Regionalism and Multilateralism 47
Chapter Five
Regionalism and Multilateralism
I. Fundamental Issues
1. What are the main types of regional trade agreements, and how do economists measure trade within regional trading groups?
2. How is a free trade area such as the North American Free Trade Agreement different from other types of preferential trade arrangements?
3. What distinguishes customs unions such as the European Economic Community of 1970s and the current Andean Community from common markets such as the European Union and Mercosur?
4. How can regional trading arrangements lead to both trade creation and trade diversion?
5. What is trade deflection, and how do rules of origin help to limit the extent to which trade deflection occurs?
6. How do multilateral trade agreements contrast with regional trade arrangements?
II. Chapter Outline
1. Regional Trade Blocs
a. Regional Trade Agreements
b. Measuring How Much Regionalism Matters for Trade
2. Preferential Trade Arrangements and Free Trade Areas
a. Preferential Trade Arrangements
b. Free Trade Areas
3. Customs Unions and Common Markets
a. Customs Unions: Treating Outsiders Equally
b. Common Markets: Freeing Up Resource Flows
4. Trade Creation, Diversion, or Deflection?
a. Trade Creation versus Trade Diversion
b. Policy Notebook: Gravity, Trade, and the Euro
c. Trade Deflection
d. Visualizing Global Economic Issues: Trade Creation versus Trade Diversion in a Three-Country World
e. Policy Notebook: The European Union — Fortress Europe
5. Multilateral Approaches and Benefits
a. Most Favored Nation Status
b. Multilateral Trade Regulation
c. Online Globalization: The WTO—“Wired Trade Organization?”
d. Will Regionalism Ultimately Evolve Into Multilateralism
e. Policy Notebook: Section 201—Safeguard or Flashpoint?
6. Questions and Problems
III. Chapter in Perspective
This chapter covers the growing usage of bilateral and regional trade agreements. Measures of global trade such as global trade shares and regional trade concentration ratios are developed, and different types of trade agreements are covered. A major purpose of the chapter is to encourage students to consider how trade agreements may or may not lead to increased global trade and freer markets. Finally, most-favored-nation status is discussed, and the WTO and GATT are introduced.
IV. Teaching Notes
1. Regional Trade Blocs
a. Regional Trade Agreements
There are more than 130 either bilateral or regional trade agreements currently in effect. About half have been adopted since 1990.
Types of arrangements (ordered from simplest or least integrated to most complex or most integrated):
· Preferential trade arrangements
One country unilaterally grants trade preferences to another country for a certain set of goods and services. Sometimes there are reciprocal agreements also.
· Free trade area
A reciprocal agreement between two or more countries where the participants agree to remove all or most trade barriers. Each country maintains its own unique trade barriers for non-member countries.
Teaching Tip:
Don’t confuse a free trade area with a free trade zone within a country, although the two are related. Sometimes countries establish free trade zones within their borders through which goods can enter, be processed and then either leave the country duty free or be sold in the country. This is done to encourage locating an assembly or processing plant in a given country.
· Customs union
A customs union is a free trade area that has adopted common trade rules or barriers that apply to non-member countries. This is usually a much more complex step than establishing a free trade area.
· Common market
The next step beyond a customs union is to establish a common market. In a common market, the participating countries allow (more or less) free movement of factors of production (capital, labor and other resources) between the countries.
· Economic union
After a common market is established, the participating countries may begin to closely coordinate their economic policies, particularly in the areas of monetary policy, stability of currency values and probably restrictions on fiscal deficits and debt.
b. Measuring How Much Regionalism Matters For Trade
It is normal to measure international trade flows as the sum of export and import flows within a given time interval relative to total global trade flows. These are called trade shares. In 2001, the U.S. and the European Union (EU) accounted for about 15 percent and 35 percent of global trade respectively. As indicated in Table 1, The EU, NAFTA, Mercosur, the Andean Community and ASEAN collectively have a trade share of over 64 percent of global trade.
