Preferential trading agreements: Adding spices and noodles to a spaghetti bowl

MASTER CILA

2002

Preferential trading agreements: adding

spices and noodles to a spaghetti bowl

Mia Mikic

U N I V E R S I T É L Y O N 2

2

Preferential trading agreements: adding spices and

noodles to a spaghetti bowl

Mia Mikić*

Contents

1. Introduction

2. Motivation for Liberalization Through Preferential Trading Agreements

3. Textbook Classification of Preferential Trade Agreements

4. A Non-technical Overview of Approaches to Analyzing the PTAs

5. Adding Spices and Noodles to a Bowl of Plain Spaghetti

6. Preferentialism – a Friend And an Enemy to Multilateralism?

References

Appendix – A list of selected PTAs

* Department of Economics, The University of Auckland and Graduate School of

Economics and Business, University of Zagreb; correspondence to [email protected]

mailto:[email protected]

3

Preferential Trading Agreements: adding spices and noodles to a

spaghetti bowl

1 INTRODUCTION

Economists may agree or disagree on the net effect of the proliferation of the preferential

trading agreements in a global economy but none of their analyses will stop the trend of

new trade blocs being increasingly built. Many nation states as well as already formed

preferential trading agreements (PTAs) work on adding more and more into an already

full spaghetti bowl.1 This paper provides a non-technical overview of the analyses of

preferential trading agreements and talks about reasons for their proliferation in the

aftermath of the establishment of the WTO. Section two introduces the concept of

preferential liberalization (a.k.a. regional trade agreements, regionalism, economic

integration) and discusses the motivation for national governments to turn to this

approach to liberalization with more zest compared to their efforts for unilateral and

multilateral liberalization. The third section gives the textbook classification of the

different types of the PTAs. The forth section summarizes the main approaches to

analyzing economic impacts of preferential agreements, while section five provides some

evidence and discussion on proliferation of PTAs. The last section compares and

contrasts the preferential trading agreements with multilateralism in order to examine if

and how the preferentialism acts as a building block for multilateralism. This is important

because almost 90% of the WTO members are parties to one or more regional

arrangements.

1 This term, which describes a mixture of overlapping and intersecting preferential agreements with

frequently inconsistent provisions, originally linked to the EU, is credited to Bhagwati (1992).

4

2 MOTIVATION FOR LIBERALIZATION THROUGH

PREFERENTIAL TRADING AGREEMENTS*

Trade liberalization implies gradual or complete removal of existing barriers to trade in

goods and services. If a country decides to lower or remove all of its trade barriers (tariffs

and non-tariff barriers) without the expectation of reciprocal actions by other countries,

we speak of unilateral liberalization.2 The case for unilateral liberalization is built along

the same reasoning as the case for free trade:

The removal of import barriers benefits domestic consumers and producers who

gain access to more variety at lower prices.

Domestic producers in sectors not directly competing with imports gain as they

cease to compete for resources and inputs against previously privileged sectors.

Now allocation of resources is in accordance with comparative advantage.

Even the sectors which lose privileges (import-substituting sector) benefit in the

long run as international competition forces them to become more productive.

Needless to say, not all producers would improve sufficiently to remain in the market.

But subtracting the losses incurred by those which have to leave the market from the

gains other producers and consumers obtain, a society is left with net gains.3 These net

gains should be sufficient reason to wholeheartedly accept unilateral free trade.

However due to many, mainly political economy type reasons, governments rarely decide

to go along the path of unilateral liberalization.4 Instead countries seek reciprocal

concessions or preferences. In other words, a government is prepared to lower tariffs and

* This section borrows from Mikic (2001).

2 Unilateral liberalization should not be confused with unilateralism, which describes a desire to impose

one‟s view of the desirable features of global trade policy or trade in a particular products on other

countries and have it accepted by them. 3 The size of the net gains is still a matter of heated debate. While pro-trade economists claim that net gains

are underestimated given the imperfections of tools (like so-called Harberger triangles in a partial

equilibrium model or estimation of compensating variation in the general equilibrium models), anti-trade

activists claim that these net gains are in fact too small to be relevant. 4 Governments typically do not focus on net effects for the whole society. Instead they tend to care more

about the net effects for special interest groups, say exporters or producers in the import-substitution sector

(or "in import-substitution sectors" or a subgroup of the labour force.

5

other barriers impeding imports in exchange for equivalent concessions from a trading

partner, but not otherwise.5 When liberalization is done on this reciprocal basis, it limits

the increase in foreign competition in domestic market and improves market access for

domestic producers in foreign markets. Since these markets may be enjoying high

protection from the rest of the world competition, there are opportunities to make large

profits. This drives producers to lobby with governments for non-unilateral liberalization

and therefore reciprocal liberalization might be easier or the only feasible path for

liberalization. World Bank publication Trade Blocs cites the former ministry of industry

in Morocco Mr. Hasan Abouyoub saying that trade liberalization would have been

infeasible without first entering into a free trade arrangement with the EU (p.27). In any

case, this practice of “quid pro quo” or exchanging concessions in the form of lower

tariffs has been entrenched into the world trading system and has been the driving force

behind the repeated rounds of multilateral trade liberalization.

Multilateralism or multilateral trade liberalization is described thus as a simultaneous

commitment to the reduction of trade barriers in all member countries. In addition to

reciprocity, the principle of non-discrimination has been instrumental in this multilateral

approach to trade liberalization. In practice, this principle has taken the form of the so-

called most-favoured nation (MFN) principle enunciated in the GATT /WTO Article I.

