# Introduction

Cumulative number of ACPr in force, 1950-2010, notified and non-notified, by country group.

Source: OMC (2011)

The new wave of regionalism that began in the early 1990s is different from the first wave of regionalism in the 1970s:

• It lasted longer;
• More intense in terms of the number of agreements signed;
• And deeper in terms of the topics covered by those agreements.
Source: OMC (2011)

More than 350 agreements (goods and services) have been notified to the GATT/WTO by its members, and there are more than 290 of them in operation today.

Of these 290, about 70% have been notified since 1995.

If all the agreements planned and under negotiation are implemented, the number of regional agreements would easily reach 400.

Average number of participants in rRTAs per WTO Member (153), 1958-2010, notified rRTAs

Source: OMC (2011)

Global phenomenon although Europe and the American continent have the leadership in terms of the number of agreements signed

Participation in the rCPAs in force in 2010, notified and non-notified, by country

The "spaghetti bowl" of the Americas

Share of intra-ACPr trade in world merchandise exports, 1990-2008 (percentage)

Thus, around 50% of world trade is discriminatory and does not respect one of the fundamental principles of the GATT-WTO (stipulated for example in Article I of the GATT): the MFN clause. It is however allowed as an exception through GATT Article XXIV and GATS Article 5 as long as the regional agreement:

1. The preferences granted are reciprocal and cover "a substantial part" of trade (~ more than 80%).
2. Protection from non-member countries does not increase

# Forms of regional integration

Partial trade agreements: partial preference without removing all barriers. This also includes non-reciprocal agreements (GSP, Lome, EBA, AGOA, etc.). Compatible with GATT rules: "Enabling Clause" => exception of an exception for developing countries (Article XXIV is itself an exception to Article I).

Free Trade Area: All internal barriers are eliminated, but member countries retain their independent trade policies but with Rules of Origin (e.g., EFTA, Chile-Mercosur, NAFTA). Regulated by GATT Article XXIV and GATS Article V (as the rest).

Customs Union: FTAs + members have a common commercial policy (Common External Tariff, e.g. SACU, Mercosur, Andean Community).

Common market: All internal barriers are eliminated on trade in goods, services and factors of production, tariff barriers but also non-tariff barriers (regulations, standards, etc.).

Economic Union: Macroeconomic policies are harmonised and a single currency is introduced (e.g. EU).

Share (%) of each form of integration in the world total.

## A and B form an FTA (Viner 1950 analysis)

Domestic production in A competes with imports from B and C.

Creation if the establishment of the FTA leads to the replacement of domestic production in A by more efficient (lower cost of production) production from a partner country B.

Diversion if the establishment of the FTA induces the replacement of imports from C (low-cost production) by imports less efficient (at a higher cost) from a partner country B.

## Example

1 good / 3 countries: ${\displaystyle H}$ (the reference country)/ ${\displaystyle P}$ (the partner country)/ ${\displaystyle W}$ (third country).

 Countries ${\displaystyle H}$ ${\displaystyle P}$ ${\displaystyle W}$ Price excl. tax = production costs 35 25 20 Price including a 100% tariff - 50 40 Price including a 50% tariff - 37;5 30

1. Free world trade = ${\displaystyle H}$ imports good from ${\displaystyle W}$

2. Initial fee of 100%.

• NPA status: ${\displaystyle H}$ = no imports.
• ${\displaystyle H}$ and ${\displaystyle P}$ sign a SU with a TEC=100%: ${\displaystyle H}$ imports from ${\displaystyle P}$

=>UD has the effect of creating business

3. Initial fee of 50%.

• NPA status: H imports from W
• ${\displaystyle H}$ and ${\displaystyle P}$ sign a CU with a TEC=50%: ${\displaystyle H}$ imports from ${\displaystyle P}$

=>UD has the effect of trade diversion

## Partial equilibrium analysis

Initial situation: ${\displaystyle H}$, small country, levies a tax ${\displaystyle T}$ on all its imports. =>Imports only from ${\displaystyle W}$ (${\displaystyle Pw+T) Setting up a DU with ${\displaystyle P}$ : => trade creation (${\displaystyle M_{1}-M_{0}}$) and trade diversion (${\displaystyle M_{0}}$)

## Wellness Analysis

The wellness effects of TU on ${\displaystyle H}$:

• aire ${\displaystyle A}$ = internal redistribution from producers to consumers
• aire ${\displaystyle C}$ = internal redistribution from the state to consumers
• area ${\displaystyle B+D}$ = "trade creation" effect of the DU area ${\displaystyle B}$ : positive effect for ${\displaystyle H}$ due to lower production costs
• aire ${\displaystyle D}$ : positive effect for H due to the increase in the quantities consumed.
• area ${\displaystyle E}$ = "trade diversion" effect of the TU Corresponds to the welfare loss due to the additional costs of imports

Net effect on well-being = area (${\displaystyle B+D-E}$).

