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Part IV: the bigger picture views from academia: Preferential trade agreements: a multilateral perspective.

Introduction The relationship between preferential trade agreements (PTAs)2 and the multilateral trading system has sparked endless debate about how PTAs have affected the integrity and relevance of the World Trade Organization. For some, preferential ism is divisive, costly and largely unwelcome. This has become something of a minority view in recent years, although a wide body of literature acknowledges that whatever the benefits are of these kinds of agreements, they nevertheless carry costs avoided by a non-discriminatory regime. For others, PTAs are a reflection of the need for governments to maintain a context for trade cooperation in the face of the WTO's failure for almost two decades to negotiate anything. If PTAs are really a self-help mechanism, the argument goes, one should not be too critical of their discriminatory fallout.

While both of these views can be defended, neither of them is particularly conducive to a search for pragmatic middle ground in a situation where both complementarity and conflict are possible. A nuanced view recognises that non-delivery on the part of the WTO has almost certainly contributed to the explosion of PTAs in the last two to three decades. At the same time, some PTAs are clearly designed to integrate their members more deeply and across a wider range of issues, going beyond what the WTO can realistically offer.

This article explores the origins of PTAs and their rationale, the costs of preferentialism, the reasons for stasis in the WTO's negotiating functions, and a possible way forward for attaining greater coherence between the WTO and PTAs.

The Origins and Rationale of PTAs

The possibility of discriminatory trade arrangements was permitted from the GATT's inception3 (liudec, 1991), in no small part to cover arrangements already in place. The first major preferential agreements were established in Europe--the Treaty of Rome establishing the European Community in 1957 and the creation of EFTA in 1960. By 1990 some 70 PTAs existed'. Today, more than 300 preferential agreements are in operation. Many more are being negotiated. Every WTO member belongs to, or is in the process of negotiating, one or more PTAs. Some countries belong to many, with the result that, on average, each WTO member is signatory to no fewer than 13 different preferential agreements. Approximately half of the PTAs in existence today are bilateral, while the rest incorporate three or more members.

Over the years. PTAs have become less about tariff preferences and more about the regulatory side of trade. It is somewhat surprising that in 2008 only 16% of trade between WTO members received preferential treatment in the face of positive most-favoured-nation (MFN) tariffs. Half of the balance was already MFN duty free and the rest were items to which PTAs partners did not extend discriminatory access. It is notable that two-thirds of goods attracting MFN tariffs in excess of 15% were not granted preferences under any PTA. Thus, while the non-tariff measure side of PTAs has become more important, it does not mean that tariffs are no longer an issue in relation to some trade flows.

Why have PTAs proliferated so much in recent years? It is tempting to attribute this to the failure of the GATT/WTO to deliver on negotiations. No doubt there is some truth to this, but it is far from the whole story. A major expansion in PTAs took place during the Uruguay Round, for example, even though this was considered a highly successful negotiation. An element in PTA formation is political, possibly embracing considerations that are not relevant in a multilateral setting. Forging neighbourly relations or solidifying political links are likely to be relevant in some cases. The recent drive to establish "mega-regionals" such as the Trans-Pacific Partnership (TPP), the Regional Comprehensive Economic Partnership (RCEP) and the Transatlantic Trade and Investment Partnership (TTIP) arc clearly suffused with geopolitics. Some of the politics behind PTA formation, such as regional rivalries, could perhaps be partly addressed in a multilateral setting, but other elements need the specificity of a narrower setting.

Among the other reasons why governments are attracted to PTAs is the fear of exclusion, or the domino effect. Some PTAs aspire to go further and faster than the WTO, reflecting frustration with ponderous multilateral processes. In other cases a PTA may seem appealing as an insurance policy against the risk of emerging protectionism, on the assumption that preferential partners would be the least and last affected. Alternatively. PTAs could serve as a protectionist mechanism, explicitly designed to draw some economies closer together while excluding others. While discrimination obviously has exclusionary effects, there is not much evidence that PTAs have been designed with this objective in mind, at least not until the strategically-driven mega-regionals appeared. It would be fair to withhold judgment on these agreements, however, until we see what they look like. Finally, some PTAs have been motivated in part by the desire to impart a sense of credibility about a government's policy intent, as well as continuity and greater stability through a tie-in effect.

Taking all these considerations together, it is implausible to suggest that PTAs will go away in any foreseeable future. This does not mean that PTAs cause no harm or run no risk of fragmenting trade relations in ways that would be very difficult to reverse. Nor does it mean that nothing can be done to minimise the costs of discrimination through preferential trade. These issues are taken up in the rest of the article.

