Reaction Paper 1

Free Trade Areas – Discrimination in a

‘Non-Discriminatory’ System

Reading: Jackson, John H. (1997). The World Trading System Law and
Policy of International Economic Relations, 2nd Edition, Cambridge, MA:
The MIT Press. pp. 157-174 and 213-228.

Fazilda Nabeel
MPA 2008-2009
 The cornerstone of the WTO is the ‘non-discrimination’ principle supported by
Most-Favored-Nation Principle (MFN) principle and national treatment obligations. But
if non-discrimination is the core value underpinning the multilateral regime, then why
have its members increasingly resorted to preferential liberalization? This paper intends
to focus on one of the most prominent and difficult problems engendering exceptions to
the MFN and GATT – the formation of PTAs and FTAs. Specifically, the paper intends
to explore two sets of pressing questions with regards to the increased proliferation of
PTAs and FTAs1: a) Does regionalism promote or erode trade liberalization? Or in other
words, is regionalism compatible with multilateralism? b) Is the increased trend towards
regionalism conditioned by problems in the GATT/WTO itself?
Trading blocks are regarded by neoclassical economists as the ‘second best’
alternative to multilateral free trade2, arguing that it may not necessarily result in overall
welfare improvements. This view is based on Jacob Viner’s (1950) concepts of ‘trade
creation’ versus ‘trade diversion’. A preferential trading arrangement promotes trade
creation when a country’s more expensive domestic products are replaced by cheaper
products from a participating country. Greater domestic consumption encourages
additional trade and welfare in the process. Conversely, trade diversion occurs when the
imports of inexpensively manufactured goods from non-member countries are replaced
by more expensive manufactured goods from participating countries. Thus the increase in
intraregional trade takes places at the direct expense of imports from outside the block.
Hence, trade diversion reduces, or at best, does not increase global welfare in this
scenario. It is clear that no general statement can be made about the overall welfare
effects from the creating of a trading block – it depends on the extent of trade creation
relative to trade diversion.
Given that the welfare effects resulting from the formation of a trading block are
ambiguous, what is the implication of the proliferation of regional trading blocks for the
overall quest for multilateralism? Is regionalism compatible with multilateralism? One
answer to the question could be that to the extent that if a trading block promotes trade
creation rather than trade diversion, it will also promote global trade liberalization,
1
See Figure 1 in Appendix
2
Bhagwati (1988)
theoretically at least. This would be like the paradigm case of abolished (or increasingly
permeable) boundaries between the buyer and the seller in the international sales
transaction idea discussed at the beginning of the course. However, as we have seen
throughout the course, schism between the theory and practice of international trade is
way too large to support theoretical conclusions without giving due consideration to the
actual practice of international trade. Article XXIV of 1947 in GATT stipulates that
member states are permitted to form a PTA only if it eliminates barriers to substantially
all the trade among its members and does not ‘on the whole’ increase protectionism
against non-members. In practice, however, GATT members joining a PTA almost
routinely violate Article XXIV – trade barriers within PTAs are almost never completely
eliminated and members frequently raise trade barriers on non-member products.
Germany’s average tariff on third parties, for example, almost doubled after its accession
to the EU in 1958.
In my opinion it is the discrepancy between the theory and practice of
international trade, as discussed above, had made it particularly difficult for the world
trading system to realize the proposed theoretical benefits of PTAs from trade creation
between member states. Some eminent scholars feel that regional trade agreements can
provide the stepping stone for building political support and strengthening the will for
negotiating freer trade worldwide (Summers 1991; Krugman 1993). According to
Jackson (1993) trading blocks can actually increase welfare if the MFN principle is
applied. There is also this fear of “excessive regionalization”, resulting from the creating
of trading blocks such as the EU and NAFTA that practically embrace the entire
continent. Whatever concerns about the effects of regionalism on achieving the goal of
multilateral free trade, one thing is clear: the increased trend towards regionalism is
certainly signals the breakdown of multilateralism, at least as the ‘first best’ option.
After having discussed the implications of proliferation of regionalism for the
multilateral regime, I come to the more fundamental question of whetherthe multilateral
regime has conditioned the spread of PTAs? Or to be more specific, what are the blind
spots in the multilateral regime of the GATT/WTO that has made nation states look
towards regionalism as an alternative? Mansfield and Reinhardt (2003) argue that the
GATT/ WTO regime has played a large role in stimulating the formation of PTAs. A
central reason why nation states enter PTAs is to increase their bargaining power.
Preferential Agreements serve this purpose by insuring states against emergence of
conditions within the GATT/WTO that could threaten their economic interests, as well as
giving the states a greater voice in multilateral talks and increase their market power.
Developments within the multilateral regime can create incentives for states to enhance
their bargaining power, hence triggering the establishment of preferential groupings.
Such developments include growth of the GATT/WTO membership – as new members
are taken on, each participant’s leverage is reduced and collective action problems arise
within the regime, thus making it more difficult to conclude new multilateral agreements,
monitor all members’ behaviors and enforce the regimes rules effectively. Thus, forming
PTAs with a small number of other nations that have similar economic interests is one
way of insuring against the consequences arising from such problems. Another reason
why states find it particularly attractive to enter into PTAs is to enhance their bargaining
position in the multilateral trade negotiations to insure that they will not be left behind in
the MTN talks. Small countries in the Caribbean have entered PTAs because of the fear
that they may be wiped out if they do not coalesce to safeguard their interests. Trade
disputes within the GATT/WTO members are yet another reason whether and when
states accede to a PTA – a country that is involved in a GATT/WTO dispute may seek a
PTA with third parties in order to increase its leverage in the dispute. Similarly, a country
that has just lost a GATT/WTO dispute may enter into a PTA with third parties to gain
countervailing market access or insuring against future GATT/WTO enforcement
failures.
Thus, entering into PTAs are a way for countries of safeguarding access to crucial
overseas market because enforcement mechanisms in the multilateral trade regime that
are designed to minimize discrimination and protectionism are weak and not properly
implemented. Again, the discussion goes back to the discrepancy between theory and
practice: in theory the multilateral trade regime is committed to removing trade barriers
and promoting ‘non-discrimination’ as a core value, but in practice it engenders a lot of
loopholes like Article XXIV of GATT to let nations exercise their own preferences while
choosing with whom to liberalize trade. The increased tendency towards formation of
PTAs may also be the result of crafty attempts by nation states to maintain their own
sovereignty and limit interference with their national jurisdiction in the multilateral
trading system which gives supremacy to the global trading regime rather than the
individual nation states.
-
References

Jackson, John H. (1997). The World Trading System Law and Policy of International
Economic Relations, 2nd Edition, Cambridge, MA: The MIT Press. pp. 157-174 and 213-
228.

Mansfield, Edward D., and Reinhardt, Eric. (2003). Multilateral Determinants of

Regionalism: The Effects of GATT/WTO on the Formation of Preferential Trading
Arrangements International Organization, Vol. 57, No. 4. pp. 829-862

Michalak, Wieslaw, and Gibb, Richard. (1997).Trading Blocs and Multilateralism in the World
Economy. Annals of the Association of American Geographers, Vol. 87, No. 2 pp. 264-279
Appendix

Figure 1: Number of Reciprocal PTAs notified to the GATT and WTO: 1948-1997

Source: Mansfield and Reinhardt (2003)