inputs from other countries has undergone sufficient pro- regional trade, agricultural markets often remain confined cessing or a substantial transformation: (a) a change of tar- within national borders or focused on traditional trade iff classification; (b) a minimum amount of domestic value exchanges with overseas partners. added; or (c) use of a specific manufacturing process. No Overall, the dearth of empirical studies on economic one method is dominant; each has its advantages and dis- integration in agricultural markets makes for a lack of clear advantages, and different rules of origin can lead to differ- guidance for policy makers. To help close that gap, the ent determinations of origin. Other features of the rules of chapter provides a brief review of experience with agricul- origin that can influence whether origin is conferred on a tural provisions in selected PTAs. The issues common to all product include cumulation, which allows producers to PTAs, as they contemplate the agricultural component of import materials from a specific country or regional group the agreement, include the way in which tariffs are cut, the of countries without undermining the origin of the prod- use of tariff-rate quotas to open up markets on a progres- uct; tolerance, or de minimis, rules, which allow a certain sive basis, the employment of safeguards to help domestic percentage of nonoriginating materials to be used without sectors cope with import surges, the treatment of subsidies affecting the origin of the final product; and the absorption (both domestic and on exports), and the provision of principle, which provides that parts or materials that have 8 Jean-Pierre Chauffour and Jean-Christophe Maur acquired originating status by satisfying the relevant rules Furthermore, provisions differ significantly for the same of origin for the particular product can be treated as country across different PTAs, and countries do not com- being of domestic origin in any further processing and monly incorporate the same trade remedy provisions in all transformation. their PTAs. In some cases, trade remedy provisions in PTAs Restrictive rules of origin constrain international spe- make protection easier, but in most cases, the additional cialization and discriminate against small, low-income rules in PTAs tend to make protection harder to impose. countries where the possibilities for local sourcing are lim- Any country considering entering into a PTA should there- ited. Simple, consistent, and predictable rules of origin are fore consider carefully what provisions potential partners more likely to foster the growth of trade and development. have included in prior agreements. Rules of origin that vary across products and agreements Another finding of the chapter is that PTAs are less add considerably to the complexity and costs of participat- likely to alter existing countervailing duty provisions than ing in and administering trade agreements. The burden of they are either antidumping or global safeguard rules. This such costs is particularly heavy for small and medium-size is partly because few PTAs have created common policies firms and for firms in low-income countries. Complex on subsidies and state aid. Without such rules, and given systems of rules of origin add to the burdens of customs the global nature of subsidy distortions, there appears to services and may compromise progress on trade facilita- be little motivation for PTAs to limit the application of tion. Specification of generally applicable rules of origin, countervailing duties against members. PTA provisions with a limited number of clearly defined and justified regarding antidumping, countervailing duties, and global exceptions, is appropriate if the objective is to stimulate safeguards generally make protection more difficult to integration and to minimize the burdens on firms and cus- impose than do the existing WTO rules; that is, these pro- toms services in complying with and administering the visions are WTO+. They work against protection through a rules. Producers should be given flexibility to meet origin combination of additional specific rules that relax the rules by, for example, specifying in the rules that the prod- threshold and duration of application of measures and ucts may satisfy either a change of tariff requirement or a through the creation of institutions that help to defuse dis- value added criterion. putes. By contrast, PTA provisions on bilateral safeguard Preferences granted by member countries of the Organ- actions (e.g., transition safeguards and special industry isation for Economic Co-operation and Development safeguards) offer new avenues for PTA members to restrict (OECD) would be more effective in stimulating exports intra-PTA trade. from developing countries if they were governed by less- Overall, the evidence shows that PTAs reduce the inci- restrictive rules of origin; ideally, specific rules of origin dence of intra-PTA antidumping and safeguard disputes. should be designed, and producers in developing countries At the same time, there appears to be an increase in actions should be able to gain preferential access to all developed- against non-PTA members. So, although the liberalization country markets if their product satisfies a single origin effects of PTA tend to be reinforced by global safeguard test. Restrictive rules of origin should not be used as tools and antidumping rules in PTAs, the trade diversion effects for achieving economic development objectives—they are can also potentially be reinforced. In addition to the dis- likely to be counterproductive. The potential benefits of crimination introduced by preferential tariffs, PTAs can trade agreements among developing countries can be sub- lead to increased discrimination against nonmembers stantially undermined if those agreements contain restric- through more frequent trade remedy actions against them. tive rules of origin. Overall, the chapter calls for vigilance about the impact of trade remedy provisions in PTAs. The sheer number of PTAs with trade remedy rules is heightening the promi- Trade Remedies nence of the issue. The diversity of PTA types, ranging from goods-only agreements to customs unions, means that the political and Standards economic demands for trade remedy provisions vary greatly across PTAs. In chapter 9, Thomas Prusa shows that Provisions relating to the management of standards for the proliferation and diversity of PTAs have produced a protection of human, animal, or plant life or health are complicated pattern in the use and inclusion of trade rem- now a common feature of most PTAs. In chapter 10, Jean- edy provisions across PTAs that defies simple characteriza- Christophe Maur and Ben Shepherd discuss the unique tion. Whereas some PTAs contain long discussions of trade role that PTAs can play in reducing standards barriers to remedy rules, others do not even mention trade remedies. trade through the recognition of equivalence of rules and Overview 9 procedures. They observe that standards provisions in and consultations on legal and administrative matters PTAs are likely to have welfare-enhancing effects on partic- through regular dialogue. ipating members. Although standards are classified as one of many nontariff barriers—the relative importance of Standards, in Practice which is growing with the decline in tariff duties—an important economic distinction is that standards serve a Andrew Stoler, in chapter 11, discusses specific best-practice different policy objective than simple discrimination against provisions in PTAs concerning the treatment of technical foreign goods. Standards represent a quasi-regulatory barriers to trade (TBTs) and sanitary and phytosanitary means of pursuing important public policy objectives such (SPS) measures. He recommends that the parties to a PTA as environmental protection, consumer safety, food quality, aim at using international standards whenever possible and compatibility between different types of apparatus. because doing so guarantees a high level of protection in The policy objective should therefore not be to eliminate the integrated market and makes it easier for third parties standards but to make them more efficient and cost to trade into that market. If the parties to the PTA decide to effective. pursue harmonization of their standards and conformity Harmonization to international standards is an effective assessment procedures, they should accept that it might be way of reducing the duplication of costs of complying with necessary to limit harmonization to essential health and different sets of standards. Standards harmonization may safety standards and to rely on mutual recognition and also facilitate market access and enable countries with no equivalence techniques for other areas. Where one partner or inefficient standard policies to put better practices in is less developed than the other, the PTA will have to place. But it does mean compromising governments’ ability include technical assistance and capacity-building measures to set national standards that may better fit the needs to assist the institutions and exporters of the developing- of local industries and consumers. country partner in adjusting to harmonization. There are, broadly, two models for dealing with stan- If technical regulations and conformity assessment dards measures in PTAs. Where the European Union is procedures cannot be harmonized, it is important for the involved, the agreement often expects the EU partner purposes of the PTA that the parties work to eliminate country to harmonize its national standards and conform- requirements for duplicate or multiple measures or tests ity assessment procedures with those of the EU. PTAs in for the same product. This is particularly important for the Asia-Pacific region and those in which the United small and medium-size enterprises that cannot afford the States is a partner typically address problems resulting high cost of meeting differing regulations and testing from different national standards and conformity proce- regimes. Mutual recognition agreements (MRAs) are dures through a preference for international standards important tools in this respect. or the use of mutual recognition mechanisms. Both Transparency is important for business and consumers approaches can be successful in reducing the negative in this area of international trade. PTA partners should impact of different standards and conformity assessment consider incorporating WTO+ notification obligations procedures, but there is a risk that they can introduce into and a commitment not to implement any technical regu- global markets de facto discrimination, particularly against lation or SPS measure until it has been published and developing countries, because achieving conformity in comments by the PTA partner have been taken into account. technical standards requires capacity and resources. It is recommended that the PTA be drafted as a “living Standards indeed have the potential to discriminate agreement� with a commitment to a work plan or priori- against nonmember countries when mutual recognition tization of problem resolution through harmonization, agreements are not open to third countries or when har- mutual recognition, equivalence measures, and other monization is not carried out on the basis of interna- policy tools that enable elimination or mitigation of trade- tionally agreed standards. As in the case of contingent related problems over time. PTA provisions on TBTs and protection measures and restrictive rules of origin, stan- SPS measures should be legally binding, through a judi- dards may end up raising external barriers against coun- cious combination of “soft� and “hard� law. The provisions tries outside the PTA, thus eroding some of the benefits of should provide a pathway that permits integration to multilateral liberalization. Good practices regarding stan- evolve and deepen over time by allowing the gradual reso- dards in PTAs usually promote institutional arrangements lution of TBT and SPS issues in the bilateral relationship. to supervise the effective implementation of standards Such a pathway should be considered an integral part of provisions. Important objectives of such arrangements are, any PTA that aims to deal effectively with standards, certifi- most frequently, transparency, the diffusion of expertise, cation, and conformity assessment problems. Eventual 10 Jean-Pierre Chauffour and Jean-Christophe Maur recourse to the PTA dispute settlement provisions should listing, most notably in the area of transparency. Studies be an option, along with recourse to the WTO Dispute devoted to the practice of preferential market opening Settlement Understanding (DSU). suggest that North-South PTAs based on a negative-list Finally, PTA parties should agree to an overall commit- approach tend to achieve the deepest, WTO+ liberalization. ment always to apply technical regulations and conformity The chapter also shows that gains from PTAs are likely to assessment procedures on a national treatment basis and to be significant in services areas where there is scope for reap- allow third parties whose technical regulations and con- ing large economies of scale. In principle, these gains can formity assessment procedures can be demonstrated as also be realized through MFN liberalization, but in practice being equivalent to the level agreed to by the PTA partners the full integration of markets may require a deeper conver- to benefit from the arrangements between the partners. A gence of regulatory regimes. Regulatory cooperation may be commitment to open regionalism would help ensure that more desirable, and probably more feasible, within a subset the PTAs support the multilateral system. of countries than if pursued on a global scale. Regional or international harmonization or standardization can be an important and cost-effective way of improving national stan- Services dards. Yet the best partners for regulatory cooperation are In recent years, increasing numbers of PTAs have sought to likely to be those with the soundest regulatory frameworks, include provisions on liberalizing cross-border trade in serv- and they may not always be found within regional compacts. ices, investments in goods- and services-producing activities, There are gains from regulatory cooperation, but also and the temporary movement of business people. In chapter costs. The former will dominate where national regulation 12, Aaditya Mattoo and Pierre Sauvé show that liberalization can be improved and where regulatory convergence or har- of trade in preferential services differs fundamentally from monization can be carried out, taking into account local liberalization of trade in goods in that the effect of many circumstances. The costs are likely to be smallest when for- restrictive measures in services trade (given their regulatory eign regulatory preferences are similar and regulatory insti- nature) is to increase the costs of operation faced by foreign tutions are broadly compatible. providers without necessarily generating equivalent domes- Unless there are liberal rules of origin for investment that tic rents. There is therefore little or no cost to granting pref- confer the full benefits of an integration scheme on third- erential access for services trade because there is little or no country investors, the establishment of preferences may revenue to lose. In such circumstances, preferential liberal- result in entry by inferior suppliers. Because the most effi- ization will necessarily be welfare enhancing, but countries cient suppliers may also generate the greatest positive exter- outside the preferential arrangement may lose. nalities, the downside risks of preferential liberalization may PTAs covering services tend to follow two broad be greater, especially in crucial infrastructural services. This approaches with respect to liberalization of services trade is particularly the case in services sectors with high location- and investment. Some PTAs tend to replicate the use, found specific sunk costs that need to be close to consumers. Pref- in the General Agreement on Trade in Services (GATS), of a erential liberalization may then exert more durable effects positive-list or hybrid approach to market opening whereby on the nature of competition than in the case of trade in agreements list sectors, subsectos, and modes of supply in goods. For instance, concluding an agreement that allows which governments are willing to make binding liberaliza- second-best providers to obtain a first-mover advantage may tion commitments; others pursue a negative-list approach, imply that a country could be stuck with such providers, in which exceptions to liberalization are listed. More than even if it subsequently liberalizes on an MFN basis. half of all the PTAs concluded to date that feature services Finally, PTAs have generally made little progress in tack- provisions use a negative-list approach. Such agreements ling the interface between domestic regulation and trade in are more prevalent in the Western Hemisphere, reflecting services (e.g., subsidies). Despite the greater initial similar- the influence of the North American Free Trade Agreement ities in approaches to regulation and greater cross-border (NAFTA), and in agreements conducted along North-South contact between regulators that geographic proximity can lines (with the exception of the EU and EFTA agreements). afford, progress in the area of domestic regulation has been Although both approaches can in theory generate broadly slow and generally disappointing, even at the PTA level. equivalent outcomes with respect to liberalization, as a prac- tical matter, a negative-list approach can be more effective Labor Mobility in locking in the regulatory status quo. In addition, the process of “getting there� tends to differ; a number of good The temporary movement of natural persons is a key mode governance–enhancing features are associated with negative of service delivery across borders. In chapter 13, Sherry Overview 11 Stephenson and Gary Hufbauer show that, notwithstand- Investment ing the strong sensitivity that surrounds the movement As trade and investment become more and more inter- of people and the confusion about the fine line between twined in the context of international supply chains and temporary movement of workers and permanent migra- firms’ strategies of vertical specialization, countries are tion, PTAs are increasingly being used as vehicles for dealing increasingly incorporating investment provisions into with labor mobility issues. Several PTAs between devel- PTAs instead of negotiating bilateral investment treaties oped and developing countries have included new cate- (BITs). In chapter 14, Sébastien Miroudot presents the gories of labor, such as technicians, nurses, and health care salient features of investment provisions in PTAs. By com- workers, in their trade agreements or have offered an bining trade liberalization provisions with investment lib- expanded number of categories for service suppliers, com- eralization and protection, PTAs emphasize the comple- bined with expanded quotas. Other PTAs have eliminated mentary relationship between trade and foreign direct the quotas altogether for certain categories of services sup- investment (FDI). In contrast to BITs, investment provi- pliers (usually, professionals). To date, nearly all PTAs that sions in PTAs ensure that disciplines are not limited to cover services focus either exclusively or primarily on investment in the postestablishment phase but also deal professional services suppliers. with the preestablishment stage (i.e., market access, Members of South-South regional integration group- national treatment, and most favored treatment), thus pro- ings of geographically contiguous countries in Africa, Asia, viding economic incentives for investors, in the form of and Latin America and the Caribbean often contemplate market access, in addition to the legal incentives (the pro- completely liberalized labor markets as part of their agree- tection of investment, once established). Given liberal rules ments. Progress is slowly being made toward the imple- of origin, investment provisions in PTAs do not seem to mentation of these commitments for all categories of introduce severe distortions among investors; and develop- workers, both for temporary movement and for perma- ing countries have usually been able to maintain some of nent settlement. The chapter confirms the intuition that the restrictions needed for legitimate policy considerations. the countries that have gone furthest in opening their mar- Investment disciplines hold an important place in PTAs kets to temporary labor movement under PTAs are the that they have not found in the multilateral negotiations. ones that are experiencing a relative shortage of labor sup- This is one of the four “Singapore issues� that were sup- ply at home (e.g., Canada, Japan, and New Zealand). Con- posed to become the new additions to the WTO in the versely, the countries that have been most reluctant to open Doha negotiations. (The other three—trade facilitation, their market to temporary labor movement under PTAs government procurement, and competition policy—are are those that are experiencing a strong wave of migration discussed in the following chapters). There are two main pressure—notably, from Mexico, in the case of the United models of investment provisions in PTAs, one inspired by States, and from new EU members in Eastern Europe, for NAFTA, which places investment in goods and services the EU. industries in the same chapter, and one that follows the Looking forward, the chapter observes that developed GATS model for part of the provisions on investment in countries should proactively search for labor market niches services. Despite important differences, these two types of in which additional temporary workers can become valued agreement offer the same degree of protection for invest- members of the workforce and the community. In that ment and are equally liberalizing of investment, even respect, there has been some progress within a new genera- if, empirically, NAFTA-inspired agreements are more tion of bilateral labor agreements (BLAs) and temporary ambitious in their scope and sectoral coverage. For devel- worker programs (TWPs). In the case of workers with oping countries, North-South PTAs with substantive lower skill levels, the best vehicle for promoting greater investment provisions are found to positively affect FDI labor mobility may not be a formal PTA but, rather, the flows. They can also offer an opportunity to address con- more flexible instrument of a TWP that specifies the length cerns about dispute settlement for countries that are not of stay for a certain number of workers in a specific eco- ready to face commercial arbitration. nomic activity. TWPs have the advantage that both govern- ments are better able to enforce the clauses, and they can be more easily adapted to the cycle of economic fluctuations. Trade Facilitation Canvassing the extent of TWPs in the world economy today is challenging, as no one organization is responsible Trade facilitation is a relatively recent domain of interna- for maintaining an inventory of these agreements, but their tional trade cooperation, and countries are still very much numbers appear to be increasing. in the process of learning how to design the best approach. 12 Jean-Pierre Chauffour and Jean-Christophe Maur In chapter 15, Jean-Christophe Maur notes that the cur- countries deal with competition problems, including those rent approaches to trade facilitation in PTAs are mainly emanating from international trade, such as import distri- extensions of customs cooperation provisions, with some bution monopolies and cartels, overseas export cartels, and variations depending on the signatory countries. Trade the abuses of dominant firms from abroad. They observe facilitation provisions are also closely related to the pro- that international trade presents complex competition pol- posals in the Doha Round of trade negotiations concerning icy issues because an abuse of market power can occur trade facilitation involving developed countries. Good unevenly across several markets and jurisdictions, with practice in this area seems to be to strive for living agree- consequences for the jurisdictional limits of a national ments, whereby institutional arrangements are set up for authority. promoting exchange and joint initiatives with a view to Effectively enforced regional competition provisions possibly amending agreements through new provisions on may serve to lock in reforms that are politically difficult to trade facilitation. In addition, PTA signatories should sustain because of the influence of strong domestic lobby- extend their trade facilitation commitments beyond the ing groups that do not immediately benefit from competi- sole remit of customs administration to include other bor- tion law. PTAs can also pioneer or test-run provisions and der agencies (largely ignored in existing agreements) and so facilitate their negotiation at a multilateral level at a later services and standards, which are often treated separately. date. Finally, regional competition regimes offer a demon- Indeed, recent PTAs that incorporate more advanced trade stration effect of the positive gains to be had from effective facilitation provisions demonstrate the increased interest national cooperation to underpin and improve the market in using PTAs to reduce transaction costs. liberalization process. The trade facilitation agenda in PTAs remains largely In the case of North-South PTAs, greater development driven by the most developed partners, which tend to set benefits can be reaped if the more developed party offers the agenda and to propose terms of agreement (e.g., appropriate technical assistance and capacity building. ambitious reforms such as risk management) that may For developing countries with little experience in imple- not necessarily reflect the needs and capacity of their less- menting competition rules, the PTA provisions should developed partners. Reflecting this relative lack of consid- initially be limited to the exchange of information, tech- eration, there are few examples of special and differential nical assistance, and capacity-building support, as it may treatment by trading partners, or of clear commitments on be more beneficial at first to focus on establishing a cul- provision of technical assistance. ture that values competition at the national or subre- More generally, PTAs seem to fail to capitalize on gional level. Subsequent negotiations could expand the opportunities to provide value added: that is, domains of agreement. The use of soft law could be beneficial if gov- potential regional cooperation are not always given prior- ernments are uncertain of the underlying technical issues ity. For instance, PTAs could have a much more active role and the consequences of the provisions. Other nonjudi- in implementation through mutual recognition and assis- cial mechanisms, such as voluntary peer review and con- tance, the eventual sharing of resources, and joint efforts to sultations, may also be appropriate. improve the trade supply chain. Trade facilitation provi- The economic and human resources necessary to imple- sions that focus on reform on the ground, implementation, ment even a minimal regional decentralized competition and monitoring of measurable objectives, as in Asia-Pacific regime arrangement are significant for both developed and Economic Cooperation (APEC), seem to deliver more developing countries. Nevertheless, the emerging evidence effective and successful reforms. Such agreements tend to shows that the economic and welfare costs associated with be pragmatic, flexible, and country specific and are gener- cross-border anticompetitive practices are higher. Short- ally well suited to the type of reforms required in the con- term political costs should be weighed against the under- text of regional trade facilitation. standing that the long-term and sustainable benefits of a strongly enforced regional competition regime will almost always outweigh its costs. Competition Policy Decentralized agreements that only require the exis- The lack of a multilateral competition framework has coin- tence of a local competition law and authority to apply the cided with a surge in PTAs that contain competition provi- law, such as NAFTA, are not as economically demanding as sions intended to address market failures that national a regime that establishes a fully centralized law with a sup- competition laws cannot remedy. In chapter 16, Kamala porting regional authority, such as the EU or the Common Dawar and Peter Holmes discuss how well-designed Market for Eastern and Southern Africa (COMESA). Com- regional competition arrangements can help developing petition provisions in customs union agreements are, in Overview 13 general, more specific and demand higher commitments. A government that has improved its national procure- The economic burdens of implementation can be offset if ment procedures in compliance with PTA provisions may the parties are able to exchange information effectively and not find it worthwhile to maintain separate procurement avoid duplications and conflicting decisions. For instance, processes for bidders from PTA signatories and nonsigna- the competition regime in the Caribbean Community tories. Government procurement provisions therefore (CARICOM) points to potential economies of scale from offer the prospect of being implemented across-the- regional cooperation; the provisions allow for resource board and more formally, on an MFN basis. Third-party pooling among neighboring countries when national MFN rules are an important way of furthering nondis- capacity is not adequate to implement and enforce the criminatory liberalization over time and of diffusing regional framework. good practices. Although improvements to procurement regimes required by PTAs, such as increased transparency, may Government Procurement be costly, the expense could be mitigated through techni- In the same vein, according to Kamala Dawar and Simon cal assistance and capacity-building programs negoti- Evenett, in chapter 17, government procurement provi- ated as part of the PTA. Flexibilities are available to sions may have received greater attention in PTAs because negotiators, including exclusion of certain entities from of the prospects they offer for reforming national procure- the agreement, the threshold set in order for procure- ment systems, The authors note that all the PTAs that ment to be covered by the agreement, the exclusion of include government procurement provisions promote a sectors such as defense and financial services, and the use liberal agenda, acknowledging the benefits of transparent of offsets or set-asides to accommodate domestic poli- nondiscriminatory and competitive procurement markets. cies such as the promotion of indigenous communities Agreements differ in the scope and strength of their com- or small businesses. mitment to progressive liberalization of procurement mar- kets, but the provisions typically cover a dozen aspects of Intellectual Property procurement policies, including nondiscrimination princi- ples, procedural rules, dispute settlement mechanisms, As Carsten Fink shows in chapter 18, rules for the protec- commitments to cooperation and further negotiations, tion of intellectual property rights (IPRs) have become a state entities and sectors covered, and special exceptions common, albeit controversial, feature of PTAs, especially know as offsets. those involving developed partners. Over the past decade For many countries, government procurement outlays or so, the United States has negotiated numerous PTAs are a sensitive matter, making for reluctance to take on that contain ambitious IPR chapters. These chapters strong and legally binding international obligations. The introduce standards of protection for all types of IPRs that desire for value for money from public purchasing has exceed those of the WTO Agreement on Trade-Related often been tempered by other objectives, such as support Aspects of Intellectual Property Rights (TRIPS)—that is, for specific domestic industries and interests. Accordingly, they are TRIPS+. The most prominent, and sometimes in many PTAs, particular attention has been paid to elimi- most controversial, standards include patent term exten- nating the more transparent forms of discrimination, such sion, patenting of life forms, patent-registration linkage as price preferences. This may have had the unintended for pharmaceutical products, exclusive rights to test consequence of driving discrimination into nontransparent data, prolonged copyright protection, rules on technolog- forms such as contract thresholds, limitation on number of ical protection measures and the liability of Internet serv- bidders, exclusion of sensitive sectors, and the like. Yet the ice providers, and more stringent requirements for the rules governing procurement provisions in PTAs appear less enforcement of IPRs. These rules seek to deepen and discriminatory than the provisions governing market update preexisting multilateral IPR rules, as embedded in access. One reason is that government is only one among the TRIPS Agreement. In May 2007 the United States numerous national buyers, which limits the impact on mar- adopted a new trade framework, the Bipartisan Agree- ket outcome of its decisions to award specific preferences. ment, to roll back some of the TRIPS+ provisions as they Another focus of attention in PTAs has been improvement relate to pharmaceutical products. Although the Biparti- of the transparency of those public institutions in signatory san Agreement covers only three PTAs, it marks an impor- countries that are responsible for state purchasing. tant shift in U.S. trade policy toward greater sensitivity Transparency provisions in PTAs tend to generate bene- with respect to the implications of global IPR rules for fits for nonmembers of the PTA, as well as members. public health concerns. 14 Jean-Pierre Chauffour and Jean-Christophe Maur Until recently, the agreements concluded by the EU dispute in this area so far, the rapid spread of PTAs and were less far-reaching than those of the United States. In BITs may well lead to the initiation of arbitration claims the past, the main TRIPS+ element of the EU’s PTAs took in the future. the form of separate agreements on wines and spirits that included lists of geographic names to which signatories Environment had to apply rigorous geographical indication protection. In 2006 the EU embarked on a new set of negotiations, Practically all countries recognize the critical importance and it is demanding the inclusion of more comprehensive of environment, but many do not believe that dealing with IPR chapters in these new agreements. The EU’s eco- environment issues under trade agreements is necessarily nomic partnership agreement (EPA) with the Caribbean the best approach. In chapter 19, Anuradha R. V. does not Forum of African, Caribbean, and Pacific (ACP) States seek to build a rationale for the trade-environment linkage or (CARIFORUM), gives a sense of the new EU approach, to discuss whether environmental issues should be addressed including as it does TRIPS+ provisions not only on geo- in trade agreements or in stand-alone environmental agree- graphical indications but also in other areas, notably IPR ments. Instead, she focuses on the main contours of the trade enforcement. Future EU agreements with more developed and environment debate at the multilateral level and on how trading partners may well be more ambitious than the environmental provisions are increasingly being incorpo- agreement with CARIFORUM. rated into PTAs, especially by major developed economies. TRIPS+ standards of protection are found in several The United States, the EU, Canada, and New Zealand PTAs that do not involve the United States or the EU. are the principal proponents of environmental provisions Notably, several trade agreements negotiated by EFTA pro- in PTAs. On the basis of a review of existing agreements, it vide for patent term extension and exclusivity of pharma- would appear that the key issues in the negotiation of envi- ceutical test data. Although agreements among developing ronmental provisions in a PTA include an understanding countries usually do not go beyond TRIPS, several of the of (a) the nature of legal obligations emerging from provi- PTAs signed by Chile and Mexico include lists of geograph- sions relating to the environment under a PTA; (b) the ical indications that benefit from protection in the signa- potential economic costs of specific environmental require- tory countries. ments; (c) areas where technical assistance and capacity The adoption of TRIPS+ standards is often an impor- building would be necessary to ensure compliance with tant element in the overall package of quid pro quos neces- environmental obligations; (d) the nature and extent of the sary to conclude a preferential trade deal, reflecting the financial assistance required; and (e) the nature of dispute importance of IPRs as a market access concern for devel- settlement and enforcement mechanisms. oped countries. Yet the logic of negotiating new IPR stan- Even before negotiations, pre-PTA impact assessments dards differs from the traditional logic that economists could provide important benchmarks for assessing the have applied to the reciprocal dismantling of tariff barriers, scope of the trade-environment linkage. For instance, the in several ways: EU’s use of sustainable impact assessments (SIAs) to appraise the environmental implications of the PTA for • Optimizing the degree of IPR protection entails striking both parties offers a basis for addressing the linkages a proper balance between the interests of IPR owners between environmental provisions and sustainable devel- and the public at large. There is no guarantee that ever- opment in the trading partners. Technical and financial higher standards of IPR protection will necessarily assistance and capacity-building support by the party that improve economic welfare. has more experience with such assessments should be a • Because of the MFN obligation under TRIPS, PTA par- necessary aspect of the PTA process. ties usually cannot implement TRIPS+ standards in a preferential way, which affects the bargaining incen- Labor Rights tives of countries that are engaged in multiple PTA negotiations. Provisions on labor rights in PTAs are becoming increas- • IPRs have been included in the definition of investment ingly common, particularly in PTAs between large, power- in many PTA investment chapters and in BITs. Such a ful, developed countries and smaller, poorer developing broad definition of investment raises the possibility that countries. In chapter 20, Kimberly Ann Elliott observes private rights holders may directly challenge government that demands to include labor rights in PTAs began with measures affecting IPRs under the terms of an invest- the United States and have since been taken up, albeit in ment accord. Although there has been no investment somewhat different forms, by Canada, Chile, and, more Overview 15 recently, the EU. The definition of labor standards in PTA Although growing numbers of countries include or negotiations usually refers to the International Labour accept human rights provisions, the trend has limits. Many Organization (ILO) Declaration on Fundamental Princi- policy makers in middle-income countries and in the ples and Rights at Work. That document lists four core developing world are reluctant to use trade policies to labor standards as deserving of universal application: free- change the behavior of other countries. As countries grow dom of association, and “effective recognition� of the right richer and more influential, however, these policy makers to collective bargaining; abolition of forced labor; effective may become more willing to accept or to demand human abolition of child labor; and elimination of discrimination rights provisions. Nevertheless, some industrial countries, in employment. Notwithstanding this common definition, such as Australia, that themselves have strong human the negotiating stances of the main demandeurs differ rights records have refused to include human rights widely, especially on questions of implementation and requirements in trade agreements. Other nations, such as enforcement. Overall, it is difficult to assess the implica- China, have accepted such provisions. tions of these agreements for developing countries because The human rights embedded in these PTAs exhibit a great sustained attention to implementation is rare. PTA negoti- variety; they include civil and political rights to privacy, polit- ations with the United States have led to changes in existing ical participation, due process, and access to information, but labor laws in several cases in which those laws were deemed also economic, social, and cultural rights, rights of indige- inadequate, but monitoring and enforcement after agree- nous peoples, and access to affordable medicines. Although ments are signed are sporadic, at best. countries with interests in promoting human rights may Four key findings emerge from the review of labor pro- prod their trade partners to change their laws or devote visions in PTAs: (a) enforceable provisions for labor stan- greater resources to human rights, little is known about the dards are a condition for negotiating a PTA with the United actual effect of provisions in PTAs on human rights condi- States and are likely to remain so; (b) labor provisions in tions. These provisions, especially the more positive eco- PTAs not involving the United States or Canada are nomic, social, and cultural rights, are probably expensive unusual and are almost always hortatory, rather than for developing countries to implement—just like IPRs. legally binding or enforceable; (c) the EU appears to Developing countries must devote scarce resources to human be joining the trend, if the model used in its EPA with rights, perhaps before they have the national income or will CARIFORUM is replicated in other similar agreements, to do so. If human rights provisions are carefully designed, but the language on labor, although nominally binding, they can focus on improving governance (the supply side), includes no sanctions for noncompliance; and (d) even in as well as on empowering people to demand their rights. U.S. PTAs—which have the strongest language, on paper— If these rights provisions are to be workable and lasting, enforcement is rare, sanctions have never been applied, and policy makers will need to understand their effects on trade financial, technical, and capacity-building assistance to and governance. Policy makers, scholars, and activists improve implementation of labor standards is uncommon. should use human rights impact assessments, as well as widely accepted datasets, to gain greater understanding of how to make the match between trade and human rights Human Rights effective and enduring. The growing number and scope of PTAs containing human rights provisions reflects a new reality: policy mak- Dispute Settlement ers perceive that economic integration will not be success- ful without a stronger focus on improving governance In theory, the parties to a PTA are the masters of their own among trade partners. In chapter 21, Susan Ariel Aaronson treaty and could design an original dispute settlement notes that the United States, Canada, the EU, and the mem- mechanism from the ground up, or have no dispute settle- bers of EFTA are the main demandeurs of human rights ment mechanism at all. In chapter 22, Amelia Porges language in PTAs. The EU and EFTA focus on human observes that, in practice, almost all PTAs employ one of rights under the Universal Declaration on Human Rights three general types of dispute settlement mechanism: (UDHR), but they rely on aspirational language and on diplomatic settlement, use of standing tribunals, or a dialogue. Canada and the United States focus on specific WTO-type system in which ad hoc panels determine human rights, embed these provisions in the body of the whether disputed measures are in conformity with the trade agreement, and often make them binding. These PTA’s obligations. approaches have become more similar over time, but they Dispute settlement is useful in several ways. A PTA must remain distinct. provide an orderly way for its members to settle disputes 16 Jean-Pierre Chauffour and Jean-Christophe Maur and move on, or the disputes will poison bilateral relations, will be helpful, but it will require an up-front investment. reduce the benefits from the PTA, and perhaps even lead to The details of panel procedures can be left to be agreed later, the demise of the agreement. Dispute settlement is also although negotiators can set key parameters in advance. essential to ensure that the promises set forth in a PTA are Various approaches exist for dividing the expenses of dis- kept. By participating in a PTA with strong dispute settle- putes, handling translation and documentation issues, and ment provisions, a government signals its level of commit- regulating presentation of evidence and arguments. ment to private and public interests at home and abroad. PTAs with dispute settlement experience have sought Even if no disputes are anticipated, enforcement provisions (like the WTO negotiators) some way to ensure sound and in a PTA reinforce the governments’ precommitments, consistent panel decisions: almost all ad hoc panel systems make their promises more credible, and signal that the PTA allow the parties to comment on panel reports in draft is a sound platform for investment that will create jobs and form, and two PTAs have committed to appellate mecha- economic growth. Solid dispute settlement is even more nisms. Then there is the question of participation in the important in North-South (or South-South) PTAs with process. Who are the decision makers? Every PTA has a asymmetrical power relations. Recently concluded PTAs in process for selecting members of panels or standing tri- Latin America, Europe, and Asia demonstrate to a striking bunals and ensuring their impartiality. Who (other than extent that as PTA obligations deepen, become more the governments) may provide input into this process? complex, and provide more value, PTA partners seek Every government that engages in dispute settlement relies more certainty than purely diplomatic dispute settlement on its private sector to identify problems, to provide rele- can provide. vant factual information, and to identify commercial pri- The WTO-type ad hoc panel model is an often-used orities. Will the PTA permit panels to consider input from option, but some PTAs employ a standing tribunal instead. civil society in general? Must submissions and hearings be A tribunal may involve more fixed investment in infrastruc- open to the public? ture than ad hoc panels, but its permanence may make it Finally, it is important to have some mechanism for available to take on more functions for the integration determining whether government measures breach PTA process. Thinking ahead toward coexistence and even mul- obligations—but formal dispute settlement is not always tilateralization of PTA networks, however, it may be easier the quickest way to resolve a measure that is causing a com- to mesh ad hoc panel systems than court-based systems. mercial problem. The committees and other institutions In doing so, one should be aware that even an ad hoc created by a PTA provide a practical setting for addressing system involves many procedural choices: and resolving such issues. Some PTAs go further and build in a role for mediation, conciliation, or other rule-agnostic • Should the PTA limit panels to determining whether practical settlement methods. The benefits of such media- a PTA government has violated PTA law? Some PTAs tion are sure to exceed its costs. follow the General Agreement on Tariffs and Trade The final, and unavoidable, problem is compliance. (GATT) by making provision for disputes about gov- Unless a PTA’s dispute settlement instruments can (like the ernment measures that do not violate the rules but still European Court of Justice) impose fines on members for frustrate reasonably expected PTA benefits. noncompliance, PTAs’ leverage to obtain compliance con- • Should the PTA provide that all of its obligations are sists of authorizing withdrawal of PTA benefits or exercis- subject to dispute settlement? Some do, whereas others ing moral suasion. To the extent that a PTA’s preference exclude particular areas (for instance, soft law or com- margin is low relative to MFN benefits in the WTO, a PTA petition law). member may have much more leverage litigating in the • How should the PTA deal with overlap between PTA WTO, if it can. Indeed, the record of experience with PTA obligations and those of the WTO or other PTAs? In disputes shows that except in the Southern Cone Common practice, most give the complaining party the right to Market (Mercosur), where MFN tariffs are high, many PTA ask for consultations in either or both forums, but they parties have chosen to turn to the WTO. prohibit a second panel process after a panel has been requested in one forum. References The parties to a PTA will also need to consider how they De Melo, Jaime, and Arvind Panagariya, eds. 1996. New Dimensions in Regional Integration. Cambridge, U.K.: Cambridge University Press. want dispute settlement to operate. Institutions are a thresh- Schiff, Maurice, and L. Alan Winters. 2003. Regional Integration and old question: if negotiators want greater consistency and Development. Washington, DC: World Bank. predictability in panel decisions, the support of a secretariat World Bank. 2000. Trade Blocs. Washington, DC: World Bank. 1 Beyond Market Access Jean-Pierre Chauffour and Jean-Christophe Maur Economists have repeatedly warned against them, non- This vision is expressed in two ways in recent PTAs. The governmental organizations (NGOs) have fought them, first is the pursuit of what can be termed a “WTO+� agenda, and some governments have signed them begrudgingly (at focusing on disciplines already espoused by the World least in appearance). Yet in the past 20 years, preferential Trade Organization (WTO) but often expanding their trade agreements (PTAs) have multiplied unremittingly. depth and breadth and seeking enforceability. The second What is even more striking is that their scope has broad- is through rules and disciplines that are not covered by the ened at the same time as their numbers have grown. Deep WTO, or are covered very imperfectly (WTO extra). In integration provisions in PTAs have become ubiquitous. practice, PTAs often pursue both objectives, to varying This first chapter looks at the background of the drive degrees. North American PTAs, for instance, focus more on toward deep integration PTAs and at how they differ, in WTO+ disciplines, while adding a few WTO extras to the content and implications, from traditional market access mix. By contrast, European PTAs include numerous WTO- agreements. It then discusses the theoretical and practical extra aspects. Horn, Mavroidis, and Sapir (2010) identify motivations behind today’s deep PTAs. Finally, it highlights no fewer than 38 areas in U.S. and European Union (EU) key areas for policy makers to consider as they contemplate PTAs that aim to go beyond WTO disciplines. their future PTA strategies. The proliferation and deepening of PTAs may offer developing countries vast opportunities to modernize and upgrade their rules and disciplines with a view to greater A Preference for Deep Integration economic efficiency. At the same time, these trends pose a Gaining market access or preserving a level playing field serious challenge for policy makers, especially in low- has remained an important motivation for entering into income countries, because of the added burden of covering PTAs. But with the liberalization of trade around the world an increasingly large and complex set of issues with limited and the related diminishing size of preferential rents, the administrative resources for negotiation and implementa- growing success of PTAs cannot be explained by traditional tion, and frequently with no preexisting experience.1 market access motives alone (even factoring for the possi- Indeed, PTAs are increasingly addressing policy areas that ble substitution of tariffs for less transparent forms of pro- are entirely new to developing countries. These broader tection). Countries are also interested in a host of other agreements may deeply affect countries’ development objectives—importing higher policy standards, strength- processes. To take an often-cited example, it is possible that ening regional policy coordination, locking in domestic the inclusion in PTAs of the most advanced forms of intel- reforms, and even addressing foreign policy issues (see lectual property rights (IPR) protection may require an alter- Schiff and Winters 2004; Hoekman, ch. 4 in this volume). native economic development model whereby knowledge All this translates into a beyond-market-access vision and know-how are no longer acquired through imitation for PTAs that includes a broad set of rules and disciplines and reverse engineering (as happened with the generic phar- governing areas such as investment regimes, technical and maceutical industries in middle-income countries), but sanitary standards, trade facilitation, competition policy, through a less optimal, more demanding, and yet-unproved government procurement, intellectual property, environ- process of accumulation of capital and knowledge. ment protection, migration, labor rights, human rights, and The deep integration commitments in new PTAs, with other “behind the border� issues. their concomitant challenges, stand in sharp contrast to 17 18 Jean-Pierre Chauffour and Jean-Christophe Maur older trade agreements, which chiefly had to do with dis- mechanisms for redress, whereas positive integration mantling barriers to trade and making trade policy sim- requires taking active steps toward integration by defining pler to administer. Although multilateral trade agreements common policies and setting up the legal and administra- under the WTO have pursued a similar path toward tive framework to implement them. The difference is, how- greater complexity—for instance, with the 1994 agree- ever, not as clear-cut as it appears at first (see, e.g., Ortino ment on Trade-Related Aspects of Intellectual Property 2004; Torrent 2007). In both cases, a certain degree of legal Rights (TRIPS) agreement—nowhere is the policy ambi- alignment is required, as is the establishment of minimal tion as sweeping as in PTAs, under which regulatory disci- common institutions. For instance, agreeing on new rules plines are spreading to nontrade areas. that limit the way governments can intervene in markets Before looking at the issues in detail, it is useful to try to could be seen as an instance of either positive or negative capture the essence of the difference in the nature of the integration.3 liberalization challenge posed by the new disciplines in Nevertheless the distinction remains useful for thinking PTAs. The trade literature usually characterizes this process broadly about important characteristics of deep integra- in terms of positive versus negative integration and of tion, because new dimensions of PTAs clearly imply behind-the-border versus at-the-border integration. greater retooling of legal frameworks at the domestic level. Positive integration can be conducted in various ways, depending on how it is legally instrumentalized. Torrent Positive versus Negative Integration (2007) notes, for instance, the substantive differences The first Nobel laureate in economics, Jan Tinbergen, artic- between U.S. and EU agreements regarding procurement ulated the notions of positive and negative integration in provisions. The U.S. approach is more normative in that it characterizing the process of international economic inte- inserts the rules in the agreement, whereas the EU adopts a gration (Tinbergen 1954). Negative integration refers to more progressive approach by defining the rules through the removal of trade barriers and the principle of nondis- specialized organizations such as expert committees. Rela- crimination. This is the traditional remit of trade negotia- tive to negative integration, positive integration entails tions.2 Tinbergen defines positive integration as substantial differences in the drafting of language in agree- ments (the instruments of implementation being more [the] creation of new institutions and their instruments complex) and therefore in negotiations and, probably, in or the modification of existing instruments. . . . More the predictability of implementation. For instance, when generally, positive integration should consist of the cre- tackling trade facilitation issues, it is not sufficient to agree ation of all institutions required by the welfare optimum on items that should be prohibited (e.g., the use of con- which have to be handled in a centralized way. (Tinbergen sular fees) or on simple positive obligations such as trans- 1954, 79) parency; countries must also agree on standards for proce- Analysts have often retained the first part of the dures, such as use of risk management screening at definition—that integration is not just about removal of borders, and must monitor agency conduct. These obliga- barriers to trade flows but about “rule making� to facilitate tions are not easily incorporated into normative commit- these flows. Interestingly, though, Tinbergen offers in the ments in trade agreements—Messerlin and Zarrouk second part of the definition a vision that suggests that (2000), for example, take the view that they should not be. the creation of intergovernmental public goods could also Beyond adopting new policies designed to open markets, be welfare enhancing. This is an important aspect, to positive integration also seeks coordination of policies with which we will return. trading partners, which may imply some form of institu- Various interpretations of the Tinbergen characteriza- tional arrangements. tion have survived in the literature (e.g., Pelkmans 1984; Hoekman and Kostecki 2009; Ortino 2004, 18–34; Torrent Behind-the-Border versus At-the-Border Policies 2007). We take from Tinbergen’s definition the basic intu- ition that positive integration calls for public intervention Another important dimension is characterized in the liter- to tackle market failures that would otherwise prevent eco- ature as behind-the-border versus at-the-border measures. nomically optimal levels of integration. National treatment and uniformization of obligations Positive and negative integration have substantively dif- indeed differ in substance from most favored nation (MFN) ferent implications for the process of integration. Negative obligations in that they require countries to change policies integration would mainly seek the prohibition of a narrow that affect internal transactions that are not necessarily set of policies, as well as joint surveillance and, eventually, related to trade. Beyond Market Access 19 The question of the impact of domestic regulations on bilateral or regional setting rather than at the multilateral trade is not new and is well recognized in the WTO. GATT or WTO level. Implied by his analysis was a sense Domestic policies have the potential to be designed so as to that the removal of traditional trade barriers was not nec- discriminate against foreign producers. Article III of the essarily solving the issue of market access. Schiff and General Agreement on Tariffs and Trade (GATT) accord- Winters (2004) subsequently reviewed alternative ratio- ingly requires that internal regulations comply with the nales for PTAs. These rationales, either nonstandard or not national treatment principle, which states that other well represented by traditional theoretical models, include nationals should be treated the same as one’s own. Beyond domestic policy anchoring, importation of good regula- addressing discrimination per se through the national tory practices, supranational coordination to achieve treatment principle, there is also a desire on the part of pol- regional policy goals, export of regulatory standards by icy makers to reduce the costs of having to comply with hegemons, and foreign policy considerations. These eco- multiple and heterogeneous requirements. As the world nomic, societal, and political-economy motives for con- economy becomes more integrated and supply chains cluding a PTA are discussed in detail next. incorporate sourcing from many countries, the calls for some uniformization are growing. This is an area in which Economic Motives PTAs play an increasing role. Behind-the-border policies directly affect domestic Market access mercantilism is the traditional force behind transactions and thus have obvious direct welfare implica- the push for trade liberalization. Led by the false logic that tions that differ from the indirect effect through prices import barriers should be lowered only if reciprocal access and volumes of trade goods. Their effect also implies a dif- for exports is granted, countries mutually agree to liberal- ferent political-economy equilibrium. Moreover, as we ize their markets, and in most cases, the result is welfare- will see later, the notion of behind-the-border measures enhancing liberalization. In a globalized world, countries could be expanded to measures that are included in trade seek to gain competitive advantage over their neighbors by agreements not because of their direct or indirect effects negotiating special (preferential) market access with key on trade, but merely because trade agreements provide a destination markets. convenient vehicle for international negotiation or Several facts challenge this traditional explanation. Pref- enforcement. erences, to start with, may not be as important as in the In sum, deep integration measures may impinge on past. Tariffs have been falling worldwide (figure 1.1), and in domestic policies that are not necessarily directly trade a very general sense, even the most protected markets now related. They require more advanced reform of the legal tend to exhibit tariff levels that are moderate compared environment and, generally, a more complex set of instru- with those of 15 years ago. There are obviously many ments for implementation. They also may involve active exceptions at the product level. Developed economies and supranational coordination. It is not hard to imagine how middle-income countries exhibit, on average, lower levels demanding and complex liberalization of these measures of protection than low-income countries. might be. Moreover, as PTAs grow in number, so does the number of recipients of preferences, leading to the erosion of the preference margins held over competitors. Carrère, de Motivations for Deep Integration Melo, and Tumurchudur (2010) construct an adjusted The reality of the new PTA landscape raises questions about market access measure of what countries receiving EU the motives for entering into regional agreements. Why preferences actually enjoy when the preferences given to would policy makers around the world invest time, political other partners are taken into account. When this measure capital, and resources in negotiating trade arrangements is compared with the unadjusted measure of preference that discriminate among trading partners and offer uncer- over the MFN tariff, it turns out that real market access is tain welfare benefits, when a multilateral approach of often much lower—for example, less than half for Cambo- nondiscriminatory market access provides a superior solu- dia, a recipient of the EU’s Everything But Arms (EBA) tion? The answer can only be that policy makers are look- preferences. In some instances, as in the case of a generalized ing for benefits that extend beyond market access for goods system of preferences (GSP) recipient, such as Indonesia, and services. there is no effective market access preference at all. As Krugman (1993) assumed that one reason for the suc- noted by Levy (2009), the reciprocal incentive apparently cess of PTAs was the convenience of dealing with the vari- fails to explain the rationale behind asymmetric North- ety, complexity, and opacity of modern trade barriers in a South types of agreement. Many developing countries 20 Jean-Pierre Chauffour and Jean-Christophe Maur Figure 1.1. Most Favored Nation (MFN) Tariff Rates, Weighted Mean, All Products 26 21 percent 16 11 6 1 88 90 92 94 96 98 00 02 04 06 08 19 19 19 19 19 19 20 20 20 20 20 high income: non-OECD high income: OECD lower middle income upper middle income low income Source: World Bank, World Development Indicators database, http://data.worldbank.org/data-catalog/world-development-indicators. Note: OECD = Organisation for Economic Co-operation and Development. already benefit from very good market access in their decreasing and sources of comparative advantage can be northern partner countries. found in small cost differences (“thin� margins of compar- To sum up: there is a tendency toward diminishing ative advantage). Even preferences that are small on paper MFN tariffs; preference margins are actually smaller than may become attractive for prospective partners. they appear; and some developing countries already enjoy Market access conditions are not determined only by virtually tariff-free access to major markets under the tariffs. First, customs procedures and other domestic poli- GSP, EBA, and other preferential regimes. Under those cies, such as standards, may affect foreign exporters’ costs circumstances, can market access incentives alone explain of access to the market. As noted by Bagwell and Staiger reciprocal liberalization in the PTA context? (2001), when governments choose these policies unilater- Market access may persist as a motive in North-North ally, there is a possibility that market access might be set at and South-South agreements. In the global South, in par- a lower and less optimal level than under reciprocal liberal- ticular, tariffs remain fairly substantial. Other incentives ization negotiations. may also be in play. Countries at the periphery of a net- Second, the market access question is not limited to work of agreements (for instance, the partners of the EU goods. Foreign investment is another way of gaining access and the United States) may suffer because industries shift to foreign markets, and the inclusion in agreements of dis- toward the hub of the network and away from peripheral ciplines relating to investment can be an additional motive countries (the spokes) and because of erosion of the outly- for reciprocal liberalization commitments.4 Many PTAs ing countries’ preferential access, since location in the hub now include investment disciplines that go beyond those provides preferential access to many more markets. This of the WTO. WTO rules are limited to the supply of services reality is what has led countries such as Chile, Mexico, and following an investment (commercial presence), as speci- Singapore to pursue “spoke-spoke� strategies by mirroring fied in the General Agreement on Trade in Services (GATS), their large trading partners’ PTA policies and pursuing and to the trade-related investment measures (i.e., the agreements with the same partners, even though their Trade Related Investment Measures [TRIMS] agreement). trade with such distant partners might be small. The strat- Moreover, GATS relies on an “enterprise-based� definition egy of the European Free Trade Association (EFTA) in par- of investment, whereas bilateral rules generally refer to a allel to the EU, and the accession of new countries to the broader “asset-based� definition that covers portfolio EU, might be seen as being driven by a similar motive (see investment and different forms of tangible and intangible Baldwin 1994). Bhagwati (2008) also argues that even property (Miroudot, ch. 14 in this volume). modest margins of preference have a sizable impact in a Third, because traditional PTA analysis focuses on globalized world in which overall transaction costs are trade in goods, trade in services is often omitted from the Beyond Market Access 21 discussion. Yet the services sector represents the largest, pricing below cost for the poorest customers in such and a growing, share of gross domestic product (GDP) in services sectors as water, electricity, finance, and trans- many developed and developing countries; many services port. Hoekman, Mattoo, and Sapir (2007) observe that (e.g., electricity, telecommunications, transport, and pro- not only do political-economy calculations become more fessional services) are key inputs into the production of complex in this environment, but also the usual reciproc- goods and other services; and the information technology ity mechanism of trade liberalization may not work any (IT) revolution has increased the tradability of services. In more because of the difficulty of clearly separating meas- these circumstances, services liberalization may offer con- ures that promote market access from measures that pur- siderable gains, both from increased trade flows and from sue legitimate regulatory objectives. reduced input costs for firms.5 For some country group- Aside from market access considerations, PTAs have a ings, such as South-South agreements, preferential integra- role to play in transnational regulation. This involve- tion in goods may bring little benefit; small countries ment reflects the standard economic-efficiency motive for with similar production structures and with small and regulation—addressing market failures. Three often-cited inefficient manufacturing sectors might not have much to market failures are in the areas of monopoly power, exter- gain from engaging in goods-only PTAs. A promising next nalities and the provision of public goods, and informa- step might be to explore other integration dimensions in tion asymmetries. which complementaries might be beneficial, such as 1. Monopoly power and supranational competition. services (Mattoo and Sauvé, ch. 12 in this volume), invest- Economies of scale and, more generally, market failures ment (Miroudot, ch. 14 in this volume), and labor mobility give rise to the possibility of monopoly power and abusive (Stephenson and Hufbauer, ch. 13 in this volume). Hoekman conduct by private firms. Trade liberalization may go some and Sekkat (2010) examine this option in the case of the way toward creating competition by making markets con- Pan-Arab Free Trade Area (PAFTA). testable, but this will not always be sufficient. Domestic Yet the reality is that even if some limited sectoral enforcement of competition rules is linked to market advances (on movement of professionals, for instance) access. If, in a national jurisdiction, competition is weak have been recorded in recent agreements, PTAs have made because of lack of enforcement, market concentration only modest inroads where access to services markets is and collusion in the domestic market may deter entry by concerned. Regulatory policies tend to pursue noneco- foreign suppliers. In such instances, competition policy nomic objectives along with economic concerns (such as should complement trade liberalization to secure the lowering the costs of barriers and compliance), and this, gains from the opening of markets. Hoekman, Mattoo, and Sapir (2007) remark, makes for a The threats of market power and abusive conduct may particularly complex political-economy calculus. As with not justify the inclusion of competition rules and disci- tariffs, the transaction costs imposed by deep integration pline in a PTA on economic grounds alone. After all, policies will lead incumbent services industries sheltered countries can individually opt to implement competition by regulatory protection to resist liberalization. policies unilaterally. But such policies may not be effective The bias against liberalization can be reinforced in the in dealing with the risk of cross-border externalities and case of services by reluctance on the part of consumers and the abusive behavior of exporters abroad. Competition government. Consumers may fear that regulatory liberal- rules may be particularly relevant in PTAs where the risk ization will affect their well-being—for instance, through of abuse of market power or collusive practice involves slacker standards and lower quality of products and serv- more than one national jurisdiction and where interna- ices.6 Government and regulatory agencies may also view tional legislation and cooperation could effectively curb liberalization reluctantly, for several reasons: (a) regulation anticompetitive behavior. For instance, a firm may use its may be a source of indirect taxation, in that governments market power in one market to extract monopoly rents in benefit from rents generated by regulatory protection (as is another; a dominant position may span several countries common in the area of standards); (b) governments may (as with Microsoft), potentially leading to anticompetitive fear that their latitude to pursue regulatory objectives will market conduct; or firms may have agreed in one jurisdic- be curtailed because cross-border supply could undermine tion to collude in another, making it necessary for author- local suppliers while being subject to different (lower) ities to cooperate in order to collect evidence. regulatory requirements; and (c) governments also pur- Because such competition issues are related to trade and sue redistribution objectives by, for instance, imposing investment, there are complementarities in dealing with requirements for universal provision (e.g., in water sup- them in the same forum as trade arrangements. PTAs offer ply, telecommunications, and postal services) and for a scope for creating disciplines that the WTO does not. 22 Jean-Pierre Chauffour and Jean-Christophe Maur Arguably, the degree of cooperation in international com- • Joint decision making to ensure that national policies are petition arrangements will depend on the size of individual coordinated at the regional level (e.g., management of economies, the level of trade, and the enforcement capacity food stocks). of the actors. • Transfer of resources to solve externality problems when 2. Externalities and provision of public goods. An exter- contributions by individual member states are required. A nality (or transaction spillover) is a cost or benefit, not common instance is when institutions are weak and transmitted through prices, which is incurred by a party capacity building is needed to bring a partner country that did not participate in the action causing the cost or to a higher standard for the regional common good benefit. As the examples of climate change and the deple- (e.g., customs enforcement). tion of fish stocks show, externalities are not necessarily confined within the borders of a given country. In some Regional externalities should arguably be dealt with in cases, externalities may be best tackled by a small group of those jurisdictions in which they occur, and they therefore countries; for instance, river management and some trans- require transnational mechanisms of cooperation. It is not port issues should involve neighboring countries. External- entirely clear whether regional externalities (positive or ities are closely related to the need to provide public negative) should necessarily be addressed in the specific goods—that is, goods that are nonrivalrous and nonex- context of a PTA (Schiff and Winters 2002). There is always cludable.7 In the presence of externalities, markets may not the possibility (as for all commitments agreed in PTAs) of spontaneously provide goods, such as clean air, that are addressing these issues through dedicated agreements and socially desirable. transnational institutions such as bilateral customs or Addressing regional externalities should logically be a water management agreements. Historically, many such priority of regional PTAs, given the need for some form of problems have been addressed in this way. supranational coordination to help internalize the exter- 3. Information asymmetries. Sometimes goods charac- nalities or share them fairly. Coordination can take several teristics may not be discernible to buyers before consump- forms: tion. Credence goods do not—for example, chemicals may be harmful to health, unbeknownst to the people exposed • Alignment (for instance, through mutual recognition to them; thus regulation is needed to inform consumers agreements) or harmonization of policies. These meas- before purchase. Information asymmetries may affect pro- ures eliminate segmentation of markets and duplication ducers themselves in situations where consumers’ charac- of the costs generated by barriers at the border. teristics are hidden (e.g., in the insurance market). In most • Alignment and harmonization of policies to avoid leakage. instances, the market itself deals with these information Leakage is a concern when, for instance, one jurisdiction asymmetries through information dissemination and in the PTA has lower regulatory standards that might brand signaling. When, however, the asymmetries are not undermine the regulatory efforts of its trading partners. addressed, the market outcome is suboptimal. The problem An example is a country’s deficient control of animal of information is particularly acute for services because of epizooties or pests that spill over to neighbors. (Animal their intangibility, which makes it harder for the buyer to border crossings cannot be totally controlled.) learn about quality prior to consumption (Hoekman, • Alignment and harmonization of policies to create net- Mattoo, and Sapir 2007). Regulation may then be called works and to facilitate information exchange. This for—perhaps through licensing or the imposition of com- method essentially refers to the adoption of common pulsory standards. International cooperation may help standards and regulatory language in order to facilitate reduce the overall complexity of the regulatory framework flows within the region (for instance, ensuring interop- for international traders by aligning and harmonizing erability of national networks at a regional level). Such regulations. Failure to tackle issues of this kind in a coordi- alignment is of particular relevance for services sectors nated fashion may generate negative externalities. such as finance and insurance, IT, professional services, In the specific PTA context, the challenge will be to transport, and electricity. assess whether information asymmetry problems are best • Pooling of efforts to create infrastructure or pooling finan- tackled at the bilateral or regional level, rather than in cial and human resources to provide a regional public other international forums. In most instances, this will be a good. For example, combined financing might be question of judging the trade-offs between the transaction needed for a large infrastructure serving a region, such costs of cooperating with a limited number of countries, as as a hydroelectric dam, or for a large port. against the international community, and between the Beyond Market Access 23 benefits of coordination at the PTA versus the global level. procedures) in international flows arising from the trade There is a clear risk, for example, that regional standards in agreement would spill over into other domestic areas.8 PTAs may exclude third, nonadhering, countries. Never- Clearly, in the case of trade and development, there are com- theless, it may be much easier to agree on a common plementarities between openness and poverty-alleviating approach with a small number of countries and with coun- growth, and PTAs help target specific countries. In other tries with similar preferences. Finally, in some cases (e.g., instances, and more prosaically, there might merely be a regional epizooties), a neighboring-country approach will quid pro quo between market access in the North and be appropriate. concessions on other fronts in the South. Another motivation relates to the search for the best available forum for promoting the international sharing Societal Motives of societal norms, focusing on issues that are not already Beyond the economic motives, a PTA can be driven by present in other agreements such as the WTO (for instance, societal motives or, as Bhagwati (2008) calls them, value- labor rights or environment protection) or pushing for related demands. Each society has moral and social norms higher standards than currently exist in the international and preferences that may be undermined by market forces community. (See also “Institutions for reform,� below.) left to operate on their own. For instance, trade in danger- This is a clear objective of the new U.S. trade policy of pur- ous weapons or in morally or religiously reprehensible suing PTAs that was initiated under the George W. Bush material may need to be restricted. What is considered administration. In a 2001 speech, Robert Zoellick, then dangerous or morally reprehensible will vary significantly U.S. trade representative, noted that “we need to align the according to country and culture. global trading system with our values. . . . We can encour- Social norms and values may be undermined by trade age respect for core labor standards, environmental protec- liberalization; after all, it is easier to control borders than to tion, and good health . . . And we must always seek to control a whole territory, and foreign producers may not strengthen freedom, democracy and the rule of law� hold themselves to a particular country’s standards. This (quoted in Evenett and Meier 2008). Related to this objec- issue has long been recognized in multilateral trade agree- tive is the desire to use every trade forum to reaffirm these ments, leading to the inclusion of safeguard provisions and choices, with a view toward mutual complementarity and general exceptions (on moral grounds, for instance). Safe- reinforcement between the different instruments. guard mechanisms and the language of general exceptions may, however, prove insufficient, and countries may want Political-Economy Motives to negotiate sector-specific conditions in PTAs, such as reservations concerning universal provision of services. Beyond the need for coordinating policy making with trad- Conversely, trade agreements may help further societal ing partners, PTAs also serve as forums for policy objec- objectives. Development policy concerns, for example, are tives that are strictly related neither to exchanges nor to the increasingly present in agreements such as the EU-sponsored preferential nature of PTAs. PTAs can be seen as efficient economic partnership agreements (EPAs). Northern part- forums for achieving broader geopolitical, institutional, ners also push for provisions related to good governance, and policy-anchoring objectives. democracy, labor rights, and human rights (Elliott, ch. 20 in Geopolitical objectives. Geostrategic considerations have this volume; Aaronson, ch. 21 in this volume). historically commanded the formation of PTAs. There are What is the specific value added of PTAs in helping to numerous examples of trade agreements that have been achieve these objectives? One motivation might be that used to promote peace. Chief among them is the EU, threats to societal preferences are localized in a limited which was born from the desire to prevent war from hap- number of partners, and thus it makes sense to deal with pening again in Europe. Winston Churchill called in 1946 those countries directly. Some PTAs, for example, have for a “United States of Europe,� but it was with economic been specifically linked to measures for fighting narcotics integration and the 1951 European Coal and Steel Com- production and trafficking; an example is the Central munity that European integration began (Winters 1997; America Free Trade Agreement and the U.S. stipulations Baldwin 2008).9 Other examples of agreements used for concerning narcotics in that PTA (Hornbeck 2003). stability purposes, as noted by Bergsten (1996) include the PTAs might be seen as a locus of positive spillovers Southern Cone Common Market (Mercosur, Mercado between trade and societal policy issues. For instance, Común del Sur) and Asia-Pacific Economic Cooperation provisions on governance (e.g., open and transparent (APEC). More recently, the push by the United States to 24 Jean-Pierre Chauffour and Jean-Christophe Maur conclude PTAs has had foreign policy motives (Bhagwati Sapir (2009), who show that binding and nonbinding pro- 2008; Evenett and Meier 2008), as has Europe’s neighbor- visions coexist in agreements on nearly all the issues cov- hood policy (European Commission 2007).10 ered. Such flexibility, it should be noted, might appear as a Thus, PTAs can contribute to delivering peace and sta- virtue to policy makers but may not necessarily contribute bility as a regional public good (Schiff and Winters 2004; to factual reform. World Bank 2005, box 2.6). Two mechanisms may come In contrast to multilateral forums, PTAs often feature into play. First, trade exchanges increase economic interde- innovative institutions. One innovation is the involvement pendence and, thus, act as a disincentive for conflict. They of the private sector, from participation in stakeholder may also help increase familiarity and trust and defuse forums to the possibility of lodging complaints in, for trade-related disputes.11 Second, and more specific to example, the European Court of Justice, the General Secre- PTAs, institutions themselves serve as a conduit for diplo- tariat of the Andean Community, or under the investment macy, allowing for frequent and repeated interaction provisions of the North American Free Trade Agreement among officials and for better exchange of information (NAFTA). Some PTAs offer more substantial transfers of (Haftel 2007). Deep PTAs seem more attractive in this sovereignty. Governments can also opt to devolve some of respect because they have more sophisticated institutions. their authority to institutions created by PTAs, such as Empirically, Mansfield and Pevehouse (2000) have regional competition authorities, as described by Dawar found that membership in a PTA significantly decreases and Holmes (ch. 16 in this volume). the likelihood of armed conflict. More recently, Lee and The transaction costs of agreement are lower in PTAs Pyun (2009) provide statistically significant evidence that with a small number of participating countries. In addi- PTA institutions decrease the probability of conflict tion, small PTAs do not lend themselves to free riding, between members, whereas WTO membership seems only which is a practice that poses a key obstacle to successful marginally significant. Martin, Mayer, and Thoenig (2010) global liberalization (Krugman 1993). Lower transaction test the interaction between conflict and PTAs over the costs allow for more binding constraints on each partner period 1950–2000 and find that the hypothesis of geopolit- (noncooperation is more difficult) and for legal flexibility. ical motivations behind the agreements is supported by Since the number required to reach consensus is lower, the evidence. Yet for PTAs to help ease the probability of con- agreement could be amended and revisited more often flict, there must be sufficiently large trade gains between than is the case with multilateral agreements. A smaller the partners. Economics and political motives thus com- number of participant countries enables more frequent plement each other. and probably less formal interactions, which can con- Institutions for reform. By offering a different set of insti- tribute to problem solving and deeper relations. That tutions and related services from those of other forms of seems an important feature for the regulatory aspects, international agreements, PTAs provide an infrastructure which require agreement on complex issues (such as for institutional dialogue and cooperation. As noted by the mutual recognition arrangements) and the setting up of World Bank (2005), many issues covered by PTAs, such as expert bodies. This is the road followed by the EU under the externality problems described earlier, could well be the Florence Forum.12 handled without a trade agreement. If PTAs are used, this Resource transfers are more likely to occur in the frame- must be because they are perceived as offering a good work of PTAs than in other international agreement set- framework for achieving progress. tings. Many PTAs—North-South ones, in particular—do PTAs are relatively flexible instruments insofar as they incorporate such transfers. Agreements signed by the EU allow for various levels of legal commitment and offer are the most striking examples; other cases include U.S. nearly infinite ways of creating policy space. For example, free trade agreements (FTAs) with Latin American partners the options with dispute settlement are numerous: there and South-South agreements such as the Common Market may be no mechanism at all, or one or several dispute set- for Eastern and Southern Africa (COMESA). Resource tlement mechanisms (Porges, ch. 22 in this volume). Each transfers matter, in particular, for deep and asymmetric PTA can come with its own ad hoc instruments, which may PTAs. Arguably, deep integration places heavier demands be sector specific or may refer to external mechanisms such on capacity. Less developed trade partners may have diffi- as international arbitration or WTO dispute settlement. culties in, for example, meeting the regulatory standards of Various ways of reaching settlement before recourse to for- their partners and thus obtaining effective market access. mal dispute settlement are available, such as good offices, They may lack capacity to compensate for some of the third-party mediation, and conciliation. Indirect evidence adjustment costs of reform; to contribute effectively to the of legal flexibility is also provided by Horn, Mavroidis, and production of regional public goods; and, even more Beyond Market Access 25 broadly, to help achieve geopolitical and societal objectives Rica and Peru used their FTA negotiations with the United (development, conflict prevention, and so on). States to push domestic reforms. Levy (2009) does not find Policy anchoring. A traditional political-economy expla- much in the way of market access motives for Peru, except nation for a country’s entering into binding international a desire for greater certainty about future access (trading trade commitments is the pursuit of a domestic reform temporary preferences for more permanent ones), but the agenda and the use of external commitments to lock in agreement did help the country cement its economic pol- progress and prevent future reversals. The opportunity to icy reforms. Some of these reforms, notably in the areas of lock in is also a motive for including behind-the-border services and investment, were part of the FTA implementa- aspects in agreements. PTAs may be perceived as more tion program, but the agreement also helped lock in prior effective lock-in mechanisms than other international policy reforms, such as tariff reductions. Another motiva- agreements, and they may complement other external tion for signing the FTA with the United States, Levy notes, instruments in the process of reinforcing and consolidat- may have been the hope that it would generate broader ing domestic reforms. positive spillover effects on Peru’s governance and the rule By extending their reach to regulatory issues, PTAs offer of law. By imposing good disciplines to protect foreign a way of improving policy credibility (Hoekman, ch. 4 in investors and market access, the FTA would signal a com- this volume). What are the differences, then, between the mitment to a better legal environment, in general. sort of anchor offered by PTAs and that provided by the In sum, there are strong rationales for policy makers to WTO? Aside from the obvious point that PTAs may offer embark on deep and comprehensive PTAs, but the relative commitments in WTO+ and WTO-extra areas, they may merits of regional integration are also issue specific and have specific advantages. The possibility of picking a part- country specific. The choice of whether to include regula- ner may help reinforce credibility, as the partner of choice tory aspects in PTAs is essentially dictated by a dual concern: may be perceived as a strong proponent of reform. The EU, securing market access and addressing market failures, the United States, and other developed countries do, in whether national (through the lock-in effect of policy fact, promote various agendas through their respective reform and policy upgrading) or regional. Market failures PTAs. Picking a partner or a group of partners may also will be of different natures and will involve different sets of signal a preference for a certain regulatory approach. In countries, depending on the sector and the issue at hand— addition, lock-in through PTAs can be complemented by hence the need, as with any regulation, for a case-by-case transfers of finance and knowledge. approach. Other noneconomic considerations, such as fos- An argument put forward by Schiff and Winters (1998) tering societal choices, may apply to some issues of a regu- is that PTAs may actually be well suited for locking in poli- latory nature. Finally, specific institutional characteristics cies because of the credibility of enforcement in these and advantages may motivate the choice of PTAs as ade- agreements. Incentives to enforce commitments are greater quate forums for reform. in a PTA because there is less possibility of free riding and fewer of the coordination problems that may arise in Specificities of Deep Integration multilateral forums. In addition, there is more scope for retaliation because concessions in a PTA may go beyond The increased scope and depth of PTAs create opportuni- just tariffs. Schiff and Winters note, however, that the disci- ties but also pose extra challenges to policy makers as they plining effect is limited to the partner countries in the PTA, negotiate and implement the complex market-access and not third-country members. (They cite the peso crisis of regulatory web of these agreements. Policy makers may 1994–95, when Mexico raised its tariffs on 500 items for have to reevaluate their approach when negotiating and non-NAFTA suppliers.) These dynamics are echoed by the implementing deep integration PTAs. In particular, to what conclusion reached by Prusa (ch. 9 in this volume), that extent are the multiple goals of PTAs consistent and PTAs tend to discipline the use of contingent protection congruent? Do the new disciplines incorporated in PTAs measures among partners while, at the same time, the use of create a different category of obligations? Does the deepen- protection against third countries seems to be increasing. ing and popularity of PTAs create new challenges for the There are several recent examples of countries that have multilateral trading system? In this section, we suggest four used PTAs to pursue an ambitious domestic agenda; Schott major areas of emphasis for policy makers, especially in (2003) cites Mexico and Chile. Similarly, the accession of developing countries, as they refine their regional trade Eastern European countries to the EU was strongly moti- strategies: reexamining the question of discrimination and vated by the desire to break irrevocably with socialism and preferential access, adopting a holistic approach, building consolidate market economy reforms. More recently, Costa in flexibility, and focusing on implementation. 