SESSION I REGIONALISM: BASICS AND OVERVIEW

1. SESSION I REGIONALISM: BASICS AND OVERVIEW JAIME DE MELO This version, March 2004

2. OUTLINES: SESSION I-VI

3. OUTLINE: SESSION I  Regional Integration agreements (RIAS) and the WTO  Types of Barriers to Trade  Classifying regional trading arrangements (RTAs)  Definitions, terms, and abbreviations  Some examples of RTAs  Objectives of RTAs  RTAs in history  “Basic” economics RTAs: Trade creation and trade diversion.  Annex: Selected WTO provisions on RIAs

4. OUTLINE: SESSION II PART II: THEORY  Viner’s analysis: trade creation and Trade diversion  What do we know about the welfare effects of RTAs? (effects related to discriminatory trade preferences) PART II: EMPIRICS  Detecting (ex-post) trade diversion (TD) and trade creation (TC)  Sophisticated anti-monde: the gravity model  Annex: Tools for trade policy analysis (you must master these to follow discussion in this and next session)

5. OUTLINE: SESSION III  Evaluating the welfare effects of RTAs (ex-ante) using simulation models  Non-traditional effects of RTAs (anything but TD and TC)  Location & agglomeration effects, and growth  Investment  Deep integration  Regionalism and Services Annex: welfare effects of trade policy under imperfect competition

6. OUTLINE: SESSION IV  Elements of the political economy of protection  Are government commitments credible?  Is regionalism likely to increase or diminish protection towards the outside world?  Application: The CET in the MERCOSUR  Regionalism as politics  Implementation issues : Rules of Origin  Application: Rules of Origin in NAFTA

7. OUTLINE: SESSION V  Relation of regionalism to multilateralism: static and dynamic issues  Regionalism and Tariff levels  Trade Blocs and excluded countries  Domino Regionalism  Regionalism as Insurance

8. OUTLINE: SESSION VI  A checklist to keep in mind  Rules of Thumb for Regionalism  Where are we Heading?

9. BACK TO SESSION I

10. ARE RIAs ALLOWED UNDER WTO? Article XXIV: allows members to form an RIA provided they: 1. eliminate within-union trade barriers on “substantially” all trade 2. do not raise trade barriers on goods produced outside the union • seems to rule out partial PTAs; but later amendments allow them for developing countries under certain circumstances (“enabling clause”) • See annex for the language of these rules

11. TWO WAVES OF RIAs Figure 1.1 RIAs Notified and Active, 1948-April 2002* *Source: WTO; Note: Inactive data for years 2000-2002 are not available.

12. ANNOUNCING MY COLOURS!!! Much heated debate on the topic, notably regarding the relation between regionalism and multilateralism …as regards N-S and N-N integration, the regional approach is likely to be justifiable to small countries; rising uncertaintes wrt to the openness of the WTS will induce them to look to regionalism as an instrument of insuring future market access, [MP chp.1 (1993),p. 20]. …Will N-S regional agreements be successful?… the chapters in this volume suggest several lessons. First, the new initiative, unlike the old ones—such as the Lomé convention– are reciprocal so the opportunity for the accedant countries to maintain high protection barriers is avoided. Second, the experience of the EC shows that the adoption of common rules (institutions) is not easy to achieve. Third, substantial compensation was a key to the success of the second (Southern) EC enlargement. Compensation turned out to be an unsurmountable barrier for S-S integration. It could still foil the success of the new initiatives if the need for some redistribution is not directly adressed. [MP chp.1 (1993), pp . 18-20]. Have I changed my views? Only marginally (Market access less than I thought then, but there is hope via trade facilitation (second generation trade reforms) that is likely to be deeper at a regional level .

13. p S p1 A C D B p0 D Q0 C0 Q , C  TYPES OF BARRIERS TO TRADE (see Annex to PTA_ECON1 for Welfare Analysis) DWL= dead weight (or efficiency) loss 1) A tariff (that raises the price from p0 to p1) gives rise to gov’t revenue (area C) which is a rent. DWL=B+D 2) A quota (like a tariff) gives rise to a rent that is captured by domestic residents (area C), DWL=B+D 3) Technical barriers to trade (TBT) : DWL= B+C+D

14.  CLASSIFYING RTAs By increasing order of integration: PREFERENTIAL TRADING AREA (PTA): Gives preferential access to partner without eliminating protection FREE TRADE AREA (FTA): eliminates protection among members but each member keeps its own tariff structure CUSTOMS UNION (CU): FTA + common external tariff (CET) SINGLE MARKET (SM): CU + harmonization of norms and regulations ECONOMIC UNION: SM + single currency and common economic policies (NB: RIAs also include cooperation arrangements: but those do not involve preferential market access = non-discriminatory)

