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Regional Trade Arrangements
Table of Contents:
Types of Regional Trade Arrangements
Free Trade Agreement
Regional Trade Arrangements: Case Studies
Benefits and Costs of Regional Trade Arrangements
Welfare Effects of Regional Trade Arrangements
Static Effects of RTAs
Dynamic Effects of RTAs
Conditions inducing Regional Trade Arrangements
World Trade Organization and Regional Trade Arrangements
Multilateralism vs. Regionalism
The RTA and WTO Relationship
I- Types of Regional Trading Arrangements
A- Free Trade Agreement:
The main functions of a free trade agreement are eliminating tariffs on goods, abolishing of trade barriers such as restrictive regulation on trade in services. For the free trade agreement, member countries donÐ²Ð‚â„¢t establish common tariffs of outside signatories, so that each member country establishes certain trade restraints to outsiders independently. Moreover, one of the most important functions of the free trade agreement is establishing a stiff political and cultural relationship among member countries.
The free trade agreement is provided by GATT (The General Agreement on Tariffs and Trade) article 24 of general agreements regarding customs and trading and GATS (The General Agreement on Trade in Services) article 5 of general agreements regarding trade in services.
By 2002, more than 130 of schemes for the free trade agreements are reported to the WTO. Major examples of the free trade agreements are the following: NAFTA (The North American Free Trade Agreement), CEFTA (Central European Free Trade Agreement), and SAFTA (The South Asia Free Trade Agreement). In addition, the free trade agreements are usually established among 2 nations; however, there are some multinational free trade agreements.
B- Customs Union
In general, the functions of a customs union are based on free trade agreement -- eliminating tariffs on goods, abolishing of trade barriers such as barrier to trade in services. Moreover, for the customs union, member countries set common external trade restraints such as tariffs and quotas to the third nation. The purpose of the common external trade restraints is
Prominent examples of the customs union are the following: Benelux (Belgium, the Netherlands, and Luxembourg), EUÐ²Ð‚â€œTurkey Customs Union, COMECON (The Council for Mutual Economic Assistance), and SACU (The Southern African Customs Union).
C- Common Market
A common market subsumes aforementioned regional trading agreements including free trade agreement, and customs union. Furthermore, the common market enables factor inputs such as land, labor, and capital to move freely among member nations; and besides it encourages entrepreneurings. The purpose of this function is to promote capital, labor, goods, and services move as facile as possible.
In order to permit member countries to these free movements, member countries need to adjust many sorts of policy area. More specifically, to achieve the free movement of labor, mutual certification of academic degrees and job certifications; and also compatibility of social policies are required. Additionally, to achieve the free movement of services, facilitation of establishment of facilities is required.
Well-known examples of the established common market are the following: EU (The European Union), MERCOSUR (Spanish: Mercado ComÐ“Ñ”n del Sur, English: Southern Common Market), and CARICOM (The Caribbean Community single market). Note that, however, the EU especially focuses on mutually certifying standardization and job certifications, and legislations regarding these things and making adjustment to policies.
D- Economic Union
With an economic union, member countries establish a supranational institution, which is a political and economic community. The institution optimizes national, social, taxation, and fiscal policies.
Currently there are not that many established economic unions in the world. Examples of established and pending economic union are as follows: Established: EU (The European Union) Pending: GCC (Gulf Cooperation Council), UNSUL (The Union of South American Nations), AEC (The African Economic Community), and SAEU (The South Asian Economic Union). In fact, the BLEU (Belgium-Luxembourg Economic Union) was once established; however, the union was annexed to the Benelux later on.
II- Benefits and Costs of Regional Trade Arrangements:
Ai- Benefits of Common Market
Generally speaking, the common market gives member countries the following advantages: 1) improving services such as transportation and communication provided by private and public sectors, 2) increasing employment and higher standards of living, and 3) promoting tourism among member nations.
Aii-Costs of Common Market
Initially, when member countries adapt for the common market, international competition becomes furious. This thing influences badly on certain divisions of national economy in the short run. For instance, companies which are sustained by a government with subsidies or protections from international markets may be buffeted about by the storms of the international competition, because of lacking in competitiveness against international markets. What is worse, if the companies fail to manage with the international competition, it will lead to increase in unemployment.
Bi- Benefits of Economic Union
The economic union gives member countries the following advantages: 1) promote international comprehension, 2) greater overall democratic function, 3) creating economic unity, benefit, and evolution, and 4) foreign policy and common security as well as with cooperation in areas such as justice and home affairs.