26 Jean-Pierre Chauffour and Jean-Christophe Maur Preferences government procurement rules do not affect the market as a whole, and therefore, exclude suppliers only from serving Are the traditional concerns of discriminatory liberaliza- the public share of the domestic demand (Dawar and tion valid for the new areas of deep commitments in Evenett, ch. 17 in this volume). Depending on the size of PTAs? Do deep integration measures generate trade diver- public markets, this may not be enough to exclude foreign sion? Can they harm the liberalizing country? Do they act suppliers from the market altogether. as stumbling blocks to further liberalization? These Impact on third parties. The standard effect of discrimi- issues—in particular, those related to the impact of deep nation will still be harmful for third parties (the excluded integration on multilateral architecture—have generated countries). This is, for instance, the case when countries considerable interest as of late (OECD 2003; Baldwin, adopt European standards instead of international ones Evenett, and Low 2009; Estevadeordal, Suominen, and Teh (Maur and Shepherd, ch. 10 in this volume; Stoler, ch. 11 in 2009), thanks to mounting evidence provided by new this volume). It is important to ask, however, whether pref- PTAs. The new regulatory commitments found in today’s erential measures are always discriminatory. PTAs are discussed here in light of the three classical eco- An important characteristic of regulatory measures is nomic concepts for analyzing market access discrimina- that de jure preferential treatment might be difficult to tion in PTAs: trade diversion, third-party effects, and apply, making de facto MFN liberalization a preferable systemic effects. option. That is, devising a new regulatory regime applica- Trade diversion. Discrimination in deep integration ble to each PTA may be impracticable, or the concept of agreements can secure the benefits of market access with- rules of origin that applies to product characteristics sim- out generating the potential cost of trade diversion. In this ply cannot be as easily applied to regulations or intangible sense, regulatory discrimination does not raise the same transactions.16 For instance, provisions on protection of concerns as tariff discrimination would. The certitude that intellectual property rights apply equally to all origins, better market access will be beneficial and that no diversion including domestic ones. Carving out specific regimes for costs will occur leads to an important consideration for some countries (as in the case of the WTO Article 6 excep- policy makers: all things being equal, PTA partners will tion for least-developed countries) requires complex legal unambiguously gain in preferential deep integration and practical arrangements. Similarly, for customs proce- efforts. This may explain why deep integration issues are dures, although trade rules may differ depending on the winning popularity in PTAs. (See Baldwin, ch. 3, and origin of the product, it makes sense to maintain, as much Baldwin and Freund, ch. 6, in this volume.) as possible, similar procedures regardless of the origin of Protection afforded by lack of regulatory openness is not the good because most objectives of border controls apply necessarily protectionist in intent. Regulatory requirements to all imports. Those examples show that the concern often impose a transaction cost on the exporter without about negative impact on excluded parties can largely dis- generating rents for the home country.13 A case in point is appear in the case of deep commitment provisions and superfluous or antiquated border controls, which create that preferential liberalization could generate positive additional costs without any corresponding benefits.14 externalities for third countries.17 In such instances, liberalization of services, harmo- This is, however, not a universal rule. A characteristic of nization of standards, trade facilitation, investment liber- deep integration liberalization is that there are instances in alization, and openness of government procurement can which discrimination is inevitable and even necessary. The generate benefits even if carried out preferentially. It is, main illustration of this conclusion is provided by mutual however, important to stress that this positive effect only recognition agreements (MRAs). MRAs can be negotiated occurs if there is no sizeable rent transfer from domestic to in any regulatory area and are basically a way of lowering foreign producers.15 In trade in services, for instance, the barriers to entry into the domestic market for foreign impact of preferential liberalization will be determined by producers without outright harmonization of rules, thus the nature of the regulatory barriers present. If lack of preserving regulatory diversity and allowing countries to competition is an issue, regulatory liberalization may well maintain national objectives and preferences. Under this replace a domestic monopolist practice with a foreign one principle, parties agree, in essence, to maintain their own (Mattoo and Sauvé, ch. 12 in this volume). Similarly, where regulatory procedures provided that they meet minimum access to services markets is subject to some form of licens- common objectives. Recognition can be agreed both for ing, rents may arise, and with them, the cost of trade diver- regulatory standards and for their testing and can be sion. In the case of government procurement, there is an applied in several areas: services (e.g., professional stan- additional aspect at work: restrictive and discriminatory dards and transport), trade facilitation (e.g., declarations Beyond Market Access 27 made with foreign customs), and technical trade barriers component of an overall dynamic of liberalization (Bald- and phytosanitary measures. Another instance in which win and Freund, ch. 6 in this volume). discrimination is needed relates to customs controls. Mod- In the context of deep integration, similar concerns pre- ern and efficient, risk-based border management calls for vail. How do complex and largely ad hoc PTAs touching on the selective control of imports, focusing on categories that services and behind-the-border measures interplay with present the highest risk of noncompliance. Risk criteria the multilateral order? Part of the answer was provided in discriminate, for instance, by product category, country of the previous section, where the point was made that origin, and identity of shipper, allowing simplified controls liberalization is often MFN in nature, thereby removing for authorized economic operators and express shippers. concerns about stumbling-block effects in these instances. Finally, the fact that liberalization in preferential set- There is also more to this story, as discussed by Baldwin, tings could de facto lead to MFN liberalization has pro- Evenett, and Low (2009) and in OECD (2003). Several found implications for overall liberalization negotiating mechanisms that support further liberalization are actually strategy. Concessions given to one partner cannot be found in PTA provisions: offered again to another when they are nondiscriminatory and are implicitly offered to the rest of the world. One • PTAs may enforce or encourage adherence to interna- implication might be that such liberalization is more diffi- tional standards in, for example, sanitary and phytosan- cult to achieve because it is more likely to be resisted by itary measures and technical barriers to trade (Lesser domestic firms that would lose not only to the preferential 2007). Numerous PTAs also refer directly to WTO rules. partners, as would be usually the case in a trade-diverting • Third-party, nonparty MFN clauses are often found in PTA, but also to the world as a whole (Krishna 1998). The services provisions (Fink and Molinuevo 2007) and in reciprocity rationale for signing North-South agreements government procurement (Baldwin, Evenett, and Low would also be undermined because offsetting market 2009). According to third-party MFN rules, future and access preferences for goods (the objective of the South) more advantageous commitments with other partners against deep regulatory commitments (the objective of the should be granted to PTA partners as well, thus trigger- North) seems to make little sense for developing coun- ing automatic liberalization. A benefit of such rules is tries. Preferences are bound to be eroded over time, but that small countries avail themselves of the bargaining regulatory commitments are both permanent and MFN. power of more powerful countries with common trade Alternatively, as argued by Limão (2007), this asymmetry partners and so gain increased market access (Baldwin, could provide an incentive for PTAs to maintain high bar- Evenett, and Low 2009). riers against third countries (through high preferences), in • When regimes operate under liberal rules of origin order to provide greater incentives for cooperation in non- (ROOs) or liberal “denial of benefits� provisions, the trade areas and postpone to a distant future the threat of provisions are applied not only to preferential trade in preference erosion. goods but also in any instance requiring the establish- Another related consideration is that parties that want ment of the origin of the partner subject to preferential to export a certain regulatory model—one more advanta- rules. There are various instances in PTAs; they include geous to their own firms—could gain from being the first access by third parties to MRAs, ROOs that apply to for- to negotiate with a given country. This may be one aspect eign firms that establish local presence in the partner of the competitive liberalization framework described by country (Mattoo and Sauvé, ch. 12 in this volume),18 Bergsten (1996). and government procurement (Dawar and Evenett, Systemic effects: Deep integration as a building block. Are ch. 17 in this volume). ROOs applying to regulations deep commitments in PTAs building blocks or stumbling often happen to be liberal either because they otherwise blocks with respect to multilateral liberalization? This is a become complex to administer or because, as we saw legitimate question, given that the slew of new commit- earlier, it does not make sense to operate parallel regula- ments in PTAs makes these agreements much more inva- tory systems instead of an MFN system. sive and, by adding new dimensions, may create even more • The diffusion of identical and liberalizing rules in PTAs hurdles for the welfare-superior objective of multilateral has been particularly noted in “contiguous� PTAs hav- liberalization. Even when the more traditional aspect of ing one partner in common. This occurrence can be tariff preferential liberalization is considered, the answer to seen in investment provisions in agreements in North this question is not entirely clear, with some analysts argu- and South America, in procurement provisions, and in ing that PTAs fundamentally undermine the multilateral contingent protection (Baldwin, Evenett, and Low system (Bhagwati’s “termites�) and others seeing in PTAs a 2009). There could, however, be a downside, as large 28 Jean-Pierre Chauffour and Jean-Christophe Maur trading powers export their own—and not necessarily rules concerning movement of persons; and standards compatible—vision of a liberalization agenda. Prusa policies. (ch. 9 in this volume) describes a phenomenon of rules The other aspect of the broader agenda is, of course, the diffusion in which the EU and the United States act as regulatory one and the inclusion of domestic and other spokes in their respective networks. More broadly, tem- policies that have the objective not of protection but of plate approaches to liberalization are often used in remedying some sort of market failure. Such policies are PTAs. Rules relating to investment, services liberaliza- included in PTAs at least in part because trade liberaliza- tion, or standards tend to replicate one of two or three tion interacts with their objectives in ways that may often existing models. seem to make these objectives more difficult to achieve. Trade policies can no longer be designed on the assump- In sum, discrimination in the implementation of deep tion of their separability from other policies.19 commitments in PTAs should not be underestimated, but Deep integration is as much about trade as it is about there are ways of dealing with it. It should not be underes- other dimensions of economic management and public timated because deep integration creates stealthier and policy. Starting with liberalization of services, all deep inte- more complex ways to discriminate. Trade partners can gration policies meet specific objectives, and the liberaliza- push for specific regime designs with the aim of carving tion question cannot be divorced from the consideration of out more favorable market access conditions. One example these goals. Policy makers should carefully think about why is the insistence by the United States on including customs and how trade agreements should serve these objectives in rules in its FTAs that allow for preferential treatment for the specific context of PTAs. Table 1.1 offers a snapshot of express carriers—an industry in which the United States is the variety of such objectives. well represented. However, the parallel with the tariff In Termites in the Trading System (2008), Bhagwati analysis of preferential liberalization does not necessarily pointedly mocks the ever-expanding notion of trade- hold because there is less risk of trade diversion, and the related policies: “If I sneeze and use imported cough syrup, welfare implications of preferential liberalization are then that immediately affects imports; if I use domestic cough necessarily positive. In such cases, PTAs would contribute to syrup, that potentially reduces exports of the syrup I have overall welfare gain. Moreover the rather complex nature of used up.� It is true that by pushing the logic ad absurdum, regulation tends to work to the advantage of MFN liberal- every issue becomes trade related and has a trade effect. ization because managing multiple regulatory regimes to Although this does not mean that the impact of non-trade- create specific preferences is often too complicated. related policies on trade (and vice versa) should be ignored, it is important to be clear about the primary objectives of policies and how to achieve them. The ques- Policy Complementarities: Taking a Holistic Approach tion for regulatory issues, which are, in essence, behind the The expansion of PTAs into new disciplines implies that pol- border and not unique or specific to traded goods, is of icy makers are confronted with multiple policy choices with three orders: different objectives and complex interactions. In essence, new PTAs capture a broader paradigm than traditional ones. 1. What are the issues of true international dimension that Evans et al. (2006) characterize one aspect of this expanded can only be addressed through international agreements? paradigm by pointing out that, unlike traditional trade 2. How should behind-the-border rules in PTAs be liberalization that focuses chiefly on goods trade, deep inte- designed to minimize trade-distorting effects? gration aims at broad factor mobility, including liberalization 3. How should policy makers prepare themselves to nego- of investment (capital movement), trade in services, and tiate or resist such rules? migration and labor standards. Perhaps nowhere are all the liberalization dimensions explored as deeply and compre- The first two questions roughly ask, what is the actual hensively as in PTAs. The complementarities created might link with trade issues? On the first question, as was seen explain the attraction of PTAs (Mattoo and Sauvé, ch. 12 in earlier, market failures and externalities of a supranational this volume). A good example is the trade facilitation nature can be addressed using PTAs; for instance, interna- agenda, which embraces such goals as the streamlining of tional transit is a trade facilitation concern that clearly has numerous border measures (all of which have specific reg- a regional dimension. Arguably, these issues can also be ulatory objectives in sectors such as health, immigration, addressed in separate, dedicated agreements such as bilat- and security controls); the inclusion of services sectors that eral cooperation treaties for competition law or stand- facilitate trade (transport, logistics, insurance, and so on); alone transit agreements (see Maur 2008; Dawar and Beyond Market Access 29 Table 1.1. Types and Scope of Regulatory Objectives in Selected Areas Covered by Trade Liberalization Agreements Area Regulatory objectives Services Universal provision (access, prices) Standards (professional, safety, interconnection of networks) Prudential regulations (banking) Cultural exceptions (media) Standards for goods Human, plant, and animal health Safety Network economies Intellectual property rights (IPRs) Innovation and creativity Trade facilitation Fiscal revenue Border security Prohibitions Immigration control Enforcement of domestic laws with respect to foreign goods Transit Government procurement Preference for national goods Protection of sensitive sectors (defense) Consumer law Consumer information and protection Labor and human rights Minimum standards Environment Public goods Minimum standards Movement of persons Immigration management Source: Authors’ compilation. Holmes, ch. 16 in this volume). International trade may be standards in such a way as to exclude foreign products), or an important source of market failure—for instance, with by raising standards abroad (e.g., by exporting new regula- respect to environmental protection (Anuradha, ch. 19 in tory requirements that increase the cost of production this volume).20 Because of the binding nature of interna- abroad and shift comparative advantage patterns). tional agreements and the international trade dimension of On the third question, that of negotiating or resisting externalities and market failures, there is a space for regula- such rules, a first step is to clarify the policy-making tory frameworks in the context of PTAs. Issues that were process involved in making future commitments—to previously dealt with under dedicated bilateral instruments, begin with, by involving the key ministries and administra- such as bilateral investment treaties, customs cooperation tions that oversee the nontrade objectives and by ensuring agreements, and cooperation on competition policy, are mutual understanding and coherence of objectives. Histor- now increasingly incorporated into PTAs. Although the ically, PTA negotiations have typically been led by finance, jury is still out as to the most effective instrument for foreign affairs, or trade ministries. These ministries would implementation, PTAs may be superior because of the seldom coordinate with other ministries or specialized possibility of issue links and institutional-savings costs, bodies of government, and sometimes their understanding given that one body serves several purposes (Devlin and of the issues at stake is limited. Another step is to minimize Estevadeordal 2006). the costs of meeting the regulatory objectives, with reason- On the second question, that of reducing distortionary able statistical confidence. This step is often not done; effects, the approach should be to minimize the conflicts instead, solutions that meet the objective of regulation irre- between regulatory and trade liberalization objectives. For spective of the costs caused by trade distortions are chosen. instance, harmonization to a low standards level would The notion of risk is often not embedded in the regulatory maximize trade liberalization objectives but clearly would design because agencies have no direct interest in consider- not meet regulatory objectives. (Low standards may not ing the costs borne by other parts of the economy in meet- meet a country’s preferred level of enforcement.) An obvi- ing their objectives and naturally opt for regulatory solu- ous approach is to ensure that the clarity of regulatory tions that minimize risk rather than costs. An example is objectives is such that protectionist intents cannot hide border controls, where 100 percent checking of consign- themselves behind the disguise of rules. Hidden protec- ments is not rare, to the exclusion of economically efficient tionism operates by raising the costs of (foreign) rivals, by methods of targeting only risky shipments. The marginal imposing discriminatory rules at home (e.g., by designing costs of meeting regulatory objectives (in particular, the 30 Jean-Pierre Chauffour and Jean-Christophe Maur costs for trade) should be balanced against the marginal integration requires flexibility and customization in the expected benefits. (Maur and Shepherd, ch. 10 in this vol- way provisions are drafted: ume, discuss this issue in the context of standards.) An important aspect that may justify resisting the • Provisions in the agreement compose only one of the incorporation of regulatory objectives into PTAs is the building blocks of broader cooperation, which may importance of national endowments and preferences, include institutional arrangements, whether hard (e.g., which will differ among countries. Bhagwati (2008) sug- a common institution) or soft (e.g., expert consultations), gests that the rationales for different labor standards apply as well as technical assistance and capacity building. to countries that are at different stages of development and • Gradual implementation is advisable, as reform may have different economic contexts. Although harmoniza- not be carried out overnight and will present unique tion eliminates the costs associated with duplication and challenges in a given country context. complexity, it can undermine national objectives by • Flexibility is necessary for joint projects such as harmo- departing too much from these aims, and in the case of nization work and creation of common regional tools. upward harmonization to stricter regulatory levels, it can • Areas of cooperation will need to be reexamined as reg- raise the costs faced by some countries—often, the poorest ulatory needs change over time. ones. The exportation of (higher) regulatory standards • Deep integration areas will have to be revisited as under- and practices has been flagged in the recent literature as standing of how best to address regulatory dimensions integral to the strategy of the two biggest proponents of evolves. PTAs, the United States and the EU (Maur 2005; Bhagwati • Implementation of policy has to be monitored. 2008; Horn, Mavroidis, and Sapir 2009). A closer examina- • Recourse to venues other than dispute settlement is tion of PTA disciplines suggests that template approaches needed. to PTA liberalization are indeed promoted by both hubs. This is worth highlighting because the EU and U.S. Reliance on a rigid interpretation of an international approaches generally differ quite substantially. In this agreement and on enforcement through dispute settlement volume, the influence of the EU and U.S. hubs is noted, for is insufficient for the deep integration dimensions of liber- instance, for contingent protection rules (Prusa, ch. 9), the alization (Hoekman, ch. 4 in this volume). Deep integra- use of mutual recognition versus equivalence for standards tion requires a combination of hard and soft law and (Maur and Shepherd, ch. 10; Stoler, ch. 11), differing areas enhanced capacity. The reasons for this are (a) practicali- of focus regarding IPR protection (Fink, ch. 18), and the ties, (b) uncertainty, and (c) political economy. diffusion of procurement and investment rules (Miroudot, The first problem is practical and procedural: the ch. 14; Dawar and Evenett, ch. 17). PTAs—and bilateral appropriate implementation of behind-the-border policies agreements in general—offer a means of dealing with requires a set of actions, ranging from enactment of legal heterogeneity of preferences through the principle of provisions to establishment of adequate structures, includ- equivalence, which often takes the form of mutual recog- ing appropriate governance and rules, material and per- nition, as was discussed earlier. sonnel for operationalizing the policies, and reporting mechanisms. All this is highly complex and is difficult to specify in full in an international agreement, and it might Flexibility and Customized Problem Solving as well be left to domestic authorities to work out. The flexibility offered by PTAs in terms of tailoring the The second problem arises from the fact that there is level of ambition of given disciplines to particular trading uncertainty about the most appropriate design for regula- partners is one finding from the early work on the new tory policies and their implementation, since these aspects wave of PTAs (Heydon 2003). Although special and differ- probably depends on country circumstances. A good ential treatment and policy space are important features of example is the variety of competition provision rules and modern trade negotiations involving developing countries, setups in PTAs (Dawar and Holmes, ch. 16 in this volume). here we take the logic farther, arguing that it is not only the Configurations of common competition regimes and pro- nature of partner countries and their capacity that dictate visions are greatly influenced by national regimes and by the need for such flexibility but also the regulatory issues partners’ size and level of development. Another source of themselves. uncertainty is time, because technological changes, for Many of the new policies captured in the latest genera- instance, may fundamentally affect the nature of the goods tion of PTAs do not lend themselves to reduction to stand- and services exchanged and the way markets, market alone legal language in a trade agreement. Rather, deep operators, and government bodies conduct their work (in, Beyond Market Access 31 for example, telecommunication services, standards poli- economic size—has implications for the choice of degree cies, and border controls). of flexibility and informality. In this sense, a flexible Finally, the political economy of PTAs that rely on soft- approach can be seen as a building block for more formal law mechanisms might be more supportive of actual liber- arrangements down the line. Porges (ch. 22 in this volume) alization than is the case with a top-down approach in notes that dispute settlement tends to become more legalis- which rules are rigidly imposed by a powerful trade part- tic when the relationship is symmetric, whereas when it is ner. Ownership can be enhanced through cooperation and asymmetric, political and diplomatic approaches are pre- stakeholder involvement, which would be part of a process ferred. Although the softer structure may be seen as a way of identifying appropriate regulatory solutions for liberal- of affording flexibility to smaller partners and as reflecting ization (Hoekman, ch. 4 in this volume). This is related to the unequal balance of power, it leaves the solving of dis- respect for country preferences while reducing differences putes to less transparent conduits in which power may be with a view toward mutual recognition of regulations. more easily wielded. Thus, flexibility seems to be an important dimension to be considered in deep integration. This recognition gives Implementation rise to a recommendation for “living agreements� that incorporate a work program and for associated institutions The inadequacy of a solely legalistic approach to commit- that establish a pathway allowing deeper integration over ments implies that negotiations will not settle every issue time and the resolution of standards issues. Hoekman and that, in addition to the ex ante work of negotiators, an (ch. 4 in this volume) similarly argues in favor of a con- important ex post agenda awaits countries signing PTAs. It structive rather than adversarial process in North-South can be argued that the implementation agenda is on paper PTAs. A problem with purely adversarial procedures is that more important in the case of PTAs than in the WTO. they tend to leave unaddressed public good issues, whereas There are essentially two reasons for this. The first is that supranational institutions have an incentive to pursue such PTAs commit parties to effective liberalization, whereas the matters. PTAs then become instruments of cooperation, in WTO often merely commits parties to bind only maximum addition to integration, and can provide a problem-solving levels of protection and provides numerous exemptions forum for countries that are undertaking reform and and exceptions for developing countries.21 The second rea- upgrading their regulatory capacities. son is that deep PTAs cover newer and more ambitious Another aspect of the flexible approach toward deep ground than does the WTO. integration is the implication for approaches to dispute In some areas, the track record of PTAs in implementa- settlement. On the one hand, negotiating and implement- tion has been relatively poor. Reviews of services (Mattoo ing deep integration dimensions is costly, creating a motive and Sauvé, ch. 12 in this volume), and of competition pro- for ensuring a return on this investment by the establish- visions (Dawar and Holmes, ch. 16 in this volume) suggest ment of strong dispute settlement mechanisms (Porges, unimpressive results, while in areas that have seen more ch. 22 in this volume). This may explain the observed trend pressure toward implementation, such as IPRs, the evi- toward more legalistic forms of dispute resolution, replac- dence shows much more substantial changes (Biadgleng ing the more diplomatic approaches of older agreements. and Maur forthcoming). The different treatment for IPRs In this regard, WTO-like ad hoc panels (which, among is the direct result of the greater prominence of implemen- other things, permit recourse to the expertise of specialists) tation and enforcement in recent PTAs involving the are often preferred. On the other hand, dispute settlement United States and Europe. is only one of the several mechanisms in PTAs contribut- Dealing with deep integration issues requires prepared- ing to enforcement. Panel-type disputes only occur in ness that goes well beyond the negotiation stage, and most exceptional cases, and smaller disagreements are resolved likely it entails the dedication of some permanent resources through other channels established in the PTAs. The latter to managing the agreement. The resource and policy impli- approach is what can be described as soft law. In this cations of deep integration agreements are likely to be, in respect, common institutions play an important role, part, unforeseen, as Hoekman (ch. 4 in this volume) sug- allowing technical and ad hoc approaches to solving what gests, and the problems may be compounded by countries’ are often complex issues and facilitating the involvement of lack of preparedness. Examples of possible unintended third parties, such as the private sector. consequences of commitments include incompatibilities As has already been indicated, the extent to which a PTA between PTA commitments and the existing (domestic is symmetrical or not—that is, the degree to which the and international) legal environment;22 political-economy partners are equal or similar in level of development or constraints, where commitments are not accepted by 32 Jean-Pierre Chauffour and Jean-Christophe Maur domestic constituencies, including legislators who may and which of the hard-law–soft-law approaches, or combi- have to vote on new laws; limitations on regulatory free- nations thereof, contribute most to liberalization. The dom; inefficiency in implementing the new regulatory inference from the above discussion is that although many environment; and economic implications that are less examples and many distinctive approaches to integration beneficial than initially thought. now exist, there is still relatively little basis for recommen- Beyond the principle of liberalization agreed in the PTA, dations on how to appropriately implement deep integra- a work program of implementation must be devised in tion provisions in PTAs, beyond a core set of principles. order to make liberalization a reality. The implementation For developing countries, one attraction of PTAs with of the provisions of an agreement may require different lev- more developed partners, at least in theory, is the prospect els of intervention. First, institutional changes may be nec- of access to capacity building and transfer of resources. Yet essary because the implementation of new areas of policy whether and how development assistance contributes to may call for the establishment of new regulatory agencies or implementation is generally difficult to assess, and is even the reorganization of existing institutions. Second, new laws more so in the context of PTAs, given the naturally non- for regulatory reform will be required to reflect PTA com- transparent nature of institutions. mitments. The need for such legislation will vary, depend- An important issue that appears prominently in the ing on the legal standing of international commitments in discussion on competition policy, government procure- domestic law: some commitments require translation into ment, and standards is to what extent the process of imple- domestic law, while others have direct effect, and some law mentation should be run from the center. For instance, systems rely more on a case law approach. The third dimen- competition regimes in PTA contexts range from regional sion of implementation consists of the administrative, pro- institutions to national institutions that cooperate on cedural, and operational changes required to comply with international issues. Several considerations affect whether the new regulatory framework. This can include the man- the implementation process will be left to national gov- agement of the agreement itself, including transparency and ernment or devolved to a transnational body (Dawar and monitoring requirements. Finally, enforcement of the newly Evenett, ch. 17 in this volume). adopted regulations needs to be considered; the requisite The first, obvious point is that a prerequisite for com- staff and resources will have to be allocated. Attention mon institutions or rules is the willingness of trade part- should be given to the quality of enforcement and to meas- ners to abandon some of their sovereignty. When this does ures for assessing the effectiveness of the application of the not happen (often, in the context of North-South agree- laws (Biadgleng and Maur forthcoming). ments), only “lighter� options remain, and only core prin- The text of the PTA is only one initial element of the ciples guaranteeing good policy and governance can be process of integration. Implementation issues must also be agreed. This is the solution chosen for procurement provi- carefully examined to determine whether liberalization is sions. A related concern is the choice between maintaining effective. Monitoring and accountability matter. This is a national preferences and adopting international stan- more complex process than verifying that trade barriers are dards. In this area, the answer to the question of harmo- effectively dismantled, and the necessary information is nization versus recognition depends on whether the often not readily available. In general, implementation in benefits of harmonization outweigh the costs of loss of PTAs is not a very transparent process, and sustained atten- preferences. National ability to issue regulations is also a tion to implementation is rare. This is an additional reason parameter to be taken into account. In particular, one for the constructive cooperative approach recommended motivation for preserving diversity in regulation and by Hoekman (ch. 4 in this volume), given the complemen- implementation is to derive the benefits from competition tarity between information generation and exchange and between different regulatory solutions and procedures. the process for discovery of the best trade-facilitating regu- Messerlin and Zarrouk (2000) advocate less centralization latory solution. in the context of conformity assessment in order to pro- In spite of some evidence that monitoring is taking mote competition between different conformity bodies place, information about implementation remains scarce, and their services (e.g., testing, surveillance, inspection, and most of the analysis of PTAs rests on the evidence pro- certification, etc.). vided by the agreements themselves and on some measures A second point is the degree of coordination that is of outcomes such as trade flows.23 Although such analysis required by the integration policy. For some transnational provides useful insights, the policy recommendations that public goods, common institutions and a top-down can be drawn from it are limited. Little is known about approach may be preferable in order to solve the coordina- which liberalization strategies work best as agents of change tion problems that lead to inadequate supply of the goods. Beyond Market Access 33 Beyond public goods per se, common institutions appear already been clearly articulated, and a call for multilateral- particularly necessary when frequent interactions, decision izing regionalism has been voiced in the WTO (Baldwin making, adjudication, and exchange of information are and Low 2009). The concern that PTAs “compete� with needed, as in customs unions. (See Andriamananjara, ch. 5 multilateral negotiations for the attention of negotiators in this volume.) A related dimension is the desire to and represent an untidy way of proceeding to liberalization achieve certain scale or efficiency effects. Competition pol- remains legitimate. icy illustrates the possibility of opting for a common, cen- Yet, an important emerging lesson is that the economic tralized competition regime—as in the cases of the EU, the paradigm of shallow PTAs does not necessarily apply to Caribbean Community (CARICOM), COMESA, and the deep and comprehensive PTAs. “Old� concepts such as Andean Pact—when parties to a PTA do not differ much mercantilist reciprocal liberalization, trade creation and in their preferences regarding the type of competition diversion, or a textual approach to negotiating PTAs may enforcement. still underpin the reasoning of many policy makers but are For developing countries in particular, a top-down often archaic or incomplete for deep integration liberaliza- approach may prove attractive. A first incentive might be to tion. Failure to understand the new paradigm of preferen- improve governance. By decentralizing decision making tial integration may, in turn, explain why most PTAs either within a PTA, member countries may be better able to have not fully exploited the liberalization opportunities of shield policies from the risk of reversal and guarantee their behind-the-border measures or have not prioritized the independence. This strategy may be helpful, for example, opportunities closest to the parties’ interests—although it for competition policy, where it might be difficult in some might be naïve to attribute lack of progress solely to a lack countries to escape the influence of particularly large firms of understanding. and to discipline them. More generally, as discussed earlier, 2. Deep integration PTAs are potentially powerful tools for countries with weak judicial systems might find it advanta- pushing wide-ranging government-owned reforms. Beyond geous to rely on supranational judicial institutions as a way market access, deep integration PTAs create opportunities of anchoring or locking in policies. Poor administrative to complement trade liberalization with other behind-the- resources at the country level could also motivate the pool- border reforms. In addition, they offer unique instruments ing of resources among a group of countries—something for promoting bilateral or plurilateral cooperation and small island countries have done. resource transfers, transparency mechanisms, mutual Finally, a third consideration is efficiency motives, equivalence, informal mechanisms for dispute resolution, which may lead some countries to seek to replace their in-depth and expert dialogue, and deeper liberalization existing regulations with superior systems “imported� among the willing parties. These are not approaches that from partner countries and, through the institutional can be easily, if at all, replicated in the large and formal set- mechanisms of the PTA, to obtain access to the superior ting of multilateral institutions. expertise and systems of the partner country. Yet PTAs are worthwhile only if governments are them- selves committed to reform and liberalization. PTAs offer a variety of mechanisms by which the process of reform will Conclusions become more effectively and irremediably set in motion, Modern PTAs are evolving rapidly. They are increasingly but a prerequisite is that meaningful commitments be deep, and they affect all countries and regions of the world, agreed to in the first place. Deep integration PTAs should including the most remote quarters. As academics and pol- therefore strive to provide open access to regulatory rules icy makers try to deal with this new generation of PTAs, and disciplines in order to ensure equality of treatment of four tentative conclusions can be suggested regarding this all members and nonmembers and so minimize the occur- changing landscape. rence of “regulatory preferences.� This means—beyond 1. Deep integration introduces a change of paradigm. To national treatment—liberal rules of origin, transparency, be sure, PTAs still have to do with preferences, discrimina- and the availability of due process. Good regulatory practice tion, and exclusion. They may lead to suboptimal out- should lead de jure preferential liberalization to become, in comes and could complicate and even undermine progress effect, MFN liberalization. The question of discrimination toward a more open, rules-based, and nondiscriminatory in deep PTAs is likely to remain convoluted. Discriminatory multilateral trading system. More worrying than discrimi- regulations could take many forms, whether codified in nation, perhaps, is the additional inherent complexity that rules or not. De facto preferences can arise from rules that is created by the overlapping and conflicting regulatory look nonpreferential on paper, or from preferential enforce- regimes promoted by myriads of PTAs. This concern has ment. Furthermore, discrimination may, paradoxically, 34 Jean-Pierre Chauffour and Jean-Christophe Maur be the only form of acceptable liberalization, as parties norms, and to trigger competitive liberalization effects in mutually agree to accept each other’s rules. partner countries. A related logic can be observed in the EU, 3. Deep integration should be pursued strategically and which, as Maur (2005) notes, is attempting to leverage its selectively. Another answer to complexity that is, in our PTAs to shape South-South agreements in its recent wave of view, not sufficiently considered by developing countries, is agreements with the Mediterranean countries, the Balkans, selectivity. (This is also suggested by Hoekman and Sekkat and the African, Caribbean, and Pacific (ACP) countries. 2010.) Liberalization is a complex matter, not only from a capacity standpoint but also from a political one. The Notes political economy of deep integration involves many (often The authors thank Jaime de Melo, Ndiame Diop, Bernard Hoekman, and opposing) interests and a large set of potential stakehold- Richard Newfarmer for helpful comments and suggestions. ers. Overloading the negotiating agenda (which will later 1. In a WTO working paper, Fiorentino, Verdeja, and Toqueboeuf become the implementing agenda) diverts the focus from (2006) note that country negotiating resources are being shifted away from multilateral negotiations toward negotiations on PTAs. what may be achievable and from the areas where gains 2. The General Agreement on Tariffs and Trade (GATT) architecture may be the most important. Agreements bloated by too was historically built, essentially, around the notion of negative integra- many issues may lose significance and fail to achieve much. tion and the prohibition of the most detrimental policies through elimi- Picking meaningful issues with the right partner, along nation of border trade barriers and the espousal of nondiscrimination principles (Hoekman and Kostecki 2009). Recently, however, new forms with having adequate technical assistance and a coopera- of economic integration have been included in the multilateral trade tive approach, may bring about substantial progress on lib- framework, starting with the Kennedy Round and the General Agreement eralization and serve as a positive signal or trigger for more on Trade in Services (GATS) in 1979 and continuing with the WTO (and the incorporation of TRIPS, in particular). The WTO incorporates much challenging areas. Market access should not be the only more significant elements of positive integration than previously. PTAs item on the agenda of negotiators, especially those of follow the same trend and go even further in many instances. developing countries, since deep integration really entails 3. Torrent (2007) provides the following example: “The European Community directives on the liberalization of movements of capital seem thinking about a domestic reform strategy. Prioritization to be a clear example of ‘negative’ integration, but they were enacted of core objectives and sequencing should be central con- according to what, in Tinbergen’s terms, would be a clear example of ‘pos- cerns of negotiators. Sound regulatory practice should itive integration’ (and they would be defended in this way by many in the underpin liberalization to minimize the prevalence of reg- European Commission). In political terms, NAFTA’s [North American Free Trade Agreement’s] Chapter XI on investments would be looked at ulatory preferences and ensure the overall consistency of by many around the world as a typical example of ‘negative integration’ liberalization and regulatory objectives. that sharply reduces the capacity of Governments to intervene in the 4. There is no one-size-fits-all model of deep integration. economy. It is also an example of ‘positive integration’ that creates com- mon rules that go beyond the liberalization of access (for example on As policy makers more and more integrate these new protection of investments).� dimensions, we can expect that they will use PTAs more 4. According to Ethier (1998) and, subsequently, Levy (2009), attract- intensively to further liberalization objectives—it may be ing foreign direct investment (FDI) is one of the main incentives for entering into PTAs. hoped, in a way complementary to multilateral efforts. 5. Technology allows services to be traded under several modal Liberalization in any sector is not a simple matter. It forms; for instance, medical diagnostics can now be provided at a dis- escapes easy characterization, as well as one-size-fits-all tance, thanks to electronic imagery. types of answers. This complexity means that there are few 6. Note that well-being can be understood in broad terms as includ- ing not only economic welfare but also value-related preferences. universal rules to follow; rather, carefully designed and spe- 7. In economics, nonrivalry means that consumption of the good by cific solutions are needed. Deep integration is essentially a one individual does not reduce the availability of the good for consump- sui generis process, as is illustrated by Winters (2010) in the tion by others. Nonexcludability means that no one can be effectively excluded from using the good. case of the EU. Yet complexity means that some core prin- 8. According to Levy (2009), several mechanisms could be in play: ciples should be followed in order to promote, to the extent (a) once a bureaucracy commits to good governance in a trade agreement, possible, market-based solutions. it may make little sense to maintain a different attitude for the domestic market; (b) good governance with respect to international flows could The dynamics of North-South, South-South, and North- serve as a signal, spurring reform on the domestic front; and (c) if the rule North PTAs differ considerably. Asymmetric agreements of law is not followed within the country, there might be costly and make cooperation less easy and may provide less scope for adverse reputational spillovers that could affect the decisions of foreign transnational public goods and mutual recognition but investors and traders. 9. The decision to focus on coal and steel came about not only offer more prospects for lock-in and greater access to because of the economic importance of the two sectors but also because imported regulatory regimes, when needed. Market access these materials were considered the main inputs for making weapons. considerations will be paramount for the small partner, “The pooling of coal and steel production should immediately provide for the setting up of common foundations for economic development as whereas the larger partner will seek, beyond market a first step in the federation of Europe, and will change the destinies of access, to diffuse its regulatory norms, including values those regions which have long been devoted to the manufacture of Beyond Market Access 35 munitions of war, of which they have been the most constant victims� Labor and Environmental Issues.� Journal of Economic Perspectives (Robert Schuman, Declaration of 9 May 1950). 15 (3): 69–88. 10. “The EU can make an important contribution by working around Baldwin, Richard E. 1994. “Towards an Integrated Europe.� Centre the conflict issues, promoting similar reforms on both sides of the bound- for Economic Policy Research, London. http://heiwww.unige.ch/ ary lines, to foster convergence between political, economic and legal sys- ~baldwin/. tems, enabling greater social inclusion and contributing to confidence ———. 2008. “Sequencing and Depth of Regional Economic Integration: building� (European Commission 2007). Lessons for the Americas from Europe.� World Economy 31 (1): 5–30. 11. World Bank (2005), however, notes that some wars began partly Baldwin Richard, Simon Evenett, and Patrick Low. 2009. “Beyond Tariffs: as trade disputes; examples are the U.S. Civil War (1861–65) and the Multilateralizing Non-Tariff RTA Commitments.� In Multilateralizing Soccer War of 1969 between El Salvador and Honduras. Regionalism: Challenges for the Global Trading System, ed. Richard 12. The Electricity Regulatory Forum, or Florence Forum, was set up Baldwin and Patrick Low, ch. 3. Cambridge, U.K.: Cambridge to discuss the creation of a true internal electricity market in the EU. Since University Press. 1998, the forum has met once or twice a year, formerly in Florence and Baldwin, Richard, and Patrick Low. 2009. Multilateralizing Regionalism: now in Rome. Further information on the Florence Forum is available on Challenges for the Global Trading System. Cambridge, U.K.: Cambridge the Web page of the European Commission’s Directorate General for University Press. Energy; see http://ec.europa.eu/energy/gas_electricity/forum_electricity_ Bergsten, Fred. 1996. “Globalizing Free Trade.� Foreign Affairs 75 (3): florence_en.htm. A similar body, the Madrid Forum, has been established 105–20. for natural gas markets. Bhagwati, Jagdish. 2008. Termites in the Trading System: How Preferential 13. Thus, regulation does not necessarily generate positive terms-of- Agreements Undermine Free Trade. Oxford, U.K.: Oxford University trade effects for the home country (e.g., customs duties revenues, in the Press. case of tariff protection). Biadgleng, Ermias Tekeste, and Jean-Christophe Maur. Forthcoming. 14. In most cases, the situation is not that clear-cut. Regulatory “The Influence of Preferential Trade Agreements on Implementation burdens often create additional jobs for administrations and provide of Intellectual Property Rights in Developing countries: A First Look.� opportunities for graft. Issue Paper (forthcoming), ICTSD Programme on Innovation, Tech- 15. In normal circumstances, there should be no prior rent capture by nology, and Intellectual Property, International Centre for Trade and domestic interests, since the objective of regulatory controls is not to raise Sustainable Development, Geneva, Switzerland. revenue or afford protection. Carrère, Céline, Jaime de Melo, and Bormolaa Tumurchudur. 2010. “Dis- 16. The distinction is often blurred, and when identification methods entangling Market Access Effects of Preferential Trading Arrange- are imperfect, origin is often used as a very imperfect proxy for other ments with an Application for ASEAN Members under an ASEAN-EU characteristics (as is country of citizenship for migrants). FTA.� World Economy 33 (1): 42–59. 17. This claim was tested empirically by Czubala, Shepherd, and Czubala, Witold, Ben Shepherd, and John S. Wilson. 2009. “Help or Hin- Wilson (2009) in the context of adoption of international standards. drance? The Impact of Harmonized Standards on African Exports.� 18. Baldwin, Evenett, and Low (2009) cite the example of ROOs in Journal of African Economies 18 (5): 711–44. East Asian PTAs as particularly liberal, since they only require incorpora- Devlin, Robert, and Antoni Estevadeordal. 2006. “Trade and Coopera- tion under the laws of the trade partner and do not impose any other tion: A Regional Public Goods Approach.� In Multilateral and nationality requirements on the entity, regarding, for example, the nation- Regional Frameworks for Globalization: WTO and Free Trade ality of the people controlling the firm. Agreements, ed. Wonhyuk Lim and Ramon Torrent. Seoul: Korea 19. Although separability never really existed in practice, the tradi- Development Institute. tional approach was to consider trade policy in relative isolation from Estevadeordal, Antoni, Kati Suominen, and Robert Teh. 2009. Regional other policies, including other economic policies. Rules in the Global Trading System. Cambridge, U.K.: Cambridge 20. Environmental externalities could also stem from purely domes- University Press. tic economic activities. Ethier, Wilfred J. 1998. “The New Regionalism.� Economic Journal 108 21. In terms of liberalization, PTAs will at least lock in the status quo if (449): 1149–61. disciplines in an area are included. This is furthered by the use of negative- European Commission. 2007. A Strong Neighbourhood Policy. Communi- list approaches, as in some services provisions. Thus, the value of commit- cation COM(2007)774 final. Brussels: European Commission. ments in PTAs is higher than in the WTO. In this sense PTAs are more Evans, David, Peter Holmes, Leonardo Iacovone, and Sherman Robinson. rigid. This may be a reason developed countries have intensively used PTAs 2006. “Deep Integration and New Regionalism.� In Assessing Regional with smaller developing countries as a way to lock in liberalization in a way Trade Agreements with Developing Countries: Shallow and Deep Inte- that was not necessarily happening in the WTO. But with stricter commit- gration, Trade, Productivity, and Economic Performance, ch. 2. Report ments looming, resistance to liberalization may also be stronger. for DFID Project Number 04 5881, University of Sussex, U.K. 22. Biadgleng and Maur (2010) cite the example of commitments Evenett, Simon, and Michael Meier. 2008. “An Interim Assessment of made by the Arab Republic of Egypt with the EU to ratify, in contradic- the US Trade Policy of ‘Competitive Liberalization.’� World Economy tion to its own law, the Convention for the Protection of New Varieties of 31 (1): 31–66. Plants established by the International Union for the Protection of New Fink, Carsten, and Martin Molinuevo. 2007. “East Asian Free Trade Agree- Varieties of Plants (UPoV). ments in Services: Roaring Tigers or Timid Pandas?� World Bank, 23. Examples of different approaches to monitoring implementation Washington, D.C. are seen in the United States, which “certifies� implementation of FTAs Fiorentino, Roberto V., Luis Verdeja, and Christelle Toqueboeuf. 2006. before congressional approval; the EU, which reports regularly in the case “The Changing Landscape of Regional Trade Agreements: 2006 of accession and in more ad hoc fashion with other partners on implemen- Update.� WTO Discussion Paper 12, World Trade Organization, tation; APEC implementation action plans; and South-South agreements Geneva. such as COMESA, for which the secretariat monitors country progress. Haftel, Yoram Z. 2007. “Designing for Peace: Regional Integration Arrangements, Institutional Variation, and Militarized Interstate Disputes.� International Organization 61 (1): 217–37. References Harrison, Glenn W., Thomas Rutherford, and David Tarr. 2002. “Trade Bagwell, Kyle, and Robert Staiger. 2001. “The WTO as a Mechanism for Policy Options for Chile: The Importance of Market Access.� World Securing Market Access Property Rights: Implications for Global Bank Economic Review 16 (1): 49–79. 36 Jean-Pierre Chauffour and Jean-Christophe Maur Heydon, Ken. 2003. “Key Findings. Regionalism: A Complement, Not a Martin, Philippe, Thierry Mayer, and Mathias Thoenig. 2010. “The Geog- Substitute.� In Regionalism and the Multilateral Trading System. Paris: raphy of Conflicts and Free Trade Agreements.� CEPR Discussion OECD Publishing. Paper 7740, Centre for Economic and Policy Research, London. Hoekman, Bernard, Aaditya Mattoo, and André Sapir. 2007. “The Political Maur, Jean-Christophe. 2005. “Exporting Europe’s Trade Policy.� World Economy of Services Trade Liberalization: A Case for International Economy 28 (11): 1565–90. Regulatory Cooperation?� CEPR Discussion Paper 6457, Centre for ———. 2008. “Regionalism and Trade Facilitation: A Primer.� Journal of Economic and Policy Research, London. World Trade 42 (6): 979–1012. Hoekman, Bernard, and Michel Kostecki. 2009. The Political Economy of the Messerlin, Patrick, and Jamel Zarrouk. 2000. “Trade Facilitation: Technical World Trading System, 3rd ed. Oxford, U.K.: Oxford University Press. Regulations and Customs Procedures.� World Economy 23 (4): 577–93. Hoekman, Bernard, and Khalid Sekkat. 2010. “Arab Economic Integra- OECD (Organisation for Economic Co-operation and Development). tion: The Missing Links.� CEPR Discussion Paper 7807, Centre for 2003. Regionalism and the Multilateral Trading System. Paris: OECD Economic and Policy Research, London. Publishing. Horn, Henrik, Petros C. Mavroidis, and André Sapir. 2010. “Beyond the Ortino, Federico. 2004. Basic Legal Instruments for the Liberalisation of WTO? An Anatomy of EU and US Preferential Trade Agreements.� Trade: A Comparative Analysis of EC and WTO Law. Oxford, U.K.: The World Economy 33(11), 1565–88. Hart. Hornbeck, J. F. 2003. The U.S.–Central America Free Trade Agreement Pelkmans, Jacques. 1984. Market Integration in the European Community. (CAFTA): Challenges for Sub-Regional Integration. Report for the U.S. Studies in Industrial Organization, vol. 5. The Hague: Martinus Nijhoff. Congress, RL31870. Washington, DC: Government Printing Office. Schiff, Maurice, and L. Alan Winters. 1998. “Regional Integration as Krishna, Pravin. 1998. “Regionalism and Multilateralism: A Political Diplomacy.� World Bank Economic Review 12: 271–95. Economy Approach.� Quarterly Journal of Economics 113 (1): 227–50. ———. 2002. “Regional Cooperation, and the Role of International Krugman, Paul. 1993. “Regionalism versus Multilateralism: Analytic Organizations and Regional Integration.� Policy Research Working Notes.� In New Dimensions in Regional Integration, ed. Jaime de Melo Paper 2872, World Bank, Washington. DC. and Arvind Panagariya. Cambridge, U.K.: Cambridge University Press. ———. 2004. Regional Integration and Development. Oxford, U.K.: Lee, Jong-Wha, and Ju Hyun Pyun. 2009. “Does Trade Integration Con- Oxford University Press. tribute to Peace?� Asian Development Bank Working Paper on Schott, Jeffrey J. 2003. “Assessing US FTA Policy.� In Free Trade Agreements: Regional Integration 24, Asian Development Bank, Manila. US Strategies and Priorities, ed. Jeffrey Schott, ch. 13. Washington, DC: Lesser, Caroline. 2007. “Do Bilateral and Regional Approaches for Reduc- Institute for International Economics. ing Technical Barriers to Trade Converge towards the Multilateral Tinbergen, Jan. 1954. International Economic Integration. Amsterdam: Trading System?� OECD Trade Policy Working Paper 58, Organisation Elsevier. for Economic Co-operation and Development, Paris. Torrent, Ramon. 2007. “The Legal Toolbox for Regional Integration: A Levy, Philip I. 2009. “The United States–Peru Free Trade Agreement: What Legal Analysis from an Interdisciplinary Perspective.� Prepared for the Did You Expect?� American Enterprise Institute Working Paper Series Euro-Latin Study Network on Integration and Trade (ELSNIT) Con- on Development Policy 1, American Enterprise Institute, Washington, ference, Barcelona, October 26–27. DC. Winters, L. Alan. 1997. “What Can European Experience Teach Develop- Limão, Nuno. 2007. “Are Preferential Trade Agreements with Non-trade ing Countries About Integration?� World Economy 20 (7): 889–911. Objectives a Stumbling Block for Multilateral Liberalization?� Review ———. 2010. “Europe Is Sui Generis—But It Provides Lessons for of Economic Studies 74 (3): 821–55. Developing Countries.� Prepared for the Annual Conference of the Mansfield, Edward D., and Jon C. Pevehouse. 2000. “Trade Blocs, Trade Global Development Network, Prague, January 16–18. Flows, and International Conflict.� International Organization 54 (4): World Bank. 2005. Global Economic Prospects: Trade, Regionalism, and 775–808. Development. Washington, DC: World Bank. 2 LANDSCAPE Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Preferential trade agreements (PTAs) are an enduring developments. Unless otherwise stated, the data presented feature of the contemporary multilateral trading system. take account of all bilateral, regional, and plurilateral trade Sixty years after the founding of the General Agreement on agreements of a preferential reciprocal nature that have Tariffs and Trade (GATT), the global trading landscape has been notified to the GATT/WTO (see box 2.1 for defini- changed beyond recognition. Membership in the World tions). The focus is on free trade agreements (FTAs), cus- Trade Organization (WTO) continues to grow steadily, but toms unions (CUs), partial-scope agreements in the area of meanwhile, participation in PTAs is expanding at an trade in goods, and economic integration agreements unprecedented rate. Slow progress in the Doha Round (EIAs) in the area of trade in services.1 trade negotiations has no doubt contributed to this growth trend. As of February 2010, 266 PTAs were in force, and Trends among PTAs this figure did not include a significant number of agree- ments (mostly among developing countries) that had not Recent developments and trends are shaping a PTA land- yet been notified to the WTO, or the many PTAs still in the scape that presents a number of significant features. pipeline. As a consequence, a growing proportion of world The first is ubiquity. PTA participation is becoming trade is, or has the potential to be, conducted under prefer- more diverse, spreading to most geographic regions, but ential terms rather than under the nondiscriminatory especially to East Asia and the Pacific. North-South prefer- regime of the WTO. In addition, trade conducted under ential partnerships are on the rise, with a number of devel- preferential rules is increasingly subject to a plethora of oping countries electing to forgo unilateral programs— crisscrossing regulatory regimes that modify and compli- such as the generalized system of preferences (GSP) or cate the WTO’s multilateral regulatory regime. trading arrangements previously conducted under a WTO All but one of the WTO’s 153 members is a party to at waiver—in favor of reciprocal agreements. These develop- least one PTA (Mongolia is the exception), and most ments are testing the negotiating capacity of developing countries are parties to several. Today’s PTAs are charac- countries, particularly where they have to deal with issues terized by diverse geographic and physical configurations for which no multilateral rules currently exist or where the and differing regulatory content. Although PTAs offer the negotiating framework differs from that of the WTO. Such potential for increased trade and investment among their is the case, for instance, in PTAs covering trade in services. members through enhanced market access, they do so at The second is consolidation. Bilateral relationships are the cost of introducing multiple layers of complexity into being replaced by plurilateral PTAs among the same part- the global trading landscape, rendering trade relations less ners, and agreements between regional blocs are on the transparent and more unpredictable. increase. In Asia, countries long resistant to preferential The aims of this chapter are (a) to provide a snapshot trade liberalization are catching up, and plurilateral PTAs (as of February 2010) of recent developments and trends coexist alongside bilateral PTAs among the same sets of with respect to the number and scope of PTAs, (b) to ana- partners. Notwithstanding some consolidation, the grow- lyze the types of PTA initiatives that are currently under ing number of overlapping plurilateral PTAs—particularly negotiation in each geographic region, and (c) to assess the in Africa and Central Asia but also, increasingly, in the possible impact of a selection of plurilateral PTAs on trade Americas and Asia—points to a further fragmentation of 37 38 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Box 2.1. Typology of Preferential Trade Agreements Care should be taken when categorizing preferential trade agreements (PTAs), given the differences in terminology used by institutions and researchers. In this study, we use the generic term PTA to refer to all reciprocal preferential agreements. The World Trade Organization (WTO), however, uses the term regional trade agreements (RTA) for all reciprocal preferential agreements and reserves PTA for nonreciprocal preferential agreements such as the generalized system of preferences (GSP) and the African Growth and Opportunity Act (AGOA). The terminology employed in this chapter is explained below. Free trade agreement (FTA). An agreement between two or more parties in which tariffs and other trade barriers are eliminated on most or all trade. Each party maintains its own tariff structure relative to third parties. Examples are the North American Free Trade Agreement (NAFTA) and the Japan–Singapore New-Age Economic Partnership Agreement. Customs union (CU). An agreement between two or more parties in which tariffs and other trade barriers are eliminated on most or all trade. In addition, the parties adopt a common commercial policy toward third parties that includes the establishment of a common external tariff. Thus, products entering the customs union from third parties face the same tariff regardless of the country of entry. Examples are the Southern Cone Common Market (Mercosur, Mercado Común del Sur) and the agreement between the European Union (EU) and Turkey. Partial-scope agreement. An agreement between two or more parties that offer each other concessions on a selected number of products or sectors. Examples are the Asia-Pacific Trade Agreement (APTA) and the agreement between the Lao People’s Democratic Republic and Thailand. Economic integration agreement (EIA). An agreement covering trade in services through which two or more parties offer preferential market access to each other. Examples are the U.S.–Peru and Thailand–Australia PTAs. Typically, services provisions are contained in a single PTA that also covers goods. An EIA may be negotiated some time after the agreement covering goods; for example, the Caribbean Community (CARICOM) and the European Free Trade Association (EFTA) have negotiated separate services protocols. Preferential trade agreement (PTA). The generic term used in this study to denote all forms of reciprocal preferential trade agreements, including bilateral and plurilateral agreements. The figure shows the breakdown of PTAs covering trade in goods notified to the WTO and in force as of February 2010. FTAs are by far the most common type, accounting for 83 percent of all PTAs. Customs unions, a deeper form of integration, require significant policy coordination between their parties. They are more time consuming to negotiate, are less common, and make up only 10 percent of all PTAs. Partial-scope agreements account for the remaining 7 percent. Types of PTAs Notified to the WTO 7% 10% 83% free trade agreement customs unions partial-scope agreement Source: WTO Secretariat. trading relations and to complications for traders, a shift away from viewing the agreements as a means of exporters, and customs authorities alike. forging traditional regional partnerships among several The third is the changing structural configuration of geographically proximate countries and toward employing PTAs. Bilateral PTAs are increasingly becoming the norm. them, instead, as instruments for negotiating strategic, Such PTAs are concluded more quickly than those involving bilateral market access, often among countries in different multiple partners. More significantly, they are indicative of regions. Indeed, cross-regional PTAs account for two-thirds Landscape 39 of those currently under negotiation. Bilateral partnerships a manifestation of motivations that may not be addressed have the potential to generate further fragmentation of in multilateral global economic integration efforts (for global trading rules because each PTA maintains its own example, geopolitical concerns, the diffusion of social pref- distinct regulatory framework. Initiatives to alleviate frag- erences, and the establishment of regional public goods), mentation by harmonizing preferential rules of origin are the successful conclusion of the Doha Round trade little in evidence outside the pan-European system of negotiations—despite the inherent preference erosion that cumulation of origin. will result—may not be sufficient to diminish the appeal The fourth is the broadening and deepening of the regu- of these agreements. Figures 2.1–2.4 trace the chronologi- latory scope of PTAs. Increasingly, PTAs include a services cal development of PTAs within the WTO framework. component, in addition to the traditional exchange of pref- Figure 2.1 shows the number of PTA notifications erences on goods. On issues that fall under the current received by the GATT/WTO each year between 1948 and mandate of the WTO, some countries have elected to February 2010. In the five-year period 2000–04, 15 PTAs undertake bilateral commitments going beyond those were notified annually, on average. In 2005–07, notifica- they have accepted at the multilateral level (WTO+ provi- tions declined from the 2004 level, to an average of 24 per sions) and some are undertaking commitments on issues year. In 2009, 37 notifications were received, 20 covering that lie outside the current WTO mandate (WTO-extra trade in goods, and 17 covering trade in services. This was provisions). the highest number of notifications received in a single The fifth is the impact of PTAs. As discussed later in this year. chapter, trade flow data indicate that for a number of pluri- The growth in PTA notifications should be interpreted lateral PTAs, intra-PTA imports have increased as a share with caution because it reflects accession commitments of total imports, and growth in intra-PTA exports is associ- made by WTO members.2 Following its accession to the ated with growth in total exports. PTA partners in selected WTO in 2008, Ukraine notified 10 PTAs, some of which plurilateral PTAs trade more internally than would be had been in force for 10 years or more. Given that many of expected in the absence of a PTA, and the impact on extra- the countries in the WTO accession process (for example, PTA exports and imports is largely positive. the Russian Federation and the other successor states to the Soviet Union) are active PTA players, future accessions to the WTO will lead to periodic spurts in PTA notifications. The PTA Kaleidoscope In addition, recent efforts by the WTO membership to This section expands and updates an earlier study con- encourage notification of PTAs already in force but not yet ducted by the WTO in 2008 (Fiorentino, Crawford, and notified appears to be producing results, because several Toqueboeuf 2009). As in that study, we map PTA prolif- PTAs that had been in force for some time were notified in eration and examine the trends and characteristics of the course of 2009.3 PTAs with respect to their type, physical composition, Figure 2.2 shows the total number of PTAs notified to scope, and geographic spread. The focus is on PTAs noti- the GATT/WTO according to the year in which they fied to the WTO and in force, and on those currently entered into force or became inactive.4 As of February being negotiated. 2010, 457 PTAs had been notified, of which 266 (including accessions to existing agreements) are currently in force; of these, 191 are in the area of goods and 75 in services. The Quantifying and Qualifying the Proliferation of PTAs two significant dips in the cumulative active number of PTAs continue to be a prominent feature of most coun- PTAs shown in the figure are a result of the consolidations tries’ commercial policy, and we expect the current sharp of PTA networks in the European region following the upward trend in the number of new PTAs to continue for enlargements of the European Union in 2004 and 2007 and the foreseeable future. Although the multilateral tariff among Balkan countries in the enlarged Central European reductions that would accompany successful completion Free Trade Agreement (CEFTA). These periodic consolida- of the Doha Round of trade negotiations may dull coun- tions, while reducing the total number of active PTAs, are tries’ appetite for the negotiation of further PTAs in the not indicative of a decrease in the amount of trade that is medium term, we think it is likely that the number of subject to preferences; preferential trade continues to be PTAs will continue to increase in the short term as those conducted among the countries concerned, but under a PTAs already signed or under negotiation enter into force different relationship or configuration. A similar process of and those further down the pipeline, in the proposal or consolidation is expected to take place in Central America, study phase, come on line. Also, to the extent that PTAs are where bilateral agreements being concluded between 40 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.1. Total PTA Notifications Received by the World Trade Organization, by Year, 1949–2009 40 Transparency 160 Mechanism 37 35 35 140 WTO 31 30 29 120 26 cumulative number number per year 25 100 22 22 21 20 19 19 80 18 17 16 15 15 14 14 60 10 9 40 8 77 6 66 5 5 4 4 20 2 3 3 3 3 2 2 2 2 2 2 2 1 1 11 1 1 1 111 1 1 0 0 49 51 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 total notifications per year cumulative number of GATT/WTO members Source: WTO Secretariat. Note: GATT, General Agreement on Tariffs and Trade; PTA, preferential trade agreement; WTO, World Trade Organization. Figure 2.2. All PTAs Notified to the GATT/WTO, by Year of Entry into Force, 1949–2009 105 500 100 95 450 90 85 400 80 75 350 cumulative number 70 number per year 65 300 60 55 250 50 45 200 40 35 30 150 25 20 100 15 10 50 5 0 0 19 9 19 1 19 3 19 5 57 59 19 1 19 3 65 67 19 9 19 1 73 75 19 7 19 9 19 1 83 19 5 19 7 89 91 93 19 5 19 7 99 20 1 03 20 5 07 09 4 5 5 5 6 6 6 7 7 7 8 8 8 9 9 0 0 19 19 19 19 19 19 19 19 19 19 19 20 20 20 notified PTAs (goods, services, and accessions) inactive PTAs cumulative PTA notifications cumulative active PTAs Source: WTO Secretariat. Note: GATT, General Agreement on Tariffs and Trade; PTA, preferential trade agreement; WTO, World Trade Organization. Landscape 41 Figure 2.3. PTAs Notified to the GATT/WTO and in Force, by Year of Entry into Force, 1959–2009 16 200 180 14 160 12 140 10 cumulative number number per year 120 8 100 80 6 60 4 40 2 20 0 0 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 PTAs cumulative physical PTAs Source: WTO Secretariat. Note: GATT, General Agreement on Tariffs and Trade; PTA, preferential trade agreement; WTO, World Trade Organization. Figure 2.4. PTAs Notified to the GATT (Pre-1995) and the WTO (Post-1995), by Legal Provision GATT (1947–94) WTO (1995–2009) 240 220 200 180 160 140 number 120 100 80 60 40 20 0 in force inactive in force inactive Article XXIV Article V Enabling Clause Source: WTO Secretariat. Note: GATT, General Agreement on Tariffs and Trade; PTA, preferential trade agreement; WTO, World Trade Organization. 