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Preferential Trade Agreements: A Silent Enemy

Updated on November 19, 2013
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Introduction

Multilateralism and regionalism are two conflicting, yet enticing, concepts that are very significant in our world's international trade system. The relationship between the multilateral trade system along with Members of the WTO (World Trade Organization) under this system, and the regional trade system, has been vehemently studied amongst many analysts and observers of international trade. They focus on the effects of preferential, or regional, trade agreements, commonly referred to as PTAs, on the multilateral trade system and argue over whether or not PTAs supplement or harm the system.

While there are many positive aspects of preferential trade agreements when taken at face value, I would suggest that these agreements between countries tend to do more harm than good with regard to their effects on the multilateral trade system. I want to show that PTAs have a discriminatory nature that conflicts with the Most Favored Nation obligation, a core foundational principle of the WTO. Thus, WTO Members' acceptance and implementation of PTAs contradicts the role of the WTO altogether.

I also suggest that these agreements only produce more barriers to trade than openings, which in turn derails the goals of the entire global trade regime. I will provide multiple arguments and claims made by observers on both sides of the PTA spectrum. I will also discuss the impacts PTAs have had on important subcategories of international trade such as trade creation and diversion, multilateral trade liberalization, the coherence of the international trade system and dispute settlement.

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PTAs

Preferential trade agreements are essentially pacts between countries that decrease tariffs on products for countries who become a party to the agreement. They are regional agreements between developed and developing countries, and are a significant mechanism that Members of the WTO have been using in order to achieve economic integration. Examples of preferential trade agreements are NAFTA, the EC, MERCOSUR, ASEAN, COMESA, and so on.

Today, all Members of the WTO are apart of at least one PTA. A key discriminatory aspect of PTAs that derails the goals of multilateralism is that they demonstrate favoritism in trade matters with other parties, but not with countries not included in their arrangement. The formation of PTAs are permissible under the “Enabling Clause” of the GATT 1994, which allows preferential trade agreements between Members from developing countries to derogate from the MFN (most favored nation) treatment obligation (Bossche, 708). A simple requirement of the Clause is the duty of favorable treatment to promote the trade of developing countries (ibid). If it were not for these exceptions, PTAs would without reasonable doubt contradict the MFN principle of the WTO, under the circumstance that they play favorites among partner Members and lack respect toward external trading partners who are not under any preferential arrangement with them. This, in turn, hurts the multilateralist cause.

Let us try to clarify the type of relationship the multilateralist trade system has with regional trade agreements. These agreements are often viewed as a positive alternative to multilateral trade liberalization, but we must keep in mind that they “aggravate” the lack of multilateral growth (Bossche, 698). Some analysts believe PTAs complement and reinforce the multilateral system, while others view them to be discriminatory and threatening to the multilateral system (Trebilcock & Howse, 26).

We can see this by thinking about how the MFN principle of the multilateral trade system has been the victim of PTA exceptions that undermine it. For example, PTA rules permitted parties of the arrangement to “discriminate by not extending the same privileges to all regime Members” (Barton et. al., 39). At any rate, we can see how the relationship between preferential trade agreements and multilateralism is confusing and conflicting.

Arguments for PTAs

In order to avoid any biases, we must acknowledge the arguments made by supporters of PTAs and how they are seen as a positive reinforcement of the multilateral trade system. We will then compare these claims with the claim that PTAs are more harmful than prosperous to the global trade regime.

It is apparent why some countries may be interested in engaging in trade liberalization with other countries. For example, the European Union has practiced regional trade liberalization and economic integration through its Member States. The EU, in turn, resulted in a more unionized community by engaging its Members in these PTAs (Bossche, 697).

Some argue that PTAs could supplement the multilateral trade system by producing substantial economic growth within a region, and that this could further produce an increase in global trade (Bossche, 696). Other claims are that PTAs positively contribute to poverty alleviation and promote democracy (ibid, 18-19). Further, the “bicycle theory” of PTA trade liberalization suggests that regionalism is a happy alternative if multilateralism is not an option for a developing country, and that PTAs could help sustain growth in trade liberalization (Trebilcock & Howse, 29).

While all of these claims seem valid if they are taken at face value, we can dig deeper and look at the more sinister aspects of preferential trade agreements, and see how they have a harmful impact on the multilateral trade system.

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Why PTAs are Harmful

I wish now to turn to the focus of this article, which suggests that preferential trade agreements have more harmful effects on multilateralism than beneficial effects. Many arguments support this claim, and there is much consensus on the negative effects that PTAs actually have.

