Global Economy

Part IV: Regional Issues in the Global Economy
Regional Trade Agreements (RTAs) and trade creation

or trade diversion
1. Introduction
2. Political models of trade policy
2.1. The median voter theorem
2.2. Collective action
2.3. The actual trade policy is often based on a combination of
both principles
3. International Trade Agreements

3.1. The advantages of negotiations
3.2. International Trade Agreements: A Brief History

or trade diversion
4. The General agreement on Tariffs and Trade (GATT)
4.1. Principles
4.2. The Trade Rounds of the GATT
4.2.1. General
4.2.1. The Uruguay Round
5. The World Trade Organisation (WTO)

5.1. The WTO prohibits
5.2. The WTO members
5.3. The agreements and the dispute settlement procedure
5.4. Operation of the WTO rounds (until now 1: the Doha Round)
5.5. The Doha Round
5.6. Data of the WTOs World Trade Report 2011 with regard to
world trade
3

or trade diversion
6. Regional (or preferential) trade agreements
6.1. What?
6.2. Five types of Regional Trade Agreements
6.3. Regional Trade Agreements in the world
6.4. The evolution and importance of the RTAs the last 50 years
6.5. For or against RTAs
6.6. Influence of RTAs on national welfare
7. Conclusion

or trade diversion*
Reading (not compulsory):

Krugman, Obstfeld & Melitz, International Economics: Theory &
Policy, 9th edition, 2012, Chapter 10: The Political Economy
of Trade Policy, p. 249-285.
WTO, The World Trade Report 2011, 2011 (available online).
*: based on: Krugman, Obstfeld & Melitz, International Economics: Theory & Policy,
9th edition, 2012, Chapter 10: The Political Economy of Trade Policy, p. 249-285
(Pearson addison Wesley) and WTO, The World Trade Report 2011.
Regional Trade Agreements (RTAs) and trade creation or diversion
1. Introduction
How are trade policies formed in reality?
Politic models of a trade policy
International Trade Agreements: history
The GATT and the WTO
Regional (or preferential) trade agreements
2. Political models of trade policy

In reality, a trade policy is often influenced by its effect on income,
(i.e. the effects for individuals: consumers, producers, the
government, certain political pressure groups, etc ) instead of the
influences on the national welfare.
Indeed, there is not something like th national welfare.

How should this be measured?
Do all individuals count equally in the calculation?
The government equals how many individuals?
Is there a reality without pressure groups that want to
pursue their own interests? No!
How is trade policy determined?

In reality, when the governments have to choose a certain trade
policy, they are often guided by their chances of guaranteeing
their political success, rather than by the maximizing of national
welfare.
We look at three theories:

The median voter theorem
Collective action
A model that combines aspects of collective action and the median
voter theorem
2.1. The median voter theorem

What policy do political parties follow?
Assume 2 parties
Each party wants to get elected (and thus get the majority of the
votes)
Each party has only 1 topic on the agenda it can use to win votes: the
size of the tariff.
The votes of people differ with regard to the tariff they prefer.
The tariff is represented on the vertical axis from small to large.
We will line up all the voters according to the tariff rate they prefer,
starting with those who favor the lowest rate.
The median voter theorem predicts that democratic political parties pick
their policies to court (win) the voter in the middle of the ideological
spectrum (i.e. the median voter).
They want to gain the majority of the votes.
9
So both parties will opt for the same tariff.
Figure 1: The median voter theorem: Political competition
If party A chooses tA.

What will party B chose?
What policies will the parties promise to follow?

Both parties will offer the same tariff policy to court (win) the
median voter (the voter in the middle of the spectrum) in order
to capture the most votes.
Source: Krugman, Obstfeld (2012), International Economics, chapter 10, p. 260.
10

Thus, the median voter theorem implies that a two-party democracy
should enact a trade policy based on how many voters it can please.
A policy that inflicts large losses on a few people (the importcompeting producers) but that also inflicts benefits on a large
number of people (the consumers) should be chosen.
But a trade policy doesnt follow this prediction.
Free trade helps everbody a little, while protection helps a few
people a lot.
A trade policy will lead to large benefits for a small number of
people and small losses for a large number of people.
E.g. the sugarquota in the US: the consumers each pay a few
dollars a year. The small amount of producers gain each a lot from
protection.
So in the case of trade policy, this model leads almost always to wrong
predictions.
11
2.2. Collective action