42 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Chile, Panama, and individual Central American Common been superseded by newer ones between the same signa- Market (CACM) countries will be replaced by a series of tories or have been consolidated into larger geographic PTAs that link all CACM members with a respective Latin groupings. Of those that remain in force, a third were American partner. notified under the GATT Enabling Clause, which allows Asia, by contrast, exhibits a layering effect whereby preferential treatment among developing countries. Of countries are members of both plurilateral and bilateral the PTAs covering trade in goods notified to the WTO, PTAs. For example, a preexisting PTA between New 90 percent were notified under GATT Article XXIV, Zealand and Singapore coexists alongside the plurilateral which permits PTAs as an exception to most favored PTA linking the same parties, the Trans-Pacific Strategic nation (MFN) rules. Economic Partnership (SEP). Similarly, the PTA between Of the 334 PTAs notified to the WTO, 70 percent the Association of Southeast Asian Nations (ASEAN) and remain in force. As we shall see, much of the recent growth Japan coexists with bilateral PTAs between Japan and indi- of PTAs is accounted for by agreements among developing vidual ASEAN members such as Indonesia, Malaysia, the countries, many of which have notified the goods provi- Philippines, Singapore, Thailand, and Vietnam. This adds sions of their PTAs under GATT Article XXIV, rather than to the complexity of trading relations because agreements exercising their option to notify them under the Enabling may contain different schedules for tariff elimination, rules Clause. of origin, and regulatory provisions. The upward trend in the number of PTAs is evident in Continuing Evolution of the Composition of PTAs figure 2.2. Not only is the number of PTAs increasing, but the number of countries involved continues to diver- The past 15 years or so have witnessed changes in the sify. During the 1990s, much of the proliferation of PTAs dynamics of trading relationships between developed and took place in Europe and Central Asia as the countries developing countries.7 Figure 2.5 shows how participation of those regions forged new trading relationships follow- in PTAs has evolved over time. ing the breakup of the Soviet Union. Since 2000, PTA Among PTAs concluded since the establishment of the participation has become more diverse, spreading to all WTO, the number with exclusively developing-country geographic regions, particularly East Asia and the Pacific. members rose initially and has since remained fairly PTA activity is increasingly concentrated in developing steady; those exclusively among developed countries fell countries. during the first five years of the WTO and have risen Figure 2.3 distinguishes between the number of physical slightly since; and those between developed and develop- PTAs and the number of PTA notifications.5 The number ing countries show the most marked increase. In part, this of services PTAs has been increasing, particularly since mirrors the growing membership of developing countries 2000. For instance, of the 14 distinct PTAs that were noti- in the WTO and the fact that developing countries out- fied and entered into force in 2009, 11 had a services com- number developed countries in our classification by a ponent, and almost three-quarters of all PTAs in force and ratio of about 2:1. However, it also reflects the fact that notified to the WTO contain provisions on trade in serv- preferential trade relations between developed and ices. Also of note is the fact that developing countries are developing countries are increasingly becoming recipro- increasingly negotiating PTAs that include both goods and cal, in part because of the need to fulfill WTO legal obli- services components. gations. In addition, a growing number of developing A total of 183 physical PTAs have been notified to the countries are choosing to forge reciprocal trading rela- WTO (as of February 2010) and are currently in force. tionships with developed countries rather than rely on This figure does not include the hundred or so PTAs that nonreciprocal preferential trading relationships such as are currently in force but have not been notified to the GSP programs. WTO. Such PTAs are almost exclusively among developing Figure 2.6 analyzes the hundred or so PTAs under countries, and most are bilateral agreements involving two negotiation and signed (but not yet in force), based on the parties. parties’ level of development.8 The data shown in the fig- Figure 2.4 looks at the proliferation of PTAs chronolog- ure confirm our observation that North-South PTAs are ically, differentiating between the PTAs notified during the becoming increasingly prevalent. They constitute 69 per- GATT years and those notified since the establishment of cent of the PTAs under negotiation, whereas those exclu- the WTO, according to the relevant legal provision.6 Of sively between developing countries account for 22 percent the 123 PTAs notified during the GATT years, only a and those exclusively between developed countries account quarter remain in force. In many cases, older PTAs have for 9 percent. Landscape 43 Figure 2.5. Evolution of Notified PTAs in Force, by Type of Partner, 1958–2009 40 35 30 25 number 20 15 10 5 0 1958–94 1995–99 2000–04 2005–09 developed only developed-developing developing only Source: WTO Secretariat. Note: PTA, preferential trade agreement. Figure 2.6. Number of PTAs under Negotiation integration in the traditional sense—as with EFTA, and Signed, by Type of Partner, as of February 2010 ASEAN, and the Southern African Customs Union (SACU), which by definition are plurilateral partner- ships—and more as tools for negotiating strategic, bilat- eral, and more flexible market access. 9% A related development is the emergence of PTAs in 22% which all the parties are themselves members of PTAs. The first PTA of this kind notified to the WTO was that between EFTA and SACU, linking the four EFTA countries with the five-member SACU customs union. More PTAs of this type are currently under negotiation—for example, those between the European Union (EU) and the Southern Cone Common Market (Mercosur, Mercado Común del 69% Sur) and between the Gulf Cooperation Council (GCC) and Mercosur. Geographic Configuration of PTAs developed only developed-developing developing only Countries seeking preferential partners have tended Source: WTO Secretariat. recently to look beyond their regional neighbors and far- Note: PTA, preferential trade agreement. ther afield.10 As figure 2.8 shows, as of February 2010, cross-regional PTAs accounted for 28 percent of PTAs notified to the GATT and for 34 percent of those notified to the WTO. The tendency toward the negotiation of PTAs Structural Configuration of PTAs across regional boundaries is more pronounced for PTAs As can be seen in figure 2.7, which differentiates between currently being negotiated; cross-regional PTAs account bilateral and plurilateral PTAs notified and still in force, for two-thirds of the total in this group. plurilateral PTAs accounted for two-thirds of all PTAs Figure 2.9 presents the geographic regions represented notified during the GATT years.9 Since the establishment in PTAs that have been established over the past 10 years. of the WTO, bilateral PTAs have increasingly become the Countries in Europe and Central Asia, particularly mem- norm, making up more than 80 percent of all PTAs noti- bers of EFTA and of the Commonwealth of Independent fied during this period and roughly 90 percent of those States (CIS), were active PTA players during the period. currently under negotiation. This confirms the observation Also notable is the growing PTA participation of countries by Fiorentino, Crawford, and Toqueboeuf (2009) that PTAs in East Asia and the Pacific; no new PTAs came into force are less used as instruments for promoting intraregional in this region in 2000, but a yearly average of more than 44 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.7. Bilateral versus Plurilateral PTAs Notified to the GATT/WTO GATT (1947–94) WTO (1995–2009) 200 150 number 100 50 0 bilateral plurilateral Source: WTO Secretariat. Note: GATT, General Agreement on Tariffs and Trade; PTA, preferential trade agreement; WTO, World Trade Organization. Figure 2.8. Cross-Regional and Intraregional PTAs Notified to the GATT/WTO GATT (1947–94) WTO (1995–2009) 200 150 number 100 50 0 intraregional cross-regional Source: WTO Secretariat. Note: GATT, General Agreement on Tariffs and Trade; PTA, preferential trade agreement; WTO, World Trade Organization. five new PTAs did so in the period 2005–09. In 2009, most PTAs consisting of parties in two or more geographic PTA activity was conducted by countries in the Americas regions account for the largest share, 67 percent of the and the Caribbean, led by Canada, Chile, Peru, and the total. Intraregional PTAs under negotiation among coun- United States. By contrast, South Asia and Sub-Saharan tries in the Americas and the Caribbean make up the sec- Africa, home of some of the world’s poorest countries, wit- ond largest group, followed closely by the East Asia and the nessed much less PTA activity during this time, indicating Pacific region. that they may risk becoming further marginalized in their Another view of PTAs in force and under negotiation for pursuit of PTA partners. a number of selected countries is shown in figure 2.11. The Figure 2.10 shows PTAs under negotiation and signed EU continues to be the dominant PTA player, with 29 PTAs but not yet in force, by geographic region. Cross-regional in force and another 14 under negotiation. Chile, EFTA, Landscape 45 Figure 2.9. PTAs, by Region and by Year of Entry into Force, 2000–09 25 20 15 number 10 5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 East Asia and the Pacific Europe and Central Asia North America, Latin America, and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa Source: WTO Secretariat. Note: PTA, preferential trade agreement. An effort was made to classify each PTA according to the regions of its individual parties and to avoid the use of the cross-regional category. A degree of double-counting therefore arises because, for example, an intraregional PTA is counted once, whereas a PTA involving two or more regions is counted once for each region. Singapore, and Turkey constitute the second most active • Qualitatively different and new provisions lying outside group. Also of interest are Australia, Canada, the GCC, and the current WTO mandate (WTO extra). the Republic of Korea, which have only a handful of PTAs in force but are actively negotiating a number of others. PTA commitments that are also covered at the multilat- eral level include provisions concerning sanitary and phytosanitary (SPS) measures, technical barriers to trade Deepening Scope of PTAs (TBT), antidumping, state aid, and obligations already cov- PTAs are increasingly covering more than trade in goods ered by the General Agreement on Trade in Services (GATS), and services; they extend to rules and disciplines on vari- Trade-Related Aspects of Intellectual Property Rights ous regulatory border and behind-the-border policies.11 (TRIPS), and Trade-Related Investment Measures (TRIMS) For the purposes of this chapter, we define such agree- arrangements. WTO-extra obligations deal with environ- ments as deep PTAs. These might contain mental provisions, labor laws, and movement of capital and also with competition policy, intellectual property rights • Provisions that come under the current mandate of the (IPRs) not referenced in the TRIPS agreement, and so forth. WTO but only reaffirm the existing multilateral com- As figure 2.12 shows, the number of PTAs that include mitments deep provisions has been steadily increasing since the early • Provisions within the current mandate of the WTO but 2000s.12 The most prevalent of these provisions usually in which the parties to a deep PTA undertake commit- concern customs cooperation, IPRs, competition policy, ments beyond those accepted at the multilateral level TBT and SPS measures, government procurement, and (WTO+) investment. Assessing such evolution is far from an exact 46 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.10. PTAs in Force and under Negotiation, science. The WTO regional trade agreement (RTA) data- by Region base currently includes only the commitments undertaken in PTAs notified to the WTO following the introduction of 3% the Transparency Mechanism in 2006 and, to a lesser extent, agreements notified before December 2006. (The Transparency Mechanism calls for early announcement 13% of negotiations to set up an RTA and early notification of the RTA’s creation.) As a result, the database currently covers about 45 percent of the PTAs notified to the WTO. 5% Figure 2.12 attempts to supplement the WTO information with other sources to provide a more accurate picture of the basic trends in the inclusion of additional commit- 11% ments in PTAs. Although the cumulative rise in agreements 68% that include such commitments is partly the outcome of the sample composition, the sheer volume of agreements containing such provisions (compared with the total num- ber of PTAs) in recent years indicates the level of interest in deeper integration in the context of preferential trading. Although it is difficult to be precise about the share of agreements containing provisions that go beyond existing cross-regional PTAs commitments at the multilateral level, research on recent East Asia and the Pacific bilateral PTAs signed by the United States and the EU Europe and Central Asia shows that there is an increasing tendency for their agree- North America, Latin America, and the Caribbean ments to exceed existing WTO commitments. The United Middle East and North Africa States and the EU are the main players on the international Source: WTO Secretariat. trade scene, and the bilateral agreements signed by them Note: PTA, preferential trade agreement. often constitute a benchmark for other PTAs. It has been Figure 2.11. PTAs in Force and under Negotiation by Selected Countries and Groupings, as of February 2010 45 40 35 30 number 25 20 15 10 5 0 Au N lia da M ile EU CC a n p. co e ey es TA ur di or pa EA Re at CO os ra Ch rk i na EF ex In G ap Ja St st Tu AS c Ca a, M er RI ng d re M CA ite Si Ko Un PTAs in force as of February 2010 forecast (PTAs currently under negotiation or signed) Source: WTO Secretariat. Note: ASEAN, Association of Southeast Asian Nations; CARICOM, Caribbean Community; EFTA, European Free Trade Association; EU, European Union; GCC, Gulf Cooperation Council; Mercosur, Southern Cone Common Market (Mercado Común del Sur); PTA, preferential trade agreement. Landscape 47 Figure 2.12. Issues Covered in Regional Trade Agreements, 1989–2009 140 120 100 80 number 60 40 20 0 09 07 08 06 04 05 03 01 02 00 99 97 98 94 95 96 92 93 91 90 8 9 20 20 19 19 20 20 20 20 20 20 19 20 19 19 19 19 19 20 19 19 19 customs IPRs competiton TBT SPS government procurement investment Source: WTO RTA database; World Bank Global Preferential Trade Agreements database; Global Economic Prospects (World Bank 2005); and additional observations based on Horn, Mavroidis, and Sapir 2010. Note: IPRs, intellectual property rights; SPS, sanitary and phytosanitary; TBT, technical barriers to trade. estimated that these two parties account for about 80 per- agreements goes beyond multilateral commitments. For cent of the rules that regulate the functioning of world example, in the case of customs administration, the EU markets (Sapir 2007). favors the establishment of a framework for negotiation Horn, Mavroidis, and Sapir (2010) review provisions in that aims at simplifying customs procedures and reducing 28 EU and U.S. PTAs with developed and developing coun- deadweight costs. The United States also seeks to establish a tries. Table 2.1, which is based in part on their findings, framework for cooperation in customs administration, typ- indicates a high degree of coverage of WTO+ areas in both ically requesting that the other party increase transparency EU and U.S. agreements. Provisions on customs coopera- and publish all customs-related laws and regulations. tion, TBT, and public procurement are included in most Enforceable provisions concerning SPS and TBT meas- EU and U.S. agreements. By contrast, provisions on trade ures appear in fewer than half of the EU agreements under in services are included in all but one of the U.S. agree- review. Typically, on top of reinforcing the commitments ments but in only four of the EU agreements. Similarly, of the WTO TBT and SPS agreements, the EU establishes a most U.S. agreements include obligations on TRIPS and on forum designed to promote unilateral or mutual recogni- regulation of export taxes, whereas no EU agreements tion of standards and conformity assessment. These com- include such provisions. mitments are deeper than in the case of U.S. PTAs, which It often proves in EU agreements that either the lan- usually reconfirm the parties’ WTO obligations. guage regarding WTO+ obligations is not sufficiently pre- In the area of services, the obligations can be quite sub- cise to be legally enforceable, or no dispute settlement stantial. In at least one case (the U.S. PTA with Chile), the mechanism is available for enforcing the commitment. United States has adopted regulatory provisions that do Areas that are often unenforceable because of imprecise not exist in the GATS. One such provision requires the par- language include public procurement, TBT and SPS provi- ties to communicate their services-related laws at the draft sions, and environmental laws; in U.S. agreements, SPS and stage, before they are actually enacted. Although the other competition provisions tend to have this shortcoming. party’s comments are not binding, an active integration Overall, however, the U.S. agreements contain substantially process is thus established. fewer areas with legally unenforceable language. The EU and U.S. PTAs contain a number of WTO-extra The depth of the commitments with respect to nontariff measures. In the area of competition, the EU generally measures (NTMs) is increasingly substantial and in most includes legally enforceable provisions in its PTAs, whereas Table 2.1. Deep Commitments in Selected EU and U.S. PTAs, by Type of Provision 48 Parties Customs Public Labor market Environmental to PTA cooperation SPS TBT procurement Competition IPRs Investment Services regulations laws EEA Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes EU–Albania Yes No Yes Yes Yes Yes Yes No No Yes EU–CARIFORUM Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes EU–Chile Yes Yes Yes Yes Yes Yes Yes Yes No Yes EU–Croatia Yes Yes Yes Yes Yes Yes Yes No No Yes EU–Egypt, Arab Rep. Yes No Yes Yes Yes Yes Yes No No Yes EU–Israel Yes Yes Yes Yes Yes Yes No No No Yes EU–Jordan Yes Yes Yes No Yes Yes Yes No No Yes EU–Macedonia, FYR Yes Yes Yes Yes Yes Yes Yes No No Yes EU–Mexico Yes Yes Yes Yes Yes Yes Yes Yes No Yes EU–Morocco Yes No Yes Yes Yes Yes Yes No No Yes EU–South Africa Yes No Yes Yes Yes Yes Yes No No Yes EU–Tunisia Yes No Yes Yes Yes Yes Yes No No Yes EU–Turkey Yes No Yes Yes Yes Yes No No No No Total provisions 14 8 14 13 14 14 12 4 2 13 Legally enforceable provisions 13 3 5 7 13 11 8 4 2 2 NAFTA Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes United States–Australia Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes United States–Bahrain Yes Yes Yes Yes No Yes No Yes Yes Yes United States–CAFTA-DR Yes Yes Yes Yes No Yes Yes Yes Yes Yes United States–Chile Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes United States–Colombia Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes United States–Israel No Yes No Yes No No No No No No United States–Jordan Yes No No Yes No Yes No Yes Yes Yes United States–Korea, Rep. Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes United States–Morocco Yes Yes Yes Yes No Yes Yes Yes Yes Yes United States–Oman Yes Yes Yes Yes No Yes Yes Yes Yes Yes United States–Panama Yes Yes Yes Yes No Yes Yes Yes Yes Yes United States–Peru Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes United States–Singapore Yes No Yes Yes Yes Yes Yes Yes Yes Yes Total provisions 13 12 12 14 7 13 11 13 13 13 Legally enforceable provisions 13 2 11 13 0 13 11 13 13 13 Source: World Bank 2005; Horn, Mavroidis, and Sapir 2010; WTO RTA database; Tuck Trade Agreements Database, Center for International Business, Dartmouth College (http://www.dartmouth.edu/~tradedb/ trade_database.html). Note: The inclusion of deeper provisions in PTAs is shown whether or not the commitments go beyond existing commitments under the relevant WTO agreements. In addition, such provisions may or may not be legally enforceable. CARIFORUM, Caribbean Forum of African, Caribbean, and Pacific (ACP) States; EEA, European Economic Area; CAFTA-DR, Central America Free Trade Agreement–Dominican Republic; IPR, intellectual property rights; NAFTA, North American Free Trade Agreement; SPS, sanitary and phytosanitary; TBT, technical barriers to trade. Landscape 49 only about half of the U.S. PTAs considered by the Horn, and protect investment, technical assistance, and so on.13 Mavroidis, and Sapir (2010) study contain such provisions, The U.S. agreements, by contrast, generally include legally and none is legally enforceable. Most EU PTAs prohibit enforceable rules whereby parties agree to extend MFN and agreements between enterprises that have the object or national treatment to each other and provide mechanisms effect of prevention, restriction, or prohibition of competi- for compensation in case of expropriation, as well as detailed tion, and most bar, as well, the abuse of a dominant posi- rules for arbitration in case of conflict. tion by one or more enterprises in activities affecting trade As for IPRs, all of the EU and U.S. PTAs listed in table 2.1 between parties. The agreements also stipulate that the contain legally binding clauses that oblige the parties to competition authorities of the PTA parties cooperate to become signatories to various intellectual property agree- ensure that such prohibitions are enforced. Many EU PTAs ments not covered by the TRIPS agreement. The obligations also prohibit public aid that distorts or might distort com- under the U.S. agreements tend to be more comprehensive petition by favoring certain enterprises or the production and to cover more aspects of intellectual property rights of certain goods. Legal enforceability varies among EU than do EU agreements. PTAs. For example, obligations of this kind in EU PTAs with Latin American countries are less far reaching than those signed with other countries. The EU–Mexico PTA Global Landscape of PTAs: State of Play and Future Regional Developments does not refer to prohibitions, as do other agreements, but simply mandates that the parties agree on the appropriate Figures 2.13 and 2.14 show the participation of individual measures for preventing distortions or restrictions of com- countries in PTAs covering trade in goods and services petition that could significantly affect trade between the that had been notified and were in force as of February EU and Mexico. 2010. As regards trade in goods, the EU is engaged in the In the case of investment, most EU and U.S. PTAs contain highest number of PTAs, followed by the United States, legally enforceable obligations, but of quite different kinds. Chile, Mexico, and the EFTA states, which are members of Typically, the EU agreement refers only to cooperation to 10 to 19 PTAs. Canada, Australia and most countries in promote investment between parties through the establish- Asia participate in five to nine PTAs, whereas most African ment of mechanisms to provide information on investment countries and some Latin American countries are involved rules, development of a bilateral legal framework to promote in one to four. The map does not show the hundred or so Figure 2.13. Participation in Notified PTAs as of February 2010 (Goods) Source: WTO Secretariat. Note: PTA, preferential trade agreement. 50 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.14. Participation in Notified EIAs as of February 2010 (Services) Source: WTO Secretariat. Note: EIA, economic integration agreement. PTAs, mostly involving developing countries, that are in Europe and Central Asia force but have not been notified to the WTO. On the European continent, the largest network of PTAs The situation with regard to trade in services is some- revolves around the European Union. The EU itself, by what different. Most countries in Africa and the Middle virtue of successive enlargements (most recently, from 25 East have not yet notified PTAs involving trade in services. to 27 in 2007), has been part of a changing network of Interestingly, Chile, Mexico, Singapore, and the United PTAs in the region.14 In addition to its own enlargements, States are engaged in more PTAs involving services than are its longest-standing relations in the region are with the the EU and the EFTA states. EFTA states (Iceland, Liechtenstein, Norway, and Switzer- This section examines the PTAs in force and under land), beginning with PTAs in goods in the early 1970s and negotiation in each of five geographic regions. Figures in services in 1994, and with Turkey, with which it has had 2.15–2.18 show the networks of plurilateral groupings in a customs union since January 1996. The EFTA states and Europe and Central Asia; the Americas and the Caribbean; Turkey, by virtue of their association with the EU, have South Asia, East Asia, and the Pacific; the Middle East and continued to expand their own PTA networks both within North Africa; and Sub-Saharan Africa. What is immedi- and outside the region. ately clear from these diagrams is the degree of overlap- Since enlarging to 27 member states, the EU has contin- ping plurilateral PTAs, particularly in Central Asia and ued to expand its relationship with southeastern Europe Africa, but also increasingly in the Americas and Asia. For and with countries in the Mediterranean Basin. In south- ease of reference, bilateral relationships are not shown but eastern Europe, the EU has PTAs in force with Albania, are discussed in the text. Even when only plurilateral rela- Bosnia and Herzegovina, Croatia, the former Yugoslav tionships are shown, the complexity of trade relations Republic of Macedonia, and Montenegro. All these, faced by a number of countries is clearly evident. This together with Serbia, the United Nations Interim Adminis- complexity manifests itself in the resources necessary to tration Mission in Kosovo (UNMIK), and Moldova, are administer and implement the PTA; the burden placed on also members of the Central European Free Trade Agree- customs officials charged with applying differing tariff ment (CEFTA), which entered into force on May 1, 2007. schedules depending on the good and its origin; and the With the inauguration of that agreement, a number of dilemma facing exporters who supply their goods in dif- bilateral agreements between CEFTA’s members were ter- ferent markets and are confronted with different regula- minated.15 The EU launched negotiations with Ukraine in tory regimes such as rules of origin and product stan- February 2008. dards, according to the destination of the good. Landscape 51 Figure 2.15. Network of Plurilateral Groupings in Europe and Central Asia EAEC Russian Kyrgyz Federation EurAsEc Republic Belarus EEA CEZ Kazakhstan Tajikistan Ukraine CIS Uzbekistan CARICOM Georgia Turkmenistan ECO European Union OCTs Armenia Azerbaijan Iran, Islamic Rep. Moldova SACU EFTA Pakistan Norway UNMIK Iceland Serbia Afghanistan Liechtenstein Albania CEFTA Turkey Croatia Switzerland Macedonia, FYR Montenegro Bosnia and Herzegovina Euromed partners EU EFTA Morocco Algeria Tunisia Egypt, Arab Rep. Palestinian Auth. Israel Jordan Lebanon Syrian Arab Republic Source: WTO Secretariat. Note: CARICOM, Caribbean Community; CEFTA, Central European Free Trade Agreement; CEZ, Common Economic Zone; CIS, Commonwealth of Independent States; EAEC, Eurasian Economic Community; ECO, Economic Cooperation Organization; EEA, European Economic Area; EFTA, European Free Trade Association; EU, European Union; OCTs, Overseas Countries and Territories; SACU, Southern African Customs Union; UNMIK, United Nations Interim Administration Mission in Kosovo. Progress is being made toward the formation of a Euro- Authority, Syria, and Tunisia, and it is currently negotiating pean Union–Mediterranean PTA, which was expected to be agreements with Algeria, Jordan, and Lebanon. Once the completed by 2010 but is not yet complete with respect to PTA is completed, it will permit diagonal cumulation of geographic coverage or scope. The EU has signed Euromed origin across all the parties (the EU, EFTA, Turkey, and the association agreements with all its Mediterranean partners. Mediterranean partners) and the Faroe Islands. The most recent, with the Syrian Arab Republic, was Farther afield, the EU has increased its interest in PTAs expected to be completed in 2010 but is not yet in force.16 in recent years. In the Americas, negotiations on an agree- Efforts are also under way to deepen agreements with the ment with Canada, to include goods and services, were Arab Republic of Egypt, Israel, Lebanon, the Palestinian launched in May 2009, and negotiations have been ongoing Authority, and Syria, through the addition of services with Central American countries. In early March 2010, the chapters, and to enhance agricultural liberalization com- EU announced that it had concluded a PTA covering goods mitments in a number of the agreements. The EFTA and services with Colombia and Peru. Negotiations with states and Turkey, through their agreements with the EU, Mercosur, stalled since 2004, have recently restarted and are following suit. EFTA has thus far notified agreements may be concluded in 2010. Negotiations with Ecuador (in goods) to the WTO with all the Mediterranean part- were suspended in July 2009. ners except Algeria and Syria. Turkey has notified agree- In Asia, the EU’s PTA with Korea was initialed in ments in goods with Egypt, Israel, Morocco, the Palestinian October 2009. Negotiations with ASEAN, which began in 52 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.16. Network of Plurilateral Groupings in the Americas and the Caribbean NAFTA EFTA Canada Mexico EU Mexico-Northern triangle EFTA LAIA/ALADI United States CAFTA-DR Honduras CAN Guatemala Venezuela, RB Bolivia El Salvador Colombia Cuba Nicaragua Ecuador Costa Rica Dominican Mercosur SACU Rep. Peru CACM Argentina Brazil Paraguay Panama CARICOM Uruguay EU EU Chile EFTA Trans-Pacific SEP Source: WTO Secretariat. Note: CACM, Central American Common Market; CAFTA-DR, Dominican Republic–Central America Free Trade Agreement; CAN, Andean Community; CARICOM, Caribbean Community; EFTA, European Free Trade Association; EU, European Union; LAIA/ALADI, Latin American Integration Association/ (Asociación Latinoamericana de Integración); Mercosur, Southern Cone Common Market (Mercado Común del Sur); NAFTA, North American Free Trade Agreement; SACU, Southern African Customs Union; Trans-Pacific SEP, Trans-Pacific Strategic Economic Partnership. July 2007, are currently on hold while the EU pursues bilat- But Arms (EBA) scheme would be able to export to the EU eral negotiations with each of the ASEAN member states, under the GSP. The EU is conducting EPA negotiations with beginning with Singapore and Vietnam. Negotiations with seven groups of countries: the Economic Community of India were launched in June 2007 and are currently in West African States (ECOWAS), plus Mauritania; the Eco- progress. nomic and Monetary Community of Central Africa Following the expiration of the WTO waiver for the 2000 (CEMAC, Communauté Économique et Monétaire de Cotonou trade preferences for the African, Caribbean, and l’Afrique Centrale), plus São Tomé and Principe and the Pacific (ACP) states, the EU has pursued negotiations for Democratic Republic of Congo; Eastern and Southern economic partnership agreements (EPAs) with these coun- Africa (ESA); the East African Community (EAC); the tries. On December 20, 2007, the EU adopted a market Southern African Development Community (SADC); access regulation to grant duty-free and quota-free access to CARIFORUM (CARICOM and the Dominican Republic); ACP countries that had concluded negotiations on agree- and 14 Pacific countries. Agreements between the EU and ments establishing or leading to the establishment of EPAs the CARIFORUM states, Cameroon, and Côte d’Ivoire are as of January 1, 2008, for all products except rice and sugar; already in force. Only the agreement between the EU and the latter two products are expected to become duty-free in the CARIFORUM states includes services. 2010 and 2015, respectively. Countries that have neither ini- The EFTA states have also been very active in PTA nego- tialed an agreement nor have access to the EU’s Everything tiations in recent years, having notified 14 agreements in Landscape 53 Figure 2.17. Network of Plurilateral Groupings in South Asia, East Asia, and the Pacific Mercosur APTA Japan SAFTA China India Bhutan Pakistan Sri Lanka Korea, Rep. EFTA Maldives Bangladesh Nepal Lao PDR PICTA ASEAN Cambodia Kiribati Myanmar Cook Islands Indonesia Malaysia Micronesia, Fed. Sts. Thailand Vietnam Niue Nauru Tuvalu Singapore Philippines Marshall Islands Samoa EFTA Tonga Solomon Islands Brunei Darussalam Vanuatu Fiji MSG Papua New Guinea Trans-Pacific Australia SEP PATCRA ANZCERTA New Zealand SPARTECA Source: WTO Secretariat. Note: ANZCERTA, Australia–New Zealand Closer Economic Relations Trade Agreement; EFTA, European Free Trade Association; APTA, Asia-Pacific Trade Agreement; ASEAN, Association of Southeast Asian Nations; Mercosur, Southern Cone Common Market (Mercado Común del Sur); MSG, Melanesian Spearhead Group: PATCRA, Papua New Guinea–Australia Trade and Commercial Relations Agreement; PICTA, Pacific Island Countries Trade Agreement; SAFTA, South Asian Free Trade Arrangement; SPARTECA, South Pacific Regional Trade and Economic Cooperation Agreement; Trans-Pacific SEP, Trans-Pacific Strategic Economic Partnership. goods and 5 in goods and services to the WTO. In addition, successful, in that it has not been implemented by all the EFTA has signed agreements with Albania, Colombia, and parties. Preferential trade liberalization in the region has Serbia. It is involved in negotiations with Algeria; Hong therefore developed through a complex network of over- Kong SAR, China; India; Peru; Thailand; and Ukraine and lapping bilateral PTAs and plurilateral initiatives between is considering launching negotiations with Indonesia, the states of the region. For instance, Ukraine has notified Malaysia, Russia, and Vietnam. An interesting development PTAs with Armenia, Azerbaijan, Belarus, Georgia, Kaza- was the decision by Switzerland to break ranks and sepa- khstan, the Kyrgyz Republic, FYR Macedonia, Moldova, rately negotiate PTAs with Japan and China; the former Russia, Tajikistan, Turkmenistan, and Uzbekistan.17 entered into force on September 1, 2009, and the latter is In addition to the CIS PTA, other plurilateral agree- currently being negotiated. The other EFTA members have ments between the same parties include the Common Eco- also launched separate negotiations with China. nomic Zone (CEZ) between Belarus, Kazakhstan, Russia, In Central Asia, trade relations are still very much and Ukraine and the Eurasian Economic Community defined by historical linkages between the successor states (EAEC), made up of three CEZ parties (Belarus, Kaza- to the former Soviet Union and with the bordering coun- khstan, and Russia), plus the Kyrgyz Republic and Tajik- tries. The PTA set up by the CIS was negotiated in an istan. In addition, Belarus, Kazakhstan, and Russia have attempt to maintain these links, but it has not been very formed the EurAsEc Customs Union, which entered into 54 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.18. Network of Plurilateral Groupings in Africa and the Middle East ECOWAS Qatar Kuwait Cape Verde Bahrain Oman Iraq Gambia, The United Arab Emirates Agadir Lebanon Guinea Saudi Arabia Yemen, Rep. Sierra Leone WAEMU/ AMU Syrian Arab Republic UEMOA GCC Liberia Palestinian Auth. Mali PAFTA Ghana Niger Tunisia Jordan Mauritania Morocco Nigeria Burkina Faso Egypt, Arab Rep. Senegal Algeria Libya Sudan Guinea-Bissau Benin Togo Chad Uganda Equatorial Guinea Ethiopia Kenya Côte d’Ivoire EAC Eritrea Rwanda Central African Republic Comoros Burundi Gabon Congo, Rep. Djibouti CEMAC Zambia COMESA Tanzania Cameroon Congo, Dem. Rep. Zimbabwe Malawi Madagascar Mauritius Seychelles SADC Namibia Swaziland Angola Botswana Mozambique Lesotho EFTA SACU Mercosur EU South Africa Source: WTO Secretariat. Note: AMU, Arab Maghreb Union; CEMAC, Economic and Monetary Community of Central Africa (Communauté Économique et Monétaire de l’Afrique Centrale); COMESA, Common Market for Eastern and Southern Africa; EAC, East African Community; ECOWAS, Economic Community of West African States; EFTA, European Free Trade Association; EU, European Union; GCC, Gulf Cooperation Council; Mercosur, Southern Cone Common Market; PAFTA, Pan-Arab Free Trade Area; SACU, Southern African Customs Union; SADC, Southern African Development Community; WAEMU/UEMOA, West African Economic and Monetary Union/Union Économique et Monétaire Ouest-Africaine. force in January 2010 and will be implemented over a five- Bahrain, Israel, Jordan, Morocco, and Oman in the Middle year transition period. There is also an overlap between the East and North Africa (MENA) region; and Australia and EAEC, the CEZ, and the CIS, as some parties to these Singapore in the East Asia and the Pacific region. Agree- agreements are also members of the Economic Coopera- ments with Colombia, Korea, Panama, and SACU have tion Organization (ECO), which consists of Afghanistan, been signed but have not yet entered into force pending Azerbaijan, the Islamic Republic of Iran, Kazakhstan, the congressional approval. Negotiations appear to be in Kyrgyz Republic, Pakistan, Tajikistan, Turkmenistan, progress with Malaysia, Thailand, and the United Arab Turkey, and Uzbekistan. Emirates, and an enlargement of the Trans-Pacific Strategic Economic Partnership (SEP) between Brunei Darussalam, Chile, New Zealand, and Singapore to include the United The Americas and the Caribbean States has been proposed. The Americas and the Caribbean continue to be actively Canada has been less involved for a number of years but involved in PTAs. In addition to NAFTA, the United States has recently stepped up its participation in PTAs. Agree- has agreements with numerous countries, including Chile ments with EFTA and with Peru have been notified and and the Central America Free Trade Agreement plus the entered into force in 2009. Agreements with Colombia and Dominican Republic (CAFTA-DR) in its own hemisphere; Jordan have been signed but have yet to enter into force, Landscape 55 and negotiations with Panama were concluded in August negotiating with Korea. Both Colombia and Peru have 2009. Canada is also currently involved in negotiations recently completed PTA negotiations with the EU.20 with CARICOM, the Dominican Republic, four Central Ecuador currently has agreements in force with Chile, America countries, Singapore, Korea, and the EU, while Cuba, and Mercosur within the LAIA/ALADI framework. PTAs have been proposed with India, Mercosur, Morocco, Mercosur has signed several framework agreements and Ukraine. aimed at establishing of PTAs but has only one partial- Mexico continues to expand its already substantial net- scope agreement in force, that with India, in addition to work of PTAs.18 In addition to countries within the hemi- agreements under the LAIA/ALADI framework.21 The sphere, it has PTAs with EFTA, the EU, Israel, and Japan. group is currently negotiating agreements with Canada, Further expansion of its PTA network is planned, with the EU, and Turkey. negotiations in progress with Korea and Singapore. The Chile has for several years been among the most active Central and South American regions maintain complex participants in PTA negotiations, and its agreements span intraregional and extraregional relations. Within the all the continents. It has agreements in force with Australia, region, there are four customs unions at various stages of Canada, China, Colombia, Costa Rica, El Salvador, EFTA, completion: CACM in Central America, CARICOM in the the EU, Honduras, Japan, Korea, Mexico, Panama, Trans- Caribbean, and the Andean Community (CAN) and Mer- Pacific SEP members (Brunei Darussalam, New Zealand, cosur in South America. In addition, a large number of and Singapore), and the United States. It also has a partial- bilateral agreements, representing varying degrees of inte- scope agreement in force with India and several agree- gration, have been negotiated within the Latin American ments under the LAIA/ALADI framework.22 In addition to Integration Framework (LAIA; in Spanish, ALADI, Aso- these, it has signed an agreement with Guatemala in the ciación Latinoamericana de Integración). CACM members context of its agreement with Central American countries have also concluded PTAs with other countries in the and has extended the agreement with China to include region. Chile has bilateral protocols in force with all the services. Negotiations are ongoing with Malaysia, members of the CACM except Guatemala and Nicaragua, Nicaragua (under the Central American agreement), Thai- where negotiations are still going on. Panama’s individual land, Turkey, and Vietnam. bilateral protocols with CACM members are in force, and the country also has agreements in force with Chile, South Asia, East Asia, and the Pacific Colombia, the Dominican Republic, Mexico, Singapore, and Taiwan, China.19 Agreements with Canada and the After several years of resistance to signing PTAs, the Asia United States have been signed but have yet to enter into and the Pacific region has been playing catch-up and has force, and Panama is considering negotiations with Merco- become one of the most active regions in PTA negotiations, sur. In the Caribbean, CARICOM, in addition to its PTAs both among countries in the region and with extraregional with Colombia, Costa Rica, Cuba, the Dominican Repub- partners. East Asia has been particularly active, with Japan lic, and the República Bolivariana de Venezuela, is negotiat- and China taking the lead. Japan alone has 11 agreements ing with Canada and is considering an agreement with in force, 8 of which have taken effect since 2007. Most of Mercosur. CARICOM members together with the Domini- these agreements are with ASEAN and its members can Republic are parties to the EU–CARIFORUM EPA, (Brunei Darussalam, Indonesia, Malaysia, the Philippines, which became effective at the end of November 2008. Singapore, Thailand, and Vietnam), but agreements are In South America, two of the main regional blocs, also in force with Chile, Mexico, and Switzerland. An Mercosur and the Andean Community, are pursuing a agreement with Peru entered into force on March 1, PTA. Individual Andean Community members are also 2010, and Japan is negotiating with Australia, the GCC, negotiating PTAs, both within and outside the region. As of India, and Korea. China currently has nine agreements in 2009, Peru had PTAs in force with Canada, Singapore. and force: with ASEAN; with the Asia-Pacific Trade Agreement the United States, and its agreement with China entered (APTA), which includes Bangladesh, India, Korea, the into force on March 1, 2010. It also has agreements under Lao People’s Democratic Republic, and Sri Lanka; and the LAIA/ALADI framework with Chile, Cuba, Mercosur, with Chile; Hong Kong SAR, China; Macao, China; New and Mexico and is currently negotiating with EFTA, Japan, Zealand; Pakistan; Peru; and Singapore. Negotiations with Korea, and Thailand. Colombia, in addition to having Australia, Costa Rica, the GCC, Iceland, Norway, and agreements in force with CARICOM, Chile, Costa Rica, El Switzerland are in progress. Korea, in addition to being a Salvador, Guatemala, and Panama, has signed agreements party to APTA, has agreements with ASEAN, Chile, EFTA, with Canada, EFTA, and the United States and is currently and Singapore, has signed agreements with the United States 56 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard and the EU, and has launched PTA negotiations with a developed a significant list of preferential partners. Australia number of parties, including Australia, Canada, Colombia, currently has PTAs with Chile, Singapore, Thailand, and the GCC, India, Japan, Mexico, New Zealand, and Peru. the United States; a trilateral agreement with ASEAN and Taiwan, China, is expanding its network of PTAs, having New Zealand has recently entered into force. Negotiations notified agreements with Nicaragua and Panama to the are being held with China, the GCC, Japan, Korea, and WTO in 2009; agreements are in force with Guatemala and Malaysia, and entry into the Trans-Pacific SEP is being dis- with Honduras–El Salvador. An agreement with the cussed. New Zealand’s PTAs are with Australia, China, Dominican Republic is currently being negotiated, and dis- Singapore, and Thailand, and it is a party to the Trans- cussions on a PTA with China began recently. Pacific SEP. It has signed an agreement with Malaysia and In Southeast Asia, the major trading bloc, ASEAN, is has concluded agreements with the GCC countries and with working toward the creation of an East Asian Economic Hong Kong SAR, China. Negotiations are ongoing with Community by 2015. When fully implemented, this India and Korea. Australia and New Zealand are renego- scheme is expected to form a single market in goods, serv- tiating their nonreciprocal agreement, the South Pacific ices, and investment. ASEAN members are also negotiating Regional Trade and Economic Cooperation Agreement PTAs with other parties, both as individual members and (SPARTECA), with the Pacific Island countries, with the aim as a group. ASEAN itself has agreements in force with of replacing it with a reciprocal PTA (PACER Plus). In the China, India, Japan, and Korea and with Australia and meantime, the Pacific Island Countries Trade Agreement New Zealand. It is currently negotiating with the EU. (PICTA), which was notified to the WTO in August 2008, is Individually, Singapore has led the way, with 11 PTAs in being implemented by most of the parties. The PICTA coun- force (with Australia, China, EFTA, Japan, Jordan, Korea, tries are negotiating an EPA with the EU, but to date, only India, New Zealand, Panama, the Trans-Pacific SEP, and Fiji and Papua New Guinea have initialed interim EPAs. the United States), and it is negotiating another 7 (with Canada, Costa Rica, the EU, the GCC, Mexico, Pakistan, The Middle East and North Africa and Ukraine). Other active ASEAN members are Thailand, which has four agreements in force and five under In the Middle East and North Africa, the key plurilateral negotiation, and Malaysia, with two in force and another agreements are the Agadir Agreement between Egypt, six under negotiation.23 Jordan, Morocco, and Tunisia, in force since 2007; the Gulf PTAs in South Asia have largely been confined to agree- Cooperation Council customs union, in force since 2003; ments among neighboring countries, although this is chang- and the Pan-Arab Free Trade Agreement (PAFTA), which ing rapidly. India and Pakistan have both expanded their has been in force since January 1, 1998, and includes negotiations to countries outside the immediate region. In members of the GCC and the Agadir Agreement, as well as addition to agreements within the region, such as the South other countries in the region. The Arab Maghreb Union Asian Free Trade Area (SAPTA, which includes Bangladesh, (AMU) includes Agadir parties Tunisia and Morocco, as Bhutan, Maldives, Nepal, Pakistan, and Sri Lanka) and PTAs well as Algeria, Libya, and Mauritania. In addition, a with Afghanistan, Bhutan, Nepal, Pakistan, and Sri Lanka, crisscrossing network of bilateral agreements exists. For India has PTAs with APTA, Singapore, and, more recently, instance, Jordan has agreements with Bahrain, Egypt, ASEAN. It also has partial-scope agreements with Chile and Israel, Morocco, the Palestinian Authority, Sudan, Syria, Mercosur and is currently in negotiations with EFTA, the Tunisia, and the United Arab Emirates and is negotiating EU, the GCC, Japan, Korea, Mauritius, Thailand, and the with the GCC. Tunisia has agreements with Egypt, Iraq, Bay of Bengal Initiative for Multi-Sectoral and Economic Jordan, Libya, and Morocco. Egypt has agreements with Cooperation (BIMSTEC). Pakistan, in addition to being a Iraq, Jordan, Lebanon, Libya, Morocco, the Palestinian party to SAPTA, the Protocol relating to Trade Negotiations Authority, Syria, and Tunisia and has proposed negotia- among Developing Countries (PTN), and ECO, has notified tions with India. agreements with China, Malaysia, and Sri Lanka to the Links with countries outside the region are also expand- WTO; PTAs with Mauritius and the Islamic Republic of ing. Several countries are part of the Euromed process of Iran are also in force. Pakistan is negotiating agreements agreements with the EFTA and EU. The United States has with the GCC and Singapore and is in negotiations to agreements with Bahrain, Israel, Jordan, Morocco, and expand the ECO. Oman, and is currently negotiating with the United Arab In the Pacific region, Australia and New Zealand, in Emirates. The GCC as a group is also negotiating with a addition to their long-standing Closer Economic Rela- large number of partners across the world; an agreement tions Agreement (ANZCERTA), in effect since 1983, have with Lebanon is in force, and agreements have been signed Landscape 57 with EFTA, Singapore, and Syria. The GCC’s extensive PTA members and with the rest of the world. Several factors negotiating agenda includes Australia, China, the EU, can contribute to the success or the failure of a PTA in India, the Islamic Republic of Iran, Japan, Jordan, Korea, stimulating trade flows. Coverage and the degree of liberal- Mercosur, New Zealand, Pakistan, and Turkey. ization are of crucial importance; clearly, agreements that cover substantially all trade, including agricultural prod- ucts and services, and those that incorporate significant Sub-Saharan Africa tariff and quota reductions are more likely to lead to higher Regional integration in Sub-Saharan Africa has, for the trade flows among their members. If the barriers to trade most part, taken the form of PTAs among geographically with the rest of the world are kept low, as well, the risk of contiguous countries. SACU, the world’s oldest customs trade diversion is minimized, and trade with third parties is union, is engaged in negotiating PTAs and recently notified likely to be created as a result of the PTA. an agreement with EFTA. Other efforts at creating intrare- The proliferation of PTAs that leads to overlapping gional and extraregional partnerships have fallen short of agreements with varying rules of origin and diverse tariff their ambitious statements of intent. In several cases, mem- schedules may complicate integration into global value bership of regional groupings is defined by political chains and prove detrimental to trade. Hence, a successful alliances rather than market access goals, resulting in PTA is likely to be associated with nonrestrictive rules of overlapping memberships that create difficulties in imple- origin. In addition, trade facilitation measures, because of mentation.24 Negotiations for an economic partnership their effect on the costs of trade, are important to a success- agreement with the EU, although intended to strengthen ful PTA. Finally, the comprehensiveness of the PTA is of regional integration, have created further confusion in importance. The inclusion of behind-the-border regula- eastern and southern Africa because memberships of the tory measures that foster increased cross-border competi- EPA groups and the regional agreements are different.25 tion, including competition in services, and that establish With regard to the current state of play of the EPA negotia- rules governing investment and IPRs suitable to the part- tions, in June 2009, an interim EPA was signed between ners’ level of development contributes to the success of the the EU and Botswana, Lesotho, and Swaziland (part of PTA. Finally, even the best-designed agreements, if not the SADC EPA); Mozambique joined soon afterward. An implemented in full, will not bear the expected fruits. interim EPA was initialed (but not yet signed) between Often, the most effective PTAs have been those designed to the EU and the Seychelles, Zambia, and Zimbabwe in complement a general program of economic reform. November 2007 and with the Comoros, Madagascar, and This section surveys trade flows for a selection of major Mauritius in December 2007 for the Eastern and Southern plurilateral PTAs; both intra-PTA and extra-PTA trade Africa (ESA) EPA. An interim agreement was initialed flows are included. Trade between members of the selected between the EU and Uganda in November 2007 for the PTAs is equivalent to roughly 40 percent of world trade. A East African Community (EAC) EPA. gravity model is developed to quantify the importance of In West Africa, the main regional groups are the West these PTAs in stimulating trade among their members and African Economic and Monetary Union (WAEMU; in with third countries. French, Union Économique et Monétaire Ouest-Africaine, UEMOA), ECOWAS, and CEMAC, all three of which are Trade Developments for Selected Plurilateral PTAs customs unions in force or in the making. The eight WAEMU members are all members of ECOWAS. The EU is negotiat- The most intuitive indication of the success of a PTA is the ing EPAs with ECOWAS and CEMAC. With regard to the increase in trade among PTA partners as a share of total ECOWAS EPA, only Côte d’Ivoire and Ghana have initialed trade.26 Even when the share of regional trade does not the interim agreement, in December 2007; the EU and Côte increase, it is possible that the volume of intra-PTA trade d’Ivoire notified the interim EPA in goods to the WTO in will rise if liberalization with respect to third partners leads December 2008. In the case of the CEMAC EPA, the EU noti- to expansion of total trade. fied the WTO of the provisional application of the interim As figure 2.19 shows, for most of the PTAs under con- agreement in goods with Cameroon in October 2009. sideration, intra-PTA imports as a share of total imports increased following the introduction of the PTA. (Extra- PTA trade and possible trade diversion are discussed Impact of PTAs on Trade below.) The most pronounced increases in the shares This next-to-last section examines the extent to which of intra-PTA imports were observed in the EU, ASEAN, PTAs have contributed to the expansion of trade among the Andean Community (CAN), SAFTA, and, initially, 58 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.19. Evolution of the Share of Intra-PTA Imports in Total Imports, 1970–2008 ASEAN CACM 30 20 25 15 20 percent percent 15 19% 10 18% 10 17% 5 8% 5 0 0 19 0 19 3 19 6 19 9 19 2 19 5 19 8 91 19 4 20 7 00 20 3 06 08 19 0 73 19 6 19 9 19 2 19 5 19 8 19 1 19 4 20 7 00 03 2006 08 7 7 7 7 8 8 8 9 9 0 7 7 7 8 8 8 9 9 9 19 19 20 20 19 19 20 20 COMESA ECOWAS 10 20 8 15 percent percent 6 10 4 11% 5 2 3% 0 0 19 0 19 3 19 6 19 9 82 19 5 19 8 19 1 19 4 20 7 00 03 2006 08 19 0 19 3 19 6 19 9 82 19 5 19 8 19 1 19 4 20 7 00 20 3 2006 08 7 7 7 7 8 8 9 9 9 7 7 7 7 8 8 9 9 9 0 19 19 20 20 19 19 20 EU Mercosur 70 25 60 66% 64% 20 50 62% 62% percent percent 40 53% 15 30 10 14% 20 5 10 0 0 19 0 19 3 19 6 19 9 19 2 19 5 19 8 91 94 20 7 00 20 3 2006 08 19 0 73 19 6 19 9 19 2 19 5 19 8 19 1 19 4 20 7 00 20 3 20 6 08 7 7 7 7 8 8 8 9 0 7 7 7 8 8 8 9 9 9 0 0 19 19 19 20 19 19 20 NAFTA WAEMU/UEMOA 50 12 40 10 8 10% percent percent 30 39% 6 20 4 10 2 0 0 19 0 19 3 19 6 19 9 82 19 5 88 19 1 19 4 20 7 00 20 3 06 08 19 0 19 3 19 6 19 9 19 2 19 5 19 8 19 1 94 20 7 00 03 2006 08 7 7 7 7 8 9 9 9 0 7 7 7 7 8 8 8 9 9 19 19 19 20 20 19 19 20 20 Source: International Monetary Fund (IMF), Direction of Trade Statistics (DOT). Note: ASEAN, Association of Southeast Asian Nations; CACM, Central American Common Market; COMESA, Common Market for Eastern and Southern Africa; ECOWAS, Economic Community of West African States; EU, European Union; Mercosur, Southern Cone Common Market (Mercado Común del Sur); NAFTA, North American Free Trade Agreement; WAEMU/UEMOA, West African Economic and Monetary Union/Union Économique et Monétaire Ouest- Africaine. The dot on the plot line in each panel indicates the date of entry into force of the agreement (or enlargements, in the case of the EU). Landscape 59 NAFTA. The share of intra-NAFTA trade began to fall in Next, we consider external protection as one of the the early 2000s, largely because increased imports from likely factors determining whether the presence of PTAs China replaced Mexican exports on the U.S. market might be an obstacle to growth of trade with external part- (Batista 2008) and also crowded out domestic production ners. Low external tariffs reduce the potential for trade in Mexico. The average share of intra-ASEAN imports in diversion, ensure access to competitively priced inputs, and total imports increased from 17 percent in the 1980s to increase competition in the domestic market. The external 25 percent in the 2000s; for intra-CAN trade during that protection of all PTAs under consideration has been falling period, the average share increased from 5 to 14 percent. over the past decade (see figure 2.21).27 Several PTAs The intra-Mercosur share increased substantially, from (EFTA, the EU, the GCC, and NAFTA) have an average 9 percent in the 1980s to slightly more than 20 percent in MFN tariff of about 5 percent or lower. Most PTAs impose the late 1990s. The rise, however, preceded the creation of MFN tariffs that are, on average, less than 10 percent; these the PTA by several years, and so it is uncertain to what include ASEAN, CACM, CAN, CEFTA, Mercosur, SACU, extent Mercosur was responsible for increasing trade flows and SADC. Preferential agreements with third parties and among its members. In many cases, increases in regional multilateral liberalization have also led to growth in the trade have been associated with unilateral or multilateral proportion of imports entering PTA markets tariff-free liberalization, as well, and with growing economic rela- (see figure 2.22). The share in total imports of imports sub- tionships with PTA partners. ject to zero MFN rates (calculated as an average for all For several PTAs, the share of intra-PTA imports in total members) has increased since 1995 for all PTAs except imports has been falling or stagnant. These include EFTA, ECOWAS and WAEMU. On average, more than half of all where the share of intra-PTA imports decreased from imports enter the markets of developed countries at zero 22 percent in the 1980s to 17 percent in the early 2000s, and MFN tariffs. Several developing-country PTAs (ASEAN, the CACM, with a drop from 12 to 7 percent over the same CACM, EAC, SACU, and SADC) also have relatively open period. Several other PTAs, such as ANZCERTA, CEMAC, trade regimes. the GCC, the Papua New Guinea–Australia Trade and In Latin America and Africa, only a low share of imports Commercial Relations Agreement (PATCRA), and SADC, enters existing PTAs free of duty (figure 2.22). PTAs for experienced an increase in intra-PTA trade flows in the which this is true, including CAN, CEMAC, the GCC, and 1990s, followed by a decline in the early 2000s. The decrease WAEMU, are likely to perform worse with respect to cre- in intra-PTA trade may be less worrying if the value of total ation of trade with nonmembers than PTAs that are more trade is increasing. Figure 2.20 indicates that the share of open. This result is consistent with the findings of Global intraregional trade (imports and exports) in gross domestic Economic Prospects 2005 (World Bank 2005), in which, on product (GDP) has indeed been growing in most of the the basis of the gravity model, the authors concluded that sampled PTAs since the early 1970s. EFTA was the only PTA several PTAs (CEMAC, CIS, COMESA, EAC, ECOWAS, in which, on average, the share of intraregional trade in SADC, and WAEMU) registered lower-than-expected GDP was higher in the 1980s than in the early 2000s. overall exports. Moreover, for all the PTAs under review, the growth in intra-PTA exports has been associated with growth in total Question of Intra- and Extra-PTA Trade Creation exports (table 2.2). The coefficient of correlation is positive for most PTAs and is quite high for several of them, such as A simple gravity model of trade could help insulate the ASEAN, EFTA, the EU, the GCC, and NAFTA. In the case effect of PTAs from all the other factors in play in explain- of some African PTAs (Common Market for Eastern and ing trade developments. Bilateral trade between any two Southern Africa [COMESA], ECOWAS, and WAEMU), the countries depends on their market sizes measured by correlation is either negative or low, indicating that these GDP (the equivalent of mass) and the distance between may not have been successful in stimulating extra-PTA them. Because of their empirical robustness, gravity exports. These statistics, however, are mainly useful for models have been extensively used to explain bilateral understanding some basic associations; they do not permit trade between countries and to estimate the impact of inferences about the direction of causality between growth PTAs. Although early applications of gravity models have of intra-PTA trade and exports in general, or the impor- been criticized for their lack of theoretical foundations, tance of PTAs themselves in stimulating exports. We will later studies have shown that with special assumptions, a return to the importance of intra-PTA trade below, using simpler version of the gravity model can be derived from econometric analysis to establish the relationship between the factor proportions model (Deardorff 1995), from PTA membership and trade flows. increasing returns to scale and product differentiation 60 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.20. Evolution of the Share of Intraregional Trade in Gross Domestic Product, 1970–2008 ASEAN CACM 40 7 6 30 5 percent percent 4 20 3 10 2 1 0 0 19 0 19 3 19 6 19 9 19 2 85 88 19 1 19 4 20 7 00 20 3 20 06 08 70 19 3 76 79 82 19 5 88 19 1 94 20 7 00 03 2006 08 7 7 7 7 8 9 9 9 0 7 8 9 9 19 19 19 20 19 19 19 19 19 19 19 20 20 EFTA EU 14 50 12 40 10 percent percent 8 30 6 20 4 10 2 0 0 19 0 19 3 19 6 79 19 2 19 5 88 19 1 94 20 7 00 20 3 2006 08 19 0 19 3 19 6 79 19 2 19 5 88 19 1 94 20 7 00 20 3 2006 08 7 7 7 8 8 9 9 0 7 7 7 8 8 9 9 0 19 19 19 19 20 19 19 19 19 20 Mercosur NAFTA 5 14 12 4 10 percent percent 3 8 2 6 4 1 2 0 0 19 0 19 3 19 6 19 9 19 2 19 5 88 19 1 19 4 20 7 00 20 3 2006 08 70 73 76 79 82 85 19 8 19 1 19 4 97 00 03 2006 08 7 7 7 7 8 8 9 9 9 0 8 9 9 19 19 20 19 19 19 19 19 19 19 20 20 20 Source: International Monetary Fund (IMF), Direction of Trade Statistics (DOT). Note: ASEAN, Association of Southeast Asian Nations; CACM, Central American Common Market; EFTA, European Free Trade Association; EU, European Union; Mercosur, Southern Cone Common Market (Mercado Común del Sur); NAFTA, North American Free Trade Agreement. models, or from a combination of both (Shelburne 2000; exporter and importer time dummies. In a refinement of Evenett and Keller 2002). the model, Baldwin and Taglioni (2006) suggest that biases Typically, a gravity model equation explains the trade from unobserved pairwise characteristics could be signifi- between two partners by using several factors: their income cant and proposed the inclusion of pair dummies to reduce levels; a vector of explanatory variables that depend on the omitted-variables bias. Following this approach, the the specific country pair but are constant over time (distance estimated gravity equation includes country-pair dummies among trading partners, dummies for a common land bor- and a time dummy instead of exporter and importer time der, a common language, a common colonizer, a current dummies. It is worth noting that the inclusion of these colonial relationship, a past colonial relationship, and an dummies precludes the use of country-pair-specific vari- index of religious similarity); a set of time- and country- ables such as distance between countries, contingency, com- pair-varying explanatory variables (membership in the mon language, and colonial relationships.28 The estimated same PTA, membership in the same currency union); and coefficients of PTA dummies are presented in table 2.3. Landscape 61 Table 2.2. Correlation between Intra-PTA and Total Export Table 2.3. Estimation Results of the Gravity Model of the Growth Rates, 1970–2008 Average Trade between Two Partners, Selected PTAs PTA Correlation coefficient Intra-PTA Extra-PTA Extra-PTA trade exports imports ANZCERTA 0.76 ASEAN 0.88 AFTA 1.556*** 0.860*** 0.745*** CACM 0.30 ANZCERTA 0.162 –0.0832** –0.0191 CAN 0.63 CACM –0.324 0.120*** 0.314*** CARICOM 0.30 CAN 0.588*** 0.120*** 0.0254 CEFTA 0.31 CARICOM –0.381*** –0.439*** –0.395*** CEMAC 0.12 CEFTA 0.0212 –0.110*** –0.0304* CIS 0.51 CEMAC 0.364 0.164*** 0.295*** COMESA –0.05 CIS –0.701*** 0.208*** 0.152*** EAC 0.33 COMESA –0.155*** –0.318*** –0.269*** ECOWAS 0.03 EAC 1.221*** 0.0545** 0.137*** EFTA 0.96 ECOWAS 0.514*** 0.0484** 0.171*** EU 0.98 EFTA 0.503*** 0.149*** 0.0768*** Euromed 0.89 EU 0.472*** 0.108*** 0.00367 GCC 0.91 Euromed 0.124*** 0.346*** 0.217*** Mercosur 0.55 GCC 0.374*** 0.413*** 0.303*** NAFTA 0.86 Mercosur 0.689*** 0.741*** 0.645*** PATCRA 0.48 NAFTA 0.878*** 0.192*** 0.175*** SADC 0.33 PATCRA 0.339 0.158*** 0.182*** SAFTA 0.33 SADC 0.842*** –0.134*** –0.0332 WAEMU/UEMOA –0.08 SAFTA 0.466*** 0.506*** 0.542*** WAEMU/UEMOA 0.465*** 0.123*** 0.00836 Source: International Monetary Fund (IMF), Direction of Trade Statistics (DOT); authors’ calculations. Source: Authors’ calculations. Note: ANZCERTA, Australia–New Zealand Closer Economic Relations Trade Note: AFTA, ASEAN Free Trade Area; ANZCERTA, Australia–New Zealand Agreement; ASEAN, Association of Southeast Asian Nations; CACM, Closer Economic Relations Trade Agreement; ASEAN, Association of Central American Common Market; CAN, Andean Community; CARICOM, Southeast Asian Nations; CACM, Central American Common Market; CAN, Caribbean Community; CEFTA, Central European Free Trade Agreement; Andean Community; CARICOM, Caribbean Community; CEFTA, Central CEMAC, Economic and Monetary Community of Central Africa European Free Trade Agreement; CEMAC, Economic and Monetary (Communauté Économique et Monétaire de l’Afrique Centrale); CIS, Community of Central Africa (Communauté Économique et Monétaire de Commonwealth of Independent States; COMESA, Common Market for l'Afrique Centrale); CIS, Commonwealth of Independent States; COMESA, Eastern and Southern Africa; EAC, East African Community; ECOWAS, Common Market for Eastern and Southern Africa; EAC, East African Economic Community of West African States; EFTA, European Free Trade Community; ECOWAS, Economic Community of West African States; EFTA, Association; EU, European Union; Euromed, European Union–Mediterranean European Free Trade Association; EU, European Union; Euromed, European Free Trade Area; GCC, Gulf Cooperation Council; Mercosur, Southern Cone Union–Mediterranean Free Trade Area; GCC, Gulf Cooperation Council; Common Market (Mercado Común del Sur); NAFTA, North American Free Mercosur, Southern Cone Common Market (Mercado Común del Sur); Trade Agreement; PATCRA, Papua New Guinea–Australia Trade and NAFTA, North American Free Trade Agreement; PATCRA, Papua New Commercial Relations Agreement; SADC, Southern African Development Guinea–Australia Trade and Commercial Relations Agreement; SADC, Community; SAFTA, South Asian Preferential (Free) Trade Arrangement; Southern African Development Community; SAFTA, South Asian Preferen- WAEMU/UEMOA, West African Economic and Monetary Union/Union tial (Free) Trade Arrangement; WAEMU/UEMOA, West African Economic Économique et Monétaire Ouest-Africaine. and Monetary Union/Union Économique et Monétaire Ouest-Africaine. * p < 10% ** p < 5% *** p < 1%. Overall, we find that the impact on intra-PTA trade of infer whether it was the PTA alone that led to those poli- the PTAs covered in this study is positive. Almost all the cies. Again, AFTA seems to be the most successful, with the PTA members seem to trade more with each other than highest impact on bilateral trade (see figure 2.23). By con- would otherwise be expected from a typical trading rela- trast, CARICOM, CIS, and COMESA members seem to be tionship between countries with similar incomes and other trading with each other less than a normal trading relation- characteristics. Our statistical analysis indicates that AFTA, ship would predict. In the case of COMESA, the negative CAN, EAC, ECOWAS, EFTA, EU, GCC, Mercosur, NAFTA, impact is rather small. Intra-COMESA trade is estimated to SADC, SAFTA, and WAEMU trade more internally than have been 14 percent smaller than expected under “normal� would be expected in the absence of a PTA.29 The countries trading conditions.30 The strong negative impact on CIS that belong to those PTAs seem to have adopted policies bilateral trade can be understood in the light of the disman- more conducive to bilateral trade expansion, but we cannot tling of the Soviet Union and increasing openness to the rest 62 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard Figure 2.21. Most Favored Nation Applied Tariffs, Trade-Weighted Average of All PTA Members Selected Periods 25 20 15 percent 10 5 0 N CM N M CO C EC AC AS 7 M CC CU U / DC A A TA TA A r su -2 FT ES O A EA CA CO W EF AF M E co G SA M SA EU CA M CE AS O CE N UE er RI CA M AE W 1995–99 2000–04 2005–08 Source: World Bank, World Trade Indicators database. Note: ASEAN, Association of Southeast Asian Nations; CACM, Central American Common Market; CAN, Andean Community; CARICOM, Caribbean Community; CEFTA, Central European Free Trade Agreement; CEMAC, Economic and Monetary Community of Central Africa (Communauté Économique et Monétaire de l’Afrique Centrale); COMESA, Common Market for Eastern and Southern Africa; EAC, East African Community; ECOWAS, Economic Community of West African States; EFTA, European Free Trade Association; EU-27, European Union after 2007 (27 members); GCC, Gulf Cooperation Council; Mercosur, Southern Cone Common Market (Mercado Común del Sur); NAFTA, North American Free Trade Agreement; SACU, Southern African Customs Union; SADC, Southern African Development Community; WAEMU/UEMOA, West African Economic and Monetary Union/Union Économique et Monétaire Ouest-Africaine. Figure 2.22. Proportion of Tariff-Free Imports as a Share of Total Imports, All Goods, Selected PTAs and Periods 90 80 70 60 percent 50 40 30 20 10 0 N CM CA CAN M CO AC C AS 5 7 CC CU U/ DC CE A A TA TA A r su -1 -2 FT ES O EA EA CO W EF AF M co G SA M M SA EU EU CA M CE AS O N UE er RI EC M AE W 1995–99 2000–04 2005–08 Source: World Bank, World Trade Indicators database. Note: ASEAN, Association of Southeast Asian Nations; CACM, Central American Common Market; CAN, Andean Community; CARICOM, Caribbean Community; CEFTA, Central European Free Trade Agreement; CEMAC, Economic and Monetary Community of Central Africa (Communauté Économique et Monétaire de l’Afrique Centrale); COMESA, Common Market for Eastern and Southern Africa; EAC, East African Community; ECOWAS, Economic Community of West African States; EFTA, European Free Trade Association; EU-15, European Union before the 2004 enlargement (15 members); EU-27, European Union after 2007 (27 members); GCC, Gulf Cooperation Council; Mercosur, Southern Cone Common Market (Mercado Común del Sur); NAFTA, North American Free Trade Agreement; SACU, Southern African Customs Union; SADC, Southern African Development Community; WAEMU/UEMOA, West African Economic and Monetary Union/Union Économique et Monétaire Ouest-Africaine. Tariffs include ad valorem rates and ad valorem equivalents of specific tariffs. Landscape 63 Figure 2.23. Percentage Changes in Trade from Entry into Force of a Preferential Trade Agreement to 2008, Based on Gravity Model Estimates 4.0 3.5 3.0 2.5 2.0 percent 1.5 1.0 0.5 0 –0.5 –1.0 CA N CM RI N M AC CO S C AS ro EU ed RO M CC AS A CE A A TA PA TA RA M S C UE TA A N r su CI T FT ES O EA D EA CA CO -M W ER EF AF TC U/ AF M co EU G M SA M CE O ZC er EC CA Eu AN AE W intra-PTA trade extra-PTA exports extra-PTA imports Source: Authors’ calculations. Note: ANZCERTA, Australia–New Zealand Closer Economic Relations Trade Agreement; ASEAN, Association of Southeast Asian Nations; CACM, Central American Common Market; CAN, Andean Community; CARICOM, Caribbean Community; CEFTA, Central European Free Trade Agreement; CEMAC, Economic and Monetary Community of Central Africa; CIS, Commonwealth of Independent States; COMESA, Common Market for Eastern and Southern Africa (Communauté Économique et Monétaire de l’Afrique Centrale); EAC, East African Community; ECOWAS, Economic Community of West African States; EFTA, European Free Trade Association; EU, European Union; Euromed, European Union–Mediterranean Free Trade Area; GCC, Gulf Cooperation Council; Mercosur, Southern Cone Common Market (Mercado Común del Sur); NAFTA, North American Free Trade Agreement; PATCRA, Papua New Guinea–Australia Trade and Commercial Relations Agreement; SADC, Southern African Development Community; SAFTA, South Asian Preferential (Free) Trade Arrangement; WAEMU/UEMOA, West African Economic and Monetary Union/Union Économique et Monétaire Ouest-Africaine. The bars show the magnitude of the impact of the respective PTAs on intra-PTA trade, calculated on the basis of statistically significant dummy variables from table 2.3. of the world. Figure 2.23 translates the estimates presented trade diversion.31 These results are broadly consistent in table 2.3 into the percentage impact on trade following with the findings of the previous sections and Baldwin the introduction of the PTA, up to 2008. For example, it is and Freund, ch. 6 in this volume indicating that PTAs estimated that trade between AFTA members from its with higher external barriers are likely to be associated founding to 2008 was three times higher than would have with trade diversion. been predicted by a typical trading relationship between countries with similar income and other characteristics. Conclusions We also analyze the impact of the introduction of PTAs on extra-PTA exports and imports and find that Today’s multilateral trading system is characterized by a most of the PTAs considered here have been trade creat- multiplicity of overlapping and intersection preferential ing. The agreements whose members trade more with trade agreements. The number of PTAs has grown the rest of the world than would have been expected markedly since 2000. PTAs offer members a means of from a normal trading relationship include AFTA, securing enhanced market access and attracting invest- Mercosur, and SAFTA. Members of CARICOM, CEFTA, ment, but at the cost of rendering the trading landscape COMESA, and SADC, however, are trading less with the less transparent and more unpredictable. Each PTA tends rest of the world than our gravity model would have pre- to create its own web of regulatory rules that coexist along- dicted in the absence of PTAs, indicating some degree of side multilateral rules. 64 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard The PTA landscape shows a number of distinctive different regions. This development risks generating fur- features: ther fragmentation of global trading rules, because each PTA maintains its own distinct regulatory framework. • Ubiquity. PTAs have spread to most geographic regions, • Scope. The regulatory scope of PTAs is broadening and especially East Asia and the Pacific, and North-South deepening. Increasingly, PTAs include a services com- preferential partnerships are often chosen over unilat- ponent, as well as commitments that exceed those they eral programs, such as the GSP. have accepted at the multilateral level or that lie outside • Consolidation. In some cases, bilateral relationships are the current WTO mandate. being replaced by plurilateral PTAs among the same • Impact. Analysis indicates that for a number of plurilat- partners. eral PTAs, PTA partners trade more internally than • Nature. Bilateral PTAs are increasingly the norm. This would be expected in the absence of a PTA and the movement corroborates the observation of a shift away impact on extra-PTA trade is largely positive. Similar from the use of PTAs to forge traditional regional partner- calculations to determine the effects of bilateral PTAs ships among geographically proximate countries and would be useful. In addition, the effects of PTAs on toward their employment as instruments for negotiating stimulating trade in services and investment is an area strategic, bilateral market access, often among countries in worthy of future study. Annex Annex Table 2A.1. Membership of Selected Plurilateral Preferential Trade Agreements Abbreviation Name of PTA Members AFTA ASEAN Free Trade Area Brunei Darussalam, Cambodia, Indonesia, Lao People’s Democratic Republic, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam ANZCERTA Australia–New Zealand Closer Economic Australia, New Zealand Relations Trade Agreement APTA Asia-Pacific Trade Agreement Bangladesh, China, India, Republic of Korea, Lao PDR, Sri Lanka (Bangkok Agreement) ASEAN Association of Southeast Asian Nations Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam CACM Central American Common Market Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua CAFTA-DR Central America–Dominican Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Republic–United States Nicaragua, United States CAN Andean Community Bolivia, Colombia, Ecuador, Peru CARICOM Caribbean Community Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, Trinidad and Tobago CEFTA Central European Free Trade Agreement Albania, Bosnia and Herzegovina, Croatia, former Yugoslav Republic of Macedonia, Moldova, Montenegro, Serbia, United Nations Interim Administration Mission in Kosovo (UNMIK) CEMAC Economic and Monetary Community of Cameroon, Central African Republic, Chad, Republic of Congo, Central Africa/Communauté Économique Equatorial Guinea, Gabon et Monétaire de l’Afrique Centrale CEZ Common Economic Zone Belarus, Kazakhstan, Russian Federation, Ukraine CIS Commonwealth of Independent States Armenia, Azerbaijan, Belarus, Kazakhstan, Kyrgyz Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, Uzbekistan COMESA Common Market for Eastern and Burundi, the Comoros, Democratic Republic of Congo, Djibouti, Southern Africa Arab Republic of Egypt, Eritrea, Ethiopia, Kenya, Libya, Madagascar, Malawi, Mauritius, Rwanda, the Seychelles, Sudan, Swaziland, Uganda, Zambia, Zimbabwe EAC East African Community Burundi, Kenya, Rwanda, Tanzania, Uganda (continued next page) Landscape 65 Annex Table 2A.1. (continued) Abbreviation Name of PTA Members EAEC Eurasian Economic Community Belarus, Kazakhstan, Kyrgyz Republic, Russia, Tajikistan ECO Economic Cooperation Organization Afghanistan, Azerbaijan, Islamic Republic of Iran, Kazakhstan, Kyrgyz Republic, Pakistan, Tajikistan, Turkey, Turkmenistan, Uzbekistan ECOWAS Economic Community of West Benin, Burkina Faso, Cape Verde, Côte d’Ivoire, The Gambia, African States Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone, Togo EEA European Economic Area European Union, Iceland, Liechtenstein, Norway EFTA European Free Trade Association Iceland, Liechtenstein, Norway, Switzerland EU European Union Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovak Republic, Slovenia, Spain, Sweden, United Kingdom GCC Gulf Cooperation Council Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates LAIA/ALADI Latin American Integration Association/ Argentina, Bolivia, Brazil, Chile, Colombia, Cuba, Ecuador, Mexico, Asociación Latinoamericana de Integración Paraguay, Peru, Uruguay, República Bolivariana de Venezuela Mercosur Southern Cone Common Market/ Argentina, Brazil, Paraguay, Uruguay Mercado Común del Sur MSG Melanesian Spearhead Group Fiji, Papua New Guinea, Solomon Islands, Vanuatu NAFTA North American Free Trade Agreement Canada, Mexico, United States OCT Overseas Countries and Territories Anguilla, Aruba, British Antarctic Territory, British Indian Ocean Territory, British Virgin Islands, Cayman Islands, Falkland Islands, French Polynesia, French Southern and Antarctic Territories, Greenland, Mayotte, Montserrat, Netherlands Antilles, New Caledonia, Pitcairn, Saint Helena, Saint Pierre and Miquelon, South Georgian and South Sandwich Islands, Turks and Caicos Islands, Wallis and Futuna Islands PAFTA Pan-Arab Free Trade Area Algeria, Bahrain, Egypt, Iraq, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Palestinian Authority, Qatar, Saudi Arabia, Sudan, Syrian Arab Republic, Tunisia, United Arab Emirates, Republic of Yemen PATCRA Papua New Guinea–Australia Trade and Australia, Papua New Guinea Commercial Relations Agreement PICTA Pacific Island Countries Trade Agreement Cook Islands, Fiji, Kiribati, Federated States of Micronesia, Nauru, Niue, Papua New Guinea, Samoa, Solomon Islands, Tonga, Tuvalu, Vanuatu PTN Protocol relating to Trade Negotiations Bangladesh, Brazil, Chile, Egypt, Israel, Republic of Korea, Mexico, among Developing Countries Pakistan, Paraguay, Peru, Philippines, Romania, Tunisia, Turkey, Uruguay, former Yugoslavia SACU Southern African Customs Union Botswana, Lesotho, Namibia, South Africa, Swaziland SADC Southern African Development Community Angola, Botswana, Democratic Republic of Congo, Lesotho, Madagascar, Malawi, Mauritius, Mozambique, Namibia, Seychelles, South Africa, Swaziland, Tanzania, Zambia, Zimbabwe SAPTA/SAFTA South Asian Preferential (Free) Trade Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka Arrangement SPARTECA South Pacific Regional Trade and Economic Australia, Cook Islands, Fiji, Kiribati, Marshall Islands, Federated States of Cooperation Agreement Micronesia, Nauru, New Zealand, Niue, Papua New Guinea, Samoa, Solomon Islands, Tonga, Tuvalu, Vanuatu Trans-Pacific Trans-Pacific Strategic Economic Partnership Brunei Darussalam, Chile, New Zealand, Singapore SEP WAEMU/ West African Economic and Monetary Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, UEMOA Union/Union Économique et Monétaire Niger, Senegal, Togo Ouest-Africaine Source: Authors’ compilation. Notes reviews; and other public sources. The information may not be exhaustive because, whereas it is possible to account accurately for all notified PTAs, 1. The information used in this study is based on several sources: information on nonnotified PTAs, agreements under negotiation, and notifications to the WTO; documentation submitted to the WTO’s Com- agreements in the proposal stage is often scarce or inconclusive. mittee on Regional Trade Agreements (CRTA) or the Committee on Trade 2. There is, of course, no obligation for nonmembers of the WTO to and Development (CTD); WTO accession documents; trade policy notify their PTAs, but PTAs that involve both members and nonmembers 66 Rohini Acharya, Jo-Ann Crawford, Maryla Maliszewska, and Christelle Renard of the WTO should be notified by the respective WTO member or 16. The Mediterranean parties are Algeria, the Arab Republic of members. Egypt, Israel, Jordan, Lebanon, Morocco, the Palestinian Authority, the 3. According to the WTO’s Transparency Mechanism for Regional Syrian Arab Republic, and Tunisia. The agreement with Syria was adopted Trade Agreements (WTO document WT/L/671), notification is to take by the EU Council on October 27, 2009; signature of the agreement awaits place as early as possible, no later than directly following the parties’ rati- further notice from Syria (European Commission, Overview of PTA and fication or application, and before the application of preferential treat- other Trade Negotiations, February 5, 2010). ment between the parties. 17. Ukraine is also negotiating PTAs with EFTA, the EU, and Singa- 4. There is sometimes a significant time lag between the entry into pore, and an agreement with Canada has been proposed. force of a PTA and its notification. For instance, of the 37 PTA notifica- 18. In addition to its plurilateral agreements such as NAFTA, tions received in 2009, 12 relate to PTAs that entered into force before LAIA/ALADI, the Protocol relating to Trade Negotiations among Devel- 2009. Delays in notification may be caused by lengthy ratification proce- oping Countries, the Global System of Trade Preferences among Develop- dures, countries’ lack of knowledge of notification obligations, indecision ing Countries (GSTP), and the Mexico-Northern Triangle agreement about which legal provision (for example, Article XXIV or the Enabling (with El Salvador, Guatemala, and Honduras), Mexico has eight PTAs and Clause) to invoke (in the case of PTAs covering trade in goods), or recent another eight agreements under the LAIA/ALADI framework. accession to the WTO, creating notification obligations. 