15.  Definitions, Terms and abbreviations • Regional Trading agreement (RTA); Regional Integration Agreement (RIA); preferential trading agreement (PTA)  generic terms (often used interchangeably) to describe all types of agreements, preferential and non-preferential  Rules of origin (RoO): rules applied to identify origin of a product  Common external tariff (CET): Applies to a CU

16. EXAMPLES OF RIAs Selected Regional Integration Agreements with Developing Country Members/Type of RIA/Notification to GATT-WTO DEVELOPED AND DEVELOPING ECONOMIES European Union (EU)/Common Market/Article XXIV: formerly European Economic Community (EEC) and European Community (EC), 1957: Belgium, France, Germany, Italy, Luxembourg, Netherlands; 1973: Denmark, Ireland, United Kingdom; 1981: Greece; 1986: Portugal, Spain; 1995: Austria, Finland, Sweden. European Economic Area (EEA)/FTA/Article XXIV: 1994: EU, Iceland, Liechtenstein, Norway. Euro-Mediterranean Economic Area (Euro-Maghreb)/FTAs/ Article XXIV: Bilateral agreements, 1995: EU and Tunisia; 1996: EU and Morocco.

17. EXAMPLES OF RIAs (ct’d) EU bilateral agreements with Eastern Europe/FTAs/Article XXIV: 1994: EC and Hungary, Poland, 1995: EC and Bulgaria, Romania, Estonia, Latvia, Lithuania, Czech Republic, Slovak Republic, Republic of Slovenia. Canada-US Free Trade Agreement (CUSFTA)/Article XXIV: 1989. North American Free Trade Area (NAFTA)/Article XXIV: 1994: Canada, Mexico, United States. Asia Pacific Economic Co-operation (APEC): 1989: Australia, Brunei Darussalam, Canada, Indonesia, Japan, the Republic of Korea, Malaysia, New Zealand, Republic of the Philippines, Singapore, Thailand, United States; 1991: People’s Republic of China, Taiwan (China), Hong Kong (China); 1993: Mexico, Papua New Guinea; 1994: Chile; 1998: Peru, Russia, Vietnam.

18. EXAMPLES OF RIAs (ct’d) LATIN AMERICA AND CARIBBEAN Andean Pact/Customs Union/Enabling Clause: 1969: revived in 1988, Bolivia, Colombia, Ecuador, Peru, Venezuela. Central American Common Market (CACM)/Article XXIV: 1960: revived in 1993, El Salvador, Guatemala, Honduras, Nicaragua; 1962: Costa Rica. Southern Cone Common Market, Mercado Común del Sur (MERCOSUR)/Enabling Clause: 1991: Argentina, Brazil, Paraguay, Uruguay. Group of Three (G3)/FTA/Enabling Clause: 1995: Colombia, Mexico, Venezuela. Latin American Free Trade Area (LAFTA), 1960/Article XXIV: revived as Latin American Integration Association (LAIA)/ Enabling Clause: 1980, Mexico, Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Paraguay, Peru, Uruguay, Venezuela.

19. EXAMPLES OF RIAs (ct’d) Caribbean Community and Common Market (CARICOM)/Article XXIV: 1973: Antigua and Barbuda, Barbados, Jamaica, St. Kitts and Nevis, Trinidad and Tobago; 1974: Belize, Dominica, Grenada, Montserrat, St. Lucia, St. Vincent and the Grenadines; 1983: The Bahamas (part of the Caribbean Community but not of the Common Market). AFRICA Cross-Border Initiative (CBI): 1992: Burundi, Comoros, Kenya, Madagascar, Malawi, Mauritius, Namibia, Rwanda, Seychelles, Swaziland, Tanzania, Uganda, Zambia, Zimbabwe. East African Cooperation (EAC): 1996: [formerly East African Community (1967), broke up in 1977]: Kenya, Tanzania, Uganda.

20. EXAMPLES OF RIAs (ct’d) Economic and Monetary Community of Central Africa (CEMAC): 1994: formerly Union Douaniere et Economique de l’Afrique Centrale (UDEAC), 1966: Cameroon, Central African Republic, Chad, Congo, Gabon; 1989: Equatorial Guinea. Economic Community of West African States (ECOWAS): 1975: Benin, Burkina Faso, Cape Verde, Côte d’Ivoire, Gambia,Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Mauritania, Niger, Nigeria, Senegal, Sierra Leone, Togo. Common Market for Eastern and Southern Africa (COMESA)/ Enabling Clause: 1993: Angola, Burundi, Comoros, Djibouti, Egypt, Ethiopia, Kenya, Lesotho, Malawi, Mauritius, Mozambique, Rwanda, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zambia, Zimbabwe. Indian Ocean Commission (IOC): 1984: Comoros, Madagascar, Mauritius, Seychelles.

