THE GREATEST CHALLENGE? REGIONAL
TRADE ARRANGEMENTS AND THE WORLD
TRADE ORGANIZATION
Regionalism is one alternative that has gained particular appeal. Indeed,
many observers believe that regional trade arrangements pose the single
greatest challenge to the multilateral trade system. Regional trade
arrangements pose a challenge to the WTO because they offer an
alternative, and often more discriminatory, way to organize world trade.
A regional trade arrangement (RTA) is a trade agreement between
two or more countries, usually located in the same region of the world, in
which each country offers preferential market access to the other. RTAs
come in two basic forms: free-trade areas and customs unions. In a freetrade
area, like the North American Free Trade Agreement, governments
eliminate tariffs on other members’ goods, but each member retains
independent tariffs on goods entering their market from non-members. In a
customs union, like the EU, member governments eliminate all tariffs on
trade between customs union members and impose a common tariff on
goods entering the union from non-members.
Because RTAs provide tariff-free market access to some countries, but
not to others, they are inherently discriminatory. Though such
discrimination is inconsistent with the GATT’s core principle, GATT’s
Article XXIV allows countries to form RTAs as long as the level of
protection imposed against nonmembers is no higher than the level of
protection applied by the countries prior to forming the arrangement.
Nevertheless, the discriminatory aspect of RTAs makes many worry about
the impact they will have on the nondiscriminatory trade encouraged by
the WTO.
Such worries arise because of the rapid proliferation of RTAs.
According to the WTO, there are currently 279 RTAs in operation. If all
RTAs now planned are created, there may be as many as 445 RTAs in
effect. Free-trade agreements constitute the vast majority of these RTAs,
for 86 percent of existing RTAs and for 99 percent of arrangements
currently being negotiated. More than half of all RTAs are bilateral
agreements. The others are “plurilateral” agreements that include at least
three countries. RTAs are densely concentrated in Europe and the
Mediterranean region. Agreements between countries in Western, Eastern,
and Central Europe, and in the Mediterranean account for almost 50
percent of RTAs in operation. North and South America take second place,
accounting for about 12 percent. Until quite recently, sub-Saharan Africa
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and Asia-Pacific states have joined few RTAs.
RTAs have emerged in three distinct waves (see Figure 2.1). The first
wave began early in the 1950s and extended to the mid-1970s. This wave
began with the construction of the original European Economic
Community in 1958 and the Latin American Free Trade Area in 1960, and
concluded with the formation of the Economic Community of West
African States in 1975. This wave was motivated in part by a desire to
promote deeper economic cooperation within particular regions in an
attempt to promote peace and achieve more rapid economic development.
In this regard, the contribution of the EEC to Franco-German political
reconciliation after World War II and to rapid postwar economic recovery
encouraged governments in other regions to emulate the approach. This
early enthusiasm waned, however, as the economic gains realized in
Europe did not materialize in the so-called developing world imitators.
FIGURE 2.1
Regional Trade Arrangements, 1950–2016
Source: The World Trade Organization, WTO Secretariat, RTA Section, 20 June 2017.
The second wave began in the context of far-reaching trade policy
reforms in Eastern and Central Europe, the former Soviet Union, and other
developing countries. Governments in former members of the Soviet Bloc,
for instance, sought new ways to organize their trade, and sought access to
Western European markets. Consequently, a large number of agreements
were reached between countries within the region and between these
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countries and the EU (WTO 2000). Moldova, for example, entered RTAs
with eight other newly independent countries formed from the former
Soviet Union between 1992 and 1996. Russia entered at least nine RTAs
with this same set of countries. Ten Eastern and Central European
countries reached bilateral RTAs with the European Union between 1991
and 1997. There were also substantial changes in developing-country trade
policies in the late 1980s and early 1990s, which led to a greater
willingness to enter RTAs (WTO 2000). Mexico, for example, negotiated
RTAs not only with the United States and Canada (NAFTA), but also with
Chile, Costa Rica, and Nicaragua. Chile negotiated RTAs with Colombia,
Ecuador, and Peru, in addition to completing the agreement it reached with
Mexico.