Mancur Olson described political activity as a public good that leads to
a collective action problem: (see chapter 7)
While consumers as a group have an incentive to advocate free
trade, each individual consumer has no incentive because his
benefit is not large compared to the cost and time required to
advocate free trade.
Policies that impose large losses for society as a whole but small
losses on each individual may therefore not face strong opposition.
12

This problem of collective action can be nullified when the group is small
enough (and as a consequence each number of the group will get large
gains if the preferred policy is followed).
This is what happens to groups that ask for the implementation or
preservation of a trade policy.
For groups who suffer large losses from free trade (for example,
unemployment), each individual in that group has a strong incentive
to advocate the policy he desires (i.e. protection).
In this case, the cost and time required to advocate restricted
trade is small compared to the gain (i.e. no unemployment).
These kinds of interest groups will often try to bargain their
preferred policy.
13
2.3. The actual trade policy is often based on a combination

of both principles
While politicians may win elections partly because they advocate
popular policies as implied by the median voter theorem (= aiming at
the policies this median voters want), they also require funds to run
campaigns.
These funds may especially come from groups who do not have a
collective action problem and are willing to advocate a special interest
policy in exchange for some money to fund the campaign.
This way, politicians will often deviate from the popular policy of the
median voter and opt for the interests of their sponsors, in exchange
for large sums they can use for their campaigns.
Models of trade restrictions try to measure the trade-off between the
reduction in general welfare and the increase in campaign
contributions from special interest groups.
14
3. International Trade Agreements

3.1. The advantages of negotiations
After rising sharply at the beginning of the 1930s, the average U.S. tariff
rate has decreased substantially from the mid-1930s to 1998.
E.g. in the US
Figure 2: The tariffs in the US throughout time
Source: Krugman, Obstfeld (2012), International Economics, chapter 10, p.264.
15

How was this decrease in tariffs politically feasible?
Through international negotiations: governments decided to
mutually lower their tariff rates.
This is better achievable through multilateral than through
unilateral negotations because:
Multilateral negotiations mobilize exporters to support free
trade if they believe export markets will expand.
This support would be lacking if it would be a unilateral
decision.
These exporters counteract partially or even completely
neutralise the practices of the importers that try to
keep/maintain a protection of trade (e.g. the sugar
producers in the US).
Multilateral negotiations also help avoid a trade war between
countries (= a war where each country enacts trade
restrictions as a response on the action of the other country).
16

When can a trade war emerge?
A trade war could result if each country has an incentive to apply
some trade restrictions, independently of what the other countries
will do.
Then there will be a possibility that all countries will enact trade
restrictions, even if it is in the interest of all countries to have free
trade.
So, countries need agreements to prevent a trade war or to
eliminate the protection from one.
Example:
2 countries (US and Japan)
2 possibilities (trade protection through some kind of restriction or
free trade)
17
Table 2: The problem of trade wars
Each country acting individually would be better off with

protection (20 > 10).
Both countries would be better off if they both opt for free
trade (10), than if both opt for protection (5).
This is an example of a Prisoners Dilemma.
Source: Krugman, Obstfeld (2012), International Economics, chapter 10 p. 265.
18
If Japan and the U.S. can establish a binding agreement to

maintain free trade, both can avoid the temptation of protection
and both can be made better off (10 > -5).
Or if the damage has already been done, both countries can
agree to return to free trade.
In reality, there are more than two countries and more than two
possibilities. E.g. it is possible to apply free trade in general,
and protection for some well defined industries.
19
3.2. International Trade Agreements: A Brief History

In 1930, the United States passed the Hawley-Smoot Tariff Act.
This was a remarkably irresponsible tariff law.
Tariff rates rose steeply (even to 60 %), tariffs were put on more than
12 000 products and the U.S. trade fell sharply.
Other countries reacted (trade war) by increasing their own tariffs.
This resulted in the Great Depression of the 1920s-1930s.
= beggar-your-neighbour policies
= competitive devaluations and high tariffs in order to shift their
economic problems onto other countries.
20

This led to an almost total collapse of the international trading
system.
The impact of this policy can be illustrated through the spider web
spiral.
- This measures the size of the worldimport per month by
looking at the distance to the origin.
- In a period of only four years time, world trade flows
decreased to 1/3th of their previous level.
21

Figure 3: The spider web spiral: the size of the world import from 75
countries in millions US dollars during the Great Depression (January
1929 to March 1933)
January
january
1929
December
February
1930
1929 2998
1931
November
March
1930 2739
1932
1933
1931 1839
October
April
1932 1206
1933 992
September
Source: Van Marrewijk,