However, there are three alternative provisions allowing the WTO members to

discriminate against other members when it comes to their trade policy (Panagariya,

2000, p.289):

1. Generalized System of Preferences (GSP) allows developed countries to give

one-way preferences to developing countries. The GSP was designed to promote

South–North trade, in particular exports from South to North.

2. Enabling Clause allows developing countries to exchange virtually any trade

preference to which they mutually agree. This exception to the non-discrimination

concept is introduced to promote South-South trade and that is why it‟s wide

5 In addition to seeking reciprocal tariff concessions (multilateral or regional) instead of unilateral free for

trade for terms of trade reasons, countries also have other arguments such as infant industry and specific

country arguments, domestic political reasons and occasionally balance of payments arguments.

6

coverage enables developing countries to enter into any type of PTAs among

themselves. Therefore all such arrangements formed among the developing

countries (e.g. MERCOSUR, AFTA, SAPTA, Bangkok Agreement) are notified

to the GATT / WTO under this clause.

3. Article XXIV allows for any two or more members to form a preferential trading

area under strictly defined conditions. A key condition is that the exchange of

preferences is not partial but extends to “substantially all the trade” in products

originating in participating countries. Another restriction is linked to the height of

the protection in trade with the outside world. Depending on the actual type of

agreement between countries, the Article stipulates that external tariffs of member

countries must not be raised nor must the incidence of the common external tariff

exceed that of individual tariffs of participating members prior to agreement. As

this is the only avenue for developed countries to grant trade preferences to each

other, this Article is behind all preferential agreements formed between developed

countries (e.g. EU, EFTA, ANCERTA, NAFTA) and those between developed

and developing or transition economies (e.g. former Lome Convention and now

Cotonou Agreement, Europe Agreements).

These three exceptions allow member countries to discriminate against other members by

extending reciprocal or non-reciprocal trade preferences to some but not all the WTO

members. Since many of the preferential trading agreements involve geographically

neighboring countries, we often refer to them as a regional approach to trade

liberalization or regionalism. However it would be better to term this approach as

preferentialism since regional aspects of the agreements are less and less important.

Obviously preferentialism as an approach to trade liberalization may take place in parallel

to multilateral actions or may develop to replace them.

7

3 TEXTBOOK CLASSIFICATION OF PREFERENTIAL

TRADING AGREEMENTS

We distinguish among four levels of PTA (see Table 1). This classification is not

watertight in the sense that most of the „real world‟ integrations are „mutants‟ across

these textbook types featuring elements of more than one form..

The most common type of PTA is known as a free trade area (FTA). A free trade area is

the type of regional liberalization where tariffs on goods traded among participating

countries are removed but each country retains its own national trade policy and tariff

schedule against non-members. It is typically assumed that trade liberalization resulting

from such an agreement would cover all tradable products in the participating countries.

However, in reality, there are always so-called “sensitive” activities or sectors that are

granted special treatment (including protection from international competition) and this

status is kept even when a country forms a regional integration – most FTAs apply only

to trade in non-sensitive goods (typically excluding agriculture, services, textiles and

clothing).

Even though in most cases countries forming a free trade area would be at a similar level

of development, their trade policies and levels of protection might be quite dissimilar. In

such cases, with one country in the free trade area having higher trade barriers than the

others, freeing of intra-area trade will result in a phenomenon known as trade deflection.

8

Table 1 Main features of different levels of preferential liberalization

Levels of

integration

Elimination of

tariffs on intra-

regional trade

Elimination of

tariffs on intra-

trade and

common

external tariffs

Free movement

of capital and

labour

Coordination of

economic

policies and

harmonization

of standards

Free trade area

Customs union

Common

market

Economic

union

Trade deflection occurs when imports enter the FTA market through the member country

that has the lowest tariff. For example if there was a FTA among A, B and C, and A had

the lowest tariffs for widgets, the non-FTA exporters of widgets would re-route their

trade with the FTA so that widgets would be exported to A and then shipped duty-free

from there to B and C. For trade deflection to be effective, transport costs and other costs

related to re-routing of imports through the lowest-tariff country must be sufficiently low

not to outweigh the difference in tariff rates. Trade deflection affects members of the

FTA with higher tariffs in two ways:

1) it shrinks tariff revenue these members would otherwise collect (tariff revenues

are in effect redistributed in favor of low-tariff members), and

2) it weakens the protective impact of high-tariff members‟ trade policies.6

To avoid trade deflection from occurring all FTAs impose rules of origin (ROO). They

are used to determine the country of origin of the goods in cases where the production

takes place in more than one country (by definition each good can only originate in one

country / area). There are basically two types of ROO: non-preferential and preferential.

Non-preferential ROO are used for a number of reasons but most often for the application

of tariffs and tariff quotas. Preferential ROO prescribe the characteristics of goods

6 In effect, the consequences of trade deflection are equivalent to countries forming a customs union with

the common external tariff set to the level of the country within the FTA with the lowest tariffs.

9

eligible for preferential or duty-free trade within the FTA. The main task of the

preferential ROO is to ensure that benefits from preferential trade liberalization (such as a

FTA) are “restricted to those goods which originate and are traded within the particular

preference area” (APEC, 1997, p.5). More details on the ROO are contained in Box 1.

_______________________________________________________________________

Box 1 Rules of origin

Rules of origin (ROO) is a set of laws and regulations applied by national (or FTA) trade

authorities to determine the country of origin of goods. ROO affect different aspects of trade

because the origin of goods has a direct bearing on the administration of trade measures such as

quota systems, tariff preferences, or anti-dumping and countervailing duties. Another purpose for

which rules are applied relates to trade under preferential arrangements, where the ROO is

evidence needed for a country to enjoy a preferential status. Furthermore, determination of ROO

is necessary in the process of collection of trade statistics and labeling to indicate origin for

different reasons including government procurement (ITC, 1999, p.155-6).