Bii- Costs of Economic Union
The economic union costs member countries the following: 1) -power is not distributed equally to individual institutions and overall, 2) numbers of votes on various issues are distorted based on population or the scale of a nation, 3) certain elites hold a large amount of power unfairly, and 5) requiring to limit substantially the use of expansive fiscal policies at a domestic level.
III- Regional Trade Arrangements: Case Studies
A- North American Free Trade Agreement (NAFTA):
Canada, Mexico, and the United States started bilateral trade negotiations at various levels in the mid-1980s.2 For example; Mexico and the United States undertook trade negotiations on specific sectors and reached framework agreements in 1985, 1987, and 1989. Mexico and Canada started discussions toward closer bilateral trade relations in 1990. Canada and the United States began negotiations for a free trade area in 1986 and launched the Canada-U.S. Free Trade Agreement (CUSFTA) in 1989. Negotiations for NAFTA formally started in June 1991. Since the member countries had held bilateral discussions earlier, negotiations moved forward quickly and were completed in August 1992. The United States and Mexico passed the NAFTA legislation in November 1993, and Canada did the same in December 1993. Finally, NAFTA entered into force on January 1, 1994.
NAFTA was a groundbreaking agreement in several aspects. The agreement was the first comprehensive free trade arrangement between advanced countries and a developing economy. It also created the worldÐ²Ð‚â„¢s largest free trade area in terms of total gross domestic product (GDP) and it is the second largest, in terms of total trade volume, after the EuropeanUnion.3 Moreover, NAFTAÐ²Ð‚â„¢s reach was unusual as it liberalized trade flows in a broad range of sectors, introduced a unique dispute settlement mechanism, and included side agreements on labor and environmental issues.
Both political and economic considerations in Mexico helped spur NAFTA forward. For example, Whalley (1998) argues that the central objective of Mexican negotiators was to make sure that the agreement helped secure the permanence of MexicoÐ²Ð‚â„¢s economic reform program. Tornell and Esquivel (1997) also conclude that NAFTA was a commitment device to ensure the continuation of the reform process. DeLong, DeLong, and Robinson (1996) argue that the agreement formally linked MexicoÐ²Ð‚â„¢s domestic economic reform program to an international agreement and made it unlikely for future governments of Mexico to abandon it. Mexico also hoped that its NAFTA membership would increase the credibility of its reform agenda, improve its risk profile, and boost foreign investment inflows. For example, Hufbauer, Schott, and Wong (2003) emphasize the importance of NAFTAÐ²Ð‚â„¢s dispute settlement process in ensuring the NAFTA partners that Mexico was serious about implementing various reforms. Moreover, they argue that NAFTAÐ²Ð‚â„¢s dispute settlement process was viewed as a tool for Mexico to gain institutional legitimacy to attract foreign investment flows.
Separating the effects of NAFTA on Mexico from macroeconomic shocks over the past decade is difficult. Following the agreement, the U.S. economy experienced a prolonged boom, followed by the 2000 stock market collapse and subsequent recession. The Mexican economy also suffered a major financial crisis in the mid-1990s, from which the banking sector has slowly recovered. Subsequently, the implementation of sound domestic economic policies along with the strength of the U.S. economy played important roles in boosting Mexican growth.
Nonetheless, most studies suggest that NAFTA spurred a dramatic increase in trade and financial flows. For example, MexicoÐ²Ð‚â„¢s exports to the United States and Canada tripled in dollar terms between 1993 and 2002. While the growth of trade has slowed since 2000, MexicoÐ²Ð‚â„¢s trade (exports plus imports) with NAFTA partners still accounted for around 40 percent of its GDP in 2002. The agreement also appears to have significantly altered the nature of trade flows, with a substantial increase in intra-industry trade between Mexico and its NAFTA partners. Similarly, NAFTA helped boost FDI flows to Mexico, which rose from US$12 billion over 1991Ð²Ð‚â€œ93 to roughly US$54 billion in the 2000Ð²Ð‚â€œ02 periods. Increased trade and financial linkages have affected the dynamics of economic growth in Mexico in several ways. Contributions of exports and investment to GDP growth have increased substantially following the introduction of the agreement. In particular, the contribution of investment to GDP growth reached 3 percentage points during the period 1996-2002 as the average growth rate of investment rose to more than 8.5 percent. Recent studies suggest that NAFTA induced a sizeable increase in total factor productivity in Mexico, helping double GDP growth from an annual average of 2 percent in 1980Ð²Ð‚â€œ93 to 4 percent in 1996Ð²Ð‚â€œ2002. NAFTA appears to have also been associated with significant changes in the Mexican business cycle. MexicoÐ²Ð‚â„¢s output volatility decreased by almost 30 percent and the volatility of investment fell by more than 40 percent, since 1996. Business cycles in Mexico and the United States have become significantly more synchronized, with marked increases in the cross-country correlations of the major macroeconomic aggregates. NAFTA also has been instrumental in improving macroeconomic as well as institutional policies in Mexico. Recent research emphasizes the importance of NAFTA as a commitment mechanism ensuring the continuation of MexicoÐ²Ð‚â„¢s reform process during the 1990s. This, in turn, improved the risk profile of the Mexican economy and helped attract foreign investment flows. In addition, there have been improvements in institutions in charge of competition policy and intellectual property protection.
