Lecture 8: Preferential Trade Agreements: © Kenneth A. Reinert, Cambridge University Press 2012

Lecture 8: Preferential Trade
Agreements
Kenneth A. Reinert, Cambridge University

Press 2012
Introduction
The term multilateralism refers to the GATT/WTO system and

the trade negotiations that take place within it
One of the founding

nondiscrimination
principles
of
this
system
is
Involves the most favored nation (MFN) and national treatment (NT) subprinciples

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Introduction
Regionalism refers to a violation of the nondiscrimination

principle in which one member of a regional trade agreement
(RTA) discriminates in its trade policies in favor of another
member of the RTA and against nonmembers
Has been allowed

circumstances:
by
the
GATT/WTO
under
certain
Free trade areas (FTAs)

Customs unions (CUs)
Interim agreements leading to a FTA or CU within a reasonable
length of time

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Table 8.1: Types of Preferential Trade

Agreements
Type of PTA
Description
Number in
Force
2014
GATT Article
XXIV (FTA)
An agreement on the part of a set of countries to

eliminate trade restrictions among themselves.
221
GATT Article
XXIV (CU)
An agreement on the part of a set of countries to

eliminate trade restrictions among themselves
and to adopt a common external tariff.
17
Enabling
Clause
Allows PTAs in goods trade among developing

countries.
37
GATS Article V
An agreement to reduce barriers to trade in

services among a set of counties.
131
Total: 406

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Table 8.2: Steps to Regional Integration

Type
Description
Free trade
area
An agreement on the part of a set of countries to eliminate

trade restrictions among themselves.
Customs
union

trade restrictions among themselves and to adopt a common
external tariff.
Common
market

trade restrictions among themselves, to adopt a common
external tariff, and to allow the free movement of labor and
physical capital among member countries.
Monetary
union
A common market that adopts a common currency and adopts

a common monetary policy.
Economic
union
A monetary union that adopts a process of domestic policy

harmonization in areas such as tax and spending policies and
domestic regulation.
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The WTO and PTAs
WTO members who wish to form FTAs or CUs

may do so
However, there are certain requirements
Trade barriers against non-members cannot be higher or

more restrictive than those in existence prior to the FTA or
CU
FTA or CU must be formed within a reasonable length of
time
FTA or CU must eliminate trade barriers on substantially all
the trade among the members
With regard to services, the General Agreement on Trade in
Services (GATS) requires that the FTA or CU involve
substantial sectoral coverage
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The WTO and PTAs: Enforcement
The WTO has a Committee on Regional Trade

Agreements (CRTA)
Despite the institutional structure present in the WTO to

govern PTAs, there has never been any serious
evaluation or enforcement
Most PTAs are of doubtful WTO consistency
A cooperative equilibrium exists where no WTO

member contests anothers PTA
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Rules of Origin
In FTAs (but not CUs), a product can be imported into a

low-tariff member and then resold in a high-tariff member
This process is known as tariff rate arbitrage
To protect tariff rate arbitrage FTA members established

rules of origin (ROOs) to protect against this
Domestic content
Change in tariff heading
Specific processes
Substantial transformation
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HS

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Economic Effects of PTAs
TWO concept exist in PTAs
Trade creation
Occurs when the formation of a FTA or CU leads to a

switching of imports from a high-cost source to a lowcost source
Tends to improve welfare
Trade diversion
Occurs when imports switch from a low-cost source to

a high-cost source
Tends to worsen welfare

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Trade Creation and Trade Diversion
Trade creation and trade diversion using the absolute

advantage model of lecture 2
Along with Brazil (B) and Argentina (A), we are also

going to refer to a third country, El Salvador (S)
Brazil and Argentina are members of a PTA, whereas El

Salvador is not

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Figure 8.1: Trade-Creating PTA

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Trade Creation
Before the PTA, Brazil has in place a specific (per unit)

tariff on imports from both Argentina and El Salvador
Argentina is the lower-cost producer in comparison to

Brazil, itself
Therefore Brazil imports good from Argentina

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Trade Creation
Once Brazil joins either a PTA with Argentina, tariff is

removed on imports from Argentina
Good continues to be imported from Argentina and imports

increase because price has fallen due to removal of tariff
Consumer surplus in Brazil increases while producer

surplus and government tariff revenue falls
Net increase in welfare due to trade creation

