TCS Daily

Lateral Moves

By Bibek Debroy - September 10, 2003 12:00 AM

The Fifth WTO Ministerial is being held in Cancun. Anything done through the WTO (or through its forerunner, GATT) represents multilateral liberalization. In contrast, free trade agreements (FTAs) represent less-than-multilateral liberalization. Sometimes, they are bilateral. At other times, they are regional. Regional trade arrangements (RTAs) can of course fall short of free trade. They may merely have preferential tariffs, as opposed to zero tariffs of FTAs.

Whether FTAs support or contradict multilateral trade principles has been often debated, and the literature is full of theoretical and empirical analysis of trade creation versus trade diversion (and in more recent times, investment creation versus investment diversion). Conceptually, the idea is quite simple. FTAs generate welfare gains and lead to income growth. Ipso facto, they lead to greater trade. That's the trade or investment creation part.


However, if trade is substituted -- if it leads to trade with a more efficient country switching to trade with a less efficient country simply because the less efficient is a member of the FTA while the more efficient is not -- there are welfare losses. This represents trade or investment diversion.


Empirically, the issue hasn't been decided one way or the other. What we do know is that whenever multilateral negotiations tend to get stuck, as they did in the second half of the 1980s or second half of the 1990s, RTAs proliferate. It is therefore tempting to argue that RTAs represent a retreat from the multilateral goal of liberalization. The only problem with this argument is that RTAs haven't decreased in number since the Uruguay Round was successfully completed and WTO came into being in January 1995. Nor have they diminished in importance after the Doha Development Agenda (DDA) was successfully launched in 2001. Almost 200 RTAs have been notified to the WTO and the number increases every day.

There are different types of RTAs. There are pure FTAs. Going beyond FTAs, there are customs unions that have a common external commercial policy. Going beyond this, there are common markets that free up cross-border input flows. And finally, there are economic unions that coordinate macroeconomic policies. Had GATT or WTO been able to resolve the issue of whether RTAs are against multilateral liberalization or for it, Article XXIV of GATT (which governs RTAs) wouldn't have existed. Article XXIV legitimizes RTAs, provided that two conditions are satisfied. First, barriers to trade among members must be completely eliminated (usually over ten years), not just reduced. This is to ensure that most favoured nation (MFN) treatment, which is a building block of GATT but does not apply to RTAs, is not violated. Second, barriers to trade vis-à-vis non-members mustn't increase. There is some evidence that FTAs and customs unions lead to rules of origin requirements that act as non-tariff barriers (NTBs) faced by non-members. If this line of argument is accepted, one should argue that Article XXIV needs modification so that FTAs and customs unions are prohibited. But common markets and economic unions should be allowed.

However, both EU and the U.S. are likely to argue that RTAs are stepping stones toward the goal of multilateral trade liberalization. After all, negotiation among a few members has lower transaction costs than negotiating among 146 WTO members. Therefore, RTAs supplement multilateral liberalization efforts. After completing one with Jordan, the U.S. now has FTAs with Chile and Singapore and has been trying to push a Free Trade Areas of the Americas idea. Extrapolated, there will some day be a huge economic area in America, with a similar one covering all Europe. There will possibly be a third centred on ASEAN and including China, South Korea and Japan. Africa and South Asia are not yet members of any major RTAs.

Some trade experts sometimes argue that with tariffs dropping through WTO and GATT, FTAs no longer matter. NTBs (non-tariff barriers) are also getting disciplined. This argument is true, but one must be careful.


Tariffs and NTBs are being reduced or disciplined only for industrial products; but not yet for agriculture, as most FTAs exclude agriculture. Nor has the services sector been liberalized through multilateral negotiations, where we have only had the beginnings of liberalization. RTAs or FTAs can push the services sector liberalization faster than WTO. They can also ensure stronger compliance and better norms for intellectual property rights.


Hence, RTAs fast track when the WTO gets stuck and offers a precedent for future WTO negotiations. But also remember that RTAs have clauses on labour and the environment, clauses that should not only be out of the WTO, but should also be out of RTAs. WTO negotiations discipline asymmetry in negotiating power. No such luck with RTAs.

We therefore don't know whether RTAs are good or bad. We know they are here and will continue to be. We also know that governments sign RTAs. Governments don't determine trade and investment flows. Individual companies do. Government-signed RTAs usually formalize what is already happening on the ground. Perhaps we should be less obsessed with them.


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