Magazine 2012
Regionalism versus Multilateralism in
International Trade: An Overview of
the on Going Debate
Dr. Falguni Desai
Maniben Nanavati Womenb s College,Mumbai.
Introduction
The agreements reached in the Uruguay Round constitute a significant step forward in reasserting the principles
of nondiscrimination and open markets. Without these agreements the World Trade Organization (WTO) would
have been much less credible as an organization. But over the last three decades, Regional Trading Arrangements
(
RTAs) have proliferated; virtually all members of WTO belong to some kind of an RTA. This development
represents both a challenge and an opportunity for the WTO. In this paper we examine the conflict that arises
between b Regionalism versus Multilateralism.b
Regionalism is not new and has existed for many years, its numbers multiplying soon after the IInd world war
and reaching its peak in the early 1970s. But this first wave of regionalism was not very successful. After being
dormant in the 1980s, it revived again in the 1990s - termed as the second wave of regionalism. By Mid 1998
there were 102 regional agreements notified under Article XXIV of the General Agreement in Trade and Tariff
(GATT), compared to 40 in 1990. As on January 2012, some 511 notifications of RTAs, counting goods, services
and accessions separately, have been received by the GATT/WTO. Of these, 370 notifications were made
under Article XXIV of the GATT 1947 or GATT 1994; 36 under the Enabling Clause; and 105 under Article V of the
GATS.
The RTAs have deepened and widened in scope. The Free Trade Area of the Americans (FTAA) covers more
than half a billion people. The European Unionb s agreements with Central and Eastern Europe and the
Mediterranean are comparable in scope to the FTAA. Mexico signed a FTA with the EU in 1998, EU-MERCOSUR
(Argentina, Brazil, Paraguay and Uruguay) talks are ongoing, Chile completed negotiations for setting up a FTA
with the EU in 2002, and thus EUb s preferential arrangements talks with South America include block-to-block
negotiations and single country negotiations.
There is also an expanding web of interlocking agreements. European countries and Mexico belong to more
than ten agreements. Brazil, Colombia, Venezuela, Chile and some Central American countries belong to
between five and ten such agreements. Moreover, joining blocs centered on the major powers has a number of
advantages for developing and transition economies. Apart from the improved access to the developed country
market, such an arrangement involves considerable liberalization of the trade and trade related policies of the
developing or transition economy. Such associations may bring additional benefits, such as US support for
Mexico in the financial crisis of 1994 or access to structural funds from the EU (Laird 1999).
Naturally, therefore concern about rise in regionalism is justified. These issues have no easy answers. Countries
seek regional cooperation for a variety of reasons and these wide ranging differences have to be taken into
account in analyzing RTAs. Section 1 spells out the differences between GATT and RTAs principles emphasizing
that GATT has never formally objected to RTAs, and Article XXIV of the GATT has provisions for coexistences of
RTAs with the multilateral trading system if certain conditions are fulfilled. Further discussions in the paper are
spread over 5 sections. Section 2 traces the Principles of GATT and causes of failure of the first wave of
regionalism, Section 3 examines the second wave of regionalism and the causes of rise in the number of RTAs
in the1990s and in this context in Section 4 we examine the debate on b Regionalism versus Multilateralismb
investigating whether RTAs constitute b Building blocb or b Stumbling blocsb for the multilateral trading system.
Section 5 draws the main conclusions.
2
.0 RTA Principles in GATT
The GATT has never formally objected to regional agreements. But concern about regionalism arises partly
because of the differences between GATT and RTA principles that are presented in Table 1.0
Article XXIV of GATT departs from the MFN principle and allows RTAs to coexist with the general agreement
under certain conditions. The rationale behind Article XXIV is discussed below.
b "
Full integration on trade would be allowed among any subset of GATT members since it created an
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important element of a singleb nation characteristics among these nations.
TABLE 1.0 GATT AND RTA PRINCIPLES
GATT Principles
Non b Discrimination
MFN
RTA Principles
1
2
.
.
Discrimination
Special preference not granted to nation
outside the bloc
3
4
.
.
Protection should be provided through Protection could be provided through
tariff
quantitative restrictions as well as tariffs.
GATT / WTO is open to all who are
willing to follow membership rules
The RTA could be an exclusive arrangement
Source: From Landau (2001)
Exception would be permitted only for case where all trade barriers would need to come down, excludes
the possibility of the world breaking up into many fragmented, discriminatory blocs.
b "
b "
Articles XXIV can also be considered a supplemental, practical route to the universal free trade that
GATT favoured as the ultimate goal, with the general negotiation during the many rounds leading to a dismantling
of trade barriers on a GATT wide basis while deeper integration would be achieved simultaneously within those
areas where politics permitted faster movement to free trade under a strategy of full and time bound commitment
(
Bhagawati 1992 b).