There are different ways in which the origin of goods produced in more than one country could be

determined. Despite a wide variety in the actual methods, in most countries the basic principle

behind ROO determination is so-called “substantial transformation”. This identifies the last

country in which substantial transformation of a product has occurred measured by either:

- the value added in manufacturing / further processing, or

- the changes in tariff classification.7

Under the system of value added, for a product to be considered to have been produced or

manufactured in the country or within a preferential area for which origin is being claimed, a

specified percentage (e.g. 40%, 50%, 60%) of the product value has to be added by processing

within that country / area.

When substantial transformation has occurred so that a good is re-classified into a different tariff

heading we talk about applying the principle of the changes in tariff classification to determine

the origin of goods. WTO encourages its members to use the tariff classification known as the

Harmonized System Nomenclature (HS) for the purposes of collecting trade statistics and

assigning custom duties. The HS arranges products according to the degree of processing starting

with raw materials and ending with finished products. The country of origin is determined by

identifying where the last change in its tariff classification has occurred.

GATT did not require parties to adopt any specific set of rules. Most countries typically had two

sets of rules: general or non-preferential rules applicable to all countries, and some special rules

(often not transparent) for preferential trade and/or regional arrangements. The Generalized

7 There are of course other methods of determining substantial transformation including a specified process

of manufacturing.

CAHIERS DE COMMERCE INTERNATIONAL No 3, 2002 « Preferential trading agreements: adding spices and noodles to a spaghetti bowl », Mikić, Mia.

10

System of Preferences (GSP) is for example one way in which preferential ROO are set.8 The

lack of international agreements on the ROO also allowed for the use of ROO as a protectionist

devise.

In order to make ROO simpler, more uniform and more stable, the Uruguay Round considered it

desirable to prepare a harmonized set of ROO to be adopted by all member countries. The

Agreement on Rules of Origin signed in Marrakesh in 1994 (WTO, 1995b, p.31) requires WTO

members to ensure that their rules of origin:

-are transparent,

-have no restricting, distorting or disruptive effects on international trade,

-are administered in a consistent, uniform, impartial and reasonable manner, and

-are based on a positive standard.

The Agreement focuses on the MFN based-trade and does not apply to preferential agreements. It

was envisaged that technical work on harmonization of ROO across members would take at least

several years and therefore the Agreement carries two sets of provisions: one contains disciplines

countries are expected to follow during the transition period (until new harmonized rules enter

into force), and another to be applied after the transition period is over and the new harmonized

set of ROO are in place. These harmonized rules provide that the origin of goods shall always be

“the country where the last substantial transformation has been carried out” and this should be for

any purpose of the origin determination. The adoption of harmonized rules is expected to ease the

administrative burden on exporters and reduce exporting costs, as exporters

8 A detailed account of the ROO used in the GSP could be found in Digest of Rules of Origin: Generalized

System of Preferences by UNCTAD.


11

should be able to meet ROO requirements much easier.

________________________________________________________________________

Customs union involves the suppression of all intra-area trade barriers among member

countries and the establishment of a common external tariff (CET) on imports from

non-members. The European Union began as a customs union (then under the name of

the European Economic Community, EEC). Previous to that in 1947, Belgium, the

Netherlands, and Luxemburg had formed a customs union called Benelux which became

part of the EEC when it was formed in 1958. Because participating countries introduce

the CET there is no trade deflection and no need for the rules of origin to police the

transshipment by non-members. By the GATT/WTO rules (Article XXIV) the CET must

on average be no higher than the pre-union tariff, and the compensation is negotiated by

non-member countries when non-members are harmed.

Common market is the next level of regional integration in which all tariffs and trade

barriers are removed on trade between members, a CET is adopted for outside trade and

barriers on movement of labour and capital, as well as enterprises between member

countries are removed. The most successful example of a common market in the real

world is of course the European Community (which completed the common market stage

in 1968).

Even deeper integration is achieved in the form of an economic union. It includes all the

features of a common market as well as full harmonization of national economic policies

As mentioned above, the various regional trade groupings actually established in the real

world do not fully correspond to the above classification. For example, a number of real

world FTAs also include one or two characteristics of the integration of the higher level:

ANCERTA allows for free movement of labour and some movement of capital across the

Tasman Sea, while NAFTA in addition to removing most restrictions on foreign

investment also deals with intellectual property protection and government procurement.


12

Likewise, the EU still does not show full harmonization of fiscal or financial systems

even though it has reached the level of economic union. One of the reasons for the

mismatch between “theoretical” or textbook and “practical” types of integration is that

often after starting to form a particular level of integration, countries find themselves

pressured by initial success or failure to either proceed / evolve into a more complex type

of integration or revert to a more primitive type of integration.

4 A NON-TECHNICAL OVERVIEW OF APPROACHES TO

ANALYZING THE PTAS9

The basic ideas on economic effects of PTA could be obtained by using an example of a

customs union between two countries (as in such way we do not have to worry about

differential external tariffs nor of movements of factors of production or harmonization of

other economic policies). Take then two countries A and B, which form a customs union.