The third wave began in 2008 or so and has been closely associated with
the so-called mega-regional agreements. The two most prominent of
these mega-regional agreements are the Trans-Pacific Partnership (TPP),
negotiated between the U.S. and the EU, and the Transatlantic Trade and
Investment Partnership (TTIP), which was negotiated by 13 states in Asia
and North and South America. A third mega-regional, the Regional
Comprehensive Economic Partnership, ties China to 15 other economies
throughout Asia and the Pacific. In contrast to previous waves, which
tended to focus most heavily on trade liberalization, the mega-regional
agreements seek deeper economic integration among their members. To
achieve this goal, these agreements are both broader in scope and reach
more deeply into domestic arrangements than prior agreements. The TTIP
and the TPP were intended to promote cooperation and harmonization on
technical barriers to trade, which are domestic rules, regulations, and
administrative procedures that can limit trade flows. In addition, these
agreements included trade in services, more ambitious rules regarding the
protection of intellectual property than are present in the WTO and
agreement on the treatment and protection of foreign investment. The TPP
included most of these issues as well as an elaborate and enforceable code
on labor standards.
Why have RTAs proliferated, especially since 1990? Scholars have
advanced a number of general explanations for this trend. Some emphasize
a country’s desire to gain more secure access to the market of a
particularly important trading partner. In the U.S.–Canada Free Trade
Agreement concluded in the late 1980s, for example, Canada sought
secure access to the U.S. market—the most important destination for
Canada’s exports. During much of the 1980s, the United States made
frequent use of anti-dumping and countervailing duty investigations to
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protect American producers from Canadian imports. Such measures
clearly interfered with the ability of Canadian producers to export to the
American market. The Canadian government hoped that the U.S.–Canada
Free Trade Agreement would give Canada “some degree of exemption”
from these measures (Whalley 1998, 72–73).
Other scholars emphasize a government’s need to signal a strong
commitment to economic reform. Governments use RTAs to convince
foreign partners that they will maintain open markets and investor-friendly
policies. This argument has been applied most commonly to Mexico’s
decision to seek a free-trade agreement with the United States. Mexico
shifted from a highly protectionist to a more liberal trade policy in the
mid-1980s. The success of that strategy hinged in part on Mexico’s ability
to attract foreign investment from the United States. The Mexican
government feared, however, that American investors would not believe
that the Mexican government was committed to its new strategy. What
would prevent Mexico from shifting back to protectionism and
nationalizing foreign investments? If American businesses didn’t believe
the Mexican government was committed to this liberal strategy, they
would be reluctant to invest in Mexico. Absent American investment,
Mexico would be deprived of foreign capital that was critical to the
success of its strategy.
A free-trade agreement with the United States allowed Mexico to signal
to American investors the depth of its commitment to market
liberalization. It did so in part because NAFTA contained very clear and
enforceable rules concerning the treatment of foreign investment located in
Mexico. A similar argument might be used to understand at least part of
the interest that Eastern and Central European governments had in signing
free-trade agreements with the EU. These governments were also
reorienting their economic policies and were trying to attract foreign
investment. Like Mexico, they might have needed an external institution,
such as an agreement with the EU, to signal to foreign investors their
commitment to market reforms. Notice that these arguments actually place
less emphasis on the trade benefits that might result from an RTA and
focus more on the need to attract foreign investment.
Other scholars argue that countries enter RTAs to increase their
bargaining power in multilateral trade negotiations. A small country
bargaining individually in the WTO lacks power because it does not have a
large market to offer. By pooling a group of small countries, the market
that can be offered to trade partners in WTO negotiations increases
substantially. Consequently, each member might gain larger tariff
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concessions in WTO negotiations. Current American enthusiasm for RTAs
might also be seen as an attempt to gain bargaining power in the WTO. As
it has become more difficult to reach decisions within the WTO, the
United States has explicitly threatened to rely more on free-trade
agreements. By doing so, the United States denies its market to countries
unwilling to make concessions in the WTO. The fear of losing access to
the U.S. market could induce governments to make concessions in the
WTO that they would not otherwise make. The threat to rely more on
RTAs and less on the WTO, therefore, enhances American power in the
organization.
Finally, and clearly relevant to the emergence of the mega-regional
agreements, the impasse in the Doha Round encouraged states to find other
paths along which to pursue their trade policy goals. These agreements
have enabled the EU, the U.S., Canada, Mexico, and South American
countries with Pacific ties, as well as a few partners in Asia to pursue
economic integration on issues of common interest and concern that they
could not address in the WTO, given the resistance by many members to
the initiation of negotiations on new issues. Digital trade, for instance,
which is commerce in products that are delivered via the Internet (such as
music, video, apps, e-books, etc), constitutes an important and growing
share of the global economy and international trade. Current estimates
indicate that its total value is $4.2 trillion worldwide (U.S. International
Trade Commission 2013). Yet, in spite of its growing importance, the
issue was kept out of the Doha Round. Within the mega-regionals,
governments could negotiate extensive rules to govern this trade.
Moreover, the growing importance of global value chains has provided
multinational businesses with a strong incentive to pressure their
governments to negotiate these deeper agreements in order to better protect
their investments, to harmonize product standards across national markets,
and to make it easier and cheaper to ship goods across national boundaries
(Baldwin 2014).
