The Case for Free Trade and the Role of RTAs

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The Case for Free Trade and the Role of RTAs

• P. J. Lloyd and Donald MacLaren
• University of Melbourne
• Seminar on
• Regional Trade Agreements and the WTO
• Geneva, 14th November 2003

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The Case for Free Trade and the Role of RTAs

• Introduction
• 1. Predictions of trade theory
• 2. Evidence from CGE models
• 3. Hub and spokes arrangements
• 4. Effects of RTAs on multilateral trade
  negotiations
• 5. Conclusions

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1. Predictions of Trade Theory

• The theory of RTAs on which GATT Article XXIV
  could have been based
• Viners contribution
• trade creation and trade diversion
• ... where the trade-diverting effect is
  predominant, one at least of the member countries
  is bound to be injured, the two combined will
  suffer a net injury, and there will be injury to
  the outside world and to the world at large.
• During the 1950s and 1960s it was demonstrated
  that parts of Viners predictions may not hold,
  e.g., trade diversion did not necessarily imply a
  lowering of welfare

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• Modern analytics for a single, open economy with
  perfect competition and constant returns to scale
  (first-generation assumptions), can use a
  compensation function
• B e ( p, u ) g ( p, v ) ( p p ) m
  (1)
• where e is national expenditure, g is national
  product and ( p p ) m is trade tax revenue
• B measures the compensation needed to allow
  households in the economy to reach a given level
  of utility

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• Suppose this economy joins an RTA
• Then p will change as tariff rates are adjusted
  from pre-RTA MFN levels to preferential RTA
  levels
• Then
• ? B ? e ? ? g ? ? R
• which can be expanded, after some algebra, to
  give
• ? B ?trade volume ?intra-union terms of
  trade ?extra-union terms of trade (2)
• The sign of ?B is ambiguous
• If ?B 0, it
  loses
• However, there is a presumption that members gain
  from the RTA

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• This expression for ?B also shows clearly that
  measuring changes in trade volumes alone will not
  predict whether a country gains or loses
• Other assumptions
• imperfect competition (love of variety and
  economies of scale) second generation models
• investment, factor accumulation and growth third
  generation models
• Second and third generation models tend to
  strengthen the presumption that members gain
• For second-generation models, equation (2)
  becomes
• ? B ?trade volume ?intra-union terms of
  trade ?extra-union terms of trade ?output
  ?average cost ?varieties

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• What are the welfare effects for excluded
  countries which, pre-RTA, traded with the
  members?
• In first generation models, theory predicts that
  excluded members, as a group, lose, although some
  individual countries may gain
• In second generation models, theory predicts that
  these losses may be greater than in
  first-generation models
• What does the evidence from computable general
  equilibrium (CGE) models suggest?

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2. Evidence from CGE Models

• Structure
• data base of bilateral trade flows
• data base of transportation costs and tariff
  rates
• tariff on good i from region r to region s
• behavioural equations
• accounting identities
• Caveats
• design of the experiment
• values of the elasticities
• the Armington assumption and CES functions
  biases
• Summary of Results

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• Formation of NAFTA (Brown et al. (1992))
• using a second generation model they found that
• each member gained
• 31 excluded countries lost
• using a third generation model they found that
• the gains to Mexico were three times greater
• the excluded countries lost
• EU Single market (Haaland and Norman (1992))
• using a second generation model and representing
  deeper integration by a 2.5 reduction in
  intra-EU trade costs, they found that
• EU gained 0.64 of GDP (internal markets
  integrated) and 0.40 (internal market
  segregated)
• EFTA lost 0.22 and 0.15 of GDP, respectively
• conclusion excluded members lose but the size
  depends on assumptions about market structure in
  the RTA
• Asia-Pacific Region

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Table 1 Welfare Changes as a percentage of base
period GDP
Source Scollay and Gilbert (2001)
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• Conclusions about gainers and losers
• global, multilateral trade liberalisation
  generates the greatest gains to the world economy
• the size of the gains is dependent upon the
  underlying theory, the base period and the design
  of the experiment
• countries, in aggregate, lose from being excluded
  from an RTA
• the larger the RTA, the larger are these losses
• in principle, a Pareto improvement is possible
  but in the absence of inter-regional transfers,
  RTAs are undesirable for outside countries

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3. Hubs and Spokes

• The configuration of RTAs has changed
• from a given country being a member of one and
  only one RTA, if a member at all
• to the same country being a member of more than
  one RTA
• The configuration today has been described as hub
  and spokes
• The hub may be
• a single country, e.g., the U.S. or Singapore
• a group of countries (plurilateral hub), i.e., an
  RTA itself, e.g., ASEAN
• The spoke may be
• a single country
• an RTA (plurilateral spoke)

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RTAs in Effect in the APEC region, 2003
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• Hubs and spokes create
• two layers of discrimination
• the hub enjoys access to each and every spoke on
  a preferential basis as most hubs are developed
  countries, it is to them that the bulk of the
  gains have gone
• each spoke enjoys preferential access only to the
  hub
• each hub and each spoke discriminates against
  non-members
• complex rules of origin
• forces for RTAs to coalesce into regional blocs
• increased discrimination against excluded
  countries, particularly developing and
  least-developed countries

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4. Effects of RTAs on Multilateral Trade
Liberalisation

• The growth of RTAs may affect the rate of
  multilateral liberalisation by
• affecting the pace of liberalisation from MTNs
  the building block or stumbling block debate
• affecting the pace of unilateral liberalisations
• Evidence on the first
• if based on theory, is ambiguous, depending on
  whether the objective is welfare maximising or
  political self-interest
• if based on empirical evidence pre-Cancún, RTAs
  have not slowed the pace
• post-Cancún, the EU and the U.S. have signalled a
  passive role in MTN but a pro-active role in RTAs

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• Evidence on the second is mixed
• countries in ASEAN, CER and Latin America have
  continued to liberalise unilaterally within their
  RTAs
• within NAFTA, Mexico and Canada have done
  likewise
• neither the EU nor the U.S. has engaged in
  significant unilateral liberalisation over two
  decades

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5. Conclusions

• the growth in RTAs has substantially increased
  discrimination in world trade
• with the creation of plurilateral hubs and
  spokes, that discrimination has become
  multi-layered
• rules of origin have become more complex
• Article XXIV of GATT has failed to protect the
  interests of outside countries because
• it was based on inadequate trade theory
• it is inconsistent with the elimination of
  discriminatory treatment in international
  commerce (preamble to GATT 1947, see WTO (1995))

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• the elimination of discriminatory treatment in
  international trade relations appears in the
  preamble to the Marrakesh Agreement establishing
  the WTO (WTO (1995)) and yet it, too, is being
  ignored by those Members who are forming RTAs

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References

• Brown, D. K., A. V. Deardorff and Stern, R. M.
  (1992), A North American Free Trade Agreement
  Analytical Issues and Computational Assessment,
  The World Economy, 15, 11-29
• Haaland, J. and V. Norman (1992), Global
  production effects of European integration, in
  L. A. Winters (ed.) Trade Flows and Trade Policy
  after 1992, Cambridge University Press,
  Cambridge
• Scollay, R. and J. P. Gilbert (2001), New
  Regional Trading Arrangements in the Asia
  Pacific?, Institute for International Economics,
  Washington, D. C.
• Viner, J. (1950), The Customs Union Issue,
  Carnegie Endowment, New York
• WTO (1995), The Results of the Uruguay Round of
  Multilateral Trade Negotiations The Legal Texts,
  Geneva