19. Panama’s agreements with Guatemala and Nicaragua are in force 5. WTO statistics are based on notification requirements that do not but have not yet been notified to the WTO. reflect the physical numbers of PTAs and so tend to overstate the total 20. Colombia also has agreements with Cuba, Mercosur, and Mexico number of PTAs. Notifications to the WTO include those made under under the LAIA/ALADI framework. GATT Article XXIV, General Agreement on Trade in Services Article V, 21. The agreements are with the Andean Community, Bolivia, Chile, and the Enabling Clause, as well as accessions to existing PTAs. The noti- Colombia, Cuba, Ecuador, Mexico, Peru, and República Bolivariana de fication requirements contained in WTO provisions require that PTAs Venezuela. covering trade in goods and services be notified separately. For a com- 22. The agreements are with Bolivia, Cuba, Ecuador, Mercosur, Peru, plete list of PTAs notified to the GATT/WTO and in force, see the WTO’s and the República Bolivariana de Venezuela, Regional Trade Agreements Database (http://rtais.wto.org/). The total 23. Thailand has agreements in force with Australia, Japan, the Lao number of notified PTAs in force minus economic integration agree- PDR, and New Zealand. Negotiations are ongoing concerning the ments in services and accessions to existing PTAs yields the number of Bangladesh, India, Myanmar, Sri Lanka, and Thailand Economic Cooper- physical agreements. ation (BIMSTEC) and with Chile, EFTA, India, and the United States. 6. Before the establishment of the WTO in 1995 and the negotiation Malaysia has agreements in force with Japan and Pakistan and is currently of the General Agreement on Trade in Services (GATS), there was no obli- negotiating with Australia, Chile, EFTA, India, New Zealand, and the gation to notify PTAs with services provisions. United States. 7. The World Bank’s classification of developed countries includes all 24. Nowhere is overlapping membership more problematic than in countries defined as high income, whether members of the Organisation simultaneous membership of multiple customs unions. For instance, for Economic Co-operation and Development (OECD) or non-OECD. Tanzania is a member of the East African Community (a customs union) This differs from the WTO classification, in which developing-country and of SADC, a group that plans to become a customs union. Similarly, status is based on WTO members’ self-selection. several countries are members of the SADC and of the Common Market 8. Information on PTAs under negotiation and signed is based on for Eastern and Southern Africa (COMESA), both of which plan to available figures and is accurate to the best of our knowledge. Infor- become customs unions. mation on some geographic regions, such as Central Asia and the Mid- 25. For example, Tanzania is negotiating under the EU-SADC EPA, dle East, is difficult to obtain and, thus, can only be considered a best although it is a member of the EAC, and a number of SADC and estimate. COMESA members are negotiating together under the EU-ESA EPA. 9. Bilateral PTAs may include more than two countries when one of (The Comoros, Djibouti, Eritrea, Ethiopia, and Sudan are COMESA the parties is itself a PTA. For example, for our purposes, EFTA-Chile is members; Madagascar, Mauritius, the Seychelles, Zambia, and Zimbabwe considered a bilateral PTA, although it involves the four countries of are members of the SADC.) EFTA plus Chile. A plurilateral PTA refers to one in which the number of 26. This simple measure ignores the issue of preference utilization; constituent parties exceeds two countries, such as Mercosur, CARICOM, that is, in some instances intra-PTA trade might not be conducted on a and the SADC. preferential basis. Furthermore, the growth of intra-PTA imports might, 10. The World Bank regions used in this study are as follows: East in some cases, be associated with trade diversion. Asia and Pacific; Europe and Central Asia; North America, Latin America, 27. The reduction of external protection could be associated with the and the Caribbean; Middle East and North Africa; South Asia; and Sub- creation of this particular PTA or with other bilateral or plurilateral liber- Saharan Africa. The regional classification of countries differs somewhat alization. from that used in the WTO framework. 28. The sample covers all 179 countries available in the International 11. This section relies heavily on Horn, Mavroidis, and Sapir (2010). Monetary Fund Direction of Trade statistics over the period 1970–2008. 12. Figure 2.12 shows the inclusion of such provisions in RTAs GDP data originate from the IMF’s World Economic Outlook database. whether or not the commitments go beyond existing commitments under Dummies are included for the membership of the following PTAs: the relevant WTO agreements. In addition, such provisions may or may ASEAN, CACM, CAN, CARICOM, CEFTA, CEZ, CIS, COMESA, EAC, not be legally enforceable. ECOWAS, EFTA, EU, GCC, Mercosur, NAFTA, PATCRA, SADC, SAFTA, 13. Until the conclusion of the Lisbon agreement, EU law did not and WAEMU/UEMOA. cover investment provisions with third countries. Instead, this was a bilat- 29. These results are consistent with the gravity estimates of the eral issue like double-taxation agreements. impact of PTAs on intraregional trade found in Global Economic Prospects 14. The enlargement led to the termination of a number of bilateral 2005 (World Bank 2005). Although the World Bank analysis covers an ear- agreements between the EU-25 (referring to the EU before the latest lier time period (1960–2000) and the gravity model specification is differ- enlargement) and the new member states, and between the two new ent, the relative values of the coefficients on intra-PTA trade are similar to member states (Bulgaria and Romania) and third parties. The termina- our findings. tion of these agreements was notified to the WTO (WT/REG/GEN/N/4). 30. The impact on trade is equal to e–0.155 –1 = –14 percent. 15. The termination of these agreements was notified to the WTO 31. The result for CEFTA is not easy to interpret because membership (WT/REG/GEN/N/5). of the bloc has changed dramatically with EU enlargements. Landscape 67 References Trading System, ed. Richard Baldwin and Patrick Low. Cambridge, U.K.: Cambridge University Press. Baldwin, Richard, and Daria Taglioni. 2006. “Gravity for Dummies and Horn, Henrik, Petros C. Mavroidis, and André Sapir. 2010. Beyond the Dummies for Gravity Equations.� NBER Working Paper 12516, WTO? An Anatomy of EU and US Preferential Trade Agreements. The National Bureau of Economic Research, Cambridge, MA. World Economy 33(11), 1565–88. Batista, Jorge Chami. 2008. “Competing for the US Import Market: NAFTA Sapir, André. 2007. “Europe and the Global Economy.� In Fragmented and Non-NAFTA Countries.� In Economic Integration in the Americas, Power: Europe and the Global Economy, ed. André Sapir. Brussels: ed. Joseph A. McKinney and H. Stephen Gardner. London: Routledge. Bruegel. http://www.bruegel.org/publications/show/publication/ Deardorff, A. V. 1995. “Determinants of Bilateral Trade: Does Gravity fragmented-power-europe-and-the-global-econom.html. Work in a Neoclassical World?� NBER Working Paper 5377, National Shelburne, R. C. 2000. Intra-Industry Trade, the Gravity Model and Simi- Bureau of Economic Research, Cambridge, MA. larity in Endowments and Country Size. Papers and Proceedings of the Evenett, S. J., and W. Keller. 2002. “On Theories Explaining the Success of International Trade and Finance Association, San Diego State Univer- the Gravity Equation.� Journal of Political Economy 110: 281–316. sity, San Diego, CA. Fiorentino, Roberto V., Jo-Ann Crawford, and Christelle Toqueboeuf. World Bank. 2005. Global Economic Prospects 2005: Trade, Regionalism, 2009. “The Landscape of Regional Trade Agreements and WTO Sur- and Development. Washington, DC: World Bank. veillance.� In Multilateralizing Regionalism: Challenges for the Global 3 ECONOMICS Richard Baldwin Preferential trade agreements (PTAs) have been important preferences (Viner’s ambiguity). Issues related to scale features of the world trade system since the inception in economies and procompetitive effects are then explored. 1947 of the General Agreement on Tariffs and Trade Finally, the discussion turns to the additional benefits that (GATT), which was succeeded in 1995 by the World Trade PTAs may offer in terms of learning effects, increased for- Organization (WTO). For the first 50 years of the eign investment, the provision of regional public goods GATT/WTO, PTAs dealt mainly, and often exclusively, with such as transport networks, and other positive externali- preferential tariff reduction. It is therefore natural that ties. The annexes to the chapter contain technical explana- most economic analyses of PTAs focused on preferential tions for interested readers. tariffs. This view, however, has come to be outdated, as dis- cussed by Chauffour and Maur, ch.1 in this volume. The GATT/WTO’s success in cutting developed coun- Basic Economic Effects of Regionalism tries’ most favored nation (MFN) tariffs, coupled with rapid The terminology behind the basic economics of discrimi- unilateral MFN tariff reductions by developing countries natory liberalization is marked by a conceptual tangle of (Baldwin 2010b), means that today’s margins of tariff pref- conflicting, overlapping, and competing terminologies. To erences are relatively small. Carpenter and Lendle (2010), set the stage for discussion and analysis, we cover the three for instance, show that whereas almost half of world trade elemental effects at work. All have been known at least is between countries that share a PTA, only 16 percent is since 1950. To avoid creating yet another set of terms, we eligible for preferences, and most of these preferences are label them according to their intellectual fathers. small; only 2 percent of world trade outside the EU has margins over 10 percent. The reason is that much of world trade is now granted MFN duty-free status, so that Smith’s Certitude, Haberler’s Spillover, and preference margins are zero by definition. Moreover, the Viner’s Ambiguity preference margins that do exist are typically small. Less Early contributions to the theory of preferential trade than 2 percent of world imports, excluding intra-EU trade, include Adam Smith, Robert Torrens, and Frank Taussig is eligible for preference margins that exceed 10 percent (see Pomfret 1997 for discussion and references). One of (Carpenter and Lendle 2010). As a result, analysis based on the most robust findings in the field is what might be called the traditional, preference-centric perspective is no longer “Smith’s certitude�: sufficient. Nevertheless, the traditional view remains the core of received wisdom on PTAs, and so the bulk of this When a nation “exempt[s] the good of one country from chapter deals with the economics of tariff preferences. duties to which it subjects those of all others . . . the mer- Specifically, this chapter examines the economics and chants and manufacturers of the country whose commerce is so favored must necessarily derive great advantage.� political economy of preferential trade liberalization, start- (Pomfret 1997, quoting Smith 1776) ing with the elemental effects of preferential tariff cutting: the gain to partners receiving the preference (Smith’s Much later, Gottfried Haberler (1936, 384) asserted certitude); the loss to third countries that must compete that all members of a preferential trade agreement must with the preference-receiver (Haberler’s spillover); and the gain, while third nations must lose. We now know that ambiguous welfare impact on the nation granting the the first part of the assertion is wrong, but what might be 69 70 Richard Baldwin called “Haberler’s spillover�—the part about third nations and factors, given tastes, technology, and endowments). losing—turns out to be almost as robust as Smith’s certitude. The action of the free market, according to the first wel- Haberler’s spillover and Smith’s certitude are the linchpins of fare theorem of Walrasian economics, guarantees an the political economy of preferential tariff cutting. increase in economic efficiency, and lump-sum transfers The only basic element added in the postwar period within the PTA ensure welfare gains for all. Third nations came with Jacob Viner’s famous 1950 book, The Customs are not affected because their trade vectors do not change. Union Issue. His key finding was that preferential tariff lib- Dixit and Norman (1980) generalize the analysis, show- eralization has ambiguous welfare effects on the preference- ing that the Kemp-Wan improvement can be obtained granting nation (“Viner’s ambiguity�). Viner’s ambiguity without lump-sum transfers; intra-PTA commodity taxes is quite general, yet one is hard pressed to see this from and subsidies are sufficient. the analysis in his book. A preferential tariff is nothing Of course, real-world PTAs do not adjust external tariffs more than a special case of nonuniform commodity taxa- in a Kemp-Wan manner, nor do they have access to large tion, but Viner did not have the benefit of modern economic lump-sum transfers. Nevertheless, the theorem is impor- tools for tax analysis. Rather, he relied on the enduring but tant from a policy perspective; it proves that PTAs are not imprecise concepts of “trade diversion� and “trade cre- necessarily bad for world welfare. Moreover, it helps us ation.� These terms are misleading because they suggest that think about why the combination of multilateral and pref- trade volumes are the key, even though Viner’s words clearly erential tariff cutting, which has been in operation since indicate that cost changes are what matter. Moreover, they the 1950s, has had a relatively benign to date. fail to cover all the effects generated by discriminatory tariff liberalization, even in a simple Walrasian setting. Given Illustration of Basic Economic Effects these shortcomings, and the decades-long debate on “what Viner really meant� (a debate in which Viner himself partic- Smith’s certitude, Haberler’s spillover, and Viner’s ambiguity ipated, without notable effect), it is curious that the terms capture most of the basic economics of PTAs and, together have enjoyed such enduring success.1 with the Kemp-Wan logic, most of the political-economy The generality of Viner’s ambiguity is glaringly obvious reasoning in the “big-think� regionalism literature.2 It is to readers schooled in the theory of the second-best (pref- possible to deal with these mathematically. However, to erential liberalization induces new distortions while demonstrate the basic interactions among the elemental removing others), but Viner’s book was a landmark. The effects and to facilitate the subsequent exposition of the theory of the second-best was unknown in 1950, and many logic of the big-think regionalism literature, a graphical of Viner’s contemporaries—Haberler, for example—were analysis may be useful. muddled about the essential differences between general The simplest framework that meets the requirements is and preferential liberalization. a Walrasian three-nation model (Home, Partner, and Rest A fourth elemental effect in the regionalism literature of the World [RoW]) with three goods, numbered 1, 2, and concerns the interaction between preferential and multilat- 3. Each nation exports two goods and imports the other eral tariff cutting. It is not really a basic economic effect good (figure 3.1). Since each nation has two sources of but, rather, a specific combination of effects brought to prominence by the fact that the most important regional Figure 3.1. Trade Pattern for a Simple Preferential Trade Association liberalizations over the past 60 years have been accompa- nied by multilateral liberalization. When thinking about this teaming of multilateral and regionalism liberalization, the Good 1 guiding light is the Kemp-Wan logic, which is discussed next. Good 2 Partner Home James Meade (1955) introduced analysis that led to one of the few general statements that can be made about Good 1 Good 2 PTAs—the Kemp-Wan theorem. Kemp and Wan (1976) demonstrated that PTAs could be designed to be Pareto improving for every member of the PTA and for the world at large. The logic is elegant. Assume that two nations sign Good 3 Good 3 a PTA and alter their external tariffs to freeze their external trade flows. The external trade flows can then be treated as RoW part of the bloc’s endowment. Removal of all intra-PTA barriers thus shifts the two-nation bloc from a second-best situation to a first-best situation (i.e., laissez-faire in goods Source: Author’s elaboration. Economics 71 imports, tariff discrimination can be a real issue in all exporter and Partner is the importer. Nothing happens in markets. To rule out Meade’s secondary effects, tastes are the market for Good 3, where RoW is the importer: RoW assumed to be identical across nations and additively sepa- maintains its MFN tariff, and the strong separability rable in all goods.3 For simplicity’s sake, the three nations assumptions rule out Meade’s secondary and tertiary are symmetric in size and with respect to the most favored effects. nation (MFN) tariff they initially impose.4 We see Smith’s certitude and Haberler’s spillover imme- The two trading equilibriums (regionalism versus diately in figure 3.2. Smith’s certitude shows up as Partner multilateral free trade) in a typical market (Good 1) can gains a + b from the higher border price and the expansion be worked out with the help of the PTA diagram shown of exports. Since the FTA is reciprocal and nations are sym- in figure 3.2. The analyses for imports of Good 2 (into metric, Home gains the same in Good 2. Haberler’s Partner) and Good 3 (into RoW) are isomorphic because spillover shows up in the fact that RoW loses area e because of the strong symmetry. of the drop in the border price it faces (from P – T to P' – T) The diagram shows the export supply curves (marked and the reduction of its exports to Home and Partner. XS, with the appropriate superscript to indicate the origin The preference rent. A critical observation, as far as nation) for Home’s two potential suppliers. The horizontal big-think regionalism is concerned, touches on a decom- sum of the XS curves is shown as MSFT, along with Home’s position of Smith’s certitude—that is, how PTA-based import demand curve, MD. Under global free trade, the exporters gain from two distinct features of their improved domestic and border price is PFT, as shown in all nations market access. First, the removal of the intra-PTA tariff for all goods. Assuming that all nations impose a specific boosts their market access directly. Second, PTA-based tariff T on an MFN basis, the internal price in Home exporters benefit from the reduction in RoW exports is driven up to P, while the border price is driven down to induced by the tariff discrimination. The second part of P – T for both suppliers. Home imports drop, with the the gain—area a in figure 3.2—could be called the prefer- reduction divided equally between the two suppliers. ence rent because if the tariff cutting were multilateral From MFN tariffs to preferential trade agreements. If a instead of preferential, PTA partners would gain only b, PTA is formed between Home and Partner, the total not a + b. This preference rent a is vulnerable to so-called import supply curve becomes the kinked MSPTA curve.5 preference erosion and thus plays a leading role in countries’ The resulting internal price falls to P', but there are now resistance to moving from preferential tariff liberalization to two border prices. The border price facing Partner-based multilateral liberalization. exporters rises from P – T to P', while the border price fac- On the import side (figure 3.3), Home gains a trade- ing RoW firms falls from P – T to P' – T. Partner exports volume effect, equal to area A, from expanding its imports; expand, and RoW exports contract. Identical things hap- that is, from replacing high-cost domestic production with pen in the market for Good 2, but here Home is the lower-cost imports. Home also gains from a border-price Figure 3.2. Trading Equilibriums in a Preferential Trade Association border price border price internal price MSMFN XSR XSP MSPTA P P’ P’ MSFT c a P FT P FT d b P–T P–T e P’ – T MD T XR’ RoW XP’ Partner Home exports exports M exports Source: Author’s modification of figure in Baldwin and Wyplosz 2009, ch. 5. 72 Richard Baldwin Figure 3.3. Ambiguous Net Welfare Effects Standards and regulations can influence economic activity and the structure of industry in ways too numer- border price domestic price ous to count. The World Bank, for instance, has conducted XSP A a large multiyear project studying the impact of standards D2 P on trade.7 To focus on essentials, however, we abstract from P’ many details and model TBTs as frictional barriers; that is, D1 C1 barriers that raise the marginal cost of selling a good inter- P–T nationally.8 The effect of such frictional barriers is similar B P’ – T C2 to that of a tariff except that no tariff revenue or other form MD of rent is generated. The gap between the prices of the good inside the importing nation and inside the exporting NB: C1 = D1 nation is burnt up by costly activities that are required to satisfy the TBT. X X’ PTA XR’ XR M Home To keep things simple, consider again a three-nation exports imports world with TBT liberalization between two countries, Source: Author’s elaboration. Home and Partner; the third nation (RoW) remains out- side the arrangement. We start by assuming that all three nations impose TBTs that have a specific-tariff equivalent of T. The policy change to be studied is a lowering of T to effect—the terms-of-trade improvement against RoW zero on all trade between Home and Partner, with no (area B)—while losing from the terms-of-trade loss against change in the barriers on trade between RoW and Home or Partner (area C1 + C2). Home’s terms-of-trade gain on the between Partner and RoW. export side partly offsets the terms-of-trade loss on the The price and quantity effects of the preferential liberal- import side (D1 = C1), so Home’s net welfare change is A + B ization are very similar to those discussed above in the case + D2 – C2.6 As drawn, it looks as though Home and Partner of tariff liberalization; the only change concerns the border gain, but whether they in fact do depends on elasticities and price. With frictional barriers, the domestic price is the the initial MFN tariff. In general, Viner’s ambiguity holds in border price for the importing nation, so the liberalization this framework. As can be demonstrated mathematically, the lowers Home’s border price. At the same time, the exporter PTA reduces welfare when the MFN tariff is sufficiently high that benefits from the liberalization receives a higher price (Baldwin and Venables 1995). for its exports, and so the exporter’s border price rises. The The net welfare impact on RoW is unambiguously neg- point is made concretely in figure 3.4. ative (Haberler’s spillover). RoW experiences no change on Starting from the situation in which the TBT is applied the import side but twice loses area e (shown in the left- to both Partner and RoW imports (i.e., when the equilib- most panel in figure 3.2)—once on its exports of Good 1 to rium price is P'), the preferential liberalization shifts Home, and once on its exports of Good 2 to Partner. The Home’s import supply curve (MS) to MSPTA, from MSMFN. Haberler spillover is an externality as far as the global trade The internal Home price falls to P", and this also system is concerned, and, as such, it plays a central role in becomes the price in Partner. The price that RoW the big-think regionalism literature. exporters receive (net of the cost of the TBT) falls to P" – T. Partner exports expand and those of RoW contract, but the former contract less than the latter expand, so A Note on Nontariff Barriers overall, Home’s imports rise. The welfare implications The traditional view of regionalism focuses almost are shown in figure 3.5. exclusively on preferential tariffs, but many PTAs also As with preferential tariff cutting, the liberalization cre- include liberalization of nontariff barriers. Here, we turn ates a positive trade volume effect for Home equal to area to the basic economics of technical barriers to trade A. Since, however, the price that Home actually pays for its (TBT) liberalization, or, more generally, frictional bar- imports from Partner and RoW is Home’s internal price rier liberalization. “Frictional,� in this sense, means that (rather than the external price, as in the case of tariff pro- the barriers impose a wedge between domestic and bor- tection), the liberalization leads to an unambiguous terms- der prices, but the wedge is “burnt up� rather than col- of-trade gain. Home gets its imports—both from RoW and lected as a rent by the government (as with a tariff) or by a from Partner—for less, that is, for P" instead of P'. This quota holder (as with a quota). gain corresponds to area F in figure 3.5. Thus, although the Economics 73 Figure 3.4. Effects of Preferential Frictional Barrier Liberalization on Prices and Imports RoW Partner Home border price border price domestic price MSMFN MSPTA XSR XSP P’ P’’ T P’ – T P’’ – T T P* MD RoW Partner Home XR’’ XR’ exports XP’ XP’’ exports M’ M’’ exports Source: Author’s elaboration. Figure 3.5. Welfare Effects of Preferential TBT Liberalization: Viner’s Ambiguity Vanishes euros euros XS A P’ F P’’ D P’ – T P’’ – T MD XP ’ XP’’ exports XR’’ XP’ M’ M’’ imports Source: Author’s elaboration. Note: TBT, technical barriers to trade. discriminatory application of the TBT leads to supply Thus, in the market under study, the PTA partners switching from RoW to Partner, this “trade diversion� has unambiguously gain. Notice that Viner’s ambiguity has no welfare consequences for Home. disappeared. RoW unambiguously loses, for the usual As usual, Partner unambiguously gains from the pref- reasons; that is, the heightened competition in Home’s erences because it enjoys a positive trade volume effect market induces RoW firms to sell less and to charge a (its exports expand) and a positive terms-of-trade effect. lower net price. 74 Richard Baldwin Dynamic Gains of Regionalism however, liberalization can unleash a virtuous circle of more competition, lower prices, increased sales, and higher One of the principal justifications for PTAs, especially employment. those involving developing countries, is the belief that uniting small economies will make regional firms more efficient and more competitive by allowing them access to a The Break-Even–Competition Curve bigger market. The boost in efficiency would allow the Diagram in a Closed Economy firms to lower prices, raise quality, and increase their com- To study the logic of the effect of integration on scale and petitiveness, both internally and externally. competition, we need a simple yet flexible framework Plainly, this logic cannot work in the supply-and- that allows for imperfect competition. The break-even demand-diagram world considered in the preceding sec- (BE)–competition curve (COMP) diagram employed here tion, since that worldview assumes that a firm’s efficiency assumes a knowledge of simple imperfect-competition has nothing to do with market size. This section offers a models. (Annex B provides an introduction for readers window into the dynamic gains of regional integration and who are not familiar with such models.) explains the logic of how regional integration could lead to To study the effects of integration on firm size and effi- a situation of fewer, larger firms operating on a more effi- ciency, number of firms, prices, output, and the like, it is cient scale and facing more effective competition. useful to consider a set of diagrams in which all these things are determined. To keep things simple, we begin with the case of a closed economy. Liberalization, Defragmentation, and The key relationship is shown in figure 3.6, where the Industrial Restructuring number of firms and the profit-maximizing price-cost National markets are separated by a very long list of barri- margin are determined. As usual, the equilibrium will be ers. These include tariffs and quotas, but also multiple the intersection of two curves, the BE curve and the COMP technical, physical, and fiscal impediments that make it curve. To explain the economics of the diagram, we start easier for companies to sell in their local market than in with the COMP curve. other markets. The typical outcome of these explicit and hidden barriers is that national firms can often be success- Figure 3.6. Competition (COMP) and Break-Even (BE) Curves ful in their home markets while being marginal players abroad. This state of affairs, known as market fragmenta- markup (μ) tion, reduces competition, which, in turn, raises prices and keeps too many firms in business. Keeping firms in busi- μmono ness is not, of course, a bad thing in itself. The problem is that it results in an industrial structure marked by too many inefficient small firms that can get away with charg- ing high prices to cover the cost of their inefficiency. Tearing down regional barriers defragments the mar- μduo kets and generates extra competition. This procompetitive BE (break-even) curve effect puts pressure on profits, and the market’s response is “merger mania�: the least efficient firms are squeezed out by the competition, prompting an industrial restructuring whereby weaker firms enter into mergers or are bought up. μ’ Schematically, the successive steps can be summarized as liberalization → defragmentation → procompetitive effect COMP curve → industrial restructuring. The result is fewer, bigger, more efficient firms that face more effective competition from each other. All this means improved material well-being for all, as prices fall and output rises. In some industries, restructuring may be accompanied by a sizable reallocation n=1 n=2 number n’ of employment: firms cut back on redundant workers and of firms close inefficient plants and offices (a painful process for Source: Author’s elaboration. workers who have to change jobs). In other industries, Note: The superscript mono refers to monopoly; duo, to duopoly. Economics 75 The competition (COMP) curve. It is easy to under- even when the markup is high. That is, taking the markup stand that imperfectly competitive firms charge a price as given, the BE curve shows the number of firms that can that exceeds their marginal cost; they do so in order to earn enough to cover their fixed cost—say, the cost of set- maximize profit. But how wide is the gap between price ting up a factory. and marginal cost, and how does it vary with the number Equilibrium prices, output, and firm size. It is important of competitors? These questions are answered by the to note that firms are not always on the BE curve, since they COMP curve. can earn above-normal or below-normal profits for a If there is only one firm, the price-cost gap—the markup while. In the long run, however, firms can enter or exit the of price over marginal cost—will equal the markup that a market, and so the number of firms rises or falls until the monopolist would charge. If more firms are competing in typical firm earns just enough to cover its fixed cost. By the market, competition will force each firm to charge a contrast, firms are always on the COMP curve, since firms lower markup. This “competition-side� relationship between can change prices quickly in response to any change in the the markup and the number of firms is shown in figure 3.6 number of firms. as the COMP curve. It is downward sloping because com- With this in mind, we are ready to work out the equilib- petition drives the markup down as the number of com- rium markup, number of firms, price, and firm size in a petitors rises, as explained above. We denote the markup by closed economy, using figure 3.7. The right-hand panel the Greek letter μ, (“mu,� an abbreviation for markup). The combines the BE curve with the COMP curve. The inter- size of the markup is an indicator of how competitive the section of the two defines the equilibrium markup and the market is. long-run number of firms. More specifically, the COMP The break-even (BE) curve. The markup and the num- curve tells us that firms would charge a markup of μ' when ber of firms are related in another way, summarized by the there are n' firms in the market, and the BE curve tells us BE curve. that n' firms could break even when the markup is μ'. The When a sector exhibits increasing returns to scale, there equilibrium price is, by the definition of the markup, just is only room for a certain number of firms in a market of a the equilibrium markup plus the marginal cost, MC. Using given size. Intuitively, more firms will be able to survive if the MC curve from the left-hand panel, we see that the the price is far above marginal cost, that is, if the markup is equilibrium price is p' (μ' plus MC). The middle panel high. The curve that captures this relationship is called the shows the demand curve, and this allows us to see that the zero-profit curve, or the break-even (BE) curve (figure total level of consumption implied by the equilibrium 3.6). It has a positive slope because more firms can break price is C'. Figure 3.7. Prices, Output, and Equilibrium Firm Size in a Closed Economy Home market euros price markup (P + MC) demand curve BE E’ E’ p’ p’ μ' E’ AC COMP MC n’ n� number of firms sales C’ total x’ per firm sales Source: Author’s elaboration. 76 Richard Baldwin The left-hand panel helps us find the equilibrium firm words, the new BE curve must pass through point 1 in the size, that is, sales per firm, which we denote x. This panel figure. At that point, the markup is μ', the number of firms shows the average and marginal cost curves of a typical is 2n', and logic tells us that this combination of μ and n firm. A typical firm’s total profit is zero when price equals would result in all firms breaking even. Point 1, however, is average cost. (When price equals average cost, total revenue merely an intellectual landmark used to determine how far equals total cost.) Since we know that total profits are zero out the BE curve shifts. It is not where the economy would at the equilibrium and that the price is p', the equilibrium be right after liberalization, since the markup would imme- firm size must be is x', which is where the firm’s size diately be pushed down to μA. implies an average cost equal to p'. Because the increase in competition would immediately In summary, this three-panel figure lets us determine the push down the markup to μA, the two newly integrated equilibrium number of firms, markup, price, total con- markets will initially be at a point below the BE curve. We sumption, and firm size, all in one diagram. With this in know that all firms will be losing money at point A because hand, we are now ready to study how regional integration— the actual markup (μA) is less than what would be needed or indeed, any source of increase in market size—could lead to have all 2n' firms break even. This loss of profit is not a to industrial restructuring. problem in the short run because firms only need to break even in the long run. Indeed, the profit losses are what would trigger the process of industrial restructuring that The Impact of Regional Liberalization eventually reduces the number of firms. Regional integration removes trade barriers gradually, but The corresponding effect on prices is shown in the mid- the basic economic effects can be better illustrated by con- dle diagram, as the move from E' to A and then to E ". sidering a much more drastic liberalization—taking a Before we explain this, observe that the middle panel shows completely closed economy and making it a completely the demand curve for Home only, so the no-trade-to-free- open economy. To keep things simple, we suppose that trade liberalization does not shift the demand curve. The there are only two nations, Home and Partner, and that Foreign market has an identical demand, but since exactly they are identical. Since they are identical, we could trace the same thing goes on in Foreign, we omit the Foreign the effects by looking at either market, but for convenience, demand curve to reduce the diagram’s complexity. we focus on Home’s market. As mentioned above, the initial impact of the extra The immediate impact of the no-trade-to-free-trade competition (2n' firms, rather than n', selling to the Home liberalization is to provide each firm with a second market market) pushes the equilibrium markup down to μA, so the of the same size and to double the number of competitors price falls to pA. Thus, during the industrial restructuring in each market. How does this change the outcome? phase, the price would rise to p" (from pA), but this rise The competition aspect of the liberalization can be does not take the price all the way back to its preliberaliza- simply traced. The increased number of competitors in tion level of p'. each market makes competition tougher. In reaction, the The impact of this combination of extra competition typical firm will lower its markup in each market to point and industrial restructuring on a typical firm is shown in A in figure 3.8. the left-hand panel. As prices fall, firms that remain in the The doubling of the market size facing each firm also market increase their efficiency—that is, lower their aver- has an important effect. The liberalization adds a new mar- age cost—by spreading their fixed cost over a larger num- ket for each firm, so it makes sense that more firms will be ber of sales. Indeed, since price equaled average cost able to survive. To see how many more firms can survive, before the liberalization and equals average cost in the we work out the impact of the liberalization on the BE long run after liberalization, we know that the price drop curve and find that the curve is shifted to the right, specifi- is exactly equal to the efficiency gain. In the left-hand cally, to BEFT, as shown in the rightmost panel of figure 3.8. panel, this is shown as a move from E ' to E ". Increasing The shift means that at any given markup, more firms can returns to scale are at the root of this efficiency gain. As break even. This is true because, as market size increases, the equilibrium scale of a typical firm rises from x ' to x ", sales per firm increase, providing a higher operating profit average costs fall. per firm at any given level of markup. To summarize, the no-trade-to-free-trade liberaliza- The size of the rightward shift is determined without tion results in fewer, larger firms. The resulting scale difficulty. If there were no change in the markup, a dou- economies lower average cost and thus make these firms bling of the number of firms could break even, since each more efficient. The extra competition ensures that these firm would be selling the same number of units. In other savings are passed on to consumers, so prices are lower. Economics 77 Figure 3.8. Prices, Output, and Equilibrium Firm Size with Integration Home market only euros price markup demand curve BE BE FT E’ E’ E’ 1 p’ p’ μ' E� p� E� E� p� A μA A pA AC COMP MC n’ n� 2n’ number of firms x� sales C’ C� total x’ per firm sales Source: Author’s elaboration. It is useful to think of the integration as taking place in two E ". During this process, firms enlarge their market steps, as follows. shares, the markup rises somewhat, and profitability is restored. 1. Short term: Defragmentation and the procompetitive effect (from E' to A). We start with the short-term The welfare effects of this liberalization are straightfor- impact, that is to say, the impact before the number of ward. The four-sided area C marked out by p', p", E', and firms can adjust. Before the liberalization, each market E" in the middle panel of figure 3.9 corresponds to the was extremely fragmented in the sense that firms in gain in the Home consumer surplus. As usual, this gain each country had a local market share of 1/n' and a zero can be broken down into the gain to consumers of paying share in the other market. After the liberalization, the a lower price for the units they bought prior to the liberal- market share of each firm is the same in each market, ization and the gains from buying more (C " versus C '). that is, 1/2n'. This elimination of market fragmentation Exactly the same gain occurs in the Foreign market (not has a procompetitive effect, which is defined as a shown in the figure). decrease in the price-cost markup, shown in the right- As it turns out, the four-sided region labeled C in fig- hand panel of figure 3.8 as a move from E' to A. The ure 3.9 is Home’s long-term welfare gain because there is short-term impact on prices and sales can be seen in the no offsetting loss to producers and there was no tariff rev- middle panel as a drop from p' to pA. enue to begin with. Firms made zero profits before liberal- 2. Long term: Industrial restructuring and scale effects (A to ization, and they earn zero profits after liberalization. Note, E"). Point A is not a long-term equilibrium because the however, that this long-term calculation ignores the operating profit earned by a typical firm is insufficient medium-term adjustment costs. to cover the fixed cost. We see this by noting that point A The discussion above has shown that integration ini- is below the BE curve, telling us that the markup is too tially leads to big price reductions and large profit losses. low to allow 2n' firms to break even. To restore a normal These profit losses are eliminated as the number of firms level of profitability, the overall number of firms has to falls and as profits are restored to normal levels. During fall from 2n' to n". In some cases, this process occurs via this industrial restructuring process, prices rise slightly. This mergers and buyouts; in others, the number of firms is sequence of steps, sometimes called industrial consolidation reduced by bankruptcies. As this industrial consolida- or an industry shakeout, is relevant to some industries. In tion occurs, the economy moves from point A to point other industries, firms anticipate the increased competition 78 Richard Baldwin Figure 3.9. Welfare Effects of Complete Liberalization Home market only euros price markup demand curve BE BEFT E’ E’ E’ p’ p’ μ’ C E� p� E� E� μ� p� AC COMP MC number n’ n� of firms x’ x� sales C’ C� total per firm sales Source: Author’s elaboration. and undertake mergers and acquisitions quickly enough to activity, whereas dispersion forces discourage such concen- avoid big losses. In figure 3.8, this would look like a move tration. The spatial distribution of economic activity at any from E' directly to E". moment in time depends on the balance of the proconcen- tration (agglomeration) forces and the anticoncentration (dispersion) forces. Agglomeration and the The main question in this section is, how does trade New Economic Geography integration affect the equilibrium location of industry? To Industrialization and deindustrialization are core concerns set the stage for the equilibrium analysis, we first consider of developing-country policy makers around the world. dispersion and agglomeration forces in isolation. For better Or, to put it differently, policy makers care about the loca- understanding of how trade arrangements affect profitabil- tion of industry. Although a whole host of policies affects a ity, and thus industrialization, it is convenient to employ a nation’s industrialization, trade policy has proved to be a simple analytical framework, one constructed by Puga and critical element in industrialization in almost all countries. Venables (1998). It focuses on four forces: two dispersion This section considers an analytical framework that per- forces (factor-market competition and local-market com- mits us to think logically about several of the key forces petition), and two agglomeration forces (input-cost link- affecting industrialization and how they interact with trade ages and demand linkages). barriers. The framework is often called the new economic geography, following the terminology of 2008 Nobel laureate Dispersion and Agglomeration Forces Paul Krugman. The basic focus of the new economic geography is on Dispersion forces favor the geographic spreading out of whether firms would enter or exit a particular market. economic activity. Land prices are the classic example. The The key determinant, in this simplified view of the price of land, and therefore the price of housing, office world, is the firms’ profitability. If setting up a new firm space, and so on, is usually higher in built-up areas such as in a particular country would be profitable, then the firm central London than in rural areas such as northern Wales. is created. If production in a particular country becomes If everything else were equal, firms and workers would pre- unprofitable, the firm ceases production. The entry or fer to locate in less built-up areas. (Of course, we know that exit decision rests on the balancing of two sets of forces: other things are not equal.) The forces that make built-up agglomeration forces and dispersion forces. Agglomeration areas more attractive are called agglomeration forces; we set forces promote the spatial concentration of economic them aside for the moment to concentrate on dispersion Economics 79 forces. Dispersion forces counteract agglomeration forces require many intermediate inputs—parts and compo- by increasing the attractiveness of less developed regions. nents. When these parts and components are produced In addition to land prices, there are several other forms of locally, they tend to be cheaper and can be supplied in a congestion-based dispersion forces, including wages, timelier manner. Demand linkages reflect the attractive- which tend to be higher in built-up areas. ness of a country that has easy access to customers, In this section, we focus on only two dispersion forces. whether local or in a trading partner. Factor-market competition captures the way that industrial- Demand-linked circular causality rests on market-size ization tends to push up wages. (That is, the competition is issues—hence its name. Firms want to locate where they for labor and operates between industry and other sectors have good access to a large market such as Japan or the within a single country.) Local-market competition reflects United States. If a firm locates in the big market, it incurs the fact that the presence of many industrial firms in a par- shipping costs to sell to other markets, but its costs of sell- ticular country tends to increase the degree of competition ing to big-market customers are low. (It is cheaper to sell to for customers in the local market. An important point is nearby customers.) Since there are more customers in the that local-market competition depends on trade barriers. If big market, firms can reduce their shipping by moving a country’s markets are perfectly open to international there. This is where the circular causality of demand link- competition, the competition for local customers is a ages starts. Other things being equal, firms want to be in global competition. At the other extreme, if the country is the big market. completely closed off, local competition depends solely The causality becomes circular because the movement on the number of local firms. As trade barriers fall, the of firms from the small market to the big market makes the nature of competition shifts gradually from fully local to big market bigger and the small market smaller. The reason fully global. is that firms buy inputs from other firms. Thus, firms mov- Always assuming that other things are equal, factor- ing to the big market create more demand in the big mar- market competition means that countries with little indus- ket and less in the small one. We call this an agglomeration try tend to have low wages and are thus more attractive to force, since spatial concentration of economic activity cre- industry. Local-market competition means that countries ates forces that encourage further spatial concentration. with little industry are markets in which the extent of com- The basic idea is illustrated in figure 3.10. It is useful to petition is rather low, and they too are attractive to indus- separate two things that are closely related: market size (big try. Both types of competition are dispersion forces that market as a share of total market, or the spatial distribution tend to make firms want to avoid spatial concentration. of demand), and firm location (share of firms in the big Agglomeration forces exist when the spatial concentra- market, or the spatial distribution of firms). tion of economic activity creates forces that encourage fur- Starting from the left-hand arrow, we see that market ther spatial concentration. This definition is more circular size affects the location of firms. The logic rests on firms’ than the straight-line chain of causes and effects usually desire to minimize shipping costs. The right-hand arrow presented in economics, but its circularity is the heart of shows that the location of firms affects relative market size. the subject. The logic is simply that firms tend to buy inputs locally. There are many agglomeration forces, but some of them operate only on a very local scale. These explain, for instance, why banks tend to group together in one part of a Figure 3.10. Demand-Linked Circular Causality city such as Paris or London and theatres cluster in another part of the city. The study of agglomeration at this level—it Share of firms in the big is called urban economics—is fascinating, but it is not the market level of agglomeration that interests us. Trade arrange- When firms To reduce move to big ments affect agglomeration at the level of countries, and at market, local shipping PRODUCTION EXPENDITURE that national level, city-level agglomeration forces are costs, firms SHIFTING SHIFTING purchases makes the big unimportant. The third and fourth forces we consider in prefer to locate in market bigger this section are agglomeration forces that tend to encour- and the small big market. age the clustering of industry in a single country. market smaller. Input-cost linkages capture the fact that a well-devel- Size of big oped local network of suppliers can boost a country’s market as share of world attractiveness as a site for industrial production. This idea turns on the real-world fact that manufacturing firms Source: Author’s elaboration. 80 Richard Baldwin If no dispersion forces were in operation, this circular presence of many suppliers in the big market and how the causality would continue until the small market was movement of firms to the big market widens the range of entirely empty of industrial firms. supplies and thus makes the big market even more attrac- This brings us to the second major type of agglomera- tive from a cost-of-production point of view. This sort of tion force. Input-cost-linked circular causality works in a logic is sometimes called “cluster economics.� fashion that is similar to demand-linked circular causality, but it involves production costs rather than market size. Locational Effects of Liberalization In the modern economy, firms buy plenty of things from other firms. These range from raw materials and Trade integration affects the balance of agglomeration and machinery to specialized services such as marketing, dispersion forces in complex ways. Such complexity is accounting, and information technology (IT) services. important for understanding the real world, since trade Since it is cheaper to find and buy such inputs from firms liberalization has produced very different results in differ- that are nearby, the presence of many firms in a location ent developing countries. The best way to understand this tends to reduce the cost of doing business in that location. complex logic is to follow the principle of progressive com- Thinking this through, we can see that a similar circular plexity. We start with a set of simplifying assumptions that causality will encourage agglomeration (see figure 3.11). allow us to focus on the critical logical relationships. Once The figure separates two things that are closely related we have understood this logic in a setting reduced to essen- but are worth keeping distinct: firm location (share of tials, we add back complicating factors. firms in the big market, or the spatial distribution of A simple diagram such as figure 3.12 helps with the firms), and the cost advantage of producing in the big mar- study of the balance of the agglomeration and dispersion ket (cost of producing in the big market, or the spatial dis- forces. In the figure, the strength of agglomeration and dis- tribution of production costs). persion forces is plotted on the vertical axis, and the hori- Starting from the left-hand arrow, we note that if many zontal axis shows the share of all firms that are located in firms are already in the big market, then doing business in the big region—here, in the North. the big market will, all else being equal, be cheaper than doing business in the small market. This production-cost • The agglomeration force line rises because of circular differential influences the location of firms. The right- causality—that is, agglomeration forces become stronger hand arrow shows how the relocation of firms tends to as industry agglomerates. improve the business climate in the big market and • The dispersion force line rises because the benefit of worsen it in the small market, at least in terms of the range staying in the small region increases as more firms move of available inputs. Again, if there were no dispersion to the northern market. For example, as more industry forces, this circular causality would empty out the small moves to the North, the wage gap widens, and so does market entirely. In other words, cost-linked circular causal- the difference in local competition. ity describes the way in which firms are attracted by the The locational equilibrium in the left-hand panel is shown by point E; this is where the share of firms in the Figure 3.11. Input-Cost-Linked Circular Causality North rises to the point at which incentives to agglomerate are just balanced by incentives to disperse. It is instructive Share of firms to consider why other points are not the equilibrium. For in the big market example, consider the point at which half the firms are in When firms the North. For this equal distribution of firms, the strength To take move to the big market, of the agglomeration force is shown by point a, and the advantage of PRODUCTION COST the wider the range of strength of the dispersion force is shown by point b. SHIFTING SHIFTING range of intermediate goods expands Because a is greater than b, we know that the agglomera- intermediate goods, firms while tion force—the force that tends to make firms want to move to the contracting move to the North—is stronger than the dispersion force, big market. in the small market. which tends to make firms want to move to the South. As a Cost of consequence, the situation in which only half the firms are producing in in the North cannot be the equilibrium; with agglomera- the big market tion forces stronger than the dispersion forces, some firms Source: Author’s elaboration. will move from South to North. As firms move northward, Economics 81 Figure 3.12. Locational Equilibrium Diagram Some industry in All industry in both nations one nation strength of the strength of the agglomeration and agglomeration and dispersion forces dispersion forces dispersion force D E A A D E a agglomeration force b B S share of share of 1/2 1 1/2 1 firms in firms in North North Source: Author’s elaboration. the gap between the agglomeration force and the disper- costless trade, industry would spread out much more than sion force narrows. The location equilibrium is where the is the case today. two forces just offset each other, that is, point E. This global statement—that lower trade costs foster the The example in the left-hand panel shows an equilib- industrialization of poor countries—must be tempered, rium with some industry in both nations. The right-hand since partial removal of trade costs (e.g., the lowering of panel shows the situation in which agglomeration forces tariffs without removing natural trade barriers) can shift are so strong that all industry ends up in the North (full the locational equilibrium in either direction or may have agglomeration). This is not a bad approximation of the sit- no effect at all. What matters is whether the agglomeration uation that confronts many developing countries today forces fall sufficiently relative to the dispersion forces. (that is, they have essentially no competitive industry) and The basic idea is shown in figure 3.13. A trade liberaliza- that faced almost all developing countries before the emer- tion will shift the agglomeration forces line down. If the lib- gence of the newly industrializing countries in the 1980s. eralization has a big impact on the agglomeration forces, Finally we come to the main subject of this section: how the line could shift to A2; if the effect is more modest, the does tighter economic integration affect the location of shift could be only to A1. The liberalization also erodes the industry across countries? Here, we view trade integration dispersion forces, and this is shown as the shift to D1. (We as simply reducing trade barriers such as tariffs and other could also consider large and small effects on the D curve, restrictions. How do we show the trade-cost reduction in but that would clutter the diagram without adding insight.) the locational equilibrium diagram? The key is that, in the case of A1 and D1, the liberaliza- As the discussion above suggests, lower trade costs tion has had no effect on industry location; industry is all between the two nations in our simple framework will in the North, before and after. In the A2 and D1 case, how- weaken both the agglomeration forces and the dispersion ever, the liberalization has sparked some industrialization forces. After all, at the extreme of costless trade, there is in the South; as the new equilibrium, E', implies a share of no advantage to being in any particular market, with the industry in the North (S') that is less than one. sole exception of that conferred by the factor-market competition dispersion force. The other three forces rely Trade Arrangements on differences that are created by costly trade. Factor- market competition, however, has nothing to do with We now employ the tools presented above to organize our trade costs; all that matters is how much industry is in each thinking about how preferential trade arrangements could nation. The conclusion, then, is that if the world went to affect the location of industrial production. Here we follow 82 Richard Baldwin Figure 3.13. Locational Equilibrium Diagram with Trade Figure 3.14. Trade Arrangements and Industrialization Liberalization share of share of All industry in one nation industry in South industry in South strength of the agglomeration and dispersion forces S 1 = S2 E S1 A A1 D D1 S1 A2 S2 E’ freer freer B trade trade Source: Puga and Venables 1998. Note: The notation S1 = S2 denotes that the two lines are identical and that both countries have an equal share of world industry. S’ share of 1/2 1 firms in North Source: Author’s elaboration. lower wages outweighs the demand and cost advantages in the North, and some firms move south. the thinking of Puga and Venables (1998) who assume four Importantly, cluster economics continues to operate in nations: two northern nations with free trade in manufac- the South, so industry initially only starts operating in one tured goods between them, and two southern nations of the southern countries. In this exercise, the two southern whose exports face equal tariffs in all markets. In this countries are identical, so the choice of which starts first is model, initially, all industry is in the two northern nations. entirely a matter of chance; to be concrete, this nation is (Four nations are required if the intrinsic economic mass labeled southern nation 1, and its industry share is marked of the integrating area is to equal the intrinsic mass of the S1. The reason for this lumpy industrialization is that the third nations when all nations are symmetric.) first firms to set up create cost and demand linkages to The Puga and Venables framework is too complex to other firms in the same country. They also raise wages, solve with paper and pencil, and so the effects are simu- but the linkage effects are stronger, so what we see is a sec- lated with the use of a computer. The outcome is plotted in ond industrial agglomeration forming in just one of the a diagram (figure 3.14) in which the share of world indus- developing countries. This implication of cluster eco- try is on the vertical axis and the level of tariffs is on the nomics is both quite in line with real-world experience and horizontal axis. Because the focus is on the industry in the somewhat unexpected for economists familiar with more South, the paths of the industry share of the two southern neoclassical, marginalist reasoning, where things tend to nations are plotted as S1 and S2. change smoothly. Notice that when the industrialization process spreads, the emergence of the second southern industry Global Multilateral Tariff Liberalization is initially harmful to the first because of the extra com- To set the stage, consider the impact of a global reduction petition. (Think of the effect of the emergence of China of tariffs (remember that North-North tariffs are already on the exports of the Philippines and Thailand.) This is zero before starting). As global tariffs fall, the tendency another implication of cluster economics that is not at for industry to disperse rises. At some point, it becomes first obvious. profitable for some firms to relocate to the South. The local-market competition dispersion force is weakened, Unilateral Liberalization the factor-market dispersion force is unaffected, and both agglomeration forces are weakened as the advantages of Next, consider unilateral liberalization in this simple Puga- being near customers (demand linkages) weaken and the Venables setup. We examine three types: only one southern advantages of being near suppliers (cost linkages) also nation liberalizes; both southern nations liberalize; and weaken. At some point, the attractiveness of the South’s both northern nations liberalize. Economics 83 Liberalization in a single southern economy. Here, only sufficiently high, industrialization will start in one south- southern nation 1 engages in unilateral import tariff liber- ern nation. As before, the logic of cluster economics tells us alization, with all other barriers held constant. The solid that the process begins in only one southern nation but line marked S1 in the right-hand panel of figure 3.14 then shifts to the other. shows the outcome, with the unilateral opening leading to industrialization. This is not always what happens, but it is Preferential Liberalization certainly one possibility, and the one that actually occurs under the specific Puga-Venables setup. If the two southern nations sign a PTA and lower tariffs The point is that although extra import competition between themselves, something like multilateral liberaliza- from the North has a negative effect on industrial location tion occurs. As long as the two markets are not too small, in the South (the product-market local competition effect), the liberalization will cause industry to become established the cheaper supply of imported intermediate goods in the South, but the mechanism is completely different: becomes the dominant force at some point, and industry the driving force here is the effective market enlargement becomes established in southern nation 1. This result is not caused by reducing intra-South barriers. This is, of course, general; for example, if southern nation 1 were very small the classic argument made in the 1960s and 1970s for and faced high export barriers, unilateral liberalization South-South PTAs. would not induce industrialization. But where this is not As in the multilateral case, the spread of industry to the case, the combination of low wages and low-cost developing countries is uneven, initially taking place in one intermediates (resulting from import liberalization) country and only spreading to the second when trade bar- eventually leads to industrialization, as is shown in the riers are lower. Indeed, this sort of uneven development right-hand panel. did occur in some early South-South PTAs. For example, in Unilateral liberalization by northern economies: The gen- the East African Community, industry started to grow in eralized system of preferences (GSP). Next, consider the case Kenya at the expense of Uganda and Tanzania. The key dif- in which the North makes a gesture to the South by unilat- ference is that the countries do not benefit from better erally removing tariffs on imports from the South. The access to northern markets or to North-produced interme- outcome will be similar to that shown in the right-hand diate inputs. panel. The northern tariff cutting improves the prospects The impact of a North-South PTA is particularly inter- of locating industry in the South because it erodes the esting. Here, the southern nation obtains better access to demand-linked causality that favors the North to begin the big northern market and benefits from lower-cost with. However, since the South is not lowering its tariffs and inputs, but in each case only with respect to the partner. much industry will remain in the North, the input-cost The liberalizing southern economy suffers from more linkage continues to strongly favor a northern location. competition from northern firms, but because its wages are Moreover, as mentioned above, if the southern market is lower, the balance of better reciprocal market access is in small enough, or the input-cost linkages are strong enough favor of the South. This spread of industry is associated (or both), the North’s unilateral tariff cutting may have no with a large decline in the North’s share of industry. The effect on industrialization. In terms of figure 3.13, we could loser is the other southern economy, which does not attract have a situation like A1 and D1 where, despite the shift in any industry and now has to contend with industrial clus- attractiveness toward the small region, the balance of forces ters in both North and South. It is not difficult to see how a still favors full agglomeration in the North. Given how little single North-South PTA such as the U.S.–Mexico agree- most GSP programs have done to promote southern ment proposed in 1991 or the one between Japan and industry, this is not a case worth keeping in mind. Malaysia could trigger a spate of requests from other Liberalization by both southern economies. We now look southern nations. at MFN liberalization by southern economies in tandem. All southern import tariffs are reduced in the same way, so Liberalization of Parts and Components only northern tariffs against southern exports remain. Ini- But not Final Goods tially, the outcome is like that of unilateral liberalization by a single southern nation. The lower southern tariffs A very common liberalization strategy among developing heighten the anti-industrialization product-market com- countries is to reduce tariffs unilaterally on inputs but petition from the North, but it encourages southern pro- not, or to a lesser degree, on final goods. This evokes the duction by lowering the cost of inputs. If the southern old measures of the effective rate of protection, whereby markets are not too small and the importance of inputs is the actual protection provided by a nominal tariff of, say, 84 Richard Baldwin 10 percent on automobiles can be vastly larger than 10 per- final good. Of course, this might not work if the southern cent if the tariff on imported intermediates is zero. A nation is too small. numerical example will illustrate. Suppose a country can The members of the Association of Southeast Asian buy autos at US$10,000 and adds a 10 percent tariff, so that Nations (ASEAN) are working on a slight variant of this the auto sells for US$11,000 on the internal market. Fur- uneven liberalization strategy. They are lowering regionally thermore, suppose the country charges no tariff on the the within-ASEAN tariffs—the common effective prefer- parts needed to assemble an auto and can buy these parts ence tariffs (CEPTs)—on final goods, as well as on parts for US$8,000. This implies that the cost of assembly, when and components, but preferences only emerge on final it is done most efficiently, is worth US$2,000. But now we goods as they are lowering their MFN applied tariffs on see that assembly of autos inside the country will be prof- parts and components in line with their preferential cuts. itable as long as it costs less than US$3,000. Thus, in some This has made sales of ASEAN-assembled autos very sense, the effective rate of protection on the assembly activ- attractive within the ASEAN group. ity is 50 percent, not 10 percent as the tariff on autos sug- The point can be seen in table 3.1. Apart from Malaysia gests. This is an old story, and countries around the world and Thailand, which have tried to build up more complete still keep up the fiction of having an automobile industry auto industries, the main ASEAN countries have lowered by maintaining a high tariff on autos and a low tariff on their MFN tariffs on engines to zero. More important, all of completely knocked down (CKD) autos—basically, kits them also have lowered their preferential tariffs on engines that are opened and assembled like IKEA furniture. to zero. Tariffs on autos are still very high (30 to 80 percent) Recently, however, the situation has become far more on an MFN basis but are much lower (5 percent) on a pref- subtle. Many developing countries, especially in East Asia, erential basis. Although these tariff cuts are impelled by the are industrializing on the basis of parts and components logic of supply-chain manufacturing in East Asia (much of manufacturing rather than final goods manufacturing. In this driven by Japanese firms), the cuts have also fostered essence, they industrialize by becoming part of the global such trade. From the perspective of the Puga-Venables supply chain. (Actually few of these supply chains are analysis, this combination of regional preferences is a way global; apart from some electronics, they are regional, in of favoring agglomeration of parts and final goods indus- order to reduce transport cost and delays.) try at the regional level. For a wide range of countries, the import and export of parts and components are much more important than the Regional Interindustry Trade export of final goods (Fukunari and Ando 2005). For the Philippines, for instance, 60 percent of the country’s International trade occurs when a product is made in one machinery exports consists of parts, as does 45 percent of country and purchased in another. In traditional trade the- its imports in this category. Plainly, the Philippines’ indus- ory, a country’s production is thought of as stemming from try is in the business of importing parts, adding some its advantages, or, to be more precise, comparative advan- value, and then exporting the parts. tages. Countries with abundant farmland would produce In terms of the Puga-Venables analysis, this uneven lib- more cereal than they could consume and would thus be eralization of parts and final goods fosters southern exporters of cereals, and the same logic would apply to industry in that it reduces the cost of inputs without the export patterns of countries that are especially well increasing the competition from northern industry in the endowed with unskilled labor, high technology, or oilfields. Table 3.1. ASEAN Tariffs on Engines and Automobiles, Most Favored Nation (MFN) Tariffs and Common Effective Preference Tariffs (CEPTs), 2008 (percent) Malaysia Indonesia Philippines Thailand Item MFN CEPT MFN CEPT MFN CEPT MFN CEPT Small-auto engines 25 0 0 0 0 0 10 0 Medium-size-auto engines 30 0 0 0 0 0 10 0 Automobiles 30 5 55 5 30 5 80 5 Source: ASEAN Secretariat Web site, http://www.aseansec.org/12025.htm. Note: ASEAN, Association of Southeast Asian Nations. Small-auto and medium-size-auto engines correspond to ASEAN tariff lines 8407.31.00.00 and 8407.32.00.10. Automobiles correspond to 8703.21.29.10. Economics 85 Much of the world’s trade, however, involves two-way was strengthened as the latter—Hong Kong SAR, China; trade in similar goods—usually, manufactured goods— the Republic of Korea; Singapore; and Taiwan, China,— and often between countries that have similar comparative experienced their own “hollowing out� and followed the advantages. To account for this, Paul Krugman and a num- lead of Japanese manufacturing companies by offshoring ber of other theorists in the late 1970s and early 1980s the most labor-intensive production stages to East Asian developed the so-called new trade theory. This took a quite countries that had a comparative advantage in such tasks different view of the determinants of a country’s exports. (that is, countries whose low wages more than compensated The point of departure is firm-level scale economies for their low labor productivity). that explain why the production of each good is spatially Information technology advances and the falling costs concentrated, not just in one country, but even in one fac- of transportation, especially air freight, facilitated and tory. If the production of most goods is spatially concen- accelerated the development of Factory Asia by making trated but the customers for that good are spread across complex production structures easier and cheaper to man- many countries, goods are made in one country but are age, while at the same time making them more flexible and bought in another, generating international trade. More- more reliable. China’s opening up was another huge spur, over, scale economies tell us that no country can efficiently bringing as it did something like a half-billion low-wage, produce all goods, so each country specializes in a subset of low-productivity workers to the gates of Factory Asia. This the world’s goods. Trade in similar products arises very nat- accelerated the erosion of the headquarter nations’ com- urally between similar countries. France and Germany, for parative advantage in labor-intensive production processes example, both produce autos, and they both consume them. while simultaneously increasing the attractiveness of the Since the production of each model of auto is spatially con- offshoring solution. centrated but the customers are spatially dispersed, the Figure 3.15 shows the number of plants from Japanese result is two-way trade in autos between countries that have electrical machinery and automobile industries that set up quite similar comparative advantages. in the listed East Asian economies. (Plainly, the number of Until recently, the focus of this intraindustry trade was plants is only a rough indicator of the actual degree of off- between developed countries, to a large extent because they shoring.) The offshoring process started gradually but were the only ones that had significant and competitive picked up speed in the late 1980s. Between 1975 and 1990, manufacturing sectors. Since the mid-1980s, however, the total number rose three and a half times, with almost the so-called second unbundling phase of globalization half of this increase coming between 1985 and 1990. The has meant a rapid rise of industry in developing coun- figure also shows that China was not a major player in the tries. A great deal of this new industry does not involve competition for plant locations before 1990. The plants full production of goods; rather, it focuses on parts and components for export. The general trend is discussed in Brulhart (2009). Figure 3.15. Location of Japanese Auto and Electrical A good way to introduce the topic of this trade in parts Machinery Plants in East Asia, 1975–2004 and components is to tell the tale of how it started in East Asia. The phenomenal growth of Japanese incomes and 900 wages in the 1980s and 1990s eroded the country’s compara- 800 tive advantage in manufacturing. Japanese businesses reacted 700 by seeking lower-cost manufacturing sites for labor-intensive 600 stages of production. The obvious solution was to offshore number these stages to nearby East Asian economies. 500 This tendency started the development of what is 400 called “Factory Asia.� Instead of Japanese goods being 300 made in Japan and sold in the United States or Europe, a 200 new pattern of “triangle trade� emerged. Firms that were 100 headquartered in Japan would produce certain high- technology parts in Japan, ship them to factories in 0 1975 1980 1985 1990 1995 2000 2004 ASEAN nations for labor-intensive stages of production China Thailand Malaysia (including assembly), and then ship the final products to Indonesia Vietnam Western markets or back to Japan. This division of East Asia into headquarters economies and factory economies Source: Baldwin 2008. 86 Richard Baldwin Table 3.2. Intraindustry Trade as a Share of Internal and undermining the WTO. The new perspective, the so-called External Trade of PTAs twenty-first-century regionalism, is really about defining (percent) the new international disciplines necessary to underpin Internal External twenty-first century international commerce—that is, EU-15 46.6 24.8 international production networks and the flows of people, CEMAC 1.2 0.1 things, and information that they generate (Baldwin WAEMU 0.9 0.4 2010a). Here, twenty-first century regionalism is defined as EAC 0.3 0.4 consisting of three parts: (a) the system of deep North- SACU 0.3 9.0 South agreements signed by the United States, the EU, and Source: Brulhart 2009. Japan; (b) the system of bilateral investment treaties and Note: CEMAC, Economic and Monetary Community of Central Africa other facilitating agreements such as double-taxation (Communauté Économique et Monétaire de l’Afrique Centrale); EAC, East African Community; EU-15, European Union before the 2004 enlargement treaties; and (c) the massive unilateral policy reform (15 members); SACU, Southern African Customs Union; WAEMU, West undertaken by emerging nations (of which unilateral tariff African Economic and Monetary Union. cutting is the most easily measured part). This chapter has focused on the economics of the tradi- generated new intraindustry trade, almost all of it in tional view of PTAs: that they are mostly about preferential machinery and much of it in parts and components. tariffs. As tariffs are just a form of tax, all of the traditional- Intraindustry trade, however, is not universally impor- view economics can be thought of as applied tax econom- tant in PTAs. The two strongest contrasts are the EU and ics. A great part of the deeper disciplines involved in the African PTAs. As table 3.2 shows, the degree of two-way twenty-first-century regionalism, however, turns on regu- trade in similar products inside the EU is very high, almost lation economics, and the regionalism literature has not 50 percent, but the share is much lower for the EU’s exter- focused much on this type of economics when it comes to nal trade. Much of this intraindustry trade involves parts PTAs. There is still much to be done. and components, and such trade tends to be regionalized in order to reduce the costs and difficulties of managing complex manufacturing processes at great distances. Annex A. Policy Pitfalls of Classic but Incomplete Diagrammatic Analyses Among the African PTAs, two show higher intraindustry trade measures within the regional arrangement, and two Until the 1990s, the main points in the economic literature exhibit the opposite. In all cases, the figures are quite low, were presented using diagrammatic analysis. Two diagrams reflecting the marginal role of manufacturing in these were particularly pivotal. The fact that they ignored some countries’ exports. of the three elemental effects discussed in this chapter (Smith’s certitude, Haberler’s spillover, and Viner’s ambi- guity) distorted the direction of the literature and, with it, Conclusions academic trade economists’ perceptions of PTAs. Since For most of the history of the GATT/WTO, regionalism these older, incomplete diagrams occasionally enter today’s was all about tariff preferences. The literature has therefore regionalism debate, it is worth presenting them briefly and focused primarily on the economics of preferential tariff highlighting their shortcomings. The first is the Johnson liberalization. The first key concern—the issue facing diagram that is still used in most undergraduate textbooks; nations in the early postwar period in Europe and Latin the second is the Shibata “small PTA� diagram. America—was whether an individual nation would gain from joining a PTA. The answer is unclear. Discriminatory The Johnson (1960) Diagram and the liberalization is a synonym for preferential liberalization; Johnson-Cooper-Massell Proposition this is both “liberalization�— which removes some price wedges and thus tends to improve economic efficiency— Although economists have been well aware of the three and “discrimination,� which introduces new price wedges effects since Meade (1955), this analysis was not integrated and thus tends to harm efficiency and welfare. From the into mainstream trade theory, in part because it was mar- 1990s on, concern shifted to the more systemic question of ginal, whereas trade economists were interested in studying whether regionalism was good or bad for the multilateral the discrete liberalization implied by PTAs. Viner (1950) trading system but the focus on tariffs remained. provided no diagrams. Accordingly, customs union theory, More recently, fundamental changes in international as it was known at the time, was a distinctly wordy subject commerce have led to a dramatic reduction in tariff until Johnson (1960b) introduced his famous diagram preferences, but no reduction in worries that PTAs are that illustrated Viner’s ambiguity in a manner that was Economics 87 immediately transparent to all economists (figure 3A.1). identical to MFN free trade. (Both before and after, all For policy analysis, Johnson’s diagram is fatally flawed as it imports would come from A.) Home’s domestic price falls assumes that FTAs and the like only have welfare effects on from PA + T to PA, and the net welfare gain is B + G + the import side—export effects are assumed away. D + H, in the right-hand panel.10 In the diagram, Home imports can come from partner Readers will immediately note that Smith’s certitude country A or B. Home’s demand is an infinitely small and Haberler’s spillover are missing. Third nations are share of world demand, so it faces perfectly elastic export entirely unaffected by the trade policy of an infinitely small supply curves from both sources (labeled XSA and XSB). nation such as Home. In Johnson’s diagram, the partner We start with Home’s imposing an MFN specific tariff of nations care no more about Home’s trade policy than a T, so that all imports come from the low-cost supplier, perfectly competitive firm does about gaining or losing one country A. The domestic price is PA + T, and the border atomistic buyer. This omission was an attractive feature price is PA. when the pivotal question was whether a single nation Home can form a customs union with country A or B, would gain from joining a customs union, but it renders so we consider both. The customs union with B would the diagram useless for consideration of systemic issues. remove the tariff only on imports from B (the high-cost The diagram assumes that Home’s decision to form a PTA supplier), leading to supply switching. Home switches has no systemic effects at all. Also missing from the dia- from importing everything from A to importing every- gram is an analysis of the preferential access that Home’s thing from B. Home’s domestic price falls from PA + T to exports win in its partner’s market. PB. Assuming a utilitarian metric, the net welfare effects are For two decades, the Johnson diagram dominated eco- (B + D) minus E, which may be negative or positive nomic analyses of PTAs to such an extent that Smith’s cer- depending on elasticities and the height of the initial tariff; titude and Haberler’s spillover came to be largely forgotten this is Viner’s ambiguity.9 by academic trade economists. This went so far that many The customs union with country B was termed “purely mainstream trade theorists came to view PTAs as econom- trade diverting,� yet if the initial tariff was high and the PB – ically irrational—a view encapsulated in the Johnson- PA border-price gap was small, it can be welfare improving Cooper-Massell proposition stating that a small nation for Home. This result—a welfare-improving but purely should always prefer unilateral MFN liberalization to any trade-diverting customs union—seemed to contradict PTA (Cooper and Massell 1965). The point is easily illus- Viner’s reasoning, and it produced the first of what was to trated in figure 3A.1: cutting T to zero on imports from A be a long series of ivory-tower debates over terminology; and B will always yield net welfare gains that are at least as this one pitted Meade (1955) against Johnson (1960b) and high as those from any customs union. Corden (1965). From the modern perspective, Johnson’s analysis seems If Home chooses to form a customs union with A, the impossibly simplistic, and the disconnect between aca- ambiguity disappears. Such a customs union is unam- demic and real-world thinking is truly astounding. For biguously welfare improving, since its positive effects are instance, when the United Kingdom submitted its first Figure 3A.1. Johnson’s Diagram, Small Home and Partner Countries euros euros D S PB + T XSB + T PA + T XSA + T B+D A B C D PB XSB E F G E H PA XSA MD M M’ imports quantity Source: For right-hand panel, Johnson (1960b); for left-hand panel, author’s elaboration. Note: The right-hand panel is the standard open-economy supply-and-demand diagram in price-quantity space for an infinitely small nation (Home). The left-hand panel transcribes the analysis into a more compact diagram in price-import space. 