Difficult to say a priori if the sum is positive.

A TU is all the more likely to increase the welfare of the importing country if all other things are equal:

• the difference in production costs between P and W is small...
• import demand is elastic
• the initial rate is high
• the initial amount of imports is low

## Empirical Evaluation of Creations and Trade Diversions

Theoretical Analysis

• Uncertainty about the benefits of a customs union; (Depends on the extent of creation vs. trade diversion)
• empirical studies to determine the net effect of the agreements.

Questions:

• Has integration increased intra-union trade?
• If so, is this due primarily to trade creation or trade diversion?

Difficulty: to construct a hypothetical fashion, an anti-world, to show how the trade of member countries would have developed in the absence of the union; the difference between the development of "hypothetical" and real trade is attributed to the effects of the union.

## Two examples of ex-post methods

### Econometric method based on the Gravity Model

Severity model = explains trade flows between countries (bilateral trade flows) by its structural determinants, GDP of the two countries and distance between them.

Cross-cutting gravity model

${\displaystyle lnM_{ij}=\beta _{0}+\beta _{1}lnY_{i}+\beta _{2}lnY_{j}+\beta _{3}lnD_{ik}+\omega _{ij}}$

${\displaystyle M_{ij}}$: total bilateral imports from the country ${\displaystyle i}$ from the country ${\displaystyle j}$. ${\displaystyle Y_{i(j)}}$ : GDP of the country ${\displaystyle i(j)}$, (${\displaystyle \beta _{1}>0}$, ${\displaystyle \beta _{2}>0}$); ${\displaystyle D_{ij}}$: distance between countries ${\displaystyle i}$ and ${\displaystyle j}$ (${\displaystyle \beta _{3}<0}$).

According to Viner, following the establishment of a PCA, creations (CT) and trade diversions (TD) are reflected in trade flows at the Union level as follows:

• Pure TRQ = intra-regional trade increases and imports from the rest of the world (RoW) remain unchanged;
• Pure TR = the increase in intra-regional trade is fully compensated by the decrease in imports from RoW;
• Both TC and DT = intra-regional trade increases more than the decrease in imports from RoW.

The ex-post evaluation of the effects of a PCA on the volume of trade includes the following variables (coefficients in brackets) :

1. <D_I (\alpha_I) = 1[/itex] if both countries belong to the PCA [zero otherwise] (captures intra-regional trade);
2. <D_M (\alpha_M) = 1[/itex] if the importing country ${\displaystyle i}$ belongs to the CPA and the exporting country ${\displaystyle j}$ to RoW [otherwise zero] (captures block imports from RoW);

• ${\displaystyle \alpha _{I}>0}$ and ${\displaystyle \alpha _{M}\geq 0}$ (${\displaystyle \alpha _{X}\geq 0}$) indicate a pure TRQ in terms of imports (exports);
• ${\displaystyle \alpha _{I}>0}$ and ${\displaystyle \alpha _{M}<0}$ (${\displaystyle \alpha _{X}<0}$) indicate a TC in terms of imports (exports).

## Conclusion

These studies find modest traditional gains in % of GDP; and today the ACP will be less important in terms of relative preferences and market access.

Preferential trade by importer, 2008, shares based on margin of preference and MFN rates (percentage)

The expected gains are therefore more at the level of :

• Economies of scale, increased competition, increased variety of products;
• "Deep" integration (single market, single currency).
• convergence, location and agglomeration effects
• Investment
• Effects in the presence of asymmetric information (time inconsistency, signal, etc.)

## Convergence and Divergence, Location and Agglomeration Effect

theory of comparative advantages = it all depends on the comparative advantages of countries within the union and relative to the rest of the world.

N-N: Canada is between the US and RoW. This generates WD for the US => convergence

N-S: Canada and Chile are on either side of the global average staffing ratio. Can go either way depending on the distance between these countries and the world average. Other effects are expected from these agreements.

S-S: Chile is between Bolivia and RoW. Bolivia (less developed) suffers from DT=>divergence

The theory of comparative advantage is not the only force explaining reallocations of economic activity between countries. Agglomeration forces add up = a combination of economies of scale and trade costs.

"New Geographic Economy" study these different forces of agglomeration and dispersion which operate simultaneously and which determine the geographic distribution, at equilibrium (for a given level of costs to trade) of economic activity.

How does regional integration affect the geographical location of equilibrium of economic activity? Implementation of a Regional Integration agreement lowers costs to trade. result of "centre-periphery" (see chapter 4).

