Part 11 - Regional Trade Agreements (RTAs) and trade liberalization

Question 1

Is multilateral trade liberalization (GATT/WTO) preferable to regional trade agreements (RTAs) or not?

Answer 1

Yes, because multilateral trade liberalizations are always welfare enhancing but on the other hand agreement among all WTO-members necessary and more difficult to find any compromise among 164 countries.

Question 2

Regional Trade Agreements (RTAs)

Answer 2

• Used as an umbrella term for all sorts of free trade agreements (including costums unions). Note that RTAs are sometimes also called free trade agreements (FTAs) or preferential trade agreements (PTAs).
• RTAs were historically often confined to a region not true any longer.
• RTAs can be between two countries (bilateral) or more than two countries.

Question 3

Regional Trade Agreements (RTAs) are

Answer 3

agreements between countries in which they lower tariffs and other trade barriers for each other but not for the rest of the world and other WTO-members, respectively.

Question 4

RTAs are an important exception MFN-principle, examples are:

Answer 4

• customs unions
• other free trade agreements
• Famous RTAs include the North American Free Trade Agreement (NAFTA), the European Union (EU) and the Association of Southeast Asian Nations (ASEAN).

Question 5

why are RTAs controversial?

Answer 5

due to their discriminatory nature:
• trade creation vs. trade diversion
• expect a negative welfare effects for non-members and members possible.

Question 6

Important distinction between customs union and other forms of RTAs:

Answer 6

• Members of a customs union have a common external tariff, i.e., all members of a customs union apply the same tariff rate fora given product vis- -vis an external trade partner.
• In constrast, each member of a free trade agreement can independent of other members decide over the tariff it applies for a given product vis- -vis an external trade partner.

Question 7

RTAs are increasing or decreasing?

Answer 7

Strong increase in RTAs starting from early 1990s. As of April 2020, 303 RTAs were in force (covering goods or services or goods and
services). This number increases to 321 RTAs including accessions.

Question 8

Two main economic explanations for RTA-formation:

Answer 8

• Natural trading partner hypothesis.

* Domino theory of regional integration.

Question 9

Natural trading partner hypothesis:

Answer 9

• Countries closer to each other and with existing high levels of trade integration are more likely to sign RTAs.
• Two important implications:
− Strong trade diversion and, hence, negative welfare effects less likely.
− Formation of RTAs not by chance.
− Self-selection of „better“ trading partners into agreements makes causal inference more challenging.

Question 10

Domino theory of regional integration:

Answer 10

The „domino theory“ of regional integration goes back to Baldwin (1994, 1995).

The key idea to success is relative competitiveness, i.e., whatever helps the rivals of a given firm hampers a firm‘s success and outlook.

Question 11

EEC vs EFTA

Answer 11

• In response to formation of the European Economic Community (EEC) in the 1950s, seven nations formed their own trade liberalization bloc (EFTA) in 1960.
 
• Main driver: Fear of discrimination and marginalization.
 
• The European Free Trade Association (EFTA) encompassed Britain, the largest European economy by that time.
 
• Discrimination in Europe started to appear, since trade barriers fell within the EEC and within EFTA (but not between the groups). NOT ACROSS THEM.
 
• The EEC club became far more attractive to exporters due to bigger potential market and higher growth rates new political pressure for EFTA nations to join the EEC.

• The United Kingdom applied for EEC membership in 1961 and Denmark, Ireland and Norway also followed since they would otherwise face stronger discrimination.
 
• Other EFTA nations did not apply for political reasons.
 
• Note that EFTA consists of Iceland, Liechtenstein, Norway, and Switzerland today.

Question 12

Are trade agreements signed to reduce discrimination created by third-nation RTAs?

Answer 12

Baldwin and Jaimovich (2012) show that RTAs are indeed contagious and the degree of contagion is related to the importance of the partners‘ markets.

Question 13

Direct market access refers to

Answer 13

tariffs on a bilateral trade.

Question 14

Relative market access refers to

Answer 14

the tariff advantage or disadvantage that the system of preferences provides relative to all foreign competitors.

Question 15

Fugazza and Nicita (2013) show that …

Answer 15

direct market access has primary effect on trade flows, but also indirect market access matters.

For some countries overall effect is negative (India, Iran, Japan, Korea and Taiwan).

Question 16

How large are the trade effects of RTAs?

Answer 16

Trade effects of RTAs are positive and quite large, in particular if we take the self selection of better trading partners into RTAs into account.

Question 17

Welfare estimations approximated with trade flows:

Answer 17

RTAs increase national welfare when more new trade is created, than existing trade from the outside world is diverted to trade with member countries which causes a positive net trade creation.

Question 18

Trade creation:

Answer 18

− New trade within the RTA is created by agreement.

− Shift of production from inefficient domestic providers to efficient RTA-members positive welfare effects.

Question 19

Trade diversion:

Answer 19

− Trade within RTA simply replaces trade with countries outside it.
− Shift of production from efficient external suppliers to inefficient RTA-members potentially harmful for both non-members and members.

Question 20

Net trade creation:

Answer 20

Trade creation minus trade diversion

Question 21

Net trade creating effect evidences:

Answer 21

Most studies find evidence for trade creation but little or no evidence for trade diversion. Overall, the empirical literature finds a net trade creating effect, i.e., trade creation dominates trade diversion.

But for some RTAs (e.g., MERCOSUR –Argentina, Brazil, Paraguay and Uruguay) or some industries trade diversion can be substantial.

Question 22

trade creation > trade diversion

Answer 22

positive welfare effect as a consequence

Question 23

trade creation < trade diversion

Answer 23

negative national welfare effect as a consequence

Question 24

empirical evidences on trade effects of RTAs

Answer 24

Most studies find evidence for trade creation but little or no evidence for trade diversion. Overall, the empirical literature finds a net trade creating effect, i.e., trade creation dominates trade diversion.

Question 25

For some RTAs (e.g., MERCOSUR –Argentina, Brazil, Paraguay and Uruguay) or some industries trade diversion can be substantial.

TRUE OR FALSE?

Answer 25

TRUE

Question 26

EEC trade

Answer 26

EEC countries liberalized trade with each other, so they granted better direct market access but they also enjoyed a relative better market access

Question 27

Concluding RTA

Answer 27

1. No empirical evidences on average negative economic effects of RTAs (trade flows) at least if we compare trade creation and trade diversion, but RTAs remain controversial in the public.
2. Politicians often stress the positive employments effects of trade liberalization.
3. If we do not sign RTAs you may be in disadvantage of other trading partners that are signing RTAs.
4. RTAs relation to employment - it does not create new jobs however we can think that it secures jobs that already exists and potentially increase it.