Under Article XXIV, Customs Unions and free trade area agreements are permitted because it is recognized that
such agreements have the potential to further economic integration without adversely affecting the interest of
third countries. There are four criteria that must be adhered to in forming a Customs Union or a free trade area.
These include b substantially allb criteria; the b Not on the whole higherb criteria; the interim agreement plan and
schedule, and the problem of notification and decision of the GATT .
2
.1 The First Wave of Regionalism
The architects of the GATT did not see regionalism as antithetical to the GATT and its principals. According to
Bhagwati (1992b) the first wave of regionalism failed because:
i) United States restrained itself from resorting to Article XXIV and remained strongly committed to multilateralism.
But at the same time, United States supported the formation of the European Community in 1958 because it
saw this as a political beneficial union to maintain peace in Europe.
ii) There was an outbreak of free trade area proposals in the developing countries as well. They were motivated
by different rationale formulated by Cooper and Massell (1965a and 1965b), Johnson (1965) and Bhagwati
(
1968). This was that given any targeted level of import-substituting industrialisation, the developing countries,
with their small markets, could reduce the costs of this industrailisation by exploiting economies of scale
through preferential opening of market with one another. By the end of 1960s, the attempts of forming regional
free trade area and Custom Unionb s along these lines collapsed. This was because bureaucratic negotiations
were used for allocation of industries rather than trade liberalization and hence prices to guide industry allocations.
Moreover, although many of these agreements had achieved the objective of achieving free trade on a limited
number of products, these arrangements could not be used as conduit of development because there was no
wide sectoral coverage, limiting the gains from trade.
Regionalism had virtually died by the end of 1960 except for the original EC and EFTA.
3.0
The Second Wave of Regionalism
The surge in RTAs in the 1990s constituted a break from the previous wave of regionalism. Previous regional
agreements had been neither so numerous, nor so successful, as those of recent years. Developments in four
essentially independent areas seem to have come together in the late 1980s to create a movement towards
regionalism: Europe integration, United States strategy, developments in Canada and changing attitude towards
trade in the developing world (Frankel (1997).
i) The influence of Europe
The European community took major steps with the single Europe market initiative that was adopted in 1987
and took effect in 1992. Although there have been set backs, but still European Communityb s scope, depth and
geographical area covered is a remarkable achievement. Political and economic integration among EU countries
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has been having a synergetic effect.This success has had a demonstration effect, encouraging other countries
to emulate in forming RTAs.
ii) The Reversal of the American position
At the GATT ministerial conference in Geneva United States showed willingness for regional initiative with
interested partners. The swift outcome was the U.S.- Israel free trade area and the Caribbean Basin initiative.
But there is a deeper historical significance to this American policy b the decline of American hegemony. In this
view, a non-discriminatory global trading regime, enforced by an institution such as the WTO, is an international
public good. That is, the non-discriminatory regime benefits everyone, but support to initiate and maintain it
will not be provided if each country acts to maximize its self-interest under the assumption that it is too small to
affect the action of others. In this view, the cooperation to support such a regime will only be forthcoming if
there exists a hegemonic power b that is a power large enough to recognize the effects its action have on the
global system and therefore large enough to organize the others into collective action. The United States has
been the necessary hegemony since World War II but now no longer (Frankel (1997). In response, the United
States have decided to abandon active support for the non-discriminatory regime in favour of pursuing its own
regionalist agenda.
iii) Canada enters the picture
Canada initiated negotiations with the United States and this bilateral deal was completed in 1988. In doing so
it reversed the 100 years of explicit rejection of such proposals with larger neighbors. The view among Canadian
business people was that, their market was too small to exploit economies of scale.
iv) Developing countries abandonment of import substitution
The developing countries have taken serious regional initiatives. Those countries have dumped the import
substitution model which dominated their thinking in 1960s and 70s, are now in favour of market liberalization.
As long as goal was to find regional market for favoured industries that could not compete in world markets,
the arrangement was bound to fail. But when the goal is to make industries better able to compete internationally,
regional arrangements are more likely to succeed.
Regionalism is now here to stay. So, then does it pose a threat to the multilateral trading system or is regionalism
complementing the multilateral trading system? We take up this debate in the subsequent section.
4.0
Conflict between Regionalism versus Multilateralism
A number of studies, for e.g. Bhagwati (1992b), are concerned about the negative effects of growing regionalism
on the rule based multilateral trading system. Bhagwati gives a number of reasons for the growth of regionalism,
but emphasizes the importance of multilateralism for freer trade. According to him the revival of regionalism is
unfortunate, but it is important to contain and shape it in such a way that it becomes maximally useful and
minimally damaging.