21. EXAMPLES OF RIAs (ct’d) Southern African Development Community (SADC): 1980: for-merly known as the Southern African Development Co-ordination Conference (SADCC), Angola, Botswana, Lesotho, Malawi, Mozambique, Swaziland, Tanzania, Zambia, Zimbabwe; 1990: Namibia; 1994: South Africa; 1995: Mauritius; 1998: Democratic Republic of the Congo, Seychelles. Economic Community of West Africa (CEAO): 1973: revived in 1994 as UEMOA, Benin, Burkino Faso, Côte d’Ivoire, Mali, Mauritania, Niger, Senegal. West African Economic and Monetary Union (UEMOA or WAEMU): 1994: Benin, Burkina Faso, Côte d’Ivoire, Mali, Niger, Senegal, Togo, 1997: Guinea-Bissau. Southern African Customs Union (SACU): 1910: Botswana, Lesotho, Namibia, South Africa, Swaziland.

22. EXAMPLES OF RIAs (ct’d) Economic Community of the Countries of the Great Lakes (CEPGL): 1976: Burundi, Rwanda, Democratic Republic of the Congo. EUROPE Central European Free Trade Area (CEFTA): 1993: 1996: Czech Republic, Hungary, Poland, Slovak Republic, Slovenia; 1997 Romania; 1988 Bulgaria. Committee for Mutual Economic Assistance (CMEA): Bilateral Agreements between individual CEFTA members and individual Baltic countries.

23. EXAMPLES OF RIAs (end) MIDDLE EAST AND ASIA Association of South-East Asian Nations (ASEAN): 1967: ASEAN Preferential Trading Arrangements/Enabling Clause: 1977: ASEAN Free Trade Area (AFTA)/Enabling Clause: 1992, Indonesia, Malaysia, Philippines, Singapore, Thailand; 1984: Brunei Darussalam; 1995: Vietnam; 1997: Myanmar, Lao People’s Democratic Republic; 1999: Cambodia. Arab Common Market/Article XXIV: 1964: Agreement for Economic Unity among Arab League States. Gulf Co-operation Council (GCC)/Enabling Clause: 1981: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates. South Asian Association for Regional Co-operation (SAARC)/ Enabling Clause: 1985: Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka.

24.  RTAs in history Irwin paper (DM chp. 4) shows how Anglo-French treaty of 1860 that included the unconditional MFN clause ushered the open trade regime of the 19th- C. •  France reduced duties to 10-15% range, GB the number of dutiable goods from 419 to 48 and reduced the wine tariff • GB lowered to all partners, FR only to GB. • Other countries wanting to get access to FR market, “… rapidly cascaded into a series of bilateral trade agreements, all linked by the inclusion of the unconditional MFN clause ( MP, p. 97) • What ushered this? Mostly desire to get access to FR market (recall GB and FR were the two largest markets then)

25.  RTAs in history (end) • Irwin also compares the 19th- c WTS with current one under WTO • Both had unconditional MFN clause • but no external constraint on tariff behavior…see his discussion on the erosion of the liberal order

26.  Objectives of RIAs Selection of stated objectives in the Treaties  Boosting trade and income “To enhance the competitiveness of their firms in global markets” North American Free Trade Agreement (1992). “To create an expanded and secure market for the goods and services produced in their territories. To reduce distortions to trade” Treaty on Free Trade Between the Republic of Colombia, the Republic of Venezuela and the United Mexican States (1994).

27.  Objectives of RIAs (ct’d) “To modernize their economies in order to expand the supply and improve the quality of available goods and services, with a view to enhancing the living conditions of their populations” Southern Common Market (MERCOSUR) Agreement (1991).  Boosting investment “To ensure a predictable commercial framework for production activities and investment” Treaty on Free Trade Between the Republic of Colombia, the Republic of Venezuela and the United Mexican States (1994). “Prerequisite for the stimulation of domestic, regional and foreign direct investment and the expansion, growth and the development of the economies of each member state and the region as a whole” Kinshasa Resolution on the Establishment of a COMESA: Common Market for Eastern and Southern Africa (1998).

28.  Objectives of RIAs (ct’d) “A stimulus to the development of the national economies by expanding investment and production opportunities, trade, and foreign exchange earnings” Agreement on the Common Effective Preferential Tariff Scheme for the ASEAN Free Trade Area (1992).  Stimulating development “To ensure in particular that these arrangements encourage the development of the less advanced members of the customs union and the diversification of their economies” South African Customs Union Agreement (1969).  Democracy and Human Rights “To involve the peoples of the Region centrally in the process of development and integration, particularly through the guarantee of democratic rights, observance of human rights and the rule of law” Treaty of Southern African Development Community (1992).