The rapid growth of RTAs raises questions about whether they
challenge or complement the WTO. This is not an easy question to answer.
On the one hand, RTAs liberalize trade, a mission they share with the
WTO. In this regard, RTAs complement the WTO. On the other hand,
RTAs institutionalize discrimination within world trade. In this regard,
RTAs challenge the WTO.
Economists conceptualize these competing consequences of RTAs as
trade creation and trade diversion. Consider an RTA between France
and Germany. Because the RTA eliminates tariffs on trade between France
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and Germany, more Franco-German trade takes place. This is trade
creation. Because the RTA does not eliminate tariffs on trade between
France and Germany on the one hand, and the United States on the other,
some trade between the United States and Germany is replaced by trade
between France and Germany. This is trade diversion. An RTA’s net
impact on trade is the difference between the trade it creates and the trade
it diverts. If more trade is created than diverted, the RTA has liberalized
trade. If more trade is diverted than created, the RTA has pushed the world
toward protectionism.
Which of these effects predominates in existing RTAs? Nobody really
knows, in large part because it is difficult to evaluate trade creation and
trade diversion empirically. It is especially difficult once we begin to think
about how RTAs evolve once created. An RTA that originally diverts
more trade than it creates might over time create more trade than it diverts.
Or an RTA could evolve in the opposite direction. Consider the first case.
Some scholars have argued that RTAs exert a kind of gravitational force
on countries that are not currently members. Countries that do not belong
to the EU, but that engage in lots of trade with it, have a strong incentive to
join. So it is no surprise, therefore, that over the last 40 years the EU has
expanded from six to 25 member countries. Some see a similar dynamic at
work in the Western Hemisphere. Mexico’s decision to seek a free-trade
agreement with the United States was at least partially motivated by
concerns about the cost of being outside a U.S.–Canada Free Trade Area
that had been negotiated in the late 1980s (Gruber 2000). The interest of
many Latin American countries in a Free Trade Area of the Americas
(FTAA) is at least partially a consequence of Mexico’s entry into NAFTA
(Baldwin 1995). Over time, this gravitational pull attracts so many
additional members that a regional RTA evolves into a global free-trade
area. In this optimistic scenario, RTAs lead eventually to global free trade
in which trade creation outweighs trade diversion and RTAs complement
the WTO.
Policy Analysis and Debate
The United States and the TPP
Question
Should the United States embrace aggressive bilateralism?
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Overview
The Trump administration appears committed to a strategy of
aggressive bilateralism in its trade relationships with the rest of the
world. In its first major outline of trade policy, submitted to Congress
in March 2017, the USTR stated that the guiding principle for its
policy was to “expand trade in a way that is freer and fairer for all
Americans.” And it stated that this goal “can be best accomplished by
focusing on bilateral trade negotiations rather than multilateral
negotiations—and by renegotiating and revising trade agreements”
when necessary. Consequently, one of the first steps the Trump
administration took upon entering office was to withdraw the U.S.
from the TPP. In April of 2017, President Trump called the WTO
“another one of our disasters” and ordered the Department of
Commerce to undertake an extensive review of WTO rules. One
month later, the administration notified Congress of its intention to
renegotiate NAFTA, and in September 2017, Trump and other
administration officials began to speak publicly about scrapping the
U.S.–South Korea Free Trade Agreement. At present, the
administration has wavered on its orientation toward TTIP and has yet
to state publicly whether it intends to withdraw from this agreement as
well.
The administration’s stated rationale for these changes is twofold.
First, members of the administration assert that existing trade
agreements between the United States and other countries put the U.S.
at an “unfair advantage in global markets” (USTR 2017). Foreign
governments enact unfair trade policies and practices such as
subsidies, piracy of intellectual property, and currency manipulation
that “harm American workers, farmers, ranchers, services providers,
and other businesses” (ibid). And the WTO and other international
enforcement mechanisms do not permit the U.S. to take steps to punish
such transgressions. Second, the administration asserts that it can
negotiate a series of bilateral trade agreements that prevent these unfair
practices. It intends to use these bilateral negotiations to “hold our
trading partners to higher standards of fairness” and will use American
trade law “in response to trading partners that continue to engage in
unfair activities.”
Policy Options
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 ■
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The United States should retain its postwar policy based on
multilateral cooperation within the WTO supplemented by
regional trade agreements.
The United States should be more aggressive in its trade
relationships and the shift to bilateralism is a good way to
implement such an approach.
Policy Analysis
Does the United States derive benefits from the mega-regionals
and the WTO that it cannot otherwise enjoy?
