6 Preferential trade agreements AND MULTILATERAL LIBERALIZATION Richard Baldwin and Caroline Freund
With the Doha Round of trade negotiations ailing, the future of multilateral liberalization in the near term looks bleak. By contrast, preferential trade agreements (PTAs) continue to multiply (see Acharya et al., ch. 2 in this volume), making regionalism the most active mode of trade liberalization. The regionalization of trade is of serious concern to many international economists who view multilateralism as far superior to regionalism for improving welfare. At issue is the preferential nature of regional agreements, which could divert trade and reduce the potential for future multilateral liberalization. The multilateralists argue that, although regionalism may increase trade, its effects on welfare and on the world trade system are likely to be harmful. There are two main concerns.1 The first is trade diversion: preferential trade agreements, by diverting trade away from the most efficient global producers in favor of regional partners, may prove welfare reducing. The second concern, which is of greater importance, is that regionalism may hinder multilateralism, leading to a bad equilibrium in which several regional trade blocs maintain high external trade barriers. Regionalism can also undermine multilateralism simply by diverting limited government resources from multilateral negotiations. These two concerns are related: in a highly regionalized world, there is likely to be significant trade diversion and hence lower welfare. Still, this feature of the bad equilibrium makes it less likely in practice. It is precisely because the trade diversion is costly to bloc members that there is an incentive to reduce external tariffs. As tariffs fall, trade diversion disappears, and regionalism becomes a force for general liberalization. Thus, despite the potential for a grim
outcome from high-tariff regional blocs and for large amounts of trade diversion, the theoretical literature shows that incentives to reduce external trade barriers so as to limit costly diversion are likely to be present.2 The nascent empirical literature is tackling the question of how trade liberalization has been affected by the formation of PTAs. Although the verdict is not yet in, the evidence indicates that regionalism is broadly liberalizing. This chapter summarizes the available theoretical and empirical evidence on the relationship between regionalism and multilateralism, with the aim of discerning whether the spread of regionalism is likely to be a threat to, or an opportunity for, broader trade liberalization. The next section identifies the distortions that generate a need for regional and multilateral trade agreements. There follows an overview of the available theoretical work on whether regionalism constitutes a stumbling block or a building block on the path to trade liberalization. The effect of regionalism on world welfare is then examined, the empirical literature is surveyed, and conclusions are drawn. Reciprocal Trade Agreements If there is one thing economists agree on, it is that free trade is best. Why, then, do we need trade agreements to lower tariffs? In fact, although global free trade may be good for world welfare, countries nevertheless have reasons to maintain tariffs. There ensues a prisoner’s dilemma: each country may be unilaterally better off with a tariff, but jointly they are worse off. Cooperation through a trade agreement is necessary to liberalize trade.
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