Table 1 (Source: Text Table 5-1)
Regional Trading Bloc / 2001 Share of Global TradeEU / 35.28%
NAFTA / 22.07%
ASEAN / 5.06%
Mercosur / 1.28%
Andean Community / 0.65%
Total / 64.34%
The large trade shares of the EU and NAFTA do not necessarily imply that regional trade blocs result in large amounts of international trade. Nor does the trade share data indicate whether trading blocs affect regional trading patterns. For example, the question of whether Mercosur countries such as Argentina and Brazil trade more intensively with other members of Mercosur than NAFTA countries trade among themselves cannot be answered with the given trade share data. NAFTA’s global trade share is larger than Mercosur because the U.S. economy and level of international trade in the United States. is much larger than any country in Mercosur. To compare the intensity of trade within groups we need to calculate trade concentration ratios. A trade concentration ratio is calculated as the bloc’s trade that occurs between member nations, expressed as a percentage of the bloc’s total trade divided by the trade bloc’s total global share of trade. The higher the trade concentration ratio the more intensively the bloc trades among its member nations as opposed to the rest of the world.
Table 2 (Source: Text Chapter 5)
Regional Trading Bloc / Trade Concentration RatioEU / 8.4
NAFTA / 1.4
ASEAN / » 3.0
Mercosur / 9.9
Andean Community / 17.2
Teaching Tip:
Sample calculations of global trade shares and trade concentration ratios:
Given the data in Table 3, find each country’s share in global trade (there are only three countries in this world) and then, assuming that Country 2 and Country 3 constitute a trade bloc, find the trade concentration ratio for the trade bloc.
Table 3
Country of Origin / AmountExported / Exported
to
Country 1 / $60 / Country 2
Country 1 / $40 / Country 3
Country 2 / $35 / Country 1
Country 2 / $75 / Country 3
Country 3 / $45 / Country 1
Country 3 / $120 / Country 2
Solution [Notice that global trade is “balanced” in that the trade surpluses and deficits must sum to zero, or equivalently, global exports = global imports]:
Country 1 exports $100 and imports $80 (= $35 + $45), (as indicated by the bold lines in the table). Country 1’s total trade is $180. Thus, Country 1 has a trade surplus of $20.
Similarly, Country 2 exports $110 and imports $180 (= $60 + $120). Country 2’s total trade is $290, and Country 2 has a trade deficit of $70.
Country 3 exports $165 and imports $115 (= $40 + $75). Country 3’s total trade is $280, and Country 3 has a trade surplus of $50.
Total global trade is ($180 + $290 + $280) = $750
Country 1’s share of global trade is $180 / $750 = 24.00%
Country 2’s share of global trade is $290 / $750 = 38.67%
Country 3’s share of global trade is $280 / $750 = 37.33%
———
Sum = 100.00%
If Country 2 and Country 3 constitute a regional trading bloc, we can find the trade concentration ratio for the bloc by first calculating the ratio of total trade between Country 2 and Country 3 as a share of the bloc’s total trade. Refer once more to Table 3 reproduced below:
Table 3
Country of Origin / AmountExported / Exported
to
Country 1 / $60 / Country 2
Country 1 / $40 / Country 3
Country 2 / $35 / Country 1
Country 2 / $75 / Country 3
Country 3 / $45 / Country 1
Country 3 / $120 / Country 2
Country 2’s trade with Country 3:
Country 2 exports $75 to Country 3 and imports $120 from Country 3 for total trade of $195.
Country 3’s trade with Country 2:
Country 3 exports $120 to Country 2 and imports $75 from Country 2 for total trade of $195.
Total bilateral trade between Country 2 and 3 is found as $195 * 2 = $390.
This total may be expressed as a share of the total trade of Country 2 and Country 3 by dividing it by the sum of total trade for Country 2 and Country 3, which from above is $290 and $280 respectively: $390 / ($290 + $280) = 68.42 percent. Of the total trade from Country A and Country B, 68.42 percent of that trade is between countries A & B.
Finally, the trade concentration ratio can now be found by dividing the bilateral trade percentage by the total trade share of the trading bloc as follows:
Total global trade share of the bloc = 38.67% + 37.33% = 76%
Country 2 and Country 3 bloc trade concentration ratio = 68.42% / 76% = 0.90. A trade concentration ratio less than unity (as is the case here) implies that the trading bloc trades less intensively within itself than it trades with the rest of the world. A trade concentration ratio greater than 1 implies that the trading bloc trades more intensively within itself than it trades with the rest of the world. Table 2 indicates that the Andean Community, Mercosur and the European Union trade much more intensively within their bloc than does NAFTA and ASEAN.