Conclusions:

• North-North agreement as EU, even if convergence between countries, increase in per capita income inequality within each country (sectoral agglomeration) - Empirical studies at regional level;
• South-South agreement, agglomeration forces reinforce the inequalities already observed at the country level (total agglomeration of the manufacturing sector). This phenomenon is potentially further reinforced by FDI.

## Effect on investment

### Direct gains via treaties

Traités bilatéraux d’investissement (TBI), plus de 2000 aujourd’hui entre pays de tous les continents et tous niveaux de développement.

Généralement, TBI = traité « négatif » = fixe des normes pour la protection légale des investissements et investisseurs étrangers. Baisse l’incertitude qui affecte l’investissement (Traitement équitable, sécurisation de la propriété privée, règlement des conflits)

Traités d’investissement associés aux accords régionaux

• Au niveau régional, certains traités sont de simples extensions multi-pays des TBI (MERCOSUR)
• D’autres sont plus importants et font partie intégrante du traité régional (marché unique du capital et de l’investissement dans l’UE, voir aussi ALENA, Pacte ANDIN, etc.)

## Indirect gains through integration

Credibility and Signal

• Use of PCA to initiate a signal = reform, no rewind

(this is also the case upon accession to the WTO).

• Indirectly reduces the uncertainty that affects investment (Transparency and predictability of external tariffs and other barriers to trade thus stimulates investment, especially FDI).
• Problem of credibility in some South-South agreements (insufficient sanctions), solution with EPAs?

Enlargement of the market

• increases incentives to invest, especially as integration is "deep" and the external tariff is high

("tariff-jumping" IDE). This is especially true for investments from countries outside the agreement.

• Problem of locating new investments or reallocating FDI intrabloc, especially if there is a large potential for economies of scale (FDI "platform").

## Indirect gains through integration

With integration, lower transaction costs lower the relative price of tradable (be)/non-tradable (bne) goods, shifting demand towards tradable goods. Common assumption: be more capital intensive than bne => increase in relative demand for capital => increase in return on capital.

Vertical FDI between member countries

If differences in factor endowments among member countries, more efficient reallocation of production operations (and thus investments) among member countries according to the level in the production chain (North-South agreement with investments in the activities labour-intensive in the south);

## Effects in the presence of asymmetric information

Fernández et Portes (1998) identifient 5 effets:

1. Time inconsistency: impossibility for government to determine credible policies in the medium to long. RIA can help solve time inconsistency problems if the cost of exiting the agreement is sufficiently high.
2. Signaling: In a world with asymmetric information, RIA can help signal what type of government or policies each country may adopt, if the cost of entry is sufficiently high
3. Insurance: Against a trade war, or reaction of trading partners to necessary devaluations
4. Barganing power: stronger bargainers when countries negotiate together rather than alone, but only if there are sufficiently large complementarities, otherwise bargaining power can get diluted.
5. Coordinating device: it is sometimes difficult to identify winners from unilateral trade reforms (general equilibrium effects). RIA can help identify them and then undertake welfare increasing unilateral reforms. Thus, the RIA serves as a coordinating device

But why are these non traditional gains to be observed at the regional level rather than at the multilateral level? Size effect; easier to monitor. Are these non-traditional gains more likely to be important for smaller members of RIA, and for South countries signing agreements with North countries? In principle yes, but:

• Time inconsistency: Larger members may have more important credibility issues than smaller members. So it may solve the smaller members’ time inconsitency problems as long as they are not the same as the larger members’ time inconsistency problems.
• Signaling: It depends on the political direction given by the larger members.....
• Insurance: Similar size among members is probably a better bet....
• Barganing power: Yes, now somebody wants to sit with the small member in a bargaining table, but it may end up with only the large members interests being represented (e.g., Brazil in Mercosur)
• Coordinating device: as long as there is little trade diversion, i.e., what I export to the ROW is similar to what I export within the region....

# Summary

A large and growing share of international trade takes place within regional agreements and not under the MFN clause (exceptions granted by Article XXIV of GATT, Article 5 of GATS + exceptions to these articles in the enabling clause or "enabling clause" in the case of partial tariff preferences granted to developing countries or LDCs).

Preferential trade liberalization within an FTA is not necessarily beneficial to its members. It will depend on whether the agreement creates more trade creation than trade diversion.

In a world with asymmetric information there may be significant gains from signing a regional agreement with larger or developed countries.

Most of these gains are not present for regional agreements between small developing countries.

The problem of North-South agreements are the other reforms that can be imposed on developing countries by the DCs and which go against their development objectives (e.g., intellectual property agreements in Chile-US for example).