Regional Trading Arrangements under the Multilateral Trading System
Issues for Future Negotiation
Somasri Mukhopadhyay
CEA 38th Annual Meetings
Ryerson University, Toronto
June 2004
Abstract
The world trading arena is experiencing two parallel trails of liberalization initiatives, one at the regional
level and the other at the multilateral level. With the global experience of increased favoritism for trade
liberalization at the regional level even at times of satisfactory progress of the multilateral trade liberalization,
doubts have come up regarding the motive behind the formation of RTAs and thus the role of RTAs in aiding
multilateral trade liberalization. The in-built discrimination present in RTAs cannot be denied. The existing
provisions under the multilateral trading system are designed to minimize the discrimination. But experience
has brought out certain limitations of the provisions in producing the desired results. Coupled with this is the
inadequate functioning of the multilateral trading system in implementing the provisions for formation of
RTAs. As a consequence, members of the multilateral trading system in the Doha Ministerial Meet have
agreed to open negotiations on the existing provisions relating to the formation of regional trading
arrangements. The above issues needs to be taken up and given due consideration in the proper perspective.
Failure to do so might result in the RTAs turning out to be stumbling blocs to a freer and fair global trading
regime.
Keywords: Regional Trading Arrangement, Trade Liberalization, Trade Negotiation, World Trade
Organization
Jel Codes: F03, F13, F15
1: Introduction
The Multilateral Trading System has opened up Regional Trading Arrangement (RTA) issues for negotiation.
In the Doha Ministerial (2001) members of the World Trade Organization (WTO) have agreed to go for
Article XXIV for re-negotiation. Paragraph 29 of the Doha Ministerial Declaration (2001) reads
“ We also agree to negotiations aimed at clarifying and improving disciplines and procedures under the
existing WTO provisions applying to regional trading agreements. The negotiations shall take into account
the developmental aspects of the regional trade agreements.”
That is, members of the multilateral trading system have aimed to improve and clarify the existing provisions
relating to forming of regional trading arrangement (RTA). While doing so, due considerations would be
given to the developmental aspect of RTA.
Right from its inception, the multilateral trading system has allowed the formation of regional trading
arrangements as an exception to its principle of non-discrimination. The General Agreement of Tariff and
Trade (GATT), 1948 allowed the trade liberalization at the regional level with the presumption that the same
would aid trade liberalization at the multilateral level.
Both being trade liberalization initiatives, there seems to be no apparent contradiction between regional trade
liberalization and multilateral trade liberalization. Moreover, at the time the General Agreement on Tariff and
Trade was signed, the theory of RTA has been not fully developed. It is only in the mid 20th century that we
got Jacob Viner’s contribution in this field. However, the discriminatory aspect of the RTAs have been
acknowledged by the GATT contracting parties. Accordingly, formation of RTAs has been allowed as an
exception to the non-discriminatory principle of the multilateral trading system.
With the passage of time, the world has experienced increased popularity of trade liberalization at the
regional level. This increased popularity has resulted in substantial contribution in the theory of regional
trading arrangement. However, trade liberalization at the regional level has gained popularity in spite of the
same initiative at the multilateral level progressing quite satisfactorily. This has led to an urge to have a relook at the existing provisions in respect to the formation of RTA. Thus, Para 29 got included in the Doha
Ministerial Declaration.
This paper aims at discussing the principle issues relating to RTA to be given due consideration in the renegotiation phase. The paper is designed as follows. The next section discusses the trade liberalization
processes. Section three describes regional trade liberalization under a rule based multilateral trading system.
In section four, a comparative analysis is made to bring out the issues pertaining to RTAs in aiding the
creation of a freer and fair global trading regime. Based on the discussion in section three, future negotiating
concerns have been presented in section five. Section six is the concluding section.
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2: Trade Liberalization: Regional and Multilateral
The world is increasingly experiencing countries going for a liberalized trading regime. This can be cited as
the fall out of the trade theories pointing out the gains from trade liberalization. Analyzing the question “why
do nations trade”, trade theories over the decades have discussed the benefits accruing to nations practicing
free trade.
Simultaneously, with the claim made by the trade theories that free trade is the first best policy any nation can
practice, arguments favoring a restrictive external sector policy have also developed over the years.
An interesting point to note is that the incentives of protection lie in the theories propounding free trade.
Having a re-look at the two most significant and extensively discussed theories of International trade – the
Ricardian and the Heckscher - Ohlin Theories, one finds the roots of protection embodied. They are in the
form of some powerful implications of the theories. The first major implication of free trade is factor price
equalization and the second major is the Rybczynski Theorem.
With these two implications, we are likely to observe demand for protection from the effects of free trade
from precisely those sectors in the economy that are hurt. More important, for an economy in the process of
development, an absence of protection might result in creating an adverse environment for industries to
develop. This would ultimately affect the economic development of the country. Least but not the last, certain
strategic criteria, like developing export sector, sometimes lead to opting for a restrictive trade policy by a
country.
That is, countries to achieve some domestic economy goals sometimes need to go for a restrictive trade
policy.
A protectionist trading regime is always welfare decreasing. Realizing this, increasing number of countries
have opted for a liberalized trading regime. However, considering the domestic compulsions, one understands
that it is not possible or rational for any country to go for an absolute free trade regime overnight.
Liberalization of the external sector is thus a gradual process and that is what countries have opted for.
This process can be of two broad types. One is gradually decreasing restriction of the external sector, to all
the trading partners. The other is liberalizing the trading regime for select group of countries. The first is the
multilateral trade liberalization or multilateralism, while the second is regional trade liberalization or
regionalism.
Turning towards the global developments one finds a highly restrictive trading regime during the early part of
the twentieth century. It is a well-recognized fact that high degree of protectionist external sector policy
practiced by countries prior to and during the Second World War period resulted in the rethinking of the
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concept that free trade is the first best policy. This led countries deciding the formation of a multilateral
trading system to achieve a freer and fair global trading regime. A revival of the belief on the trade theory
claim and a reaction to the restrictive trade regime experienced world wide came in the form of signing of the
General Agreement of on Tariff and Trade (GATT). This can be considered to be a movement towards
initiating regularized multilateralism.
Regional Trading Arrangement (RTA) can be said to be the other form of reaction, running parallel to the
one described above. Thus, there are two parallel phenomenon taking place in the global trading scenario.
One is the emergence of the GATT - a set of multilateral trading rule to discipline the world trading system
finally leading to the formation of the World Trade Organization (WTO); the other is the formation of
regional trading arrangements, that is, multilateralism and regionalism.
Both multilateralism and regionalism call for liberalization of trade. Both are the outcomes of the realization
that “free trade is the first best policy”. The difference between the two is that, one creates a liberalized
trading regime at the global level, the other aims at creating the same at the regional level.
Following Winters (1996), regionalism can be loosely defined as any policy designed to reduce trade barriers
between a subset of countries regardless of their commonality or closeness. Multilateralism on the other hand
can be defined as a characteristic of the world economy or world economic system. However it boils down to
the behavior of individual countries - the extent to which they behave in a multilateral fashion.
Elaborating Winters’ (1996) definition, multilateralism is a function of:•
The degree to which discrimination is absent that is, the proportion of trade partners that receive identical
treatment; and
•
The extent to which the country’s trading regime approximates free trade.
The first condition brings out the non-discriminatory aspect of multilateral trade liberalization. However, it
implicitly assumes an worsening of multilateral trade liberalization with formation of a regional trading
arrangement. But each and every case of RTA cannot be considered as adversely affecting multilateral trade
liberalization. On the contrary the liberalization aspect of and thus the added benefits from an RTA cannot be
denied. Also, regional trade liberalization is a higher degree of liberalization, though among a limited number
of countries. This missing criterion gets added in the definition through the second condition.
According to Yarbrough and Yarbrough, (1992) multilateralism is a process whereby countries solve
problems in an interactive and co-operative fashion. This definition appears to be closely associated with
professional negotiators and international bureaucrats, and seems to be not quite appropriate in tackling the
issue of what purpose the process serves if it is not to generate outcomes. However, this can be used in the
following way. Multilateralism can be considered to be a process where countries negotiate market access
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with their trading partners with the objective of creating a freer and fair global trading regime. Keeping in
mind the underlying non-discriminatory principle of the multilateral trading system, the market access
advanced by each country is similar for all trading partners. Against this, regionalism can be considered to be
an arrangement of increased market access among select group of countries. This arrangement running
parallel to the process of multilateralism can either re-enforce the latter or might create an opposite wave.
