Transcript Document 7470825

Regional Trade
Agreements
CHAPTER 8
Reinert/Windows on the World Economy, 2005
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) subprinciples
• 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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Regional Trade Agreements

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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Regional Trade Agreements

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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Regional Trade Agreements

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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Regional Trade Agreements

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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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-àvis 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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Regionalism and Multilateralism

Opponents argue
 RTAs are discriminatory by nature
 They draw attention to “spaghetti-bowl” nature of secondwave 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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Regionalism and Multilateralism
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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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