B- European Union
The evolution of the European Union (EU) from a regional economic agreement among six neighboring states in 1951 to today's supranational organization of 25 countries across the European continent stands as an unprecedented phenomenon in the annals of history. Dynastic unions for territorial consolidation were long the norm in Europe. On a few occasions even country-level unions were arranged - the Polish-Lithuanian Commonwealth and the Austro-Hungarian Empire were examples - but for such a large number of nation-states to cede some of their sovereignty to an overarching entity is truly unique. Although the EU is not a federation in the strict sense, it is far more than a free-trade association such as ASEAN, NAFTA, or Mercosur, and it has many of the attributes associated with independent nations: its own flag, anthem, founding date, and currency, as well as an incipient common foreign and security policy in its dealings with other nations. In the future, many of these nation-like characteristics are likely to be expanded. Thus, inclusion of basic intelligence on the EU has been deemed appropriate as a new, separate entity in The World Factbook.
Following the two devastating World Wars of the first half of the 20th century, a number of European leaders in the late 1940s became convinced that the only way to establish a lasting peace was to unite the two chief belligerent nations - France and Germany - both economically and politically. In 1950, the French Foreign Minister Robert SCHUMAN proposed an eventual union of all Europe, the first step of which would be the integration of the coal and steel industries of Western Europe. The following year the European Coal and Steel Community (ECSC) was set up when six members, Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands, signed the Treaty of Paris. The ECSC was so successful that within a few years the decision was made to integrate other parts of the countries' economies. In 1957, the Treaties of Rome created the European Economic Community (EEC) and the European Atomic Energy Community (Euratom), and the six member states undertook to eliminate trade barriers among themselves by forming a common market. In 1967, the institutions of all three communities were formally merged into the European Community (EC), creating a single Commission, a single Council of Ministers, and the European Parliament. Members of the European Parliament were initially selected by national parliaments, but in 1979 the first direct elections were undertaken and they have been held every five years since. In 1973, the first enlargement of the EC took place with the addition of Denmark, Ireland, and the United Kingdom. The 1980s saw further membership expansion with Greece joining in 1981 and Spain and Portugal in 1986. The 1992 Treaty of Maastricht laid the basis for further forms of cooperation in foreign and defense policy, in judicial and internal affairs, and in the creation of an economic and monetary union - including a common currency. This further integration created the European Union (EU). In 1995, Austria, Finland, and Sweden joined the EU, raising the membership total to 15. A new currency, the euro, was launched in world money markets on 1 January 1999; it becomes the unit of exchange for all of the EU states except the United Kingdom, Sweden, and Denmark. In 2002, citizens of the 12 euro-area countries began using the euro banknotes and coins. Ten new countries joined the EU in 2004 - Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia - bringing the current membership to 25. In order to ensure that the EU can continue to function efficiently with an expanded membership, the 2003 Treaty of Nice set forth rules streamlining the size and procedures of EU institutions. An EU Constitutional Treaty, signed in Rome on 29 October 2004, gave member states two years to ratify the document before it was scheduled to take effect on 1 November 2006. Referenda held in France and the Netherlands in May-June 2005 that rejected the constitution suspended the ratification effort. Despite the expansion of membership and functions, "Eurosceptics" in various countries have raised questions about the erosion of national cultures and the imposition of a flood of regulations from the EU capital in Brussels. Failure by all member states to ratify the constitution or the inability of newcomer countries to meet euro currency standards might force a loosening of some EU agreements and perhaps lead to several levels of EU participation. These "tiers" might eventually range from an "inner" core of politically integrated countries to a looser "outer" economic association of members
Domestically, the European Union attempts to lower trade barriers, adopt a common currency, and move toward convergence of living standards. Internationally, the EU aims to bolster Europe's trade position and its political and economic power. Because of the great differences in per capita income (from $10,000 to $28,000) and historic national animosities, the European Community faces difficulties in devising and enforcing common policies. For example, both Germany and France since 2003 have flouted the member states' treaty obligation to prevent their national budgets from running more than a 3% deficit. In 2004, the EU admitted 10 central and eastern European countries that are, in general, less advanced technologically and economically than the existing 15. Twelve EU member states introduced the euro as their common currency on 1 January 1999. The UK, Sweden, and Denmark do not now participate; the 10 new member states may choose to adopt the euro when they meet the EU's fiscal and monetary criteria and the member states so agree.