In either case, an adjustment process gets initiated for the RTA members and the excluded trading partners. If
the increased market access enjoyed by members gradually gets extended to the excluded countries,
regionalism might be considered as an aiding force to multilateralism. In the long run thus, multilateralism
can be expected to be achieved at the end of the adjustment process. This would happen if the urge for
liberalization is the motive behind RTA countries. However, the possibility of an opposite wave cannot be
ignored. If the motive behind the formation of RTA is not only attaining a liberalized trading regime, the
RTA members can be seen to increase the extent of liberalization among them keeping the trade policy for
the ROW unchanged. Then multilateralism cannot be expected to be achieved at the end of the adjustment
process. Rather, regionalism might affect the probabilities with which different outcomes occur. That is,
whether multilateralism can be reached via regionalism is not certain. This is where the issue of regionalism
aiding or adversely affecting multilateralism comes in. Thus, the impact of regional trade liberalization on
global trade becomes an important aspect of discussion.
The first theoretical work on the aspect of Regional Trading Arrangement is done by Jacob Viner in 1950.
His theory is known as the theory of Customs union. However, what he has dealt with is basically the
concept of a preferential trading arrangement.i
With the formation of the Regional Trading Arrangement, the home country reduces tariff on imports from
the member country, keeping the tariff on goods from the non-member country unaffected. This, according to
Viner, creates trade between member states in response to the mutual elimination of tariffs on each other's
goods. On the other hand, another effect, trade diversion also takes place which shifts the trade flows from
non-member countries to member countries in response to tariff discrimination produced by the union's
formation. That is, with lowering of the tariff on the item imported from the member countries, the price
competitiveness increases for that vis-à-vis imports from the rest of the world. This will result in an increase
in imports.
Thus, according to Viner, with the formation of the PTA, imports into a member country increase. This
increase can be broken ion to two aspects.
i. An increase in total imports of the commodity, the increase resulting from the increase in imports from
the members.
ii. The share of the members increases lowering the share of the rest of the world.
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The first effect is trade creation. The second one is trade diversion. Trade creation represents the substitution
of inefficient (higher-cost) domestic production by efficient regional partner-country production. This raises
the welfare of the members and the world as a whole. However trade diversion has a welfare cost since it
involves inefficient regional partner-country production substituting for efficient third-country production.
That is, Regional Trading Arrangements remove the discrimination between partner countries and domestic
firms, and hence, home and partner country prices of tradable tend to be equalized as barriers to trade fall.
Relatively inefficient domestic production therefore contracts ("trade creation") in favor of partner-country
production. However, RTAs create a new form of discrimination, that is, between partner and non-partner
country exports. Partner-country exports will displace more efficient non-partner exports in the home market
if the degree of preferential access is sufficient ("trade diversion").
It is argued that so long as trade creation is greater than trade diversion, the RTA is net welfare enhancing.
But the point which needs to be highlighted here is that comparing trade creation and trade diversion to judge
the impact leaves out one important issue, that of the third country. The comparison brings out the overall
effect; one’s losses more than compensated by somebody else’s gains giving a positive effect at the
aggregate. But, the one who is suffering the losses, through the trade diversion is not getting compensated.
This loss is arising because of the discriminatory environment created by the formation of an RTA. Under
such a situation, would it be appropriate to expect that the regional trade liberalization running parallel to the
process of multilateralism would work hand in hand to create a freer and fair global trading regime?
3: Regional Trade Liberalization Under the Multilateral Trading System
From the last century, multilateralism has been pursued through multilateral trade negotiations under the
auspices of the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade
Organization (WTO). This multilateralism practiced under GATT/WTO rests on the principles of nondiscrimination in trade. This principle of non-discrimination has two pillars – The Most Favored Nation
Treatment and the National Treatment. They are enunciated in article I ("General Most Favored Nation
Treatment, or MFN) and article III ("National Treatment on Internal Taxation and Regulation," or NT) of
GATT. The most favored nation treatment ensures equal treatment to all the member countries of WTO.
Regional trading arrangement goes for liberalization of trade within a group of countries - a discriminating
policy towards the rest of the world. This appears to be against the most favored nation treatment of WTO,
which says that a country cannot discriminate among its trading partners.
The WTO rules contains exceptions to the MFN principle; one such being the scope for the formation of Free
Trade Areas and Customs Union.
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In the first place, way back in 1947, when GATT was signed, there already existed certain bilateral trading
arrangements. These could not be terminated. These bilateral arrangements basically implied preferential
treatment to some countries leading to a scenario of discrimination. To make these arrangements GATT
compatible, the founder contracting parties to GATT provided the "Grand Father Clause". This basically
recognized the "historical preferences", that is, the bilateral/plurilateral trading arrangements already existing
were exempted from the MFN obligations. The clause that the countries which already had some form of
regional trading arrangement before GATT was formed would get MFN exemptions is given in Paragraph 3
of Article I and the RTAs are listed in Annexes A-F to the Agreement. That is, GATT recognized the
existence of certain preferential arrangements at the time it was established. These provisions allowed the
pre-existing agreements to stand without subjecting preferences accorded under them to the MFN obligation.
Moreover, the Contracting Parties may also agree to exempt an existing regional agreement at the time that
one of its members joins the GATT. However, the "Grandfather Clause" got terminated in 1994.
Not only recognizing the already existing bilateral/plurilateral trading arrangements, the GATT contracting
parties, based on the ideology that liberalizing trade even at the regional level would help liberalization of
global trade, incorporated provisions for future establishment of regional integration agreements, otherwise
inconsistent with MFN obligation. The provisions were designed to minimize the in-built discriminatory
aspect of RTA so that the basic theme of GATT does not get eroded away.
Initially, article XXIV formed the main basis of contracting parties entering into regional integration
agreements with select countries. Later, the enabling clause (1979) was introduced into GATT having the
same objectives but less rigid than Article XXIV to promote trade and development of the less-developed
countries. Further down the line, with WTO coming into existence and services getting included under its
gamut, Article V of GATS introduces such waiver for trade in services. An elaborate discussion of the
existing provisions would aid identifying the issues for future negotiation.
Article XXIV of the General Agreement on Tariff and Trade
GATT Article XXIV is the central GATT provision on regional integration. It deals explicitly with customs
unions and free-trade areas as well as with interim agreements leading to both.
The primary objective for allowing the formation of regional trading arrangement has been incorporated in
Paragraph 4 of Article XXIV of GATT 1948. It reads as under.
“The contracting parties recognize the desirability of increasing freedom of trade by the development,
through voluntary agreements, of closer integration between the economies of the countries parties to
such agreements.”
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However it has been re-asserted that RTAs are not to be designed for creating barriers for the rest of the world.
Paragraph 4 thus, further reads
“They 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 the trade of other contracting
parties with such territories”.
Acknowledging the discriminatory aspect of regional trading arrangements, certain conditions have been
imposed by the GATT contracting parties while allowing trade liberalization at the regional level.
Paragraph 5 of Article XXIV of GATT 1994 reads
“Accordingly, the provisions of this Agreement shall not prevent, as between the territories of
contracting parties, the formation of a customs union or of a free-trade area or the adoption of an
interim agreement necessary for the formation of a customs union or of a free-trade area; Provided
that:
with respect to a customs union, or an interim agreement leading to a formation of a customs
union, the duties and other regulations of commerce imposed at the institution of any such
union or interim agreement in respect of trade with contracting parties not parties to such
union or agreement 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 or the adoption of such interim agreement, as the case may
be;
with respect to a free-trade area, or an interim agreement leading to the formation of a freetrade area, the duties and other regulations of commerce maintained in each if the constituent
territories and applicable at the formation of such free-trade area or the adoption of such
interim agreement to the trade of contracting parties not included in such area or not parties to
such agreement 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, or interim agreement as the case may be; and
any interim agreement referred to in sub-paragraphs (a) and (b) 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.
