Chapter 8: Preferential Trade
Agreements
An Introduction to International
Economics: New Perspectives on the
World Economy
© Kenneth A. Reinert, Cambridge University
Press 2012
Analytical Elements
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Countries
Sectors
Tasks
© Kenneth A. Reinert, Cambridge University
Press 2012
Introduction
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The term multilateralism refers to the GATT/WTO system
and the trade negotiations that take place within it
One of the founding principles of this system is
nondiscrimination
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Involves the most favored nation (MFN) and national treatment (NT) subprinciples
“Regionalism” refers to a violation of the
nondiscrimination principle in which one member of a
regional trade agreement (RTA) discriminates in its trade
policies in favor of another member of the RTA and
against nonmembers
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Has been allowed by the GATT/WTO under certain circumstances:
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Free trade areas (FTAs)
Customs unions (CUs)
Interim agreements leading to a FTA or CU “within a reasonable length of
time”
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 8.1: Types of Preferential Trade
Agreements
Type of PTA
Description
Number in
Force
2014
GATT Article
XXIV (FTA)
An agreement on the part of a set of countries to
eliminate trade restrictions among themselves.
221
GATT Article
XXIV (CU)
An agreement on the part of a set of countries to
eliminate trade restrictions among themselves
and to adopt a common external tariff.
17
Enabling
Clause
Allows PTAs in goods trade among developing
countries.
37
GATS Article V
An agreement to reduce barriers to trade in
services among a set of counties.
131
Total: 406
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 8.2: Steps to Regional Integration
Type
Description
Free trade
area
An agreement on the part of a set of countries to eliminate
trade restrictions among themselves.
Customs
union
An agreement on the part of a set of countries to eliminate
trade restrictions among themselves and to adopt a common
external tariff.
Common
market
An agreement on the part of a set of countries to eliminate
trade restrictions among themselves, to adopt a common
external tariff, and to allow the free movement of labor and
physical capital among member countries.
Monetary
union
A common market that adopts a common currency and adopts
a common monetary policy.
Economic
union
A monetary union that adopts a process of domestic policy
harmonization in areas such as tax and spending policies and
domestic regulation.
© Kenneth A. Reinert, Cambridge University
Press 2012
The WTO and PTAs
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WTO members who wish to form FTAs or CUs
may do so
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However, there are certain requirements
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Trade barriers against non-members cannot be “higher or
more restrictive than” those in existence prior to the FTA or
CU
FTA or CU must be formed “within a reasonable length of
time”
FTA or CU must eliminate trade barriers on “substantially all
the trade” among the members
With regard to services, the General Agreement on Trade in
Services (GATS) requires that the FTA or CU involve
“substantial sectoral coverage”
© Kenneth A. Reinert, Cambridge University
Press 2012
The WTO and PTAs: Enforcement
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The WTO has a Committee on Regional
Trade Agreements (CRTA)
Despite the institutional structure present in
the WTO to govern PTAs, there has never
been any serious evaluation or enforcement
Most PTAs are of dubious WTO consistency
A “cooperative equilibrium” exists where no
WTO member contests another’s PTA
© Kenneth A. Reinert, Cambridge University
Press 2012
Rules of Origin
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In FTAs (but not CUs), a product can be
imported into a low-tariff member and then
resold in a high-tariff member
This is known as tariff rate arbitrage
Rules of origin (ROOs) protect against this
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Domestic content
Change in tariff heading
Specific processes
Substantial transformation
© Kenneth A. Reinert, Cambridge University
Press 2012
Economic Effects of PTAs
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Trade creation
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Occurs when the formation of a FTA or CU leads
to a switching of imports from a high-cost source
to a low-cost source
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Tends to improve welfare
Trade diversion
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Occurs when imports switch from a low-cost
source to a high-cost source
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Tends to worsen welfare
© Kenneth A. Reinert, Cambridge University
Press 2012
Trade Creation and Trade Diversion
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Trade creation and trade diversion using the
absolute advantage model of Chapter 2
Along with Brazil (B) and Argentina (A), we
are also going to refer to a third country, El
Salvador (S)
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Brazil and Argentina are members of a PTA,
whereas El Salvador is not
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 8.1: Trade-Creating PTA
© Kenneth A. Reinert, Cambridge University
Press 2012
Trade Creation
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Before the PTA, Brazil has in place a specific (per unit)
tariff on imports from both Argentina and El Salvador
Argentina is the lower-cost producer in comparison to
Venezuela
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Once Brazil joins either a PTA with Argentina, tariff is
removed on imports from Argentina
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Therefore Brazil imports good from Argentina
Good continues to be imported from Argentina and imports
increase because price has fallen due to removal of tariff
Consumer surplus in Brazil increases while producer
surplus and government tariff revenue falls
Net increase in welfare due to trade creation
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 8.2: A Trade-Diverting PTA
© Kenneth A. Reinert, Cambridge University
Press 2012
Trade Diversion
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Before the PTA, Brazil has in place a specific (per unit)
tariff on imports from both Argentina and El Salvador
El Salvador is the lower-cost producer in comparison to
Argentina
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Once Brazil joins a PTA with Argentina, however, Brazil
switches to Argentina as an import supplier
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Brazil imports the good from El Salvador
Imports expand as the domestic price falls
Consumer surplus in Brazil increases while producer
surplus and government revenue fall
Whether net welfare effect is positive or negative is
ambiguous
© Kenneth A. Reinert, Cambridge University
Press 2012
Summary of Economic Effects of PTAs
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PTAs can be either welfare-improving or
welfare-worsening.