C- The GCC Union
The Gulf Cooperation Council (GCC), established in 1981, has as its goal the Integration of the economies of the six member states: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE). Trade between the member states is duty- free, and nationals of each country are free to establish and seek employment in other GCC countries. For the past several years, the GCC Secretariat was involved with identifying a mutually agreed CET. Finally, in December 2001 members agreed on a common external tariff (CET) at 5 percent for merchandise imports, and the establishment of a customs union on January 2003, two years earlier than originally planned.
The GCC Ministers of Finance also agreed on adopting a two tier CET structure; a zero percent rate on imports of 53 tariff lines at the HS 6-digit level, mainly Ð²Ð‚Ñšessential Ð²Ð‚Ñšgoods, and a 5 percent CET that applies on Ð²Ð‚ÑšotherÐ²Ð‚Ñœ goods Ð²Ð‚â€œi.e., non-essential and no basic. Further steps are in the process of being finalized by customs officials of the GCC countries before the establishment of the customs union in 2003. To this end, a consensus has been reached regarding the adoption of a common list of prohibited products and another list of restricted products maintained for safety, health or moral ground that will require import licensing. Concerns about the import of alcohol and pork products also seem to be solved, according to the GCC Secretariat. An initial agreement will allow for the import of these items through the entry ports of the member countries that allow for such imports only. The recipient member country will keep the collected customs duties on these items.
As regards the protection of domestic industry, a consensus among the GCC member countries has emerged for not resorting to tariff escalation, but to grant tariff exemptions instead on imports of intermediate inputs and equipment for domestic production and export industries. There will be common procedures for granting such exemptions.
As far as the collection of tariff revenue is concerned, the GCC Customs
Committee reached an initial agreement that will allow Customs Department in each member country to collect revenues at their ports of entry. The national authorities will then transfer these funds to a common account, on a monthly basis (within the first three days of each month). Once the funds are in the common account, they will be prorated using an agreed allocation formula and then disbursed to GCC member countries via a bank transfer. However, no decision as yet has been taken on the selection of the common body.
The allocation formula of collected tariff revenues relies on a mix of criteria, such as the member countriesÐ²Ð‚â„¢ share of total GCC imports, share of total GCC GDP and share of total GCC population, computed as an average of the last five years. An initial agreement was also reached showing the revenue shares ranging between 45 and 47 percent for Saudi Arabia, and 20 to 23 per cent for the UAE. The remaining will be shared proportionately by Kuwait (12 percent), Bahrain (9 percent), Oman (7 percent) and Qatar (6 percent). This report updates the earlier study prepared by the World Bank team and reiterates the recommendations made in that study regarding the actions that should be taken to support implementation of a common external trade policy. These include harmonization of customs procedures at the external customs frontier; abolition of internal customs borders; development of domestic tax bases where needed to reduce the reliance on trade taxes; and common policy measures for the use of contingent protection (safeguard actions) against imports from non-GCC countries.
IV- Welfare Effects of Regional Trade Arrangements:
A- Static Effects of RTAs:
Static gains are caused because of an allocation improvement in resources such as land, labor and capital. Static effects have been defined in terms of relative sizes of trade creations to trade diversions. In 1950, Viner first differentiated between the effects of trade creation and trade diversion. The following section illustrates this distinction.
Trade creation is when a country switches from consuming a high-cost product (produced domestically) to a low-cost product produced by a partnering country. In a different way of putting things, trade is created when an RTA leads a member country X to export more to another member country Y by altering the production of country BÐ²Ð‚â„¢s firms. Trade creation increases economic welfare as it provides gains on both the demand and supply sides of the market. Assuming full employment, resources are reallocated from protected industries to firms producing goods for the regional market since the protection is reduced; this benefits the supply side of the market. As for the demand side, buyers will benefit because they could be able to buy from lower-cost producers in the region.
