Bilateral and regional trade agreements: A case for economic reform?

Speaker: Paul Gretton, Australian National University

Chair: David Vines, Balliol College, Oxford

In this PEFM seminar, Paul Gretton tackled one of the thorniest questions plaguing trade policy today –the implications of the shift from a multilateral system to a proliferation of bilateral and regional trade agreements (BTAs and RTAs). As global action through the Doha round has stalled and trade growth has significantly slowed down, countries have sought other instruments to advance trade liberalization. By far the most common approach has been to rely on preferential agreements, either of ‘hub-and-spoke’ nature such as the EU, or on a bilateral basis.

However, such preferential deals that liberalize trade between participants but not externally have created a phenomenon known as a ‘noodle bowl’ of agreements. Their proliferation has led to complexity through associated rafts of regulations necessary to enforce them and has eroded productivity by diverting trade from lowest cost suppliers. Thus, such BTAs and RTAs are increasingly viewed not as a stepping-stone to a global agreement, but as impeding trade liberalization.

Within this context, Mr. Gretton’s talk assessed the possibilities to disentangle this ‘noodle bowl’. Such strategies range from harmonization and simplification through rules about precedence, accession clauses for new members, and more liberal rules of origin, to the simplest approach of liberalizing by removing tariffs and border measures that are the cause for the regulations in the first place. 

For his economic modelling, Mr. Gretton relies on a global general equilibrium framework (GTAP model) with a longer-run perspective. It is a comparative static approach, but allows for regional capital to vary while labor and land are assumed to be fixed. His database covers 32 economies, including nearly all Regional Cooperation and Economic Participation agreements in Asia (RCEPs), potential TPP and TTIP members, and G20 countries, as well as data across 57 industries. 

The key message from his results is that open regionalism and MFN strategies dominate preferential agreements on the path to global liberalization. In such open regionalism scenarios, countries get together and decide, as a group, to set tariffs to zero on a MFN basis, i.e. with all countries. It is partners with highest domestic tariffs and large trade exposure that have most to gain, such as Thailand, Vietnam, and Korea. In these cases, MFN open regionalism adds more trade on top of the benefits that come with access as part of a PTA such as TPP.

After this intriguing finding, Mr. Gretton moved to discuss the growing body of evidence on the costs of rules of origin that are essential to preferential agreements. Such costs can be variable but have been estimated to reach up to 25% of product value and fall heaviest on SMEs with lower accountant capacity. They can also reduce intermediate-good inputs from non-members, which can lead to trade diversion and even negative trade if such diversion occurs from fast-growing regions. Mr. Gretton finds that liberalizing rules of origin might not offer significant benefits, but if it does, then it is because the original agreement offers little in the first place.

He then goes on to assess the benefits of two alternative trade liberalization approaches – accession of economies outside PTAs to a preferential agreement and unilateral liberalization. The former suggests that the main benefits would accrue to the accession economy, with only very modest flow-on impacts, as ultimately the purpose it to divert trade from somebody outside the PTA. In contrast, unilateral liberalization seems to offer most of the benefits of global trade reform. This represents a scenario where G20 economies remove their own tariffs, thus taking care of the ‘noodle bowl’ problem. The results of the model indicate that in most cases individual action will take countries most of the way towards the benefits expected in a global liberalization scenario.

Before closing, Mr. Gretton discussed some implications from his findings. In terms of labour market consequences, he points out the ‘noodle bowl’ of regulations lowers household income by constraining potential output. Yet, to reap the real wage gains from liberalization, countries require flexible labor and capital markets and policies that support transition of labor through retraining and social measures. In relation to non-tariff measures, he points out that nearly all gains would accrue from domestic productivity. Therefore, matters that can be addressed domestically should not be delayed just to retain bargaining advantage for preferential negotiations. Finally, where matters require cooperation, provisions that are non-discriminatory in terms of national treatment such as MFN should be adopted. 

In summary, Mr. Gretton’s quantitative analysis illustrates the case for trade openness and addresses the case of the ‘noodle bowl’ of preferences. He finds that transition strategies focused on piecemeal improvements through preferential frameworks are likely to be slow and productivity retarding. Instead, strategies based on concerted unilateral or open regional frameworks have much more to offer, even if they are also more politically controversial. Therefore, even though the GTAP model can be improved, particularly by adding dynamic components, he concludes that quantitative evaluations that examine the full range of options and their comprehensive effects on the economy can be a powerful tool in identifying the key policy measures to achieve the largest possible gains from trade. 

Ivaylo Iaydjiev (St Antony’s College, Oxford)