Preferential Trade Agreements and Multilateral Liberalization
The results imply that regionalism is a building block for free trade. There is no clear evidence that trade preferences lead to higher tariffs or smaller tariff cuts, and there is strong evidence that preferences induce a more rapid decline in external tariffs in free trade areas. For example, if a country that follows a strict policy of nondiscrimination offers free access to another country in a sector in which it applies a 15 percent multilateral tariff, the country would tend to subsequently reduce that external tariff by more than 3 percentage points. As in the study by Bohara and colleagues, Estevadeordal, Freund, and Ornelas (2008) find that the complementarity effect is stronger in sectors where trade bloc partners are more important suppliers, which is precisely where trade discrimination would be more disruptive. Using a similar methodology for the Association of Southeast Asian Nations, Calvo-Pardo, Freund, and Ornelas (2009) also find evidence that regionalism is associated with unilateral tariff reduction. Recent studies by Limão (2006) and Karacaovali and Limão (2008) address a related question: whether preferential liberalization by the United States and the EU hindered multilateral trade liberalization at the Uruguay Round. In the context of the theoretical literature described earlier, they examine the goodies-bag stumbling block and, specifically, whether commitments to liberalize were significantly different in goods that offered preferences and in goods that did not. These papers, however, do not take into account the size of the preferences or the importance of trade in the products that received preferential treatment. Both papers find that liberalization was relatively smaller in products where preferences were used. They argue that, intuitively, because the United States and the EU offer preferences on a unilateral basis to extract concessions from recipients in nontrade areas, they tend to resist liberalization to prevent erosion of preferences. The evidence in Limão (2006) is widely misrepresented as showing that the United States raised tariffs in the Uruguay Round for items on which it granted PTA preferences. Of course, this cannot be correct, since MTN market access talks only involve tariff bindings, and the United States did not violate any of its bindings in the Uruguay Round. Indeed, the data show U.S. tariffs decreasing for all but 12 of the thousands of tariff lines, defined at the Harmonized System–8 product level in the WTO’s database. Formally, Limão estimates an econometric model of U.S. tariff cuts during the Uruguay Round. His famous stumbling block finding is that the United States cut tariffs by less than his econometric model predicted they should have on items for which the United States had granted PTA preferences before the Uruguay Round. In short, he shows that the U.S. preferences acted as a “slowing block,” not as a stumbling block.
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The findings of Foroutan (1998), Bohara, Gawande, and Sanguinetti (2004), Estevadeordal, Freund, and Ornelas (2008), and Calvo-Pardo, Freund, and Ornelas (2009)—all of which imply that regionalism is a building block for external liberalization in developing countries—contrast sharply with those of Limão (2006) and of Karacaovali and Limão (2008), who find that the United States and the EU liberalized less during the Uruguay Round in sectors in which preferences were granted. One reason for differing results is that that the countries analyzed are very different. Since the multilateral system has not enforced much tariff reduction on developing countries, tariffs are relatively high among that group, creating a large potential for trade diversion. Lower external tariffs moderate that loss. The results of the first group of researchers named above suggest that this force is important in explaining changes in MFN tariffs of developing countries involved in free trade areas. In contrast, Limão’s work focuses on industrial countries. Tariffs were already quite low in the United States and the EU at the onset of the Uruguay Round, thus reducing the importance of this channel. In addition, the theoretical underpinnings of Limão’s analysis, which is used to justify the importance of preferences in NorthSouth agreements, rely on the formation of PTAs for noneconomic reasons; preferential treatment is extended in return for noneconomic benefits, such as cooperation on migration, drug trafficking, or a global political agenda. This is not the case in South-South PTAs, where the goal is to exchange access to markets and improve regional economic cooperation. Welfare Consequences of PTAs A large portion of the empirical literature on trade diversion versus trade creation has attempted to provide answers to the question of whether bilateralism is bad (see box 6.1, above). If regionalism is moving world trade away from natural trade patterns, thus reducing world welfare, more diversion will be observed; if regionalism is pushing trade in the right direction, we should observe little diversion. The analyses also offer an indirect check on the effect of regional agreements on trade liberalization. If regional members tend to raise barriers to nonmembers, there should be strong evidence of trade diversion—increased trade with members at the expense of nonmembers. By contrast, if regional members tend to lower barriers to nonmembers in concert with PTAs, diversion should be limited. Unfortunately, estimating trade diversion is no easy task. It requires knowledge of the counterfactual: what would have happened to trade if there were no trade agreement? Since this is unknown, assumptions must be made.