Topic 5: Global and Regional Free Trade Arrangements

Reference: K&O: Chpt 9 pg 227-248** Kreinin: Chpt 4: pg 83-91** Chpt 7: pg 140-149** Key issues: The evolution of global free trade negotiations over time Why the popularity of regional preferential trading arrangements What are the issues going forward for global free trade (I) Global Free Trade Arrangements Global free trade agreements over the years have brought down tariff rates dramatically Used as an instrument for domestic reforms Used to balance interests of different groups Used to achieve certain income redistribution Help to avoid destructive trade war Cooperative vs Nash equilibrium (see slide)

(A) General Agreements on Tariff and Trade (GATT) Informal framework for trade negotiations 1947-1994 Origin of GATT (International Trade Organization) Three pillars of new world order: GATT, World Bank and IMF Principle of Most Favored Nation (MFN): tariff concessions agreed among member countries are extended to all other member countries; tariffs levied on a good are applied to all supplying countries Eight rounds of negotiations under GATT Each round named after the city that hosts the first meeting Each round results in some changes in international trade rules, tariff and NTB reduction etc. Not all were deemed successful. Trend towards Managed Trade over the years Tariff reduction under GATT accompanied by rise in NTB Difficulty in reducing/removing NTBs

(B) World Trade Organization (WTO) Began on 1 Jan 1995. Replaced GATT. Based on following principles MFN principle: with some exceptions for developing countries General prohibition of export subsidies (except for agriculture) and import quotas (exceptions for developing countries) New tariff to be offset by reduction in other tariffs More power than GATT through dispute settlement mechanism Special clauses dealing with needs and situations of developing countries Extend trade negotiations to other areas Agreement on Trade in Services (GATS) Agreement on Trade-Related Aspects of Intellectual Property (TRIPS) Agreement on Trade-Related Measures on Direct Foreign Investments Other issues on the agenda: competition law, environmental issues, labor laws etc Recent developments in WTO negotiations Future of global trade talks?

(II) Regional Preferential Trade Arrangements (PTAs) A group of countries eliminate trade discriminations among themselves but maintain discriminations towards countries outside the group Against global free trade and MFN principle Exception within WTO: seen as intermediate step towards multilateral free trade (A) Different forms of PTAs Free Trade Area: trade barriers removed among members, but each member maintains its own trade barriers against non-members. NAFTA, AFTA, Bilateral FTAs etc Customs Unions: No trade barriers among members and common trade barriers against non-members Common Market: Free movement of capital and labor, in addition to free movement of goods and services, among members.

Economic Union: Harmonization of fiscal and monetary policies (and/or other policies) among members, in addition to free movement of goods and factors. European Union

Difference with Free Trade Zone/Export Processing Zone: enclave within an economy to promote investment (B) Trade Effects of PTAs: Trade Creation vs Trade Diversion Trade creation: arises from elimination of barriers among members Trade diversion: arises from discrimination against non-members Illustration of trade creation and trade diversion (see Diagram) Net gain/net loss of PTAs PTA a second best solution to global free trade: Net gain/loss depends on relative size of trade creation and trade diversion. Factors that matter: The number of member countries: global free trade being the extreme Does geographical proximity matter? The common tariff against non-members: the lower the tariff, the less will be trade diversion The nature of the relationship between the two members: The more competitive (rather than complementary) the relationship i.e. the more similar the production pattern, the more the trade creation effect

(C) Overall Welfare Effects of PTAs Static gains The net welfare gains of trade creation vs trade diversion Saving on administration cost among members Increased bargaining power for PTAs members against rest of world Dynamic Gains Increased competition among members: a la free trade argument Economies of scale: a la free trade argument Stimulus to investment: attract more FDI If it is common market: gains from free movement of factors

(D) Other issues related to PTAs Lack of success in WTO talks. What happens to Doha Round? Conflict between global free trade and regional free trade arrangements o Concept of WTO consistent open regionalism No less links with non-member countries Expansion of FTA to include more members over time e.g. Singapore-NZ-Chile Better management of the political implications of free trade o Different templates for different FTAs to limit damages Spaghetti bowl effects of FTA o How to manage problems of different templates? o How trade disputes between two countries may spread to all countries linked by FTAs Economic integration is ultimately a political act o Surrendering of sovereignty o Political, cultural, historical backgrounds of member countries matter o Success of the EU? East Asia economic integration?