Nations and firms in the
Global economy, p. 179
May
August
June
July
22

We had to get out of the Great Depression, but how?
Aim: to get rid off (or lower) the very high tariffs that had nearly
liquidated all world trade.
Initial attempts to reduce tariff rates were undertaken through bilateral
trade negotiations:
E.g. the U.S. offered to lower tariffs on some imports coming from
country X if country X would lower its tariffs on some U.S. exports.
Bilateral negotiations, however, do not take the full advantage of
international coordination.
Benefits can spill over to countries that have not made any
concessions.
23

Afterwards, since 1944, much of the reduction in tariffs and other
trade restrictions has come about through international negotiations
(multilateral trade negotiations).
The allies wanted an International Trade Organisation (ITO)
that had to guide these negotations. However, this organisation
was never introduced.
In 1947 23 countries started trade negotiations that would lead to
the General Agreements on Tariffs and Trade (GATT).
It was begun as a provisional international agreement.
It was replaced by a more formal international institution called
the World Trade Organization in 1995 (during the Uruguay
Round).
24
Documentary: The Routes of Trade

What is trade? Where does the WTO fit into it?
The Routes of Trade looks at the origins of trade and the role of
the WTO within the international trading community.
http://www.youtube.com/watch?v=6dErtHD87U4
25
4. The General agreement on Tariffs and Trade (GATT)

4.1. Principles
See chapter 2
The GATT (and now the WTO) was (is) based on the following principles:
National treatment: Imports must be given similar treatment on the
domestic market as domestically produced goods.
Nondiscrimination: Enshrined in the concept of most favored
nation (MFN); every WTO member must treat every other member as
it treats its most favored trading partner.
This is a prohibition on discrimination.
What with the recent trade agreements such as NAFTA under the
WTO?
In theory, the WTO permits such agreements as long as they
do not harm the overall level of international trade.
In practice, the WTO has never challenged the validity of a
trade agreement between member countries.
26
4.2. The Trade Rounds of the GATT

4.2.1. General (see chapter 2)
The GATT (now WTO) continued trade talks and sector-specific
discussions in comprehensive rounds of negotiations.
until now there have been 8 rounds of negotiations under the GATT
(They are all completed). Under the WTO, there is the Doha round
which is still in progress.
Table 3:
The GATT/WTO
Rounds
Source:
Gerber,
International
Economics,
p. 23.
27

Figure 4: Length of the GATT/WTO Rounds and the number of
participating countries
W TO/GATT negotiation rounds
120
predicted duration of Doha round
100
Uruguay
duration (months)
80
Tokyo
60
regression
line
40
Kennedy
20
Geneva
Dillon
Annecy

International Economics
(2007), p. 244.
Torquay
Geneva II
30
60
90
120
number of participants
150
28

4.2.2. The Uruguay Round
The Uruguay Round was ratified in 1994:
Tariffs went down worldwide by 40 %. However, the tariffs were
already relatively low, so this 40 % decrease was not that big.
E.g. the average tariff fell from 6.3 to 3,9 %, and was only
responsible for a small increase in world trade.
All quantitative restrictions (like e.g. quotas) on the trade in textile
and apparel (clothing) as previously specified in the Multi-Fiber
Agreement (MFA) were to be eliminated by the year 2005.
It were exactly these products that were politically sensitive in the US
(cf. chapter 7).
However, the quotas on imports of textile and apparel, coming from
China, had to be temporarily reimposed, as a result of the huge
amounts of imports of these goods when the MFA expired.
These new importquotas have to disappear by 2013.
29

The exportsubsidies for agricultural products had to be phased out.
This Round established the WTO.
30
5. The World Trade Organisation (WTO)

5.1. The WTO prohibits:
Exportsubsidies:
Except for agricultural products
Import quotas:
Except if these are used as a means against market disruption
(e.g. the sudden surge in imports of a certain product).
Tariffs:
Each tariff or each increase in tariffs has to be abolished by a
decrease in other tariffs to compensate the affected exporting
countries.
31
5.2. The WTO members:

Figure 5: WTO members
160 members (25 June 2014)
Source: WTO website, 26th October 2014
What is a WTO observer?
32
WTO members
33
34
35
36
37
38
39
Observer
governments
40

Figure 6: Composition of geographical regions
The composition of the WTO in different regions (these are used
when making the statistics, etc.)
Source: WTO, International Trade Statistics 2011, p. 182.
41
WTO members are frequently referred to as countries, although

some members are not countries in the usual sense of the word but
are officially customs territories.
The WTO reports divide the world into 7 regions:
- North America
- South and Central America and the Caribbean (in short: South
and Central America)
- Europe
- Commonwealth of Independent States
- Africa
- Middle East
- Asia
42
5.3. The agreements and the dispute settlement procedure