How disadvantaged are American producers by unfair trade
practices?
Take a Position
Which option do you prefer? Justify your choice.
What criticisms of your position should you anticipate? How
would you defend your recommendation against these criticisms?
Resources
Online: Visit the U.S. Trade Representative website (www.ustr.gov)
for timely information about current negotiations. The fullest
statement of the Trump administration’s approach is in the USTR’s
“The President’s 2017 Trade Policy Agenda,” which you can find at
the Resource Center at USTR.gov
In Print: See Jeffrey J. Schott, US Trade Policy Options in the Pactific
Basin: Bigger is Better, PB17-7 (Washington, DC: Peterson
Institute for International Economics, 2017); Doug Irwin, 2017,
“The False Promise of Protectionism,” Foreign Affairs 96
(May/June): 45–56.
By contrast, the creation of a large RTA in one region could encourage
the formation of rival and more protectionist RTAs in other regions. In this
scenario, NAFTA as well as FTAA could be seen as an American response
to the EU. An emerging free-trade area in Pacific Asia could be seen as a
response to regionalism in Europe and the Western Hemisphere. In this
view, world trade is becoming increasingly organized into three regional
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and rival trade blocs. Once regional trading blocs have formed, each bloc
might raise tariffs to restrict trade with other regions. A tariff increase by
one RTA could provoke retaliation by the others, leading to a rising spiral
of protection that undermines global trade liberalization (Frankel 1997,
210). In this case, trade diversion outweighs trade creation and RTAs pose
an obvious challenge to the WTO.
It is impossible to predict which of these two scenarios is the more
likely. The world does seem to be moving toward three RTAs: one in
Europe, one in the Western Hemisphere, and one in Asia. At the same
time, governments appear to be aware of the challenges RTAs pose to the
WTO, as they have created a WTO committee on RTAs that is exploring
the relationship between these arrangements and the multilateral system.
Only time will tell, however, whether RTAs will develop into
discriminatory trade blocs that engage in tariff wars or if instead they will
pave the way for global free trade.
CONCLUSION
The multilateral trade system is an international political system. It
provides rules that regulate how governments can use policies to influence
the cross-border flow of goods and services. It provides a decision-making
process through which governments revise existing rules and create new
ones. And it provides a dispute-settlement mechanism that allows
governments to enforce common rules. By promoting nondiscriminatory
international trade, by establishing a formal process for making and
revising rules, and by allowing governments to enforce the rules they
create, the WTO reduces the impact of raw power on international trade
relationships. In short, the WTO brings the rule of law to bear in
international trade relations.
Like all political systems, the WTO reflects the interests of the
powerful. Its creation reflected the interests of a hegemonic United States;
its strengthening during the Cold War era reflected the growing interest of
European and Japanese governments that trade liberalization promised real
gains. Although one can argue that the WTO reflects only the interests of
the advanced industrialized countries, the trends over the last 20 years
suggest otherwise. The rapid growth in the number of countries joining the
WTO during that period suggests that most of the world’s governments
believe that they are better off with the WTO than without it. This doesn’t
mean that the system is perfect. It does suggest, however, that in the
contemporary global economy, the majority of the world’s governments
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believe that they do better when world trade is organized by a system
based on nondiscrimination and market liberalism than they do in a
discriminatory, protectionist, and rule-free environment. The WTO will
weaken, and perhaps even crumble, when governments no longer believe
this is true.
The largest contemporary challenges to the WTO emerge from the
ability of its decision-making process to continue to produce outcomes in a
changing world. On the one hand, the growth of WTO membership and the
emergence of the G-20 as a powerful bloc within the organization has
raised the stakes of trade negotiations and made it more difficult to find
packages acceptable to the full membership. On the other hand, the
emergence of a vocal NGO movement critical of the WTO’s apparent
tendency to place business interests before consumer interests has made it
even more difficult to reach agreements within the organization. The full
consequences of these two challenges remain uncertain. Can governments
reform decision making in the system in a way that simultaneously
enhances its legitimacy and efficiency? Or will continued decision-making
paralysis impart additional impetus to regionalism?
KEY TERMS
Customs Union
Dispute Settlement Mechanism
The Doha Round
Free Riding
Free-Trade Area
Generalized System of Preferences
Hegemon
Hegemonic Stability Theory
Intergovernmental Bargaining
Market Liberalism
Mega-Regional Agreements
Ministerial Conference
Most-Favored Nation
National Treatment
Nondiscrimination
Non-tariff Barriers
Public Good
Regional Trade Arrangement (RTA)
Tariffs
Trade Creation
Trade Diversion
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