The analysis we use is of a partial equilibrium nature as we also apply other standard

assumptions of trade theory.10

Suppose that country A has a tariff tA against country B

and the rest of the world (W) and suppose that country B is more efficient than the rest of

the world (pB<p

W). Also assume that supplies from country B and the world are perfectly

elastic at prices pB and pW (i.e. country A is a small country). In that case prior to any

agreements the country A will be importing from country B (0M0 in part a of Figure 1)

and not from the world. When Country A and B form a union agreeing on a common

tariff tA against the rest of the world the effects will be as shown in part a of Figure 1.

After the customs union all imports still come from the country B but trade expands (to

0M1) because now without a tariff country A pays less for imports - there's a surplus gain

(note that this is an excess demand curve) to country A and when lost tariff revenues are

9 This section leans heavily on Mikić, 1998, pp.445-59 and Richardson (2002).

10 That is perfect competition, no distortions other than the tariffs and the CU, no externalities, no

international movements of factors, and no other trade costs.


13

subtracted, a country is left with a net gain, as shown. This is called trade creation and is

unambiguously a good thing for country A.


14

Figure 1

Part a Part b

Trade creation describes trade that occurs between members of a regional integration

that replaces what would have been produced in the importing country were it not for the

preferential liberalization. It is associated with welfare improvement for the importing

country since it represents a substitution of higher-cost domestic production by efficient

regional partner country production. As this is a shift in the direction of what would have

been a free-trade allocation of resources, it has a beneficial welfare effect.

Another net effects is however possible given that our preferential partner might not be

the most efficient of all countries we trade with. This situation is presented in part b of

Figure 1. Before the customs union country A buys only from the rest of the world at a

price pW+tA. After the union with country B, it does not pay to import from the world as

the imports from a partner country B is now duty-free. With pB<pW+tA country A

switches to purchasing imports from the partner country. Again there is a surplus to be

reclaimed, but there is also a loss in tariff revenues (see Figure 1, part b). A net effects

pA

p0

A

p1

A

EDA

PB

pW

W

PB+t

A

pW

+tA

MA M1M0

gain

n

pA

p0

A

p1

A

EDA

pW

W

PB

pW

+tA

PB+t

A

MA M1 M0

gain

loss


15

may be negative if country B is much less efficient than the rest of the world. This effect

is trade diversion.11

Trade diversion is trade that occurs between members of a preferential agreement that

replaces what would have been imported from a country or countries outside of the bloc.

It is a consequence of discrimination introduced by a preferential agreement. Because it

represents a shift away from a free-trade allocation of resources it is associated with

welfare reduction for the importing country – it increases the cost of imports.

Both trade creation and trade diversion are possible effects and the net effect of the

preferentialism depends on the relative strengths of these two. The following are some

circumstances where trade diversion will be less of a problem (World Bank, 2000, pp.40-

1):

1) as trade diversion can only occur if the country has a tariff on imports from the

rest of the world, it is clear that lowering those tariffs would reduce the cost of

trade diversion

2) as trade diversion arises only if partner country costs are out of line with costs and

prices in the rest of the world, if partner country itself had lower tariffs against the

rest of the world there will be a downward pressure on it‟s costs

3) with transport and transaction costs, it is likely that costs of trade diversion are

smaller if partner country is close (geographically) and more similar (in terms of

production structure).

To summarize, the net effect of forming a customs union (or some other form of PTA)

could be positive or negative. However, this result depends on the external tariff of the

PTA against the rest of the world to remain the same as it was before the PTA. This is of

course very restrictive assumption and there are different reasons why this might not

11

This is one reason why the GATT provisions on bilateral deals are inadequate to protect other countries:

even with domestic tariff unchanged the external volume of trade falls and when the third countries are not

large they might very well suffer a loss (cf. Richardson, 2002).


16

happen with real PTAs. Namely the external tariff of the PTA may be influenced by the

parallel unilateral or multilateral liberalization of a partner or partners; by the particular

set of political-economy factors; by the delegation of tariff-setting authority within the

customs union, or by the free-riding within the union.

Another dimension lacking in the above analysis is the economic impact on the countries

outside the PTA. Article XXIV of the GATT of course attempts to minimize the adverse

effects on these countries by requiring that the level of external tariffs of the PTA

countries is not higher than before the PTA. It seems however that this does not prevent

the harm PTAs could cause to the third countries; it is the PTAs effects on the terms of

trade and the imports of the countries left outside the PTAs that determines the changes in

their economic welfare (see more in Winters, 1996).

There are also so-called dynamic effects arising from preferential trading agreements,

which help integrated larger integrated markets. They refer to:

better utilization of economies of scale

increased competition within the integrated market

greater investment and technology transfers in countries within the

regional integration

benefits from increased labour and capital mobility.

There are of course political impacts as well. Often the purpose of integration is political

while the economic consequences are only side-effects of the political payoff (World

Bank, 2000, p.11). The most important of these political payoffs are:

intra-regional and extra-regional security (like in case of MERCOSUR,

Association Agreements with Central Europe, and in Africa, etc.)

bargaining power (like in the case of Cairns Group, the EU, and OPEC)

project cooperation (like in areas of fishing -EU and EFTA, energy –SADC, etc.)


17

locking-in domestic reforms (like in the case of Mexico with NAFTA, central

European countries with the Association Agreements with the EU, or Greece and

Portugal with the EU, etc.).

As this overview indicates, the estimation of economic impacts of PTA is a complex task.

Even if the net result is positive we need to ask if there is a better alternative to reach

such an outcome. In other words, if a country liberalizes unilaterally would it be worse

off compared with liberalization through a PTA? The answer based on economic

implications is simple: unilateral liberalization is at least as good as preferential (if

partners are internationally efficient) or superior to preferential liberalization (if partners

are inefficient by world standards). There must be then the reasons belonging to the area

of political control of liberalization (monitoring and exchange of concessions) that tip the

scale in favour of preferential agreements compared to unilateral liberalization since we

witness only an upward trend in the number of the PTA under negotiation.