To bring out the net welfare enhancing and multilateralism aiding properties of the RTA, Paragraph 8 of
Article XXIV of GATT 1994 reads
“For the purposes of this Agreement:
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A customs union shall be understood to mean the substitution of a single customs territory
for two or more customs territories,
(i) so that duties and other restrictive regulations of commerce (except, where
necessary, those permitted under Articles XI, XII, XIII, XIV, XV and XX) are
eliminated with respect to substantially all the trade between the constituent
territories of the union or at least with respect to substantially all the trade in
products originating in such territories, and,
(ii) subject to the provisions of paragraph 9, substantially the same duties and other
regulations of commerce are applied by each of the members of the union to the trade
of territories not included in the union;
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.
So, Article XXIV allows countries to enter regional trading arrangements as an exception to the nondiscriminatory principle of the multilateral trading system. While doing so, it explicitly assumes a tradefacilitating role to RTAs. Along with that, the provision lays down certain conditions for countries going for
regional trade liberalization in an attempt to minimize the discrimination inherent in RTAs. They can be
summarized as follows.
Free Trade Areas and Customs Unions should
1. Cover "substantially all trade"
2. Not raise the average level of protection against excluded countries
In case of an interim arrangement, the member countries should
3. Reduce internal tariffs to zero and remove internal quantitative restrictions other than
those justified by other GATT articles within a reasonable time frame.
The first condition tries to ensure minimization of trade diversion. It says that all trade or at least a substantial
amount of trade has to be covered. This, to certain extent ensures that interest groups would not drive a RTA.
Trade diversion unambiguously generates gains for partner exporters so when two countries swap tradediverting concessions, both sets of producers gain. On the other hand, if they swap creating concessions,
producers lose some sales in their home markets and may or may not gain overall. Condition 1 implies that
governments cannot select only commodities that are likely to feature trade diversion, and this in turn seems
likely to encourage more efficient free trade areas and customs unions.
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The second condition can be viewed as an attempt to preserve the sanctity of tariff bindings. It ensures that
the formation of any regional trading arrangement is not accompanied with dilution of pre-committed
increased market access to the other trading partners. It has to be remembered that the basic advantage from a
regional trading arrangement comes from the discriminatory treatment between the members of the group and
the non-members. With this, it also needs to be kept in mind that the RTAs are believed to be facilitating the
creation of a liberalized multilateral trading regime. To move towards a liberalized trading regime
negotiations are carried out at the multilateral level. If a regional trading arrangement were accompanied with
increase in trade restriction for other WTO members, then it would be a movement away from the objective
that would erode the sanctity of the multilateral trading system. On the contrary, the expectation out of these
regional trading arrangements is that they would start with an increased liberalization among a group that will
gradually get extended to the remaining members of the multilateral trading system. Thus, the second
condition is primarily to ensure that the non-members do not face increased trade restrictions in the RTA
countries markets after the formation of the same; they continue to enjoy the previous commitments given by
the member countries in terms of market access. In the next place, the condition can also be viewed as one
ensuring the minimal amount of trade diversion. It is well recognized that formation of a regional trading
arrangement leads to trade diversion because of the discriminatory situation created out of the same. In
addition to that, if after the formation, the trade barriers for the non-members get increased, that results in an
increased amount of trade diversion. So, it indirectly acts as a check to the increase in trade diversion.
So, the two conditions together, offer reasonable assurances about the barriers facing non-members in the
member country markets after the formation of the regional trading arrangement.
Condition 3 ensures that the basic rationale behind granting the MFN exception does not get diluted. That is,
the driving force behind the urge to liberalize – the claim made by the trade theories that free trade is the most
beneficial external policy should be given due importance. So, within a reasonable time frame an interim
arrangement should finally materialize into a free trade arrangement or customs union, thereby enhancing the
trade creation aspect.
Apart from the three conditions discussed above, it has also been specified in Article XXIV of GATT 1994
that the multilateral trading system should be notified regarding the formation of such arrangements if the
countries happens to be GATT contracting parties and now WTO members.
Paragraph 7 of Article XXIV of GATT 1994 reads
a) Any contracting party deciding to enter into a customs union or free-trade area, or an interim
agreement leading to the formation of such a union or area, shall promptly notify the CONTRACTING
PARTIES and shall make available to them such information regarding the proposed union or area as
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will enable them to make such reports and recommendations to contracting parties as they may deem
appropriate.
b) If, after having studied the plan and schedule included in an interim agreement referred to in
paragraph 5 in consultation with the parties to that agreement and taking due account of the
information made available in accordance with the provisions of subparagraph (a), the
CONTRACTING PARTIES find that such agreement is not likely to result in the formation of a
customs union or of a free-trade area within the period contemplated by the parties to the agreement
or that such period is not a reasonable one, the CONTRACTING PARTIES shall make
recommendations to the parties to the agreement. The parties shall not maintain or put into force, as
the case may be, such agreement if they are not prepared to modify it in accordance with these
recommendations.
The multilateral body retains the right to judge the compatibility of the RTA; in case it is found incompatible
to Article XXIV, recommended changes have to get incorporated into the regional trading agreements.
The Enabling Clause
The Enabling Clause is the other provision incorporated later into the multilateral trading system that allows
the formation of regional trading arrangements. That provision got included under the multilateral trading
system under the Enabling Clause (1979). This is the decision on Differential and More Favorable Treatment,
Reciprocity, and Fuller Participation of Developing Countries, a result of the Tokyo Round of GATT
negotiations (1973-79). It was incorporated into the GATT system with the intent to promoting the trade and
development of less-developed countries.
Under this clause allows Contracting Parties grant preferential treatment to developing countries on a nonMFN basis. This significantly relaxes the conditions for creating free trade area or customs unions that
include only developing countries. It drops condition 1, on the coverage of trade, and relaxes condition 3,
allowing developing countries to reduce tariffs on mutual trade in any way they wish and NTMs “in
accordance with criteria which may be prescribed by the CONTRACTING PARTIES.” It then supplements
condition 2 by requiring that the arrangement does not constitute a barrier to MFN tariff reductions or cause
“undue difficulties” for other contracting parties.
Article V of the General Agreement of Trade in Services
With WTO coming into operation on Jan 1st 1995, trade in services came under the rule based multilateral
trading arrangement. The General Agreement on Trade in Services (GATS) negotiated under the Uruguay
Round of Trade Negotiations is also based on the principle of non-discrimination. Thus, it is also built on the
two basic pillars, that is the most favored nation treatment and the national treatment. However, the approach
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is a bit different because of the inherent nature of trade in services, discussion of which is beyond the scope
of this thesis.
To incorporate the provisions for MFN exemptions in trade in services in line with Article XXIV in GATT,
we have Article V of GATS. This allows for the liberalization of trade in services among a group of
countries, with similar conditions of Article XXIV under GATT attached. The conditions talk about the
coverage of all or substantial service sectors and gradually going towards total elimination of restrictions.
In line with enabling clause, Article V of GATS includes the provision for liberalizing service trade on
regional level among developing countries.
4: Regional Trading Arrangement Under the Multilateral Trading System: The Issues
Trade liberalization implies increased market access, and thus expanded market for participating countries.
More the number of participating countries, larger is the market available. As such, it is expected that
multilateral trade liberalization would be more attractive than regional trade liberalization initiative.
But, global experience reveals that there has been a spurt of regional trading arrangements in recent days.
This increased popularity of RTAs has led to serious concern by economists and negotiators. One of the
concerns is regarding the impact of trade liberalization at the regional level on trade liberalization at the
multilateral level. Another concern, or rather a related concern is the rationale behind this increased
popularity for RTAs.
The point that cannot be denied is that a multilateral initiative for trade liberalization through a negotiation
process among a large number of countries is expected to achieve a lower degree of liberalization as
compared to a regional initiative over the same time frame. This might be a valid point for countries to go for
trade liberalization at the regional level, simultaneously with trade liberalization at the multilateral level.
Moreover, though countries are interested in a liberalized trading regime, yet there exist certain domestic
compulsions. One might be the existence of a strong producers lobby, arguing against liberalization, as that
would expose them to foreign competition. As such, the country might not give a high degree of market
access at the multilateral level. But, it might be a viable option for it to gradually open up the market.
Moreover, it is also true that a liberalized policy regime should not lead to de-industrialization of the
economy. Keeping this in mind, it seems quite logical for a country to first open up its domestic market to
few countries and get prepared to face global competition. Placing this against the backdrop of the global
trend in RTAs, it might be quite consistent to claim that the fast pace of global liberalization urged nations to
get prepared to face global competition.
