Regionalism Worries?

Antoni Estevadeordal, Caroline Freund, Emanuel Ornelas, 25 July 2008

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At a moment when the successful conclusion of the Doha Round seems very much at risk, the question once again arise of whether governments’ seemingly irreducible interest in forming regional trade agreements (RTAs) is a blessing or a burden for the multilateral trading system.

Policymakers all over the world are voting with their feet, choosing regionalism as the preferred mode of liberalization. The WTO reports that over 250 RTAs are already in force, with several others currently under negotiation.

Many trade economists, led by Jagdish Bhagwati (2008), are concerned with this rise of regionalism, viewing preferential trading arrangements as inimical to the world trade system. In their view, regionalism reduces the incentives of governments to liberalize trade vis-à-vis non-member countries.

Not everyone agrees with that view, and theoretical results offer support for both sides, so whether regional and multilateral trade liberalization are antagonistic or complementary, ultimately, an empirical matter. This is our approach in a recent research paper, “Does Regionalism Affect Trade Liberalization towards Non-Members?” where we offer the first attempt to evaluate empirically the effect of preferential tariffs on external trade liberalization in a large group of developing countries.

When countries form a regional trade agreement, they lower the tariffs they apply on each other, but the duties they apply on imports from outside countries can increase, decrease, or remain unchanged. We study how countries in Latin America, where regionalism forces have been particularly strong since the early 1990s, have altered their trade policies vis-à-vis countries outside the bloc after forming RTAs. Specifically, we examine whether sectors with relatively large preferences have been liberalized or protected to the same extent as other sectors. If countries raise their external tariffs (or reduce them by less) as a result of regional liberalization, such preferential arrangements should indeed raise concerns about the recent trend. If instead preferences lead to relatively lower external tariffs, then regional agreements deserve a more benign reputation than they currently have.

Regionalism is a building bloc to free trade

Our results imply that regionalism is a building bloc to free trade. There is no clear evidence that trade preferences lead to higher tariffs or smaller tariff cuts. There is strong evidence that preferences induce a faster decline in external tariffs in free trade areas. For example, if a country that follows a strict policy of non-discrimination offers free access to another country in a sector where it applies a 15% multilateral tariff, the country would tend to subsequently reduce that external tariff by over 3 percentage points. This complementarity effect is stronger in sectors where trade bloc partners are more important suppliers, precisely where trade discrimination would be more disruptive.

Regionalism is most helpful in sectors where multilateralism works best

The complementarity between preferential and external liberalization is particularly strong also in sectors in which WTO ceilings prevent increases in applied tariffs. That is, reductions in preferential tariffs induce deeper cuts in external tariffs when WTO commitments bind. Thus, our research suggests that the more effective the WTO is in terms of having members binding their multilateral import tariffs at levels near the applied rates, the more effective free trade areas become in bringing multilateral tariffs down. Or put differently, regionalism is likely to be more helpful precisely when the multilateral system works best.

It doesn’t work for customs unions

These results apply to free trade areas (FTAs), where members exchange preferences but keep independent trade policies vis-à-vis nom-members. NAFTA is probably the best known example of an FTA, which represent over 90% of the existing regional agreements. The other main type of agreement are customs unions (CUs), which are distinguished from FTAs mainly because they presume a coordination of the external trade policies of their members, as in the European Union.

Interestingly, the results depend on the type of agreement considered. When we look at how CU members adjust their external tariffs after they exchange preferences, we find no meaningful effect. External tariffs are largely unresponsive to preferential liberalization when members set them cooperatively. This is in a way surprising, since many economists tend to favour CUs over FTAs, because integration under the former is often deeper. We find that, at least to the extent that external tariff adjustments are concerned, FTAs have an edge over CUs.

Conclusion

The most important message of our research is that neither of the two main types of regional integration induce countries to adopt more protectionist policies toward outsiders. This probably helps to explain why, despite several years of intense negotiations of regional trade agreement deals, there are no clear signs that regional partners are trading more among themselves at the expense of trade with outsiders.

In that sense, our findings offer an optimistic view of the current wave of regionalism. On this issue at least, multilateralists do not seem to have much to worry about.

References

Bhagwati, Jagdish (2008). Termites in the Trading System, Oxford University Press.
Estevadeordal Antoni, Caroline Freund, and Emanuel Ornelas, Does Regionalism Affect Trade Liberalization Towards Non-Members? CEP Discussion Paper No. 868, May 2008.

Topics: International trade
Tags: customs unions, free trade areas, multilateralism, regional trade agreements, regionalism

Manager of Integration and Trade, Inter-American Development Bank
Lead Economist, International Trade Team of the Development Research Group at the World Bank
Reader in the Managerial Economics and Strategy Group, London School of Economics