88 Richard Baldwin application for EU membership in 1961, better market The diagram presumes that the two PTA partners, access for U.K. exporters was the key concern, but aca- Home and Partner, import the same good from the RoW. demic economists were working with the Johnson diagram Home and Partner are “small� with respect to RoW and that assumed this away. Moreover, the main preferential so face a perfectly elastic RoW export supply curve, trade agreement in existence at the time, the European XSRoW. This sets the initial border price to PR in both Economic Community (EEC), accounted for a substantial nations. Home has a higher MFN tariff than Partner to fraction of world imports, and the key nations—France, start with (TH, as opposed to TP), so the pre-PTA price is Germany, and the United Kingdom—were far from higher in Home. atomistic. As Pomfret (1997) points out, a number of When Home and Partner form their PTA, Partner- frameworks were developed at the time that would have based firms initially see a higher price in Home and so allowed the necessary extension, including Johnson begin exporting to Home. In equilibrium, all post-PTA (1957, 1958), Humphrey and Ferguson (1960), and Black- Home imports, M'H, are supplied by Partner firms. Part- hurst (1972), but the Johnson diagram’s hold on the liter- ner’s internal price remains at PR + TP, so its consumption ature was so firm that the early efforts were obliged to and production are unchanged, which means that the new stick with his small-country fiction.11 exports to Home are replaced, one for one, by new Partner imports from RoW. In the case illustrated in figure 3A.2, Partner is large enough relative to Home to ensure that The “Small PTA� Diagram Home’s entire demand can be satisfied by Partner’s pro- An important analytical extension of the Johnson diagram ducers at PR + TP. In terms of welfare, the PTA results in a came with the “small PTA� analysis (Shibata 1967). It positive trade volume effect for Home but a negative bor- allowed for Smith’s certitude, although it still assumed der price effect. (Home pays PR + TP for its imports instead away Haberler’s spillover. The diagram continues to be of PR.) Partner expands its imports across the tariff wedge, used even today (e.g., Grossman and Helpman 1995), so it and this results in a positive trade volume effect equal to TR is worth presenting briefly. times the expanded imports (M'H). The small PTA diagram shows somewhat different Although it seems an odd objective from today’s per- assumptions concerning the pattern of comparative advan- spective, where rules of origin (ROOs) are a major barrier tage and the size of the two partners. The various combina- to trade, Shibata’s goal was to illustrate the irrelevance of tions of assumptions yield a range of results that have been rules of origin. His point was that ROOs only prevent bla- covered by three decades of literature. (See Panagariya tant trade deflection. Because goods from Partner and 1999 for a comprehensive survey of literature using the RoW are fungible, the equilibrium is the same with and small PTA diagram in recent decades.) Here we study a without rules of origin, as long as Partner’s supply is suffi- fairly standard case and illustrate the diagram’s properties cient. If Partner’s supply were not large enough to supply by demonstrating two classic results in the regionalism lit- all of Home’s imports at PR + TP, the PTA with ROOs erature (figure 3A.2). would have somewhat higher prices than one without. Figure 3A.2. The Small PTA Diagram: A Simple Case PARTNER HOME euros euros trade trade volume price D S gain gain PR + TH trade P R + TP price loss PR XSRoW D S quantity quantity M’H M’H Source: Author’s modification of a diagram in Pomfret (1997). Economics 89 The use of this exercise in the big-think regionalism unit brings in extra revenue (represented by areas D + E), literature comes in the form of “imported liberalization/ but it also depresses the price received for all units sold ini- protection� (Grossman and Helpman 1995). tially, lowering revenue by an amount equal to area A. The Another application that found popularity in the aca- net change in revenue, termed “marginal revenue,� is given demic literature but seems odd today is the proposition by areas D + E minus area A. The change in cost, termed that PTAs will always break down. Using a diagram similar “marginal cost,� is area E. Plainly, profit only increases if to figure 3A.2, Vousden (1990, 234) argues that Home the extra revenue D – A exceeds the extra cost E. As it is would be tempted to lower its MFN tariff to just under that drawn, D – A + E appears to be negative, so marginal rev- of Partner in order to recapture the tariff revenue and that enue is less than marginal cost at Q' + 1. This means that Partner would have an incentive to reply. The resulting raising output from Q' would lower profits, and so the ini- race-to-the-bottom tariff cutting was viewed as making tial guess of Q' turned out to be too high. PTAs “unsustainable.� Vousden (1990) did not attract To find the profit-maximizing level using this trial-and- much attention until Richardson (1995) extended and error method, we would consider a lower guess—say, Q' popularized his proposition. These two results (irrelevance minus four units—and repeat the procedure applied of rules of origin and unsustainability of PTAs) are classic above. At the profit-maximizing level, marginal revenue examples of how academic thinking on regionalism often just equals marginal cost. This level must be optimal, since followed literature-driven paths that had little relevance to any increase or decrease in sales will lower profit. Increas- real-world policy concerns. ing sales beyond this point will increase cost more than revenue, while decreasing sales would lower revenue more than cost. Both would reduce profit. Annex B. A Brief Review of Imperfect The right-hand panel of figure 3B.1 presents an easier Competition Models way of finding the point at which marginal revenue equals We start with the simplest problem: the decision faced by a marginal cost. The diagram includes a new curve, the mar- firm that has a monopoly. The monopoly case is easy ginal revenue curve, which shows how marginal revenue because it avoids strategic interactions. When a firm is the declines as the level of sales rises. (It declines because area only seller of a product, it can choose how much to sell and A from the left-hand panel becomes very small for low lev- what price to charge without considering the reaction of els of sales.) At the sales level marked Q*, marginal revenue other suppliers. The only restraint a monopolist faces is the just equals marginal cost. The firm charges the most it can, demand curve. A downward-sloping demand curve is a P*, at this level of sales. These are the profit-maximizing constraint because it forces the monopolist to confront a levels of sales and price. trade-off between price and sales; higher prices mean lower Several aspects of imperfect competition come through sales. When considering the impact of regional integration even in the monopoly case. First, in setting up the problem, on imperfectly competitive firms, we need to determine we had to make assumptions about the firm’s beliefs con- how various policy changes will alter prices and sales. The cerning the behavior of other economic agents. In this case, first step in this direction is to see what determines a the monopolist is assumed to believe that consumers are monopolist’s price and sales in a closed economy. The nat- price takers and that the trade-off between prices and sales ural question then is, what is the profit-maximizing level of depends only on the demand curve rather than, for exam- sales for the monopolist? ple, on the reaction of firms in other markets. Second, the An excellent way to proceed is to make a guess at the critical difference between perfect and imperfect competi- optimal level—say, Q' in the left-hand panel of figure 3B.1. tion comes out clearly. As part of the definition, perfectly Almost surely, this initial guess will be wrong, but what we competitive firms are assumed to take the price of their want to know is whether it is too low or too high. To this output as given. (A classic example is a wheat farmer who end, we calculate the profit earned when Q' units are sold at cannot set his own price but just sells at the current market the highest obtainable price, P'. The answer is A + B, since price.) This means that such firms are assumed to be igno- the total value of sales is price times quantity (area A + B + rant of the fact that selling more will depress the market C) minus cost (area C). price. In terms of the diagram, perfectly competitive firms Would profits rise or fall if the firm sold an extra unit? ignore area A, so they maximize profits by selling an Of course, to sell the extra unit, the firm will have to let its amount at which price equals marginal cost. Of course, any price fall a bit, say, to P". The change in profit equals the increase in sales would have some negative impact on change in revenue minus the change in cost. Consider first price, so it is best to think of perfect competition as a sim- the change in revenue. This has two parts. Selling the extra plifying assumption that is close to true when all firms have 90 Richard Baldwin Figure 3B.1. Monopoly Profit Maximization price price P’ P* A P� marginal demand B D revenue curve curve marginal cost curve C E Q’ Q’ + 1 sales Q* sales Source: Author’s elaboration. market shares which are close to zero. By stepping away that economists call duopoly. For simplicity, we assume from this simplification, imperfect competition allows that the firms have the same marginal cost curves. Taking firms to explicitly consider the price-depressing effect— firm 2’s sales as given at Q2, firm 1 has a monopoly on the area A—when deciding how much to sell. residual demand curve labeled RD1. Firm 1’s optimal out- The monopoly case is instructive but not very realistic; put in this case is x1', since at point A1 the residual marginal most firms face some competition. Taking account of this revenue curve, RMR1, crosses the marginal cost curve, MC. reality, however, brings us up against the strategic consider- The right-hand panel shows the same sort of analysis for ations discussed above. The convention we adopt to sort firm 2. Taking firm 1’s output as fixed at Q1, firm 2’s opti- out this interaction is the so-called Cournot-Nash equilib- mal output is x2'. rium that won John Nash a Nobel prize. That is, we assume Note that the situation in the figure is not an equilib- that each firm acts as though the other firms’ outputs were rium. To highlight the importance of the difference fixed. The equilibrium we are interested in is that in which between expected and actual outcomes, the diagram each firm’s expectations of the other firms’ outputs turn shows the solutions of the two firms when expectations out to be correct; that is, no one is fooled. This no-one- about the other firm’s output do not match the reality. The fooled notion proves to be somewhat difficult to compre- consistent-expectations outcome (the Nash equilibrium) is hend in the abstract, but, as we shall see below, it is easy in shown in the next figure, but we first consider why figure specific applications. 3B.2 is not an equilibrium. As drawn, this is not a Cournot-Nash equilibrium because the firms’ actual output levels do not match Residual Demand Curve Shortcut expectations: firm 1 produces x1', which is greater than Since firms take as given the sales of other firms, the only what firm 2 expected (that is, Q1), and similarly, firm 2 constraint facing a typical firm is the demand curve produces x2', which is greater than what firm 1 expected shifted to the left by the amount of sales of all other (Q2). We can also see the problem by observing that the firms. In other words, each firm believes it is a monopo- implied prices are not equal. If these quantities were actu- list on the shifted demand curve. (We called the shifted ally produced by the firms, then firms would not be able to demand curve the residual demand curve.) This realiza- charge the prices they expected to charge. In other words, tion is handy because it means that we can directly apply this is not an equilibrium because the outcome is not con- the solution technique from the monopolist’s problem; sistent with expectations. the only change is that we calculate the marginal revenue curve on the basis of the residual demand curve instead Finding the Expectations-Consistent Equilibrium of the demand curve. This trick is shown in figure 3B.2 for a competition The easiest way to find the expectation-consistent set of between two firms producing the same good—a situation outputs is to exploit the assumed symmetry of firms. In Economics 91 Figure 3B.2. Duopolist as Monopolist on Residual Demand: Example of a Nonequilibrium price price ’s firm 1 expectation of firm 2’s expectation of sales by firm 2, Q2 sales by firm 1, Q1 p 1’ demand demand curve (D) curve (D) p2’ residual demand curve, firm 1 (RD1) residual demand curve, firm 2 (RD2) MC MC A1 A2 x1’ firm 1 sales x2’ firm 2 sales residual marginal revenue residual marginal revenue curve, firm 1 (RMR1) curve, firm 2 (RMR2) Source: Author’s elaboration. Figure 3B.3. Duopoly and Oligopoly: Expectation-Consistent Outputs DUOPOLY OLIGOPOLY price typical firm’s expectation price typical firm’s expectation of the other firm’s sales of the other firm’s sales p* D D p** RD RD’ A MC A MC RMR RMR’ x* 2x* sales x** sales 3x** Source: Author’s elaboration. the symmetric equilibrium, each firm will sell the same to note are that (a) the optimal output for a typical firm is amount. With this fact in mind, a bit of thought reveals x*, given by the intersection of RMR and MC; (b) total that the residual demand curve facing each firm must be sales to the market are 2x*, and at this level of sales the half of the overall demand curve. This situation is shown in overall market price (given by the demand curve D) is con- the left-hand panel of figure 3B.3 for a duopoly. Some facts sistent with the price each firm expects to receive, given the 92 Richard Baldwin residual demand curve, RD; and (c) the outputs of the the market equilibrium. Modeling TBTs in such “sexy� industries will cer- tainly be the subject of much future work, but in this chapter we focus on identical firms are equal in equilibrium. mundane industries in which TBTs act by raising the costs of foreign Although allowing for two firms is more realistic than firms more than the costs of local firms. allowing for only one firm, studying the impact of integra- 9. The left-hand panel of figure 3A.1 translates the effects into tion on mergers and acquisitions requires us to allow for an Meade’s two-part framework: B + D is the trade volume effect (related to the change in the volume of imports), and E is the trade price effect arbitrary number of firms. In economists’ jargon, such a (related to the change in the border price). situation is called an oligopoly. As it turns out, this situa- 10. This contrast is the source of the rule of thumb that a PTA with tion is straightforward in dealing with the case in which your main trading partners is more likely to be welfare improving, since you are giving preferences to the partners that have demonstrated them- firms are symmetric. As more firms compete in the market selves to be the low-cost suppliers by winning the largest market share in (consider three instead of two), the residual demand curve an even competition with other suppliers. facing each shifts inward, so that the residual marginal rev- 11. The early 1980s saw a number of widely read studies that sought to reverse the Johnson-Cooper-Massell (JCM) proposition while retain- enue curve also shifts inward. The implications of this shift ing the small-country framework. These efforts (e.g., Wonnacott and for prices are clear. The new RMR = MC point occurs at a Wonnacott 1981; Berglas 1983) strike the modern reader as awkward lower level of per-firm output, implying a lower price. In because of the small-nation assumption and the intricate diagrammatic equilibrium (i.e., where outcomes match expectations), analysis. each of the three firms produces an identical amount and charges an identical price. What happens is that as the num- Bibliography ber of firms continues to rise, each increase in the number of competitors shifts the RD facing each firm. This will Balassa, Bela. 1967. “Trade Creation and Trade Diversion in the European Common Market.� Economic Journal 77: 1–21. inevitably lead to lower prices and lower output per firm. Baldwin, Richard. 1989. “The Growth Effects of 1992.� Economic Policy Of course, this analysis simply formalizes what most 9: 247–82. readers would expect. If one adds more competitors to a ———. 2008. “Managing the Noodle Bowl: The Fragility of East Asian Regionalism.� Singapore Economic Review 53 (3): 449–78. market, prices will fall, along with the market share of ———. 2010a. “21st Century Regionalism: Filling the Gap between 21st each firm. As is so often the case, the brilliant concepts Century Trade and 20th Century Trade Governance.� http://eiitf.iift are simple. .ac.in/Richard%20Baldwin%20-%2021st%20Century%20Regionalism .pdf. ———. 2010b. “Unilateral Tariff Liberalisation.� NBER Working Paper Notes 16600, National Bureau of Economic Research, Cambridge, MA. Baldwin, Richard, Simon Evenett, and Patrick Low. 2009. “Beyond Tariffs: 1. The basic problem was that the profession found the simple trade Multilateralizing Non-Tariff RTA Commitments.� In Multilateralizing creation–trade diversion paradigm to be effective in communicating the Regionalism: Challenges for the Global Trading System, ed. Richard crucial welfare-ambiguity result, but the words did not fully capture all Baldwin and Patrick Low. Geneva: World Trade Organization. the basic economic effects. Arvind Panagariya suggests that the terms per- http://us-cdn.creamermedia.co.za/assets/articles/attachments/19838 sist because they are “highly effective tools of focusing policy makers’ _multila_region_e.pdf. attention on the ambiguous welfare effects of [regional trade associa- Baldwin, Richard, and Anthony Venables. 1995. “Regional Economic tions]� (Panagariya 1999). Integration.� In Handbook of International Economics, vol. 3, ed. Gene 2. Of course, when considering the full economic impact, one must Grossman and Kenneth Rogoff, 1597–1644. Amsterdam: North consider scale economies, procompetitive effects, variety effects, location Holland. effects, and growth effects (Baldwin and Venables 1995). Most of these, Baldwin, Richard, and Charles Wyplosz. 2009. The Economics of European however, are not critical in the “big-think� regionalism literature. Integration. 3rd ed. New York: McGraw-Hill. 3. Readers may mentally insert a fourth untaxed good that enters the Berglas, Eitan. 1983. “The Case for Unilateral Tariff Reductions: utility function linearly, to formally eliminate Meade’s tertiary effects. Foreign Tariffs Rediscovered.� American Economic Review 73 (5): 4. The PTA diagram can be thought of as a modification of the Black- 1141–42. hurst (1972) diagram. Bhagwati, Jagdish. 1971. The World Trading System at Risk. Princeton, N.J.: 5. Given the symmetry, an FTA is automatically a customs union. Princeton University Press. 6. Area C2 might be called the “trade diversion� effect, and D2 + A Blackhurst, Richard. 1972. “General versus Preferential Tariff Reduction might be call the “trade creation� effect, but, as usual, the trade creation- for LDC Exports: An Analysis of the Welfare Effects.� Southern Eco- trade diversion dichotomy is incomplete. Here, it omits the third-nation nomic Journal 38: 350–62. terms-of-trade gain, B. Brulhart, Marius. 2009. “An Account of Global Intra-Industry Trade, 7. For the results, see World Bank, Trade, http://www.worldbank.org/ 1962–2006.� World Economy 32 (3): 401–59. trade/standards. Carpenter, Theresa, and Andrea Lendle. 2010. “How Preferential Is World 8. In certain industries, the impact of TBTs is radically more complex. Trade?� CTEI Working Paper. In industries with network externalities, such as mobile telephones, stan- Cooper, C. A., and B. F. Massell. 1965. “A New Look at Customs Union dards can be manipulated to throw up barriers against nonlocal firms. In Theory.� Economic Journal 75: 742–47. industries with patent races (e.g., pharmaceuticals) a regulation that Corden, W. Max. 1965. “Recent Developments in the Theory of Interna- merely delays the introduction of foreign goods can radically alter the tional Trade.� Special Papers in International Economics 7, Interna- market outcome in favor of home firms. In industries with learning tional Finance Section, Princeton University, Princeton, N.J. curves, product standards that apply to only a fraction of the market— Dixit, Avinash, and Victor Norman. 1980. Theory of International Trade. government or military purchases, for example—can have large effects on Cambridge, U.K.: Cambridge University Press. Economics 93 Fukunari, Kimura, and Mitsuyo Ando. 2005. “Two-Dimensional Frag- ———. 1999. “Preferential Trade Liberalization: The Traditional Theory mentation in East Asia: Conceptual Framework and Empirics.� Inter- and New Developments.� Journal of Economic Literature 39 (2): national Review of Economics and Finance 14 (3): 317–48. 287–331. Grossman, Gene M., and Elhanan Helpman. 1995. “The Politics of Free- Panagariya, Arvind, and Ronald Findlay. 1994. “A Political-Economy Trade Agreements.� American Economic Review 85: 667–90. Analysis of Free Trade Areas and Customs Unions.� Policy Research Haberler, Gottfried. 1936. The Theory of International Trade with Its Appli- Working Paper 1261, World Bank, Washington, DC. cations to Commercial Policy. New York: Macmillan. Pomfret, Richard. 1997. The Economics of Regional Trading Arrangements. Humphrey, D. C., and C. E. Ferguson. 1960. “The Domestic and World Oxford, U.K.: Oxford University Press. Benefits of a Customs Union.� Economia Internazionale 13: 197–213. Puga, Diego, and Anthony Venables. 1998. “Trading Arrangements and Johnson, Harry G. 1953. “Optimum Tariffs and Retaliation.� Review of Industrial Development.� World Bank Economic Review 12 (2, May): Economic Studies 21 (2): 142–53. 221–49. ———. 1957. “Discriminatory Tariff Reduction: A Marshallian Analysis.� Richardson, Martin. 1995. “Tariff Revenue Competition in a Free Trade Indian Journal of Economics 5: 39–47. Area.� European Economic Review 39: 1429–37. ———. 1958. “Marshallian Analysis of Discriminatory Tariff Reduction: Shibata, Hirofumi. 1967. “The Theory of Economic Unions: A Compara- An Extension.� Indian Journal of Economics 6: 177–82. tive Analysis of Customs Unions, Free Trade Areas and Tax Unions.� ———. 1960a. “The Cost of Protection and the Scientific Tariff.� Journal In Fiscal Harmonization in Common Markets, ed. Call S. Shoup, of Political Economy 68: 327–45. vol.1, 145–264. New York: Columbia University Press. ———. 1960b. “The Economic Theory of Customs Unions.� Pakistan Smith, Adam. 1776. The Wealth of Nations. Repr., Chicago, IL: University Economic Review 10: 14–30. of Chicago Press, 1977. ———. 1965. “An Economic Theory of Protectionism, Tariff Bargaining Taussig, Frank. 1892. “Reciprocity.� Quarterly Journal of Economics 7: and the Formation of Customs Unions.� Journal of Political Economy 26–39. 73: 256–83. Torrens, Robert. 1844. The Budget: On Commercial and Colonial Policy. Kemp, Murray C., and Henry Y. Wan, Jr. 1976. “An Elementary Proposi- London: Smith, Elder. tion Concerning the Formation of Customs Unions.� Journal of Inter- Viner, Jacob. 1950. The Customs Union Issue. New York: Carnegie Endow- national Economics 6 (1): 95–97. ment for International Peace. Meade, James E. 1955. The Theory of Customs Unions. Amsterdam. North- Vousden, Neil. 1990. The Economics of Trade Protection. Cambridge, U.K.: Holland. Cambridge University Press. Panagariya, Arvind. 1996. “APEC and the United States.� CIES Discussion Wonnacott, Paul, and Ronald J. Wonnacott. 1981. “Is Unilateral Tariff Paper 96/08, Center for International Economic Studies (CIES), Reduction Preferable to a Customs Union? The Curious Case of the University of Adelaide, Adelaide, Australia. Missing Foreign Tariffs.� American Economic Review 71: 704–14. 4 NORTH-SOUTH Preferential Trade Agreements Bernard Hoekman This chapter argues that if preferential trade agreements The next section provides a brief context for the trade- (PTAs) are to be development-friendly, they must focus on related reform agenda that confronts developing countries. complementing liberalization in trade goods with behind- Some rationales for and challenges facing North-South the-border regulatory reforms that are supported through PTAs are then discussed from a development perspective, development assistance instruments and that engage the and the evolving status quo is described. Suggestions for private sector. Such an extension of the PTA agenda to reg- further steps are presented, proceeding from the assump- ulatory issues can be beneficial to developing countries. Yet tion that the focus of North-South trade agreements is to deep and comprehensive PTAs between developed and promote development. Given that preferential market developing countries bring new risks. The proposed norms access liberalization is a second-best exercise from a global may limit policy freedom in inappropriate ways or may welfare perspective, proposals are developed to encourage result in the allocation of resources to areas that offer few the pursuit of nondiscriminatory liberalization and a immediate benefits or that are complex and costly to much more targeted focus on the key constraints that pre- implement. A redesign of the approach to PTAs—to liber- vent developing countries from benefiting more from trade alize and expand market access, to build in policy flexibility opportunities. Current approaches toward PTAs with and accountability, and to broaden technical assistance—is developing countries that are being pursued by the Euro- needed. pean Union (EU) are assessed in light of these proposals. A basic premise is that a shift in objective from market The intention is not to be comprehensive or to single out access or market integration to development means that the EU; a similar analysis could be applied to recent U.S. the modus operandi of negotiating and implementing PTAs. It is, however, true that the EU has been at the fore- trade agreements will have to change. One reason is that front in seeking to use PTAs as instruments for promoting many of the poorest countries may not benefit much from development. Finally, the conclusions from the discussion a traditional trade agreement; they already have good are summarized. access to major markets through nonreciprocal preference schemes, and they confront potential welfare losses if they Stylized Facts and Key Policy Challenges pursue preferential liberalization in favor of PTA partners only. Another reason is that the priority needs in many Until the global economic crisis struck in 2008, the world poor developing countries are not related to trade policy had witnessed a rapid expansion in developing-country but revolve around bolstering trade capacity, improving trade. The share of the developing economies in world the investment climate, and maintaining a competitive real trade increased from 20 percent in 2000 to 30 percent in exchange rate. PTAs can help address some of these priori- 2008 (World Bank 2010b), and all regions experienced ties, but only if they are appropriately designed and effec- greater integration with the rest of the world. There are, tively implemented. however, important differences among developing countries 95 96 Bernard Hoekman with respect to both the growth in trade and its pattern and objective at lower social cost, or complementary policies can structure. The poorest countries generally did less well be identified to address the by-product costs of openness. than middle-income economies in the 1990s, partly The persistence of trade policies can be explained by because of the dependence of their foreign exchange earn- political-economy reasons. Even though the aggregate ings on agricultural commodities. This helps explain why income and wealth of a nation may be expected to grow Sub-Saharan Africa’s share of nonoil world trade remains when trade distortions are reduced, not everyone will far below the level that prevailed in the 1970s, despite rela- gain. Owners of previously protected inefficient firms tively good growth and trade performance during most of will lose, as may their workers, especially if there are the first decade of the twenty-first century. doubts regarding the creation of new employment Research suggests that a lack of diversification is associ- opportunities. Social insurance and adjustment assis- ated with lower growth and greater output volatility. Africa tance mechanisms may not exist or may be weak. These is the least diversified region in the world today. Agricul- realities underline the importance of complementary tural trade remains highly important for Sub-Saharan reforms to increase the likelihood of realizing the bene- African countries, accounting for 25 percent or more of fits from trade reforms. total exports. One consequence is that countries are subject The list of beneficial concomitant reforms can be long to greater commodity price (terms-of-trade) volatility than and rather formidable. This, however, does not necessarily are more diversified economies, and the effect of this imply that there are difficult trade-offs to be made; most of volatility is more persistent (World Bank 2010a). Imbs and the policies are essentially additive to trade liberalization in Wacziarg (2003) note that countries at early stages of devel- the sense that they do not give rise to trade-offs (Winters opment experience a positive relationship between export 2004).2 Social costs may be lower if adjustment can be (output) diversification and growth, suggesting that from a spread over a period of time, as long there is confidence development perspective, the policy focus should be on that reform will actually occur. Without credible commit- support for greater diversification (Newfarmer, Shaw, and ment to a clearly defined and commonly known final goal, Walkenhorst 2009; Haddad, Lim, and Saborowski 2010). investments and adjustments may look undesirable, and Existing programs that center on promoting trade of efforts may be diverted to lobbying. Trade agreements can developing countries—especially nonreciprocal preferen- play an important role in this connection by laying out a tial access to Organisation for Economic Co-operation timetable for gradual liberalization that is credible because and Development (OECD) markets—have not been very it is enforceable by trading partners. effective.1 Major reasons for this inefficiency include supply- Failure to maintain a realistic real exchange rate has side weaknesses, civil conflicts, macroeconomic policies been one of the main causes of unsuccessful trade liberal- that resulted in overvalued currencies, governance prob- izations in developing countries (World Bank 2001). lems, corruption, and institutional weaknesses that inhibit Another cause is failure to address the fiscal consequences local entrepreneurs from taking advantage of market of tariff revenue losses. These losses are far from inevitable, opportunities. The question, then, is to identify what PTAs especially if nontariff barriers are converted into tariffs, could do to help achieve progress on such issues. exemptions are reduced, and tariff collections are improved. But they can pose a problem for poorer coun- tries in which trade taxes account for large proportions of Reform Priorities total revenue. Developing alternative sources of revenue Because average tariff barriers in developing countries may take time. Experience suggests, however, that moving remain higher than in industrial ones, much of the poten- toward a more uniform tariff structure and a concomitant tial welfare gain from trade reforms will arise from their elimination of exemptions may increase revenue collec- own liberalization. The reasons for imposing trade barriers tion, providing the space to develop alternative tax bases vary; they include infant-industry protection (import- before undertaking more far-reaching liberalization. substitution industrialization), balance of payments con- A major area in which administrative constraints bind is siderations (concerns that liberalization will increase institutional reforms. Given the importance of building up imports more than exports), and fiscal revenue objectives. the legitimacy and ownership of these reforms among the (Tariffs are easy to collect and can be a significant source of population, not only significant “technical� setup time but government income.) All these reasons are second-best in also a good deal of “political� time is required. Getting most circumstances, in that a lower-cost domestic policy institutions right the first time is very difficult, if not instrument can, in principle, be identified to satisfy the impossible, and continuing monitoring and adjustment North-South Preferential Trade Agreements 97 are needed. There are often advantages to proceeding on a is labor mobility. If labor markets are segmented or dis- broad front in order to maintain some semblance of fair- torted, benefits will be reduced. ness, and extensive institutional reforms are likely to • Establishment of new businesses. Cumbersome regula- require time and considerable administrative skill to carry tions for establishing new firms, constraints on access out. These observations apply, in particular, to regulatory inputs (such as utilities), and restrictions on physical policies and the agencies responsible for implementing expansion or labor recruitment and separation can cur- them, because regulation can give rise to significant operat- tail the willingness of entrepreneurs to start or expand ing costs and entry barriers for firms in a given market operations. once tariffs have been lowered. Tariff reforms can be exe- cuted at the stroke of a pen; regulatory reforms are much All these themes are highlighted in the research that more complex. focuses on the magnitude and determinants of adjustment costs and the factors that affect the size and distribution of the gains from trade reforms (Porto and Hoekman 2010). Designing Successful Reforms Thus, the benefits of trade liberalization depend, in part, on Governments have to build up support for their policies. support from other policies and institutions. Openness can Powerful interests will need to be assuaged—unless help induce improvements in these dimensions by making reforms are implemented in the context of major eco- them more “visible� and by creating incentives to fix the nomic crises. Compensating these interests through the problems, but additional investments and reforms will be careful design of complementary policies is not just a mat- required to address many of the constraints. For landlocked ter of sordid logrolling.3 Although any single efficiency- countries and poor, remote economies, reducing trade costs enhancing reform will hurt someone, if enough of them is often of critical importance. As discussed below, develop- are packaged together, negative effects will be netted out, ment assistance and mechanisms for monitoring impacts and many more people and interests will gain, on balance. can help ensure that reforms are effective and can anchor This is one of the main reasons for proceeding on a broad expectations (i.e., increase credibility). Trade agreements front. It is of great importance to ensure that potential ben- can provide focal points, but only if they address national eficiaries from trade-related reforms have the capacity to priorities—and are seen to do so—and are implemented. actually exploit new trade opportunities. This requires attention to the business environment and transaction Trade Liberalization Strategies: What Role Is costs, measures to enhance the productivity of firms and for Preferential Agreements? farms, improvement of connectivity to markets, steps to ensure access to finance, and the like. Specific areas for For governments that have decided to pursue opening of attention may include the following: the economy, a practical question is how to do so. Starting in the 1960s, a number of economies were highly successful • Infrastructure support. Farmers need to be able to reach in increasing incomes and reducing poverty. Notable major market centers at reasonable cost, firms need examples include Chile; Hong Kong SAR, China; the access to a reliable and efficient power supply, and so Republic of Korea; Singapore; and Taiwan, China. More on. In poor countries, transport (logistics) and transac- recently, China, Malaysia, Mauritius, and Turkey, among tion costs are often a multiple of any tariffs exporters others, have joined the list. All of them dramatically confront. This is one explanation for the more limited increased their ratio of trade to gross domestic product participation of poor countries in the process of inter- (GDP), but they pursued considerably different models of national specialization that was noted previously. trade policy reform and economic integration. The success • Credit markets. Access to finance is a critical input, both stories may be grouped into four broad categories: for new start-ups and for the expansion of existing plants. For example, achieving minimum consignment • Economywide trade liberalization. Some economies have size might entail hiring draft power or seasonal labor, pursued very liberal, most favored nation (MFN) trade but this is not possible without credit. Credit con- regimes, avoiding nontariff barriers and adopting either straints are a major reason for limited adjustment to free trade (as did Singapore and Hong Kong SAR, trade reforms. China) or low, nonnegotiable, uniform tariffs (e.g., Chile • Labor markets and mobility. The primary vehicle for and Estonia, before the latter’s accession to the EU). Since spreading widely the benefits of increased labor demand the creation of the World Trade Organization (WTO) in 98 Bernard Hoekman 1995, a number of countries have pursued MFN liberal- countries simply will not be that interested because the ization in the context of accession to that body, using developing countries’ markets are too small. Second, and a the WTO to anchor and precommit to reform; this was related factor in PTA negotiations, quid pro quo “pay- the case for China and Vietnam. ments� are likely to be requested in nontrade areas such as • Protection with offsetting policies for exporters. Other regulatory regimes, investment policy, and so on (Schiff economies reduced the incentives created by protection and Winters 2003; Limão 2007). That raises the issue of to produce for the domestic market, employing elabo- whether, in the negotiating process, governments lose rate systems that offset the bias against exports, includ- access to potentially useful instruments for promoting ing complex duty-drawback systems. Japan (in the early development. (See, for example, Fink, ch. 18 in this volume.) stages); Korea; and Taiwan, China, are examples. • Protection with export-processing zones. Along with pro- The Primacy of National Circumstances and Priorities tection, exporters located in specific zones are offered tariff-free access to intermediate inputs, with better A challenge for developing-country governments is not only infrastructure and fewer regulatory requirements. The to generate better access to partner markets but also to use limited geographic scope of the zones makes them eas- the PTA as a vehicle for promoting competition, reducing ier to manage, for countries with weak governance, than policy uncertainty, and improving the investment climate the “Asian� economywide model. Few countries have and business environment. Ensuring that deep integration succeeded in stimulating exports substantially through will benefit developing-country PTA members requires that this model. An exception is Mauritius, where the zones the specifics of regulation and cooperation reflect national generated about two-thirds of gross exports and circumstances. Regulatory standards and institutions need employed one-sixth of the workforce. Zones have also to be tailored to national circumstances to be effective and played a significant role in China. attain the desired objective. An increasing body of evidence • PTAs. An increasing number of countries are joining has shown that a “one-size-fits-all� approach—including PTAs to provide a focal point or blueprint for reforms, a international best-practice norms—may not be appropriate. mechanism for increasing market size and enhancing For example, Barth, Caprio, and Levine (2006), in a com- the contestability of markets, and a means of overcom- prehensive cross-country assessment of the impact of the ing political-economy resistance to reforms. Examples Basel Committee’s standards for bank regulation, find no are accession to the EU by many Central and Eastern evidence that any single set of best practices will necessarily European countries, Turkey’s entrance into a customs promote well-functioning banks. They argue that a high union with the EU, and Mexico’s membership in the degree of country specificity may be needed, rather than North American Free Trade Association (NAFTA). In all mere adoption of international norms “off the shelf.� these instances, PTA membership complemented WTO What may be most appropriate from an economic wel- accession or membership. fare (development) perspective is to create a framework for assisting governments in identifying good policies, rather The first three approaches are unilateral. Trade liberal- than a system that is premised on negotiated harmoniza- ization by other countries is clearly desirable, however; tion or convergence. Instead of being (too) prescriptive ex trade negotiations are the time-honored mechanism for ante, there is a case for maintaining flexibility conditional seeking such liberalization. In South-South agreements, on ex post monitoring of outcomes. An important corol- the focus is increasingly on expanding the size of the mar- lary of such an approach must be “restraint� on the part of ket by not only abolishing trade barriers but also easing large industrial partner countries in PTAs and accounta- internal constraints on intraregional trade and investment bility for performance and outcomes. Creating a focal through improvement of infrastructure trade facilitation point for constructive, as opposed to adversarial, interac- and transit and corridor management. Given the large tions between governments on the competitive, market- asymmetries in economic power (as indicated by market segmenting effects of regulation—or lack of regulation— size), the challenge for small and poor countries in North- and on the costs and benefits of specific reforms could do South agreements is to ensure that any negotiated outcome much to mobilize the needed support by constituencies in is in their interest. Such countries have very little scope to developing-country PTA members. This is especially so if use their trade policies as an instrument for inducing other the high costs of adjustment and of subsequent compliance countries to open up their markets. There are two implica- by developing-country members are recognized through tions. First, unilateral reforms cost developing countries increased technical assistance and investment to upgrade little in mercantilist terms—large (potential) PTA partner facilities (Hoekman and Winters 2009). North-South Preferential Trade Agreements 99 The Continuing Evolution of PTAs development perspective, the acid test is whether the pro- posed or negotiated rules in regulatory areas will improve The growth of PTAs has been significant. Recent PTAs tend the business environment and address supply-side priori- to be more open than earlier vintages, many of which were ties. Proponents of deep integration in North-South agree- designed to implement import-substitution strategies at the ments argue that binding disciplines in areas such as regional level. They also increasingly involve North-South competition and investment policy are critical for integrat- cooperation and extend to behind-the-border regulatory ing markets. This point is discussed further below. policies relating to investment, labor, environment, and All this information may help explain why recent PTAs competition. Examples involving the United States include involving countries that object to the inclusion of issues bilateral agreements with Australia, Chile, Central America, such as investment and competition in the WTO—not to Jordan, and Morocco. Investment and competition policies speak of more controversial subjects such as labor and are being discussed as part of the economic partnership environmental standards—may include disciplines in these agreement negotiations between the EU and the African, areas at the regional level. Presumably the net balance is Caribbean, and Pacific (ACP) countries and are on the positive, in part, because the smaller number of negotiating agenda of the EU’s association agreements with non-ACP parties makes it easier to exclude issues that are sensitive countries.4 and to identify quid pro quo deals. But deeper integration Often, the implementation of such policies may entail may not be beneficial to all signatories. From a develop- pecuniary spillovers to other countries, providing a ment perspective, the issue is not whether there are net rationale for cooperation on, for example, tax or other benefits but how to maximize the potential payoffs. There incentive programs to attract foreign direct investment. In may be cause for concern, in particular, about PTAs that many cases, however, the purported rationale is that the offer partial access to large markets for goods in exchange disciplines themselves will promote development. From a for acceptance of regulatory norms that may do little, if development perspective, the extension of PTAs to regula- anything, to increase the flow of investment to developing- tory issues can be beneficial if it improves policy credibil- country partners. The use, however, of PTAs as a frame- ity, thereby reducing risk premiums and helping attract work to reduce the frictional costs of trade by harmonizing investment. There is a prima facie case that regional coop- regulations and standards, increasing the credibility of eration on regulatory issues may be advantageous. Part- reform initiatives, or acting as vehicles for governments to ners, to begin with, may be rather similar and may have test the waters of freer trade may be very beneficial, even if common legal or administrative systems. North-South they are difficult and complex to realize. PTAs also tend to be associated with transfers of finance Summing up, there is a clear trend for PTAs to go and knowledge (technical assistance), potentially helping beyond trade in manufactures. Recent U.S. PTAs include reduce implementation and adjustment costs. In addition, agriculture, and movement on this front is discernable in high-income partners may provide offers of assistance in the EU; the Euro-Mediterranean negotiations include a the form of implicit “insurance,� as in the case of U.S. proposal to pursue reciprocal liberalization of trade in financial intervention to assist Mexico during the “tequila agricultural products. Services, investment, and regulatory crisis.� regimes are areas where, it can be argued, there is much to In part, the expansion of the negotiating agenda is be gained by developing countries from policy reforms and driven by a need to mobilize additional political support liberalization. There are potential concerns about these for abolishing the remaining trade-distorting policies in areas insofar as developing countries perceive proposed or areas such as agriculture. The Uruguay Round was actual disciplines not to be in their interests but still neces- premised on such a grand bargain, with developing coun- sary if these countries are to (continue to) gain preferential tries accepting new disciplines in a variety of areas, includ- access to northern markets. Clearly, much depends on the ing intellectual property rights (IPRs) and services, in coverage of the agreements and, in particular, on whether return for the elimination of the Multifibre Arrangement, the regulatory disciplines for behind-the-border policies the outlawing of voluntary export restraints, and inclusion are appropriate in the sense that the benefits outweigh the of agriculture in the WTO.5 A similar dynamic is driving costs of implementation. Much also depends on the extent PTAs today. The regulatory standards that are written into to which merchandise trade is liberalized, through, for trade agreements generally start from the status quo pre- example, access to agricultural markets and removal of the vailing in OECD countries, so that the lion’s share of asso- threat of contingent protection, and whether services liber- ciated implementation costs—but presumably also of the alization is covered, through all modes of supply, including benefits—lies with developing-country signatories. From a mode 4 (temporary movement of service providers). 100 Bernard Hoekman The tariff equivalents of the trade-restricting effects of The first two objectives are the bread and butter of PTAs. domestic policies are a large multiple of the prevailing bor- Their realization is constrained by political-economy der tariffs today. Further services liberalization would have forces. Small, poor countries have little to offer, in mercan- much greater positive effects on national welfare than would tilist terms, to induce large countries to remove policies that the removal of trade barriers—see, for example, Konan and harm them. Such market access, however, is important for Maskus (2006) on Tunisia, and Jensen, Rutherford, and Tarr mobilizing political support for domestic reforms in the (2007) on the Russian Federation. The “standard� increase in developing-country partner. A problem is that nonrecip- welfare from goods liberalization is 1 percent, but introduc- rocal preference programs may imply that exporters tion of greater competition on services markets raises the already have free access to the high-income market or gains to the 5–10 percent range or more. These large effects markets. The third objective, MFN-based liberalization, of services liberalization—for which there is increasing does not, of course, drive PTAs, which revolve around dis- econometric evidence (Francois and Hoekman 2009)— criminatory access.6 reflect both the importance of services in the economy and Realization of the fourth objective, adoption of comple- the extent to which many sectors continue to be protected. mentary measures, is the key challenge, if North-South There are, indeed, potentially large gains from reducing the PTAs are to be most relevant from a development perspec- prevalence and costs of differences in regulation, as well as tive. It may be impeded by the fact that the rules embedded the incidence of policies that simply prevent access to spe- (or proposed) in North-South PTAs tend to reflect the sta- cific markets. A key question, however, is whether progress tus quo in the high-income countries. From a development on liberalization can be, and is being, facilitated through perspective, the extension of PTAs to regulatory issues can PTAs, specifically. be beneficial if it improves policy quality or credibility, A recent assessment by Roy, Marchetti, and Lim (2006) thereby reducing risk premiums and helping to attract concludes that many of the trade agreements reported to investment. Regional cooperation may be more effective in the WTO since 2000 show a sectoral coverage that greatly this regard than multilateral cooperation because the part- exceeds the commitments the countries involved made in ners may be more similar; for example, they may have the General Agreement on Trade in Services (GATS). In common legal or administrative systems. As discussed areas where there are no WTO disciplines (e.g., on safe- below, North-South PTAs also tend to be associated with guards, subsidies, and procurement), there tend not to be more extensive transfers of finance and knowledge (techni- PTA rules either. The same is true for domestic regula- cal assistance), potentially helping to reduce implementa- tion; only one PTA (the Trans-Pacific Economic Partner- tion and adjustment costs. Proponents of deep integration ship Agreement, between Brunei Darussalam, Chile, in North-South agreements often argue that binding com- New Zealand, and Singapore) has established an across- mitments in areas such as competition law and regulation the-board necessity test—that is, an assessment of are critical for integrating markets and that it is easier to whether the trade-restricting effects of a policy are neces- envisage enforcement among the small number of partner sary to achieve the underlying regulatory objective (Fink countries. Although this can certainly be the case, the spe- and Molinuevo 2007). cific disciplines that are embedded in a PTA may not be a priority for development, implying that even if financial and technical assistance is made available, it could consti- Harnessing Regional Integration for tute diversion because the resources would have had a Development higher return elsewhere. It can be argued that, to be most beneficial to developing- None of the four objectives is straightforward to country signatories, PTAs should achieve, explaining why many PTAs have partial coverage in market access terms and include rules that may not • Remove foreign barriers to trade in products in which be first-best for developing-country members. If PTAs are developing countries have a comparative advantage. to do more to satisfy the four criteria suggested, the modus • Lower domestic barriers that raise the prices of goods operandi of designing and implementing them should give and services that firms and households consume. more weight to development considerations (economic • Promote more general MFN-based liberalization, which efficiency and equity). Concretely, four changes could best serves global development prospects. make North-South PTAs more development-friendly: • Support the adoption of complementary measures, reforms, and investments that allow the potential bene- • Unconditional acceptance by all parties to a PTA of fits of trade opportunities to be realized. MFN liberalization of trade in goods and services by North-South Preferential Trade Agreements 101 developing-country signatories, and preferential removal should be MFN reform as well—there is no reason to dif- of all barriers by OECD partner countries—bound, in ferentiate between developing countries. In effect, the both cases, by an enforceable treaty instrument MFN proposal implies emulation of the type of asymmet- • Construction of mechanisms to pursue priority ric liberalization that has been the norm in the General national regulatory policy objectives in developing- Agreement on Tariffs and Trade (GATT) and WTO, with country partners, as opposed to harmonization with the the difference being that in the North-South PTA con- standards of OECD countries, while maintaining the text, the northern countries “go all the way�—commit to role of PTAs as a commitment device free trade. Insofar as the North is not willing to do this for • Strengthened, grant-based financing mechanisms (aid large developing countries, the WTO can and should be for trade) to improve trade supply capacity and increase used as an instrument for reciprocal liberalization; the fact the benefits of trade reforms for poor households, using that the full preference rule might prevent PTAs from a local analysis of needs, with allocations determined by forming is, of course, not a problem from a global welfare the country’s overall development strategy perspective. • Active engagement by and with the private sector in the The “full Monty� rule for the North is consistent with surveillance and enforcement of the implementation of the thrust of current WTO rules for regional agreements, the various dimensions of the PTA, including the provi- except that it would go beyond the “substantially all trade� sion of financial and technical assistance. requirement to cover all trade. Although a formal rule change to this effect would be desirable, as noted by many—see, for example, Mavroidis (2005)— GATT Article Adjusting the Rules to Promote Market Access XXIV (allowing an exception to the MFN rule to permit PTAs are a steadily increasing source of discrimination in PTAs) and the Committee on Regional Trade Agreements trade today. Lowering the external levels of PTA protection to are basically defunct. Absent effective enforcement of the reduce the extent of discrimination against nonmembers— rules, seeking to change them is a largely irrelevant exer- which will often be developing countries—would promote cise. Thus, in practice, full liberalization is an action that the global public good. A solution offered by “realists� has needs to be taken unilaterally by northern countries. There been to point to MFN liberalization through WTO nego- is no need to change Article XXIV to permit the implemen- tiating rounds, according to the fact that efforts to regu- tation of this aspect of the proposal; what is needed is a late PTAs through the WTO rule-making and enforcement meaningful commitment to take development seriously.8 process have been totally ineffective (Mavroidis 2005). In That cannot be said for the suggestion that developing principle, however, if development were to be taken more country partners commit to MFN liberalization. Both seriously as a goal, changing the WTO rules on regionalism Article XXIV and the Enabling Clause—which allows could help make the PTA process more development- developing countries to liberalize less, especially where friendly. Concretely, high-income countries would be South-South agreements are concerned—would be required to liberalize in all sectors (not just “substantially implicated by an MFN rule. In terms of Article XXIV all�) on a preferential basis, with liberal and simple rules requirements, it may be easier to pursue a waiver for spe- of origin.7 Conversely, developing-country signatories cific PTAs, as MFN-based reform implies that all WTO would reduce their tariffs and apply negotiated trade policy members stand to gain from the PTA. This solution leaves commitments on an MFN basis. This MFN liberalization the inconsistency with the Enabling Clause to be resolved. would not imply a requirement to move to zero tariffs Arguably, the economics here are clear: pursuing a MFN across the board; instead, the goal would be a significant strategy has much less potential for welfare loss and can reduction in applied MFN tariffs by developing-country enhance benefits.9 partners, bound by the WTO. This method would pre- The argument in favor of a MFN approach by developing- vent trade diversion; reduce the administrative burden on country PTA members extends to services. Although actual customs authorities (as there would be no need to enforce additional liberalization in the services area has not been rules of origin on imports); help ensure that the PTA great—with the exception of the EU, most PTAs have not benefits all trading partners, not just members; and allow gone much beyond the GATS—services and investment governments more time to put in place alternative sources policies are very much on the PTA agenda. Multilateral of fiscal revenue. liberalization opens the market to the largest number of Large northern partners will not offer complete duty- competitors and gives consumers maximum choice. It also free and quota-free access to large developing countries leads to a less complex policy regime than a preferential without a quid pro quo. In principle, such a quid pro quo arrangement, implying lower administrative costs for the 102 Bernard Hoekman government and lower transaction costs for the private norms in OECD countries as examples of best practice, sector. cooperation would be geared toward assisting countries in If the market access rule proposals outlined for PTAs attaining their objectives efficiently. The specific content of are formalized in the WTO, then the next question is what regulation should reflect national (or local) circumstances. to do about existing PTAs. In practice, the revealed prefer- Thus, what may be most appropriate from an economic ence of members of these PTAs is clear: full liberalization is welfare (development) perspective is to create a framework often not the objective, and MFN is certainly not the goal. for helping governments identify good policies, not a sys- Seeking to change this status quo is unlikely to be fruitful. tem that aims at harmonization. Existing PTAs will therefore need to be grandfathered, in An important corollary of such an approach must be the unlikely event that it proves possible to change the accountability for performance and outcomes, generating WTO rules. That said, there is no reason existing agree- information (based on analysis) on whether the policies ments could not be reopened by a developing-country gov- employed are effective, what their costs and benefits are, ernment, assuming that development is indeed a major and so on. The fact that trade agreements are binding con- objective of the northern partner. tracts—that commitments are enforceable—gives them their value: traders have greater certainty regarding policy, and governments know what they are “buying� when they Policy Flexibility and Better Economic Governance make commitments. Any approach toward recognizing dif- We next turn to the second element of a strategy for ferential capacities and identifying regulatory options and increasing the development-friendliness of North-South priorities should minimize uncertainty for traders and PTAs. The market access dimension of PTAs arguably investors. Binding, enforceable disciplines on the use of should involve hard law—binding and enforceable com- trade policy are likely to be beneficial for development. The mitments. As mentioned previously, a major element of the case for trade policies designed to deal with specific gov- status quo is an increasing focus on harmonization and ernment and market failures that may prevent a supply hard law for behind-the-border policies concerning response to reforms from emerging is very weak (Pack and services, investment, and regulation. This may well be ben- Saggi 2006). It may not be obvious, however, what types of eficial to signatories, but much depends on country circum- domestic policies might be most appropriate and effective, stances. What are the preconditions for such commitments which suggests that experimentation and learning should to be beneficial? Have they been satisfied? Do the commit- be encouraged (see, for example, Rodríguez-Clare 2004; ments remove access to policy instruments that are desir- Rodrik 2004). able or are the only ones a government can feasibly employ The prevalence of complicated trade policies in many to address a market failure? Given that there is likely to be countries is often driven by industrial policy objectives, uncertainty with respect to these issues—and, often, differ- which have a long history. They span not only trade protec- ences in views between governments—an approach that tion but also subsidies and direct government involvement allows for greater policy flexibility could do much to in industry. Although opinions differ, the weight of the enhance the perceived benefits of engaging in PTA-based evidence suggests that such policies are generally very commitments. costly, often prolong the adjustment period, and distort A precondition for ownership of international agree- competition. That said, subsidies can facilitate learning, ments is that governments and stakeholders perceive the technology acquisition, and dynamic comparative advan- rules as benefiting the economy overall. A more economi- tage in situations where returns to such activities cannot be cally based mode of cooperation—as opposed to a focus on appropriated by private agents. Many commentators have harmonization-cum-approximation of laws—could help argued that policy interventions, including implicit or enhance such ownership. From an economic development explicit subsidies, lay behind the economic “miracles� in perspective, a mechanism for identifying good practices East Asia and were a major factor in the economic devel- makes sense, as these will often differ across countries. opment of European states, the United States, and Japan The focus would be on the provision of information and in the 19th and 20th centuries. Their case is that import learning through regular interactions of relevant policy protection and carefully targeted subsidies allowed govern- makers and constituents (stakeholders), peer review, and ments to stimulate key sectors that became efficient in their multilateral monitoring of the impacts of policies and their own right and provided positive spillovers for the economy effectiveness in attaining stated objectives (see Chayes and as a whole. Chayes 1995; Abbott and Snidal 2000; Helleiner 2000; In considering this infant-industry argument for gov- Sabel and Reddy 2007). Rather than seek to impose existing ernment support, it is important to differentiate between North-South Preferential Trade Agreements 103 sector-specific subsidies and policies aimed at facilitating the reality that PTAs are extending deeper behind the bor- learning and the development of private enterprise. The der. Moreover, with the exception of the WTO, trade policy case for general policy support for certain types of activity, is not a consistent focus of the activities of international including innovation, education, transport infrastructure, organizations. A major advantage of a PTA is that the focus and similar public goods, is uncontroversial. The same is is on trade and trade-related policies. Creation of a focal true for policies aimed at promoting socially beneficial point for a constructive, as opposed to adversarial, interac- activities. Markets can and do fail. There may be good tion between governments could do much to heighten rationales for governments to provide incentives for firms the domestic profile of the trade agenda for developing- and agents to undertake activities that would otherwise be country PTA signatories. It would also increase information undersupplied (Rodrik 2004). Specific interventions, how- on the effects of existing policy instruments—a necessary ever, will often get it wrong, in part as a result of rent seek- condition for adopting better policies—and ensure that ing and in part because of general equilibrium effects (a trade-related policy actions and investments are taken into subsidy for one activity implies a tax on all others).10 Mon- consideration when decision makers allocate resources to itoring and analysis of impacts and of the performance of public expenditures. supported sectors and activities are therefore important, as All these measures can be characterized as an effort to is the establishment of credible exit mechanisms; govern- improve economic governance in partner countries and, ments need to be able to withdraw support for experiments in the process, enhance the ownership of PTAs. Clearly, that fail. Trade agreements offer a potential vehicle for sup- the effectiveness of the implementation of the interactive porting such mechanisms. mechanisms will be critical for their credibility. In the end, PTAs can help by creating institutional mechanisms when governments (the partners jointly) deem that a that can assist in identifying policies that would be effective binding commitment in an area makes sense, entering and efficient in attaining specific goals set by governments into such a commitment will increase the probability of and by increasing the transparency of policies and their enforcement. Insofar as cooperation in specific areas con- outcomes through joint monitoring and analysis. A first tinues to be of the soft-law variety, legal enforcement step is to identify the relevant policies via the equivalent of mechanisms are not available. Here, accountability can what is done at the WTO through the Trade Policy Review only come from transparency, engagement, and publicly Mechanism and then to carry out an economic assessment disseminated analysis of actions and impacts. Oversight by of the rationale for and effectiveness of the relevant poli- parliaments and analytical assessments by institutions in cies. An example of an institution that does the latter is the the North—the U.S. Congressional Budget Office and Productivity Commission in Australia. Assessment of General Accountability Office; similar national institu- whether instruments are achieving development objectives tions in the EU such as the French research institutions and whether less trade-distorting ones can be identified Centre d’Etudes Prospectives et d’Informations Interna- requires judgments regarding appropriate sequencing and tionales and the Centraal Plan Bureau in the Netherlands; the need for complementary reforms and investment. and Australia’s Productivity Commission—could help These judgments must be made by the government con- inform development assistance programs. But strengthen- cerned but would benefit from inputs from other PTA ing the capacity to undertake such analysis in developing- members.11 country partners is crucial. Even if one is not convinced by the upside of pursuing Might such monitoring and interaction be better dele- greater flexibility on regulatory disciplines in PTAs, the gated to the WTO? Although non-PTA members may have downside risk is arguably limited. At worst, the cost is that little immediate interest in the policies pursued by a spe- PTA members conclude after a number of years that the cific developing-country PTA member, the substantive approach is not beneficial. Such an attitude may, however, coverage of PTAs will generally overlap to a great extent be too complacent. A case can certainly be made that if the with the issues that are addressed by WTO agreements or raison d’être of a trade agreement is the negotiation of that may be taken up in the future. There is much to be said binding commitments, policy dialogue discussions may do for considering an expansion of the WTO Trade Policy more harm than good by increasing uncertainty; duplicat- Review Mechanism to enable it to undertake much more ing the efforts of the World Bank, the International Mone- in-depth analyses of the impacts of policies pursued by tary Fund, and others; and incurring transaction costs. An PTA members and by customs unions (Hoekman 2005). alternative is to leave economic policy dialogue to interna- An additional reason for establishing such a mechanism tional development and financial institutions. There is at the WTO is that the consultations and impact assess- much to be said for this counterargument, but it ignores ments associated with any policy flexibility mechanism 104 Bernard Hoekman will entail resource costs. These may be significant for length by Prowse (2002 and 2006), trade-related funding poor countries with a scarcity of skilled personnel. If the should be allocated within the context of an overall coun- required work is undertaken multilaterally, much of it try development program and an agreed macroeconomic could be carried out in the context of mechanisms such policy framework. As a development tool, stand-alone spe- as the Enhanced Integrated Framework for Trade-Related cific funds and associated mechanisms are less likely to be Technical Assistance, reducing the costs. (See Prowse effective than integration of the prioritization and resource [2006] for a discussion.) allocation process into national poverty reduction and More regular interaction on trade policies would pro- development strategies. vide a framework for helping governments assess Trade policy often will not be the most important policy whether instruments are achieving stated objectives. The area from a growth perspective—and it should be borne in publication and dissemination in the countries concerned mind that many low-income countries have taken actions to of the results and findings of reports and discussions move away from nontariff barriers and to reduce dispersion would also increase the public profile of trade-related in tariffs. A fortiori, trade policies and institutions that are policies. More regular cooperative interaction by regula- covered by PTAs may not be among the areas within the trade tors and trade officials concerning trade policies and area where actions and investment are most needed. As constraints on market integration could also improve stressed previously, the primary determinants of success in communications between the development and trade harnessing trade openness to deliver growth are concomitant communities, as the analysis and discussions might assist policies and institutions in the developing countries them- in identifying where development assistance has the selves. Supply capacity is a necessary condition for exploiting greatest potential to help countries benefit more from market access opportunities, which will be determined by the trade agreements and cooperation. prevailing investment climate and the trade and business environment. Much of the associated policy agenda extends beyond trade policies and cannot be addressed through Aid for Trade: Capacity Building for Competitiveness trade agreements that are narrowly conceived. Measures to The third plank of a development-focused approach is facilitate trade—to get goods and services in and out of the expanded development assistance to help address supply country for less cost—are likely to be particularly important capacity constraints in poor countries—the types of in many of the poorest countries. Given that many of these measures briefly discussed in the section on trade liberal- countries are landlocked, cooperation with neighbors to ization strategies. This effort requires identifying and pri- reduce the costs of transit and transport and of access to oritizing needs and providing funds to address them. ports may well generate a particularly high payoff. In general, Especially in small, low-income countries that already have measures aimed at improving the investment climate are relatively free access to major markets, using aid to address likely to dominate trade policy, as are macroeconomic poli- constraints that reduce their competitiveness can have high cies designed to ensure a realistic exchange rate and actions payoffs and, indeed, may be the primary source of benefits. guaranteeing that markets exist and function. A major lesson of experience with projects and programs The implication is that financial and technical resources in the trade area (and in most others) is that country own- made available by high-income countries to developing- ership and leadership at the highest levels are critical fac- country PTA partners should be allocated on the basis of tors in ensuring concrete and sustained follow-up in national priorities and not tied to the narrow ambit of removing constraints to trade expansion. The flexibility whatever is embodied in the PTA. As argued in the next mechanism proposed above could help mobilize this section, a corollary of this is that it would be desirable to follow-up by identifying where specific investments are integrate PTA-based resources into the emerging multilat- likely to be needed, but it will need to be complemented by a eral mechanisms in order to assist poor countries in bol- comprehensive diagnostic analysis of factors that constrain stering their trade capacity. supply responses and reduce competitiveness. Such diag- nostics should feed into the process through which coun- Private Sector Engagement in Implementation tries determine public investment allocations and policy and Enforcement reform priorities. In many low-income countries, this process increasingly centers on poverty reduction strategy To be credible and meaningful, PTA commitments must be papers, which form the basis for the provision of donor enforceable. Signing a PTA is one thing, but implementing assistance at the country level. As discussed at greater it and enforcing its provisions is quite another. Much of the North-South Preferential Trade Agreements 105 literature on PTAs tends to focus on the texts and the cov- the dispute resolution mechanisms of the PTA often erage of disciplines; little attention is given to monitoring choose to resort to the WTO instead. The U.S.–Mexico and assessing implementation. The same is true of enforce- Telmex dispute is an example. Piérola and Horlick (2007) ment, about which not much is known even in the best- provide other instances in which countries went to the documented PTAs. These are areas in which the private WTO because PTA rules were ambiguous or nonexistent; sector can play a major role. Mechanisms to encourage they conclude that case law under NAFTA and similar greater participation by firms, nongovernmental organiza- agreements has entailed “little or no jurisprudential devel- tions (NGOs), and consumer groups need to be designed opment� (Piérola and Horlick 2007, 891). Bown and and incorporated into PTAs. Hoekman (2005 and 2008) discuss at greater length how What matters to firms and consumer groups is PTAs can be complemented by mechanisms through whether market segmentation is being reduced. They which firms can more easily (i.e., at lower cost) obtain have an interest in knowing about the removal of tariff information on potential violations of agreements and on and nontariff barriers and in having real-time informa- the way institutions might be designed so that the behav- tion on what is happening at border crossings and how ior of government agencies can be contested directly by regulatory requirements are being enforced. Regular the private sector. engagement between government and these groups— informed by an annual process through which informa- The Proposed Approach and the tion on the implementation of the PTA is generated Evolving Status Quo (e.g., through a survey of exporters and importers)— would provide a valuable feedback loop and help increase The need for policy flexibility and aid for trade will vary ownership of the PTA. by country: priorities differ, capacity differs, and the poli- Binding commitments (on market access, for example) tics (what is feasible and to what extent there is a need to need to be enforced. Dispute settlement provisions vary use trade agreements to pursue or lock in reforms) dif- widely across PTAs but tend to be weak in many cases. This fers. Thus, differentiation in the agreements is called for. weakness reduces the relevance of the PTA for firms. The In practice, it is already applied in the PTA context. The U.S., NAFTA-type PTAs are by far the most extensive in front-runner is arguably the EU; the European Commis- their dispute settlement provisions—not surprisingly, in sion has stressed that development is an explicit objective the sectors where there are strong lobbies in the United underpinning its pursuit of PTAs with developing coun- States. These are, first and foremost, IPRs and investment tries. The economic partnership agreements (EPAs) have protection and also areas such as product standards and attracted by far the most attention, but to date most EPAs conformity assessment. The latter is actually rather asym- have not addressed behind-the-border policies. (An metric. In the Central American Free Trade Agreement, exception is the agreement with the Caribbean countries, signatories are subject to disciplines to enhance the likeli- which has yet to be implemented.) More informative are hood that U.S. certification of goods will be accepted the approaches the EU is pursuing with neighboring as equivalent, but there is no similar language on U.S. countries that are not accession candidates and with acceptance of the partners’ certification. The seriousness which it already has reciprocal free trade agreements. of U.S. implementation is reflected not only with respect to Cooperation with a number of these countries is now formal, binding dispute settlement but also in terms of under the umbrella of the 2004 European Neighborhood calling for, and setting up, bodies to monitor implementa- Policy (ENP). The ENP has a threefold goal: (a) to sup- tion. For example, the Web site of the Office of the U.S. port the national development strategy of a partner Trade Representative contains documents on compliance country; (b) to integrate partners into some EU eco- by partners, and U.S. PTAs call for and have established nomic and social structures (a stake in the Internal Mar- performance benchmarks and contact points through ket); and (c) to implement existing and future PTAs and which interested parties (citizens) can report perceived association agreements. Technical and financial assistance instances of noncompliance.12 (development cooperation) will focus on the areas that Compared with the active caseload of the WTO, which are identified as priorities under country-specific ENP has adjudicated more than 400 cases since 1995, for most action plans (CEC 2004). North-South PTAs, there is very little evidence of enforce- A premise underlying the ENP is to pursue differenti- ment action, even for U.S.