LECTURE 11
The WTO and PTAs
The Cases against Protection
• Protection either redistributes income across
countries (TT) or across groups within a
country
• Fighting for TT can lead to trade wars
• Redistributing income through trade policy is
generally both inefficient and regressive.
• Hence, one needs rules to prevent countries
entering into trade wars and to tie the hands
of governments against being hijacked by
lobbies.
International Negotiations of Trade Policy
• The average tariff rate on dutiable imports is
now quite low in most industrial countries.
• Since 1944, much of the reduction in tariffs
and other trade restrictions came about
through international negotiations.

The General Agreement of Tariffs and Trade
was begun in 1947 as a provisional international
agreement and was replaced by a more formal
international institution called the World Trade
Organization in 1995.
International Negotiations of Trade Policy
• Multilateral negotiation mobilize exporters to
support free trade if they believe export
markets will expand.

This support would be lacking in a unilateral push
for free trade.

This support counteracts the support for restricted
trade by import-competing groups.
International Negotiations of Trade Policy
• Multilateral negotiations also help avoid a trade
war between countries, where each country enacts
trade restrictions.
• If each country has a political interest (due to political
pressure) to protect domestic producers, regardless
of what other countries do,

then all countries could enact trade restrictions, even if it is in
the interest of all countries to have free trade.
• Let’s use a simple example to illustrate this point.
International Negotiations of Trade Policy
EU
Examples :
Boeing/Airbus subsidies; agricultural tariffs & subsidies.
International Negotiations of Trade Policy
• In this simple example, each country acting
individually would be better off with protection,
but both would be better off if both chose free
trade.
• If the EU and the US can establish a binding
agreement to maintain free trade, both can
avoid the temptation of protection and both
can be made better off.
World Trade Organization
•
The WTO negotiations addresses trade
restrictions in at least 3 ways:
1. Reduction of tariff rates through
multilateral negotiations.
2. Binding: a tariff is “bound” by having the
imposing country agree not to raise it in the
future.
World Trade Organization
3. Prevention of non-tariff barriers: quotas
and export subsidies are changed to tariffs
because the costs of tariff protection are
more apparent.

Subsidies for agricultural exports are an
exception.

Exceptions are also allowed for “market
disruptions” caused by a surge in imports.
World Trade Organization
• The WTO is not only a forum for trade
negotiations.
• It is also and foremost a set of rules: rights
and obligations.
World Trade Organization
• The World Trade Organization was founded in
1995 on a number of agreements

General Agreement on Tariffs and Trade:
covers trade in goods

General Agreement on Tariffs and Services: covers
trade in services (e.g., insurance, consulting, legal
services, banking).

Agreement on Trade-Related Aspects of
Intellectual Property: covers international property
rights (e.g., patents and copyrights).
World Trade Organization

The dispute settlement procedure: a formal
procedure where countries in a trade dispute can
bring their case to a panel of WTO experts to rule
upon.

The cases are settled fairly quickly: even with
appeals the procedure is not supposed to last
more than 15 months.

The panel uses previous agreements by member
countries to decide which ones are breaking their
agreements.

Decisions by the panel can be appealed.
World Trade Organization

The Appellate Body makes final decisions.

A country that refuses to adhere to the AB’s
decision may be punished by allowing other
countries to impose trade restrictions on its exports
(retaliation. Examples: EU-bananas; EU-beef
hormones; US-tax credit).
World Trade Organization
• The GATT (and the GATS) is based on two
fundamental principles:

Non-discrimination

Reciprocity (multilateral, not bilateral, not sectoral)
• Non-discrimination comes in two parts:

Most-favored-nation (MFN) principle (Art I)

National treatment (Art III)
GATT - Article I
• Paragraph 1 says: “…any advantage, favor,
privilege or immunity granted by any
contracting party to any product originating in
or destined for any other country shall be
accorded immediately and unconditionally to
the like product originating in or destined for
the territories of all other contracting parties.”
GATT - Article III
• Paragraph 2 says: “The products of the
territory of any contracting party imported into
the territory of any other contracting party
shall not be subject, directly or indirectly, to
internal taxes or any internal charges of any
kind in excess of those applied, directly or
indirectly, to like domestic products.
Two exceptions to the MFN rule
• Non-reciprocal preferential access for
developing countries to industrial country
markets