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This to certain extent matches with the trend of increase in the number of regional trading arrangement at
times when the trade liberalization initiative at the multilateral level also reveals quite impressive progress.
If this is the motive behind the formation of RTAs, then at least theoretically it can be claimed that they
would not act as stumbling blocs. The underlying reason is that with this motive, it is expected that the
member countries would gradually go for higher degree of liberalization at the multilateral level. Such a
situation matches exactly with the objective of the multilateral trading system granting this exception under
Article XXIV of GATT and the Enabling Clause Decision.
Regionalism is not so old a phenomenon in the global trading arena. In its proper framework, the world
experienced the first form of regional grouping in the twentieth century. As pointed out by Viner Regional
Trading Agreement among group of countries is a feature of the early post World War II period. Data reveal
that from the seventies there has been an increased number of RTAs coming up in the global trading arena.
(Exhibit 1). This trend appears to have got strengthened during the nineties. In fact, the post-war trade
liberalization at the multilateral level has been paralleled by the same initiative at the regional level through
the regional trading arrangements. Breaking the period, two distinct sub-periods can be seen to reveal
increased popularity of the regional trading arrangements. One is the seventies and the other during the
nineties. (Exhibit 1).
Exhibit 1: Regional Trading Arrangements Notified Under the GATT/ WTO
No.
of
RTAs
Year
Source: WTO Secretariat
There is a claim that the slow progress of the multilateral initiative led to the increased popularity of the
RTAs. There is no doubt that a trade liberalization initiative at the multilateral level, involving quite a large
number of countries is expected to take comparatively longer time compared to the relatively less complex
and diverse negotiating issue of an RTA. In fact the number of countries joining the multilateral trading
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system is increasing with the passage of time, making the negotiating process more complex with divergent
issues, and thus increasing the expected time of the liberalization process. The countries, quite eager to
achieve a liberalized trade regime prefer to go via the faster and easier process of regional trade liberalization.
This popular claim demands verification from the data relating to the multilateral trading system negotiating
process. Considering the two
distinct periods of increased
popularity of RTAs, it can be seen
that multilateralism made quite
satisfactory progress during the
two periods. The two periods that
reveal a phenomenal increase in
the number of regional trading
arrangements coincide with the
periods when the multilateral
trading system was also revealing
quite remarkable pace of
liberalization, along with
disciplining the multilateral
trading system. During the
seventies the different non-tariff
GATT/ WTO Chronology in Brief
Year
1947
1948
1949
The Event
Birth of GATT on 30th October at the Palais des Nations, Geneva
GATT comes into Force. First Meeting of its Members in Havana Club
Second Round of Talks at Annecy, France.
5000 Tariff Cuts Agreed to
Ten New Countries Admitted
1950-51
Third Round at Torquay, England
8700 Trade Concessions Exchanged
Four New Countries Admitted
1956
Fourth Round at Geneva.
Tariff Cuts worth $1.3 trillion at todays price agreed upon
1960-62
The Dhillon Round
4400 Tariff Cuts agreed to
1964-97
The Kennedy Round
Many Industrial Tariffs Halved
Membership increased to Fifty
Code on Dumping Agreed to
1973-79
The Tokyo Round
Membership increased to 99
First Serious Discussion on Non-Tarifff Barriers (Ex Subsidies & Licensing
Requirements)
Average Tariff on manufactured goods in the 9 biggest markets cut from 7%
to 4%
1986-93
The Uruguay Round
Further Cuts in Tariffs, Export Subsidies, Licensing and Customs Valuation
First Agreement on Trade in Services and Intellectual Property Rights
1995
Formation of the World Trade Organisation
Till 2004
Ministerial Conferences and certain sectoral negotiation
Source: The Economist, 16 May 1998 and WTO Documents
measures eroding the benefits of the multilateral trade liberalization gained attention in the negotiating forum.
As such, the global trading system was expecting the emergence of a more disciplined trading environment
aiding fair trade. Moreover, disciplining the non-tariff measures in turn implies removing unnecessary
restrictions on trade and thus can be interpreted as a movement towards liberalization. The late eighties and
early nineties witnessed Uruguay Round approaching a successful conclusion with a much wider framework
of trade liberalization under the aegis of the World Trade Organization. This contradicts the popular claim
that the slow progress of the multilateral trade liberalization led to the increased interest in the regional
trading arrangements. It appears that the urge for liberalization was not the only criteria driving nations to
form regional trading arrangements.
From 1947 to 1994, 109 regional trading agreements were notified under GATT. Out of these 109, 98 were
notified under Article XXIV of GATT and 11 under the Enabling Clause. ii The total number of regional
trading arrangements increased to 240 in 2000. 172 out of this 240 were already negotiated while 68 were
still in the negotiating process as of July 2000. (Exhibit 2). However, to certain extent this is an
13
underestimation as it includes the Free Trade Agreements and customs Unions and the PTAs that aim to
become so.iii
Exhibit 2: RTAs in Force and Under Negotiation (as of July 2000)
FTAs Under Negotiations
CUs in Force
CUs Under Negotiation
FTAs in Force
Source: WTO Secretariat
The interesting point that gets revealed by desegregating the data is that the level of economic integration
achieved among the members of such agreements varies
among agreements. Most of the RTAs are in the form of
free trade areas; very few customs unions have been
notified to the multilateral trading system. (Exhibit 2).
The important custom unions notified are the European
Community, CARICOM and MERCOSUR. In the year
RTAs as of July 2000
RTA Status
Free Trade Area
Customs Union
Free Trade Area Under Negotiation
Customs Union Under negotiation
Source: WTO
Number
148
24
67
1
2000, more than 85 per cent per cent of the 172 existing regional trading arrangements are seen to be in the
form of free trade area; only one out of the 68 negotiating RTAs are in the form of Customs Union, remaining
67 being in the form of Free Trade Areas.
Area-wise break up of the data reveals that RTAs have been primarily centered around Western Europe.
Among the 109 regional trading agreements notified under GATT between 1948 to 1994, 76 are between
Western European countries. The trend continues and going by the latest data available, around 50 per cent of
the RTAs currently in force are situated in the Euro-Mediterranean region. (Exhibit 3). However, at present, it
is worth noting that the number of RTAs coming up in America is not far behind that of the European region.
14
Even for non-European countries, preferential trading arrangements featured in their trade policy.
Consequently, when the World Trade Organization came into operation on January 1995, majority of its
members was parties to at least one regional trading arrangement notified under GATT. The notable
exception turned out to be Japan.
Exhibit 3: Geographical Distribution Of RTAs, Both In Force And Under Negotiation
100%
CUs under negotiation
FTAs in force
CUs in force
Number of RTAs
FTAs under negotiation
80%
60%
40%
20%
0%
Eastern
Euro-
Europe &
Mediterranea
5
11
20
17
6
29
79
4
13
4
0
1
10
7
2
Americas
Asia Pacific
FTAs under negotiation
17
CUs under negotiation
1
FTAs in force
CUs in force
Sub-Saharan
Cross
Regional
14
Region
Source: WTO Report
The WTO Report (1995) adds that very few RTAs agreements among developing countries have met their
original timetables for the establishment of a free trade area or a customs union. Coupled with this is the
absence of wide sectoral coverage and this has resulted in limiting the potential gains to the members from
liberalization.
The composition of RTA also varies; on one extreme there is a simple bilateral RTA composed of two
parties; on the other extreme there is an RTA in which all parties are themselves distinct RTAs. Bilateral
RTAs account for 98, or almost 60 per cent, of the 172 RTAs in force, and for half of all RTAs under
negotiation. Plurilateral RTAs account for 16 per cent of all RTAs currently in force, but make up less than
ten per cent of RTAs under negotiation. The percentage of RTAs where at least one party is an RTA itself is
about 30 per cent of both the RTAs under negotiation and those in force.iv The most noteworthy development
expected in the coming years is the emergence of a new category, namely RTAs where each party is a distinct
RTA itself.v These account for 9 of the 68 RTAs under negotiation and are composed of both regional and
15
cross-regional initiatives. (Exhibit 4). This is a new trend that is a reflection of the growing consolidation of
established regional trading arrangements.