-type PTAs (aside from ated convergence with EU norms—competition policy, NAFTA). Countries that are PTA members and could use regulatory action for services liberalization, and so on. The 106 Bernard Hoekman ENP’s explicit recognition of differences in capacity and progress will be idiosyncratic. Whether an instrument pro- priorities in the context of bilateral economic cooperation motes development (growth, employment creation, and so with its neighbors, and of the need to complement binding on) will depend on what is done. Major questions, then, are treaties (PTAs) with soft law–type cooperation and techni- whether deeper integration would help growth and, more cal and financial assistance, implies that the policy has par- important in the short run, in what areas integration will allels with the proposals set forth in “Harnessing Regional generate the highest payoffs. Table 4.1 simply indicates Integration for Development,� an earlier section. Partner whether the expected sign is positive in terms of realizing countries have to determine whether they want to pursue the objective. From a practical policy-making perspective, integration and, if so, in what areas and how. This presup- it is also necessary to know the rank ordering of policy poses an understanding of the benefits and costs of alterna- instruments, in which areas the goal should be to make tive instruments of cooperation, in particular, hard law binding commitments, and in which areas the focus should (expansion of the coverage of binding treaties) versus soft be on cooperation and aid. law (economic cooperation). Hard law—binding treaty instruments—involves the As table 4.1 illustrates, this is a nontrivial challenge. The extension of association agreements to include services, table maps two objectives—market integration and eco- agriculture, and possibly parts of the EU law (acquis). It is nomic development—against EU instruments. It assumes straightforward to conceptualize hard law with respect to that the EU cares about both the core objective of eco- simple market access—for example, reciprocal agreements nomic integration and economic development, whereas to provide better access for agricultural and services flows, the partner country cares exclusively about national devel- including the right of establishment (investment). There opment. Thus, for the partner country, integration is an is, however, likely to be limited scope for reciprocity when instrument, whereas for the EU it is a goal in itself, as well it comes to the acquis, which is essentially nonnegotiable. as an instrument. As can be seen from the first row, all the Here, the issue is what will be asked of partner countries various EU instruments have the potential to contribute to and the extent to which assistance is offered to achieve the achieving the goal of integration, although, in practice, required minimum standards. In practice, whether an à la much will also depend on the national policies that are carte approach is possible may depend importantly on the pursued by partner countries (e.g., implementation). It is extent to which use is, or can be, made of the recognition not obvious, however, that the instruments the EU has principle, given that regulatory convergence (harmoniza- available will necessarily help achieve development objec- tion) may not be beneficial from a national development tives. With the exception of market access, whether this perspective. It also may or may not be necessary for effec- happens will depend very much on what a specific measure tive access to the EU markets concerned (agriculture and will do in or for the country concerned—the extent to services) or for the abolition of the threat of antidumping which it addresses priority needs. The same point applies and safeguard actions. more generally to the question of whether actions to pur- Indeed, integration (defined by the acquis) may be sue integration will promote development. second-order in terms of payoffs if the associated market There is tension between national development and access benefits are much smaller than gains from purely integration, in that the latter constitutes a unique focal domestic reform. Take the example of services. The case for point which is defined by existing EU members, even if it is action to lower costs and improve quality is well known. one that is constantly evolving. The former has no such There are also incentives for domestic agents to support focal point; both the goal and the metric used to assess services reform, especially in sectors (finance, transport, Table 4.1. European Union (EU) Instruments and EU and National Objectives EU instruments Treaties Soft law Aid Border Internal market Economic Participation in National Objective barriers (acquis) cooperation common programs Grants Loans policies Integration (EU) X X X X X X X Development (EU and partners) X ? ? ? ? ? X Source: Author’s elaboration. Note: X = effective instrument; ? = sign of impact uncertain. North-South Preferential Trade Agreements 107 health, education, and so on) that are inputs into produc- good if they are designed in a way that puts development tion and consumption and that, thus, affect large segments first. Taking development seriously has a number of impli- of the population. Although, in principle, the pursuit of cations, including identification of the most appropriate market-opening reforms through trade agreements can be form of a PTA and its membership. The need to avoid trade motivated on standard political-economy grounds, if there diversion costs and attenuate tariff revenue losses is well is not enough of a domestic constituency to support known, as is the policy recommendation of complement- autonomous reform, it may be difficult to put this in prac- ing reciprocal liberalization with reductions in external tice. Thus, there may not be sufficient (or any) export (MFN) barriers to trade. The challenge is to move in this interests, or alternatively, they may be concentrated in sen- direction, which requires a willingness by the major traders sitive sectors—mode 4, for example—where the scope for to support MFN liberalization by developing-country the EU to make concessions is restricted, given the limited counterparts as an appropriate quid pro quo for preferen- mercantilist value of access to the partner markets. This tial access to their markets. Formally, this process will implies that it will be important to mobilize EU groups, require a renegotiation of GATT Article XXIV (and of such as NGOs, which attach value to the attainment of GATS Article V, which allows for agreements to liberalize development objectives. There are also potential downsides trade in services) or a waiver. Although past experience insofar as partner countries are already pursuing unilateral does not furnish cause for great optimism that this is feasi- services reforms, driven by a desire to improve interna- ble, the effort would provide a signal that development tional competitiveness. Putting the bilateral or regional concerns are being taken seriously. Given, however, that the opening of services on the negotiating table may slow WTO disciplines in this area are effectively redundant, in desirable reforms if governments perceive more open mar- practice this may not be a serious possibility. Insofar as kets as a bargaining chip. developing country partners do undertake MFN reforms, Analysis aimed at prioritizing policy measures and it may be easier to seek a waiver. related actions is therefore critical. Benefiting from North- Market access commitments should be binding to ensure South PTAs requires a coherent national development that they are credible. The acid test for whether regulatory strategy in which trade-related and integration-related disciplines in trade agreements should be binding is whether measures are part of a country’s overall agenda. Hard law, benefits outweigh costs. Often, there will be uncertainty as to soft law (economic cooperation), and financial and techni- whether this is the case. Mechanisms to exchange informa- cal assistance options all need to be clearly mapped to the tion on the effects of policies and the development of rules of pursuit of national priorities. Hard law can be useful and thumb for behind-the-border, trade-related policies could be beneficial for overcoming political-economy resistance to very beneficial for developing countries. That suggests that reform, reducing uncertainty, and locking in market access. greater reliance on a soft-law approach that establishes broad But integration for its own sake, or the adoption of the EU guidelines and relies on transparency and accountability model, is not necessarily going to be beneficial, and even if through regular (multilateral) monitoring of performance it is, it may not be a priority at a given point in time. Mech- may be more effective in promoting development than har- anisms to generate information and analysis of the impacts monization, not least because it will enhance the eventual of different options, ex ante and ex post, are therefore of ownership of any specific norms that are adopted. Although great importance. The lack of such mechanisms is perhaps detailed international harmonization through trade agree- the weakest element of the evolving status quo. ments may not be appropriate in many instances, one cannot generalize here except to note that careful, country-specific analysis and assessments are called for. International disci- Conclusions plines embedded in PTAs, starting with monitoring, analysis A precondition for benefiting from trade agreements is a of impacts of policies, and information exchange, can help clear understanding of the objectives to be achieved—in ensure transparency and promote increased accountability of particular, the type of trade policy that the government governments. wants to pursue. Trade agreements can play a useful role in The policy agenda confronting developing countries at the design and implementation of trade reforms, acting as the regional (PTA) level is similar to that at the multilateral a mechanism for locking in reforms, a focal point for level. A major difference is that in the case of North-South future reforms, and a device to help overcome resistance by PTAs, more significant development assistance commitments vested interests. are associated with the implementation of agreements. The PTAs that the EU and the United States are increas- Trade-related assistance should focus on national, country- ingly negotiating with developing countries can do much specific priorities; after all, there is only one national trade 108 Bernard Hoekman agenda. Technical and financial assistance should be man- 5. The relevant agreements on IPRs and services are the Trade- Related Aspects of Intellectual Property Rights (TRIPS) agreement and aged accordingly. the General Agreement on Trade in Services (GATS). In the past five years, much progress has been made by 6. Recent empirical analysis, however, has begun to reveal evidence the international community toward improving aid effec- that PTAs generate incentives to pursue MFN liberalization once prefer- tiveness and prioritization of aid across sectors and uses. ential market access reforms have been implemented. See Bohara, Gawande, and Sanguietti (2004) as well as Estevadeordal, Freund, and This also spans the trade area, the Enhanced Integrated Ornelas (2008). The driver for such complementary MFN liberalization Framework being a prominent example. Trade will be one may be a desire to reduce the trade diversion costs of the PTA. priority among many and should, therefore, be considered 7. Although preferential liberalization by OECD members of PTAs is, of course, undesirable from a global welfare perspective, the solution is in the context of the overall national development strategy. continued multilateral negotiations to remove trade-distorting policies on Ensuring that trade-related assistance provided in the con- an MFN basis. text of PTAs conforms to this principle would further 8. This commitment should not be difficult, insofar as partners are small, poor countries. Both the United States and the EU already give improve the potential development impact of PTAs, as it many of these countries duty-free access to markets. implies that national priorities come before PTA-defined 9. If a North-South PTA has a South-South PTA as its partner (as requirements. opposed to only one developing country), then arguably the latter PTA Indeed, much of what has been suggested in this chapter also should completely liberalize trade to ensure that an integrated market is indeed being created. Rather than continuing to use trade policies should be pursued multilaterally. There is only one domes- (including nontariff barriers) to shelter local firms from competition, tic trade agenda in developing counties, one set of regula- other policies should be used to address coordination problems, under- tory reform priorities, and one first-best trade policy. The provision of public goods, and other market failures and to achieve equity objectives. Import-substitution policies that rely on trade protection have rules of thumb proposed for PTAs are generalizable. In all proved to be largely ineffective and costly. the areas proposed, the WTO could play a supporting 10. In a comprehensive retrospective on the East Asian development role—by requiring a shift from discriminatory to MFN experience, Noland and Pack (2003) argue that sector-specific policies did not result in high rates of total factor productivity growth for manufac- reforms in a PTA context, by enhancing information on turing. In the case of Korea and Taiwan, China, productivity growth was and analysis of the impacts of PTAs and national trade- not much higher than in OECD economies. The authors argue that the related policies, and by encouraging donors to channel primary reason these countries developed rapidly has more to do with through multilateral aid mechanisms the resources that are economywide policies in areas such as education and infrastructure than with industrial targeting, not least because the government did not prove mobilized to support PTA implementation. very effective in identifying winners. 11. International financial institutions could be brought into this process, in an advisory capacity. Their involvement would be desirable for Notes at least two reasons. First, they have the mandate, experience, local pres- ence, and capacity to provide policy advice. Second, these organizations This chapter draws on joint work with Alan Winters and is a substantially generally take the lead in the development and financing of projects and revised version of a paper presented at the International Trade Round- programs in developing countries. table “The WTO at 10 Years: The Regional Challenge to Multilateralism,� 12. A noteworthy feature of recent U.S. PTAs is that dispute settlement Brussels, June 27–28, 2005. Parts of that paper were subsequently pub- makes provision for compensatory payments in lieu of implementation lished as Hoekman (2006) and Hoekman (2007). (or retaliation). In the U.S.-Chile agreement, in the case of nonimplemen- 1. There is extensive literature on the effect of preferences. See Hoek- tation of a panel finding, the losing party may offer to pay 50 percent of man and Özden (2007) for a survey and summary of both the old and the damage caused. It appears that this penalty is open-ended, as the text more recent literature. speaks of annual payments. This PTA also provides for monetary fines 2. Of course, this is not always true. For example, a trade-off between of up to US$15 million per year in case of violations of labor or environ- trade liberalization and other objectives can arise in the short run if too mental provisions. Proceeds go into a fund earmarked for labor initiatives large a shock would lead to the complete collapse of a market. Local labor or green initiatives. markets may seize up in the face of large-scale redundancies because workers cease to leave their jobs speculatively for fear of not finding others. This is essentially a matter of timing—of staggering the trade lib- eralization (as is very common in practice) and ensuring that it is not References accompanied by a negative macro shock. 3. In many countries, import-competing firms were compensated for Abbott, Kenneth, and Duncan Snidal. 2000. “Hard and Soft Law in Inter- trade reform by depreciation and other reforms that reduced their input national Governance.� International Organization 53 (3): 421–56. costs—for example, measures to improve the efficiency of service providers. Barth, James R., Gerard Caprio, Jr., and Ross Levine. 2006. Rethinking 4. Bilateral investment treaties (BITs) have been the primary vehicle Bank Regulation: Till Angels Govern. Cambridge, U.K., and New York: for international cooperation in this area. BITs are, in part, designed to Cambridge University Press. spur investment flows by providing recourse to international dispute res- Bohara, Alok, Kishore Gawande, and Pablo Sanguietti. 2004. “Trade olution in the event of conflict with governments. Although some PTAs Diversion and Declining Tariffs: Evidence from Mercosur.� Journal of explicitly do not include investment policy disciplines because of preexist- International Economics 64: 65–88. ing BITs—an example is the 2000 Canada–Costa Rica PTA (Gestrin Bown, Chad P., and Bernard Hoekman. 2005. “WTO Dispute Settlement 2002)—most recent U.S. PTAs have more ample rights and coverage and and the Missing Developing Country Cases: Engaging the Private Sec- generally subsume prior BITs. tor.� Journal of International Economic Law 8 (4): 861–90. North-South Preferential Trade Agreements 109 ———. 2008. “Developing Countries and Enforcement of Trade Agree- Konan, Denise, and Keith Maskus. 2006. “Quantifying the Impact of Serv- ments: Why Dispute Settlement Is Not Enough.� Journal of World ices Liberalization in a Developing Country.� Journal of Development Trade 42 (1): 177–203. Economics 81 (1, October): 142–62. CEC (Commission of the European Communities). 2004. “European Limão, Nuno. 2007. “Are Preferential Trade Agreements with Non-Trade Neighbourhood Policy: Strategy Paper.� COM(2004) 373 final, CEC, Objectives a Stumbling Block for Multilateral Liberalization?� Review Brussels. http:// ec.europa.eu/world/enp/pdf/strategy/strategy_paper_ of Economic Studies 74 (3): 821–55. en.pdf. Mavroidis, Petros. 2005. “Testing the Compliance of PTAs with the Multi- Chayes, Abram, and Antonia Handler Chayes. 1995. The New Sovereignty: lateral Rules.� Presented at the International Trade Roundtable 2005, Compliance with International Regulatory Agreements. Cambridge, “The WTO at 10 Years: The Regional Challenge to Multilateralism,� MA: Harvard University Press. Brussels, June 27–28. Estevadeordal, Antoni, Caroline Freund, and Emmanuel Ornelas. 2008. Newfarmer, Richard, William Shaw, and Peter Walkenhorst, eds. 2009. “Does Regionalism Affect Trade Liberalization Towards Non- Breaking into New Markets: Emerging Lessons for Export Diversifica- Members?� Quarterly Journal of Economics 123 (4): 1531–75. tion. Washington, DC: World Bank. Fink, Carsten, and Martín Molinuevo. 2007. “East Asian Free Trade Noland, Marcus, and Howard Pack. 2003. Industrial Policy in an Era of Agreements in Services: Roaring Tigers or Timid Pandas?� World Globalization: Lessons from Asia. Washington, DC: Institute of Inter- Bank, Washington, DC. http://siteresources.worldbank.org/INTEAP national Economics. SUMEASPR/Resources/2576847-1163691185244/East_Asian_FTAs_ Pack, Howard and Kamal Saggi, 2006. “Is There a Case for Industrial Pol- in_Services.pdf. icy? A Critical Survey.� World Bank Research Observer 21 (2): 267–97. Francois, Joseph, and Bernard Hoekman. 2009. “Services Trade and Piérola, Fernando, and Gary Horlick. 2007. “WTO Dispute Settlement Policy,� CEPR Discussion Paper 7616, Centre for Economic Policy and Dispute Settlement in the ‘North-South’ Agreements of the Research, London. Americas: Considerations for Choice of Forum.� Journal of World Gestrin, Michael. 2002. “The Relationship between Regional Trade Agree- Trade 41 (5): 885–908. ments and the Multilateral Trading System: Investment.� TD/TC/ Porto, Guido, and Bernard Hoekman, eds. 2010. Trade Adjustment Costs in WP(2002)18/FINAL, Organisation for Economic Co-operation and Developing Countries: Impacts, Determinants and Policy Responses. Development, Paris. Washington, D.C.: World Bank and Centre for Economic Policy Haddad, Mona, Jamus Jerome Lim, and Christian Saborowski. 2010. “Trade Research (CEPR). Openness Reduces Growth Volatility When Countries Are Well Diversi- Prowse, Susan. 2002. “The Role of International and National Agencies in fied.� Policy Research Working Paper 5222, World Bank, Washington, Trade–Related Capacity Building.� World Economy 25 (9, September): DC. http://econ.worldbank.org/external/default/main?pagePK=641 1235–61. 65259&theSitePK=469382&piPK=64165421&menuPK=64166093& ———. 2006 “Aid for Trade: Increasing Support for Trade Adjustment entityID=000158349_20100226112948. and Integration—A Proposal.� In Economic Development and Multi- Helleiner, Gerald Karl. 2000. “Markets, Politics, and Globalization: Can lateral Trade Cooperation, ed. Simon Evenett and Bernard Hoekman. the Global Economy be Civilized?� 10th Raúl Prebisch Lecture, United Washington, D.C.: World Bank; Houndmills, Basingstoke, Hampshire, Nations Conference on Trade and Development, Geneva, December U.K: Palgrave Macmillan. 11. http://www.unctad.org/en/docs/prebisch10th.en.pdf. Rodríguez-Clare, Andres. 2004. “Clusters and Comparative Advantage: Hoekman, Bernard. 2005. “Operationalizing the Concept of Policy Space Implications for Industrial Policy.� Inter-American Development in the WTO: Beyond Special and Differential Treatment.� Journal of Bank, Washington, DC. International Economic Law 8 (2): 405–24. Rodrik, Dani, 2004. “Industrial Policy for the Twenty-First Century.� ———. 2006. “Trade Liberalization, Trade Agreements and Economic CEPR Discussion Paper 4767, Centre for Economic Policy Research, Development.� In The WTO Trade Remedy System: East Asian Per- London. spectives, ed. Mitsuo Matsushita, Dukgeun Ahn, and Tain-Jy Chen. Roy, Martin, Juan Marchetti, and Hoe Lim. 2006. “Services Liberalisation London: Cameron May. in the New Generation of Preferential Trade Agreements: How Much ———. 2007. “Regionalism and Development: The European Neighbor- Further Than the GATS?� WTO Staff Working Paper ERSD-2006-07, hood Policy and Integration à la Carte.� Journal of International Trade World Trade Organization, Geneva. and Diplomacy 1 (1): 1–55. Sabel, Charles F., and Sanjay G. Reddy. 2007. “Learning to Learn: Undoing Hoekman, Bernard, and Çaglar Özden, eds. 2007. Trade Preferences and the Gordian Knot of Development Today.� Challenge 50 (5, Differential Treatment of Developing Countries. Cheltenham, U.K.: Sept.–Oct.): 73–92. Edward Elgar. Schiff, Maurice, and L. Alan Winters. 2003. Regionalism and Development. Hoekman, Bernard and L. Alan Winters. 2009. “Multilateralizing Preferential Oxford, U.K.: Oxford University Press. Trade Agreements: A Developing Country Perspective.� In Multilateraliz- Winters, L. Alan. 2004. “Trade Liberalization and Economic Performance: ing Regionalism: Challenges for the Global Trading System, ed., Richard An Overview,� Economic Journal 114 (February), F4–F21. Baldwin and Patrick Low. Cambridge, U.K.: Cambridge University Press. World Bank. 2001. Global Economic Prospects and the Developing Coun- Imbs, Jean, and Romain Wacziarg. 2003. “Stages of Diversification.� tries 2002: Making Trade Work for the World’s Poor. Washington, DC: American Economic Review 93: 63–86. World Bank. Jensen, Jesper, Thomas Rutherford, and David Tarr. 2007. “The Impact of ———. 2010a. Global Monitoring Report 2010: The MDGs after the Crisis. Liberalizing Barriers to Foreign Direct Investment in Services: The Washington, DC: World Bank. Case of Russian Accession to the WTO.� Review of Development Eco- ———. 2010b. World Trade Indicators 2009/2010: Trade under Crisis. nomics 11 (3): 482–506. Washington, DC: World Bank. 5 Customs Unions Soamiely Andriamananjara A customs union (CU) is a form of trade agreement A Special Case of PTA under which certain countries preferentially grant tariff- CUs have been around for a long time and were once more free market access to each other’s imports and agree to prevalent than FTAs. Early efforts toward economic inte- apply a common set of external tariffs to imports from gration were generally driven by the desire to establish a the rest of the world. That is, they enter into a free trade political union, and the members were willing to relin- agreement (FTA) and apply a common external tariff quish some political autonomy.2 Early examples include (CET) schedule to imports from nonmembers.1 A CU can the Zollverein, formed in 1834 by several German princi- be thought of as a deeper form of integration than an palities, which turned out to be a step toward political uni- FTA, generally requiring more coordination and a greater fication, and the 1847 customs union between Moldavia loss of autonomy. and Walachia, a precursor to the creation of Romania. The aims of this chapter are to provide, from an eco- More recently, CUs appear to have become less popular, nomics perspective, an overview of the key features of at least with respect to the number of arrangements. As is CUs and to examine some design issues that may be of thoroughly documented by Acharya et al. (ch. 2 in this interest to policy makers and (nonspecialist) analysts. The volume), almost 85 percent of the regional integration discussions are meant to be relatively conceptual and arrangements notified to the World Trade Organization nontechnical, but real-world illustrations are provided (WTO) through 2009 consisted of FTAs. This trend when available. reflects the nature of the current wave of regionalism, To begin with, the main economic costs and benefits of which has been broadly characterized by smaller cross- opting for a CU, relative to those for an FTA, are discussed, regional deals, flexibility, selectivity, and, most important, and selected issues regarding the design and determinants speed.3 Recent FTAs are inclined to be pragmatic and to of a common external tariff are examined. Although a focus more on strategic commercial market access and number of arguments seem to suggest that CUs may be less on geographic considerations or political ambitions.4 subject to more protectionist pressures than FTAs, the They generally involve a small number of partners (fre- existing literature does not provide an unequivocal answer. quently, just two), which are often geographically distant There then follows a conceptual discussion of the implica- from each other. They tend to achieve significant prefer- tions of the various administrative options related to the ential and reciprocal trade liberalization within a short collection and sharing of customs duties; this, it is shown, time while simultaneously preserving a member’s sover- is not only a technical issue, but also (and perhaps more eignty over its trade policy vis-à-vis the rest of the world, important) a question of trust among member countries. including its option of joining other preferential trade The chapter concludes with an overview of a number of agreements (PTAs). systemic aspects of CUs. Readers interested in the more By contrast, CUs usually involve a relatively large num- operational and detailed aspects of CUs are referred to the ber of geographically contiguous countries (see table 5.1 for excellent surveys in Development Network Africa (2007) a selected listing). They generally take longer to negotiate and Keick and Maur (2011). 111 112 Soamiely Andriamananjara Table 5.1. Selected Customs Unions, in Force and Planned Agreement Date In force Southern African Customs Union (SACU) 1910 Switzerland–Liechtenstein 1924 European Union (EU) January 1, 1958 Central American Common Market (CACM) October 12, 1961 Caribbean Community (CARICOM) August 1, 1973 Andean Community (CAN) May 25, 1988 EU–Andorra July 1, 1991 Southern Cone Common Market (Mercosur, Mercado Común del Sur) November 29, 1991 Israel–Palestinian Authority 1994 EU–Turkey January 1, 1996 Eurasian Economic Community (EAEC) October 8, 1997 Economic and Monetary Community of Central Africa (CEMAC, Communauté Économique et Monétaire de l’Afrique Centrale) June 24, 1999 West African Economic and Monetary Union/Union Économique et Monétaire Ouest-Africaine (WAEMU/UEMOA) January 1, 2000 East African Community (EAC) July 7, 2000 EU–San Marino April 1, 2002 Gulf Cooperation Council (GCC) January 1, 2003 Customs Union of Belarus, Kazakhstan, and Russia July 1, 2010 Planned Arab Customs Union (ACU) 2010 Southern African Development Community (SADC) 2010 Economic Community of Central African States (ECCAS) 2011 Economic Community of West African States (ECOWAS) 2015 African Economic Community (AEC) 2019 Arab Common Market (ACM) 2020 Australia–New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) 2020 Source: Author’s compilation. and implement than do PTAs, and they entail a certain loss of Central African States (ECCAS)—take in virtually every of policy-making autonomy. By 2009, they accounted for country in the region. Many countries in the Middle East and less than 10 percent of the regional integration arrangements North Africa regions are members of the Gulf Cooperation notified to the WTO. CUs are less numerous than PTAs, but Council (GCC), the Arab Customs Union (ACU), or both. they generally have much larger memberships. They also tend Although a CU is no longer the most popular option, to cover much larger geographic areas. The four main CUs in it remains a central component of regional integration Latin America—the Central American Common Market strategy in many developing regions. For many developing (CACM), the Andean Community (CAN), the Caribbean countries, the design and implementation of a CET, along Community (CARICOM), and the Southern Cone Common with the elimination of intraregional trade barriers, con- Market (Mercosur, Mercado Común del Sur)—include tinue to be key drivers of trade policy reform and to almost all the region’s economies. The existing and planned occupy an important place in policy debates. Given that CUs in Sub-Saharan Africa—the Economic and Monetary customs duties constitute a significant source of govern- Community of Central Africa (Communauté Économique et ment revenues in most of those countries, choosing the Monétaire de l’Afrique Centrale), the East African Commu- appropriate mechanism for collecting and allocating cus- nity (EAC), the Southern African Customs Union (SACU), toms revenues is an important challenge for officials. the West African Economic and Monetary Union (WAEMU), the Economic Community of West African Economic Implications of Customs Unions States (ECOWAS), the Common Market for Eastern and Southern Africa (COMESA), the Southern African Develop- Chauffour and Maur (ch. 1 in this volume) discuss in detail ment Community (SADC), and the Economic Community the economic, societal, and political-economy motives for Customs Unions 113 signing preferential trade agreements. A central issue is form of an FTA, member countries grant free trade to each whether to opt for an FTA or a CU. By definition, both are other but effectively maintain sovereignty over the con- preferential in nature and discriminate against third-party duct of trade policy vis-à-vis the rest of the world. Thus, (nonmember) suppliers. The primary effect of a customs the tariffs charged to nonmember suppliers will vary union, as with an FTA, is the expansion of trade flows among across members. This could lead to opportunities for trade member countries, often at the expense of trade with non- deflection—a situation in which goods from outside the members. This expansion, a consequence of the removal of FTA are shipped to a low-tariff country and then trans- the intraunion tariff barriers, can be decomposed into trade shipped tariff-free to the high-tariff country. Such round- creation (more efficient suppliers in CU partners replace about shipping patterns, which have the sole purpose of domestic suppliers of a given good) and trade diversion exploiting the existing tariff differential, are inherently (more efficient third-party suppliers are displaced by less inefficient and can create friction among members.8 efficient suppliers located in partner countries, as a result of One way to avoid such wasteful trade deflection is for the discriminatory liberalization).5 As is well established in the members of the FTA to adopt a rules-of-origin system. the literature, when trade diversion dominates trade cre- Rules of origin can take various forms, but generally they ation, CUs and FTAs tend to be welfare reducing (Viner require that goods (or value added) qualifying for tariff- 1950).6 The likelihood of significant trade diversion is free trade be produced within the FTA and that imports closely related to the degree of discrimination associated from outside the FTA pay the tariff of the final destina- with the agreement (see Baldwin, ch. 3 in this volume). tion country, even if they pass through another member country (see Brenton, ch. 8 in this volume). In practice, rules of origin are particularly complex, and their imple- Reasons for Choosing a Customs Union mentation costs can be high.9 They necessitate significant There are many possible rationales for choosing a CU over internal border controls to ensure compliance and to col- an FTA, including political and economic ones. Some lect the relevant customs duties. regional groupings consider the establishment of a CU a Another way to prevent trade deflection is to establish prerequisite for the future establishment of a political a customs union, which would require all members to union, or at least some deeper form of economic integra- apply the same external tariff to imports coming from tion, such as a common market.7 The African Economic outside the union. Because of the common external tariff Community provides an illustration. The Abuja Treaty of (i.e., the absence of tariff differentials across members), 1991 envisaged gradual implementation in the following the potential for trade deflection and the need for intra- stages: (a) creation of regional blocs, by 1999; (b) strength- union border inspections are, theoretically, minimized. In a ening of intrabloc integration and interbloc harmonization, fully implemented customs union, it is no longer neces- by 2007; (c) establishment of an FTA and then a CU in each sary to maintain internal border controls for customs regional bloc, by 2017; (d) establishment of a continentwide duty purposes or to design and implement the cumber- customs union, by 2019; (e) realization of a continentwide some and costly rules of origin that are necessary in a African Common Market (ACM), by 2023; and (f) creation free trade area in which members have different external of a continentwide economic and monetary union (and tariff structures.10 The simplification offered by a CU can thus also a currency union) and a parliament, by 2028. greatly facilitate cross-border trade, which is especially Some groups, such as CARICOM, consider a CU to be relevant because existing CUs generally involve geograph- a useful way of pooling market power, coordinating trade ically contiguous countries, reflecting the traditional policies, and combining efforts to negotiate with the rest objective of regional integration.11 In this regard, a CU can of the world. The more intense degrees of coordination approximate a larger single market (as compared with a and interaction associated with a CU can foster trust and number of separate markets in an FTA), which can gener- familiarity among the parties and may even decrease the ate greater economies of scale, as well as procompetitive risk of conflicts, as has been the case with the European pressures. These, in turn, can greatly benefit consumers Union (EU). The fact that the external tariff is agreed with and can translate into lower business costs and enhanced other parties through a legal agreement may help reform- competitiveness for member countries. minded governments lock in their trade policies and can shelter them from domestic lobbies. Economic Implications of the Common External Tariff On a lower level, a customs union can simply be a prac- tical device for avoiding trade deflection while facilitating As was mentioned earlier, the key difference between a CU more fluid trade flows among member states. In the simplest and an FTA is the need to adjust the tariff structure applied 114 Soamiely Andriamananjara to third-party suppliers, at least for some members. Coun- discriminatory aspect of the FTA is, in a sense, diluted in tries that join an FTA are not required to change the tariffs this case. Starting from an FTA situation, a decrease in B’s they apply to imports from the rest of the world.12 What external tariff would have two effects, both working in the will differentiate the effects of a CU from those of an FTA same direction. First, the liberalization will directly will be the extent to which the external tariff is increased or increase B’s imports from the rest of the world (trade cre- decreased by a given member with respect to a given good. ation). Second, since it effectively dilutes the existing The net economic effect of a CU crucially depends on how preference margin, it will reduce the attractiveness of the adjustment of the external tariff affects the degree of sourcing from country A relative to sourcing from the rest discrimination vis-à-vis nonmember countries. of the world (less trade diversion). By reversing the trade In order to isolate the impact of a CU, it is useful to diversion caused by the FTA (i.e., by inducing consumers start with a case in which an FTA is already in place (i.e., to switch from less efficient suppliers in A to more effi- trade is already liberalized among the partners) and mem- cient ones in the rest of the world), country B’s tariff ber countries are considering establishing a customs reduction will benefit its consumers. It could also help union by harmonizing their external tariff duties.13 For increase government revenues. as dutiable imports from ease of presentation, the following discussion assumes the rest of the world expand (albeit at lower tariffs) and that two countries, A and B, are members of an FTA and as country B shifts to dutiable imports and away from have decided to form a customs union. Without loss of duty-free imports from A. Domestic producers will face generality, it will be further assumed that, for a particular more competition from nonmembers, but this will be good, A has a low tariff and B has a high one. Two possi- offset by consumer gains resulting from lower prices and, ble cases are relevant and are examined here. potentially, by higher tariff revenues. Although adopting One possibility is that the agreed common external a lower CET may not lead to tariff-jumping investment, the tariff (CET) leads to a higher tariff rate for a given CU higher returns associated with the more liberal economic member (say, country A). The bloc’s degree of discrimi- environment could attract efficiency-seeking investments. nation is thus enhanced, and the negative impact of trade Krueger (1995) has argued that if the CET level is chosen as diversion caused by the FTA is exacerbated. This usually the union’s average tariff for a given commodity, an FTA happens when a less advanced member has to implement will not lead to more net trade creation than a CU. Fur- a CET aimed at protecting the industries of a more devel- thermore, as long as the CET is set below the tariff level of oped member.14 In this case, consumers in country A will the high-cost country, an FTA will not be more welfare lose because they have to pay higher prices for imports enhancing than a CU. from the rest of the world or switch to less efficient In the actual implementation of a CET, an individual suppliers from country B. Despite the higher external CU member will generally have to increase its external tariff, the government in country A could collect less tariff tariffs on certain products while decreasing them on oth- revenues if the higher degree of discrimination leads to a ers. The overall impact will depend on the balance. Kemp greater propensity for switching the sourcing of imports and Wan (1976) demonstrate the existence of conditions to duty-free, country B suppliers. Producers of the good in that suffice to ensure that a CU is welfare enhancing. A face less competition from the rest of the world but In particular, they show that if the CET is chosen so that more competition from B. In fact, the adoption of a high trade with the rest of the world is kept unchanged, then tariff by A effectively extends the protection received by following the establishment of a CU, welfare could poten- country B producers to country A’s markets. These pro- tially increase for all parties, including nonmembers, con- ducers may be the only ones to gain from the CU in this tingent on compensatory transfers. This increase occurs scenario. In some cases, and in a more dynamic setting, because any additional trade between CU members would the expansion of the protected market may lead to some be welfare-enhancing trade creation. Although this is an tariff-jumping types of investment in the customs union, important result, it is a “possibility� and does not guarantee motivated by the prospect of taking advantage of the that the existing political-economy equilibrium will be a larger, more protected market. welfare-enhancing one.15 Joining a CU may offer a second possibility to consoli- date the existing tariff schedule and adopt a more liberal Factors Driving the Design and Level of the trade regime. If the establishment of the CU yields a CET Common External Tariff that is lower than the pre-CU tariff (say, in country B), the potential for trade diversion is reduced, or even reversed, A well-designed and generally accepted CET is crucial for because there is less potential for switching suppliers. The the sustainability of a customs union.16 National tariffs Customs Unions 115 must be harmonized at some agreed level, taking into favored nation (MFN) tariffs by making them more uni- account not only the often-conflicting positions of each form and lower. (This is referred to as the “uniform tax member but also the various special interests within each rate principle.�) In a related fashion, if trade diversion member. Setting the level of the CET in a consensual becomes apparent (i.e., if a country sees itself importing manner could be a complex undertaking, entailing long a good from a partner country at a higher cost than the and involved negotiations between member country cost of similar goods from nonmembers), an FTA mem- governments, which are themselves subject to lobbying ber has the flexibility to cut tariffs on these third-party by different interest groups. For instance, it took the EU imports.19 Similarly, the potential for trade deflection may 11 years (1957 to 1968) to complete its CET, and Mercosur lead high-tariff countries to cut tariffs to just below the level members took four years just to agree on their nonagricul- of their partners’ rates to prevent imports from going tural CET. through low-tariff countries that would otherwise capture In many developing-country customs unions, the diffi- the tariff revenue. In addition, lowering import tariffs on culties of agreeing on a common external tariff and on the inputs used in producing exports to other FTA members distribution of revenues have proved to be so great that can render exporters more competitive.20 Do these argu- the resulting tariff schedules tend to include numerous ments apply to CUs? country or sector-specific exceptions and sensitive lists. An often-stated objective of most customs unions Although the CARICOM CET is largely in place, it allows among developing countries is to promote a harmonized broad scope for tariff reductions and suspensions, as well reduction in internal and external trade barriers in order as for national derogations. The CET in Mercosur does to better integrate the region into the multilateral trading not cover all sectors, and it includes special regimes for the system. There are, however, arguments that seem to sug- automotive and sugar sectors.17 In some CUs, temporary gest that CUs create pressures for more protectionism. national exemptions are allowed—for example, EAC Like other integration initiatives, CUs permit member members Kenya and Tanzania were allowed to unilaterally countries to combine their market size and thereby increase reduce tariffs on selected grain imports. Derogations and their market power. Since trade policy is set jointly, this safeguards are widely used in most CUs. Not only can measure could strengthen their incentive to adopt high these exceptions reduce the transparency and effectiveness CETs in order to improve their terms of trade.21 That is, of the CU, but they also can complicate trade negotiations they can reduce global demand for an imported product, and increase transaction costs. Furthermore, they reintro- and thereby decrease the import price, by charging higher duce the potential for trade deflection—the very phenom- tariffs. The larger the size of the union, the stronger this enon that the CU is designed to prevent. proprotectionist effect will be. Like most other forms of regional integration agree- Furthermore, if CU members negotiate effectively as a ments, a CU is inherently preferential and is, thus, discrimi- bloc, they can pool their negotiating power and enhance it natory against third parties. As argued in the previous sec- against the rest of the world, thus affecting the outcome of tion, the economic impact of a CU will be closely related to negotiations. Given the mercantilist nature of trade negoti- the degree of discrimination, which depends on the CET ations, increased negotiating power is likely to lead to a level that is selected. The higher the CET, the more trade more protectionist outcome (in exchange for better market diversionary will the union be. An important question is access). It could also be argued that nonmembers will act in thus whether a CU provides incentives for selecting higher a more conciliatory way when negotiating with a (single, or lower external tariffs than those in, say, an FTA.18 The large) customs union than with separate FTA members, and existing theoretical and empirical literature does not provide the result will be smaller requests for concessions. an unequivocal answer to this question. The result seems to The internal process of decision making within the CU depend on the way preferences (or objective functions) are could also place upward pressure on tariffs. The joint, con- aggregated across members and within each member. sensual determination of the external tariffs may provide A number of analysts have demonstrated that an FTA incentives to agree on higher CETs, since these imply may create downward pressure on external tariffs. (See, higher preference margins and benefit partners’ firms. for example, Richardson 1993; Bagwell and Staiger 1999; (Protection is afforded to all producers in all CU member Freund 2000.) For instance, Baldwin and Freund (ch. 6 in countries.) CU members will internalize this fact and will this volume) argue that preferential trade liberalization choose a higher external tariff (Freund and Ornelas 2010). in an FTA tends to make tariffs against nonmembers’ Accordingly, one can think of a situation in which each third-nation tariffs more distortionary and that it creates CU member feels strongly about protecting a particular an incentive for FTA members to reoptimize their most sector but would like lower tariffs on the other sectors. As 116 Soamiely Andriamananjara Winters (1996) argues, this may create a prisoner’s-dilemma Overall, whether opting for a CU leads to higher external outcome under which the CET would provide high protec- tariffs remains an open question. A number of arguments tion in all sectors, even though each country would be better seem to suggest that CUs may provide more protectionist off with low protection in all sectors.22 pressures than FTAs. This, however, remains an empirical The establishment of a CU also changes the power of question to which the existing literature has not been able to lobbies, but it is not clear whether the result will be provide an unequivocal answer. stronger or weaker demand for protection. It is possible that lobbying pressure within a CU may be diluted, com- Allocation and Collection of CET Revenue pared with national lobbying for protection within an FTA. As Winters (1996) suggests, it is more costly to lobby For most CUs among developing economies, the potential for a tariff increase in a CU than in an individual FTA for losses of tariff revenues constitutes an important nego- member country because there may be more opposition to tiation issue. These losses may result from the liberalization overcome or more representatives to influence. Moreover, of intraunion tariffs, from the adoption of the common the returns to lobbying activities are less under a CU, given tariff schedule, or from changes in trade patterns. Given that an extra 1 percent tariff protection becomes available the significance of tariff revenue for most developing to all members. Panagariya and Findlay (1996) provide a countries, at least two issues need to be addressed when formal treatment of the argument that a customs union is establishing a customs union: (a) Who has a claim on the a more effective instrument for diluting the power of collected customs duties? (b) Where and how should those interest groups than is an FTA. The high cost and low duties be collected? returns of lobbying under a CU could lead to a free-rider problem in lobbying, and all lobbying could end up taking Ownership of the Collected Duties place in one country. The author finds that such a process would yield a lower (common) external tariff under a CU The use or allocation of the collected duties is an impor- than under an FTA. The larger the size of the customs tant consideration. Should the customs revenues collected union, the lower the resulting (lobbied) level of common be treated as community property, or as income accruing external tariff would be. to each member state? Generally, it is necessary to establish The argument could, of course, cut in the other direc- a regional, supranational institution or a secretariat to tion. In some sectors, lobbyists in different member ensure smooth operations of the union. Although such an countries may be able to overcome the free-rider prob- institution could be funded through direct contributions lem, pool their resources, and cooperate. This is likely to from members—for example, WAEMU provides for an happen in sectors in which they produce relatively similar additional tax of 1 percent on imports— treating customs goods (say, in agriculture) and where there is little intra- revenues as the collective property of the union may be a bloc trade flow. In this case, the national lobbies would be more useful financing mechanism. In some cases, such as able to organize themselves into a regional lobby, and the the EU, the union may decide to allocate (a fraction of) resulting common external tariff would be higher in a CU these revenues to a joint fund to finance regional develop- relative to what would prevail in the individual markets ment initiatives or to provide support to poorer CU mem- under an FTA. bers.23 Of course, pooling customs revenues necessitates a The degree of “permanence� of the policy outcomes will high level of coordinating capacity and a certain degree of also affect the incentives for, and the amount of, lobbying. trust among members. This arrangement seems more An FTA does not require member countries to immediately likely to be sustainable when tariff revenues do not consti- adjust their external tariffs, and it preserves discretion for a tute an important part of government revenue for individ- country to adjust its trade policy in the future. By contrast, ual members—as is the case in the EU, but usually not for a CU requires both tariff adjustments and a relatively developing economies. longer-term commitment to the trade policy jointly agreed In other cases, CUs treat customs revenues as the on by the CU members—the CET. It is therefore likely that property of individual members. Collected duties are lobbying for protection would be stronger during the allocated either according to the final destination or in negotiation and establishment of a CU than in the case of line with an agreed sharing formula. Such a formula an FTA. Also, the difficulties in renegotiating or readjusting could provide for a simple reallocation based on negoti- the CET could lead to the emergence of less transparent ated and fixed shares, or it could involve a more complex nontariff barriers that would be implemented at the range of economic and demographic variables. SACU, national (instead of the regional) level. for instance, has a fairly complicated revenue-sharing Customs Unions 117 system in which the share accruing to each member is would not need to monitor the passage across their borders calculated from three basic components: a customs pool, of goods originating outside the CU for duty collection an excise pool, and a development component. The cus- purposes.26 This method would greatly enhance efficiency toms pool is allocated according to each country’s share by reducing transaction costs at internal border posts, but of total intra-SACU trade, including reexports. The excise it requires the existence of the appropriate institutional component is allocated on the basis of gross domestic capacity to administer the revenues and, most important, product (GDP). The development component (fixed at a high level of trust among members. Both of these meas- 15 percent of the total excise pool) is distributed to all ures tend to be harder to achieve as the number and SACU members according to each country’s per capita diversity of member states increase. The mechanism is GDP; that is, countries with lower per capita income will more likely to be sustainable if customs duties are deemed receive more (WTO 2003). to be community property of the CU and are used for col- Most existing customs unions allocate revenues lectively determined community purposes, or if members according to the final-destination principle. This method, can devise a mechanism for identifying imports accord- although apparently simple in theory, requires a mecha- ing to their final destinations.27 A potential issue is the nism for identifying the final destination of each shipment possibility of some diversion in revenue collections (and entering the union; the destination country would then even economic activity) away from landlocked and less claim the appropriate duty amount. One way to handle developed countries and toward the more developed this procedure is to keep the imported shipment in trading hubs in the region. bonded facilities until it reaches the country of ultimate Alternatively, customs duties could be collected at consumption. This may work for whole shipments of final the final destination or the final consumption point.28 goods that are entirely consumed in the destination coun- Although conceptually straightforward, this type of agree- try, but it may not be the appropriate mechanism for an ment can be complex to implement and can be very costly. imported shipment that undergoes transformation in an In fact, to be workable, it requires that significant border intermediate country before reaching its final destination. controls remain or that goods be shipped in some sort of Indeed, incentives could emerge for some members to transit and bonding facility all the way to the final destina- collect revenues on imports that are then wholly trans- tion, where duties would be collected.29 Not only would shipped or minimally “transformed� or “repackaged� the logistical costs of running such facilities be substantial, before being exported duty-free elsewhere in the CU. In but they would also tend to diminish some of the expected such cases, burdensome internal border controls, guaran- gains from establishing a CU. For instance, they could dis- tee mechanisms, or even some rules of origin are needed courage the establishment of regional value chains or pro- within the CU to determine what fraction of the collected cessing chains (using imported inputs) or the generation duties should go to which member. This could be an of retail and wholesale services in intermediate locations important issue for small landlocked economies that rely between the initial port of entry and the final destination. on their larger coastal neighbors for transit and that could It is clear from the foregoing discussion that the collection lose revenues as a result of leakages or fraud. When trade and allocation of customs revenue in a customs union setting flows are sufficiently symmetrical, a member’s losses could are not only technical issues, but also (perhaps more impor- be offset by the gains it realizes when goods imported into tant) a question of trust. Good technical coordination and its territory (for which it collects the tariff) are consumed enforcement generally promote trust among CU members. in a neighbor’s.24 Conversely, lack of trust would require more stringent and cumbersome controls on intrabloc transit and stricter appli- cation of the agreed disposition of revenue. This is clearly an Collection of Duties area in which harmonization of border management (cus- At what point should customs duties be collected—at the toms procedures), cooperation, modernization, and capacity initial port of entry into the CU or at the final import building could be very useful (see Keick and Maur 2011; destination? Collecting import duties at the first port of Dawar and Holmes, ch. 16 in this volume). entry into the CU (say, in the coastal member with the more developed port and transit facilities) could be one Conclusions way of ensuring freer movement of goods within the CU and minimizing intra-CU border controls.25 Indeed, if all The conceptual discussions in this chapter demonstrate trade taxes were collected at the point of first entry and that CUs generally require a much greater degree of policy administered or distributed centrally, member countries coordination among members than do FTAs. This is 118 Soamiely Andriamananjara because they require member countries to agree to a are valued, membership in a CU, if played by the rules, common external tariff and to set up institutional mecha- could constitute a straitjacket for some countries. nisms to collect and distribute the tariff revenue. When a In reality, of course, there are numerous cases in which country joins a customs union, it agrees to relinquish a CU member alone negotiates an FTA with a third party. some of its national sovereignty with respect to the formu- Examples of such a situation include the FTAs between the lation and implementation of trade policy. The fact that a EU and South Africa (a member of SACU) and between country is willing to surrender such autonomy over trade the United States and Bahrain (a member of the GCC). policy suggests that it considers this loss to be more than Similarly, Bolivia, Colombia, Ecuador, Peru, and the offset by the economic benefits of securing access to a República Bolivariana de Venezuela form the Andean Pact larger and more harmonized regional market and of (a CU), while Colombia and the República Bolivariana de enhancing the depth and effectiveness of the ongoing Venezuela have joined with Mexico to make up the Group regional integration. The loss of autonomy may also be of Three, an FTA. In some instances, one CU may overlap acceptable to members because in most cases, CUs are another. For example, Lesotho, Namibia, and Swaziland driven by objectives that go beyond trade, such as eco- belong to COMESA while also belonging to SACU, and nomic and monetary unions or even political integration, Tanzania is a member of both the SADC and the EAC. and that require supranational institutions. Multiple and overlapping memberships in regional trade Ceding the control of some aspects of national trade agreements can create difficulties because different groups policy may yield economic benefits, to the extent that it can have conflicting operational or liberalization modali- shelters the trade policy–making process from the influ- ties, and so member countries will have to make different, ence of special interests, at least at the national level. Com- incompatible commitments. This not only could render mitting to a regionally agreed trade policy regime can CUs less effective but could also confuse traders (and even serve as an effective lock-in mechanism for trade reform customs officers) as to which commitments or tariff efforts and can send a strong signal to investors regarding schedules apply to a particular shipment. Unnecessary the predictability of the policy environment.30 In some transaction costs will be created because traders are cases, it may be more practical for a country to delegate obliged to find their way around a number of trade the conduct of trade policy to another (larger) CU mem- regimes with different tariff schedules, different rules of ber or to a supranational agency. In others, a larger mem- origin, and different procedures. ber country can impose its own trade policy or tariff structure on that of the union. In this case, there may be grounds for establishing a regional mechanism, such as a Notes development fund, to compensate other member coun- The author thanks Jean-Christophe Maur and anonymous reviewers for tries for adopting a tariff structure that is not inherently in their helpful comments and suggestions. 1. GATT Article XXIV:8(a) defines a customs union as a single cus- their own economic interests. toms territory substituting for two or more customs territories and having It should be noted that the loss of autonomy implied two characteristics: (a) duties are eliminated on substantially all trade by a CU also covers certain aspects of national trade poli- between the constituent territories, and (b) substantially the same duties are applied by each member to trade with nonmembers. cies, going beyond external tariffs. For instance, whereas 2. Historically, the early academic literature on regional integration FTA members retain full flexibility with regard to future tended to focus on customs unions; classic works are Viner’s The Customs PTA partners, CU members may be limited in their indi- Union Issue (1950) and Meade’s The Theory of Customs Unions (1955). vidual choices for future partners Indeed, membership in 3. Fiorentino, Verdeja, and Toqueboeuf (2007) suggest that CUs are “out of tune with today’s trading climate.� a CU, at least in principle, prevents an individual member 4. In some cases, PTAs are driven by narrow foreign policy or diplo- from acting individually, since any agreement with a third matic considerations. party or any change to the CET needs to be decided by the 5. In practice, tariff liberalization could be accompanied or comple- mented by a rationalization of border management policies. See Keick CU as a whole. It can be argued that CUs could help pre- and Maur (2010) for a thorough survey of the border management issues vent the emergence of a hub-and-spokes trading pattern facing CUs. (see the discussion in Baldwin and Freund, ch. 6 in this 6. Interestingly, although the seminal work by Viner (1950) focused on CUs, the analysis studied the removal of the intrabloc tariff while volume). assuming that other policies (e.g., external tariffs) remained constant. In a world of criss-crossing and overlapping trade Thus, it was more a study of FTAs than of CUs. agreements, the issue of the loss of autonomy can severely 7. In the traditional literature on regionalism, the degrees of eco- constrain members of CUs in using trade agreements as an nomic integration correspond to different stages: preferential trading area, free trade area, customs union, single market, economic and mone- effective commercial instrument—at least in theory. In the tary union, and complete economic integration. These stages were gener- current wave of regionalism, in which flexibility and speed ally thought to be a progression, with political union as the ultimate Customs Unions 119 objective. Nowadays, this progression seems a bit outdated, as many exist- 20. Winters (1996) suggests that Canada’s decision to reduce 1,500 ing FTAs have no ambition to move to the next stage. tariffs on inputs shortly after the initiation of the North American Free 8. This situation effectively reduces the tariff of every FTA member to Trade Agreement was driven by this consideration. that of the lowest (plus the transport cost involved in roundabout 21. This possibility is demonstrated, for instance, by Kennan and importing). Riezman (1990) and by Krugman (1990). 9. Given that rules of origin have to take into account tariffs on 22. This situation is illustrated by the disproportionate influence imported intermediate goods used in the products manufactured within of EU members on policy in sectors in which they claim “vital interests.� the FTA, as well as the extent of value addition, they tend to be complex to Other members strategically and willingly accommodate, in anticipa- administer. Rules of origins also raise other issues; they can, for instance, tion that the favor will be returned when their own “vital interests� create incentives for regional buyers to purchase high-cost inputs from come up. partner countries, thus exacerbating trade diversion, and they can be cap- 23. It should be noted that in the case of the EU, tariff revenues con- tured by interests that favor protection in the form of stringent require- stitute a small portion of government revenue, which is why EU members ments. Robson (1998) argues that even with rules of origin, the problem of are more willing to forgo them and cede them to the commission. trade deflection is not entirely solved, as the low-tariff partner may meet its 24. On a related note, Dawar and Holmes (ch. 16 in this volume) own requirements for a product from the rest of the world and can then argue that CUs provide incentives for stronger regional cooperation in export a corresponding amount of its own production to its partners. the area of trade facilitation. Indeed, there is a need for harmonization of 10. The implementation of a customs union does not necessarily the quality of border enforcement across CU members to ensure that the mean the abolition of border posts. These facilities serve many other weaknesses of one member do not undermine the tax collections of other (trade-related or nontrade-related) purposes, including collecting other members (since imports may be diverted to the border where enforce- taxes, controlling the movement of persons, and enforcing compliance ment is weakest). with domestic standards and health and safety requirements. 25. In SACU, for instance, most customs duties are collected by South 11. The contiguous pattern of CU formation contrasts with the pro- Africa, the dominant economy and trading hub of the bloc. liferation of cross-regional PTAs that characterizes the current wave of 26. In this context, it should be noted, again, that in addition to regionalism. import duties, other taxes may be collected by customs at the border and 12. Although PTA members are not required to change their external that the establishment of a CU does not mean abolition of all border con- tariffs, there may be strong political-economy pressures or incentives for trols. Keick and Maur (2010) discuss the issues related to border manage- adjusting them after the removal of intrabloc tariffs. See Winters (1996) ment in the context of CUs. and Freund and Ornelas (2010) for useful reviews of the literature on this 27. Of course, no existing customs union allocates tariff revenues topic. according to where imports first enter the union. The EU allows member 13. This method is of course a simplification. In many CUs, many states to keep 10 percent of the tariffs they collect. transitional tariffs and not-so-transitional nontariff barriers on intrabloc 28. Conceptually, setting up a CU among countries that have already trade remain. Even the EU only removed the last physical, technical, and established an FTA among themselves does not necessarily require any tax-related obstacles to intraunion trade in 1993, 36 years after the com- changes in the procedure for collecting customs duties. In most cases, munity was founded. The free trade area component of the East African duties are collected on a destination basis before and after the establish- Community (EAC) completely abolished tariffs on trade between ment of a customs union. Tanzania and Uganda and on exports from these two countries to 29. Some customs unions allow for members to establish customs Kenya. Many goods exported from Kenya to Tanzania or Uganda, how- facilities in the territories of other member states in order to collect the ever, continue to be subject to tariffs (Development Network Africa customs that are due to them at the first point of entry. In practice, duties 2007). In Mercosur, there is not yet free internal trade in sugar, and most paid on imports from the rest of the world could still be collected by the favored nation tariffs are applied with a 20 percent preference for intra- country of final destination. zone trade. 30. This argument is generally true for international trade agree- 14. In Mercosur, for instance, the smaller economies (Paraguay and ments, whether bilateral, regional, or global. The need for agreeing on the Uruguay) preferred a CET structure with low tariffs, whereas Argentina CET makes it stronger in the case of customs unions. and Brazil successfully pressed for higher rates. 15. As Hoekman argues in chapter 4 of this volume, real-world PTAs do not select their CETs in a Kemp-Wan manner, nor do they have access References to large compensatory or lump-sum transfers. 16. A poorly designed CET can create divisive tensions among CU Adams, Charles. 1993. For Good and Evil: The Impact of Taxes on the members. Adams (1993) provides an interesting example of how external Course of Civilization. Lanham, MD: Madison Books. tariffs triggered conflicts between the North and the South in the antebel- Bagwell, Kyle, and Robert Staiger. 1999. “Regionalism and Multilateral lum United States. Tariff Cooperation.� In International Trade Policy and the Pacific Rim, 17. Mercosur allows members to temporarily deviate from CET rates ed. John Piggott and Alan Woodland. London: Macmillan. under specific conditions and with some limitations. Following the peso Bohara, Alok K., Kishore Gawande, and Pablo Sanguinetti. 2004. “Trade crisis, Argentina raised tariffs to 35 percent on numerous consumer goods Diversion and Declining Tariffs: Evidence from Mercosur.� Journal of and cut the tariff on capital goods to zero. International Economics 64 (1, October): 65–88. 18. Note that CETs are, in principle, subject to multilateral rules. Development Network Africa. 2007. “Evaluation of an Appropriate GATT Article XXIV:5(a) stipulates that the duties (in this case, the CET) Model for a SADC Customs Union.� Report commissioned by the and other trade regulations imposed on trade of nonmembers shall not, SADC Secretariat, Southern African Development Community, on the whole, be higher or more restrictive than the general incidence of Gaborone. duties and other trade regulations applicable in the participants prior to Fiorentino, Robert, Luis Verdeja, and Christelle Toqueboeuf. 2007. “The the formation of the CU. Under the usual interpretation, this implies Changing Landscape of Regional Trade Agreements: 2006 Update.� that the common tariff of a CU should not be higher than the preunion WTO Discussion Paper 12, World Trade Organization, Geneva. average. Freund, Caroline. 2000. “Different Paths to Free Trade: The Gains from 19. Bohara, Gawande, and Sanguinetti (2004) provide some empiri- Regionalism.� Quarterly Journal of Economics 115 (4): 1317–41. cal evidence for this argument in the context of Argentina’s external tariffs Freund, Caroline, and Emanuel Ornelas. 2010. “Regional Trade Agree- under Mercosur. ments.� Policy Research Working Paper 5314, World Bank, Washington, 120 Soamiely Andriamananjara DC. http://www-wds.worldbank.org/external/default/WDSContent Panagariya, Arvind, and Ronald Findlay. 1996. “A Political Economy Server/IW3P/IB/2010/05/19/000158349_20100519101328/Rendered/ Analysis of Free Trade Areas and Customs Unions.� In The Political PDF/WPS5314.pdf. Economy of Trade Reform: Essays in Honor of Jagdish Bhagwati, ed. Keick, Erich, and Jean-Christophe Maur. 2010. “Regional Integration and Robert C. Feenstra, Gene M. Grossman, and Douglas A. Irwin. Customs Unions.� World Bank, Washington, DC. Cambridge, MA: MIT Press. Kemp, Murray C., and Henry Y. Wan, Jr. 1976. “An Elementary Proposi- Richardson, Martin. 1993. “Endogenous Protection and Trade Diversion.� tion Concerning the Formation of Customs Unions.� Journal of Inter- Journal of International Economics 34 (3–4, May): 309–24. national Economics 6 (1, February): 95–98. Robson, Peter. 1998. The Economics of International Integration. 4th ed. Kennan, John, and Raymond Riezman. 1990. “Optimal Tariff London: Routledge. Equilibria with Customs Unions.� Canadian Journal of Economics Viner, Jacob. 1950. The Customs Union Issue. New York: Carnegie Endow- 23: 70–83. ment for International Peace. Krueger, Anne O. 1995. “Free Trade Agreements versus Customs Unions.� Winters, L. Alan. 1996. “Regionalism versus Multilateralism.� Policy NBER Working Paper 5084, National Bureau of Economic Research, Research Working Paper 1687, World Bank, Washington, DC. Cambridge, MA. http://www-wds.worldbank.org/external/default/WDSContentServer/ Krugman, Paul. 1990. “Is Bilateralism Bad?� In International Trade and IW3P/IB/1996/11/01/000009265_3970311114958/Rendered/PDF/mu Policy, ed. Elhanan Helpman and Assaf Razin. Cambridge, MA: MIT lti0page.pdf. Press. WTO (World Trade Organization). 2003. “Trade Policy Review: Southern Meade, James. 1955. The Theory of Customs Unions. Amsterdam: North- African Customs Union.� Press release, April 25. WTO, Geneva. Holland. http://www.wto.org/english/tratop_e/tpr_e/tp213_e.htm. 6 Preferential trade agreements AND MULTILATERAL LIBERALIZATION Richard Baldwin and Caroline Freund With the Doha Round of trade negotiations ailing, the outcome from high-tariff regional blocs and for large future of multilateral liberalization in the near term looks amounts of trade diversion, the theoretical literature shows bleak. By contrast, preferential trade agreements (PTAs) that incentives to reduce external trade barriers so as to continue to multiply (see Acharya et al., ch. 2 in this vol- limit costly diversion are likely to be present.2 The nascent ume), making regionalism the most active mode of trade empirical literature is tackling the question of how trade liberalization. The regionalization of trade is of serious liberalization has been affected by the formation of PTAs. concern to many international economists who view mul- Although the verdict is not yet in, the evidence indicates tilateralism as far superior to regionalism for improving that regionalism is broadly liberalizing. welfare. At issue is the preferential nature of regional agree- This chapter summarizes the available theoretical and ments, which could divert trade and reduce the potential empirical evidence on the relationship between regionalism for future multilateral liberalization. and multilateralism, with the aim of discerning whether the The multilateralists argue that, although regionalism may spread of regionalism is likely to be a threat to, or an oppor- increase trade, its effects on welfare and on the world trade tunity for, broader trade liberalization. The next section system are likely to be harmful. There are two main con- identifies the distortions that generate a need for regional cerns.1 The first is trade diversion: preferential trade agree- and multilateral trade agreements. There follows an ments, by diverting trade away from the most efficient global overview of the available theoretical work on whether producers in favor of regional partners, may prove welfare regionalism constitutes a stumbling block or a building reducing. The second concern, which is of greater impor- block on the path to trade liberalization. The effect of tance, is that regionalism may hinder multilateralism, lead- regionalism on world welfare is then examined, the empiri- ing to a bad equilibrium in which several regional trade cal literature is surveyed, and conclusions are drawn. blocs maintain high external trade barriers. Regionalism can also undermine multilateralism simply by diverting limited Reciprocal Trade Agreements government resources from multilateral negotiations. These two concerns are related: in a highly regionalized If there is one thing economists agree on, it is that free world, there is likely to be significant trade diversion and trade is best. Why, then, do we need trade agreements to hence lower welfare. Still, this feature of the bad equilibrium lower tariffs? In fact, although global free trade may be makes it less likely in practice. It is precisely because the good for world welfare, countries nevertheless have reasons trade diversion is costly to bloc members that there is an to maintain tariffs. There ensues a prisoner’s dilemma: incentive to reduce external tariffs. As tariffs fall, trade each country may be unilaterally better off with a tariff, but diversion disappears, and regionalism becomes a force for jointly they are worse off. Cooperation through a trade general liberalization. Thus, despite the potential for a grim agreement is necessary to liberalize trade. 121 122 Richard Baldwin and Caroline Freund Countries have tariffs for three main reasons. First, reciprocal tariff cutting. Moreover, once the agreement is terms-of-trade considerations may induce a country to use in place, the reciprocity can help lock in the reform—can tariffs to drive down the price of its imports relative to the tie the government’s hands, so to speak—in a way that price of its exports, thus raising welfare for the nation as a helps governments resist special-interest pressures for whole. For example, suppose a large country exports wine protection. Even if domestic consumers do not object to and imports cheese. By placing a tariff on imported cheese, new protection, the export interests of the foreign trade the country increases domestic demand for wine relative to partner will. cheese, and if the country is large enough, this practice The third reason for tariffs, revenue generation, is raises the world price of wine relative to cheese. If both the slightly different, as the government faces a loss of income importing and the exporting country impose tariffs, how- with no offsetting added source of revenues if tariffs are ever, the relative world prices of wine and cheese remain reduced. Trade agreements with the World Trade Organi- roughly unchanged, leaving consumers in both countries zation (WTO), or bilateral agreements with industrial worse off because domestic prices are distorted. Con- countries, therefore often include provisions to help coun- sumers in both countries are consuming more of the tries adjust to revenue loss. domestic good than is ideal (given world prices), terms-of- Both the WTO and PTAs allow countries to cooperate trade gains do not materialize, and world welfare is and commit to reducing trade barriers, but there is an reduced. important distinction between the two types of agreements. Second, there may be political constraints. Tariffs can be In particular, PTAs go against the principle of nondiscrimi- used as an internal redistribution tool by governments— nation that is at the heart of the multilateral system. The typically to shift income to some favored industry, region, first article of the General Agreement on Tariffs and Trade or group of voters or political contributors. For example, (GATT) concerns nondiscrimination, or most favored many economies tend to protect steel because production is nation (MFN) treatment. MFN means that every time a commonly concentrated regionally and the workers and country lowers a tariff, it has to offer the same treatment to firm owners tend to be politically organized. This combina- all its trading partners. The purpose of this clause is to pre- tion of political organization and geographic concentration vent trade diversion and the cumbersome tariff structure often means that the sector’s concerns may receive much that would likely prevail in the absence of MFN. greater weight in political decisions than would be sug- By offering preferences to specific countries, PTAs gested by its share of employment or output. Similarly, cer- definitively violate MFN treatment. Yet they are allowed, in tain industries may receive special treatment if the owners part, because the MFN clause creates a free-rider problem. of capital are connected to the government. Protection MFN means that countries in the WTO must offer the reduces consumer welfare, since consumers are forced to same tariff to all members. But if only a subset of members pay more than the world price, but governments cannot agrees on significant tariff reduction, other members can credibly commit to withholding protection of the special “free ride�—they get expanded market access without new sectors.3 In addition, protection may be in place because of commitments. If all members participated equally in MFN historical reasons and can be politically difficult to remove tariff reduction, PTAs might not be needed. PTAs enable because industry has adapted to it. countries that want to pursue deeper trade liberalization to Third, countries, especially developing countries, may evade the free-rider problem. Snape (1993) discusses the rely on tariffs for a share of the tax revenue they need to history of GATT Article XXIV, which allows for an excep- fund general government expenditures. Border transac- tion to nondiscrimination, and argues that this article is tions are an easy way to collect revenue when income tax vital for maintaining the multilateral club because some systems are weak. This motive tends to be more important members might opt out if it were not included. (In partic- in developing countries, where other forms of revenue col- ular, the United Kingdom, which was the largest importer lection are difficult. at the time, insisted on keeping its Commonwealth prefer- Reciprocal liberalization helps neutralize the first two ences.) Summers (1991) asserts that all types of liberaliza- forces described above: terms-of-trade motivations are tion, whether unilateral, bilateral, or multilateral, are very neutralized, and joint welfare is higher because, with lower likely to be good and that regionalism gives governments a tariffs, consumption patterns are less distorted. Reciprocity way to maintain progress on liberalization. in tariff cutting makes it easier to form a proliberalization This section has shown that reciprocal liberalization is coalition because the political strength of the domestic usually necessary for removal of barriers to international losses from tariff cutting can be balanced against the polit- trade. Although multilateral liberalization is preferable, ical strength of the exporters that gain from foreigners’ regional liberalization is ubiquitous and cannot be Preferential Trade Agreements and Multilateral Liberalization 123 ignored. The key question is whether this advancement of countries, most notably members of the Southern Cone regionalism is broadly beneficial or detrimental to global Common Market (Mercosur, Mercado Común del Sur).6 trade and welfare (see box 6.1). In the next section, we dis- The rise of North American regionalism coincided with cuss the recent rise of regional liberalization and how, in two other major developments in the world trade system. theory, it may affect the multilateral trade system.4 First, GATT negotiations lurched from crisis to crisis in the late 1980s and then seemed to die with the acrimonious collapse of the Uruguay Round’s “final� summit in Decem- Stumbling Blocks and Building Blocks ber 1990. Second, European regionalism was reignited by From 1960 to the late 1980s, regionalism was a simple the Single European Act and the collapse of the Soviet matter. It was represented by the European Economic Union. Community (EEC), which encompassed a third of world Many respected thinkers looked at this temporal corre- trade in a highly effective customs union, and by a slew of lation and saw causality. They feared that the spread of PTAs among developing nations that covered a trivial regionalism might kill the world trade system. These fears fraction of world trade and in any case never operated are easy to understand. Two-thirds of world imports went effectively. The systemic implications of regionalism were to North America and Europe; 40 percent of this total was simply not an issue. intrabloc trade that was soon to be covered by discrimina- Regionalism became complicated in the late 1980s tory liberalization schemes. Still more worrisome, North when Canada and Mexico changed their minds about American and European countries were the stalwarts of the regionalism (Krugman 1991b, 7).5 The United States had GATT system. If regionalism weakened their support of long been interested in regional preferential trade, but multilateralism, the GATT was indeed in deep trouble. Canada and Mexico had resisted, fearing domination by Spreading regionalism had become much more than a their giant neighbor. In 1985, Canada proposed a free small-think “should I join?� question. trade agreement (FTA) with the United States that These fears promoted regionalism to a prominence on entered into force in 1989. In 1990, Mexico, too, proposed the world’s policy agenda that it had not enjoyed since the an FTA with the United States. This initiative evolved into 1950s. The shift naturally attracted paradigm-setting efforts the North American Free Trade Agreement (NAFTA) at by the profession’s leading international economists. the insistence of Canada, which wished to safeguard its Krugman (1991b) is clearest in rejecting the relevance Auto Pact arrangement with the United States for tariff- of the 1950s small-think approach, which focused on static free trade in automobiles and parts. The U.S.–Mexico ini- welfare issues and delineating the outlines of a new line of tiative triggered a wave of Latin American requests for inquiry—what we call big-think regionalism: bilateral trade agreements with the United States and gave In a fundamental sense, the issue of the desirability of free greater urgency to arrangements among Latin American trade areas is a question of political economy rather than of economics proper. While one could argue against the formation of free trade areas purely on the grounds that Box 6.1. Is Bilateralism Bad? they might produce trade diversion . . . the real objection is a political judgment: fear that regional deals will under- Paul Krugman, in a series of papers published in 1991, mine the delicate balance of interests that supports the reframed the 1950s national welfare question as a global- GATT. (Krugman 1991b, 14–15) level question. Krugman (1991a) introduced a new approach by asking whether the spread of regionalism raises or lowers world welfare. This discussion spawned a Krugman’s framing of what he identified as the key decade-long literature and continues to influence research issue—the impact of regionalism on support for the GATT even today. The “is bilateralism bad?� literature—also system—did not catch on, however.7 known as multilateralism versus regionalism literature— looks distinctly odd from today’s perspective in that it tries The focus of this part of the discussion is on what we to use simple theory to answer what is intrinsically a consider to be the central theoretical question: does complicated empirical question. At the time, however, it regionalism help or hinder multilateralism? Ultimately, was the best that economists could do; they had limited access to the necessary data and lacked the panel this question is also empirical, but given the relative econometric techniques to exploit them. Moreover, paucity of experience with the regionalism-multilateralism spreading regionalism was at the time more of a threat interface (only one multilateral trade negotiation has been than a reality, so there was little experience to support empirical tests. Baldwin (2009) offers a full discussion of completed since 1991), convincing empirics is at an early the issue. stage, with some tantalizing results just beginning to emerge (see “Welfare Consequences of PTAs,� later in this 124 Richard Baldwin and Caroline Freund chapter). Moreover, given the complexity of the interlink- are put forward in the help-or-hinder literature (for exam- ages, a clear theoretical understanding is a necessary condi- ple, PTAs may slow the achievement of global free trade), tion for well-structured empirical work. but the desire for clarity has led the profession to focus on the strong form. In our opinion, only three forms of stumbling block Are Regionalism and Multilateralism Friends or Foes? logic are currently relevant to real-world policy analysis: Bhagwati, in The World Trading System at Risk (1991), does the preference-erosion (exploitation), goodies-bag, and not focus on regionalism. In the first part of the book, “The cherry-picking variants. (Many more will undoubtedly be GATT Architecture under Threat,� he lists regionalism as illuminated in coming years.) For simplicity’s sake, these one of four main threats. Nevertheless, his writing has possibilities are demonstrated under the naïve but trans- helped establish big-think regionalism as the new para- parent assumption that national governments choose tar- digm. In the first paragraph of his chapter on regionalism, iffs to maximize national welfare. he writes, “These regional alignments have led to fears of Preference erosion, or exploitation. Starting from a world fragmentation of the world economy into trading blocs in in which all nations have MFN tariffs, the question is antithesis to GATT-wide multilateral free trade. Does such whether some group of nations can raise its collective wel- regionalism truly constitute a threat to multilateralism?