5 ADDING SPICES AND NOODLES TO A BOWL OF PLAIN

SPAGHETTI

In the 20th century we have witnessed two large waves of regionalism: one during the

1950s and 1960s (Bhagwati, 1992), and the other during the 1990s. As Panagariya (2000,

p.287) claims the effective regional liberalization during the first wave did not spread

beyond Western Europe (EC and the EFTA). The second wave of regionalism however

was much more successful driving virtually all countries – developed and developing - to

seek some form of regional trading arrangement. By 1999 more regional agreements had

been notified to the WTO than it had countries as members (World Bank, 2000, p.123;

see Box 2). Even Japan, Hong Kong and Korea, countries that refused repeatedly to enter

into any contractual trading arrangements, are presently working on forming free trade

areas. Due to this continuing proliferation of regionalism real pressure has arisen on the

multilateral trading system (see also section 6).

https://www.researchgate.net/publication/291778092_Regionalism_versus_multilateralism?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==


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According to Hoekman and Kostecki (2001, p.348-9) there are a number of factors

behind the steady growth of preferential trade agreements:

1) Former socialist economies using regional liberalization as a tool of re-integration

into the global economy.

2) Changed attitude of the US towards regionalism.

3) Domino effects putting pressure on countries remaining out of the block to get in.

4) Globalization i.e. increased internalization of all markets putting pressure on firms

to seek efficiency through larger markets.

5) Using regional agreements to lock in domestic reforms and grow credibility.

6) Regionalism is often driven by foreign policy and national security

considerations.

________________________________________________________________________

Box 2 Preferential trading agreements in the world today Similar to GATT previously, the WTO requires its members to notify it of the preferential

(regional) trade arrangements in which they participate. Most of the current members have

notified participation in one or more of the arrangements. However it seems the number of

notifications has increased since the establishment of the WTO. During the GATT era in the

period 1948-94, there were about 125 notifications (relating to trade in goods), and since 1995,

another 125 more arrangements related to trade in goods and services have been notified to the

WTO (or are to be notified).

Many of the notified arrangements are not in force any longer. Some of them have been

superseded by redesigned arrangements among the same members. Out of total 250 agreements

notified, more than 170 are deemed to be active. However a large number of those are just

components of the two major regional integration agreements/arrangements among developed

countries (the EU and NAFTA). It seems that less than 40 arrangements presently exist with a

wide variety of rules and characteristics.

Historically, most preferential agreements were concentrated on the European-Mediterranean

region (Chart 2) which accounts for more than 50% of all agreements in force. However, as

number of agreements currently under negotiation in the Americas is quickly increasing, the

European region might lose its traditional supremacy. Another region which was quite dormant in

proliferating regionalism – Asia-Pacific- has lately also become surprisingly active in adding to

the total tally of agreements. Another interesting phenomenon is a rise in cross-regional

negotiations. As can be seen from Chart 2, 14 such agreements are being negotiated with 15

already in force.


19

Chart 1 The number of preferential trade agreements notified each year (1948-2000)

Source: WTO (2000)

Source: WTO (2000)

0

50

100

150

200

250

300

1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000

Year

No.

of R

TA

sEstablishment

of the WTO

Chart 2: Geographical Distribution of RTAs, both in force

and under negotiation

0

20

40

60

80

100

120

Americas Asia Pacific Eastern Europe

& Central Asia

Euro-

M editerranean

Sub-Saharan Cross Regional

Region

Nu

mb

er

of

RT

As

FTAs under negotiation

CUs under negotiation

FTAs in force

CUs in force


20

TABLE 2 MERCHANDISE TRADE OF SELECTED REGIONAL

INTEGRATION ARRANGEMENTS, 1999 (BILL DOLLARS AND

%)

Share in total

Value exports/imports Annual percentage change

1999 1990 1998 1999 1990-99 1998 1999

APEC (21)

Total exports 2497 100.0 100.0 100.0 7 -4 6

Intra-exports 1774 67.5 69.3 71.0 8 -7 9

Extra-exports 723 32.5 30.7 29.0 6 4 0

Total imports 2625 100.0 100.0 100.0 7 -7 10

Intra-imports 1883 65.4 71.3 71.8 8 -6 11

Extra-imports 741 34.6 28.7 28.2 5 -10 8

EU (15)

Total exports 2180 100.0 100.0 100.0 4 4 -1

Intra-exports 1385 64.9 63.1 63.5 4 7 0

Extra-exports 796 35.1 36.9 36.5 5 0 -2

Total imports 2232 100.0 100.0 100.0 4 6 1

Intra-imports 1389 63.0 62.8 62.2 4 7 0

Extra-imports 843 37.0 37.2 37.8 4 5 3

NAFTA (3)

Total exports 1070 100.0 100.0 100.0 7 0 6

Intra-exports 579 42.6 51.2 54.1 10 5 11

Extra-exports 491 57.4 48.8 45.9 5 -5 -1

Total imports a 1420 100.0 100.0 100.0 9 5 12

Intra-imports 575 34.4 40.3 40.5 11 6 12

Extra-imports 846 65.6 59.7 59.5 7 5 11

ASEAN (10)