Exhibit 4: Composition of RTAs
200
180
All Parties are distinct RTAs
At least one party is an RTA itself
Plurilateral
Bilateral
160
Number of RTAs
140
120
100
80
60
40
20
0
In Force
Under Negotiation
All Parties are distinct RTAs
0
9
At least one party is an RTA itself
47
20
Plurilateral
27
5
Bilateral
98
34
Source: WTO Report
The above data bring out certain issues for consideration. In the first place, there is a larger number of Free
Trade Areas than Customs Union. A Free Trade Area is trade liberalization, or basically creating free trade
within the region, without affecting the individual member country’s trade policy with the rest of the world.
In case of customs union it is free trade within the region, similar to a free trade area, along with
harmonization of trade policy for the rest of the world. Looking purely from theory angle, there is not much
to gain in terms of increased market access for non-members; the only advantage is that they face similar
market entering conditions for the whole region. In fact, the issue, looking purely from theory side is more
important for the members. In case of a customs union, each member having similar trade policy for the rest
of the world, the non-member can enter the regions market through any country without having any extra
advantage. But in case of a free trade area, the non-members can take the advantage of choosing to enter
through the member-country having the minimum tariff and thus catering to the regions market. To ensure
that this does not happen, it is necessary for the RTA to have strict Rules of Origin.
Thus a customs union appears to be a less complex form of RTA to handle vis-à-vis free trade area.
Moreover, the condition that no RTA members can increase the market entry barrier for the rest of the world
16
after the formation of the RTA imposes a binding on members’ external trade policy. Also, members having
higher entry barrier vis-à-vis other members have to accept a decrease in the external barrier as a result of the
same clause.
But the fact that there appears to be greater preference for free trade areas than customs union puts a question
mark on the motive of the members behind formation of the RTAs. Under a free trade area, member
countries can retain their individual trade policies for the rest of the world. Thus, each country joining an
RTA in the form of free trade area can continue a quite restrictive trade policy for the rest of the world while
giving zero duty market access to the RTA members. By doing so, the country continues to protect the
domestic producers from global competition.
In case of a customs union to set in the common external trade policy member countries having
comparatively more restricted trading regime have to bring down the level of the restriction for the rest of the
world because of the condition of non-increase of trade restriction for the rest of the world. Otherwise, the
condition of non-increase of trade restriction would get violated for the members having lower trade
restriction for the rest of the world. Moreover, agreeing to a common external trade policy, no individual
members can unilaterally take an external trade policy decision. Thus, even though the discrimination cannot
be wiped out, yet, customs union appears to be a better option than free trade areas.
Under free trade area, with each country retaining quite restrictive trade policy for the rest of the world, the
extent of discrimination is expected to be more complex and hence more problematic against the backdrop of
global trade liberalization. In this case, there is no binding on the individual members’ external trade policy
coming from the RTA. The RTA in this case can be considered to be more focussed on the welfare
implications of the members rather than any motive of global liberalization.
Secondly, there is relatively higher number of RTAs formed among the developed countries. If we consider
the argument that domestic compulsions force countries to enter a moderate level of liberalized trading
regime through RTAs, then the trend should have been more RTAs among developing countries. However, at
this point it needs mentioning that very recently an increased number of RTAs among developing countries is
reported. But lack of authentic data bars detailed discussion.
Turning to the global trading arena and the developments in the multilateral trading system, one can very
easily find a trace of protectionist agenda practiced, not only by the developing but also for the developed
countries. In fact, the fear of competition from newly industrializing countries led to the emergence of
various NTMs in the global trading arena. In the context of these RTAs, keeping these aspects in mind, can it
be claimed that to certain extent the creation of a “safe heaven” for the member countries urge nations to go
for RTAs?
17
The third issue crops up from the fact that data reveal that the RTAs among developing countries, using the
Enabling Clause have not yet reached the stage of Free Trade Area or Customs Union. They are still in the
PTA stage. This in turn implies that the domestic producers in the member countries continue to enjoy some
form of protection, at least for the select sectors thereby not achieving the extent of welfare maximization
possible. Moreover, being notified under the Enabling Clause, the PTAs might be selective in choosing the
different sectors to be covered under the RTA, thus not allowing the maximum extent of trade creation
possible. Under this situation then, can it be argued that the liberalization zeal played a major role in urging
nations to enter into regional trading arrangements?
So, the data on one hand data reveal an increased dependence of countries on regional trade liberalization. On
the other hand it raises doubt regarding the motive of the countries behind the formation of RTAs.
Even if it is assumed for the time being that the motive is trade liberalization, the in-built discriminatory
mechanism of a regional trading arrangement operating under the multilateral trading system cannot be
denied.
As has already been mentioned, the multilateral trading system ruled by the World Trade Organization is
based on the principle of non-discrimination, embodied in the Most Favored Nation Treatment and National
Treatment. The Most Favored Nation prohibits member countries of the multilateral trading system to
discriminate among members. Concentrating on the issue of market access, it can be said that countries are
required to open up the market to the same extent to all members of WTO. Few WTO members coming
together to sign a regional trading arrangement, implies increased market access for the RTA members as
compared to other WTO members.
Thus, a discriminatory scenario between RTA members and the excluded WTO members emerges. This
discrimination turns out as a restriction for non-members of RTA to enter the regions market. The process is
as follows.
Negotiations at the multilateral level ensure certain extent of market access in each of the WTO member
country market. This increased market access mainly comes through decreased tariff (considering the case of
goods only). This decrease in tariff results in decrease in protection to the domestic industry. The very fact of
tariff existence reveals uncompetitiveness on part of the domestic producers vis-à-vis foreign producers. The
decrease in protection level allows foreign players to enter. But, some extent of protection still exists for
domestic producers. This in turn implies an artificial competitiveness for domestic producers; but when it is
the competition among foreign players in the domestic country market, everybody is at par.
With few countries coming together to form a regional trading agreement, the countries entering a members
market are no longer at par. The RTA members enjoy increased market access vis-à-vis non-members
18
through decreased tariff. This discrimination helps the RTA members to take away the share of the domestic
market previously enjoyed by the non-members – the trade diversion. This trade diversion can be taken as
erosion of the negotiated market access of the non-RTA members in the regions market. Thus, the in-built
discriminatory mechanism of regional trading arrangement results in the erosion of negotiated market access
in the regions market. That is, through the in-built mechanism, regionalism tends to create a wave against
multilateralism.
The GATT contracting parties, understanding and acknowledging this discriminatory feature of RTAs
imposed certain conditions while allowing for the formation of an RTA. Through these conditions, the
contracting parties tried to ensure minimization of the discrimination. Are the conditions imposed sufficient
to impart a “building bloc” role to regional trading arrangements?
The first condition, that is substantial trade coverage claims to ensure limited trade diversion. As we have
already seen, the non-inclusion of this clause would have resulted in the RTA members getting engaged in
more of “trade diverting” concessions rather than “trade creating” concessions. This in turn would have
resulted in a situation going against a multilateral trade liberalization initiative as the gains coming to the
RTA member countries in the regions market would have come more at the cost of non-members of the RTA
rather than by displacing inefficient producers of the region.
However, as it has been already discussed in great details, no regional trading arrangement is possible
without trade diversion taking place. In case of free trade area the member countries give duty free entry to
goods among themselves, while retaining their individual trade policies for the rest of the world. Higher the
entry barrier for the rest of the world, higher is the extent of trade diversion taking place as the extent of
preference available to the members vis-à-vis the non-members is higher. In case of customs union also,
though the member countries have uniform trade policy for the rest of the world, yet, the extent of entry
barrier for non-members varies from commodity to commodity. This results in higher trade diversion for
some items, depending on the comparative advantage enjoyed by members vis-à-vis non-members. Thus,
even the substantial coverage condition does not ensure absolute stoppage of trade diverting activities. Yet,
there is no doubt that without this condition, situation would have been worse.
Moreover, there is a different aspect associated with this condition. “Substantial Coverage” implies that the
RTA would consider all or substantial items traded when going for the negotiation at the regional level. What
is the other alternative? The RTA drops this condition and goes for negotiation in select items. Under such a
situation, it is expected that the relatively more uncompetitive sectors would be left out. That is, for these
sectors, the imports, whether from members or non-members would face the same level of protection in the
import market. In case of substantial coverage and these sectors getting included in the RTA offer, member
countries get increased market access. But the non-member countries are in worse situation compared to the
19
situation of dropping this condition. That is, more the number of items outside the purview of RTA
negotiation, lower is the discrimination advanced towards non-members. But the dropping of the substantial
coverage would lead to lesser amount of trade creation, thereby having adverse implications on the welfare
level. Thus, there is a trade-off found between the welfare implications of RTAs and adverse implications for
third countries in the RTA markets.