Regionalism was originally seen by GATT Members as a sort of “insurance policy” for smaller or developing nations that were not ready to enter the multilateral spectrum. However, over time this only persuaded countries to start solving their trade problems in places other than the multilateral trade system because countries began to favor the idea of regionalism (Barton et. al., 4). This is how PTAs first started to conflict with the multilateralism of the GATT and the WTO.

There are many dangers of the proliferation of PTAs to the multilateral trading system. For example, Guy De Jonquieres argues that “abandonment of multilateral liberalization in favor of [...] regionalism could [...] erode the rules and disciplines underpinning the WTO” (Bossche, 697). He goes further to say that Members of the WTO will gradually pay less respect to dispute settlement proceedings in accordance with the WTO as their political commitment to the multilateral system weakens (ibid).

Jagdish Bhagwati is another critic of preferential trade agreements. He holds that the global trading system will only become a more tangled web of trade barriers as PTAs continue to become more popular arrangements between countries (Trebilcock & Howse, 196). This shows how PTAs derail the role of the WTO in the global trading system because of their contradiction to the MFN treatment obligation (ibid). These agreements, whose parties are Members of the WTO, contradict the very contract that those Members are obliged to in the WTO.

There is the argument that “although PTAs create an intellectual tension between the discriminatory and the nondiscriminatory trading areas [regionalism vs. multilateralism], this tension is not evident in the role...of the regime” (Barton et. al., 55). This claim is obviously untrue, since we have already seen how Members who sign preferential trade agreements are starting to find more incentive to stop following the rules of the multilateral trade system. It clearly shows that PTAs harm multilateralism and place it in a negative light to its Members. Further, the simple fact that these regional trade arrangements are forcing WTO Members to dismiss the rules of the multilateralist trade system as they merge toward regionalism proves how PTAs are harmful to multilateralism as a whole.

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Impact of PTAs on the Trade System

We have seen how PTAs harm multilateralism, so now we must think about the impacts they have on the trade system. We shall start with the impact these agreements have on trade creation and trade diversion. Trade diversion is another negative aspect of PTAs. Trade diversion of PTAs, it has been argued, distort an equal distribution of resources globally, thus derailing global welfare altogether (Trebilcock & Howse, 195). There have also been suggestions that PTAs have had a higher impact on trade diversion than they have on trade creation, since participant trading conflicts with trading with non-participants (Bossche, 696). In short, the trade diversion that is produced by preferential trade agreements often brings along with it much political tension and conflicting goals with the multilateral trade system, creating a barrier to an increase in multilateral trade growth (Barton et. al., 3).

With regard to the impact of preferential trade agreements on multilateral trade liberalization, the Sutherland Report claims that there is good reason to have doubts about their success. The report states that “there is...real reason to doubt assertions that the pursuit of multiple PTAs will enhance, rather than undermine, the attractiveness of multilateral trade liberalization” (Bossche, 697). Further, some argue that trade liberalization will skyrocket if pursued within “regional trading blocs”, but that such a claim is not valid because of the discriminatory nature of preferential trade arrangements that slows the multilateral liberalization of trade (ibid, 696).

The impact of PTAs on the coherence of the international trade system and dispute settlement process also shows signs of danger. How do these agreements alter the principles of the system?

For one, the proliferation of preferential agreements has led to much of our world’s trade not being conducted accordingly with the MFN treatment obligation mentioned before (Bossche, 323). The design of regionalism and the preferential agreements that fall under it essentially deter the goal of free international trade by restricting trade to Members that do not belong to the same arrangement as they do.

With regard to the dispute settlement process, good things are not arising from PTAs here either. Settlements of dispute within preferential trade agreements are concluded informally, and the flexibility of regionalism has sparked such a reaction out of WTO Members to ignore or dismiss the rules of the multilateral system by committing acts such as forcing compliance through arbitration. This is counterproductive to both regionalism and multilateralism and thus proves itself to be harmful (Barton et. al., 3 & 216).

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Analysis

A brief analysis of the current status of preferential trade agreements is crucial for our purposes. The Doha Development Round has had its Members to work towards improving the current rules of PTAs (Bossche, 698). So far, they have been able to develop a “transparency mechanism” which requires Members to notify other Members of any negotiation they may be involved in concerning preferential trade arrangements, and of any agreement they recently took part in (ibid).

