Regional trade agreement

Reinert/Windows on the World Economy, 2005

Regional Trade Agreements

CHAPTER 8


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Introduction “Multilateralism” refers to the GATT/WTO system as well as the trade

negotiations that take place among all GATT/WTO members as a group Recall that one of the founding principles of this system is

nondiscrimination Involves the most favored nation (MFN) and national treatment (NT) sub-

principles• Each WTO member must grant to each other member treatment as favorable as

they extend to any other member country “Regionalism” refers to a violation of the nondiscrimination principle in

which one member of a regional trade agreement (RTA) discriminates in its trade policies in favor of another member of the RTA and against nonmembers Has been allowed by the GATT/WTO under certain circumstances

• Free trade areas (FTAs)• Customs unions (CUs)• Interim agreements leading to a FTA or CU “within a reasonable length of time”


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Introduction

Regionalism and multilateralism represent two alternative trade policy options

When multilateralism “falters” regionalism “picks up the pace” Nearly every member of the WTO is also a

member of at least one RTA Over 150 RTAs exist


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Table 8.1. Types of Regional Trade Agreements


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Consider two countries—Brazil and Argentina Suppose these countries initially pursue independent and

non-preferential trade policies• Trade policies of these two countries are not coordinated in any

way and do not discriminate among countries• There is no integration of the countries’ labor, capital, and money

markets First-level RTA is known as preferential trade area

Brazil and Argentina lower their trade barriers between each other, but do not eliminate them

• Labor and capital markets remain unintegrated Because the two countries have not fully eliminated trade

barriers between each other, this type of RTA is not allowed by the WTO


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Second-level RTA is known as free trade area Brazil and Argentina eliminate the trade barriers between each other With regard to non-member countries Brazil and Argentina pursue

independent policies Labor and capital markets remain unintegrated

Third-level regional agreement is known as customs union Brazil and Argentina eliminate the trade barriers between each other Additionally, member countries adopt common trade barriers with

regard to non-member countries (often referred to as a common external tariff)

Labor and capital markets remain unintegrated Fourth-level RTA is known as common market

A customs union in which labor and capital markets are integrated into a regional market

• Any restrictions on movements of labor and physical capital (direct foreign investment) have been removed


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WTO members who wish to form FTAs or CUs may do so However, there are certain requirements

• Trade barriers against non-members cannot be “higher or more restrictive than” those in existence prior to the FTA or CU

• FTA or CU must be formed “within a reasonable length of time”

• FTA or CU must eliminate trade barriers on “substantially all the trade” among the members

• With regard to services, the General Agreement on Trade in Services (GATS) requires that the FTA or CU involve “substantial sectoral coverage”


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How to determine whether a product is from a partner country Suppose that Brazil and Argentina form a RTA

• Shirt produced in Venezuela is imported into Brazil and label “Made in Brazil” is attached

• Shirt can then be imported into Argentina with no restrictions or tariffs—product is not really made in Brazil

• To protect against such possibilities, RTA members usually define rules of origin

Can be defined in a number of ways, including by Amount of value added in an RTA partner country Degree of product transformation


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The Economic Effects of Regional Trade Agreements

Trade creation Occurs when the formation of a FTA or CU leads

to a switching of imports from a high-cost source to a low-cost source • Tends to improve welfare

Trade diversion Occurs when imports switch from a low-cost

source to a high-cost source • Tends to worsen welfare


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Trade Creation and Trade Diversion

Let’s discuss trade creation and trade diversion using the absolute advantage model

Along with Brazil (B) and Argentina (A), we are also going to refer to a third country, Venezuela (V) Brazil and Argentina are members of a RTA,

whereas Venezuela is not


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Figure 8.1: A Trade-Creating, Regional Trade Agreement between Brazil and Argentina


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Trade Creation

Before the RTA, Brazil has in place a specific (per unit) tariff on imports from both Argentina and Venezuela

Argentina is the lower-cost producer in comparison to Venezuela Therefore Brazil imports good from Argentina

Once Brazil joins either a FTA or CU with Argentina, tariff is removed on imports from Argentina Good continues to be imported from Argentina and imports increase

because price has fallen due to removal of tariff Consumer surplus in Brazil increases while producer surplus

and government tariff revenue falls Net increase in welfare due to trade creation


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Trade Diversion

Before the RTA, Brazil has in place a specific (per unit) tariff on imports from both Argentina and Venezuela

Assume Venezuela is now the lower-cost producer in comparison to Argentina Brazil imports the good from Venezuela

Once Brazil joins a FTA or CU with Argentina, however, Brazil switches to Argentina as an import supplier Imports expand as the domestic price falls

Consumer surplus in Brazil increases while producer surplus and government revenue falls

Whether net welfare effect is positive or negative depends If trade-diverting effects outweigh trade-creating effects then RTA

will reduce welfare in Brazil


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Figure 8.2. A Trade-Diverting, Regional Trade Agreement between Brazil and Argentina


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The European Union

Set of agreements among countries of Western Europe in the realms of economics, foreign and security policies, and justice and home affairs Extend back to the Marshall Plan under which United

States aided in the reconstruction of Europe after World War II

• Promoted liberalization of trade and payments among European countries in its zone of influence