The World Trade Organization is based on a number of agreements:
Trade in goods
(General Agreement on Tariffs and Trade)
Trade in services
(e.g. insurance, consulting, legal services, banking).
(General Agreement on Tariffs and Services)
Trade in international property rights (e.g. patents and copyrights)
(Agreement on Trade Related Aspects of Intellectual
Property Rights (TRIPS))
43

Documentary: TRIPS and health
Does the TRIPS agreement strike the right balance?
What about the availability of e.g. pharmaceuticals?
The speakers Celine Charveriat, head of Oxfams advocacy
office in Geneva and Harvey Bale, Director General of the
International Federation of Pharmaceutical Manufacturers
Association discuss whether the TRIPS agreement strikes the
right balance between the rights of governments and the rights
of patent holders.
The moderator is WTO spokesperson Keith Rockwell.
http://www.youtube.com/watch?v=FGwPiKxmpDI&feature=rela
ted
What is the good thing with TRIPS?
What is the problem of TRIPS with regard to access to
medicines?
Possible solutions?
44

The dispute settlement procedure:
a formal procedure where countries in a trade dispute can bring
their case to a panel of WTO experts to rule upon.
The panel decides whether member countries are breaking their
agreements.
A country that refuses to adhere to the panels decision may be
punished by the WTO allowing other countries to impose trade
restrictions on its exports.
45
5.4. Operation of the WTO rounds (until now 1: the Doha Round)
The WTO negotiations address trade restrictions in at least 3 ways:
1. Reducing tariff rates through multilateral negotiations.
2. Binding tariff rates:
3.
A tariff is bound by having the imposing country agree not

to raise it in the future.
Eliminating nontariff barriers:
Quotas are changed to tariffs because the costs of tariff
protection are more apparent and easier to negotiate.
- Subsidies for agricultural exports are an
exception.
- Exceptions are also allowed for market
disruptions caused by a surge in imports.
46
5.5. The Doha Round

In 2001 another round of trade negotiations was started in Doha, Qatar,
but these negotiations have not yet produced an agreement.
The Doha ronde: why is this (still) not a success?
The focus is on trade issues that are important for developing
countries.
The tariffs have already been decreased a lot. Most of the remaining
forms of protection are in agriculture, textiles, and clothing, industries
that are politically well organized in the developed world (especially
in the US, the EU and Japan).
Table 4: Percentage Distribution of Potential Gains from Free Trade
Source: Krugman (2012),
International Economics,
chapter 10, p. 273.
47

Are export subsidies for agricultural products in rich countries bad for
poor countries?
Exportsubsidies lower the world price of products..
The estimated positive gains of a positive Doha decision (i.e. the
abolition of the still existing export subsidies for agricultural products
in industrialized countries) are small and even negative for some
countries (eg. for China this would give a loss of -0,02).
Why?: see chapter 6.
Table: Gains in terms of percentages of two possible Doha scenarios
Source: Krugman (2012), International Economics, chapter 10, p. 274.
48
5.6. Data of the WTOs World Trade Report 2011 with regard to
world trade
Figure 7: Economies by size of merchandise trade in the world, 2010
- The top three traders
(US, Germany and
China) represent 28%
of world merchandise
trade.
- Asia accounts for
almost 30% of world
merchandise trade.
- No African country
exceeded US$ 250
billion of merchandise
trade in 2010
(which is low).
49
Regional Trade Agreements (RTAs) and trade creation or diversionon

Figure 8: Economies by size of trade in commercial services in the world,
2010
- The US,Germany,
UK, China and Japan
represent 33 %
of world trade in
commercial services.
- Europe accounts for
45% of total trade in
commercial services.
- Only 2 countries in
Africa exceeded
US$ 25 billion of
commercial services
trade in 2010
(which is very, very low).
Source: WTO, International Trade Statistics 2011, p. 10. 50

Documentary: WTO and Business
What does the WTO mean for Business? What can business
do for the WTO?
With the increasing interdependence of global industries and
rapidly shifting trade patterns, businesses need global rules
and an effective multilateral rule-based trade system. The
WTO provides this, increasing stability, predictability, market
access and information in the trade system.
http://www.youtube.com/watch?v=095_8rcAw4I
51
6. Regional (Preferential) Trade Agreements
Source: WTO, The World