The Costs of Preferentialism

One analytical difficulty in reaching conclusions about the costs of discrimination in trade arises from the fact that we need to be clear about the point of comparison. If the basis for assessing the downside of discrim ination is a perfect world in which no discrimination occurs. then the picture is clear. But the theory of the second best (Lipsey and Lancaster, 1955-56) tells us that if the first best is unattainable, we cannot readily make economic welfare comparisons between different, potentially second best. discriminatory scenarios. While this theoretical construct might seem arcane, it can be important when attempting to assess the impact of PTAs. It can mean that we are unable at first glance to conclude that less discrimination is better than more--it all depends on the circumstances.

From another perspective, Jacob Viner showed that discriminatory trade policy could both create and divert trade (Viner, 1950). Trade creation occurs when one country inside a PTA captures market share in the domestic market of another country inside the grouping as a result of the preferential lowering of a tariff. Trade diversion occurs in a similar situation. except that a more efficient producer outside the PTA loses the market to a less competitive preferential supplier. Trade diversion is obviously a cost to the global economy, which may be set off or partially so by trade creation or through a growth effect arising from the trade opening that occurs within a PTA from which outsiders can also benefit. The impact of trade diversion is ultimately an empirical matter depending on the situation prior to the establishment of a PTA as well as on its design. In short, we should not deny the real possibility of costs attached to discrimination.

In modern economies, it is not tariffs that are the greatest source of concern in terms of the discriminatory impact of PTAs. It is regulation and the risk of a continuing process of regulatory divergence. Trends are not easy to identify with precision, but it is not difficult to see how product standards diverge in ways that segment markets and affect competition. To the extent that PTAs reinforce regulatory differences, they augment the costs of doing business. The recognition of professional qualifications is a good example of where this occurs.

Another source of additional cost associated with PTAs is the rules of origin, which distort markets and sourcing choices when producers are obliged to trade off efficiency in production with access to markets. Rules of origin regimes also oblige businesses to incur deadweight administrative costs to ensure compliance. More generally, in a world of highly integrated production structures, where the ubiquity of global value chains has resulted in some two-thirds of merchandise trade consisting of intermediate goods, it is not difficult to see how markets fractured by crisscrossing and potentially incompatible trade regimes can frustrate trade and raise costs. The same can be said in respect of services, which are a considerably larger share of total trade than is generally appreciated, or easily measurable.

The WTO: Weakened Negotiating Capacity

The only successfully concluded negotiations under the auspices of the WTO have been on telecommunications and financial services, the Information Technology Agreement (ITA), and the re-negotiation of the Agreement on Government Procurement (GPA). These are slim pickings in comparison to what has been on the table for 12 years in the Doha Round. At the time of writing, much rides on the outcome of the WTO Ministerial meeting in Bali, Indonesia, in December 2013, in terms of making progress in those negotiations. In thinking about how PTAs and the WTO might cohere more effectively, it is worth asking what is amiss with the WTO in relation to its negotiating function.

Possible explanations fall into two broad categories. The first is political, and also applies in other realms of international cooperation such as climate change and the international financial architecture. The last few years have witnessed a sharp shift in the weight of economic power. largely towards China and the East, as well as other emerging economies. This has changed the leadership dynamics on the international scene and has made agreement more difficult.

One way this manifests itself is in terms of the substantive discussions that have taken place over the years on the balance of rights and obligations among WTO members. The industrial countries tend to the view that the emerging economies are excessively reticent about raising their level of obligations. The emerging economies feel that despite their dynamic growth rates they still face considerable developmental challenges, in respect of which the industrial countries are less than fully understanding. These differences will have to be finessed for real progress to be made.

Secondly, there is the question of what is being negotiated. One aspect of this question is whether what the WTO is negotiating more than a decade on from the launch of the Doha Round really responds to the needs of the world economy. Some have said the agenda is markedly' 20th century and the WTO is being len behind. The prominence and continued growth of international value chains is at the heart of this concern. The main point is that business cannot compartmentalise policy on goods, services, investment, procurement, standards and intellectual property in the way that the WTO does. This leads to incoherence, potential inconsistencies and makes the rules less responsive than they should be to the needs of the marketplace. This is an area where work is needed. Some lessons could be drawn from the way in which some PTAs have sought to respond to this reality.

Another argument is that historically the WTO has mis-specified its core mission, over-emphasising trade liberalisation at the expense of playing to its real strength, which is rule-making. History shows that apart from the reduction of industrial tariffs in industrial countries over several decades, the GATT/ WTO's record on market opening has not been strong. No developing country has ever lowered an applied MFN tariff on the altar of a GAIT! WTO negotiation other than in a GATT/WTO accession and in the ITA. Moreover, the record on market opening in labour-intensive manufactures, services and agriculture is modest at best. One reason for patchy and modest progress on trade liberalisation is the juxtaposition of reciprocity and MFN as principles for negotiating market access. The combination of reciprocity and MFN makes it difficult for large and small countries to negotiate. Large countries will typically be reluctant to negotiate on the basis of relative reciprocity with small ones because they do not want other large countries to free ride on such deals via MFN. They want absolute reciprocity, not relative reciprocity, however measured. The Doha Round is more intensive in trade liberalisation than practically any other negotiation in the history of the institution. We should also remember that, unlike the WTO's function of establishing global trade rules, there are other venues for trade liberalisation--namely the preferential and unilateral routes.