Total exports 359 100.0 100.0 100.0 11 -7 9

Intra-exports 79 20.1 21.9 22.1 12 -18 10

Extra-exports 280 79.9 78.1 77.9 10 -3 9

Total imports 299 100.0 100.0 100.0 7 -25 7

Intra-imports 69 16.2 22.6 22.9 11 -16 9

Extra-imports 231 83.8 77.4 77.1 6 -27 7

CEFTA (6)

Total exports 107 - 100.0 100.0 - 12 1

Intra-exports 13 - 13.0 12.0 - 6 -7

Extra-exports 94 - 87.0 88.0 - 13 2

Total imports 134 - 100.0 100.0 - 11 -2

Intra-imports 13 - 9.7 9.5 - 8 -4

Extra-imports 122 - 90.3 90.5 - 11 -1

MERCOSUR (4)

Total exports 74 100.0 100.0 100.0 5 -2 -9


21

Intra-exports 15 8.9 25.0 20.3 15 -1 -26

Extra-exports 59 91.1 75.0 79.7 4 -3 -3

Total imports 83 100.0 100.0 100.0 12 -3 -16

Intra-imports 16 14.5 21.0 19.0 16 -1 -24

Extra-imports 67 85.5 79.0 81.0 12 -4 -14

ANDEAN (5)

Total exports 43 100.0 100.0 100.0 4 -16 10

Intra-exports 4 4.3 13.9 8.9 13 -3 -29

Extra-exports 39 95.7 86.1 91.1 3 -18 16

Total imports b 36 100.0 100.0 100.0 8 2 -20

Intra-imports 4 7.7 11.7 11.7 13 -10 -20

Extra-imports 32 92.3 88.3 88.3 8 4 -20

a Imports of Canada and Mexico are valued f.o.b.

b Imports of Peru and Venezuela are valued f.o.b.

Note: The figures are not fully adjusted for differences in the way members of the arrangements in this

table record their merchandise trade.

Source: WTO, Annual Report 2000, Table 1.9, p.23


22

There are two processes taking place on the two sides of the Pacific Ocean, which

deserve commenting on. One is related to the negotiation of the Free Trade Area of

Americas and another one relates to increased activities among the Asian nations that

normally were not involved in preferentialism (e.g. Japan, Hong Kong, Singapore,

Korea). In both of these processes there is a strong involvement of the US seeking to

advance the trading agenda that is still not embraced by the WTO (e.g. trade linkages to

environmental and labour standards) or which they could better monitor and/or enforce in

preferential agreements (related to investments, intellectual property protection and

similar). These activities add new flavour to the old “spaghetti bowl” as it is not only the

number of preferential agreements (density in the bowl) that is increasing, but they also

change texture and taste as some cover areas that normally would not enter an FTA (as

agreements with Singapore and Chile do) and also for the first time we find possible

agreements with countries that so far had none (Japan, South Korea).


23

6 PREFERENTIALISM – A FRIEND AND AN ENEMY TO

MULTILATERALISM?

Following Bhagwati (1992) the implications of PTAs for multilateralism can be

examined along two separate lines: 1) the immediate (static) impact of the PTAs on world

welfare, and 2) the impact on a dynamic liberalization path since PTAs might expand to

encompass the whole world (regionalism as a stepping stone to global free trade) but

might also fragment the world economy (regionalism as a stumbling block to global free

trade).12

The static impact effect is of course the question related to the net welfare effect of the

regionalism: are they on balance more trade creating or trade diverting? The answer is

really an empirical one. There are some conditions which if satisfied may increase the

likelihood for a regional integration to be trade creating, but they cannot be generalized

(see Mikić, 1998, p. 450-52). Thus regional trading arrangements can raise welfare but

there can be no presumption that they will.

When looking at the impact on the dynamic liberalization path, it is helpful to consider

elements of speed, efficiency and certainty.

The speed of trade liberalization on a global level has become an issue during the 8th

GATT Round – the Uruguay Round – where the major players could not agree on

commitments in the newly added areas of agriculture and services trade. Many

commentators claim that the most important reason for that round‟s movement away

from the stale position was a credible threat by the US of going on a separate (e.g.

bilateral and regional) path away from multilateral talks. The situation has not improved

since the Uruguay Round closed and with the establishment of the WTO. An increased

12

There are also impacts of multilateralism on regionalism that are worth mentioning. Following

Panagariya (2000, pp.324-25), claims could be made that: a) multilateralism makes regional liberalization

more sustainable, and that b) multilateral liberalization among the developed countries leads to more

preferential trading arrangements between developed and developing countries.



24

number of members (at the moment 144 countries are full members) and widened agenda

with new issues still emerging, the multilateral negotiations are becoming complex and

definitely slower that they used to be in the early years of GATT. The failure of the

Ministerial in Seattle 1999 and the stalling Doha negotiations are clear evidence of that.

But we must be careful not to overestimate the speed of preferential trade liberalization

either.

The most successful preferential integration in terms of achieving free trade for its

members is the European Union. Yet it took a long time for free trade of goods and

services within the EU to be in fact implemented. There is a perception of regionalism

being quicker in liberalization because perhaps the negotiating time on the agreement

might be relatively short. However, the time involved from the moment an agreement is

announced until free trade is in fact materialized is very long, and in many of the

agreements it does not happen ever.

With respect to regionalism producing more efficient results, one has to be careful how to

define “efficient”. If efficient is to mean more liberalization per unit of time or resources

spent to get the result, then we cannot really say much about the efficiency of either path,

as it would be difficult to measure it.

The issue of certainty is linked to stability and irreversibility of trade liberalization

commitments made under one of the two approaches to liberalization. This is where

multilateralism is definitely superior as proven by experience. All of the trade negotiation

rounds have been mostly implemented, even though it took longer for some than others.