The second condition restricts member countries from increasing trade restriction for the rest of the world
after the formation of the regional trading arrangement. This condition attempts to ensure that the regional
trading arrangements do not take away the market access of the non-members negotiated at the multilateral
level. This in fact can be seen as an instrument to tackle the following situation. Through regional trading
arrangement members get increased market access through lowering of trade barrier in each of the member
country markets in the form of trade creation and trade diversion. The trade diversion would be higher if RTA
members, while lowering the market barrier among themselves increase the same for the non-members. The
members can also opt for a situation of just increasing the market barrier for non-members keeping it same
among themselves. In the second case, the increased market would just come via trade diversion, without
any trade creation. A regional trading arrangement leading to increased market barrier by members for nonmembers would go against the objectives of the multilateral trading system. To restrict this taking back of
negotiated market access, the second condition has been imposed.
Even then, it needs to be pointed out, that the condition is able to resist only taking back negotiated market
access; it fails to ensure non-erosion of the negotiated market access which takes place through the in-built
discrimination of regional trading arrangements.
The underlying reason is the discrimination in built in regional trading arrangements. Trade-diversion, being
the gain of the regions market to members displacing non-members only because of the lowered market
barrier enjoyed by the former, is nothing but an emerging restriction for non-member. This restriction would
not have resulted in the absence of the regional trading arrangement. Looking from the other angle, this
restriction of market is not allowed under the multilateral trading system as this entails taking away the
market access, which has been promised earlier through negotiations. So, this situation can be termed as
incompatible to the non-discriminatory principle of the system.
This incompatibility has been accepted as an exception under the system. But it cannot be forgotten that the
exception was allowed on the belief that the regional trading arrangements being liberalization initiative at
the regional level would facilitate the same at the multilateral level. But as it has been seen, the exception is
going against the principle of non-discrimination through erosion of the negotiated market access, while, the
trade liberalization initiative at the multilateral level moves ahead through market access negotiations. In this
20
situation, will it be wise enough to accept the belief that RTAs in its present state would act as building blocs
to a liberalized global trading arena?
The third condition can be perceived as a solution to an interim arrangement. It is understandable that certain
domestic compulsions compel countries to go for a restricted trade regime. Keeping this in mind, it might be
problematic for a country to bring down tariff to zero for the member countries from the day it enters into a
regional trading arrangement. This point comes as Article XXIV permits only the formation of Free Trade
Areas and Customs Unions. In case the countries party to the regional trading arrangement cannot reach a
zero duty stage right at the inception, they should do so, that is, attain least the status of a free trade area
within a “reasonable time frame”. This “reasonable time frame” has later been decided to be ten years.
There is more than one point to be considered in this condition. First of all, the article talks of only free trade
areas and customs union and not preferential trading arrangement. In case of the first two, the common
condition is duty free movement of goods among the member countries. Preferential trading arrangement
implies lesser duty for member countries. There should not be any doubt to claim that in case of duty free
movement of goods among member countries, the extent of trade creation would be larger than in the case of
a preferential trading arrangement. As the rationale behind the allowance of the formation of RTA is more of
trade creation, the multilateral trading system allowed the formation of free trade areas and customs unions
only.
But the interim arrangement is nothing but a preferential trading arrangement likely to reach a free-trade
arrangement or a customs union over a “reasonable time frame”, agreed as ten years. During this interim
arrangement then, trade creation is not at its maximum, that is the level that could have been in the case of a
free-trade area. Moreover, with the permission of this interim arrangement, the situation might be such that
member countries bring down tariff to zero for items in which they are competitive, thus not going for a large
extent of trade creation, while keeping the uncompetitive items under protection till the last date possible,
thus leading to lowering of net trade creation over the transition period. There appears to be no solution to
tackle this aspect through Article XXIV.
In the next place we deal with the forms of RTAs allowed under Article XXIV. The first form of RTA
allowed is the free trade area. Under a free-trade agreement member countries reduce tariff to zero among
themselves, while keeping the market barrier same for non-member countries. Higher the tariff for nonmembers, larger is the discrimination; thus more is the expected trade diversion. More the trade diversion,
larger is the erosion of market access for non-members in the region negotiated at the multilateral level.
Hence, the reduction of existing tariff to zero for members results in a proportionately large extent of erosion
of negotiated market access. This, in fact is expected to be higher than the same under a preferential trading
arrangement. In case of a preferential trading arrangement, there being some amount of tariff for members,
21
first of all the difference between market restriction faced by members and that faced by non-member is
lower than in the case of free trade area. In the second place, in free-trade area, there is absolutely no
artificial competition faced by members from domestic producers, while there exists competition for nonmembers both from domestic producers and other member country producers. This leads to a quite
substantial extent of erosion of negotiated market access, as compared to a preferential trading arrangement.
The other form of RTA allowed under Article XXIV of GATT 1994 is customs union. A customs union, as
has already been defined is a free-trade area along with harmonization of market entry barrier for nonmember. That is, in case of a customs union, the member countries have duty free trade among themselves
along with same market entry restriction for the non-members. This, looking from liberalization initiative,
has one advantage over and above free trade agreement. Because of the second condition of non-allowance
to increase trade restriction for the rest of the world after the formation of RTA, member countries having
higher market entry are forced to reduce them to the level of other members who have lower barriers. This,
thus automatically decreases the market barrier for non-members in those countries of the RTA who have
higher market barriers. But, the aspect of discrimination exists here also.
Moreover, the clause of non-allowance of increase in trade restriction for non-members are not very clearly
drawn. The wordings are as follows (Paragraph 5 of Article XXIV of GATT 1994):
………….. the duties and other regulations of commerce imposed at the institution of any such union
or interim agreement in respect of trade with contracting parties not parties to such union or
agreement 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 or the adoption of such interim agreement, as the case may be;
………….. the duties and other regulations of commerce maintained in each if the constituent
territories and applicable at the formation of such free-trade area or the adoption of such interim
agreement to the trade of contracting parties not included in such area or not parties to such
agreement 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 freetrade area, or interim agreement as the case may be”
The issue that has been left undefined is
the criteria for evaluating non-increase of
trade restrictions for the rest of the world.
That is, proper set of comparable data
while evaluating common external tariffs
of a customs union has not been defined.
A Case - The EEC
•
simple arithmetic average of the tariffs negotiated at the time of notification was
calculated
•
final duties on 20 percent of the most "sensitive" goods had not been set by the
time of working-party deliberations
•
refused to engage in any further discussion of calculation methods;
•
EEC's view
o Article XXIV's failure to specify a measure left that to be decided
by the RTA signatories.
22
While comparing the new common external tariffs and the presumably divergent set of pre-union national
tariffs should one use individual tariff-classification headings? Would average tariffs be used or tariffs
weighted by trade volumes would be more appropriate? This has not been clearly spelt out and thus left open
for the concerned parties to decide. Also, the question of whether "bound" or "applied" tariffs should be used
is left unanswered attracting similar confusion. The classic example of this ambiguity is the EEC case.
The fourth condition , that is, the multilateral trading system needs to be notified regarding the formation of
an RTA imparts a “watch dog” role to the multilateral trading system, to test the compatibility of the RTAs.
This is of utmost importance for the reason discussed below.
The formation of regional trading arrangement has been allowed as an exception to the MFN clause of
GATT/WTO. As has already been discussed in details, the rationale behind this is that trade liberalization
initiative at the regional level would help the same at the multilateral level. Not overlooking the
discriminatory aspect of regional trading arrangement, certain conditions are imposed to ensure minimization
of discrimination. Thus a close monitoring is required to see that the conditions are not ignored by the
regional trading arrangements, which might otherwise take away, to a large extent the facilitating role of
RTAs.
The experience is that, out of the GATT
working parties formed to review each of the
109 RTA agreements notified to the GATT
between 1948 and 1995, only 64 completed
their reviews. Out of those 64, only 6 were
The EEC Case
•
EEC's view
o
•
•
Article XXIV's failure to specify a measure left that
to be decided by the RTA signatories.