Trade Report 2011, p. 1.
52
The rapid increase in preferential trade agreements (PTAs) has

been a prominent feature of international trade policy in recent
times.
PTAs constitute an exception to the general most-favoured nation
(MFN) provision of the WTO, whereby all WTO members impose
on each other the same nondiscriminatory tariff.
With the exception of Mongolia, all WTO members are party to at
least one PTA. Interest in negotiating PTAs appears to have been
sustained despite the global economic crisis.
Indeed, the economic crisis itself may be spurring
governments to negotiate new PTAs as much to preserve
existing openness in the face of political pressure to reduce
access as to generate new openness.
The explosion of PTAs has triggered a parallel eruption of
research on the subject.
Source: WTO, The World Trade Report 2011, p. 43.
53
6.1. What?
For the GATT/ WTO: Each member state is equal to the law.
e.g. if a tariff is decreased, it is decreased for all countries that want
to import.
However, there exists also regional economic integration (RTAs =
regional trade agreements = PTAs = Preferential Trade
Agreements)
e.g. a customs-union and a free trade agreement (see chapter 2).
trade agreements between countries in which they e.g. lower tariffs
for each other but not for the rest of the world.
Aim? Make trade free between a limited number of states through
means of preferential trade agreements.
= e.g. a decrease or abolishment of some tariffs within the union,
but not for the rest of the world.
54
6.2. Five types of Regional Trade Agreements

see chapter 2:
Regional trade agreements are bilateral (two countries) or
multilateral/plurilateral (several countries).
Regional trade agreements can be classified into one of five categories:
Each level is cumulative and incorporates the features of the
previous level.
In reality, however, actual trade agreements usually combine
elements from a couple of the categories.
55
Table 5: Five types of regional trade agreements
Source: Gerber, International Economics, p. 23.

See chapter 2.
56

Under the WTO, such discriminatory trade policies are generally not
allowed:
Each country in the WTO promises that all countries will pay tariffs no
higher than the nation that pays the lowest tariff: called the most
favored nation (MFN) principle.
57

An exception is allowed only if the lowest tariff rate is set at zero.
There are different types of preferential trading agreements in which
tariff rates can be set at or near zero:
1. A free trade area:
- free trade among members, but each member can have its own
trade policy towards non-member countries (e.g. NAFTA).
2. A customs union:
- free trade among members and requires a common external trade
policy towards non-member countries (e.g. MERCOSUR).
3. A common market:
- a CU plus free mobility of factors of production, such as labor and
capital (e.g. European Union).
58

These RTAs (PTAs) can lead to trade creation (+) or
trade diversion (-)
See further
59
6.3. Regional Trade Agreements in the world

Figure 9: Economic integration in the world
Stages of economic integration around the World:

= Prominent Preferential Trade Agreements
(each country colored according to the most advanced agreement it participates in.)
60
Source: wikipedia: Economic integration stages, 9/11/11.

The different types of regional trade agreements:
Economic and monetary union (CSME/EC$, EU/)
Economic union (CSME, EU)
Customs and Monetary Union (CEMAC/franc, UEMOA/franc)
Common market (EEA, EFTA)
Customs union (CAN, CUBKR, EAC, EUCU, MERCOSUR, SACU)
Multilateral Free Trade Area (AFTA, CEFTA, COMESA, GAFTA,
GCC, NAFTA, SAFTA, SICA, TPP)
The colours:
dark green EMU
light green - economic union
blue - customs and monetary union
brown - common market
orange - customs union
red - multilateral FTA
61

Prominent regional Trade agreements
Table 6.: Prominent Regional Trade Agreements / Trade Blocs
1.) Africa
1.) Africa

62

Figure 10: COMESA(Common Market for Eastern and Southern Africa,1993)
COMESA members not listed on the map: Comoros, Mauritius, Rwanda, and
Seychells
Egypt
Sudan
Ethiopia
Uganda Kenya
Zaire
A ngola
Zambia
Namibia
Zimbabw e
Madagascar

International Economics,
p. 273.
2.) Asia
Association of Southeast Asian Nations
APEC (Asia-Pacific Economic Cooperation):

Asiatic countries and countries with borders to the Pacific Ocean
Currently 21 members ( 1989).
So it are not only Asiatic countries.
So ranked under Asia?