With respect to commitments to reductions in tariffs, these are bound and it is very

difficult for a member to renege on the agreement.13

On the other hand, it is easier for

regional agreements to fail (e.g. LAFTA) or to adjust (ASEAN) the speed of

13

It is not to say that some members might occasionally try to introduce some additional import surcharges

without previously clearing it up with other members. But sooner or later they will have to step back in line

because the large number of members in the WTO also means that it would be more difficult for all to

agree to a change.


25

liberalization to meet the specific interests of some of the members. Many transition

economies have sought membership of the WTO for the reason of obtaining a means of

“locking in” their economic reforms.

In conclusion, it is unclear whether regionalism can be considered a stepping-stone to

global free trade or a stumbling block. What is certain however is that regionalism is here

to stay and that the world economy in the future will rely upon both regional trading

blocs and the WTO. This “two-way” commitment of individual countries to trade

liberalization may push the world economy further down the path towards free trade than

would sole reliance upon multilateral negotiations. On the other hand, as Panagariya,

(2000) argues, the proliferation of the regional trading agreements with differentiating

tariff and other barriers will result in a chaotic and non-transparent trading regime -

“spaghetti bowl” spiced with agreements from the Americas and with added twists from

bilateral agreements in Asia. The only way out is to speed up liberalization based on the

MFN principle. “Once external tariffs drop to zero, tariff preferences and the spaghetti

bowl created by them will automatically disappear” (p.328).

Despite this being the best solution, it is not the most likely one (at least not in a short

run). From the point of view of developing countries and their need to secure access to

developed countries‟ markets, if the WTO-led path is not feasible, the only available

avenue is through proliferation of association agreements with the other established

integrations such as the EU, NAFTA, and individual large traders like Japan and

consequently developing countries‟ agreements such as AFTA or MERCOSUR . In fact

what the World Bank (2000, p.117) proposes is modification of the WTO rules regarding

the regional integrations to create a presumptive right of association. “Analogous to the

MFN clause, if association is granted to one country, there should be a presumption that

similar terms should be available to others: if Iceland is offered reciprocal freedom from

antidumping suits from the EU, then the same option should be available to Ghana.” By

“opening the clubs” to the membership by developing countries the advantages of

regionalism are combined with the advantages of multilateralism. In terms of the effects


26

discussed above, if this type of regionalism was pursued outsiders would be able to enjoy

the positive trade creation effects while the negative effects of trade diversion would be

minimal.


27

References

APEC, (1997) Compendium On Rules of Origin, Singapore: APEC.

Bhagwati, J. (1992) “Regionalism versus Multilateralism” World Economy, 535-55.

Bhagwati, J., P. Krishna and A. Panagariya (1999) Trading Blocs, Cambridge, Mass.:

The MIT Press.

Bhagwati, J., D. Greenaway and A. Panagariya (1998) “Trading Preferentially: Theory

and Policy,” The Economic Journal, 108 (July), 1128-48.

ESCAP (2000) The Future WTO Agenda and Developing Countries Studies in Trade and

Investment 41, New York: United Nations.

Hoekman, B. and M. Kostecki (2001) The Political economy of the World Trading

System: The WTO and Beyond Oxford: Oxford University Press

ITC (1999) Business Guide to the World Trading System, 2nd

ed, Geneva and London:

ITC and Commonwealth Secretariat.

Krueger, A. (1999) “Are Preferential Trading Arrangements Trade-Liberalizing or

Protectionist?” Journal of Economic Perspectives, 13, 4, pp. 105-24.

Mikić, M. (2001) “Training manual on Increasing Capacities in Trade and Investment

promotion” , UN/ESCAP, New York

Mikić, M. (1998) International Trade, Basingstoke: Macmillan.

Panagariya, A. (2000) “Preferential Trade Liberalization: The Traditional Theory and

New Developments,” Journal of Economic literature, XXXVIII (June), pp. 287-331.

Richardson, M. (2002) “PTAs – an overview”, presented at the University of Auckland,

September, mimeo

Winters, A.(1996) “Regionalism versus multilateralism” World Bank Policy Research,

International Economics Working Paper No. 1687 retrieved

http://monarch.worldbank.org/pub/decweb/WorkingPapers/WPS1600series/wps1687/

World Bank (2000) Trade Blocs, Washington, D.C: World Bank available at

http://www.worldbank.org/research/trade/pdf/trade%20blocs.pdf

WTO, (2000) Mapping of Regional Trade Agreements, Geneva: WTO, WT/REG/W/41

http://monarch.worldbank.org/pub/decweb/WorkingPapers/WPS1600series/wps1687/

http://www.worldbank.org/research/trade/pdf/trade%20blocs.pdf

https://www.researchgate.net/publication/4901957_Preferential_Trade_Liberation_The_Traditional_Theory_and_New_Developments?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==

https://www.researchgate.net/publication/4901957_Preferential_Trade_Liberation_The_Traditional_Theory_and_New_Developments?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==

https://www.researchgate.net/publication/4981605_Are_Preferential_Trade_Arrangements_Trade-Liberalizing_or_Protectionist?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==

https://www.researchgate.net/publication/4981605_Are_Preferential_Trade_Arrangements_Trade-Liberalizing_or_Protectionist?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==

https://www.researchgate.net/publication/4890175_Trading_Preferentially_Theory_and_Policy?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==

https://www.researchgate.net/publication/4890175_Trading_Preferentially_Theory_and_Policy?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==

https://www.researchgate.net/publication/227468120_The_Political_Economy_of_the_World_Trading_System_the_WTO_and_Beyond?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==

https://www.researchgate.net/publication/227468120_The_Political_Economy_of_the_World_Trading_System_the_WTO_and_Beyond?el=1_x_8&enrichId=rgreq-52b2e34fba2a530b61ef08556396730a-XXX&enrichSource=Y292ZXJQYWdlOzIyODg5ODc3NjtBUzoxMDI0NDAzNzIyNzcyNDhAMTQwMTQzNTA5NjExNA==



28

WTO, (1995b) Trading Into the Future, Geneva: WTO.