Whether an PTA is welfare-improving or
welfare-worsening is something that must be
assessed on a case-by-case basis, based on
evidence on the relative strengths of trade
creation and trade diversion.
© Kenneth A. Reinert, Cambridge University
Press 2012
The European Union
Year
Initiative/Treaty
Members Added
1951
European Coal and Steel
Community/Treaty of Paris
France, Germany, Italy, Luxembourg, Netherlands
1958
European Economic Community/Treaty
of Rome
1973
Enlargement
Denmark, Ireland, United Kingdom
1981
Enlargement
Greece
1986
Enlargement
Portugal, Spain
1992
European Union/Maastricht Treaty
1995
Enlargement
Austria, Finland, Sweden
1999
European Monetary Union
United Kingdom, Sweden and Denmark not included
2002
Common EMU currency: the euro
United Kingdom, Sweden and Denmark not included
2004
Enlargement
Cyprus, Czech Republic, Estonia, Hungary
Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia
2007
Enlargement
Bulgaria, Romania
2007
EU Constitution/Lisbon Treaty
2013
Enlargement
Croatia
© Kenneth A. Reinert, Cambridge University
Press 2012
Economic Assessment of the EU
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Some studies have suggested that trade
creation has dominated trade diversion in the
EU
Other studies have drawn attention to the role
of non-tariff measures, subsidies (especially
to agriculture), and trade diversion in the
expanding network of PTAs between the EU
and other countries
© Kenneth A. Reinert, Cambridge University
Press 2012
North American Free Trade Agreement
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In January 1994 a FTA between Canada, Mexico
and the United States took place (NAFTA)
Addressed the following
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Trade in goods
Financial services
Transportation
Telecommunications
Foreign direct investment
Intellectual property rights
Government procurement
Dispute settlement
© Kenneth A. Reinert, Cambridge University
Press 2012
NAFTA Issues
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Trade and wages
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Trade and the environment
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Role of Commission for Environment Cooperation
NAFTA ROOs
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Not as important as often alleged
Can be complex
Truck transportation not liberalized until 2011
Migration a continued political issue
© Kenneth A. Reinert, Cambridge University
Press 2012
Mercosur
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PTA among Argentina, Brazil, Paraguay, and
Uruguay
Launched in 1991 with the Treaty of Asunción
Took on Chile and Bolivia as associate members in
1996 and 1997, respectively
Peru, Colombia and Ecuador became associate
members in 2003-2004
Venezuela signed a partnership agreement in 2006
Not actually a common market but a CU
Free movement of labor and physical capital is
along way off
© Kenneth A. Reinert, Cambridge University
Press 2012
FTAA
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In 1994, governments of 34 countries in Western Hemisphere
agreed to pursue a Free Trade Area of the Americas
Negotiations were launched at the Second Summit of the
Americas in 1998 in nine negotiating groups
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Market Access
Investment
Services
Government Procurement
Dispute Settlement
Agriculture
Intellectual Property Rights
Subsidies, Antidumping, and Countervailing Duties
Competition Policy
© Kenneth A. Reinert, Cambridge University
Press 2012
FTAA
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The 2004 Summit of the Americas was
stymied by a number of issues
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Agriculture
Anti-dumping
The 2005 Summit of the Americas ended
negotiations on the FTAA
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Venezuela and Argentina blocked progress in
opposition to US-backed “neo-liberalism”
© Kenneth A. Reinert, Cambridge University
Press 2012
ASEAN and AFTA
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Association for Southeast Asian Nations
(ASEAN) includes Brunei, Cambodia, Indonesia,
the Lao People’s Democratic Republic,
Malaysia, Myanmar, the Philippines, Singapore,
Thailand and Vietnam
Beginning in 1992, members began to form the
ASEAN FTA or AFTA, which now includes all 10
members
ASEAN is linking its AFTA to other countries in
the region through a number of initiatives
© Kenneth A. Reinert, Cambridge University
Press 2012
Regionalism vs. Multilateralism
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Represent two alternative trade policy options
available to the countries of the world
The 1950s and 1960s saw “first wave” of PTAs in
developing world
The 1980’s saw beginning of “second wave” of
PTAs
What role will this second wave of PTAs play vis-àvis the multilateral efforts toward trade liberalization
pursued under the GATT-WTO framework
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Will the second wave of PTAs complement the
multilateral framework or will it work at cross-purposes
to this framework?
© Kenneth A. Reinert, Cambridge University
Press 2012
Regionalism vs. Multilateralism
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Opponents argue that PTAs are discriminatory
by nature
They draw attention to “spaghetti-bowl” nature of
second-wave and current PTAs
Meaning the overlapping nature of most PTAs,
with most WTO members holding simultaneous
membership in many PTAs at once
The negotiating energies put into PTAs will
detract from those put into multilateral
agreements under the auspices of the WTO
© Kenneth A. Reinert, Cambridge University
Press 2012
Appendix: Rules of Thumb for Evaluating
PTAs
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Countries excluded from a PTA almost always lose
Market access is a key determinant of the net
benefits of a PTA
Lowering external tariffs against non-members of a
PTA improves their desirability from a welfare
standpoint
Multilateral trade liberalization results in significantly
larger gains to the world than a network of PTAs
© Kenneth A. Reinert, Cambridge University
Press 2012
Appendix: Rules of Thumb for Evaluating
PTAs
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For some countries “additive PTAs” can be more
beneficial than unilateral trade liberalization due to
the market access gains involved in the former
For developing countries “North-South” PTAs can
offer beneficial increases in competition in their
home markets
© Kenneth A. Reinert, Cambridge University
Press 2012