64

Figure 11: ASEAN countries (Association of Southeast Asian Nations)
ASEAN members not listed on the map: Brunei Darussalam and Singapore
Myanmar

International Economics, p.
274.
Viet Nam
Lao PDR
Thailand
Philippines
Cambodia
Malaysia
Malaysia
Indonesia
Indonesia
Indonesia
Indonesia

Figure 12: APEC (Asia-Pacific Economic Cooperation):
Asiatic countries and countries with borders to the Pacific Ocean
Currently 21 members ( 1989).
3.) Europe
67

Figure.: Members of the EU, November, 30, 2013: 28 members
(Croatia on 1 july 2013))
Candidate member
states
Albania,
(Iceland),
Macedonia,
Montenegro,
Serbia,
Turkey
Potential member
states:
Bosnia and
Herzegovina
Kosovo
68
Source: wikipedia

Figure 13: the European Union
28 member states
28 member states
4.) Middle-East
Trade agreement aiming for economic and some sort of future political unity in North
Africa between the countries Morocco, Algeria, Tunisia, Libya, and Mauritania.
The term "Arab Maghreb Union" is considered Arab-centric, as it does not recognize
the Berber population present in all 5 nations.
The union is currently inactive and frozen, due to deep political disagreements
between Morocco and Algeria.
So ranked under Middle East?
71
5.) North and South America
Mercado Comn del Sur

72

Figure 14:
Preferential trade
agreements in
America
Canada
United States
Mexico
Venezuela
Colombia
Peru
Brazil
RTAs in America

International Economics, p.
275.
NAFTA
(3)
CARICOM
(13)
CACM
(5)
ANDEAN
(5)
MERCOSUR (4)
Boliv ia
Argentina
6.4. The evolution and importance of the RTAs the last 50

years
The importance of PTAs in 2010?
74

How did the RTAs evolve between 1950 and 2010?
1.) The level of development of the participating countries:
(= participation of which kind of countries?: developed or
developing countries only or of both developed and developing
countries?)
2.) The geographical coverage: Intra- or cross-regional RTAs?:
(intra- or cross-regional RTAs) within/across regions, e.g. Asia
(East, West, Oceania), the Americas (North, South, Central,
Caribbean), Europe, Middle East, Africa and the Commonwealth of
Independent States (CIS)
3.) The number of countries involved:
(bilateral, multilateral RTAs or RTAs between regional blocs or
between a regional blaock and an independent, new country)
4.) The degree of market integration:
What type of RTA agreement (e.g. FTA, customs union) and what
coverage (e.g. goods, services, etc)?
Source: WTO, The World Trade Report 2011, p. 47-86.
75

1.) The level of development of the participating countries :
The cumulative number of RTAs by country group (1950-2010)
Figure 15: Cumulative number of PTAs in force, 1950-2010, notified and nonnotified PTAs by country group
76

The Average number of RTAs in force per country (1950-2010)
Figure 16: Average number of PTAs in force per country,1950-2010,notified

and non-notified PTAs
Source: WTO, The World Trade Report 2011, p.55.
77

The amount of participation in RTAs for countries/regions in the world
Figure 17: Membership in PTAs in force, 2010, notified and non-notified

PTAs, by country
30
10
21
12
13
26
78

2.) The geographical coverage: Intra- or cross-regional RTAs (1950-2010)?:
In the literature the term regional trade agreements (RTAs) equals the
term preferential trade agreements (PTAs).
However, today half of the RTAs are not strictly regional, because they
often also contain countries from other geographic regions.
10 years ago the activities within 1 region were still dominant.
79

Figure 18: number of intra- and cross-regional PTAs in force, 1950-2010,
notified and non-notified PTAs
80

This trend towards a broader geographical scope of the RTAs is even
more noticeable for the most recent RTAs.
The increase in the number of those cross-regional RTAs could mean
that within certain regions the other types of trade agreements have
already been exhausted.
However, only seldom these cross-regional agreements contain
countries from more than two regions.
81

3.) The number of countries involved:
RTAs are bilateral, multilateral (plurilateral) of take place between
regional blocs or between a regional block and an independent, new
country.
Currently, there are two trends:
1.) In comparison with ten years ago, there are the last years many RTAs
that make an agreement with an independent country or that include an
independent country in their RTA.
Their number has doubled in ten years time.
E.g. the successive accessions to the EU or the RTA between
MERCOSUR and the ANCOM in the so-called Latin American Integration
Agreement framework.
82

Figure 19: Cumulative number of bilateral PTAs and types of plurilateral
PTAs in force, 1950-2010, notified and non-notified PTAs
83