Trade diversion is when a country switches from consuming low-cost goods from outside the region to consuming relatively higher cost goods produced within the region. Keeping in mind, neighboring member countries will face lower tariffs after economic integration. In other words, trade diversion is caused when partnering countries produce goods that displace lower cost imports coming from the world market.
Trade diversion generally leads to a decrease in economics welfare reducing. The economic loss comes from the decrease in government revenue that usually came from the high-tariff imports, coming from outside the region, and is displaced by imports from within the region that are subjected to much lower tariffs. In addition, consumer surplus increases as consumers will be facing lower prices. Part of consumer surplus will subsidize producers in other member countries rather than accruing for the government for the reallocation within their own country. The previous effect is called cross-border subsidy effect and it usually leads to a decrease in economic welfare.
Another short run effect is caused by transitional costs. In the short run, a fall in transition costs on inefficient sectors and immobile factors causes short run unemployment. This short period of unemployment is caused due to large firms reallocating their immobile factors and resources across the region to areas that provide lower-costs of production.
The main argument about a free trade arrangement is whether trade creation exceeds trade diversion. Therefore, such an arrangement is likely to be beneficial if, on balance, it gives rise to greater trade creation than trade diversion.
B- Dynamic Effects of RTAs:
Dynamic effects include economic growth due to gains from economies of scale, improved firms competitiveness, technology increases, and increased investment inflows. Dynamic effects take place as factors move between regions e.g. FDI (foreign direct investment). Dynamic effects are divided into three main headers and are explained in more detail in the following section.
Firstly, RTAs lead to dynamic gains because industries and firms in member countries can achieve economies of scale through larger and more diverse markets, bearing in mind the firms prior to the RTA were producing at an output level that was too small as they were restricted to the domestic market. The cost reduction effect is a resultant of reduced trade barriers and a larger demand (as the market becomes bigger). This provides an opportunity for firms to achieve greater economies of scale and reduce output prices. In addition, larger markets can also be beneficial as they create a diffusing effect of knowledge from producers to consumers. Also, mutual advantage can be reached by producing goods that are common in both member countries e.g., member countries can have a project to construct a network metro that benefits both nations such as labor mobility.
Secondly, dynamic gains are caused by increased competitiveness among producers in member countries as it leads to greater efficiency and productivity. Large firms, which usually Ð²Ð‚ÑšplayÐ²Ð‚Ñœ monopoly in their domestic markets, tend to especially make use from increased competition. This is mainly due to specialization of firms in production and thereby sharpening managerial performance in all firms. On the other hand, RTAs can also lead to less competition. Less competition might become due to each member countries specializing in the production of a certain industry good e.g. country A will produce meats while country B will specialize in producing dairy products. Commonly, RTAs lead to increased competition on the long run as at norm member countries produce have similar industry and productivity structures.
Thirdly, dynamic gains come from a boost in investment from within the member countries and from outside which in turn result in growth acceleration. As the size of the market becomes bigger and trade barriers decline this tends to increase the returns to some factors of production. Capital stock would then increase assuming the cost of capital is static. Increasing capital stocks accelerate growth and hence take the economy to higher growth path. RTAs may attract foreign direct investment (FDI) depending on the reduction of trade barriers and on transportation costs. Usually, RTA tend to decrease transportation costs making it easier for exporters to export and importers to import hence investors abroad would like to gain a piece of the pie therefore FDI increases.
V- Conditions inducing Regional Trade Arrangements:
A region can be defined as such based on several criterions, such criterion permit a group of countries to create some sort of regional trade arrangement. In 1991, Krugman came up with the concept of a Ð²Ð‚Ñšnatural trading blocÐ²Ð‚Ñœ. A natural trading bloc is a bloc of countries which trade intensively with each other because of lower intra-regional transport costs. However, transport costs are not a very important determinant of trading patterns. Comparative advantage is the main determinant of trading patterns in the absence of government-induced barriers to trade. Krugman later extended the concept to trading partners who would have done much of their trade with each other in the absence of regional trading arrangements.
An objective criterion is needed to somewhat measure the degree of integration. The best definition of a single market is one in which the Ð²Ð‚ÑšLaw of One PriceÐ²Ð‚Ñœ prevails in all markets. This means that in a competitive market, for either a produced commodity or a factor, there is only one price, allowing for transport and other transfer costs which prevent perfect arbitrage.