As stated earlier, all Members of the WTO are party to at least one preferential trade agreement (Baccini, 3). For instance, many African countries are parties to at least four agreements, while many Latin American countries are parties to at least seven agreements (ibid). However, since Article XXIV of the GATT allows the establishment of FTAs (free trade agreements) even though they contradict the MFN principle of the multilateral trade system, more and more countries have signed into PTAs (Barton et. al., 3). This does not provide any alleviation to multilateralism because regionalism is forcing WTO Members to find different incentives.

Conclusion

We have discussed the ways in which preferential trade agreements (PTAs) have a more harmful impact on the multilateral trade system than some observers may think. As stated earlier, every Member of the WTO is a participant in a preferential trade agreement, and as we have seen, many are participants of more than one. This, in turn, has made the WTO a system comprised of Members who practice discriminatory trade matters within these PTAs. It has also made the WTO a system of both discriminatory as well as nondiscriminatory rules, turning the multilateralist system into one of confusion about what is and is not acceptable.

Here are the facts: Preferential trade agreements have been proven multiple times to be harmful to the multilateral trade system as well as the global regime altogether. If the rules of regionalism become even less restrictive on favoritism between PTA Members, then the international trade system as well as the liberalization of trade is in grave danger, and could produce consequential limitations on our global cycle of trade between countries. Regionalism has the ability to increase trade, but it has proven to undermine to global trade regime. Thus, if preferential trade agreements and their participants continue to contradict the Most Favored Nation obligation under the WTO, multilateral trade liberalization could take a large and unwanted downturn on international trade.

PTAs: Good or Bad?

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Sources


  • Baccini Et. Al., Leonardo. The Design of Preferential Trade Agreements: A New Dataset in the Making. N.p.: n.p., 2011. PDF.

  • Barton, John H. The Evolution of the Trade Regime. Princeton, NJ: Princeton UP, 2008. Print.
  • Bossche, Peter Van Den. The Law and Policy of the World Trade Organization. 2nd ed. Cambridge: Cambridge UP, 2008. Print.
  • Trebilcock, Michael J., and Robert Howse. The Regulation of International Trade. 3rd ed. London: Routledge, 2005. Print.

© 2013 Ameera Nassir

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    • Mark Lees profile image

      Mark Lees 3 years ago

      Hi Crreamm,

      This is an interesting hub and it points out some, but by no means all, of the flaws with the WTO and its predecessor.

      But something that would be even more interesting to consider- why do we have national boundaries at all? Without them there would be no need for flawed organisations such as the WTO and the IMF.

    • Marie Flint profile image

      Marie Flint 3 years ago from Jacksonville, Florida USA

      Crream, I'm the last person to ask an opinion about this topic, as money seems to roll off me like water off a duck's back; what little I receive, I'm unable to keep.

      One basic buying principle I've tried to follow in life is to buy locally; this practice helps a struggling rural economy gain some stability. Applying this to world trade, the regional trade agreements, or as you call them, preferential trade agreements, would be chosen over global agreements.

      What is an agreement, anyway? It's simply two or more parties coming together with mutual interests. There's nothing wrong with that. Does this hurt world trade? I don't think so. You're still going to have a similar supply and demand, but it will just be shifted as the moods of the market change.

      When the U.S.S.R. fell apart, I think some preferential trade agreements would have done the new independent states/countries some good.

      Of course, there is the early history of China when the dynasties were still an influence. China had a rich economic system of order until the British stepped in and forced trade.

      Our high school history teacher once asked, "Would you sacrifice freedom for order?" Any contract--global or regional--will have limitations. Countries naturally try to protect their local markets. World trade is nice to the extent that it allows citizen of different nations to experience products of other countries and, thus, promote peace and understanding through that exchange.

      Today, with the internet, world communication has become instantaneous, expanding opportunities for cultural exchange and, at the same time, making the world seemingly smaller with, perhaps, a little less to discover (at least, between countries with internet access).

      When the British pulled of Hong Kong many years ago, it left the locals in a tizzy. Even CEOs of Chinese descent were leaving for places like Canada or the U.S. I attempted to help one Chinese entrepreneur with ideas on how to help his countrymen. He was well aware of long=term investments being the key to economic health for his people and looked to European markets for trade.

      So, necessity is the mother of invention, whether it be regional or global.

      This article, in spite of my ignorance of the topic, appeared substantially researched and well written. (It's so nice to read someone who knows how to use punctuation and make a paragraph!) Perhaps some statistical figures in dollars and cents comparing some global market exchanges "before" and "after" the initiation of PTAs would have added extra punch to your thesis. Voted interesting. --Blessings!