� fare above the free trade level by forming a trade bloc and (Bhagwati 1991, 58). Although he does not set out an ana- thus exploiting other nations. If the answer is “yes,� that lytical framework for answering the question, his writing bloc is a stumbling block on the road to multilateral free influenced the intellectual paradigm for more than a trade because the members would veto global free trade as decade. undermining their exploitation of third nations. Theory requires explicit questions. Asking whether In trade models, the answer is almost always “yes,� but regionalism and multilateralism are friends or foes is not the answer may depend on the level of MFN tariffs when sufficient. Pure logic identifies three mutually compatible the bloc is formed.8 Given Smith’s certitude (briefly, that all ways that regionalism and multilateralism could interact: parties to a preferential trade arrangement benefit) and Haberler’s spillover (postulating that third nations must • Regionalism could affect multilateralism. lose from such an arrangement), some combination of • Multilateralism could affect regionalism. nations is bound to be better able to exploit third nations • Both multilateralism and regionalism could be driven by acting as a bloc. This is almost trivially true if the bloc by third factors. can violate its WTO tariff bindings by raising external tar- iffs. After all, the bloc as a whole has more buying power The literature has looked at all three ways of framing than its constituents do individually, so it can better exploit the issue, but the first has dominated since Krugman foreigners. Less obvious, but equally true, is that stumbling (1991b, 1996) presented a simple analytical framework for blocks can be found even when external tariffs are main- posing the question. His explicit question was, How does tained (as has been the case for all the major postwar an exogenous variation in regionalism (specifically, the PTAs). formation of a new PTA) affect nations’ incentives to cut Consider the simple model presented in chapter 3 of tariffs multilaterally? Although most of the literature has this volume, with three symmetrical countries (Home, followed Krugman’s lead in asking how exogenous varia- Partner, and Rest of the World, or RoW) and three goods. tions in regionalism affect multilateralism, authors have Home imports Good 1 and exports Good 2 to Partner; also discussed the specific effect of PTAs on multilateral Partner imports Good 2 and exports Good 1 to Home; and trade negotiations (MTNs); the deeper forces driving Rest of the World exports Goods 1 and 2 to Home and PTAs and MTNs (Summers’ notion that all the “isms� are Partner, respectively, and imports Good 3 from both (see good); and the effect of multilateralism on regionalism. figure 3.1, in ch. 3). The first welfare theorem tells us that These are discussed below. global free trade is efficiency enhancing (a move to the first best), and symmetry ensures that each nation receives an equal slice of the gains. Three Kinds of Stumbling Block Logic This conclusion, however, can be reversed when we start In its cleanest form, the stumbling block logic asserts that if from the situation in which Home and Partner have the stumbling block PTAs were forbidden, global free trade formed a PTA by eliminating tariffs among them. Taking would be achieved, but that since they are permitted, global the PTA as the base case, a move to global free trade elimi- free trade becomes impossible. Weaker forms of this thesis nates the preference margin (P' – PFT) that Home exporters Preferential Trade Agreements and Multilateral Liberalization 125 Figure 6.1. Net Welfare Effects, Preferential Trade Figure 6.2. Relationship between MFN Tariffs and Home Agreement to Global Free Trade Welfare border price internal price home welfare XS P global free trade C2' A' 0.60 P' C1' C1' PFT D' 0.59 B' P–T P' – T MD 0.58 0.57 stumbling block tariffs MFN exports XR' imports 0.56 PTA Source: Author’s elaboration. 0 0.05 0.10 0.15 0.20 0.25 MFN tariff tariff (T) (MFN T) enjoyed in Partner, thereby leading to a terms-of-trade loss Source: Author’s elaboration. Note: Home welfare is plotted against the most favored nation (MFN) tariff of area C1' and a trade-volume loss of C2' (figure 6.1, left- for three trade regimes: MFN (all nations impose the same MFN tariff T on hand panel). all goods); PTA (Home and Partner form a preferential trade agreement, On the import side, because of lower internal prices, PTA); and global free trade, which is the MFN regime with T = 0. The parameters chosen are a = 1, b = 1/2; the qualitative results are unaltered from P' to PFT, global free trade would win Home an addi- for other choices of parameters. Note that T = 1/4 is the prohibitive tariff tional trade volume gain of area A', a terms-of-trade with a = 1, b = 1/2. In ad valorem terms, the Viner crossing occurs at a tariff of about 27 percent of the free trade price, and the ad valorem tariff improvement with respect to Partner exporters of area C1', threshold for a stumbling block occurs at about 9 percent; the prohibitive and a terms-of-trade loss on imports from RoW, shown as tariff is about 42 percent for these parameter values. area B' (right-hand panel). Global free trade would also improve Home exporters’ market access to RoW, and this would boost Home welfare by area D'. Overall, the net wel- forms of exploitation, but in exchange, it provides better fare change of moving from the PTA to global free trade access to the RoW market and more liberalization in is – C2' – B' + D' + A'; the sign of this is ambiguous. Home’s import market. It is straightforward to show that, in a simple model When the initial tariff T is low, the market access and with linear demand, a low MFN tariff and a PTA with zero home liberalization gains are modest, and so the net effect internal tariffs generate gains for the trade partners that is negative. In other words, the basic logic of the stumbling exceed those from free trade. (This is shown in figure 3.2, block result turns on the way that a PTA allows the PTA in ch. 3; see Baldwin 2009, box 4, for further details of the partners to exploit excluded nations. model.) Figure 6.2 presents the Home welfare levels for dif- The model presented here is very special, but the heart ferent values of the MFN tariff. and soul of the stumbling block effect—the exploitation of For initial MFN tariff levels that are sufficiently low, we excluded nations—is a general result, and one that is surely see that Home’s welfare is higher with the PTA than it is an important consideration in the real world. with global free trade, even though Home would have The opposition of small developing nations—especially agreed to global free trade starting from the initial situa- those that benefit from European Union (EU) unilateral tion without the PTA. (The line marked MFN is com- preferences—to agricultural liberalization in the WTO pletely below the line marked “global free trade,� but the Doha negotiations is a classic example of the preference- PTA line is above the global free trade line for sufficiently erosion stumbling block. Had the EU not unilaterally low tariffs.) granted preferences to these nations, they would probably Intuitively, the PTA allows Home to exploit RoW both have been pushing for opening of the EU market in sugar on the import side (by pushing down the price it pays RoW and other goods. exporters of Good 1) and on the export side (by raising Goodies bag. The goodies-bag version follows closely the the price in Partner at the expense of RoW exporters of fundamental economic logic of the preference-erosion Good 2). The move to global free trade undoes these two stumbling block.9 Briefly, the rents corresponding to 126 Richard Baldwin and Caroline Freund Smith’s certitude can be thought of as a set of “goodies� and only a modest amount of additional variety or com- that can be used by one or both PTA parties to buy parative advantage gains. Depending on parameters, espe- noneconomic benefits from its partners. Because the size cially the political power of the sufferers, the gains may of noneconomic benefits that can be “purchased� is linked not be sufficient to make global free trade attractive to the to the richness of the goodies bag—that is, the margin of bloc members. preferences—PTA members have an extra incentive to maintain high margins of preference by avoiding multilat- Building Block Logic eral liberalization. The goodies-bag logic, however, extends to a far greater range of issues than the tariffs that Whereas many trade policy scholars, including Krugman are the focus of the preference-erosion stumbling block. In (1991b) and Bhagwati (1991), worried that regionalism the case of a PTA between very large and very small was a stumbling block to global free trade, others, such as nations—a case that is extremely common in the new cen- Summers (1991) and Bergsten (1991), viewed regionalism tury (e.g., the United States and Costa Rica; Japan and as a largely benign or even constructive force in the world Singapore)—the large country’s interest in the PTA can trade system. hardly be thought to be preferential market access. Here, we consider the economic logic of the assertion The EU, for example, grants extensive preferences to its that PTAs can foster multilateral liberalization. There are members’ former colonies by using the justification of four main arguments in the literature. We begin with the international solidarity. In other words, the economic gains one that permeates the rationales used by countries that to the EU’s partners count as a plus inside the EU because simultaneously pursue regional and multilateral liberaliza- they advance one of the EU’s noneconomic objectives— tion: the notion that preferential liberalization creates a fostering development. Similarly, but more explicitly, the political-economy momentum that makes multilateral lib- United States justifies many of its PTAs with small, poor eralization easier (and vice versa). nations on the basis of noneconomic objectives, typically, Juggernaut. According to the juggernaut building block antidrug or antiterrorism policies. logic, liberalization begets liberalization. The logic comes The earlier discussion illustrated how the desire to safe- in two parts that are most easily explained in the context guard rents created by a PTA could make a nation reject of multilateral liberalization. When the GATT began in global free trade when it would have embraced MFN free 1947, import duties were high worldwide, since they had trade without the PTA. The goodies-bag stumbling block been set without international coordination during the logic amplifies this mechanism by making both nations tariff wars named for the U.S. Smoot-Hawley Act. The tar- interested in each other’s export rents—the area correspon- iffs balanced the supply of and demand for protection in ding to C1' in figure 6.1, with the link operating through the the “political market� of each nation separately. The main pursuit of noneconomic (in the narrow sense) objectives. demandeurs of import protection were import-competing Cherry picking. An entirely distinct mechanism is at firms and the workers they employed. Government was work in the cherry-picking stumbling block.10 Assume the supplier of protection, but concern for the country’s that the trading environment is marked by both intrain- general economic well-being meant that the government dustry trade in differentiated products and interindustry would set the protection level below what was lobbied for trade. In this world, trade liberalization will produce gains by special interests (the supply of protection being not from trade because of the variety effect in the differenti- perfectly elastic). ated product sectors (as in Helpman-Krugman models) Starting from this situation of uncoordinated tariff and because of comparative advantage effects. The com- setting, announcement of an MTN based on the princi- parative advantage gains, however, come bundled with ple of reciprocity alters the array of political forces inside politically difficult effects on domestic factor prices, which each participating nation. The central point is reciproc- will be lower (e.g., lower wages).11 Now suppose that two ity, which converts each nation’s exporters from large nations have similar factor endowments. If they form bystanders in the tariff debate to antiprotectionists. For a trade bloc, they will win a large share of the variety gains exporters, lobbying against domestic tariffs becomes a that would come with global free trade, and because of means of lowering foreign tariffs. Because the MTN their similarity, they will experience little pain from lower rearranges the political-economy forces inside each factor prices. nation, all governments find it politically optimal to Taking the trade bloc as the base case, the bloc mem- choose tariff levels that are lower than the unilaterally bers may find a move to global free trade unattractive. It optimal tariffs.12 This is the first part of the juggernaut would entail a good deal of pain in terms of factor prices theory.13 The logic is not new. Preferential Trade Agreements and Multilateral Liberalization 127 Informed observers have long known that the GATT’s Figure 6.3. Juggernaut Logic reciprocal MTNs mostly had to do with helping nations tariff (T ) internalize a political-economy externality inside their own polities, making it easier for national politicians to put FE together a national coalition in support of freer trade. Eo GFOCunil Writers such as Robert Baldwin (1970, 1985) and Destler To (1986) are explicit on this point, but historical accounts of the Cobden-Chevalier Treaties show that the use of exter- nal trade deals to realign domestic political forces was very GFOCMFN much in the minds of nineteenth-century thinkers (Irwin 1996, 96). Even Krugman writes that “the process of multi- lateral negotiation . . . sets each country’s exporting inter- ests as a counterweight to import-competing interests; as trade negotiators bargain for access to each others’ mar- Efinal size of import- kets, they move toward free trade despite their disregard for competing the gains from trade as economists understand them� sector, n (Krugman 1991b, 17). Source: Author’s elaboration of figure 4 from Baldwin 2006. The second part of the juggernaut logic concerns the Note: FE, free entry; GFOC, government first-order condition; MFN, most favored nation. effects of the tariff cuts on openness. The cuts make all nations more open: export sectors expand with the foreign tariff cuts, and import-competing sectors contract with number of firms), via politics. The politically optimal domestic tariff cuts. Assuming that political influence is tariff choice, which takes as given the size of the import- linked to industry size, this economic relandscaping competing sector, is plotted as GFOCunil, the solution to strengthens proliberalization forces and weakens antiliber- the government’s first-order condition without MTN. The alization forces in all nations—although, of course, such politically optimal tariff rises with n because the larger the industrial restructuring takes years. In other words, the ini- import-competing sector, the higher the political benefit tial reciprocal tariff cuts start a liberalization juggernaut from a marginal increase in the tariff. The free entry curve, rolling. Because of the economic relandscaping that occurs FE, relates the equilibrium number of firms to the tariff. As during the phase-in of the initial tariff cuts, all govern- the tariff rises, more firms find it optimal to enter the mar- ments find that their politically optimal tariff in the next ket. These two relationships assume that the government MTN is below the levels that they found politically optimal and firms are shortsighted and that the government chooses during the previous MTN. These fresh tariff cuts continue T, taking n as given, while firms choose n, taking T as given. the relandscaping, and the juggernaut continues to roll for- Note that the figure only captures the size of anti-trade ward. Once the liberalization juggernaut starts rolling, it forces; the size of the pro-trade export sector is suppressed crushes all tariffs in its path.14 to avoid the need for a three-dimensional diagram. To the extent that regionalism can start the juggernaut To see the two steps of the juggernaut effect, note that rolling, PTAs can serve as building blocks.15 The precise announcement of the MTN shifts the GFOC curve to mechanism is a simple extension of the juggernaut logic. GFOCMTN. This curve is lower because the government finds PTAs reconfigure members’ economies, making export it politically optimal to set a lower tariff for any given level of sectors larger and import-competing sectors smaller. Thus, n when domestic protection is linked to foreign protection the PTA can alter the member governments’ stance toward via reciprocity. As drawn, the new long-run equilibrium MFNs, making it politically optimal to cut MFN tariffs to Efinal entails free trade, but since entry and exit occur slowly, levels that would not have been politically optimal without the tariff and the state of the import-competing industry do the PTA. Of course, if a PTA results in higher external tar- not jump to Efinal. The figure illustrates one possible adjust- iffs (as in the case of the EU’s agriculture tariffs), then it ment path. Each MTN results in an instantaneous drop in can start the juggernaut rolling backward. the tariff, but slow entry and exit mean sluggish movement The basic idea is presented in figure 6.3. The two curves, of the state variable, as indicated by the horizontal arrows. FE (free entry) and GFOC (government first-order condi- The juggernaut effect acts as a building block if the PTA tion), show how the size of the import-competing sector reduces the importance of import-competing industry in depends on the tariff (free entry) and how that tariff governments’ objective functions. In many models, a PTA depends on the size of the import-competing sector (n, for between Home and Partner does reduce the size of the 128 Richard Baldwin and Caroline Freund Home import-competing sector, and then PTAs would be bundles. The nature of the proposed trade deal can affect a building blocks on the road to global free trade. nation’s ranking of choices (unilateral versus reciprocal, for The FE curve in figure 6.3 was drawn for symmetric example). These rankings, unlike the rankings of a standard MFN tariffs. When the PTA is signed, the FE curve rotates consumer, are path dependent because historical liberaliza- inward, as shown in figure 6.4, because the additional com- tion can affect the current political strength of various pro- petition from Partner producers lowers the Home price trade and anti-trade special interest groups. A number of facing import-competing firms, and some of them exit. building block arguments assume, however, that nations, like Consequently, the GFOC under reciprocal trade will yield a consumers, have exogenous preferences about outcomes. We lower MFN tariff after a PTA (point E2) than before (point next consider the easiest of these arguments, which assumes a E1). Of course, if the PTA somehow increases protection of representative consumer and a government that acts to max- the Home import-competing sector, the effect is reversed, imize the individual’s well-being. and the PTA acts as a stumbling block.16 Kemp-Wan theorem. The assertion that trade blocs may Frankel and Wei momentum. Frankel and Wei (1998) be building blocks in a static world is as easy and as general illustrate another juggernaut-like mechanism. In their as the assertion that they may be stumbling blocks. Starting model, imperfect information makes workers uncertain as from a world in which all nations have MFN tariffs, the to whether they will win or lose from global free trade. Since question is: can some group of nations always raise its col- a PTA is an intermediate form of liberalization, the authors lective welfare by forming a trade bloc? If the answer is show that a PTA could be politically feasible even when “yes,� then a piecemeal enlargement of the bloc will raise global free trade would not be. After the PTA is signed, the bloc members’ well-being monotonically. Bloc members nation’s true comparative advantage is revealed, and workers attain the highest welfare when all nations are part of the now know whether they will win or lose from free trade. If bloc. In this world, the formation of a single bloc should the parameters are chosen carefully, the certainty resolution trigger a domino effect that leads to worldwide free trade. may mean that global free trade is politically feasible only As seen in chapter 3, the Kemp-Wan theorem tells us after the PTA. Thus, the PTA is a building block, and since it that the answer to the above question is always “yes� when operates by altering the political-economy landscape, it nations have access to international lump-sum transfers can be thought of as a momentum-generating mechanism. (Kemp-Wan 1976) or to a complete set of commodity taxes The juggernaut logic exploits the fact that nations do have and subsidies (Dixit-Norman 1980). Kemp and Wan preferences about trade arrangements, in the way that indi- (1976), in probably the first formal contribution to the vidual consumers have preferences about consumption building block–stumbling block discussion, make exactly this point. (See Aghion, Antràs, and Helpman 2007 for an elaboration of the Kemp-Wan argument that uses modern Figure 6.4. Juggernaut Building Block Logic cooperative game theory concepts.)17 tariff (T ) Although the Kemp-Wan building block logic is flawless, FE (with PTA) it falls down in the face of the real-world problem that FE nations do not have access to massive lump-sum transfers. Indeed, the assumption that such international transfers are Eo GFOCunil a realistic possibility basically assumes away most of the To core difficulties facing the international trade system (and international relations more broadly). Without interna- GFOCMFN tional transfers, the logic of preference-erosion stumbling E1 blocks and cherry-picking stumbling blocks suggests that in many blocs, some members would eventually veto some E2 enlargements. Veto avoidance. The preference-erosion stumbling block logic discussed above rests on the fact that bloc members can veto the move to global free trade. The veto-avoidance size of import- building block logic points out that, although bloc mem- competing sector, n bers can veto multilateral trade liberalization, they cannot veto further PTAs that may eventually eliminate all tariffs Source: Author’s elaboration of figure 4 from Baldwin 2006. Note: FE, free entry; GFOC, government first-order condition; PTA, globally. The explosion in the number of PTAs among preferential trade agreement. small nations witnessed in the new century may very well Preferential Trade Agreements and Multilateral Liberalization 129 be attributable to a combination of the juggernaut effect world. Customs unions require supranational decision- and veto-avoidance logic.18 making capacity to keep all external tariffs in line in the We start by considering the development of an extremely face of changes in antidumping duties; special unilateral common form of regionalism, hub-and-spoke PTAs. Here, preferences to third nations, such as the generalized system one partner (e.g., the United States, the EU, or India) has a of preferences; and tariff changes in multilateral trade network of radial bilateral PTAs with some of its trading talks. The groups of nations that manage such coordina- partners, but these trading partners do not have PTAs with tion are of just two types: the EU, and nations involved each other. Simplicity dictates our continued use of the in superhegemon relations (e.g., France and Monaco; symmetric framework shown in figure 3.2 in chapter 3, so Switzerland and Liechtenstein; and the South African Cus- we arbitrarily bestow hub status on Home. toms Union). Given that the real world is covered with Roughly speaking, Home found the bilateral PTA with hub-and-spoke trade arrangements, we assume henceforth Partner attractive because the improved market access for that Partner has no veto over Home’s PTA policy, and the Home exporters in Partner’s market more than out- hub-and-spoke system is indeed set up. weighed the potential welfare losses from trade diversion in The story, however, is not finished. As it turns out, the Home’s import market. This suggests that Home might two spokes may find a spoke-spoke PTA to be advanta- also find a second bilateral PTA with RoW to be welfare geous, and this would achieve global duty-free trade. enhancing.19 (Trade, however, would not necessarily be free because of As it turns out, in the PTA diagram framework, Home the exclusion of various sensitive sectors, rules of origin, always gains from signing a second PTA with RoW. Intu- and cumulation.) itively, the point is that Home gains the same preferential The hub-and-spoke PTA puts Home in an enviable market access as it did from the first PTA, and it undoes the position, giving it the benefits of free trade for its imports potentially harmful trade diversion by fully liberalizing its and preferential market access for all of its exporters. In import market. To see this in more detail, we reinterpret this sense, hub-and-spoke bilateralism might be thought of figure 6.1. On the export side, Home’s second PTA wins its as another example of the preference-erosion stumbling preferential access to RoW’s market without giving up its block logic: Home would veto WTO talks aimed at achiev- preferences in Partner; this has a net welfare value of areas ing global free trade. This simple world, however, can D' + C1' + C2' in the left-hand panel.20 On the import side, attain global duty-free trade without multilateral talks—a the second PTA brings the price in Home’s market for PTA between Partner and RoW would do the job. So, Good 1 to the global free trade level, PFT. The welfare would Partner and RoW be interested in a PTA? impact of this is the positive trade volume effect area A' Taking hub-and-spoke bilateralism as the point of plus the conflicting terms-of-trade effects, areas –B' and + departure, the spokes (in this case, Partner and RoW) C1'. (See Baldwin 2009, box 5, for a mathematical proof.) clearly have a very different view of global free trade than Would RoW accept Home’s offer of a second PTA? As it does the hub. A move to global free trade would do nothing turns out, RoW gains from such a PTA as long as T is not to erode Partner’s preferences in Home, since those were too high (see Baldwin 2009 for details). That is, the hub- already eroded by Home’s second PTA. For Partner, the and-spoke situation is better for RoW than the initially dis- shift to the global free trade regime would involve a stan- advantaged position, when it was excluded from the dard exchange of market access with RoW; Partner would Home-Partner PTA. On the export side, a PTA with Home see its export price to RoW rise from P' – T to PFT for would improve RoW’s market access a great deal (its Good 3, and RoW would see a symmetric border price rise export price would rise from the depressed level of P'– T to for its exports of Good 2 to Partner (see figure 3.2) The the free trade price, PFT). The liberalization on the import attendant liberalization of the two nations’ import mar- side would have the usual positive trade volume effect and kets would have the usual conflicting trade volume and conflicting terms-of-trade effects, identical to those experi- terms-of-trade effects, but overall, the two nations could enced by Home in its first PTA. find the exchange to be welfare enhancing. In fact, Partner Plainly, Partner will be harmed by the formation of the and RoW would always prefer global free trade to the hub- hub-and-spoke system around Home; its preferences in and-spoke situation. Home are eroded, and it receives nothing in compensation. This is certainly not to be taken as a general result. It Partner would thus like to veto Home’s second PTA, but does, however, illustrate how regionalism could be a build- except in extraordinary circumstances, third nations can- ing block in a world in which overall free trade would be in not veto PTAs. The main exception is customs unions, but the interest of all nations, but achievement of the goal is functioning customs unions are quite rare in the modern blocked by nations that fear erosion of their preferences. 130 Richard Baldwin and Caroline Freund Related Logics: Induced Liberalization and Protection slopes of the third-nation import supply curves, Tod is likely to fall because PTAs typically reduce PTA members’ Before ending this review of the helps-or-hinders literature, trade with third nations (Harberler’s spillover); that is, Mod it should be useful to cover two economic mechanisms that is likely to fall. For example, in the simple PTA diagram link PTAs and MFN tariffs without formally making the model presented in figure 3.2 in ch. 3, the import supply connection with multilateral trade talks. Both consider the curves are linear, and so dp*/dM does not change with impact of PTAs on a nation’s MFN stance in the absence of preferential liberalization. However, Haberler’s spillover a new MTN. The first mechanism links PTAs to unilateral effect lowers third-nation trade (Mod), and so Home’s opti- MFN liberalization; the second looks at how a PTA can mal tariff on RoW exports falls. lower or raise a nation’s effective MFN tariff rate. Another mechanism that yields complementarity turns Unilateral liberalization. The building block logics on the general principle that taxes become more distor- examined earlier directly address the issue of whether PTAs tionary when the variance of rates across products help or hinder the attainment of global free trade. Here, we increases. This is termed the uniform tax rate principle, look at a related but logically distinct question: what is the and it is a feature of many economic models, especially impact of a PTA on the tariffs a nation would find unilater- when administrative and enforcement considerations are ally optimal to impose on third nations? Intuitively, the taken into account. It explains why most nations impose question is whether preferential tariffs are complements to fairly even indirect tax rates across products. Since the PTA or substitutes for MFN tariffs.21 The easiest way to organize automatically makes the import tax structure more the various mechanisms is to start from the Meade (1955) uneven, there is some presumption that the PTA makes formula for the welfare impact of any trade policy change the third-nation tariffs more distortionary. In models in a Walrasian economy: where this is true, nations are likely to lower third-nation Net home welfare effect = (p – p*)dM – (M)dp* (6.1) tariffs when they reoptimize their trade tax structures. That where p and p* are the vectors of internal and border prices is, PTAs encourage nations to reduce applied MFN tariffs. (and p – p* = T, the tariff), M is the vector of bilateral Preferential and MFN tariffs as substitutes. The most obvi- imports (exports are negative imports), and dM and dp* ous mechanism that suggests the substitutes result (i.e., are the vectors of changes in bilateral trade volumes and nations find it optimal to raise third-nation tariffs after border prices, respectively. having signed a PTA) concerns the market power of the A nation choosing its bilateral tariffs optimally would new bloc. If the PTA allows PTA members to better coordi- view this formula as a first-order condition and set it nate their third-country tariffs, the members are likely to to zero to find its optimal tariff. The optimal bilateral raise external tariffs because they will have more purchasing tariffs are: power than before. This effect is only likely to be relevant in customs unions, where countries set tariffs jointly. Even so, ⎛ dp* ⎞ two fairly unrealistic assumptions are required: that the gov- Tod = M od ⎜ ⎟ (6.2) � dM ⎠od ernments share sufficiently similar objective functions, and that their external tariffs are not subject to WTO bindings (or where o indicates the origin nation and d the destination that they are willing to violate their WTO commitments). nation (the nation choosing the tariffs). In general, any- Since most of the effective PTAs are among developed coun- thing can happen to Tod when the nation signs a free trade tries whose tariffs are almost universally bound at near-zero agreement, because, according to the Slutsky equation, the levels (apart from a few low-volume items) and since such direct and cross-good income and substitution effects of the countries rarely violate their WTO bindings, this mechanism PTA-induced price changes could raise or lower the right- is probably of little real-world relevance except for a few com- hand side of the equation (6.2). Real income is expanded modities (agriculture before the Uruguay Round) and a few because the price of the preferential good fell, raising low-trade-volume PTAs among developing countries. demand and hence the optimal external tariff. However, Imported MFN liberalization and protection. A closely there is also substitution toward the low-cost preferential related line of reasoning considers the automatic impact of good, reducing demand for other foreign goods and push- PTAs on the external protection of PTA members, when ing the optimal external tariff down. Attempts to resolve the members impose different tariffs on third countries. Under inherent ambiguity have led to the emphasis on several eco- some circumstances, the PTA effectively lowers the higher nomic mechanisms in the literature. MFN tariff (imported MFN liberalization); in other cir- Preferential and MFN tariffs as complements. If the PTA- cumstances, the PTA effectively raises the lower MFN tariff induced price changes have little impact on the equilibrium (imported MFN protection).22 Preferential Trade Agreements and Multilateral Liberalization 131 A good example of imported MFN liberalization can be The feasibility of this outcome is established by noting found in North-South PTAs. The concept can be explained that the U.S. supply at Po is more than sufficient to cover intuitively with reference to Mexico’s experience. In 1994, the entire Mexican import demand (point 2 is to the right Mexico, along with Canada and the United States, formed of point 1). Note that there is a secondary effect on world NAFTA, which phased in tariff cuts over 10 to 15 years. prices as the United States expands its imports. The new Mexican MFN tariffs were (and still are) much higher than price is at the intersection of the dotted MD curve and the U.S. and Canadian MFN tariffs, but as NAFTA brought XSRoW curve. For simplicity’s sake, this second-order Mexican prices down to the U.S. internal level, domestic impact is not shown in the two leftmost panels. prices in Mexico came to resemble those that Mexico would If one combines this imported MFN liberalization with have observed if it had lowered its MFN tariffs to U.S. levels. the juggernaut logic, the PTA can eliminate all the firms in To put it differently, the high Mexican MFN tariffs became Mexico that would otherwise have opposed MFN liberal- irrelevant because the same goods could be purchased from ization. That is, Mexican industry has no interest in lobby- the United States duty-free, and the U.S. internal price was ing for the maintenance of high Mexican MFN tariffs, linked to the world price via its low MFN tariff (leaving which provide no protection to Mexican industry. In the aside the small sectors still protected by high U.S. MFN tar- case at hand, the Mexican government signed a vast array iffs, such as clothing, textiles, and footwear). In this sense, of PTAs to exchange its now politically useless MFN tariffs Mexico ended up “importing� the low U.S. MFN tariffs.23 against preferential access for its exporters. The argument can be illustrated more precisely by using Since developed countries (the North) tend to have figure 6.5, which shows import demand by the United much lower MFN tariffs on most manufactured goods States (left-hand panel), Mexico (middle panel), and the than developing countries (the South), the mechanism world market for the good under consideration (right-hand suggests that an important implication of North-South panel). The U.S. total supply curve is shown in Mexico’s PTAs for the world trading system is their potential to panel, for reasons that will become clear. The United States lower the southern country’s resistance to further liberal- initially imposes a zero tariff on imports from the rest of ization. Given that most of the South does not participate the world, whereas Mexico imposes a tariff of TMX on in MTN tariff-cutting exercises on the basis of reciprocity, imports from both the United States and the rest of the the North-South PTAs are one of the few ways of triggering world. When Mexico eliminates duties on U.S. imports, juggernaut effects in developing countries. U.S.-made goods can enter Mexico duty-free. Since the Rules of origin and imported MFN protection. The oppo- Mexican internal price is initially above the U.S. internal site result, in which a PTA imports MFN protection to a price, U.S. firms sell to the Mexican market and, in doing country with low MFN tariffs, can occur when highly so, drive down Mexico’s internal price to the U.S. internal restrictive rules of origin are imposed. The argument can price—which, of course, is just the world price. U.S. pro- be illustrated with reference to NAFTA. Since the first U.S. duction entirely displaces Mexican imports from the rest of foray into regionalism, the 1965 U.S.–Canada Auto Pact, the world, and the Mexican MFN tariff becomes irrelevant. U.S. and Canadian rules of origin on autos have been Figure 6.5. Imported MFN Liberalization Partner Home U.S. price Mexican price RoW border price XSRoW Po + TMX SUS 1 Po 2 Po MDUS+MX MDUS MDMX imports imports imports MoMX Source: Authors’ elaboration. 132 Richard Baldwin and Caroline Freund highly restrictive. One of Canada’s motives in pushing for Figure 6.6. An Economic Theory of the GATT the trilateralization of the U.S.–Mexico free trade agree- ment was to extend its restrictive rules of origin to Mexico nation 2’s tariff, t2 and thereby avoid the undermining of the Auto Pact. The rules of origin forced Mexican-based car producers to Nash tariffs import parts and components from the United States or * t2 Canada instead of from third countries. As before, NAFTA equalized U.S. and Mexican internal prices, but this meant that the Mexican prices were linked to the world prices via the higher MFN tariffs in Mexico’s partners. In this way, “imported MFN protection� occurred. NAFTA, with its GATT tariffs rules of origin, had effects that mimicked a rise in the efficient bargaining curve tariffs Mexican MFN tariffs to U.S. and Canadian levels. Although the distortionary impact of rules of origin is * t1 nation 1’s tariff, t1 limited by the level of the MFN tariff, the all-or-nothing Source: Krugman 1991a. feature of rules of origin for final goods can lead to large effective rates of protection. For example, if a US$20,000 NAFTA-origin automobile pays zero tariff and the same non-NAFTA auto would pay 5 percent, a rule of origin of the cooperative outcome� (Krugman 1996, 72).25 The stipulating that a particular component must be made crux of his analysis is to examine the impact that an within NAFTA could make it economical to pay up to exogenously formed PTA has on the costs and benefits of US$1,000 more for the local versus the imported compo- cheating. nent. Although the distortion in the final good market is Much of Krugman’s reasoning is informal, so it is worth limited to 5 percent, the distortion in the component mar- spelling it out explicitly. The whole analysis turns on three ket can be much larger. (This distortion represents the tra- equilibrium welfare levels: ditional logic of effective rate of protection.) • WGATT is the level of a nation’s welfare with global coop- eration (GATT tariffs) Bargaining-Model Stumbling Block–Building Block Logic • WNash is national welfare under noncooperative tariffs The stumbling block–building block mechanisms discussed • Wcheat reflects the nation’s welfare when its government earlier resonate strongly with real-world considerations “cheats�—that is, chooses a tariff to maximize its own because they take advantage of the simple institutional fea- welfare when the foreign government embraces its tures of real-world tariff cutting in PTAs and MTNs. This, GATT tariffs. however, is not how big-think regionalism started reasoning about the issue (Krugman 1991b, 1996).24 There are two logical steps in the approach. The first step When Krugman wondered how regionalism would consists of the obvious point that, from a global perspec- affect the GATT, the tool he grabbed for was simple tive, tariffs are worse than a zero-sum game. Therefore, bargaining-game theory, with two countries that are con- some form of cooperation could be Pareto improving, yet sidering setting tariffs cooperatively (under GATT), or nations have an incentive to cheat. Formally, this is a pris- noncooperatively (Nash tariffs). As figure 6.6 shows, both oners’ dilemma, and it arises when Wcheat > WGATT > WNash. countries prefer the cooperative outcome. Krugman The second step involves a dynamic game that models the observes, “Trade bargaining . . . is characterised by a Prison- circumstances under which cooperation is sustained. As ers’ Dilemma. This Dilemma arises in part from the terms Krugman notes, cooperation is self-enforcing when of trade effect of conventional optimal tariff analysis, but the gains from cheating are more than offset by the also (and presumably in practice mostly) from the effect of losses from the (infinite) punishment. Taking d as the dis- each country’s tariff on the other country’s producer inter- count factor, the present value of cooperating forever is ests� (Krugman 1996, 72). He goes on to invoke all the WGATT/(1 – d ). If cooperation is to be sustained, its value usual theorems of repeated games to think about the build- must exceed the one-period gain from cheating, Wcheat, ing block–stumbling block issue and concludes, “Trade lib- plus the present value of the infinite sequence of the Nash eralisation must be supported by the belief of countries that outcomes that are felt in the next period, after the foreign- if they cheat they will lose from the subsequent collapse ers realize that cheating has occurred, d WNash/(1 – d ). Preferential Trade Agreements and Multilateral Liberalization 133 Clearing the (1 – d ) terms, the condition for self-sustain- cooperation, as depending on the strength of various ing global free trade is: domestic special interest groups. The question here, in the big-think framework, is whether a PTA weakens or WGATT > (1 – d )Wcheat + d WNash strengthens pro-trade and anti-trade interest groups. At In words, each nation compares the value of welfare one end, Winters (1993) argues that regionalism (e.g., in under cooperation with a weighted average of the cheating the EU, on agriculture) strengthened the hand of protec- outcome and the Nash outcome. tionists, since it worsened Olsen’s asymmetry (which The contribution of this approach comes in considering holds that winners from protection are few in number and how a PTA changes the three levels, Wcheat, WGATT, and are easy to organize, whereas losers are dispersed, numer- WNash. Krugman (1996) asks whether the formation of a ous, and difficult to organize politically). Winters terms trade bloc among nations makes them more or less able or this the “restaurant bill� problem. Just as diners at a table willing to cooperate. His answer is that it can cut either way. where the bill will be split equally tend to order too much, Krugman’s core insight—one that has been followed up the EU tended to grant too much protection to farmers. At in a dozen subsequent articles—is that PTAs typically act the other end, Richardson (1994) and Panagariya and to reduce their members’ trade with the rest of the world Findlay (1994) argue that a PTA tends to dilute the influ- and so reduce both the cost and the benefit of cheating. ence of special interest groups via various mechanisms. Since these work in opposite directions, some bargain- Another important line of thinking asserts that the for- approach papers find that PTAs are building blocks (i.e., mation of PTAs creates forces that induce nations to begin they make cooperation more likely), whereas others find or complete multilateral trade talks. For example, Lawrence they are stumbling blocks. (1991), WTO (1995), and Sapir (1996) all argue that the This approach works well for explaining strategic inter- threat of regionalism was a critical element in inducing actions among private agents, but it may be less useful for GATT members to initiate the Uruguay Round and to explaining trade negotiations among large countries. In accept the final Uruguay Round agreement. Bergsten (1996) particular, it requires two assumptions: that the cheating dubs this effect “competitive liberalization� and asserts that period is long enough to make it tempting, and that pun- regionalism fosters multilateralism, and vice versa. Formal- ishment can be usefully modeled as consisting only of tariff izing regional agreements as a force for competitive liber- changes. Since tariff changes are immediately observable, alization, Saggi and Yildiz (2008) study the role of PTAs in the first assumption is problematic unless partner coun- multilateral liberalization in the presence of a nondiscrim- tries are very slow to respond, which may well reflect policy ination constraint, such as the MFN rule in the WTO. in small developing countries. Punishment is likely to They show that if PTAs are not permitted, a country with include more than just tariffs; it may affect external devel- special interests aligned against free trade may oppose a opment aid, treatment of expatriates, migration, military multilateral free trade agreement because it can ride for aid, political support in the international arena, participa- free on the liberalization efforts of others. Nondiscrimina- tion in the North Atlantic Treaty Organization, and other tion means that when any small group of countries liber- concerns. With a shorter period of deviation and more alizes, all WTO members benefit from lower tariffs on tools of punishment available, as is the case for large devel- their exports. The threat of PTAs can reverse that situation oped countries, it is therefore likely that all welfare- by offering the liberalizing countries a way to stop the out- improving agreements are enforceable. Thus, the effect of sider from free riding. In this model, competition to the PTAs on the cost and benefit of deviating from cooperation multilateral system in the form of PTAs can make multi- is unlikely to have a first-order impact on multilateral lateral free trade feasible when it would not be feasible in cooperation when the major countries are involved. This the absence of that competition. type of model may help explain why some agreements A somewhat related idea, which has not been formal- among developing countries are never implemented and ized, is that PTAs are a testing ground for the GATT/WTO why some do not survive when external conditions change. (Bergsten 1996; Lawrence 1996). The prime example here is the EU, which dealt with deeper-than-tariff-cutting lib- eralization for decades before the issues arrived on the Other Links from PTAs to MTNs GATT agenda in the Tokyo and Uruguay Rounds. (See A number of points made in the literature do not fit neatly Ludema 1996 for a partial formalization of this idea.) into the stumbling block–building block framework as we Another line of thinking suggests that PTAs can provide have delineated it. One line of reasoning views a nation’s commitments that boost the credibility of a country’s policy MFN tariffs, or its stance favoring or against multilateral reforms (Fernandez and Portes 1998). This was explicitly 134 Richard Baldwin and Caroline Freund mentioned by Mexico in its request to the United States for have adjusted their external tariffs. She finds that both inte- an FTA and has been highlighted as an important reason that grating and nonintegrating countries have reduced their Eastern European countries have been keen to join the EU. trade barriers, suggesting that regionalism is benign. How- Finally, studying how regionalism affects multilateralism ever, Foroutan does not control for other factors that may is not the only way to look at the relationship between the have induced countries to behave as they did, making it two. A few authors have examined it from the other direc- impossible to disentangle the effects of trade agreements tion: how multilateralism affects regionalism. Both Ethier from those of other global, regional, or sectoral trends. (1998) and Freund (2000a) view regional initiatives as a con- Baldwin and Seghezza (2010) study the relationship sequence of the success of multilateralism. Ethier asserts that between preferential and MFN tariffs in 23 developed and it is a benign consequence, since PTAs intensify world invest- developing countries and find a positive relationship, sug- ment and create incentives for economic reforms in less gestive of the tariff complementarity discussed earlier. developed countries. Freund studies the incentives for and Because their dataset is a cross-section (for 2005), the the sustainability of preferential liberalization when multi- authors note that they cannot assess whether their result lateral tariffs are lower and finds that deeper multilateralism arises from a causal relationship or is just a consequence of, provides greater incentives to form PTAs. The intuition say, fixed effects that affect both preferential and multilateral draws from the complementarity effect between internal and tariff levels. Still, their findings indicate that regionalism has external tariffs. When external tariffs are low, the loss from not led to significantly higher external tariffs. trade diversion is small, but the gains to producers from Using a detailed cross-industry dataset on Argentina for preferential access and to consumers from lower prices 1992, 1993, and 1996, Bohara, Gawande, and Sanguinetti remain. This reasoning could help explain, at least in part, (2004) examine the influence of imports from Mercosur’s the large increase in PTAs since the conclusion of the partner Brazil on Argentina’s external tariffs. They find that Uruguay Round and the formation of the WTO in 1995. increased preferential imports vis-à-vis the value added of the domestic industry led to lower external tariffs in Argentina, especially in industries that experienced trade Regionalism Versus Multilateralism: diversion. This, again, is consistent with the complemen- Empirical Evidence tarity of tariffs. Trade diversion is costly, and to minimize The empirical literature on regionalism as a building it, tariffs were lowered in precisely those industries with the block or stumbling block with respect to free trade is most diversion. One issue is that the study concentrates on small, compared with the theoretical literature, but inter- the effects of increases in preferential imports and does not esting results are beginning to emerge. To date, there is no address the direct effect of preferential tariffs. evidence that regionalism has been a major stumbling Estevadeordal, Freund, and Ornelas (2008) offer the block to free trade and some evidence that it has promoted first attempt to evaluate empirically the effect of preferen- broad liberalization. On the question of whether regional tial tariffs on external trade liberalization in a large group agreements alter countries’ willingness to move to free of developing countries. They examine changes in prefer- trade, there is only anecdotal evidence. PTA members have ential tariffs and MFN tariffs in 10 Latin American coun- continued to participate in the WTO, with little evidence tries and 100 industries over 12 years. When countries of a distinct change in priorities. Finally, on the welfare form a PTA, they lower the tariffs they apply to each other, impact of regionalism, evidence of trade creation exceeds but the duties on imports from outside countries can evidence of diversion. increase, decrease, or remain unchanged. The authors look History points to complementarity between PTAs and at how countries in Latin America, where regionalist forces external liberalization. Irwin (1996) shows that bilateral have been particularly strong since the early 1990s, altered agreements during the nineteenth century induced their trade policies vis-à-vis bloc outsiders after forming broader liberalization. The Anglo-French treaty of 1860 PTAs and, specifically, whether sectors with relatively large led to a host of bilateral agreements that were ultimately preferences have been liberalized or protected to the same linked by the inclusion of an unconditional MFN clause. extent as other sectors. If countries raise their external tar- Precisely because trade diversion associated with high tar- iffs (or reduce them by less) as a result of regional liberal- iffs was costly, the French negotiated numerous such ization, such preferential arrangements should indeed raise MFN-style agreements. concerns about the recent trend. If, instead, preferences Using data on trade and trade policy in 50 countries lead to relatively lower external tariffs, regional agreements between 1965 and 1995, Foroutan (1998) provides a gen- should be accorded a more benign reputation than they eral account of how countries forming regional trade blocs currently have. Preferential Trade Agreements and Multilateral Liberalization 135 The results imply that regionalism is a building block The findings of Foroutan (1998), Bohara, Gawande, and for free trade. There is no clear evidence that trade prefer- Sanguinetti (2004), Estevadeordal, Freund, and Ornelas ences lead to higher tariffs or smaller tariff cuts, and there (2008), and Calvo-Pardo, Freund, and Ornelas (2009)—all is strong evidence that preferences induce a more rapid of which imply that regionalism is a building block for decline in external tariffs in free trade areas. For example, if external liberalization in developing countries—contrast a country that follows a strict policy of nondiscrimination sharply with those of Limão (2006) and of Karacaovali and offers free access to another country in a sector in which it Limão (2008), who find that the United States and the EU applies a 15 percent multilateral tariff, the country would liberalized less during the Uruguay Round in sectors in tend to subsequently reduce that external tariff by more which preferences were granted. One reason for differing than 3 percentage points. As in the study by Bohara and results is that that the countries analyzed are very different. colleagues, Estevadeordal, Freund, and Ornelas (2008) find Since the multilateral system has not enforced much tariff that the complementarity effect is stronger in sectors where reduction on developing countries, tariffs are relatively trade bloc partners are more important suppliers, which is high among that group, creating a large potential for trade precisely where trade discrimination would be more dis- diversion. Lower external tariffs moderate that loss. The ruptive. Using a similar methodology for the Association of results of the first group of researchers named above sug- Southeast Asian Nations, Calvo-Pardo, Freund, and gest that this force is important in explaining changes in Ornelas (2009) also find evidence that regionalism is asso- MFN tariffs of developing countries involved in free trade ciated with unilateral tariff reduction. areas. In contrast, Limão’s work focuses on industrial Recent studies by Limão (2006) and Karacaovali and countries. Tariffs were already quite low in the United Limão (2008) address a related question: whether preferen- States and the EU at the onset of the Uruguay Round, thus tial liberalization by the United States and the EU hindered reducing the importance of this channel. In addition, the multilateral trade liberalization at the Uruguay Round. In theoretical underpinnings of Limão’s analysis, which is the context of the theoretical literature described earlier, used to justify the importance of preferences in North- they examine the goodies-bag stumbling block and, specif- South agreements, rely on the formation of PTAs for ically, whether commitments to liberalize were signifi- noneconomic reasons; preferential treatment is extended cantly different in goods that offered preferences and in in return for noneconomic benefits, such as cooperation goods that did not. These papers, however, do not take into on migration, drug trafficking, or a global political agenda. account the size of the preferences or the importance of This is not the case in South-South PTAs, where the goal is trade in the products that received preferential treatment. to exchange access to markets and improve regional eco- Both papers find that liberalization was relatively smaller nomic cooperation. in products where preferences were used. They argue that, intuitively, because the United States and the EU offer pref- Welfare Consequences of PTAs erences on a unilateral basis to extract concessions from recipients in nontrade areas, they tend to resist liberaliza- A large portion of the empirical literature on trade diver- tion to prevent erosion of preferences. sion versus trade creation has attempted to provide answers The evidence in Limão (2006) is widely misrepresented as to the question of whether bilateralism is bad (see box 6.1, showing that the United States raised tariffs in the Uruguay above). If regionalism is moving world trade away from Round for items on which it granted PTA preferences. Of natural trade patterns, thus reducing world welfare, more course, this cannot be correct, since MTN market access talks diversion will be observed; if regionalism is pushing trade in only involve tariff bindings, and the United States did not the right direction, we should observe little diversion. The violate any of its bindings in the Uruguay Round. Indeed, the analyses also offer an indirect check on the effect of regional data show U.S. tariffs decreasing for all but 12 of the agreements on trade liberalization. If regional members thousands of tariff lines, defined at the Harmonized tend to raise barriers to nonmembers, there should be System–8 product level in the WTO’s database. Formally, strong evidence of trade diversion—increased trade with Limão estimates an econometric model of U.S. tariff cuts members at the expense of nonmembers. By contrast, if during the Uruguay Round. His famous stumbling block regional members tend to lower barriers to nonmembers in finding is that the United States cut tariffs by less than his concert with PTAs, diversion should be limited. econometric model predicted they should have on items for Unfortunately, estimating trade diversion is no easy which the United States had granted PTA preferences before task. It requires knowledge of the counterfactual: what the Uruguay Round. In short, he shows that the U.S. prefer- would have happened to trade if there were no trade agree- ences acted as a “slowing block,� not as a stumbling block. ment? Since this is unknown, assumptions must be made. 136 Richard Baldwin and Caroline Freund Most studies use a gravity equation (which predicts A different perspective is taken by Chang and Winters bilateral trade on the basis of income and other character- (2002), who study the effects of Mercosur—a trading bloc istics) and focus on variables that capture the extent to formed by Argentina, Brazil, Paraguay, and Uruguay in which PTA partners trade more or less than would other- 1991—on export prices to Brazil. They find that wise be expected.26 The key trade creation variable is a Argentina’s export prices increased, whereas the export dummy that is equal to 1 if both countries are members of prices of countries outside Mercosur fell. These price a common PTA; the key trade diversion variable is a effects indicate that Mercosur has hurt outsiders while dummy that is 1 if one country belongs to a PTA and the helping Brazil, a Mercosur partner.27 other does not. (See Frankel, Stein, and Wei 1995; Carrère As Krugman (1991b) shows, whether an agreement is wel- 2006; Lee and Shin 2006.) A positive coefficient on the for- fare improving also depends on trade costs. To determine mer offers evidence of trade creation; a negative coefficient whether nature plays a role in PTA formation, Frankel, Stein, on the latter offers evidence of diversion. Overall, the mes- and Wei (1995) examine whether regional trade is sage from such studies is that trade creation predominates. greater than could be explained by natural determinants— In fact, a concern is that the estimates of the creation effect proximity, size, per capita gross national product, common may be implausibly large, as well as too dependent on the border, common language, and so on. They find in favor of sample of countries and variables included (Haveman and the formation of “natural� trade blocs. Hummels 1998). Krishna (2003) tackles the natural trade bloc question Magee (2008) expands on the traditional approach with by using detailed U.S. trade data to estimate the welfare insights from the literature on the proper estimation of effects from 24 hypothetical bilateral trade agreements in a gravity models. He uses panel data for 133 countries general equilibrium framework and then correlating the between 1980 and 1998 and includes country-pair fixed estimated welfare changes with geographic variables and effects, exporter-year fixed effects, and importer-year fixed trade volumes. Neither geography nor trade volume is effects to capture the counterfactual more accurately than found to be significantly correlated with welfare gains, standard gravity specifications would. The dyad effects indicating that they are not good indicators of the gains pick up what is natural about the trade partners, and the from trade, as the natural trade bloc approach would sug- exporter-year and importer-year effects pick up country- gest. Still, Krishna finds that 80 percent of the potential specific dynamics. Magee finds that the average impact of agreements he examines are welfare improving. Given the agreements on trade flows is small, only 3 percent. More- predominance of trade creation, it is not clear that a cor- over, on average, trade creation dominates trade diversion relation between distance or trade volume and welfare is by about one order of magnitude. necessary to indicate that blocs are formed naturally. To Another strand of the literature uses more disaggre- determine which agreements are most natural, the costs of gated data to examine specific agreements. Clausing (2001) forming an agreement should also be included, and such develops an analysis at the product level of the 1988 costs are plausibly lower with a neighbor or with a large Canada–U.S. Free Trade Agreement (CUSFTA). Using vari- trade partner, as the relationship between the two coun- ations in liberalization across industries to identify trade tries is likely to be well developed. creation and diversion, she finds that in most sectors trade Baier and Bergstrand (2004) develop a general equilib- creation tends to be the rule and trade diversion the excep- rium model to determine which country pairs would gain tion. Taking a similar approach, Trefler (2004) finds both the most from forming PTAs. They then examine whether trade creation and trade diversion in CUSFTA but calcu- these dyads were actually linked by a PTA in a sample of lates positive welfare effects for the average Canadian. 53 countries in 1996. They find that the likelihood of a PTA Romalis (2007) finds that the expansion of CUSFTA to is larger the closer the two countries are to each other, the Mexico, through NAFTA, has been trade diverting. Romalis’s more remote they are from RoW, the larger their gross exercise is similar to Clausing’s and Trefler’s, but he uses domestic products (GDPs), the smaller the difference changes in EU trade over the period to capture what would between their GDPs, the larger their relative factor endow- have happened in the absence of the agreement. Although ment difference, and the wider the (absolute) difference this might create a better counterfactual if the NAFTA coun- between their and RoW’s capital-labor ratios. These vari- tries were very similar to the EU, it could lead to overesti- ables predict the formation of 85 percent of the bilateral mates of trade diversion in NAFTA if the EU’s trade with its PTAs in their sample. Their results thus offer support for the own new and existing trade agreement partners were to natural trade bloc view.28 In subsequent work, Baier and expand more rapidly. Even so, Romalis’s results suggest that Bergstrand (2007) use the same approach to estimate the the welfare costs of the agreement are tiny. impact of PTAs on trade flows. Their key finding is that, Preferential Trade Agreements and Multilateral Liberalization 137 once one takes into account the endogeneity of the agree- prevents countries from backtracking on previous liber- ments, the positive impact of PTAs on bilateral trade alization. Although this would be difficult to accom- becomes more robust and much larger—in fact, five times plish, it is a worthwhile goal. Tariffs in most developing larger—than in estimates that take agreements as exoge- countries are set well below their bindings (by 20 to 30 nous. Thus, countries seem to form PTAs when there is percentage points!), making the term “binding� mean- much to be gained from liberalizing bilateral trade. ingless. A move toward more restrictive bindings would Proving that agreements are natural or unnatural is make regionalism less dangerous and would give mem- daunting, as it requires an assessment of many potential ber countries a lever against a potential increase in the agreements and their welfare consequences—and calculat- political forces favoring protection. ing trade diversion and creation in even one agreement is 2. Agree to lower multilateral tariffs partway, through the already difficult. Nevertheless, there is solid empirical sup- use of preferential tariffs. Even though empirical work port for the more general premise of the natural trade bloc has shown that regionalism tends to be a force for gen- view: that trade blocs are formed by countries that have eral liberalization, irrespective of restrictions, a commit- much to gain from freer trade. ment in this direction would ensure that regionalism The theoretical literature on static effects of trade agree- serves as a building block for free trade. ments highlights the potential costs of preferential liberal- 3. Redefine North-South agreements to incorporate ization and the possibility that trade-diverting agreements preferences from the North in response to MFN liber- may be more viable politically. The empirical literature is alization on the part of the South. In the developing not entirely conclusive, but it does suggest that trade diver- countries, where tariffs are generally higher, this sion is not a major concern, although in some agreements would prevent sizable diversion. In addition, it would and sectors it may matter. Trade diversion may be less rele- be far easier to implement than a range of tariffs across vant than was initially thought because countries form various agreements. trade agreements with “natural trading partners,� where 4. Keep regional agreements open, extending eligibility to trade creation is the norm, or because governments may all countries willing to follow the rules.29 This helps respond to trade diversion by reducing external tariffs. ward against a global outcome dominated by a handful Overall, the empirical literature shows that countries in of protective trade blocs. regional agreements tend to liberalize trade broadly. There is evidence that regional agreement members tend to Trade negotiators should have these guidelines in mind, reduce external tariffs, and that this is especially true of but the WTO should also do its part to ensure a positive members of free trade agreements (as opposed to customs spread of regionalism. This can be accomplished by moni- unions). In addition, trade diversion tends to be small or toring regional agreements among members, publishing nonexistent, which is consistent with endogenous tariff reports on regional agreements that call attention to bad changes that reduce costly diversion. There is, however, behavior, and securing the authority to impose more some evidence that regional agreements may limit trade restrictions on regional agreements. liberalization in the multilateral setting. Given the concerns about regionalism, it is important to highlight where the long-run potential benefits can be found. The best way to ensure that regionalism is welfare Conclusions and Rules for PTAs improving is for countries to pursue serious deep integra- In this chapter, we have examined the effect of regionalism tion agreements. Real resource gains are obtainable if on the multilateral trade system. The theoretical literature countries integrate labor markets, combine regulatory underscores the diverse mechanisms by which regionalism institutions, harmonize standards, and cooperate exten- can be helpful or harmful to that system. So far, there is lit- sively on trade facilitation. Removal of behind-the-border tle evidence that regionalism is overwhelmingly bad for the barriers will enhance trade and welfare without the tradi- multilateral trade system, as some had feared, and there is tional costs of PTAs in tariff revenue and trade diversion. some evidence that regionalism is associated with general The benefits of deep integration include real resource liberalization. gains that will accrue to nonmembers as well as members. To ensure that regionalism is a positive force in the The focus should be on the quality, not the number, of future, four ideal guidelines can be kept in mind: agreements. There is a danger, however, that the present wave of PTAs is being generated by minor agreements that 1. Bind tariff rates at applied rates, leaving no room for tar- will not produce significant benefits, especially given their iff increases following a trade agreement. This measure cost to the world trading system. How to achieve deeper 138 Richard Baldwin and Caroline Freund integration in services, agriculture, transport, and other Nordström (1995), and Bond and Syropoulos (1996a, sec. 3) for examples of preference-erosion stumbling blocks. sectors will be the focus of most of the remaining chapters 9. The theoretical notion was formalized by Limão (2007). of this volume. 10. Levy (1997) illustrates a cherry-picking stumbling block in a highly stylized setup, but his main result is surely more general than his model. 11. This is called the Stolper-Samuelson effect in the economic Notes literature. 12. More formally, without MTNs, governments maximize a polit- The authors are grateful for comments from Jean-Pierre Chauffour, Jaime ically weighted objective function that includes matters affected by the de Melo, and Jean-Christophe Maur. nation’s own tariffs: profits of import-competing sectors, consumer 1. Bhagwati (1993, 2008) and Panagariya and Bhagwati (1999) pro- surplus, and tariff revenue. During the negotiations, a nation’s tariff vide in-depth discussions of these concerns. affects all those things, but foreign tariff levels are linked to domestic 2. Grossman and Helpman (1995), Levy (1997), and Krishna (1998) tariffs via reciprocity, and the objective function now includes the show that regionalism can lead to a reduction in support for multilateral effect of foreign tariffs on exporter’s profits. Since this new impact is liberalization. However, Bagwell and Staiger (1999), Freund (2000b), and negative (higher domestic tariffs reduce exporter’s profits via reciproc- Ornelas (2005b) find that the formation of a PTA can cause its members to ity), announcement of the MTN leads the government to find it politi- lower tariffs. Panagariya (2000) offers an excellent survey of the literature. cally optimal to choose a tariff that is lower than the politically optimal 3. A tariff can theoretically be used optimally to protect an infant tariff before the MTN. industry until it is strong enough to compete. It is difficult, however, to 13. The word “juggernaut,� defined as “any massive inexorable force identify the infants that have potential to grow, and it is often difficult to that advances crushing whatever is in the path,� stems from a British drop protection after it has served its purpose. Moreover, it is typically mispronunciation of the name of the Hindu deity of the Puri shrine, politically connected sectors, rather than growing sectors, that obtain Jagannath. A festival held in Puri involves the “chariot of Jagannath,� an protection. enormous and unwieldy construction that requires thousands of people 4. The next two sections draw heavily on Baldwin (2009). to get it rolling. Once started, however, it rolls over anything in its path. 5. Bhagwati (1991, 71) ascribes the shift to the United States’ conver- 14. The juggernaut logic is from Baldwin (1994, ch. 2.5); it is elab- sion to regionalism, but this contradicts the judgments of trade policy orated in Baldwin and Robert-Nicoud (2005) and Baldwin (2006) and scholars who were engaged in the details of policy at the time (Wonnacott formalized in part by Freund (2000b). The first part of the juggernaut 1987, 17; Schott 1988, 29; Whalley 1996; Hufbauer, Schott, and Clark mechanism—realignment of domestic special interests through 1994, 100). It also contradicts the facts. Bearing witness to the long- reciprocity—has long been recognized in histories of trade liberalization— standing U.S. interest in regionalism is a string of deals that were struck, for example, by Bergsten (1996) and Destler (2005), under the name “bicy- or almost struck, in 1854, 1874, and 1911. In March 1948 the United States cle theory and export politics.� The point was also made by many others, and Canada concluded a secret draft protocol eliminating most tariffs and including Robert Baldwin (1985). The basic idea dates much further quotas bilaterally, but this was ultimately rejected by the Canadians. In back, as Irwin (1996) points out. More recently, the first half of the jugger- 1958, U.S. government procurement was preferentially liberalized in naut logic has been studied formally by Grossman and Helpman (2001) Canada’s favor, and in 1965, the U.S.–Canada Auto Pact came into force. and by Bagwell and Staiger (2002). Juggernaut-like mechanisms were dis- The 1974 Trade Act authorized the U.S. president to negotiate an FTA cussed independently by Hufbauer, Schott, and Clark (1994, 164) and by with Canada, and the 1979 Trade Agreements Act required the president Richardson (1993). Bergsten (1998) mentions an alternative source of to study an FTA in North America. political-economy momentum (“modest liberalization begets broader lib- 6. See Baldwin (1993, 1997) and Serra et al. (1997) for an account of eralization by demonstrating its payoff and familiarizing domestic politics this domino effect. with the issue�). Staiger (1995) uses a repeated game setting, with workers 7. Krugman argued that the multilateral process had run aground moving slowly out of the import-competing sector to generate gradual- with the December 1990 failure of the Uruguay Round and was unlikely ism, but MTNs and GATT reciprocity play no role. Milner (1997) and to get afloat any time soon because the system was plagued by profound Oye (1992), working independently in the international political-economy problems. “While some kind of face-saving document will probably be context, discuss mechanisms by which PTAs can create a proliberaliza- produced, in reality the [Uruguay Round] has clearly failed either to sig- tion political-economy momentum. More recently, Hathaway (1998) nificantly liberalize trade or to generate goodwill that would help sustain presents a similar logic in her positive-feedback model. further rounds of negotiation� (Krugman 1991b, 5). Regionalism, how- 15. But multilateral tariff cutting may also lower tariffs to a level at ever, was not one of those fundamental problems. “But while the move to which PTAs become feasible, when previously they were not; this may free trade areas has surely done the multilateral process some harm, it is have been the case with the Canada–U.S. FTA. almost surely more a symptom than a cause of the decline of the GATT. . . . 16. Agriculture in Europe is a good example. Formation of the cus- The problems of the GATT are so deep-seated that it is unlikely that a toms union realigned special interests in the European Economic Com- world without regional free trade agreements would do much better� munity (EEC) in a way that fostered higher agricultural tariffs. EEC tariffs (Krugman 1991b, 20). He closed his essay with a prediction that history on agricultural goods were not bound until the 1990s, and so the commu- falsified and with a faute de mieux view of regionalism: nity was free to raise its agricultural tariffs without appealing to the Arti- cle 24 exception. Since EEC tariffs were bound for manufacturing goods, The world may well be breaking up into three trading blocs; trade EEC members needed the Article 24 exception to establish the common within those blocs will be quite free, while trade between the blocs external tariff (CET), and this led them to respect the article’s require- will at best be no freer than it is now and may well be considerably ment that the CET not be higher, on average. Roughly speaking, France less free. This is not what we might have hoped for. But the situa- lowered its tariffs; Germany raised its tariffs; and Belgium, Luxembourg, tion would not be better, and could easily have been worse, had the and the Netherlands did little, as their tariffs were initially between the great free trade agreements of recent years never happened. French and German levels. In this way, the formation of the EEC customs (Krugman 1991b, 20–21) union probably reduced the overall size of the EEC import-competing 8. The logic of the preference-erosion or exploitation stumbling sector in manufacturing but raised it in agriculture. block was demonstrated in a Walrasian setting by Riezman (1985) and 17. The key concepts are “coalition externalities� (Haberler’s spillover) Kennan and Riezman (1990) and in a Brander-Krugman setting by and “grand-coalition superadditivity� (global free trade is first-best). The Krishna (1998) and Freund (2000a). See also Goto and Hamada (1995), authors assume that one nation is the undisputed agenda setter and that Preferential Trade Agreements and Multilateral Liberalization 139 unlimited international transfers (transferable utility, in game theory ———. 2002. The Economics of the World Trading System. Cambridge, parlance) are possible. MA: MIT Press. 18. See Lloyd (2002) for a clear development of the veto-avoidance Baier, Scott L., and Jeffrey H. Bergstrand. 2004. “Economic Determinants logic. This line of thinking is one strand in the widely discussed competi- of Free Trade Agreements.� Journal of International Economics 64, no.1 tive liberalization logic advanced by Bergsten (1996). (October): 29–63. 19. This is especially true given all the separability that rules Meade’s ———. 2007. “Do Free Trade Agreements Actually Increase Members’ secondary and tertiary effects (see Meade 1955). International Trade?� Journal of International Economics 71, no.1 20. Given the separability of the markets, the second FTA with RoW (March): 72–95. would yield a price for Good 3 equal to P'. Baldwin, Richard. 1993. “A Domino Theory of Regionalism.� NBER Work- 21. Contributions to the literature that have looked at the comple- ing Paper 4465, National Bureau of Economic Research, Cambridge, mentarity versus substitutes effects include Riezman (1985), Kennan and MA. http://www.nber.org/papers/w4465. Riezman (1990), Krugman (1991a, 1991b, 1996), Richardson (1993), Bond ———. 1994. Towards an Integrated Europe. London: Centre for Eco- and Syropoulos (1996a), Freund (2000a), and Ornelas (2005b, 2007). nomic Policy Research. 22. Shibata (1967), Vousden (1990), Krueger (1993), Richardson ———. 1997. “The Causes of Regionalism.� World Economy 20 (7): (1993, 1994, 1995), and Grossman and Helpman (1995) are all important 865–88. contributors to or users of this line of analysis. ———. 2006. “Multilateralising Regionalism: Spaghetti Bowls as Building 23. Extension of this analysis led to the proposition of the unsustain- Blocs on the Path to Global Free Trade.� World Economy 29 (11): ablity of FTAs. Vousden (1990, 234) argues that Home would be tempted 1451–1518. to lower its MFN tariff to just under that of Partner in order to recapture ———. 2009. “Big-Think Regionalism: A Critical Survey.� In Regional Rules the tariff revenue and that Partner would have an incentive to reply, with in the Global Trading System, ed. Antoni Estevadeordal, Kati Suominen, the resulting race-to-the-bottom tariff making FTAs “unsustainable.� and Robert Teh. Cambridge, U.K.: Cambridge University Press. Richardson (1995) extended and popularized this result. The main results Baldwin, Richard, and Frédéric Robert-Nicoud. 2005. “Juggernaut in Shibata (1967), Vousden (1990), and Richardson (1995)—the irrele- Model—The Lego Version.� Graduate Institute of International Stud- vance of rules of origin and the unsustainability of FTAs—are of little rel- ies, Geneva. evance to real-world policy concerns. (Rules of origin are at the heart of Baldwin, Richard, and Elena Seghezza. 2010. “Are Trade Blocs Building or many current policy debates, and FTAs, not customs unions, are by far the Stumbling Blocks?� Journal of Economic Integration 25, no.2 (June): most prevalent form of PTA.) 276–97. 24. This approach came to be known as the terms-of-trade approach Baldwin, Robert E. 1970. Non-Tariff Distortions of International Trade. after Kyle Bagwell, Robert Staiger, and their students formally modeled Washington, DC: Brookings Institution. the issues, starting with Bagwell and Staiger (1993). For examples of this ———. 1985. The Political Economy of U.S. Import Policy. Cambridge, sort of application to regionalism questions, see Bond and Syropoulos MA: MIT Press. (1996b); Bond, Syropoulos, and Winters (1996); Campa and Sorenson Bergsten, C. Fred. 1991. “Commentary: The Move toward Free Trade (1996); Yi (1996); Bagwell and Staiger (1999); Conconi (2000); Conconi Zones.� Economic Review, Federal Reserve Bank of Kansas City, 76 and Perroni (2000); Freund (2000b); and Ornelas (2005a, 2007). (November–December): 27–35. 25. This is not a new point. It is very clear in the discussion of Johnson ———. 1996. “Globalizing Free Trade: The Ascent of Regionalism.� For- (1953) but probably dates much further back. Indeed, the notion that a eign Affairs 75, no.3 (May–June): 105–20. quid pro quo would be mutually advantageous was probably well under- ———. 1998. “Fifty Years of the GATT/WTO: Lessons from the Past for stood by trade diplomats as far back as Roman times. Strategies for the Future.� Working Paper 98-3, Peterson Institute 26. An alternative is to use computable general equilibrium models to for International Economics, Washington, DC. http://www.iie.com/ identify counterfactuals, but the results are highly dependent on the param- publications/wp/wp.cfm?ResearchID=144. eters assumed. See, for example, Brown, Deardorff, and Stern (1992). Bhagwati, Jagdish N. 1991. The World Trading System at Risk. Princeton, 27. Schiff and Chang (2003) find that the threat of duty-free exports NJ: Princeton University Press. from Argentina to Brazil, measured by Argentina’s exports of the same ———. 1993. “Regionalism and Multilateralism: An Overview.� In New good to another country, also lowers prices of exports by nonmembers of Dimensions in Regional Integration, ed. Jaime de Melo and Arvind Mercosur to Brazil. Panagariya. Oxford, U.K.: Oxford University Press. 28. Egger and Larch (2008) confirm those findings in a larger sample, ———. 2008. Termites in the Trading System. Oxford, U.K.: Oxford Uni- finding also that preexisting nearby PTAs increase the probability that a versity Press. country pair will form a PTA. Bohara, Alok K., Kishore Gawande, and Pablo Sanguinetti. 2004. “Trade 29. Baldwin (2006) argues that the WTO can be involved, as was done Diversion and Declining Tariffs: Evidence from Mercosur.� Journal of in the Information Technology (IT) Agreement, which bound IT tariffs at International Economics 64 (1): 65–88. zero for all countries willing to join. This is a way of “multilateralizing Bond, Eric, and Constantinos Syropoulos. 1996a. “The Size of Trading regionalism.� Blocs: Market Power and World Welfare Effects.� Journal of Interna- tional Economics 40 (3–4): 412–37. ———. 1996b. “Trading Blocs and the Sustainability of Interregional References Cooperation.� The New Transatlantic Economy, eds. Matthew Canzoneri, Wilfred Ethier, and Vittorio Grillli. Cambridge, U.K.: Aghion, Philippe, Pol Antràs, and Elhanan Helpman. 2007. “Negotiating Cambridge University Press. Free Trade.� Journal of International Economics 73, no.1 (September): Bond, Eric W., Constantinos Syropoulos, and L. Alan Winters. 1996. 1–30. “Deepening of Regional Integration and External Trade Relations.� Bagwell, Kyle, and Robert W. Staiger. 1993. “Multilateral Tariff Coopera- CEPR Discussion Paper 1317, Centre for Economic Policy Research, tion during the Formation of Regional Free Trade Areas.� NBER London. Working Paper 4364, National Bureau of Economic Research, Brown, Drusilla K., Alan V. Deardorff, and Robert M. Stern. 1992. “North Cambridge, MA. http://www.nber.org/papers/w4364. American Integration.� Economic Journal 102, no.415 (November): ———. 1999. “Regionalism and Multilateral Tariff Cooperation.� In 1507–18. International Trade Policy and the Pacific Rim, ed. John Piggott and Calvo-Pardo, Hector, Caroline Freund, and Emanuel Ornelas. 2009. “The Alan Woodland. London: Macmillan. ASEAN Free Trade Agreement: Impact on Trade Flows and External 140 Richard Baldwin and Caroline Freund Trade Barriers.� Policy Research Working Paper 4960, World Bank, Management—Center for International Business Education and Washington, DC. http://www-wds.worldbank.org/servlet/WDSCon Research (CIBER), Purdue University, West Lafayette, IN. tentServer/WDSP/IB/2009/06/10/000158349_20090610085729/Ren Hufbauer, Gary C., Jeffrey Schott, and Diana Clark. 1994. Western Hemi- dered/PDF/WPS4960.pdf. Forthcoming in Quantifying the Costs and sphere Economic Integration. Washington, D C: Institute for Interna- Benefits of Regional Economic Integration in Asia, ed. Robert Barro tional Economics. and Jong-Wha Lee. Manila: Asian Development Bank. Irwin, Douglas. 