Preferential Trade Agreements and Multilateral Liberalization
once one takes into account the endogeneity of the agreements, the positive impact of PTAs on bilateral trade becomes more robust and much larger—in fact, five times larger—than in estimates that take agreements as exogenous. Thus, countries seem to form PTAs when there is much to be gained from liberalizing bilateral trade. Proving that agreements are natural or unnatural is daunting, as it requires an assessment of many potential agreements and their welfare consequences—and calculating trade diversion and creation in even one agreement is already difficult. Nevertheless, there is solid empirical support for the more general premise of the natural trade bloc view: that trade blocs are formed by countries that have much to gain from freer trade. The theoretical literature on static effects of trade agreements highlights the potential costs of preferential liberalization and the possibility that trade-diverting agreements may be more viable politically. The empirical literature is not entirely conclusive, but it does suggest that trade diversion is not a major concern, although in some agreements and sectors it may matter. Trade diversion may be less relevant than was initially thought because countries form trade agreements with “natural trading partners,” where trade creation is the norm, or because governments may respond to trade diversion by reducing external tariffs. Overall, the empirical literature shows that countries in regional agreements tend to liberalize trade broadly. There is evidence that regional agreement members tend to reduce external tariffs, and that this is especially true of members of free trade agreements (as opposed to customs unions). In addition, trade diversion tends to be small or nonexistent, which is consistent with endogenous tariff changes that reduce costly diversion. There is, however, some evidence that regional agreements may limit trade liberalization in the multilateral setting. Conclusions and Rules for PTAs In this chapter, we have examined the effect of regionalism on the multilateral trade system. The theoretical literature underscores the diverse mechanisms by which regionalism can be helpful or harmful to that system. So far, there is little evidence that regionalism is overwhelmingly bad for the multilateral trade system, as some had feared, and there is some evidence that regionalism is associated with general liberalization. To ensure that regionalism is a positive force in the future, four ideal guidelines can be kept in mind: 1. Bind tariff rates at applied rates, leaving no room for tariff increases following a trade agreement. This measure
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prevents countries from backtracking on previous liberalization. Although this would be difficult to accomplish, it is a worthwhile goal. Tariffs in most developing countries are set well below their bindings (by 20 to 30 percentage points!), making the term “binding” meaningless. A move toward more restrictive bindings would make regionalism less dangerous and would give member countries a lever against a potential increase in the political forces favoring protection. 2. Agree to lower multilateral tariffs partway, through the use of preferential tariffs. Even though empirical work has shown that regionalism tends to be a force for general liberalization, irrespective of restrictions, a commitment in this direction would ensure that regionalism serves as a building block for free trade. 3. Redefine North-South agreements to incorporate preferences from the North in response to MFN liberalization on the part of the South. In the developing countries, where tariffs are generally higher, this would prevent sizable diversion. In addition, it would be far easier to implement than a range of tariffs across various agreements. 4. Keep regional agreements open, extending eligibility to all countries willing to follow the rules.29 This helps ward against a global outcome dominated by a handful of protective trade blocs. Trade negotiators should have these guidelines in mind, but the WTO should also do its part to ensure a positive spread of regionalism. This can be accomplished by monitoring regional agreements among members, publishing reports on regional agreements that call attention to bad behavior, and securing the authority to impose more restrictions on regional agreements. Given the concerns about regionalism, it is important to highlight where the long-run potential benefits can be found. The best way to ensure that regionalism is welfare improving is for countries to pursue serious deep integration agreements. Real resource gains are obtainable if countries integrate labor markets, combine regulatory institutions, harmonize standards, and cooperate extensively on trade facilitation. Removal of behind-the-border barriers will enhance trade and welfare without the traditional costs of PTAs in tariff revenue and trade diversion. The benefits of deep integration include real resource gains that will accrue to nonmembers as well as members. The focus should be on the quality, not the number, of agreements. There is a danger, however, that the present wave of PTAs is being generated by minor agreements that will not produce significant benefits, especially given their cost to the world trading system. How to achieve deeper