This section takes up the most debated issue of whether RTAs are b building blocsb or b stumbling blocsb towards
a liberal multilateral trading regime.
4
.1 A Building Blocs: Positive Implications of regionalism for Multilateral Liberalization
i) Integration for Lockb in to Reforms
RTAs can act as commitment mechanism to lock-in reforms, because they are built upon reciprocal preferences.
The agreements reduces the likelihood of a country reversing its trade liberalization, because if it goes back on
the trade preferences it has granted, it can be sure that its partners will respond by cancelling the preferential
access they grant. MERCOSUR provides a good example, where Brazil had to back down on its attempts to
deviate from the agreements after coming under pressure from Argentina (World Bank, 2000).
On the other hand it is argued that tariff bindings under the WTO are better devices for locking in reforms than
are regional agreements. A comparison of the of the 1982 and 1994 Mexican crises illustrates the lock-in point.
In the first debt crises, Mexico raised trade barriers against all partners sharply. In the second crises, with North
America Free Trade Area (NAFTA) in place, Mexico raised tariffs on some products against partners outside of
the Western Hemisphere but continued to cut tariffs on US trade, as called for under the agreement. This
response illustrates that the regional agreements bound tariffs more strongly than did WTO membership Frankel
(
1997).
Some regional trade agreements have explicitly added a commitment to democracy to their original design.
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This has clearly been the case with the EU, and the granting of membership to the new democracies of Portugal,
Greece and Spain, where regional group was used as a commitment mechanism.
b "
Eficiency of Negotiating with Larger Units
The idea in the 1980s was that progress towards free trade could be made more rapidly by regional negotiations
than by GATT negotiations. Within the context of multilateral negotiations, it can be slow and awkward to
negotiate separately with over 100 small countries. It is argued that it is easier for a smaller group of countries
to negotiate a Customs Union first. With common external trade policy, they can then enter multilateral
negotiations as a group (Frankel 1997).
The EU is certainly the most important example of this. Other groups such as Association of South East Asian
Nations (ASEAN), the Caribbean Common Market (caricom), can be urged to integrate regionally so they can
speak in a unified voice.
On the other hand, dozens of regional trading arrangements among Western Hemisphere countries have created
spaghetti like web. To negotiate with every possible group would be a herculean task, both in terms of time and
capital and probably worse than negotiating with 112 or more members of WTO.
b "
Competition and Scale Effect
Many countries are too small to support activities that require large economies of scale. RTA offers one route to
overcome these disadvantages as it combines markets and increases competition. This can yield three types of
gain: i) because of increased competition, firms are induce to cut prices and to expand sales, benefiting the
consumers, ii) because of market enlargement firms exploit economies of scale more fully, iii) because of
reductions in internal inefficiencies that firms are induce to make. If the RTA increases the intensity of competition,
it may induce firms to eliminate internal inefficiencies.
b "
Foreign Direct Investment
RTAs create a large market and therefore succeed in attracting FDI. Inflow of FDI may be seen as increased
confidence in the economy and as a route through which an economy can modernize. Modernization occurs
through access to modern technology, modern management, marketing networks, and sources of inputs. FDI
enters blocs to exploit investment opportunities and to use one member as a platform for serving the whole
bloc. There is considerable evidence that RTAs with larger markets have succeeded in attracting FDI. Mexico
provides the best example of this. FDI flows into Mexico more than doubled in the year following the launch of
NAFTA. The EUb s share of world wide inward FDI flows increased from 28 percent to 33 percent during 1982-
9
3(World Bank, 2000).
b "
The Pattern of Trade
Regional integration will change relative prices in member economies. Imports from partner countries will
become cheaper due to the elimination of tariff, and in response demand patterns will change, causing changes
in the flow of trade and in output levels in many sectors. It involves expansion of some sectors, contraction of
others, and relocation of industries from country to country. If the partner countryb s production displaces higher
cost domestic production, than there will be gain - trade creation. But if the partner countryb s production
displaces lower cost imports from the rest of world than there will be loss of welfare - trade diversion.
The EUb s common agricultural policy is the best-known example of trade diversion. This involves a price structure
for agricultural products designed to divert consumer purchases towards EU farmer and away from non-European
suppliers. Messerlin (1998) estimate the cost of this protection at, 12 percent of total EU farm income.