1979 Enabling Clause (no time limit): GSP

Waivers (limited in time)
• Lomé, Cotonou for EC-ACP trade relations
• Reciprocal preferential trading arrangements
(PTAs or RTAs) under GATT Art XXIV
GATT - Article XXIV
• Paragraph 5 says: “…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…;
Provided that…” certain conditions are met.
Preferential Trading Agreements
1. Free trade area: an agreement that allows
free trade among members, but each
member can have its own trade policy
towards non-member countries

An example is the North America Free Trade
Agreement (NAFTA).

Another example is the FTA between the EU and
Mexico or the EU and South Africa. Also the
Economic Partnership Agreements (EPAs) with
ACP countries.
Preferential Trading Agreements
2. Customs union: an agreement that allows
free trade among members AND requires a
common external trade policy towards nonmember countries.

An example is the European Union.

Another example is the CU between the EU and
Turkey
Preferential Trading Agreements
• Are preferential trading agreements
necessarily good for national welfare?
• No, it is possible that national welfare
decreases under a preferential trading
agreement.
• How? Rather than gaining tariff revenue from
inexpensive imports from world markets, a
country may import expensive products from
member countries but not gain any tariff
revenue.
Preferential Trading Agreements
• Preferential trading agreements increase national
welfare when new trade is created, but not when
existing trade from the outside world is diverted to
trade with member countries.
• Trade creation

occurs when high cost domestic production is replaced by
low cost imports from other members.
• Trade diversion

occurs when low cost imports from non-members are
diverted to high cost imports from member nations.
Welfare effects - Pure trade creation
Dhome
P
Shome
PTworld
PTpartner
a
Pworld
Ppartner a
b
b
SCU
c
c
ST
MT
d
d
DT
T
STworld
STpartner
Sworld
Spartner
DCU
Q
Welfare effects - Pure trade creation
• Case when Pworld > PPartner
• Before customs union:
imports = DT - ST
from Partner
• With customs union:
imports = DCU - SCU from Partner
• Welfare effects of customs union:
consumer surplus:
a+b +c+d
producer surplus:
-a
government revenue: - c
net welfare effect :
b+d
Welfare effects
Trade creation & trade diversion
Dhome
P
Shome
PTpartner
PTworld
Ppartner a
Pworld
b
SCU
c
c’
ST
MT
d
T
STpartner
STworld
Spartner
Sworld
DT
DCU
Q
Welfare effects
Trade creation & trade diversion
• Case when Pworld < PPartner
• Before customs union:
imports = DT - ST
from World
• With customs union:
imports = DCU - SCU from Partner [!]
• Welfare effects of customs union:
consumer surplus:
a+b+c+d
producer surplus:
-a
government revenue: - (c + c’)
net welfare effect :
b + d - c’
PTAs - Static welfare effects
• The formation of a PTA in the presence of
trade diversion has an ambiguous welfare
effect:

+(b + d) is a welfare gain due to the reduction in
production and consumption distortions

- (c’) is a welfare loss (in terms of foregone
government revenue) due to a shift to the less
efficient producer
PTAs - Other static welfare effects
• i. Terms-of-trade effects:

Individually, the members of a customs union
may be small relative to world markets

However, together they may become large, i.e. be
able to influence their terms of trade

It may be optimal for the customs union to restrict
trade with non-members by imposing a CET equal
to the optimum tariff
PTAs - Other static welfare effects
• ii. Pro-competitive effects:

If markets are imperfectly competitive, economic
integration leads to a reduction in market power of
each firm, leading to a reduction in average markups
• ii. Product variety effects:

If there are economies of scale, economic
integration allows consumers to buy more varieties
Economic Partnership Agreements
• The WTO waiver for Cotonou expires on
31/12/07.
• Options:

Try to obtain a new waiver

Use another form of preferential access. Nonreciprocal: GSP/EBA

Art XXIV FTA