29.  Objectives of RIAs (ct’d) “To strengthen democracy and respect for human rights, sustainable and balanced economic and social development, to combat poverty and promote greater understanding between cultures” Barcelona Declaration Adopted at the Euro-Mediterranean Conference (1995).  Regional Cooperation and Co-ordination “To establish a firm foundation or common action to promote regional cooperation in South-East Asia in the spirit of equality and partnership and thereby contribute towards peace, progress and prosperity in the region” The ASEAN Declaration (1967). “To foster coordinated action by the Parties in international economic fora, particularly in those related to the processes of Latin American integration” Treaty on Free Trade Between the Republic of Colombia, the Republic of Venezuela and the United Mexican States (1994).

30.  Objectives of RIAs (end)  Stimulate regional and global integration “To contribute the harmonious development and expansion of world trade and provide a catalyst to broader international cooperation” North American Free Trade Agreement (1992). “To facilitate the accession of Chile to the North American Free Trade Agreement” “To contribute to hemispheric integration” Canada – Chile Free Trade Agreement (1996).

31.  BASIC ECONOMICS: TRADE CREATION AND TRADE DIVERSION 3 countries: A (importer and country of interest here); B (partner in RTA) and C (ROW). Here B and C both exporters) Unit production costs assumed to be constant Initially A applies identical tariffs on both imports (t=20%) Let A and B form an FTA = no more tariffs on B imports Welfare implications for A depend on cost conditions: If the lowest cost producer is: B: all is well as partner is low cost producer = trade creation (as partner is low cost supplier initially) C:  If C imports are now replaced by (less efficient) B imports = trade diversion (partner is high cost supplier ) A: nothing happens! (A is not even importing initially).

32. NUMERICAL EXAMPLE:

33. ANNEX: SELECTED WTO PROVISIONS ON RIAs

34. Article XXIV of the GATT 4. The contracting parties…also recognize that the purpose of a customs union or of a free trade area should be to facilitate trade between the constituent territories and not to raise barriers to trade. 5.(a) With respect to a customs union…the duties and other regulations of commerce imposed at the institution…shall not on the whole be higher or more restrictive than the general incidence of the duties and regulations of commerce applicable in the constituent territories prior to the formation of such union… (b) With respect to a free-trade area…the duties and other regulations of commerce maintained in each of the constituent territories and applicable at the formation of such free-trade area...shall not be higher or more restrictive than the corresponding duties and other regulations of commerce existing in the same constituent territories prior to the formation of the free-trade area… (c) Any interim agreement…shall include a plan and schedule for the formation of such a customs union or of such a free-trade area within a reasonable length of time. 7.(a) Any contracting party deciding to enter into a customs union or a free-trade area, shall promptly notify the contracting parties and shall make available to them such information…

35. 8.(a) A customs union shall be understood to mean the substitution of a single customs territory for two or more customs territories, so that: (i) duties and other restrictive regulations of commerce (except, where necessary, those permitted under Article XI, XII, XIII, XIV, XV and XX) are eliminated with respect to…substantially all the trade in products originating in such territories… 8.(b) A free trade area shall be understood to mean a group of two or more customs territories in which the duties and other restrictive regulations of commerce (except, where necessary, those permitted under Articles XI, XII, XIII, XIV, XV and XX) are eliminated on substantially all the trade between the constituent territories in products originating in such territories. The Enabling Clause 1. Notwithstanding the provisions of Article I…contracting parties may accord differential and more favorable treatment to developing countries, without according such treatment to other contracting parties. 2.(c) The provisions of paragraph 1 apply to the…regional or global arrangements entered into amongst less-developed contracting parties for the mutual reduction or elimination of tariffs and, in accordance with criteria or conditions which may be prescribed by the contracting parties, for the mutual reduction or elimination of non-tariff measures, on products imported from one other;

36. The Uruguay Round Understanding on the Interpretation of Article XXIV 2. The evaluation…of the duties and other regulations of commerce…shall…be based upon an overall assessment of weighted average tariff rates and of customs duties collected… For this purpose, the duties and charges to be taken into consideration shall be the applied rates of duty. It is recognized that for the purpose of the overall assessment of the incidence of other regulations of commerce for which quantification and aggregation are difficult, the examination of individual measures, regulations, products covered and trade flows affected may be required. 3. The “reasonable length of time” referred to in Article XXIV 5(c) should exceed ten years only in exceptional cases.