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Symposium 2014

Proposal - Making preferential trade agreements advantageous to as many outsiders as possible

The Challenge

Regional trade agreements have increased dramatically over the last twenty years. Since 1995, the founding year of the World Trade Organization (WTO), more than 400 regional trade agreements have be ...

Regional trade agreements have increased dramatically over the last twenty years. Since 1995, the founding year of the World Trade Organization (WTO), more than 400 regional trade agreements have been registered under the General Agreement on Tariffs and Trade (GATT). In the previous 45 years, only 124 regional trade agreements were registered. Moreover, recent initiatives like the Trans-Pacific Partnership (TPP) or the Transatlantic Trade and Investment Partnership (TTIP) aim to go far beyond the size and depth of traditional trade agreements. By taking on contested issues such as government procurement and private litigation, they form a new generation of trade agreements. As a result, a patchwork of regional free trade zones has emerged, which calls into question the multilateral trade regime under the auspice of the WTO and its languishing Doha Development Round (DDR) This trend has important distributional and political ramifications. Due to their comprehensiveness, the planned regional free trade agreements potentially offer immense benefits for the participating economies. However, the resulting trade diversion effects are detrimental to non-participating countries. As rich economies are more likely to profit from trade than developing ones, the divide between the two will probably grow. Consequently, there may be a potential shift in the balance of power in the global economy that could systematically discriminate against mostly southern, developing nations.

The WTO should generally forbid rules of origin in preferential trade agreements!

Many rich countries are currently in the process of negotiating preferential trade agreements (PTAs) amongst each other. At present, the main initiatives are the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the US, the comprehensive economic and trade agreement (CETA) between the EU and Canada, the Transpacific Partnership (TPP) agreement which would involve, amongst others, the Australia, Canada, Japan, Singapore and the US, and the Trade in Services Agreement (TiSA), a plurilateral framework focused on the services industry. These agreements have in common (i) that they are mostly amongst rich developed countries, (ii) and that they are larger and more comprehensive than previous trade agreements.

According to the EU’s “Global Europe” strategy, the logic of these agreements is mostly economic, i.e., their objective is to boost growth and employment in Europe; the US trade representative has published documents with similar ambition. The effects of the mega regionals mentioned above on excluded countries, mostly in the developing world, do not figure prominently in the strategies.

However, studies have shown (e.g., Bertelsmann Foundation, 2013) that an agreement such as TTIP could have far-reaching negative effects for countries left outside. The reason is well-known, at least since Jacob Viner’s (1950) work: when country A lowers import duties on goods from country B, but not on those from country C, firms from country C will have a more difficult stance in the market of A as competitors from country B now have a price advantage. This advantage results from discrimination since, in country A, firms from C are not treated equally to firms from B. The argument is not restricted to tariffs; under most circumstances, it extends to standards and regulations as well.

Usually, PTAs include rules of origin (RoOs) provisions: If a firm from country B wants to export duty free to country A, it must show that its merchandise indeed originates in country B, otherwise no preferences are granted. This is costly, in particular for small and medium enterprises in country B. And it makes the PTA even more disadvantageous for outsiders, because exporters have an incentive to substitute suppliers of parts and components away from third countries.

However, in reality, amongst OECD countries, tariff schedules vis-à-vis developing countries are very similar. At the extreme, one could say that PTAs amongst those countries resemble “camouflaged” customs unions. This means that, to maintain levels of protection against imports from third countries, RoOs are not at all needed if two OECD members form a PTA, just as they are redundant in a customs union! Actually, if RoOs are nevertheless included in the PTA, additional protection against outsiders is created. This violates, at least in spirit, Article XXIV 5(b) of the General Agreement on Tariffs and Trade (GATT).

Clearly, the correlation between external tariffs of PTA members is not perfect, and in some instances tariffs may be very different. The WTO should not generally accept the use of RoOs, as it currently does, but rather it should generally declare them illegal. It should allow exceptions only for cases in which there is a real threat that protection towards outsiders in a PTAs may erode. The requirement to document RoOs should be limited to goods where tariffs diverge sufficiently.

Declaring RoOs illegal would make sure that PTAs are not de facto increasing barriers to outsiders; and it would lower the administrative burden to firms in PTA countries. Thus, there is scope for a win-win situation: PTAs are more clearly in line with WTO legislation; they offer more advantages to insiders as bureaucratic costs are greatly reduced; and they do not increase discrimination against third countries.

Moreover, declaring RoOs illegal could constitute the starting point for a modernized body of rules that the WTO imposes on PTAs to make them compatible with the principles of a free and fair world trade order – clearly a key objective for the WTO if it wants to remain relevant in a world where PTAs become ever more numerous, deeper, and larger.

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