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Figure 8.2: A Trade-Diverting PTA

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Trade Diversion
Before the PTA, Brazil has in place a specific (per unit)

tariff on imports from both Argentina and El Salvador
El Salvador is the lower-cost producer in comparison to

Argentina
Brazil imports the good from El Salvador

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Trade Diversion
Once Brazil joins a PTA with Argentina, however, Brazil

switches to Argentina as an import supplier
Imports expand as the domestic price falls
Consumer surplus in Brazil increases while producer

surplus and government revenue fall
Whether net welfare effect is positive or negative is

ambiguous

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Summary of Economic Effects of PTAs
PTAs can be either welfare-improving or welfareworsening.
Whether an PTA is welfare-improving or welfareworsening is something that must be assessed on a

case-by-case basis, based on evidence on the relative
strengths of trade creation and trade diversion.

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The European Union

Year
Initiative/Treaty
Members Added
1951
European Coal and Steel

Community/Treaty of Paris
France, Germany, Italy, Luxembourg, Netherlands
1958
European Economic Community/Treaty

of Rome
1973
Enlargement
Denmark, Ireland, United Kingdom
1981
Enlargement
Greece
1986
Enlargement
Portugal, Spain
1992
European Union/Maastricht Treaty
1995
Enlargement
Austria, Finland, Sweden
1999
European Monetary Union
United Kingdom, Sweden and Denmark not included
2002
Common EMU currency: the euro
United Kingdom, Sweden and Denmark not included
2004
Enlargement
Cyprus, Czech Republic, Estonia, Hungary

Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia
2007
Enlargement
Bulgaria, Romania
2007
EU Constitution/Lisbon Treaty
2013
Enlargement
Croatia
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The European Union

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Economic Assessment of the EU
Some studies have suggested that trade creation

has dominated trade diversion in the EU
Other studies have drawn attention to the role of

non-tariff measures and subsidies (especially to
agriculture) - increased

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North American Free Trade Agreement

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North American Free Trade Agreement
In January 1994 a FTA between Canada, Mexico

and the United States took place (NAFTA)
Addressed the following
Trade in goods
Financial services
Transportation
Telecommunications
Foreign direct investment
Intellectual property rights
Government procurement
Dispute settlement
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Mercosur

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Mercosur
PTA among Argentina, Brazil, Venezuela, Paraguay, and

Uruguay
Launched in 1991
Took on Chile and Bolivia as associate members in 1996 and

1997, respectively
Peru, Colombia and Ecuador became associate members in

2003-2004
Not actually a common market but a CU
Free movement of labor and physical capital is along way off

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FTAA
In 1994, governments of 34 countries agreed to pursue a Free

Trade Area of the Americas (FTAA)
Negotiations were launched at the Second Summit of the
Americas in 1998 in nine negotiating groups
Market Access
Investment
Services
Government Procurement
Dispute Settlement
Agriculture
Intellectual Property Rights
Subsidies, Antidumping, and Countervailing Duties
Competition Policy
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FTAA
The 2004 Summit of the Americas was blocked by a

number of issues
Agriculture
Anti-dumping
The 2005 Summit of the Americas ended

negotiations on the FTAA
Venezuela and Argentina blocked progress in
opposition to US-backed neo-liberalism
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ASEAN / AFTA

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ASEAN / AFTA
Association for Southeast Asian Nations (ASEAN)

includes Brunei, Cambodia, Indonesia, the Lao Peoples
Democratic
Republic, Malaysia, Myanmar, the
Philippines, Singapore, Thailand and Vietnam
Beginning in 1992, members began to form the ASEAN

FTA or AFTA, which now includes all 10 members

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FTA (Azerbaijan and some CIS

countries)
Free Trade Agreement between Azerbaijan, Armenia,

Belarus, Georgia, Moldova, Kazakhstan, the Russian
Federation, Ukraine, Uzbekistan, Tajikistan and the
Kyrgyz Republic
Launched in 1994