The review process stalled for lack of consensus.
An inconclusive report, the first of many to emerge from working
parties, was released; no further challenge was made.
able to reach a conclusion on the given RTA's
compatibility with Article XXIV. This six does not include EC or FFTA. Moreover, only two out of the six
are still alive (WTO1995, 16). In fact, "no agreement was reached on the compatibility of the Treaty…this
examination and the discussion of the legal questions involved in it could not be usefully pursued at the
present time; The examination of the EC agreement was never taken up again" (WTO 1995,11).
A critical evaluation of Article XXIV brings out some important issues. In the first place, the conditions
imposed under Article XXIV of GATT (1994) to ensure that the regional blocs aid global trade liberalization
fail to achieve the desired objective. The underlying reasons are mainly two. One is the inherent
discriminatory nature of the RTAs that is very difficult to wipe out. Secondly, the conditions, in many cases
are not adequately elaborate leaving scope for players to interpret according to their suitability. In the next
place, the implementation part of the provisions needs to be given due importance. A stricter role played by
the multilateral trading system is expected to decrease the extent of negative impact of RTAs multilateral
trade liberalization.
23
When the article XXIV suffers from quite significant weaknesses, it is beyond doubt that the enabling clause,
the alternative set of conditions particularly designed for developing and least developed countries to form
RTAs would worsen the situation. The enabling clause drops the condition of substantial trade coverage. This
in turn creates a wave for pushing ahead more of trade diverting rather than trade creating RTAs.
5: Regional Trading Arrangement Under the Multilateral Trading System: Future Negotiation
The WTO members as has already been mentioned have agreed to open up negotiations relating to regional
trading arrangements. Para 29 of the Doha Ministerial Declaration narrates the decision agreed upon by the
members of the multilateral body. It talks about clarifying and improving the existing disciplines and
procedures applying to RTAs along with not overlooking the developmental aspects of the RTAs.
The statement given in Para 29 of the Doha Declaration can be viewed as having two segments. The first
speaks of clarifying and improving the existing WTO provisions under the multilateral trading system
allowing the formation of RTAs. The second segment recognizes that there is a developmental aspect related
to RTAs and that should be given due consideration during future negotiation on the issue of RTAs.
The first segment can again be viewed as having two objectives. One talks about clarifying the existing WTO
provisions guiding the formation of RTAs. The other objective relates to improving the same provisions. This
segment of Para 29 of the Doha Declaration brings out the fact that the WTO members acknowledge the
shortcomings of the existing provisions and are concerned regarding the role of RTAs in aiding the creation
of a freer and fair global trading regime.
Let us first concentrate on the clarification objective of the Doha Ministerial Declaration.
We have already discussed that Article XXIV imparts a watch dog role to the multilateral trading system for
monitoring the RTAs. Experience reveals that this role has not been aptly played. The working committees
formed for analyzing the RTAs have, in most cases not completed the review. In cases where the working
committees have completed the reviews, the reports submitted regarding the compatibility of the RTAs with
Article XXIV are inconclusive. Reports signaling the incompatibility of RTAs with article XXIV have never
been seen to have any implementing action. A detailed clarification of the working procedure of the working
parties formed to review RTAs along with the implementation aspect of the reports submitted by the working
parties is required.
Article XXIV, while imposing the condition that countries forming an RTA should not increase the post
RTA trade restrictions for the excluded countries. The situation becomes problematic in case of countries
forming Customs Unions. Article XXIV fails to specify the form of tariff that should be considered while
analyzing whether this condition of non-increase of trade restriction for excluded countries in the post RTA
period has been fulfilled by the RTA members. More importantly, the article does not give a well-defined
24
detailed process of comparing the pre and post customs union MFN tariffs for the member countries. This
needs to be clarified to allow proper monitoring of RTAs.
Next, we concentrate on improving disciplines and procedures of the existing WTO provisions guiding the
formation of RTAs. Discussions have brought out that Article XXIV approves RTA in the form of Free Trade
Areas and Customs Unions. To make the RTAs GATT / WTO compatible three main conditions need to be
fulfilled.
In the first place, all or a substantial part of the trade of the member countries need to be covered by the RTA
negotiation. In the next place, the member countries cannot increase the level of trade restriction for the
excluded countries after the formation of the RTAs. The third condition deals with the interim arrangement.
In case countries initiate regional trade liberalization with a preferential trading arrangement, they should
reach a zero tariff stage and remove other quantitative restrictions within a reasonable time frame.
These conditions already discussed before are imposed to minimize the discrimination created by regional
trading arrangements and to maintain the sanctity of the multilateral trade negotiations. However, a critical
evaluation of the conditions has revealed that they fail to do so. By implementing condition one, RTA
members create discrimination between members and non-members. More the trade amount brought under
RTA negotiation larger is the sphere of discrimination and thus higher is the expected trade diversion. It is
true that without this condition countries might get engaged in sectoral trade coverage under RTA
negotiation, limiting the extent of gross trade creation; through the sectors opened up for RTA negotiation,
trade diversion enters; thus net trade creation gets adversely affected. But, with sectoral coverage, the WTO
compatibility of RTAs conflicts with the non-discriminatory principle of the multilateral trading system.
Under such a situation, a viable option might be of tagging RTA tariff with MFN tariff through a certain
defined relationship. This might decrease the discrimination to a large extent at the initial period of RTA
formation and then freeze the extent of discrimination with the passage of time.
The condition of non-increase of tariff for the rest of the world in the post RTA period is an attempt to
maintain the sanctity of the tariff binding achieved through multilateral trade negotiation. The decreased tariff
for members act as a new trade restriction for the excluded trading partners through the discrimination getting
created. This is one area of conflict, the other area being the discrimination itself. This is also expected to get
tackled to a large extent through designing a mechanism of tagging RTA tariff with MFN tariff.
Starting from a preferential trading arrangement, when the RTA members move towards attaining a zero
tariff situation in the region within a reasonable time frame, keeping trade restrictions for the rest of the world
unchanged, the discrimination towards the excluded countries increases. The third condition asks RTA
members to attain a restriction free trade regime within the reasonable time frame, while the in-built
25
discrimination in RTAs creates an increased discriminatory scenario for the excluded countries, if the MFN
restrictions are held constant.
Data have revealed the fact that there has been an increased popularity of RTAs among trading countries.
Analyzing the data, one finds that sharp increase in the number of RTAs in the global trading arena has
occurred at times when the multilateral trade negotiations were progressing quite satisfactorily. Two
explanations can be advanced for this. An increased protection level from the non-members and thus creating
a safe heaven among a limited number of countries can be considered to be one reason for the above
phenomena. So, RTAs can be taken as an emerging form of protectionism in the world economy. Under this
situation, this new form of protectionism can be expected to get tackled by imposing added conditions for
formation of RTAs, one of Tagging RTA trade restriction with MFN trade restriction; the other of open
membership.
This can be considered against another fact revealed by the data; that there is a larger number of RTAs in the
form of free trade areas than in the form of customs union. This has occurred in spite of the fact that Customs
Union is a much simpler form of RTA from administration point of view than Free Trade Areas under the
present multilateral trading system along with countries having certain economic compulsions to consider.
Free Trade Areas allow countries to retain their individual trade policy for the rest of the world while for
Customs Union, member countries have to agree upon a common trade policies for the rest of the world.
This, coupled with the condition that no country can increase the trade restriction for the rest of the world
after the formation of the RTA, compels some member countries to decrease their trade restrictions for the
outside world. So a larger number of RTAs in the form of free trade areas might be signaling a non-interest of
members for multilateral trade liberalization. The condition of tariff co-ordination might be a viable
instrument to address this issue.
Another fact can be considered at this point; that of a larger number of RTAs among developed countries
than among developing countries. This trend is now changing. It cannot be denied that since the signing f the
GATT, developed countries have brought down their tariff level, especially on industrial goods. ****** So,
tariff co-ordination can work in the direction of tackling this aspect also.
The other explanation is that, countries experiencing the increased pace of multilateral trade liberalization,
opted for preparing themselves for global competition through regional competition. Under such a situation,
the condition of open membership and tariff co-ordination completely fit in.
