Regional Trade Agreements

1. Regional Trade Agreements CHAPTER 8

2. 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”

3. 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

4. Table 8.1. Types of Regional Trade Agreements

5. 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

6. 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

7. 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”

8. 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

9. 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

10. 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

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

12. 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

13. 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

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

15. 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

16. Table 8.2: The Evolution of the European Union

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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?

26. Regionalism and Multilateralism • 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

27. Regionalism and Multilateralism • 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