The third aspect of the content of negotiations is about the legal character of agreements under the WTO. There is a tendency to assume that the WTO only deals with hard law which is justiciable through the dispute settlement system. Perhaps, however, there is room for softer versions of cooperation, ranging from information sharing to comity. The purpose of considering this approach is not to weaken the level of contractual commitment. but rather to facilitate and deepen it on the basis of a better understanding among potential parties to agreements. The Trade Policy Review Mechanism and the 2006 Transparency Mechanism for examining notified PTAs are examples of this approach.

The WTO and PTAs: Towards Greater Coherence

An obvious mechanism for bringing PTAs and the WTO closer together would be for the WTO to make more progress multilaterally. But there is also another possibility--the multilateralisation of regionalism'. In the case of tariffs, this might mean that each PTA would work towards narrowing the gap between MFN and preferential rates on a non-discriminatory basis. The WTO's role here would he a gradual process of consolidation and rationalisation. On the regulatory side, the process could begin by concentrating on the least contentious elements in PTAs and simply making them part of the WTO. Provisions would be crafted on the basis of whichever VIA was deemed to strike the most appropriate balance around which agreement could be achieved, or else new provisions could be fashioned from an amalgam of different approaches. The relevant provisions in the PTAs concerned would then be aligned to the new multilateral formulation. A prior stage to actually crafting new WTO provisions might be to develop best practices as a way of building confidence in the process. An obvious place to launch work in this direction would be through the Transparency Mechanism.

One key feature that would influence the success of a programme of multilateralisation relates to decision making. On the assumption that some of the leading PTAs, including between developed and developing countries, may aim for provisions exceeding the quality found in the WTO, it is reasonable to assume that some of these would go further than a number of smaller and weaker economies would consider manageable, or in their best interest. For this reason, a viable multilateralisation process would need to he based on a critical mass decision-making approach of the kind used in the telecommunications and financial services negotiations and in the ITA. The essence of this approach is that it customises the balance of rights and obligations among the membership around each issue, without embedding any discrimination against those who do not assume the obligations in question. A critical mass defines itself in terms of which members the participants believe must be part of the agreement before it can be multilateralised.

Concluding Observations

Preferential trade agreements will not disappear any time soon. They do not offer the inclusiveness of the multilateral trading system and carry additional costs. But the perfect is not necessarily the friend of the possible. Rather than gainsay preferentialism, the challenge is to blunt its downside, rejuvenate and give meaning to the global vision of the WTO, and launch a process to multi lateralise PTAs.

References Hudec, R. E. (1991) enforcing International Trade Law: The Evolution of the Modern GATT legal system, (Salem, New Hampshire: Butterworths Legal Publishers).

Lipsey, R.G. and Lancaster, K. (1955-56) The General Theory of the Second Best, Beview of Economic Studies, xXIV, 11-32.

Low, P. (2012) The TPP in a Multilateral World, in Lim, C.L., D.K. Elms, and P. Low (eds.) The Trans-Pacific Partnership: A Quest for a Twenty-first-Century Trade Agreement, (Cambridge: Cambridge University Press).

Viner, J. (1950) The Customs Union Issue, (New York: Carnegie Endowment for International Peace).

WTO, (2011) The WTO and preferential trade agreements: from coexistence to coherence, (Geneva: WTO). Downloadable at: trade_report11_e.pdf

(1) Patrick Low is Vice President for Research at the Funs Global Institute in Hong Kong. Until mid-2013, he was Chief Economist at the WTO for 16 years. The views expressed here are those of the author.

(2) The designation of agreements among a subset of WTO members as preferential is preferable to the other commonly used designations--free trade area or regional trade agreement. This is because PTAs neither achieve free trade nor are all regional.

(3) This article only discusses reciprocal preferences embodied in free trade areas and customs unions. It does not consider non-reciprocal preferences.

(4) The figures cited here and in the following paragraphs are taken from the WTO's World Trade Report 2011.

(5) The full name of the mechanism is the Decision on a Transparency Mechanism for Regional Trade Agreements (adopted on 14 December 2006).

(6) See Low (2012) for an elaboration of how this might work.
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Author:Low, Patrick
Publication:EFTA Bulletin (Switzerland)
Article Type:Column
Geographic Code:4E
Date:Dec 1, 2013
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