2. Preferential Trade Arrangements and Free Trade Areas
a. Preferential Trade Arrangements
Preferential trade arrangements (PTAs) are usually the weakest form of regional trade agreement and the simplest to construct. They are often unilateral, and serve as a substitute for direct foreign aid and/or to build political capital with neighboring countries. The text likens the different trade arrangements to a progression of a romantic relationship, in which the PTA is the early courtship stage when countries first begin to explore a more formal trade relationship with a neighboring country. The Caribbean Basin Initiative is used as an example. Information on the CBI may be found at http://www.mac.doc.gov/CBI/webmain/intro.htm.
b. Free Trade Areas
Free trade areas are the next step in the relationship and may be characterized as the “going steady” point. They are reasonably easy to create and to eliminate. ASEAN (Association of South-East Asian Nations) is a free trade area originally consisting of Brunei, Cambodia, Indonesia, Malaysia, Myanmar, Laos, Philippines, Singapore, Thailand and Viet Nam. Information on ASEAN may be found at http://www.asean.or.id/. The European Free Trade Association (EFTA) consisting of Iceland, Liechtenstein, Norway and Switzerland is another well-known FTA. Of course, the largest is NAFTA. As a result of NAFTA, imports from Mexico to the U.S. rose slightly, exports from the U.S. to Mexico also increased and Canadian-U.S. trade shares hardly changed. Mexico did substantially increase its exports to Canada and experienced a smaller increase in imports from Canada. Generally speaking, in aggregate, NAFTA had little overall effect on U.S. global trade, a somewhat larger effect on Canada and has had the greatest effect on Mexico.
3. Customs Unions and Common Markets
a. Customs Unions: Treating Outsiders Equally
In a customs union, the member countries adopt identical trade policies with nations outside the customs union. Creation of a customs union is a major step beyond a free trade area, one that generally requires extensive cooperation and negotiation among the member countries. The most important customs union in recent years was formed by the Treaty of Rome in 1957. The original signers were Belgium, France, West Germany, Italy, Luxembourg and the Netherlands. The Treaty resulted in a gradual movement toward free trade among members and common trade policies for trade with non-members. By 1969, trade among members had grown considerably inducing the U.K. and others to join, and forming the European Economic Community as a common market. The Andean Community is also a customs union, one that evolved from a free trade area over a much shorter time period. Its members include Bolivia, Colombia, Ecuador and Peru. The Andean Community has proposed becoming a common market by 2005. Mercosur is close to, but is not yet a customs union, and it hopes to eventually become a common market.
Teaching Tip:
Both Argentina and Brazil have major economic and social problems that need to be dealt with before sustainable economic growth can be achieved for any length of time, regardless of any trade policy in place. Both countries are dealing with severe corruption problems (by U.S. standards), poor fiscal policies and large numbers of people in poverty. Information about both countries can be found at the surveys conducted by the Economist at www.economist.com.
b. Common Markets: Freeing Up Resource Flows
The next step beyond a customs union is a common market. In a common market, cross-border flows of labor, capital, unfinished goods, raw materials, etc. are allowed with little or no barriers. The most well known common market was the European Economic Community. Care must be taken when predicting the effects of the formation of a trade union. For instance, the EEC (now the EU) continued to trade intensively outside its bloc long after the EEC was formed, although generally speaking, there is probably more trade within the bloc than there would have been otherwise.
4. Trade Creation, Diversion, or Deflection?
a. Trade Creation Versus Trade Diversion
Creating a regional trade area of one type or another will usually result in both trade creation (additional trade) and trade diversion (a shift in international trade patterns due to the new preferences). Trade diversion would occur to the extent that a country’s imports or exports are not increased as a result of the trade agreement, but are instead shifted from trade with non-member countries to member countries. Generally speaking, economists prefer the outcome to be trade creation, as increased trade tends to suggest firms are exploiting their greatest comparative advantages, thereby maximizing total global output. A free trade proponent would suggest that regional trade blocs are not generally good if the trade bloc does not reduce trade barriers with non-member countries, because otherwise trade diversion may be the main result. Global trade could actually decline if for instance, a group eliminates all trade barriers among member nations, but to offset lost tariff revenue, imposes higher tariffs among non-member nations. This is simply an extension of the mercantilism, beggar-thy-neighbor policies that prevailed in the Smoot-Hawley era and earlier. Taking a longer-term view however yields a more optimistic prognostication as a likely result of the recent proliferation of regional trade agreements. Namely, regional agreements are often a first step toward widespread multilateral reductions in trade barriers.