Globalism Vs. Regionalism

Published in New Business April 2014

By Hom Nath Gaire

In itself controversial, international trade, as advocated by Physiocrates, is a necessary evil because to them both foreign as well as domestic trade produce no real wealth. Classicist and Neo-classicists regard international trade as an engine of growth. Adam Smith's model of international trade postulates the existence of ideal land and labor before a country is opened to world market, his imagination of international man also justify the viability of foreign trade in economic development of any country.

In general, classical economists considered comparative advantages as determining the pattern of trade with widening of market, induced innovations, and increase productivity. Modern economists too pleaded for the gain from the trade, not only change in resource allocation but in continuous impact on economic development of a nation. It stimulates for changing productivity of the economy.

Because of continuous transform in international economic order, global trading system is rapidly changing. Until the early 1990s, multilateralism was dominant and regional remained marginal. Today, however, regionalism is well acknowledged as one of the two pillars of global trading system, together with multilateralism. It will be thus important to explore the harmony between regionalism and multilateralism in the days to come. The question is whether regionalism may be a faster way to reach multilateralism or, rather, hurt multilateral liberalization.

In this context, a question is raised by scholars that whether the regional integrations are stepping stones toward multilateralism. Since the end of the Uruguay Round, the global trading system has experienced the emergence of a large group of regional trading blocs. Ranging from the North America Free Trade Agreement (NAFTA) and the Union of South American Nations (UNASUR) to the Association of Petroleum Exporter Countries (APEC) and the enlargements of the European Union (EU) regional trading blocs seem to become factors that have to be taken seriously in the future trading system.

Regional Trade Agreements (RTAs)

One of the most striking development in the world trading system since the mid 1990s is a surge in Regional Trade Agreements (RTAs). RTA as described by the Dictionary of Trade Policy Terms is “actions by governments to liberalize or facilitate trade on a regional basis, sometimes through free-trade areas or customs unions”.

In the WTO context, RTAs have both a more general and a more specific meaning: more general, because RTAs may be agreements concluded between countries not necessarily belonging to the same geographical region. More specific, the WTO provisions which relate specifically to conditions of preferential trade liberalization with RTAs.

Initially WTO encouraged the growth of RTAs because it believed that regional integration initiatives can complement the multilateral trade regime. As a result, many countries which traditionally relied on the multilateral trade regime are increasingly joining RTAs to promote bilateral as well as intraregional trade. However, the high proliferation of RTAs in global trade and increased diversion of trade through this route is increasingly becoming a cause for concern for the multilateral trading system under WTO.

Types of RTAs

Depending upon their level of integration, RTAs can be broadly divided into five categories: Preferential Trade Agreements (PTAs), Free Trade Agreements (FTAs), Customs Unions (CUs), Common Markets (CMs) and Economic Unions (EUs). Among the RTAs, a large majority are PTAs or FTAs, which are assumed to provide deep integration with in the regional trading system. In contrast, there are only a handful of CUs, CMs and EUs worldwide. The new generation of RTAs, especially those comprising developed countries, includes more regional rules on investment, competition and standards; as well as provisions on environment and labor. Most of these new agreements also include preferential regulatory frameworks for mutual services trade.

As of Mid June 2014, there are 585 RTAs have been reported under the GATT/WTO. Of these, 379 were in force. What all RTAs in the WTO have in common is that they are reciprocal trade agreements between two or more partners.

• A PTA is a union in which member countries impose lower trade barriers on goods produced within the union, with some flexibility for each member country on the extent of the reduction.
• A FTA is a special case of PTA where member countries completely abolish trade barriers (both tariff and non-tariff) for goods within the member countries. However, in most cases, countries do not abolish trade barriers completely as FTAs tend to exclude sensitive sectors.
• A CU provides deeper integration than in FTAs where member countries apply a common external tariff on a good imported from outside countries.
• The CM is a mechanism where member countries attempt to harmonize some institutional arrangements along with commercial/financial laws and regulations among themselves. A common market also entails free movements of factors of production, i.e. removal of controls on free movement of labor and capital.

·       Finally the deep integration level is the EU where countries implement common economic policies and regulations and adopt a single currency.

 Why Countries Opt for RTAs?

A complex mix of external and internal factors, as well as economic, political and security-related factors is behind the expansion, intensification and diversification of RTAs. External factors include securing markets and providing export opportunities for domestic companies by dismantling the trade barriers between participating nations. The expansion of production that results from increased export opportunities enables companies to reap the benefits of economies of scale, which in turn leads to more efficient production. Access to markets and the expansion of export opportunities are particularly important for companies from smaller country.

Internal factors include economic growth from increased efficiency due to greater competition as a result of the markets being opened. Since the 1970s, policymakers have come to recognize the benefits of liberalization of foreign trade and investment, deregulation and the removal of domestic regulations. These reforms have facilitated high economic growth in the developing countries of East Asia, as well as industrial nations such as the US and the UK. In other words, strengthening competition pushes inefficient companies out of the market, while at the same time creating the opportunity for companies with latent competitive strengths to realize their potential. Thus, many countries throughout the world have forged ahead with the liberalization of foreign trade and investment through RTAs.