1996. “Multilateral and Bilateral Trade Policies in the Campa, José Manuel, and Timothy L. Sorenson. 1996. “Are Trade Blocs Con- World Trading System: An Historical Perspective.� In New Dimensions ducive to Free Trade?� Scandinavian Journal of Economics 98 (2): 263–73. in Regional Integration, ed. Jaime de Melo and Arvind Panagariya. Carrère, Cèline. 2006. “Revisiting the Effects of Regional Trade Agree- Cambridge, U.K.: Cambridge University Press. ments on Trade Flows with Proper Specification of the Gravity Johnson, H. 1953. “Optimum Tariffs and Retaliation.� Review of Economic Model.� European Economic Review 50: 223–47. Studies 21 (2): 142–53. Chang, Won, and L. Alan Winters. 2002. “How Regional Blocs Affect Karacaovali, Baybars, and Nuno Limão. 2008. “The Clash of Liberaliza- Excluded Countries: The Price Effects of Mercosur.� American Eco- tions: Preferential vs. Multilateral Trade Liberalization in the Euro- nomic Review 92 (4): 889–904. pean Union.� Journal of International Economics 74: 299–327. Clausing, Kimberly A. 2001. “Trade Creation and Trade Diversion in the Kemp, Murray C., and Henry Y. Wan, Jr. 1976. “An Elementary Proposi- Canada–United States Free Trade Agreement.� Canadian Journal of tion Concerning the Formation of Customs Unions.� Journal of Inter- Economics 34: 677–96. national Economics 6 (1): 95–97. Conconi, Paola. 2000. “Trade Bloc Formation under Imperfect Competi- Kennan, John, and Raymond Riezman. 1990. “Optimal Tariff Equilibria tion.� The Warwick Economics Research Paper Series (TWERPS) 571, with Customs Unions.� Canadian Journal of Economics 23 (1): Department of Economics, University of Warwick, Coventry, U.K. 70–83. Conconi, Paoli, and Carlo Perroni. 2000. “Issue Linkage and Issue Tie-In Krishna, Pravin. 1998. “Regionalism and Multilateralism: A Political in International Negotiations.� The Warwick Economics Research Economy Approach.� Quarterly Journal of Economics 113, no.1 (Febru- Paper Series (TWERPS) 558, Department of Economics, University of ary): 227–50. Warwick, Coventry, U.K. ———. 2003. “Are Regional Trading Partners ‘Natural’?� Journal of Politi- Destler, I. M. 1986. American Trade Politics. Washington, DC: Peterson cal Economy 111 (1): 202–26. Institute for International Economics. Krueger, Anne O. 1993. “Free Trade Agreements Versus Customs Unions.� ———. 2005. American Trade Politics. 4th ed. Washington, DC: Peterson Journal of Development Economics 54: 169–87. Institute for International Economics. Krugman, Paul. 1991a. “Is Bilateralism Bad?� In International Trade and Dixit, Avinash, and Victor Norman. 1980. Theory of International Trade. Trade Policy, ed. Elhanan Helpman and Assaf Razin. Cambridge, MA: Cambridge, U.K.: Cambridge University Press. MIT Press. Egger, Peter, and Mario Larch. 2008. “Interdependent Preferential Trade ———. 1991b. “The Move toward Free Trade Zones.� Economic Review, Agreement Memberships: An Empirical Analysis.� Journal of Interna- Federal Reserve Bank of Kansas City, 76, no.6 (November–December): tional Economics 76 (2): 384–99. 5–25. Estevadeordal, Antoni, Caroline Freund, and Emanuel Ornelas. 2008. ———. 1996. “Regionalism versus Multilateralism: Analytic Notes.� In “Does Regionalism Affect Trade Liberalization toward Nonmem- New Dimensions in Regional Integration, ed. Jaime de Melo and Arvind bers?� Quarterly Journal of Economics 123, no.4 (November): 1531–75. Panagariya. Cambridge, U.K.: Cambridge University Press. Ethier, Wilfred J. 1998. “Regionalism in a Multilateral World.� Journal of Lawrence, Robert Z. 1991. “Emerging Regional Arrangements: Building Political Economy 109 (6): 1214–45. Blocs or Stumbling Blocks?� In Finance and the International Economy Fernandez, Raquel, and Jonathan Portes. 1998. “Returns to Regionalism: 5: The AMEX Bank Review Prize Essays, ed. Richard O’Brien, 23–35. An Analysis of Nontraditional Gains from Regional Trade Agree- New York: Oxford University Press. ments.� World Bank Economic Review 12, no.2 (May): 197–220. ———. 1996. Regionalism, Multilateralism, and Deeper Integration. Foroutan, Faezeh. 1998. “Does Membership in a Regional Preferential Washington, DC: Brookings Institution Press. Trade Arrangement Make a Country More or Less Protectionist?� Leamer, Edward E. 1990. “The Structure and Effect of Tariff and Non- World Economy 21: 305–35. Tariff Barriers in 1983.� In The Political Economy of International Frankel, Jeffrry A., and Shang-Jin Wei. 1998. “Regionalization of World Trade: Essays in Honor of Robert E. Baldwin, ed. Ronald W. Jones and Trade and Currencies: Economics and Politics.� In The Regionalization Anne O. Krueger. Cambridge, MA: Blackwell. of the World Economy, ed. J. A. Frankel, ch. 7. Chicago, IL: Chicago Lee, Jong-Wha, and Kwanho Shin. 2006. “Does Regionalism Lead to More University Press. Global Trade Integration in East Asia?� North American Journal of Eco- Frankel, Jeffrey A., Ernesto Stein, and Shang-Jin Wei. 1995. “Trading Blocs nomics and Finance 17: 283–301. and the Americas: The Natural, the Unnatural, and the Super-Natural.� Levy, Philip I. 1997. “A Political-Economic Analysis of Free-Trade Agree- Journal of Development Economics 47: 61–95. ments.� American Economic Review 87 (4): 506–19. Freund, Caroline. 2000a. “Different Paths to Free Trade: The Gains from Limão, Nuno. 2006. “Preferential Trade Agreements as Stumbling Blocks Regionalism.� Quarterly Journal of Economics 115 (4): 1317–41. for Multilateral Trade Liberalization: Evidence for the United States.� ———. 2000b. “Multilateralism and the Endogenous Formation of Prefer- American Economic Review 96 (3): 896–914. ential Trade Agreements.� Journal of International Economics 52: 359–76. ———. 2007. “Are Preferential Trade Agreements with Non-trade Objec- Goto, Junichi, and Koichi Hamada. 1995. “EU, NAFTA, and Asian Responses: tives a Stumbling Block for Multilateral Liberalization?� Review of A Perspective from the Calculus of Participation.� NBER Working Paper Economic Studies 74 (3): 821–55. 5325, National Bureau of Economic Research, Cambridge, MA. Lloyd, Peter John. 2002. “New Bilateralism in the Asia–Pacific.� World Grossman, Gene, and Elhanan Helpman. 1995. “The Politics of Free Trade Economy 25 (9): 1279–96. Agreements.� American Economic Review 85: 667–90. Ludema, Rodney D. 1996. “Increasing Returns, Multinationals and Geog- ———. 2001. Special Interest Politics. Cambridge, MA: MIT Press. raphy of Preferential Trade Agreements.� Journal of International Eco- Hathaway, Oona. 1998. “Positive Feedback: The Impact of Trade Liberal- nomics 56 (2): 329–58. ization on Industry Demands for Protection.� International Organiza- Magee, Christopher S. P. 2008. “New Measures of Trade Creation and tion 52, no.3 (Summer): 575–612. Trade Diversion.� Journal of International Economics 75 (2): 340–62. Haveman, Jon D., and David L. Hummels. 1998. “What Can We Learn Meade, James E. 1955. The Theory of Customs Unions. Amsterdam. North- from Bilateral Trade? Gravity and Beyond.� Krannert School of Holland. Preferential Trade Agreements and Multilateral Liberalization 141 Milner, Helen V. 1997. Interests, Institutions and Information: Domestic Schiff, Maurice, and Won Chang. 2003. “Market Presence, Contestability, Politics and International Relations. Princeton, NJ: Princeton Univer- and the Terms-of-Trade Effects of Regional Integration,� Journal of sity Press. International Economics 60, no.1 (May): 161–75. Nordström, Håkan. 1995. “Customs Unions, Regional Trading Blocs and Schott, Jeffrey. 1988. “The Free Trade Agreement: A US Assessment.� In Welfare.� In Expanding Membership of the European Union, ed. The Canada–United States Free Trade Agreement: The Global Impact, Richard E. Baldwin, Pertti Haaparanta, and Jaakko Kiander, 54–78. ed. Jeffrey J. Schott and Murray G. Smith. Washington, DC: Institute Cambridge, U.K.: Cambridge University Press. for International Economics. Ornelas, Emanuel. 2005a. “Trade Creating Free Trade Areas and the Under- Serra, Jaime, et al. 1997. Reflections on Regionalism: Report of the Study mining of Multilateralism.� European Economic Review 49: 1717–35. Group on International Trade. New York: Carnegie Endowment for ———. 2005b. “Rent Destruction and the Political Viability of Free Trade International Peace. Agreements.� Quarterly Journal of Economics 120: 1475–1506. Shibata, Hirofumi. 1967. “The Theory of Economic Unions: A Compara- ———. 2007. “Exchanging Market Access at the Outsiders’ Expense: tive Analysis of Customs Unions, Free Trade Areas and Tax Unions.� In The Case of Customs Unions.� Canadian Journal of Economics 40 Fiscal Harmonisation in Common Markets, ed. Call S. Shoup, vol. 1, (1): 207–24. 145–264. New York: Columbia University Press. Oye, Kenneth A. 1992. Economic Discrimination and Political Exchange: Sinclair, P., and D. Vines 1995. “Bigger Trade Blocs Need Not Entail More World Political Economy in the 1930s and 1980s. Princeton, NJ: Prince- Protection.� University of Birmingham, U.K. ton University Press. Snape, Richard. 1993. “History and Economics of GATT’s Article XXIV.� Panagariya, Arvind. 2000. “Preferential Trade Liberalization: The Tradi- In Regional Integration and the Global Trading System, ed. Kym tional Theory and New Developments.� Journal of Economic Literature Anderson and Richard Blackhurst, 273–91. New York: Harvester 38: 287–331. Wheatsheaf. Panagariya, Arvind, and Jagdish Bhagwati. 1999, “Preferential Trading Staiger, Robert W. 1995 “A Theory of Gradual Trade Liberalization� In New Areas and Multilateralism: Strangers, Friends or Foes?� In Regionalism Directions in Trade Theory, ed. Alan V. Deardorff, James A. Levinsohn, in Trade Policy: Essays on Preferential Trading, ed. Arvind Panagariya, and Robert M. Stern. Ann Arbor, MI: University of Michigan Press. 47–111. Singapore: World Scientific Publishing. Summers, Lawrence. 1991. “Regionalism and the World Trading Sys- Panagariya, Arvind, and Ronald Findlay. 1994. “A Political Economy tem.� Economic Review, Federal Reserve Bank of Kansas City, Analysis of Free Trade Areas and Customs Unions.� Policy Research 76, no.6 (November–December): 295–302. Working Paper 1261, World Bank, Washington, DC. Trefler, Daniel. 2004. “The Long and Short of the Canada–U.S. Free Trade Richardson, Martin. 1993. “Endogenous Protection and Trade Diversion.� Agreement.� American Economic Review 94 (4): 870–95. Journal of International Economics 34 (3–4): 309–24. Vousden, Neil. 1990. The Economics of Trade Protection. Cambridge, U.K.: ———. 1994. “Why a Free Trade Area? The Tariff also Rises.� Economics Cambridge University Press. and Politics 6 (1): 79–96. Whalley, John. 1996. “Regional Trade Arrangements in North America: ———. 1995. “Tariff Revenue Competition in a Free Trade Area.� Euro- CUSTA and NAFTA.� In New Dimensions in Regional Integration, ed. pean Economic Review 39: 1429–37. Jaime de Melo and Arvind Panagariya, 352–81. Cambridge, U.K.: Riezman, Raymond. 1985. “Customs Unions and the Core.� Journal of Cambridge University Press. International Economics 19 (3–4): 355–65. Winters, L. Alan. 1993. “The European Community: A Case of Successful Romalis, John. 2007. “NAFTA’s and CUSFTA’s Impact on International Integration?� CEPR Discussion Paper 755, Centre for Economic Pol- Trade.� Review of Economics and Statistics 89 (3): 416–35. icy Research, London. Saggi, Kamal, and Halis Murat Yildiz. 2008. “Bilateral Trade Agreements Wonnacott, Paul. 1987. “U.S. and Canadian Auto Policies in a Changing and the Feasibility of Multilateral Free Trade.� MPRA Paper 17561, World Environment.� Canadian-American Committee, C. D. Howe Munich Personal RePEc Archive, Munich, Germany. http://mpra. Institute and National Planning Association, Toronto, Canada. ub.uni-muenchen.de/17561/. WTO (World Trade Organization). 1995. Regionalism and the World Trad- Sapir, André. 1996. “Discussion� of ch. 7, L. Alan Winters, “The European ing System. Geneva: WTO. Community: A Case of Successful Integration?� In New Dimensions Yi, Sang-Seung. 1996. “Endogenous Formation of Customs Unions under in Regional Integration, ed. Jaime de Melo and Arvind Panagariya, Imperfect Competition: Open Regionalism Is Good.� Journal of Inter- Cambridge, U.K.: Cambridge University Press. national Economics 41 (1–2): 151–77. 7 Agriculture Tim Josling The links between regional integration and agricultural viewpoint of developing countries, has been that the terms trade strategy are of increasing interest to developing of the PTAs are largely at the discretion of the preference- countries as they confront the challenge of opening up granting country, with little guarantee that the agreements their economies to competition while mitigating the asso- will not be changed if they lose domestic political backing. ciated adjustment costs. Countries around the world have This asymmetry also implies that the granting country can stepped up their efforts to establish regional preferential continue to extract political benefits from the preference- trade agreements (PTAs) and to coordinate trade relations receiving partner, including support for economic and with other regions. Agricultural trade is a core component political positions. of many of these trade initiatives, and a large part of the The role of PTAs in agricultural development varies gains from regional integration depends on the inclusion greatly, from strategic and deliberate to largely passive and of agricultural and food products in PTAs. Agricultural reactive. Countries can choose to plan their agricultural trade policy and regional integration agreements can strategies on a regional basis to take advantage of scale together serve as instruments for accelerating growth and economies and to overcome some of the constraints facing contributing to poverty alleviation. small national markets. Often, however, agriculture is Although the motivation for PTAs is often political, brought into regional agreements through extraneous these agreements have significant implications for agricul- circumstances rather than careful planning; agriculture ture and other sectors of the economy. Many North-South becomes one element in a broader set of complex trade-offs. agreements were concluded after a country gained inde- PTAs often have an underlying rationale of contributing to pendence in order to maintain trading links developed in increased regional cohesion and political integration, and the colonial era—typically, for trade in raw materials and the treatment of the agriculture sector becomes of inter- agricultural products. Other PTAs were instituted as part of est, beyond strictly commercial considerations. Food the development of alliances and to bolster regimes that security and the coordination of food policies and mar- were under threat. Agricultural products often provided keting infrastructure may be important reasons for the trade opportunities that reinforced such alliances. PTAs inclusion of a strong agricultural component in regional have long been used by developed countries to pursue policies. Thus, the key issues in addressing agricultural overseas developmental objectives through the provision of trade in PTAs are whether regional integration promotes preferential market access, often for primary products. or hinders the development of a sustainable, competitive Such access, however, has frequently been constrained agriculture sector and whether agricultural trade consid- when sensitive domestic agricultural products were erations contribute to or detract from the benefits of involved. regional integration. More recent thinking has cast doubt on the longer-term This chapter attempts to put into perspective what we benefits of PTAs on the grounds that they tend to lock know and do not know about the economic impact of exporting countries into a particular pattern of exports, PTAs on agricultural development. The next section sur- often of unprocessed raw materials and farm products, veys the arguments for and against preferential trade inte- while competitors develop other markets and diversify gration as a development strategy for agriculture. These their range of export products. A further problem, from the arguments relate, in general, to the effects of opening up 143 144 Tim Josling trade among selected trade partners, as opposed to relying which regional integration can provide the scale needed for on either unilateral or multilateral actions. The rationales such cost reductions depends on specific circumstances, also cite possible economies in the joint production of but, in principle, the achievement of economies of scale can public goods that benefit agriculture, ranging from be a positive argument for regional integration. If the part- research and extension to food security reserves. The sec- ner with the inefficient agriculture sector can make use of ond section then reviews what is known empirically about scale economies to become efficient, costs will decrease. the impact of PTAs on agricultural trade. The third dis- But to treat PTAs as a nursery for potentially competitive cusses some ways in which PTAs have dealt in practice with sectors is controversial at best: the infant may become a set of problems that are commonly encountered when dependent on the protected market within the PTA and agriculture is included in PTA provisions. Both regional may not have an incentive to become competitive outside and bilateral PTAs are considered, as the agricultural prob- the area. Moreover, import-competing sectors will tend to lems differ somewhat in the two types of agreements. shrink with regional integration and may lose some bene- fits of scale. Thus, the larger question is whether there is a possibility of a broad restructuring of the agriculture sec- Economics of Agricultural Trade in PTAs tors of each of the PTA partners so that economies of scale In most respects, the economics of agricultural trade in can be exploited and resources redeployed to take advan- PTAs is no different from the economics of nonagricultural tage of regional (as opposed to national) cost advantages. trade. As with trade in nonfarm goods, agricultural trade in Fluctuations in output often mark agricultural markets, PTAs benefits from static gains related to expanded market and trade is a vital means for offsetting the impact on avail- access and from more dynamic gains related to the spread able consumer supplies. The easier trade is, the less is the of ideas, innovations, and know-how (see Baldwin, ch. 3 in cost of market disruption to consumers. Greater regional this volume). food security is thus another plausible argument for inte- Two important initial questions frame any agricultural gration of the regional partners’ food supply network. All trade strategy in PTAs: (a) how high are domestic (tariff and parties to a PTA that includes an open internal agricultural nontariff) barriers relative to those of regional partners and market will enjoy the advantages of more secure access to other countries, and (b) how efficient are the export sectors regional supplies. Even where weather and other related within the region? If the region includes suppliers of agri- determinants of yield variations are regionally correlated, cultural products whose costs are lower than those of more there can still be benefits from pooling risks. Storage facili- distant exporters, then the regional strategy carries benefits ties can be collectively operated, and regionally coherent similar to the unilateral or multilateral lowering of tariff transportation systems can improve distribution. There barriers. Regional supplies can be integrated into a coun- may, however, be a political cost because of loss of the abil- try’s food policy, and ensuring access to those supplies will ity to control domestic markets. be an element in food security policy. The higher the exist- Agricultural trade in PTAs can benefit from some of the ing tariffs (and other trade barriers) that restrict regional considerations of spatial or economic geography that apply trade in these products, the greater will be the benefits of to trade in goods. Some of these have to do with the provi- preferential liberalization to consumers. But this also sion of public goods, where the good concerned is valued implies greater disruption to domestic producers, who pre- (and underprovided) across local jurisdictions. More gen- sumably have not had to face regional competition. When erally, both public and private sector actions can be there are other products that could gain from the export expanded to a regional scale with advantage. Greater coor- opportunities that would open up with regional trade, a dination of export strategies, more reliable supply chains beneficial transfer of resources from the import-competing for buyers, shared control over the quality and safety of to the exporting agriculture sector may be possible. But exports, a better bargaining position with importers in if the agriculture sector in the regional partner is not effi- other countries, and the possibilities for branding and cient, the reduction in trade barriers may merely substitute a labeling of regional products are all likely to result in high-cost partner product for a more efficient third-country expansion of export markets. supply. Under these conditions, the advantages are likely to be small and the costs high. Preferential Agricultural Trade and Multilateral These considerations need to be seen in a dynamic con- Commitments text. Inefficient agricultural suppliers could become low cost if their inefficiencies had been the consequence of lim- As noted by Baldwin and Freund (ch. 6 in this volume), a ited markets and diseconomies of scale. The extent to key tension between bilateral or regional trade rules and Agriculture 145 multilateral trade rules arises from the latter’s requirement the North American Free Trade Agreement (NAFTA), the that PTAs eliminate tariffs and other trade measures on United States is moving toward a free internal agricultural “substantially all trade� and that the level of preference be market with Mexico and Canada, with few exceptions. 100 percent. (The multilateral rules in question are those of More recently, the United States has negotiated agreements the General Agreement on Tariffs and Trade, or GATT, as with Chile, Central America, the Dominican Republic, and now embodied in the World Trade Organization, or Australia, giving those countries preferred, although not WTO.)1 Although there has as yet been no agreement on free, access to U.S. markets. Less sensitive food products are the interpretation of “substantially all trade,� agriculture is also included in the generalized system of preferences (GSP) the sector most often excluded or treated differently; man- schemes. Substantial amounts of agricultural trade thus do ufactures are far more likely to benefit from tariff reduc- face barriers less restrictive than MFN tariffs. Presumably, tions in PTAs than are agricultural goods (Fiorentino much of this trade is diverted from lower-cost suppliers. 2005). The prospect that competing exporters will chal- Yet, the short-term market access gains from a PTA have lenge the exceptional treatment of agriculture in PTAs is to be weighed against the possible adverse effects on the remote, however, because these competitors tend to benefit multilateral trading system. Many of the problems that from it. Exporters within the PTA have implicitly agreed to make the incorporation of agriculture in a PTA regime dif- the exclusion and would be reluctant to challenge a partner ficult also prevail in a multilateral context. A prominent with respect to mutually agreed decisions. issue in this regard is the extent to which disciplines on The requirement for movement toward full internal free domestic farm subsidies can be included in PTAs. It is often trade (100 percent preference) has also been problematic. assumed that the conduct of domestic policy is outside the In some PTAs, partners gain an advantage from preferential realm of PTAs, but this is not always the case. The move- tariffs but still face nonzero rates. Despite the inconsistency ment toward “decoupled� policies, encouraged by the with GATT Article XXIV, several of these preferential tariff WTO Agreement on Agriculture, has the advantage of schemes have been permitted. As noted, there would be lit- making it easier to have free trade in a commodity and still tle outside interest in challenging such schemes, given that maintain domestic support policies (box 7.1). Neverthe- the lack of 100 percent preference works to the advantage less, the existence of an active domestic support policy, of the excluded supplier.2 The WTO requirement that the involving subsidies and market management, complicates free trade area encompass “substantially all trade� (which, the negotiation of free trade in those products. If agricul- for most developing countries, includes agriculture) tural trade can be omitted from PTA provisions, the imposes costs on PTAs that include high-cost agriculture question of domestic support does not arise. Conversely, sectors. It may be therefore better in economic terms for if agriculture cannot be excluded without violating WTO such PTAs to exclude highly protected sectors, including provisions, the potentially problematic issue of domestic agriculture. support policies cannot be avoided. The complementarity of preferential tariff reduction The treatment of export subsidies in PTAs is similarly with multilateral trade developments can be part of a posi- problematic. Various trade agreements include provisions tive strategy for agriculture: the multilateral system could that countries may not employ export subsidies in mutual work to lower most favored nation (MFN) tariffs and trade. Although this stipulation sounds logical, it is not reduce trade-distorting subsidies, making it easier and less easy in practice to ban subsidies paid on internal trade costly to negotiate PTAs. The coordination of multilateral without creating an incentive to import from outside and a strategy among the regional partners also offers other pos- disincentive to export within the PTA. In effect, export sibilities for regional negotiating strategies and negotiating subsidies also have to be controlled at the WTO level. groups and opens an opportunity to develop strategies that The current Doha Round of WTO negotiations would, combine regional and multilateral integration.3 if successfully completed, make a significant difference to There are indications that PTAs may be more successful the ease with which agricultural trade could be opened up than multilateral agreements in opening markets for agri- within PTAs. Under the provisions of the 2008 draft cultural goods. It often seems easier to fine-tune market modalities, tariff levels for developed countries would access within discriminatory agreements, through selective decline by more than 50 percent for agricultural products, inclusions. The European Union (EU) provides limited and tariff-rate quotas (TRQs) for sensitive commodities access for sensitive agricultural products to the many coun- would be expanded. This would reduce both the degree of tries that have signed such agreements, including the preference for partner suppliers (and hence the risk of Mediterranean countries; the African, Caribbean, and trade diversion) and the adjustment for import-competing Pacific (ACP) countries; South Africa; and Mexico.4 Within sectors. Under an agreed schedule of WTO tariff reductions, 146 Tim Josling Box 7.1. The WTO Agreement on Agriculture The Agreement on Agriculture entered into force with the establishment of the WTO on January 1, 1995. The preamble to the document cites the agreed long-term objective of the Uruguay Round reform program: to establish a fair, market-oriented agricultural trading system. The program includes specific commitments to reduce support and protection in the areas of domestic and export subsidies and of market access and through the establishment of strengthened and more operationally effective GATT rules and disciplines. The Agreement on Agriculture also takes into account nontrade concerns, such as food security and the need to protect the environment, and it provides for special and differential treatment for developing countries, including an improvement in the opportunities and terms of access for agricultural products of particular export interest to these members. In principle, all WTO agreements and understandings on trade in goods apply to agriculture. These include GATT (incorporated into the WTO agreements as GATT 1994) and WTO agreements on such matters as customs valuation, import-licensing procedures, preshipment inspection, emergency safeguard measures, subsidies, and technical barriers to trade. Where there is any conflict between these agreements and the Agreement on Agriculture, the provisions of the latter prevail. The WTO General Agreement on Trade in Services and the Trade-Related Aspects of Intellectual Property Rights Agreement are also applicable to agriculture. Source: WTO Agreements series: Agriculture. the marginal impact of quicker reductions for regional or preferred partner with less threat to domestic agriculture bilateral partners may be more tolerable. In addition, sectors. Regional and bilateral PTAs, however, cannot deal export subsidies would finally be eliminated—a step that effectively with agricultural export subsidies and domestic has proved difficult to accomplish within PTAs. But the farm support, and so it is likely that the WTO will continue main contribution that the WTO negotiations on agricul- to be needed as a complement (Josling 2009). Meanwhile, ture can make to the process of regional and bilateral trade regionalism poses problems for the multilateral system. liberalization may be to push countries to abandon price PTAs may pick the easiest agriculture sectors to liberalize, supports in domestic markets and embrace direct pay- leaving the most difficult products to the WTO. PTAs can ments for public goods or for income relief. Such policies also lead to investment in the “wrong� countries, just to get will be more compatible with PTAs, as well as beneficial for access to their agricultural markets. Moreover, too many the multilateral trading system. simultaneous negotiations can overstretch resources. Some Because of the slow pace of the Doha Round negotia- PTAs can be “strategic�: an example is the efforts of the tions on agriculture, regional negotiations may have to Southern Cone Common Market (Mercosur, or Mercado bear the brunt of attempts to further liberalize agricultural Común del Sur) to get the rest of South America into its trade and to open access to new markets for agricultural camp before dealing with the United States and NAFTA. exports. Thus, in agriculture there is a strong degree of Some PTAs can be competitive, as when the EU and the complementarity in trade negotiations. Plurilateral agree- United States compete for the Mercosur market. Such ments can erode market access barriers, but they can also activities are likely to distract from the WTO, or they might foster less advantageous trade flows by discrimination distort the multilateral nature of the Doha Round. among suppliers. Multilateral talks can reduce the scope These issues have been discussed in the literature of for such trade diversion. The multilateral process can han- trade strategy. Analyses by Zissimos and Vines (2000) and dle subsidy reduction, which, in turn, makes it easier for by Andriamananjara (2002) suggest that joining a PTA can countries to agree to opening up regional or bilateral be the best “safe-haven� strategy when other countries are trade. This complementarity, however, depends on also doing so. But this does not imply that the end result is progress at the multilateral level. Currently, that is the one large free trade area, given that PTA membership con- stumbling block. fers a terms-of-trade gain on members at the expense of nonmembers. Some members, at least, will be better off by limiting PTA membership than by allowing expansion to Economic Integration as an Agricultural Strategy cover the world as a whole. The effect is similar to that sug- Is regionalism a better approach to agricultural trade pol- gested by the domino theory of the dynamics of regional icy than reliance on improved market access through the trade blocs (see Baldwin, ch. 3 in this volume). As PTAs multilateral system? PTAs may be better than tariff reduc- expand, the attraction of being within the bloc (or the cost tions through the WTO at improving market access for the of being outside) increases, but the marginal gain to existing Agriculture 147 members of adding one more (small) market to the bloc, with the restrictive rules of origin for many processed and the extra administrative and political cost of a large products, have severely limited the role of trade preferences membership, will act as a brake. The implication is that each in encouraging agricultural diversification in developing such agreement will tend to find its equilibrium size, where countries. the costs and benefits of enlargement are in balance.5 Tariffs introduce a wedge between the world price of a So, is the pursuit of PTAs a short-term or a long-term product and the price on the domestic market. Trade pref- strategy in agricultural liberalization? Pursuing bilateral erences allow products from the beneficiary country to North-South PTA arrangements at the regional level may enter the partner country with lower import duties than lead to short-term benefits of access to agricultural mar- are applied to other countries’ products under the partner kets for participating developing countries. But developing country’s MFN tariffs and hence capture some of the countries should be aware that preferential access is likely wedge. They give suppliers in beneficiary developing coun- to be eroded as more countries sign such deals, reducing tries access to part or all of the price premium that nor- the value of preferences (García-Alvarez-Coque 2002). For mally accrues to the importing country government as tar- PTAs to be beneficial in the longer term, governments and iff revenue. The acquisition of these rents raises returns in stakeholders should implement a set of reforms to help the developing country and, depending on the nature of sustain the growth of domestic agriculture and reduce the competition in domestic product and factor markets, stim- poverty of the agricultural population. ulates expansion of the activity concerned, with implica- As noted, this type of discriminatory trade agreement tions for wages and employment. has both positive and negative aspects. On the positive side Developing countries, especially the least developed is the ease of reaching an agreement among a small group of countries, face much higher trade-related costs than adjacent countries. Often, the countries involved will share other countries in getting their products into interna- historical and social perspectives on trade and agriculture. tional markets. Some of these costs may reflect institu- But this ease of reaching agreement comes at a cost. PTAs tional problems within the countries themselves, such as tend to “cherry-pick� the easiest trade areas in which to con- inefficient practices and corruption, and they require a clude a deal, leaving the more difficult ones to the WTO. domestic policy response. But some reflect weak trans- The ease of reaching an agreement may reflect the willing- portation infrastructure and firms’ lack of access to stan- ness of the parties to avoid hard decisions by excluding sen- dard trade-facilitating measures such as insurance and sitive sectors such as agriculture from the deal. trade finance. Those PTAs that have been most effective in opening up agricultural markets have tended to include as members Empirical Evidence on Agricultural major agricultural exporters that see the advantages of Trade and PTAs expanding markets. Countries that are mainly importers of farm products are less likely to agree to open up markets, What might a theoretical approach to the issue of agricul- and hence the benefits to the sector may be small. tural trade and regional agreements suggest? Would one In PTAs among members in different regions, the temp- expect the proliferation of PTAs to have brought about tation to exclude sensitive sectors of agriculture is even trade expansion in agricultural products? In his analysis greater, as there is less probability that the deal will include of the economic impact of regional integration on agricul- provisions of benefit to agricultural export interests. Given tural trade, Goto (1997) concludes that the higher the level that bilateral PTAs often involve countries that are not geo- of preintegration protection, and the lower the degree of graphically close, there is often an opportunity to negotiate product differentiation, the greater the impact of regional with a country with a complementary agricultural pattern integration. He hypothesizes that “regionalism has more to take advantage of trade opportunities. In practice, this [of an impact] on agricultural trade than on manufactur- often works in reverse, as countries cherry-pick partners so ing [trade], because the initial level of protection is higher as to avoid conflicts over agriculture. The existence of and the degree of product differentiation is lower for agri- political tensions in trade agreements usually indicates cultural products.� On the basis of this theoretical conclu- potential economic benefits that could be realized from sion, PTAs could be expected to have a significant role in changes in trade patterns. agricultural liberalization, and this hypothesis will be The positive and negative aspects of PTAs are com- explored in the brief review of the empirical literature that pounded by the apparent advantage that nonreciprocal follows. preferences give to the recipient country relative to others. The literature on agricultural trade issues in PTAs is But overall, the limiting factors mentioned earlier, together thin and scattered, and there is very little by way of detailed 148 Tim Josling and comparative analyses of the arrangements made for health and safety regulations for regional trade. These agriculture in regional PTAs. Bilateral PTAs are somewhat models do not evaluate the trade policies themselves better documented, as they tend to be focused on a more and cannot indicate whether a particular trade strategy is limited number of products, and the trade flows and con- desirable. ditions of market access are watched closely by the domes- The third group of studies consists of ex ante evalua- tic sectors concerned. Unilateral preferences are again the tions of prospective agreements. These studies often use subject of study, in part because of their dependence on computable general equilibrium (CGE) models to calcu- periodic renewal and in part because of their direct impact late trade flows and the welfare implications of policies. on competing suppliers. An example of a case for which Most of the few studies that focus on agriculture take a there is adequate information and several empirical analy- similar approach, analyzing the significance of trade agree- ses is the EU’s regime for bananas, where the WTO case has ments for agricultural trade. brought much transparency to the way in which the ACP Each of the three sets of studies has strengths and weak- countries sell their bananas to Europe and to the marketing nesses. The study findings are reviewed below, and issues of choices of the excluded suppliers. Sugar sales to the United relevance to the specific question of the empirical evalua- States and the EU under PTAs have also been closely ana- tion of trade preferences are then addressed. lyzed, and adequate data exist for calculating the effects of such trade arrangements. Regional Trade Flows Absent such comprehensive and detailed studies dealing with the amount and type of agricultural products traded The steady growth in world trade in relation to world out- within PTAs, the assessment of the costs and benefits of put is seen as an indicator of the success of the multilateral agricultural trade in PTAs has tended to rely on more con- trade rules put in place by the GATT and reinforced by the ceptual studies. These studies can be grouped by their WTO. The assumption has been that the elimination of focus on one of three questions: trade barriers and the extension of trade rules have stimu- lated trade flows. But has trade tended to be concentrated • Has regional trade increased faster than trade with third among regions? The literature (e.g., Lloyd 1992; Anderson countries? and Blackhurst 1993) tentatively concludes that the trading • Does the existence of PTAs explain trade flows among system has not developed into a series of intensively trad- the partners in such agreements? ing blocs, with decreased interbloc trade.6 Trade among • What are the gains and losses from participation in blocs remained resilient, despite the burst of “regionalism� regional or bilateral PTAs? in trade policy that characterized the decade from 1985 to 1995. Nevertheless, evidence of increased intrabloc trade The first group of studies essentially consists of explo- has been a widespread, if not a dominant, feature of the rations of the extent to which world trade is becoming more trading system. or less regionalized. It is difficult to derive direct implica- Several studies find that intraregional trade in agricul- tions from the outcome of such studies because regional tural and food products grew during the 1980s and 1990s trade could well increase rapidly even in the absence of (Vollrath 1998; dell’Aquila and Kuiper 2003). With regard regional agreements. The nature of agricultural and food to the effects of particular trade blocs, Diao, Roe, and trade itself is changing over time, and the goods and serv- Somwaru (2001) find that, on average, agricultural trade ices that are traded across continents may vary with the under NAFTA, the EU (then consisting of 15 countries), regional composition of trade. But it is still useful to have Mercosur, and Asia-Pacific Economic Cooperation grew these studies as a way of putting the regionalization of agri- more rapidly than did total world agricultural trade.7 In cultural trade policy in context. particular, growth in intraregional agricultural trade The second group of studies generally involves ex post exceeded the growth in extraregional agricultural trade explanations of trade flows. The most commonly used for these PTAs. technique is a gravity model. By inserting dummy variables for the existence of PTAs in regression equations, this Trade Flows and Preferences method aims to determine the significance of such trade policies in the explanation of trade flows. Agricultural A PTA increases trade among members through preferen- trade flows can be isolated in these studies, and the impor- tial treatment. The question is whether that growth comes tance of the trade policy for agriculture can be determined. at the expense of the rest of the world. Despite a number of One application has been to look at the implications of theoretical and empirical contributions in recent years, the Agriculture 149 effects of PTAs on trade in agrifood products have not been to meet import requirements at a reasonable cost. Lowering evident from the literature because most of the studies tariffs against third countries, even if done unilaterally, is have dealt with merchandise trade. To what extent agrifood a strategy that would minimize the cost of giving prefer- trade among PTA partners has increased and how much ence to high-cost imports. Making exceptions for tariff- of the increase could be attributed to trade diversion free access for high-cost partner supplies would seem less remained for some time an open empirical question. desirable. Too stringent rules of origin will also add to the Recently, researchers have tried to answer this question possibility of trade diversion because they will discourage but have come to mixed conclusions. Jayasinghe and Sarker processing of third-country raw materials in the partner (2008) analyzed NAFTA’s trade creation and trade diver- country. sion effects on trade in six selected agrifood products from The main drawback to relying on preferences for export 1985 to 2000. The results show that the share of intrare- products for agricultural development is the effect on the gional trade within NAFTA is growing and that NAFTA has pattern of domestic agricultural production. A few export displaced trade with the rest of the world. Countries par- commodities will benefit from preferences, but this will set ticipating in NAFTA have moved toward a diminished the economic context for other products that have to com- degree of relative openness in their agrifood trade with the pete for land and labor. In addition, the guarantee of access rest of the world. Grant and Hertel (2005), however, find, under unilateral preference schemes may be a Faustian bar- with only a few commodity exceptions, that PTAs have gain, as the supplying economy becomes more dependent increased trade with nonmembers even as members have over time on the continuation of the preference margin. increased trade among themselves. As these examples Preferences can create a degree of dependence that con- show, the impact of PTAs on agriculture varies among strains flexibility and diversification and results in high-cost regions and among agricultural products. production of preferred products (Topp 2001). Moreover, other countries will have an interest in reducing those preference margins over time. The most highly protected Evaluating Trade Preferences products have the highest potential margins of preference, A major problem with the standard databases on tariff lev- but these are also the products that are likely to lose the els is that they rarely incorporate preferential tariffs. Given most protection through WTO negotiations. the amount of world trade that enters countries under Many preferences are, in any case, quantity constrained. preferential (or zero) tariffs, the picture of market access When preferences are granted on products for which presented in these databases is misleading. This omission is domestic prices in industrial countries are much higher gradually being rectified; one notable advance has been the than world prices, such as sugar in the EU and the United development by the French research organization Centre States, quantities are limited, to avoid undermining the dis- d’Études Prospectives et d’Informations Internationales of tortionary policies that generate the large divergence a database that includes full information on the preferen- between domestic and world prices. In these instances, tial tariffs accorded developing countries. Analysis of the preferential access can lead to substantial gains for pre- extent to which PTAs promote the development of agricul- ferred suppliers but little hope of market expansion and ture by opening up markets remains difficult but is now high probability that the gains will be eroded. subject to empirical exploration. In addition, some of the preference rents may not be Trade preferences, both reciprocal and nonreciprocal, available for development. How much of the available rent can provide the premium over the normal rate of return is actually obtained by suppliers in developing countries that is required to encourage investment in developing depends on the nature of competition in the industry and economies. The increase in agricultural trade attributable the regulations governing the granting of preferential to preferences leads to more output and, if there are scale access, among other factors. If there is little effective com- economies, to lower costs, stimulating further trade. Thus, petition among buyers, exporters may be unable to capture the search for preferential access to foreign markets is nat- much of the price premium. Olarreaga and Özden (2005) urally a component of national trade policy. The degree of find that only a third of the available rents for African preference, however, can be fleeting if others are also nego- exports of clothing to the United States under the African tiating market access. The benefits may be those of the first Growth and Opportunity Act actually accrue to exporters. mover and can be eroded steadily over time. Furthermore, satisfying the rules governing preferences The granting of trade preferences is also a policy deci- raises costs and reduces the extent to which the preferences sion subject to evaluation. The key question is whether the increase actual returns. The costs of satisfying the rules of partner receiving the preference is able or likely to be able origin in preference schemes have been cited as a major 150 Tim Josling reason for low use of preferential access in some cases whereas for others, it will be a move toward greater protec- (UNCTAD 2001; Brenton and Ikezuki 2005; and Brenton, tion (see Andriamananjara, ch.5 in this volume). ch.8 in this volume). Gravity models and other models that seek to “explain� Tariff preferences can lead to other adverse effects that trade flows are of limited use in evaluating the value of need to be taken into account. Negotiations in the Doha preferences. Ex post analysis of why trade has taken place Round have shown that existing preferences can lead to does not answer the fundamental question of whether dif- support for highly protectionist policies in industrial coun- ferentiating one’s own tariff schedule in exchange for simi- tries and can weaken proposals that would substantially lar differentiation by others is beneficial. If the gravity reduce such levels of protection. This not only causes a rift model identifies “natural� trade partners, then the question among developing-country negotiating positions but also is, why is that natural trade, based on proximity and perpetuates policies that depress world markets and rein- income, not taking place already? The answer could be that force dependence on preferences for export revenue. the trade policy of the partner country precludes such Differences and inconsistencies between preference trade, but many other explanations could intrude. And the schemes can prevent developing-country suppliers from “best� trade partners may well be on other continents. So, evolving global market strategies. Furthermore, the prefer- gravity models are an interesting way of looking at trade ence schemes may not be directly consistent with poverty patterns, but a shaky guide to policy action. reduction objectives: beneficiaries of trade preferences are CGE models also have drawbacks for the evaluation of not always the poorest constituents in developing coun- preferences, although they do address the key issue of the tries. Although rents do accrue to the developing country, economic benefits and costs. The difficulties stem from they will tend to benefit the owners of the most intensively whether the situation to be analyzed can be specified in used and the most limiting factors. enough detail. The trade policy question may require Relatively few studies have directly measured the value knowledge of particular market conditions, such as quality of preferences. The value depends on the difference in and production cost. The device of assuming that each returns in different markets. The rents accrue to the holder country produces a somewhat different version of traded of the preference, but those rents are usually subject to the products masks the question of whether and how such dif- trade policy of the preference-giving country. A recent ferentiation can be created and exploited. An exporter will example of this view of preferences is given in Paggi, ask, “What are the regional markets that can open up for Yamazaki, and Josling (2005): the value of improved access my product, and how can I adjust to meet the market to Central American markets by U.S. exporters as a result requirements?� The CGE model will reply that the relevant of the Central America Free Trade Agreement (CAFTA) substitution elasticity is already in the model and is not a and its extension to the Dominican Republic (CAFTA–DR) part of the policy space. depends on who else has such preferences in those markets Therein lies the dilemma facing analysts in this area. and how long any advantage over other competitors will Every PTA is different in its coverage and treatment of last. The United States competes with the Mercosur coun- products. Moreover, members’ motivations and interests tries and with the EU in Central American agricultural can differ widely, making the overall analysis of the agree- markets, and evaluation of the value of CAFTA for U.S. ment of limited use to individual countries. And within exporters is as much a function of the state of trade rela- each country, the calculation of costs and benefits will be tions among these other countries as of the details of specific to conditions in particular sectors. In brief, the task CAFTA as such.8 of analyzing any particular decision for a country on the One problem with calculating the value of regional and basis of the benefits to be gained from a trade agreement is bilateral preferences in agriculture is that the models tradi- heavily data intensive, context specific, and time related. It tionally used do not adapt well to such questions. The is not surprising that the models do not produce satisfying study of trade flows and the impact of regionalism may not answers to such questions. capture the strategic and dynamic aspects of PTAs. A coun- Does this mean that the study of PTAs and their varia- try contemplating joining a PTA does not need to know tions is pointless? Clearly, one needs to continue to evalu- whether that PTA has been trade creating or trade divert- ate the overall impact of a fragmentation of the rule system ing; the issue is whether acceding to the agreement creates in world trade and the ways in which regional and multilat- beneficial trade flows, either from better market access or eral trade can coexist and become more complementary. from reliable low-cost imports. In the case of a customs But in addition to that work, there is considerable scope for union, the height of the common tariff holds the key—for focusing on the practical issues of decision making in the some countries, accession will lead toward liberalization, area of trade policy. Such work would help countries—in Agriculture 151 particular, those with limited internal analytical capacity— The decision to leave agriculture and fisheries out of the face the challenges of the day. EFTA agreement led to the exclusion of the sector from the terms of the European Economic Area (EEA), the set of bilateral PTAs that the EU negotiated with EFTA members The Practice of Agricultural Trade in PTAs as a way of keeping them close to the EU in terms of eco- Regional PTAs have the capacity to develop strong nomic regulation and price levels. The EEA allowed for free regional agricultural systems, but the path may be politi- trade in manufactured goods and cooperation in regula- cally difficult. Bilateral PTAs are free of the problem of tory issues. In effect, it extended the previous bilateral regional competition, but they often have issues with the PTAs to several aspects of trade that had been incorporated liberalization of trade in particular products, where there into the 1992 Single Market of the EU. Although some may be links between the two economies concerned. quotas on agricultural goods were expanded, there was no Regional PTAs are considered first because most of the progress toward incorporation of the rural sector into eco- difficult questions surrounding the incorporation of agri- nomic integration, as would be stimulated by enlargement. culture arise in these cases. The EU, the European Free Later, EFTA countries found themselves unable to include Trade Association (EFTA), NAFTA, and Mercosur provide agriculture in bilateral agreements that they negotiated rich examples of the ways in which the issues have been with countries such as Canada and had to settle again for tackled. The recent growth of bilateral PTAs across regions small bilateral trade deals. offers many other cases of the treatment of agriculture. In At the other extreme, the countries that formed the EEC particular, the bilateral PTAs negotiated with the EU and (later, the European Union) made a conscious decision to with the United States represent (different) standards for include all trade, including agriculture, in their trade liber- the way in which developing countries can seek to gain alization. As integration progressed, more internal agricul- secure market access in major developed-country mar- tural trade took place, some of it displacing lower-cost kets. These bilateral agreements tend to be “lighter� in the imports. In addition, the agricultural market became more area of agricultural policy, avoiding the problems that integrated as firms were able to locate in other member accompany the development of regional agricultural and states, and a European food industry began to emerge. The food markets (Josling 2009). development of a Common Agricultural Policy (CAP), with common financing and uniform support mecha- nisms, advanced further in the EU than in other PTAs. Agricultural Provisions in Regional PTAs More recently, harmonized regulations on food safety and The inclusion of agricultural trade in a regional PTA is a quality controls have reinforced the development of a challenge for negotiators. Relatively high levels of protec- regional industry. tion in agricultural markets, combined with a heightened The polar cases of EFTA and the EU bracket the degree sensitivity to issues bearing on the maintenance of a of incorporation of agriculture in PTAs. Almost all other domestic production base for staple foods, make for ten- PTAs have included agricultural trade in the liberaliza- sions. Countries in the same region are likely to have sim- tion process, to varying degrees. The agricultural content ilar production patterns. Where there has been a history of the PTAs can be explored by identifying some issues of agricultural trade among the countries, the tensions that arise in most cases. These categories are not confined may be a minor political problem, but in many cases, to agricultural trade, but they do form a set of negotiating trade with neighbors in a regional group may raise major issues that frame the agricultural agenda. They include concerns. the schedule for cutting tariffs and the use of TRQs as a Some PTAs have chosen to omit agriculture from their way of increasing access; safeguards against import surges; provisions. EFTA was created in 1960 by seven countries subsidies to domestic firms and to firms dependent on that had opted out of the European Economic Community exports; the provision of public goods, both environmen- (EEC, the precursor of the EU). Several members (Austria, tal and related to food security; and market structures Finland, Sweden, and Switzerland) had high-cost farming and institutions. sectors because of climate or topography and did not wish Tariff cutting. Elimination of tariffs among partners is to compete directly with the United Kingdom or Denmark. the defining feature of a PTA, and the inclusion of agricul- EFTA accordingly chose to exclude agriculture (and fish- tural tariff lines in the reduction schedules is a key decision. eries) from the free trade provisions. Each country was able For some products, the tariff cuts are made at the time the to maintain its own agricultural policy through tariff pro- PTA enters into force; for others, a schedule of reductions visions and domestic support.9 is agreed on. Agricultural tariff cuts, at least for sensitive 152 Tim Josling products, are usually introduced over time. The timetable in tariffs should imports surge (see Prusa, ch.9 in this for liberalization in NAFTA provides an example. volume). Agricultural products in PTAs are often subject NAFTA set in process the removal of all trade barriers to specific safeguard provisions to help guard against sud- to goods moving between countries in North America. den shifts in trade patterns. The nature of the safeguards The detailed market access provisions were embedded in for agriculture is usually in the form of a “snapback� to a three bilateral agreements (the one between the United previous tariff, no higher than the MFN tariff rate, for a States and Canada essentially continued a previous bilat- limited period of time. Similar provisions in NAFTA were eral agreement). For the U.S.–Mexico bilateral agree- used on several occasions during the transition period to ment, the time period for most sectors to achieve market react to trade surges. Countries generally reserve the right integration was 10 years, but markets for some sensitive to take action under WTO safeguard provisions, although agricultural products (beans and corn for Mexico, and not in addition to regional safeguards. The EU is again an tomatoes and citrus products for the United States) were exception; its regulations prohibit safeguard action against given 15 years to adjust. The adjustment period has trade from another member state. ended, and the U.S.–Mexico agricultural market is now Domestic and export subsidies. The thorny issue of effectively open.10 domestic subsidies in PTAs has been dealt with in two dif- Another success in removing tariff barriers on trade in ferent ways. Generally, the decision is made in negotiations farm products has been in the Australia–New Zealand not to attempt any constraints on subsidies. Indeed, it is regional market.11 The Australia–New Zealand Closer Eco- usually assumed that PTAs could not regulate domestic nomic Relations Trade Agreement (ANZCERTA) takes the subsidies because to do so on inter-PTA trade but not on two countries further toward effective market integration extra-PTA sales would be impractical at best and self- than does NAFTA in North America, although by no defeating at worst. The emphasis in several PTAs is, accord- means as far as the EU. Both countries are major agricul- ingly, on acknowledging the multilateral process as the tural exporters. The product mix of exports is somewhat location of decisions on subsidy reduction. Hence, NAFTA similar, reducing the scope for trans-Tasman trade, but contains the injunction to “endeavor to work towards there are natural trade flows based on climatic differences, domestic support measures� that have minimal trade- such as sales of Australian wheat to New Zealand and distorting effects or that would be exempt under a future exports of New Zealand dairy goods to Australia. These GATT agreement (the so-called “green box� policy instru- flows were hampered by tight restrictions on trade within ments). It recognizes, however, the right of parties to change domestic marketing legislation. It took bold political deci- domestic support measures subject to GATT obligations. sions, coupled with a significant reduction in the power of This light treatment of a contentious area enabled nego- the marketing agencies, to allow trade in agricultural prod- tiators to say that they were not altering domestic policy. ucts to flow freely. The EU took a different tack. All subsidies by member In most respects, tariff cutting in agricultural markets states are constrained by the competition regulations of the has been successful in Latin American PTAs. Among Mer- EU, and farm subsidies are not excluded from this provi- cosur countries, agricultural trade is nominally free; sion. The CAP became (in principle) the only vehicle for indeed, agricultural products are widely traded among the granting agricultural subsidies, although some exceptions member states, notably from Argentina to the others. Mer- have survived the attempts by the European Commission cosur has relatively few provisions that apply specifically to to enforce this regulation. One result of the common agriculture. There are two likely reasons for this relatively nature of the CAP has been that the EU can negotiate liberal treatment of the sector. First, Mercosur includes reductions in domestic support as a single WTO member, major exporters of temperate agricultural products, each which individual members of other PTAs are not in a posi- of which would like to strengthen its agriculture industry tion to do. and promote regional exports. Second, as a result of sweep- Export subsidies for agricultural products pose similar ing structural reforms, the countries concerned have elimi- issues. Several PTAs have contemplated banning export nated many of the state marketing monopolies that previ- subsidies on intrabloc trade, but this is easier said than ously controlled trade.12 This, together with the reduction done. The NAFTA provisions again give a good example of of subsidies and support prices, has allowed a fuller incor- the dilemma facing PTA negotiators. The text states that poration of agriculture within Mercosur than in many parties “share the objective of the multilateral elimination other PTAs. of export subsidies for agricultural goods� and promises Safeguards. As a complement to tariff cutting, PTAs fre- cooperation in the GATT to this end. The zeal for multilat- quently include safeguards that allow temporary increases eral elimination of such policies does not, however, extend Agriculture 153 to their internal use. Article 705.2 of NAFTA merely holds form the basis for improvement of the economic capacity it “inappropriate� for a party to grant export subsidies on of an agricultural area. sales to another party unless the importing country is ben- One particular public good associated with agriculture efiting from export subsidies paid by other countries.13 In deserves separate mention. Food security refers to the abil- other words, matching of EU export subsidies in Mexico is ity of a country to provide the conditions under which allowable by the United States and Canada until such food is available to (and relatively affordable by) the popu- practices are stopped multilaterally. Indeed, if the export- lation. Economic, social, and political imperatives converge ing and importing parties agree to an export subsidy on here. The contribution of PTAs to the attainment of this intra-NAFTA trade, that subsidy is allowed. This provi- objective is generally positive, as discussed earlier, but the sion, no doubt, was included to take account of the con- issue does pose some challenges for negotiators. A balance siderable importance to the United States of retaining the has to be struck between the benefits of open trade for the means to stay competitive with EU export subsidies in the regionwide sharing of risk and the ultimate national Mexican market. responsibility for ensuring food supplies. The issue that PTA discussions about the impact of different market- may cause regional friction is whether a partner in a PTA ing structures and institutions raise some interesting may restrict supplies to another partner when its own sup- issues. This is particularly true for state marketing insti- plies are scarce. The stronger PTAs, with regional food tutions in agricultural products, where historical differ- markets and coordinated policy reactions, will tend to ences in policies can lead to problems for integration. An restrain the ability of one country to impose an export ban early example was the difficulty posed for the EU at the on a partner, whereas the weaker agreements tend to leave time of U.K. accession (1973) by the existence in England this possibility open. and Wales of the Milk Marketing Board (MMB), which Many PTAs include provisions that relate to the health held a monopoly on milk sales and on imports of milk and safety aspects of agricultural and food trade, such as products. This situation was clearly inconsistent with the the harmonization (or the mutual recognition of) health competition regulations of the EU, and so the MMB had and safety regulations. (See, in this volume, Maur and to change its policies and give up its control over the milk Shepherd, ch. 10, and Stoler, ch. 11, on standards in PTAs.) market. A more recent example appears in the 1986 Most such provisions are based on the WTO Sanitary and U.S.–Canada free trade agreement. Canada was able to Phytosanitary Agreement and do not require members to exclude from the free trade provisions the products of its go far beyond those standards. In some cases, however, supply-managed sectors, primarily dairy and poultry, such as ANZCERTA, the establishment of joint agencies which were managed largely by provincial marketing to oversee such regulations acts as a guard against trade boards. Neither the United States nor Canada wished to frictions (Almeida, Gutierrez, and Shearer 2009). face the task of harmonizing marketing systems for these Institutions. Institutional innovations are also com- products, and it was felt that the operation of the boards mon, although some of the bodies set up seem to have required control of all imports, including those from the little role in policy decisions. The NAFTA trilateral agri- United States. As a result, the integration of these sectors cultural agreement, for instance, set up a Committee on was delayed indefinitely. Agricultural Trade to administer the arrangements and an Public goods. It is widely recognized that agriculture Advisory Committee on Private Commercial Disputes provides certain public goods (as well as negative exter- regarding Agricultural Goods to deal with private dis- nalities in the way of water and soil pollution). In rich putes. But there is little evidence that these bodies have countries, these public goods are often identified as the had any significant impact on agricultural trade policy stewardship of the landscape and the provision of locally over the 15 years of their existence. grown healthy foods; in less affluent societies, the benefits are food security, rural development, and poverty allevia- Agricultural Provisions in Bilateral PTAs tion. Whether society is adequately compensating the farm sector for the provision of these public goods is a The treatment of agriculture in bilateral PTAs is often subject of debate in many countries. The collective provi- markedly different from that in regional agreements.14 sion of a public good within a PTA can sometimes be The motivation for such PTAs ranges from strategic to advantageous, in particular where agricultural and envi- practical, but most often it is the exchange of preferential ronmental conditions are defined more by geography and access for goods and services, with little regard for the climate than by political boundaries. Similarly, coordina- longer-run economic relationship. No regional integra- tion of rural infrastructure within a regional PTA could tion of the agriculture sectors is envisaged, and many of 154 Tim Josling the tensions around farm policies that occur in regional liberalization road map has been defined for the agricul- pacts are absent. The main characteristics of bilateral ture sector as a whole; only for certain products have spe- PTAs are usually determined by the dominant partner, cific concessions for liberalization been determined. A often a developed country, and the discussion of these concern for the non-EU Mediterranean countries is that, PTAs is therefore conveniently organized according to with the conclusion of PTAs between the EU and other the dominant partner—in these examples, the EU and countries in Asia and Latin America, the competitive the United States. advantage that they themselves used to enjoy in EU mar- EU agreements. In the network of agreements involving kets may be eroded, and they may become marginalized. the EU and nonmembers, agriculture is still treated as The deferral of substantive negotiations on liberaliza- being largely outside the realm of unrestricted free trade. tion of trade in agricultural products has been a constant The Euro-Mediterranean free trade agreements (Euromed feature of the Euro-Mediterranean partnership (Asbil FTAs) now being finalized between the EU and the coun- 2005). The principal reason has been the reluctance on the tries of North Africa and the Middle East have so far part of European farmers to compete with Mediterranean avoided including unrestricted access for sensitive agricul- countries that are not EU members. The southern enlarge- tural products, and the same is true for the customs union ment of the EU in the 1980s redefined its relation with the that was negotiated with Turkey. The negotiation of a free Mediterranean partners. Greece, Portugal, and Spain com- trade agreement between the EU and South Africa was pete directly in agricultural products with the countries of held up by the reluctance of the EU to grant improved North Africa, and these members’ political influence access to goods that would have directly competed with largely explains the limits on trade concessions through those covered by the CAP. The agreement between the EU tariff quotas and reference quantities (García-Alvarez- and Mexico was also difficult to negotiate until Mexico Coque 2002). Agriculture has become a key sector in the abandoned its attempt to win easy access to the EU market debate between the EU and its Mediterranean trade part- for a full range of agricultural products. ners because it is seen as a necessary element in the Similarly, Mercosur and the EU are finding it difficult establishment of a balance of commercial opportunities to overcome the problems that improved access to the EU through increases in both industrial and agricultural market would seem to pose for European agriculture. The exports from the region. Cotonou Agreement between the EU and ACP countries, The other problem that Mediterranean countries need which mandated the negotiation of a transformation of to consider is the shortcomings in the diversification and the existing nonreciprocal agreements into full free trade competitiveness of their production structures. Several areas after eight years, attempted to address agricultural Mediterranean countries have very similar product com- trade issues, but these negotiations were hampered by positions of exports. Algeria, Cyprus, Israel, Morocco, and inconsistency with the CAP. The unilateral PTA between Spain all have agriculture sectors oriented toward specialty the EU and the least developed countries (the Everything products—mainly, fresh fruit and nuts, olive oil, and wine. But Arms agreement) broke significant new ground in The similarity of agricultural products means that, espe- this respect by providing duty-free and quota-free access cially since the enlargement of the EU to include Cyprus, for agricultural goods, with only temporary derogations Greece, Malta, Portugal, and Spain, EU members find it for the most sensitive commodities—rice, sugar, and easy to replace supplies from nonmember Mediterranean bananas. countries with supplies from EU members. Traditionally, the EU has used the policy of trade pref- The current negotiations between the EU and the ACP erences as a strategy of cooperation for development and countries (the signatories to the Lomé and Cotonou Agree- has unilaterally granted trade concessions to other coun- ments) have advanced through six regional talks. The EU tries. Now, Euromed agreements are taking further steps has succeeded in agreeing on a comprehensive economic toward trade liberalization on a bilateral and reciprocal partnership agreement (EPA) with Caribbean ACP coun- basis. Since the first Euro-Mediterranean Conference in tries through CARIFORUM and the Caribbean Commu- November 1995, the EU and 12 Mediterranean countries nity (CARICOM) Regional Negotiating Mechanism.15 have been engaged in negotiating association agreements In the case of the African countries, negotiations are (the Barcelona process). The overall objective is to form, being channeled through four of the main regional agree- eventually, a single Euro-Mediterranean free trade area ments. The Economic Community of West African States from the separate agreements in place. Yet, trade in agri- (ECOWAS), in collaboration with the West African Eco- culture is subjected to weak liberalization within the pres- nomic and Monetary Union (WAEMU), is the negotiating ent framework of the association agreements. No explicit partner for 16 West African states. Eight Central African Agriculture 155 states have been negotiating through the Economic and was concluded in 2001, again as a show of political support Monetary Community of Central Africa (CEMAC, Com- and economic assistance. munauté Économique et Monétaire de l’Afrique Centrale) The United States began to negotiate additional bilateral in conjunction with the Economic Community of Central PTAs in 2002 as an expression of a policy of “competitive lib- African States (ECCAS), which CEMAC has plans to merge eralization� articulated by the U.S. trade representative. This with. Seven Southern African states are negotiating policy consisted of offering swift negotiations to any country through the Southern African Development Community that was willing to conform to terms consistent with the (SADC), although some of those states are not SADC mandate of the U.S. administration, as specified in the Trade members. Another 15 are represented by the Common Promotion Authority Act. The list of willing trade partners Market for Eastern and Southern Africa (COMESA), even with which PTAs were concluded includes Bahrain, though some of them do not participate in other COMESA Morocco, Oman, Peru, and Singapore. Among other com- activities. With the exception of the agreement with the pleted bilateral PTAs with a more significant agricultural Caribbean, the EPAs are still not fully in operation. Some component were those with Chile and Australia. Talks with countries have signed partial (“goods only�) agreements, Bolivia, Ecuador, Peru, the Southern African Customs but more than half of the ACP countries failed to reach an Union, and the United Arab Emirates (UAE) are currently agreement before the January 1, 2008, deadline, when the suspended.18 Agreements with Colombia, the Republic of WTO waiver that allowed the EU to negotiate these agree- Korea, and Panama await ratification. A new front has been ments expired. Renewal of the waiver would encounter opened up in the Asia-Pacific region as the United States has some opposition. Countries that have shown opposition to begun to explore the possibility of a Trans-Pacific Partner- the EPAs include South Africa, which already has a free ship (TPP) agreement to include Australia, Brunei Darus- trade agreement with the EU, and Nigeria, with its oil- salam, Chile, New Zealand, Singapore, and possibly Malaysia based economy. A bold move by China to develop trade and Thailand. Recent agreements have often been designed and investment links with African countries appears to be as “templates� for future PTAs within a region. Thus, the causing a rethinking of the desirability of continuing close PTAs with Bahrain, Oman, and the UAE are seen as building ties with the EU if those ties come with political con- blocks toward a Middle East free trade area, and the negotia- straints. tions with Malaysia and Thailand (along with the one U.S. agreements. U.S. policy toward regional and bilat- already in place with Singapore) were originally supposed to eral PTAs changed dramatically in the mid-1980s. Long a pave the way for other bilateral PTAs with countries in the champion of the multilateral system and of nondiscrimi- Association of Southeast Asian Nations—although this nation, the United States has now become an active prospect has been overtaken by the TPP. The PTAs them- supporter of bilateral PTAs as a complement to its commit- selves usually follow from trade and investment framework ment to the WTO and its membership in NAFTA. The agreements (TIFAs) and bilateral investment treaties (BITs). United States has completed, or is currently in the midst of, The United States has a considerable number of TIFAs and trade negotiations with 27 countries aimed at creating BITS in place that would form the basis for bilateral PTAs. about 20 separate PTAs.16 The United States has economic Although all the PTAs have provisions for tariff reduc- and geopolitical reasons for expanding its commercial ties; tions that affect many food and agricultural goods, the the attraction for other countries is to secure preferred agreements, with few exceptions, control trade in a range of access to the large U.S. market.17 products considered politically sensitive in one or both The first of these recent PTAs was signed with Israel in partners. For the United States, these sensitivities include 1985 as an expression of political and economic support sugar, citrus fruits, peanuts, and dairy products; for the for that country. The free trade agreement with Canada partners, the list includes corn, beans, and rice. followed in 1986, largely at Canada’s request. It was Three current agreements have the greatest actual or designed to consolidate existing sector agreements, potential impact on U.S. agricultural markets and hence on encourage U.S. investment north of the border, and give the environment in which policy is formed: the recent Canadian firms some protection from aggressive use of PTAs with Chile and Australia, and the CAFTA–DR agree- trade remedy provisions (i.e., antidumping and counter- ment. Table 7.1 summarizes the main characteristics of vailing duty measures). In 1990, Mexico requested similar each agreement. conditions, to ensure overseas investors’ access to the large The United States and five Central American countries— U.S. market. Canada opted to join the United States and Costa Rica, El Salvador, Guatemala, Honduras, and Mexico in NAFTA, which incorporated the earlier bilateral Nicaragua—began negotiations on CAFTA in 2003, and agreement with Canada. A free trade agreement with Jordan the agreement took effect in 2006. Negotiations with the Table 7.1. Summary of Provisions Affecting Agriculture in NAFTA, U.S.–Chile, U.S.–Australia, and CAFTA Agreements Provision NAFTA Chile FTA Australia FTA CAFTA 156 Tariff cuts Some tariffs eliminated; others staged Some tariffs eliminated; others staged Most tariffs eliminated; others staged Some tariffs eliminated; others staged over 5, 10, and 15 years over 4, 8, 10, and 12 years; some cuts over 4, 10, and 18 years over 5, 10, and 15 years; other cuts delayed for 2 and 4 years delayed for 6 or 10 years; duty-free status after 15 or 20 years TRQs TRQs introduced during transition No use of TRQs introduced TRQs for imports of avocados, cotton, TRQs for sensitive products in Annex 3.3 period for sensitive products peanuts, tobacco, beef, and dairy imposed; rules on administration of products into the United States TRQs (in addition to GATT Article XIII) expanded; above-quota duties for beef put in place phased out over 18-year period; current sugar TRQs not increased: no cuts in above-quota tariff Agricultural TRQs allowed as special safeguard for Additional duties linked to price trigger Additional customs duties linked to Additional duties linked to trigger safeguards horticultural crops (Annex 703.3) (Article 3.18) for goods listed in Annex price trigger for horticultural products quantities (Article 3.14) for products 3.18; total duties not to exceed MFN (Annex 3-A, section A) and to quantity listed in Annex 3.14; total duties not to rate; safeguard not operative after 12 triggers for beef (Annex 3-A, section B); exceed MFN rate; safeguard not years, or when zero-duty stage reached price triggers used for beef in 19th year operative when zero-duty stage reached of agreement (Annex 3-A, section C); safeguard not operative when zero-duty stage reached Other Safeguards (Chapter 8A) stipulated: Trade remedies (Chapter 8) stipulated; Safeguards (Chapter 9) stipulated; GATT Trade remedies (Chapter 8) stipulated; safeguards snapback to previous year’s tariff on GATT 1994 Article XIX safeguards 1994 Article XIX safeguards adhered to GATT 1994 Article XIX safeguards bilateral trade or MFN tariff adhered to adhered to Export subsidies Agreement reached to avoid use of Agreement reached to avoid use of Agreement reached to avoid use of Agreement reached to avoid use of export subsidies on bilateral trade unless export subsidies on bilateral trade unless export subsidies on bilateral trade unless export subsidies on bilateral trade unless third countries subsidized exports to third countries subsidized exports to third countries subsidized exports to third countries subsidized exports to NAFTA markets; agreement reached to Chile or the United States; agreement Australia; agreement reached to work CAFTA markets; agreement reached to work together for elimination in the reached to work together for together for elimination in the WTO work together for elimination in the GATT elimination in the WTO WTO Domestic Agreement reached to work together in Agreement reached to work together in Agreement reached to work together in Agreement reached to work together in support GATT for reduction of domestic support WTO for reduction of domestic support WTO for reduction of domestic support WTO for reduction of domestic support levels and to shift to less-trade-distorting levels and to shift to less-trade-distorting levels and to shift to less-trade-distorting levels and to shift to less-trade-distorting instruments instruments instruments instruments SPS measures Precursor of WTO SPS agreement Affirm commitment to SPS agreement Work to resolve trade conflicts over Affirm commitment to SPS agreement (Chapter 7B) SPS barriers Dispute Dispute settlement mechanism for Dispute settlement mechanism for Dispute settlement mechanism for Dispute settlement mechanism for settlement matters arising from agreement (Chapter matters arising from agreement matters arising from agreement matters arising from agreement put in 20) put in place; separate procedures for (Chapter 22) put in place (Chapter 21) put in place; provision for place review of antidumping and countervailing monetary penalties put in place actions (Chapter 19) put in place Institutions Committee on Agricultural Trade; Working Group on Agricultural Trade; Committee on A