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Regionalism vs. Multilateralism
Represent two alternative trade policy options available

to the countries of the world
The 1950s and 1960s saw first wave of PTAs in

developing world
The 1980s saw beginning of second wave of PTAs
What role will this second wave of PTAs play vis--vis

the multilateral efforts toward trade liberalization pursued
under the GATT-WTO framework ?
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Regionalism vs. Multilateralism
Opponents argue that PTAs are discriminatory by nature
They draw attention to spaghetti-bowl nature of secondwave and current PTAs
Meaning the overlapping nature of most PTAs, with most

WTO members holding simultaneous membership in many
PTAs at once
The negotiating energies put into PTAs will detract from

those put into multilateral agreements under the auspices
of the WTO
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Appendix: Rules of Thumb for Evaluating

PTAs
Countries excluded from a PTA almost always lose
Market access is a key determinant of the net benefits of

a PTA
Lowering external tariffs against non-members of a PTA

improves their desirability from a welfare standpoint
Multilateral trade liberalization results in significantly

larger gains to the world than a network of PTAs
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Appendix: Rules of Thumb for Evaluating

PTAs
For some countries additive PTAs can be more

beneficial than unilateral trade liberalization due to
the market access gains involved in the former
For developing countries North-South PTAs can

offer beneficial increases in competition in their
home markets

Press 2012

Lecture 8: Preferential Trade Agreements: © Kenneth A. Reinert, Cambridge University Press 2012

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Lecture 8: Preferential Trade

Kenneth A. Reinert, Cambridge University

The term multilateralism refers to the GATT/WTO system and

One of the founding

Kenneth A. Reinert, Cambridge University

Regionalism refers to a violation of the nondiscrimination

Has been allowed

Free trade areas (FTAs)

Kenneth A. Reinert, Cambridge University

Table 8.1: Types of Preferential Trade

An agreement on the part of a set of countries to

An agreement on the part of a set of countries to

Allows PTAs in goods trade among developing

An agreement to reduce barriers to trade in

Kenneth A. Reinert, Cambridge University

Table 8.2: Steps to Regional Integration

An agreement on the part of a set of countries to eliminate

An agreement on the part of a set of countries to eliminate

An agreement on the part of a set of countries to eliminate

A common market that adopts a common currency and adopts

A monetary union that adopts a process of domestic policy

The WTO and PTAs

WTO members who wish to form FTAs or CUs

However, there are certain requirements

Trade barriers against non-members cannot be higher or

The WTO and PTAs: Enforcement

The WTO has a Committee on Regional Trade

Despite the institutional structure present in the WTO to

Most PTAs are of doubtful WTO consistency

A cooperative equilibrium exists where no WTO

In FTAs (but not CUs), a product can be imported into a

This process is known as tariff rate arbitrage

To protect tariff rate arbitrage FTA members established

Kenneth A. Reinert, Cambridge University

Economic Effects of PTAs

TWO concept exist in PTAs

Occurs when the formation of a FTA or CU leads to a

Tends to improve welfare

Occurs when imports switch from a low-cost source to

Tends to worsen welfare

Trade Creation and Trade Diversion

Trade creation and trade diversion using the absolute

Along with Brazil (B) and Argentina (A), we are also

Brazil and Argentina are members of a PTA, whereas El

Kenneth A. Reinert, Cambridge University

Figure 8.1: Trade-Creating PTA

Kenneth A. Reinert, Cambridge University

Before the PTA, Brazil has in place a specific (per unit)

Argentina is the lower-cost producer in comparison to

Therefore Brazil imports good from Argentina

Kenneth A. Reinert, Cambridge University

Once Brazil joins either a PTA with Argentina, tariff is

Good continues to be imported from Argentina and imports

Consumer surplus in Brazil increases while producer

Net increase in welfare due to trade creation

Kenneth A. Reinert, Cambridge University

Figure 8.2: A Trade-Diverting PTA

Kenneth A. Reinert, Cambridge University

Before the PTA, Brazil has in place a specific (per unit)

El Salvador is the lower-cost producer in comparison to

Brazil imports the good from El Salvador

Kenneth A. Reinert, Cambridge University

Once Brazil joins a PTA with Argentina, however, Brazil