In commodity markets, it implies the removal of all border and non-border restrictions on commodity trade and the harmonization of commodity taxes and other measures which affect access to markets. In factor markets it implies the removal of all border restrictions. This concept of a single market is more useful than the old concept of a common market as it is more precise and provides a standard against which one can measure the degree of integration of markets within a region. Hence, complete regional integration requires complete free trade for both commodities and factors and the removal of other on-border regulations and taxes which prevent the establishment of single markets.
There are other factors and condition are favorable among member countries to have a successful RTA, especially in the case of economic unions, such as significant intra-regional trade, diversifies economies, labor market mobility and wage flexibility, open and integrated capital markets, similar economic structure and response to shocks.
VI- World Trade Organization and Regional Trade Arrangements
A- Multilateralism vs. Regionalism
The recent surge in RTA activity could be a reflection of faltering faith in the ability of the multilateral trading system (MTS) to further sustain the momentum of trade liberalisation. While there are concerns that the rise in regionalism could weaken the MTS institution, others believe that RTAs will in fact complement and help accelerate multilateral trade liberalisation.
Opponents of regionalism believe RTAs would lead to trade diversion and reduce the overall gains in global trade compared to a multilateral trade liberalisation framework. RTAs could diminish the incentive of countries to engage in multilateralism, as well as complicate the multilateral trade negotiation process by rendering the agreement contingent to consensus both within and between the negotiating trade blocs. There is also fear that regionalism begets regionalism, and could lead to the formation of competing trade blocs.
The other school of thought believes that RTAs serve as a transition point for multilateralism. In fact, a 1995 study by the WTO Secretariat concluded that Ð²Ð‚Ñšregional and multilateral integration initiatives are complements rather than alternatives in the pursuit of more open trade.Ð²Ð‚Ñœ Regionalism can help to build domestic confidence by first confining market liberalisation to member RTA countries. Economies may be more amiable to multilateral trade liberalisation after observing the trade creation and investments that regionalism induces. Regionalism would also allow groups of countries to negotiate rules and commitments that go beyond what is possible multilaterally due to the lower bargaining complexities.
B- The RTA and WTO Relationship
RTAs and the WTO share the common objective of trade liberalization; the former is discriminatory the latter is not. The pursuance of similar objectives but according to different approaches creates inevitably some tension in this relationship. The GATT and now the WTO have seen over the years a gradual erosion of the MFN (Most Favored Nation) principle due to the emergence of several layers of preferential trade regimes. Some of them were introduced to account for the different levels of development among the Members, others (RTAs) were provided since the inception of the GATT to allow like minded Members willing to liberalize trade faster and deeper not to be held back by slow progress at the multilateral level. Considering that MFN liberalization is proving increasingly hard to attain and that certain trade policy areas that have become of crucial importance to several Members are excluded from the multilateral agenda,58 the appeal for RTAs becomes inescapable; these allow Members to single out trade liberalization with specific markets; they involve less burdensome negotiations than those at the WTO, especially if among like-minded parties; and they allow the parties to such agreements to trade according to custom-built regulatory aspects and trade policy disciplines.
The growing appeal for RTAs has implications for the MTS. First, the benefits that RTAs could bring to multilateral trade liberalization are based on the assumption that preferential concessions will at some point be extended at the MFN level; unfortunately this concept of open regionalism is not applied in practice since it is rare, if not unheard of, for countries to extend on a MFN basis their RTA preferences unless as part of a multilateral round of trade negotiations. Concerns over the preservation of preferential margins carries systemic risks for the multilateral trading system since they may create resistance to further MFN trade liberalisation. Second, the lack of specificity in the relevant WTO rules on the do's and dont's of RTAs gives Members significant leeway in the design of such agreements. As a result, RTAs rarely address comprehensively sensitive sectors such as agriculture; in the first place because certain issues such as domestic 58 These include government procurement, competition policy and investment among others.
The tension in the RTA-WTO relationship has extensive ramifications and may pose a threat to a balanced development of world trade through increased trade and investment diversion, particularly if liberalization on a preferential basis is not accompanied by concurrent MFN liberalization; it also poses a threat to the business community and to the global production system on which it operates by raising costs through regulatory complexity and shifting production from comparative advantage to Ð²Ð‚Ñšcompetitive preferencesÐ²Ð‚Ñœ. Such ramifications are of systemic importance and deserve to be explored through more rigorous empirical research. This last section addresses these issues from an institutional perspective by presenting an overview of what WTO Members are doing to address these concerns in order to ensure that the different layers of trade preferences work for the MTS and not against it.
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