This evolution from RTAs that include a new member (in whatever way)
takes primarily place in agreements between developing countries and
developed countries or in agreements between developed countries.
Look at the percentage shares in the total number of RTAs.
developed-developing: 41 multilateral with an extra member on 76 = 54%
developed-developed: 8 multilateral with an extra member on 23 = 35%
This evolution happened much less in agreements between developing

countries:
developing-developing: 18 multilateral with an extra member on 189 = 9%
Table 7: Number of bilateral PTAs and types of plurilateral PTAs in force,

2010, notified and non-notified PTAs, by country group and regional type
84
Between developed countries most agreements ate multilateral.
Between developing countries most agreements are bilateral.
2.) The last 20 years the number of bilateral RTAs has increased strongly on
the world level.
The cross-regional RTAs are mostly bilateral (89 on 142 or 63 %).
85

4.) The degree of market integration (1950-2010):
What type of RTA agreement?
The five types of regional trade agreements occur.
If countries have to choose between a free trade agreement (FTA)
or a customs union (CU), they opt for the first.
Why?
86

What coverage (e.g. goods, services, etc)?
The most recent RTAs not only aim at the traditional decrease in the
tariffs on goods.
The treatment of services (in general or on e.g. intellectual property
rights) become more important in the RTAs of the last decades.
Figure 20: Cumulative number of PTAs, 1950-2010, notified and non-notified
PTAs, by scope of coverage
87
6.5. For and Against RTAs

See chapter 2:
The central economic question is :
Are RTAs supportive of gradual, long run increases in world trade
(building blocks or stepping stones)?
or
Do they tend to become obstacles to further relaxation of trade
barriers (stumbling blocks)?
Proponents of RTAs view them as building blocks toward freer, more
open, world trade, and this for several reasons (see book).
Opponents view RTAs as undermining progress toward multilateral
(worldwide) agreements, and this for several reasons (see book).
88
6.6. Influence of RTAs on national welfare?

Are RTAs necessarily good for national welfare?
No, it is possible that national welfare decreases under a
preferential trading agreement.
Why?: because there is trade creation versus trade diversion.
Trade creation:
Trade creation takes place when after the formation of an
economic union the cost of the goods considered is decreased,
leading to an increase of efficiency of economic integration.
The replacement of expensive domestic production or
expensive imports from a non-member country by cheaper
imports from a low-cost member of the RTA.
89

Trade diversion:
With trade diversion trade is diverted from a more efficient
producer towards a less efficient one by the formation of a trade
agreement or customs union.
Occurs when low-cost imports from a non-member are
diverted to / replaced by high-cost imports from a member
nation (member of the RTA).
It is possible that country X signs an RTA with country Y that
produces a certain good under high costs.
Thanks to the RTA the good from Y can be more cheaply
imported into country X than the good coming from country Z
(i.e. the country with the lowest producing costs, that has to
pay some kind of trade restriction that country Y doesnt have
to pay)
So, wth the RTA the good will be imported from a member
country that produces the good under higher costs instead of
from the cheapest producer.
90
Regional/Preferential trading agreements increase national

welfare when new trade is created, but not when existing cheap
trade from the outside world is diverted to more costly trade with
member countries.
91

Example:
3 countries: UK (UK), France (F) and New Zealand (NZ)
Initially: a tariff in the UK on goods coming from France (pF + t)
and coming from New Zealand (pNZ+t).
This tariff is the same for F and NZ.
Assume: the UK is a small country that cannot influence the
worldprice.
92

A new RTA between the UK and France.
Will this RTA lead to trade cration of trade diversion?

Two possible situations:
France is the most efficient producer
( the RTA will lead to trade creation: slides 84-85).
or
New Zealand is the most efficient producer
( the RTA will lead trade diversion: slides 86-87).
83

Figure: France is the most
efficient producer
E.g. w.r.t. wine production
Compare situation before
and with the RTA
price
demand
supply
Before the RTA?

pNZ,p +t
+t
C
With the RTA?
tariff
pFr,p+t
B+t
pNZ
pC
pFr.pB
tariff
G
E
imports before customs union
imports after customs union
E+G
(+)
q0
D
q1
q3
q4
quantity
= decrease producer surplus

E
= net gain
E
F
= increase consumer surplus
94
= decrease government revenue

France is the most efficient producer: only trade creation (+)
Increase in imports
The reverse effect of a tariff (decrease PS, increase CS,
decrease income government).
Welfare effect: (D+E+F+G) - D - F =
E+G
E + G = positive: trade creation leads to a positive welfare

effect.
85

Figure: New Zealand is the
price
Most efficient producer
demand
E.g. production of lambmeat
Compare situation before
supply
and with the RTA
Before the RTA?
pB+t
pFr,+t
With the RTA?
tariff
pC+t
pNZ,+t
pFr.pB
p
pNZ C
F1
tariff
F2
imports before customs union
imports after customs union
q0
D
q1
q3
q4
quantity
= decrease producer surplus