These explanations can be divided into three broad categories.

·       First is the traditional explanation of welfare effects through trade liberalization and the consequent gains from trade at a regional level. In this case, efficiency gains arise from both production efficiency and consumption efficiency.

·       Second there is an emerging consensus among economists that frustration with the multilateral trading system is one of the prime reasons behind the current growth of regionalism (RTAs). Krugman, an American Novel Laureate in economics, suggests that countries find RTAs an easier alternative because large number of participants in multilateral trade negotiations reduces the cost of non-cooperation and creates rigidity in the system. He believes that regionalism did not occur because countries have lost faith in GATT or because USA has adopted regionalism.

·       Lastly, another reason why countries wish to participate in RTAs is their desire to strengthen their political and economic influence in the international arena. One of the motivations behind regional integration in Europe after World War II was for the European countries to strengthen their economic influence against the US and to reinforce their political and military power against the Communist bloc of the Soviet Union and Eastern Europe. Similarly, ASEAN, which was originally created as a political and security forum, established an FTA in 1992 because of the decline of its importance after the end of the Cold War on the one hand, and a sense of impending crisis in the face of the rapid growth of the Chinese economy on the other.

Economic effects of RTAs

The economic effects of RTAs on members and nonmembers are often divided into static and dynamic effects. Static effects include:

·       The trade creation effect—the effect whereby trade is created between the members of a group by lifting the trade barriers between them.

·       The trade diversion effect—after the establishment of RTA, imports is diverted away from more efficient nonmembers towards members that may be less efficient.

·       The terms of trade effect—the terms of trade of members are improved due to their increased influence over nonmembers as a result of the greater volume of trade between member nations.

Dynamic effects include:

·       The market expansion effect—the achievement of economies of scale and the ability to choose the best locations for production and distribution as trade barriers are removed and markets expand.

·       The competition enhancement effect—the facilitation of efficient production because companies with oligopolies in the region are made more competitive by market integration.

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WTO and RTAs

As well known, the WTO was set up to liberalize international trade on the principle of non-discrimination and to eliminate trade barriers through multilateral negotiations. It has contributed to expanding world trade and is expected to do more if the current multilateral negotiations are completed ever and the Bali (trade facilitation agreement) is implemented. RTAs represent an important exception to the WTO's principle of nondiscrimination. According to the WTO rules, countries within a RTA can trade among themselves using preferential tariffs and easier market access conditions than what is applicable to other WTO member countries.

As a result, WTO member countries that are not a part of the RTA lose out in these markets. As increasing amount of global trade is being diverted through this route, there is a certain amount apprehension about the role of RTAs in WTO. In general Article I (GATT, 1947) prohibits any preferential trading arrangements. An exception to this is that RTAs are permitted, so long as they take the form of customs unions or free trade areas satisfying the conditions of Article XXIV.

However, some analysts argue that increased regionalism is dangerous because it not only leads to inter block trade wars and domination of small countries by bigger partners in the regional blocks but also because it reduces the enthusiasm for participation in the multilateral trade regime. The worry that RTAs divert attention is that the most preferential agreements lead to trade discrimination and thereby harm the multilateral trading system. Further, the growing number of RTAs may lead to a complex system of regulatory structures. This phenomenon may lead to complexity and lack of transparency in the global trading system.

Three main reasons to worry:

·       First, the basic WTO trade norms are almost universally accepted and respected. As the mega RTAs have involved more than one in each, the small member and third nations find themselves at a huge disadvantage. Thus, it is not at all clear that the new norms of multilateral trade regime will be universally respected.

·       Second, a world where the WTO is irrelevant to trade’s most dynamic developments is not a world that fosters multilateral cooperation on other issues. Without a single forum for all trade and investment issues, it will be difficult to arrange the trade-offs necessary to make progress on trade-related policies.

·       Third, the WTO’s arbitration function is still working well, but any dispute settlement system must “walk on two legs”. The judges can connect the dots for particular cases, but the basic rules must be updated occasionally to match evolving realities. If the rules are being written in the RTAs, it may be very difficult to update the WTO rules.

Over the past 15 years, WTO members have voted for the RTA option. Without reform that brings existing agreements under the WTO and makes it easier to develop new disciplines inside the system, the trend will continue, possibly taking it beyond the tipping point where nations ignore WTO rules. In the best of cases, the WTO would continue to thrive as the institution that guide 21st-century trade flows. If the mega RTAs and their power asymmetries take over, there is a risk that the WTO could go down in future history books as a 70-year experiment in which world trade was rule-based instead of power-based.

Finally

While trade is growing fast, the multilateral trading system (WTO) has been facing a number of internal difficulties linked to the size of its membership and the diversity of economic situations, trade interests, and previous commitments. The WTO is also challenged by the outside rapid development of RTAs.

There has been a rapid growth in the number of RTAs in recent years. It has raised the question as to whether RTAs pose a threat to the WTO. The trend in the growth of RTAs should express strong concerns about the negative effects of growing regionalism. Thus, we should tend to regard regionalism much more as a complement to multilateralism.