The path to global free trade:
Spaghetti bowls as building blocs
Richard E. Baldwin
Professor of International Economics
Graduate Institute of International Studies, Geneva
World Economy Annual Lecture
Nottingham 22 June 2006
1
Introduction & Plan
•
Topic: Final steps to global free trade.
– Bhagwati’s paths.
– Define: global free trade.
– Bold prediction & caveats.
•
Outline
1.
2.
3.
4.
5.
Political economy of liberalisation.
Structured historical narrative.
Staging post 2010.
The final 2 steps.
WTO’s job.
2
6 stylised facts
1. The GATT process started when tariffs were very
high worldwide;
2. Rich nations liberalised much more than poor
nations, in both the GATT process (i.e. bound rates)
and RTAs;
3. The liberalisation focused on industrial goods in
which two-way trade in similar goods is prevalent;
4. The process took 40 years;
5. Some sectors were excluded entirely and others
experienced much less tariff cutting;
6. Regional tariff cutting went hand-in-hand with
multilateral liberalisation.
3
Political Economy
• Status quo tariff.
• Tariff balances supply & demand for
protection.
• Supply = marginal cost curve (marginal
welfare damage).
• Demand = marginal utility curve (marginal
benefit to special interests).
4
Protection
demand
S
euros
euros
a
P’
a
P’
P
Protection
demand
P
T
T’
Pw
D
T
quantity
T’
T
5
Protection
supply
S
euros
euros
b
d
P’
c
a
P
T’
e
Naïve opt’l
tariff
Protection
Supply
f
g
dW
dM
dP w
 T
M
dT
dT
dT
 ( e  f )  g
Pw
Pw’
D
quantity
T’
T
6
Juggernaut: demi-cycle 1
• Political equilibrium
tariff balances S & D
for protection.
• Reciprocal trade
talks re-align political
economy forces
inside each
participating nation.
• Protection supply
shifts up.
– Exporters become
anti-protectionists.
euros
Protection
Supply
(recip.)
Protection
Supply
(unil.)
Protection
demand
T’
T
T
7
Juggernaut: demi-cycle 2
• Politically optimal
Tariff,T
tariff depends of size
of import competing
To
sector.
FE
– Walrasian entry, n.
• Number of import
competing firms rise
with tariff.
• FE curve.
• Same for export
sector, but can’t plot.
n
no
8
Juggernaut effect
• Fold supply &
demand into GFOC.
– Solution to govt first
order condition.
Tariff,T
To
FE
Eo
GFOC (unil)
• GFOC rises with n
since politically
optimal T rises with
n.
– More to protect on
margin.
n
no
9
Juggernaut effect
• Start: unilaterally
politically optimal
tariff, To.
• Reciprocal trade
talks shift GFOC
down.
– Lower opt’l T for any
given n (exporters are
now in the game).
• Juggernaut rolls
forward to E’
Tariff,T
FE
To
A
T1
T’
GFOC
(unil)
Eo
E’
B
GFOC
(recip)
n
10
Juggernaut effect
• If all exports covered
by the reciprocity,
politically optimal
tariff is zero.
• Could take decades
crush the anti-trade
forces (import
competing firms) &
build pro-trade forces
(export firms).
Tariff,T
FE
GFOC (unil)
To
Eo
GFOC
(MTN)
Efinal
n
11
Domino effect
• Demi-cycle I: Idiosyncratic formation or deepening
of a trade bloc re-aligns the political economy forces
inside non-member nations.
• Pro-membership political economy forces:
– Non-member exporters: Trade diversion (fresh loses) &
Trade Creation (lost opportunity).
• Anti-membership political economy forces:
– If deeper, may resist more.
• If export sectors are politically larger than import
competing sectors.
• Demi-cycle II: if a new member joins, “forces for
inclusion” get stronger in non-member nations.
12
RTB unilateralism
• Competition for out-sourcing jobs and investment drive
nations to unilaterally cut tariffs.
• Re-aligns political economy forces in DCs.
• Unbundling of manufacturing process (i.e.
fragmentation, vertical differentiation, slicing up value
added chain) is key.
– Destroys import substitution (scale, competition)
– Makes export-led industrialisation more successful (foreign
technology from MNC/buyers, ready market).
• Finer division of labour may mean no import
competing industry.
• MNC role may imply imports mostly re-exported.
– Importers are also exporters => no political economy
conflict.
13
Ancillary effects
• Intra-sectoral special interest politics.
– Melitz model & reciprocal liberalisation: big firms win, small
firms lose.
– Add Mancur Olsen’s Asymmetry on political organisation &
juggernaut effect works well on intra-industry trade.
• Losers lobby harder.
• Home market magnification effect.
– Industry becomes more footloose, not less, as trade barriers
fall.
– Competition for industry becomes more fierce as tariffs fall
globally. (Small preference margins can matter a lot).
14
Historical Narrative
•
•
•
•
3 key effects: Jugger (MTNs), Domino (RTAs), RTB
(unilateralism).
“Empirical evidence” intended to “demonstrate”
usefulness of the 3 key effects.
Line sketch.
Can’t pretend to explain everything.
15
Historical Narrative
– GATT
starts.
– Juggernaut
works but
stops in
1950s.
70
60
%
1934 Trade Act
50
Geneva Round, '47
40
30
Annecy Round, '49
Torquay Round, 51
Geneva Round, 56
Dillon Round, 56
Kennedy Round, '67
20
10
0
1920
1922
1924
1926
1928
1930
1932
1934
1936
1938
1940
1942
1944
1946
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
• 1947-1958.