E
F2
FF1
G
E
F1
F2
= net gain; possible loss

= increase consumer surplus
= decrease government revenue
86

NZ is the most efficient producer
Increase in imports
But this import no longer comes from the cheapest producer.
Welfare effect: (D+E+F1+G) - D - (F1+F2) =
E+G-F2
The end result is dependent on the size of both effects: which

effect is the biggest?: E + G or F2:
E+G > F2
(+)
E+G < F2
(-)
So trade diversion can lead to a positive or negative welfare
effect.
87
Regionale Handelsakkoorden (RTAs) en trade creation of diversion

In this simplistic example we looked at an RTA between 2
countries and with regard to 1 market (1 good).
In reality an RTA very often covers mutliple countries and multiple
markets (multiple goods).
How do we have to measure the aggregated welfare effect of an
RTA?
In some import markets there will be trade creation, in others
trade diversion.
All the effects of the RTA on the different countries and the
different markets have to be added together:
If the postive effects from trade creation are larger
than the negative effects from trade diversion, then the
PTA will improve national welfare.
or
If a PTA causes more trade creation than trade
diversion, then the PTA is welfare improving.
88
So RTAs can be a first step towards free trade, but they dont mean
automatically a welfare improvement.
If trade creation:
If trade diversion:
(+)
( + ) or ( - ):
Is the RTA a stumbling block or a stepping stone?

This depends on which effect is the biggest: E + G or F2.
99
7. Conclusion
Models of trade policy choice consider the incentives politicians face
given their desire to be reelected, and the tendency for groups that gain
from protection to be better organized than consumers who lose.
Multilateral negotiations of free trade may mobilize domestic political
support for free trade, as well as make countries agree not to engage in
a trade war.
The WTO and its predecessor (the GATT) have reduced tariffs
substantially in the last 50 years, and the WTO has a dispute settlement
procedure for trade disputes.
A regional (or preferential) trading agreement (RTA or PTA) is beneficial
for a country if it creates new trade but is harmful if it diverts existing
trade to higher-cost alternatives.
100

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Part IV: Regional Issues in the Global Economy

Regional Trade Agreements (RTAs) and trade creation

3. International Trade Agreements

Regional Trade Agreements (RTAs) and trade creation

5. The World Trade Organisation (WTO)

Regional Trade Agreements (RTAs) and trade creation

Regional Trade Agreements (RTAs) and trade creation

Reading (not compulsory):

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

2. Political models of trade policy

Indeed, there is not something like th national welfare.

Regional Trade Agreements (RTAs) and trade creation or diversion

How is trade policy determined?

We look at three theories:

Regional Trade Agreements (RTAs) and trade creation or diversion

2.1. The median voter theorem

Regional Trade Agreements (RTAs) and trade creation or diversion

Figure 1: The median voter theorem: Political competition

If party A chooses tA.

What policies will the parties promise to follow?

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

2.2. Collective action

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

2.3. The actual trade policy is often based on a combination

Regional Trade Agreements (RTAs) and trade creation or diversion

3. International Trade Agreements

Source: Krugman, Obstfeld (2012), International Economics, chapter 10, p.264.

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

Table 2: The problem of trade wars

Each country acting individually would be better off with

Regional Trade Agreements (RTAs) and trade creation or diversion

If Japan and the U.S. can establish a binding agreement to

Regional Trade Agreements (RTAs) and trade creation or diversion

3.2. International Trade Agreements: A Brief History

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

Source: Van Marrewijk,

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

Documentary: The Routes of Trade

Regional Trade Agreements (RTAs) and trade creation or diversion

4. The General agreement on Tariffs and Trade (GATT)

Regional Trade Agreements (RTAs) and trade creation or diversion

4.2. The Trade Rounds of the GATT

Regional Trade Agreements (RTAs) and trade creation or diversion

Source: Van Marrewijk,

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

Regional Trade Agreements (RTAs) and trade creation or diversion

5. The World Trade Organisation (WTO)

Regional Trade Agreements (RTAs) and trade creation or diversion

5.2. The WTO members:

Source: WTO website, 26th October 2014

What is a WTO observer?

Regional Trade Agreements (RTAs) and trade creation or diversion

Source: WTO website, 26th October 2014

Regional Trade Agreements (RTAs) and trade creation or diversion