Thus, while negotiating on improving disciplines and provisions of RTAs under multilateral trading system
the conditions of open membership and tariff co-ordination can be thought of.
26
The issue that now appears is that of defining the tariff co-ordination and open membership. We start with the
tariff situation.
Let us consider a three-country-one commodity situation.
The countries are A, B and R. All three are members of
The Tariff Case
is x. Country R is the most efficient producer and Country
Countries – A, B and R
A, B, R – members of the multilateral trading
system.
A and B – members of RTA
A is the most inefficient producer of commodity x.
Commodity under Consideration - x
the multilateral trading system. The commodity considered
i
i
i
So, (Px) > (Px) > (Px) ,i = A, B, R
Where Px is the price of commodity x
To protect the x sector, country A imposes an MFN tariff t
on imports of commodity x. With the MFN tariff,
(Px)R (1+t) > (Px)A
(Px)B (1+t) > (Px)A
(Px)B (1+t) > (Px)R (1+t)
Pre-RTA Scenario
(Px)A > (Px)B > (Px)R
MFN Tariff Imposed by Country A T = t
(Px)R (1+t) > (Px)A
(Px)B (1+t) > (Px)A
(Px)B (1+t) > (Px)R (1+t)
Post RTA Scenario (zero tariff for members)
(Px)A > (Px)B
(Px)B (1+t) > (Px)A
(Px)B (1+t) > (Px)A
A Suggestion
T = ct
In the next stage, country A and country B forms an RTA.
Country A imposes zero tariff on imports from country B. Then, in the post RTA scenario,
(Px)A > (Px)B
(Px)B (1+t) > (Px)A
(Px)B (1+t) > (Px)A
That is, country R continues to face a tariff of t for entering country A market while country B faces no tariff.
Though t has not been increased, yet country R now experiences an erosion of market access in country A
market.
To reduce this, what can be thought of is coordinating the RTA negotiated tariff with the MFN tariff t. That
is, with the formation of the RTA, as country A reduces/removes tariff on imports from member countries, it
has to decrease t to ct. What is now to be decided is that c part of ct.
To define that, let us analyze the post-RTA scenario and our basic objective. In the post RTA scenario, x
sector in country A experiences decrease in protection level and starts facing competition from x sector in
country B. Country A continues to retain tariff on Country R as removal of that would imply higher
competition, country R being the most efficient producer of commodity x. Looking from country R side, it
was already facing an artificially created competition in country A market. With the removal of tariff from
country B imports it is now thrown into an unfair competition.
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Our aim is to address this discrimination created out of the formation of RTA. Due to the formation of RTA
with country B, Country A producers of x are already facing a lower price entry of x in their market from
country B. So, they should not have much objection in allowing commodity x imports entering their market at
the same price from other sources, like country R. To achieve this, the MFN tariff has to be lowered by
country A. This would place country R producers of x on the same plane with country B producers.
Definitely, the natural competitive edge country R producers are having over country B producers in
commodity x does not get revived in country A market. This situation implies selling of commodity X by
country R producers in country A market at a price that is lower than the price at which the domestic
producers sell the item. The problem in this case might be that a large amount of the item enters the domestic
market at a price at which the domestic producers cannot supply. The domestic industry might not be able to
absorb this shock if the MFN tariff is such that it fixes the import price at a level higher than the price at
which domestic producers sell. Under this situation, the option might be to define c factor in such a way that
the MFN tariff makes the import price of x coming from country R equal to the price of x at which the
domestic producers sell. Definitely, if the country A producers are protection loving people, they would not
agree to this instantaneously. But, as RTAs are taken to be facilitating instruments to global trade
liberalization, this type of adjustments needs to be done. So, the factor c needs to be adjusted so that
commodity x from country R enters country A market at a price equal to the price
Case 1 - at which domestic producers are selling the item in the market (country A market)
Case 2 - at which country B item is getting sold in country A market.
That is, define c such as
Either, (Px)R (1+ct) = (Px)A
Or, (Px)R (1+ct) = (Px)B
We have considered a particular case. Its not that always the MFN tariff ensures a price of imports higher
than the price at which the domestically produced items are sold. But, the c factor can be adjusted
accordingly.
The other aspect is, it may appear that this requires item to item negotiation. But that can be avoided
depending upon the negotiating process the RTA undertakes. An item by item determination of MFN tariff
can be done if the RTA follows a positive list approach for negotiation. It can also go for sectoral
determination of the c factor. In case of negative list approach, the sectoral average tariff can be considered
for determination of the c factor. Considering average tariff, weighted, is also an alternative. Future
negotiation might concentrate on this determination.
In the next place, we discuss the open membership issue. This implies that RTAs would allow interested
countries to join them. However, this does not, on the other hand imply that any country can join. A certain
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guideline can be drawn based on criteria like openness, economic development, market access advanced to
the RTA members, and others. It can even have the condition of import – export structure of the interested
country. Just as the multilateral trading system allows any interested country to join, the RTA negotiations
can also follow a similar pattern.
This, undoubtedly, can turn out to be a subjective issue and ultimately make RTA membership a restrictive
one. But, there can be well-defined guidelines negotiated at the multilateral level to address this.
After discussing the first segment of the Doha Declaration, we can turn our attention to the second one, that
of the developmental aspect of the RTAs to be given due consideration. Recollecting the purpose of the
Enabling Clause, it can be argued that the multilateral trading system favors increased participation of the
developing countries in global trade. It believes that integrating the developing and least developed countries
with the global trading arena would lead to their economic development. However, it does not deny the fact
that a certain level of protection for a certain period is also indispensable for the economic development.
Hence, it allows developing and less developed countries to gradually integrate with the global trading
system on soft terms and conditions. However, the ultimate objective is integration with the world trading
system.
Just as, in each of the agreements, the less developed countries enjoy a certain extent of leniency, the
provision for forming RTAs can be s designed to incorporate the same. This would work in two ways. On one
hand, the developmental aspect gets incorporated; on the other hand a situation of incorporating the enabling
clause inside the main provision for RTAs can be thought of.
6: Conclusion
Future negotiation on the provisions of regional trading arrangements can work in the direction of
strengthening the provisions to further minimize the discrimination. While doing so, the purpose for allowing
the formation of RTAs as an exception to the non-discriminatory principle of the multilateral trading system
needs to be well defined.
Data have revealed an increased favoritism towards regional trading arrangements. Though no strong
conclusion can be drawn regarding the motive, yet a signal of protectionism can be traced. The multilateral
trading system, while negotiation needs to ensure that the trace of protectionism gets addressed. Incorporating
conditions of tariff co-ordination and open membership this can be taken care of.
The theory on RTAs convey the fact that a part of the benefits to members come from discrimination, other
from liberalization. Future negotiation, keeping this in mind should send the message that the RTAs are
designed under the present global trading system as facilitating instruments for creating a freer and fair global
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trading arena. Hence, countries interested in forming RTAs cannot undermine the importance of global
liberalization and the ultimate purpose of achieving a liberalized world trading arena.
The less developed countries should understand the necessity of integrating themselves to the world
economic order and thus utilize the RTAs as really building blocs, preparing them to face global competition.
30
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End Notes
i Regional Trading Arrangements are of different forms depending on the degree of trade liberalization among participating countries.
The most fundamental type of RTA is the "preferential trading arrangement". This refers to the partial reduction of tariffs on intraregional trade. Next, "free-trade area" involves the creation of intra-regional free trade, with partner countries retaining their own
respective trade policies vis-à-vis non-partner countries. In both the above mentioned cases the trade restricting measures of the
individual countries for the rest of the world remains unchanged. This implies that the participating countries have different trade
restrictions for the rest of the world. A "customs union" is essentially a free-trade area in which a common external tariff is created,
while a "common market" ensures free flow of factors of production along with goods and services. Finally, "economic union" would
involve additional integrative measures, including monetary union, fiscal harmonization, competition policy, and related "deepening"
measures. The following paragraphs elaborate on the different types of RTAs.
iiSource:
iii
WTO Report 1995
Source: WT/REG/W/41
Examples include the RTAs signed between the EC and EFTA, as well as those signed by CARICOM and the CACM with third
parties.
iv
v
Examples include EC-MERCOSUR and Closer Economic Relations (CER)-Association of South East Asian Nations (ASEAN).
33