16
Dominos trigger juggernauts
• 1958-1972.
T
– EEC formation:
• Europe domino effect
phase I.
• Kennedy Round.
• RTAs: US Auto Pact
& EEC, EFTA.
• MTNs, RTAs &
unilateralism
proceed in tandem.
• Liberalisation begets
liberalisation.
FE”
FE
FE’
E”
Eo
GFOC
(unil)
E’
n
17
1973-1985
70
60
%
1934 Trade Act
Tokyo
50
Geneva Round, '47
40
30
Annecy Round, '49
Torquay Round, 51
Geneva Round, 56
Dillon Round, 56
Kennedy Round, '67
20
10
0
1920
1922
1924
1926
1928
1930
1932
1934
1936
1938
1940
1942
1944
1946
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
• EEC first
enlargement
and EEC-EFTA
FTAs, create
another
incentive for an
MTN (Tokyo
Round, 73-79).
• Stagflation
postpones all
forms of trade
liberalisation.
18
1986-1990
US & EU average applied industrial tariffs
9
Uruguary Round tariff cuts begin
8
7
6
5
EU
4
US
3
2
1
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
0
1988
• Juggernaut
& domino
re-engage.
• Single
European
Act, 1986.
• US-Canada
FTA talks
start, 1986.
• Uruguay
Round
starts, 1986.
%
19
1990-1994
• European spaghetti bowl forms.
– USSR collapse.
• North American spaghetti bowls forms.
– US-Mexico FTA triggers massive domino effect.
– NAFTA, Mercosur, dozens of spoke-spoke FTAs,
long queue for US bilaterals.
20
1994-2000
• European spaghetti bowl advances.
– Euro-Meds, etc.
• North American spaghetti bowls advances.
– NAFTA crushes Mexican anti-trade forces.
– Mexico ‘sells’ its politically optimal tariff cuts in
over 40 bilaterals.
• Japan, EU & US.
21
1986-2000
• RTB unilateralism in East Asia (circa 1985).
Reductions in applied MFN tariffs on
Asian crisis
22
MTNs, RTAs & unilateralism
• In 1990s, as in the 1960s & 1980s, all the ‘isms’
progress hand-in-hand.
• No evidence that ‘isms’ are substitutes.
23
2000-2006
• East Asian noodle bowl starts.
• China’s approach to ASEAN for FTA triggers
domino effect in East Asia.
– ACFTA, AKFTA, AJFTA, many bilaterals.
– No significant regionalism to date, but lots
promised.
• Western Hemisphere spaghetti bowl
advances.
– US opposition to FTAs crushed by NAFTA; US
follows promiscuous FTA strategy.
• European FTAs multiply, spokes start to
proliferate FTAs.
24
Staging Post 2010
• Europe, North America and East Asia: ‘fuzzy’,
‘leaky’ trade blocs.
– North America & Europe done deals; between &
within near-duty-free status (major flows).
• Many East Asian FTAs may have problems
(typically south-south), but Japan-Malaysia, &
4 other big ASEANs very likely to be
implemented.
– Rest due to domino and RTB unilateralism.
• Prediction: Applied tariffs will be near zero for
world’s major trade flows around 2010.
25
Fractals
• Definition: “A rough or fragmented geometric
shape that can be subdivided in parts, each of
which is (at least approximately) a
reduced/size copy of the whole.”
• World trade system made of 3 fuzzy, leaky
trade blocs each of which is made up of fuzzy
leaky sub-blocs.
• The point:
• Solution to one is the solution to all (roughly).
26
PECS
• How PECS fixed the European spaghetti bowl
and why.
• Spaghetti bowl problems:
– Multi ROOs (hard to do biz in spokes)
– Bilateral cumulation (hinders efficient sourcing in
spokes)
• 1997, EU set up PECS:
– imposed common set of ROOs on EU, EFTA &
CEECs.
– Imposed diagonal cumulation.
27
PECS
• Spaghetti bowl is not by accident.
– Pair-specific political economy forces => pair-specific policy;
especially hub & spoke.
• Unbundling & off-shoring
– Former beneficiaries of complexity downsized and offshored from EU.
– Some EU firms set up in spokes and are now harmed by the
complexity (“us” becomes “them”).
– EU firms push EU to tame the tangle of FTAs.
• “Spaghetti bowl as building blocs”
• Complexity & unbundling create new politically
economy force
– Push system the short distance from near-free trade with
matrix of bilaterals to free trade ‘lake.’
– Multilateralise the FTAs.
• Domino effect in ROOs/Cumulation.
28
2 final steps
• Penultimate:
• Multilateralise the spaghetti bowl FTAs in North
America (when US firms become victims of the
complexity).
– NAFTA ROOs already popular.
– Diagonal cumulation is next.
• East Asia, much more difficult.
– Might be RTB unilateralism makes
ROOs/Cumulation irrelevant.
– ASEAN ROOs already popular.
29
2 final steps
• Ultimate
• As global unbundling continues, SBBB
pressures will mount.
• Impractical to do a PECS given PECS, NAFTA
& ASEAN ROOs.
• Alternative is ITA-like agreement with coverage
of most industrial goods.
– Zero-for-zero.
30
WTO’s role
• Penultimate: not much, should study impact of
PECS on non-members more closely.
• The final step could be in WTO, but not like
DDA.
• ITA was much more like old-fashioned GATT
Rounds.
– Much less emphasis on S&D.
– Principle supplier ideas.
– RTB unilateral to bring newly industrialising nations
along.
31
END
Thanks for listening:
www.hei.unige.ch/baldwin/
32