1992 marked the official completion of a common market in which barriers to labor and physical capital were to be removed Actual completion of a common market is still in process


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Table 8.2: The Evolution of the European Union


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The European Union

Some economists argue that trade creation dominated trade diversion in the EC and EU

Alan Winters has a more cautionary view Despite common external tariff of European Union CU

nontariff barriers increased in certain sectors EU subsidies increased in other sectors

Tsoukalis offers an intermediate view Overall trade creation in manufactured goods and overall

trade diversion in agricultural goods• Largely the result of the Common Agricultural Policy (CAP)—has

protected EEC/EU agriculture from foreign competition and has involved the heavy use of export subsidies


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The European Union

Has ventured beyond a common market to a monetary union with the euro

A current preoccupation of the EU is the issue of enlargement Expanding membership to include selected

Eastern European countries, as well as Turkey Crucial sticking point, especially in the case of

Poland, is the extent to which CAP provisions are to be extended to new EU members


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The North American Free Trade Area

In January 1994 a FTA between Canada, Mexico and US took place (NAFTA)

Addressed the following Trade in goods Financial services Transportation Telecommunications Foreign direct investment Intellectual property rights Government procurement Dispute settlement


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NAFTA Issues

Impact of NAFTA on wages in the United States—particularly blue-collar wages If assumptions of Heckscher-Ohlin model of international trade hold

true, would expect increased North-South trade to adversely affect workers in North

Some observers concluded NAFTA would hurt US workers• Eventually, a labor side agreement was attached to main NAFTA

agreement Mathematical models of NAFTA completed by that time showed an

improvement in US wages as a result of NAFTA trade liberalization In retrospect, issue of NAFTA and wages was probably overblown

• Average monthly layoffs in United States as a result of non-NAFTA causes have been hundreds of times higher than the NAFTA job displacements following the implementation of this RTA


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NAFTA Issues

Another prominent issue was trade and the environment Resulted in provisions for the creation of a North

American Commission on Environmental Cooperation (CEC)

Focused some of its subsequent efforts to analysis of industrial pollution within North America


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Mercosur and the FTAA

RTA among Argentina, Brazil, Paraguay, and Uruguay was launched in 1991 with the Treaty of Asunción Common Market of the South, or Mercosur, took on Chile

and Bolivia as associate members in 1996 and 1997, respectively

Suggests that the RTA among the four core members is an actual common market with the free movement of labor and physical capital

• However, this is not the case• Mercosur entered into force in 1995 as a FTA with plans to

complete a CU by 2006• Free movement of labor and physical capital is a long way off


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Mercosur

Had a positive impact on amount of trade among its four core members Technology profile of traded goods is higher for trade within

Mercosur than for trade between Mercosur and the rest of the world However, intra-Mercosur trade is low by world standards

Troubled by two asymmetries that challenge its smooth functioning Argentina and Brazil dwarf Paraguay and Uruguay in economic size

• Smaller members find themselves somewhat sidelined from the core relationship between Argentina and Brazil

Fundamental macroeconomic asymmetries between Argentina and Brazil

• Exchange rate asymmetries caused a great deal of friction between Argentina and Brazil


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Free Trade Area of the Americas

In 1994, governments of 34 countries in Western Hemisphere agreed to pursue a Free Trade Area of the Americas

Negotiations were launched at the Second Summit of the Americas in 1998 in nine negotiating groups Market Access Investment Services Government Procurement Dispute Settlement Agriculture Intellectual Property Rights Subsidies, Antidumping, and Countervailing Duties Competition Policy


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Regionalism and Multilateralism

Represent two alternative trade policy options available to the countries of the world

The 1950s and 1960s saw “first wave” of RTAs in developing world

The 1980’s saw beginning of “second wave” of RTAs

What role will the second wave of RTAs play vis-à-vis the multilateral efforts toward trade liberalization pursued under the GATT-WTO framework Will the second wave of RTAs complement the

multilateral framework or will it work at cross-purposes to this framework?


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Opponents argue RTAs are discriminatory by nature They draw attention to “spaghetti-bowl” nature of second-

wave RTAs• Meaning the overlapping nature of most RTAs, with most WTO

members holding simultaneous membership in many RTAs at once

For example, Mexico has signed FTA agreements with the United States, Canada, Nicaragua, Costa Rica, Chile, Bolivia, El Salvador, Guatemala, Honduras, Colombia, Venezuela, and the European Union

The negotiating energies put into RTAs will detract from those put into multilateral agreements under the auspices of the WTO


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Key issue facing multilateral trading system is how to best manage and regulate RTAs

Responsibility falls to the WTO Committee on RTAs A number of points are worth stressing here

GATT-era oversight of RTAs was inadequate Marrakesh Agreement establishing WTO included an “understanding” on

RTAs• Specified that the relevant measure to assess the phrase “shall not be higher or

more restrictive than” is a weighted average of tariff rates and that “within a reasonable length of time” is to be no more than ten years

• Specifies that all new RTAs must be notified to the WTO and a WTO working party is to be established to examine each notification and to ascertain its impact on the multilateral trading system

WTO could go further and tighten its requirements on the external protection of FTAs and CUs

Is possible to lessen the tensions between regionalism and multilateralism but probably not possible to eliminate these tensions entirely

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Regional trade agreement