An example from NAFTA concerns clothing. Following the 1994 crisis, Mexico increased tariffs on non NAFTA
imports, just as it was reducing tariffs on NAFTA imports. Mexican imports from the rest of the world fell by 66
percent between 1994 and 1996 while those from United States increased by 47 percent. Similarly in the U.S.
markets, imports from Asia fell while imports of clothing and finished textiles from Mexico and from Canada
increased by more than 90 percent (World Bank,2000)
b "
Convergence or Divergence due to Relocation
Regional integration will lead to relocation of economic activity depending on comparative advantage, clustering
and knowledge flows. This forces acting together may lead to either convergence in the levels of income or
divergence. Comparative advantage may lead to either convergence of income between rich partners, but may
cause divergence of income between two poor countries. If the RTA is between high and low income countries,
than relocation of industries will take place with respect to factor endowments and factor prices. For examples,
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both within the EU and also its relationship with some of the transition economies, there is evidence that there
is relocation of industry with labour intensive activities moving to lower wage economies and promoting
convergence in wage rates. These are possible economic arguments favouring regional strategy (World Bank,
2000).
4
.2 B Stumbling Blocs: Negative Implications of Regionalism for Multilateral Liberalization
i) Blocb s Market Power and Incentive to Protect.
In a world consisting of a few large blocs, each unit will have more monopoly power and thus will be tempted
to seek to shift the terms of trade in its favour by raising tariff against the other blocs. Collectively the blocs fail
to improve their terms of trade and merely reduced everyoneb s welfare. But this does not stop them from
trying.
b "
Manipulation by Special Interests
Special interest argument points out that a RTA provides abundant opportunities for tradeb sensitive industries
to manipulate the process, particularly in those sectors that might be hurt. Typically it may take the form of
excluding certain sectors altogether or introducing long phasing out periods or through the rules of origin. The
members of ASEAN for example, have in the past exempted almost all the important sector from the system of
preference that they are suppose to grant each other. Another example is, EU treatment of agriculture and
steel. In the b Europe Agreementsb EU has offered longer phase out period for import from Poland and Hungary
in precisely those products which account for about one third of their exports and they fall into the sensitive
category of products in EU which may be adversely affected by such liberalization.
b "
Scare Negotiator Resources
This argument points out that negotiations are not costless. For e.g. If U.S.A special trade representatives
spend all time and capital on a regional agreement (e.g. NAFTA) there is less time and capital left to spend on
multilateral negotiations. As with the incentive to protect agreement, regional trading arrangement may set
back the process of negotiating worldwide trade liberalization under WTO (Frankel 1997).
b "
Market Access
Trade blocs block market access to vast region. This gives the bloc a substantial leverage. The bloc can
prevent further liberalistion of international trade and may foster the attitude that their markets are big enough.
Moreover, when it is the question of a large and small country negotiations, RTAs make it easier for small
countries to gain guarantee access to large markets thus exploiting economies of scale.
b "
Regionalism as Insurance
The RTA may lock in tariff reduction for the small country and may offer some defense against other trade
restrictions either in the form of agreed b disarmamentb e.g. Canada and Chile agreeing to do away with anti-
dumping duties or through enhanced dispute settlement e.g. NAFTA. This is often referred to as the b insurance
motiveb for regionalism and this name highlights a potential problem for the multilateral system: moral hazard.
A country with insurance might be less concerned about multilateral discipline than one without. Sapir (1995)
notes that the Hungarian authorities appeared to pay more attention to EU discipline than multilateral discipline
in determining their trade policy (Winters 1998).
b "
Domino Regionalism
An RTA may impose costs both mercantilist and welfare on nonmembers even if it does not raise levels of
protection. Nonb member suppliers become less competitive in member market because they continue to pay
tariffs while member producers do not. Moreover, where there are economies of scale, regional integration
may help lower member country firmsb costs by increasing their home market. Nonb members may respond to
the situation by trying to join the RTA that threatens them or by forming a bloc of their own. For e.g. EFTA was
created in response to EEC. The decision of Finland, Sweden and Austria to join EU in 1990b s may be traced
to European Unionb s single market initiative (Winters 1998).
Thus, there is no shortage of arguments in which RTAs can operate as stumbling blocs and undermine multilateral
liberalization. But fortunately they may also operate as building blocs strengthening multilateralism.
5
.0 Conclusions
The RTAs may serve as building blocs rather than stumbling bloc for global free trade. It combines markets
and increases competition, succeeds in attracting FDI and also brings about relocation of economic activity
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within the region. But on the other hand, RTAs bloc market access to vast regions and may prevent further
liberalization of international trade. RTAs are here to stay. Policies and institutions have to be design to strengthen
the linkages between RTAs and the WTO.
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