29

Appendix – The list of selected PTAs

As Chart A1 shows PTAs are concentrated in Europe. However developments in the last

two years since this mapping was done by the WTO indicate that while Europe will retain

its supremacy for the number of PTAs other regions, e.g. Americas and Asia/Pacific will

decrease the current gap.

The following list of PTAs is far from comprehensive; it includes only some of the

agreements which are in force. The detailed description of all preferential agreements see

in Frankel, J. (1997) Regional Trading Blocs in the World Economic System (IIE,

Washington).

Europe14

EU – European Union [including its subset Economic and Monetary Union (EMU)]

Established as the customs union in 1957

Current level of integration – economic union [and monetary union for a

subset]

Current members: Austria, Belgium, Denmark*, Finland, France, Germany,

Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweeden*,

United Kingdom* (countries labeled by * are not in the EMU)

Potential members by 2005: Cyprus, Czech Republic, Estonia, Hungary,

Latvia, Lithuania, Malta, Poland, Slovak Republic, Slovenia

EFTA – European Free Trade Area

Established as a free trade area in 1960

Current level of integration – free trade area

Current members: Iceland, Liechtenstein, Norway, Switzerland

14 Various bilateral agreements including partnership agreements between the EU and a number of other

countries in Europe and in the world at present are mostly non-reciprocal, non-symmetrical agreements and

are not considered here.


30

EEA – European Economic Area

Established as free trade area between EU and EFTA in 1994


Current members: members of the EU and the EFTA (except Switzerland)

CEFTA – Central European Free Trade Area

Established as free trade area in 1992


Current members: Bulgaria, Croatia, Czech Republic, Hungary, Poland,

Rumania, Slovak Republic, Slovenia

Americas

NAFTA – North American Free Trade Area


Current level of integration – free trade area (including agriculture, intellectual

property protection, investment, etc)

Current members: Canada, Mexico, United States

Potential members: Chile and CARICOM countries

MERCOSUR – Mercado Comun del Sulde



Current members: Argentina, Brazil, Paraguay and Uruguay

Andean Community

Established as free trade area in 1989 after an attempt to create a customs

union as the Andean Pact has been failing since 1969 (another failed attempt

at a customs union in 1992)


31


Current members: Bolivia, Colombia, Ecuador, Peru, Venezuela

CACOM – Central American Common Market



Current members: Costa Rica, El Salvador, Guatemala, Honduras,

Nicaragua

CARICOM – Caribbean Community

Established as free trade area (CARIFTA) in 1968

Current level of integration – customs union (1973)

Current members: Bahamas, Jamaica, Belize, Montserrat, St. Kitts and Nevis,

Antigua and Barbuda, Dominica, Saint Lucia, Barbados, St Vincent and the

Grenadines, Trinidad and Tobago, Grenada, Guyana, Suriname

Under negotiation:

FTAA – Free Trade Area of Americas

Proposed free trade area among 34 countries

Asia/Pacific

APEC – Asia Pacific Economic Cooperation

Established as a nondiscriminatory association of countries in 1989

Current level of integration – negotiation in process, still not formally a

trading bloc (vision to become a free trade region by 2020)

Current members: Australia, Brunei, Canada, Chile, China, Chinese Taipei

(Taiwan), Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New

Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Thailand,

Vietnam, US


32

ANZCERTA – Australia and New Zealand Closer Economic Relations and Trade

Agreement (aka CER)

Established as a free trade area in 1983

Current level of integration – free trade area (covering lots of extras

including free movement of labor, extensive trade facilitation and

harmonized competition law provisions)

Current members: Australia, New Zealand

AFTA – ASEAN Free Trade| Area

Established first in 1967 as ASEAN to foster economic, cultural and social

cooperation among the original five members


Current members: Brunei, Cambodia, Indonesia, Malaysia, Myanmar,

Philippines, Singapore, Thailand, Vietnam

SAARC – South Asian Association for Regional Cooperation

Established in 1985

Current level of integration – free trade area (SAPTA) since 1992

Current members: Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri

Lanka,

Under negotiation:

FTA between ANZCERTA and AFTA

ASEAN – China FTA

ASEAN – Japan FTA

CEP Hong Kong and New Zealand

Africa

Southern African Customs Union

Established in 1910


33

Current level of integration – customs union and an integrated labour market

and all members except Botswana integrated in the Common Monetary Ara

with SA rand as a legal tender

Current members: Botswana, Lesotho, Namibia, South Africa, Swaziland

African Economic Community

Established as a supranational trade body in 1994

Current level of integration – bloc striving for an EU type of integration but

nothing much achieved yet

Current members: 51 countries

Multilateral agreements

World Trade Organization

Established as preferential trading bloc in 1947 (GATT)

Current level of integration – preferential trading bloc

Current members: 144 full members, plus 2 to be ratified


34

Chart A1 Geographical distribution of the regional trade agreements in the world

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Preferential trading agreements: Adding spices and noodles to a spaghetti bowl

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