Nowadays, a broad consensus supports the goal of expanding trade liberalization. In economies that are open, deregulating trade has already proven to be a major impetus for growth. Yet, in an apparent contradiction, the richest countries still resist eliminating barriers, cutting subsidies and opening their markets even further. If these attitudes change, the further opening of trade will benefit not only rich countries but also developing countries, which will be able to take advantage of regional-integration pacts to provide incentives for raising their competitiveness. They will be able to gain access to developed countries, and enhance the credibility of their own economic reforms.
Those themes are developed by World Bank economists Maurice Schiff and L. Alan Winters in Regional Integration and Development, a practical guide for authorities in countries considering whether or not to join a trade bloc. The book should also be of great interest to academics and students of international trade.
The book presents the findings of research into more than 200 regional-integration pacts around the world. These pacts represent a major trend, and a step forward in international relations. Almost every country now belongs to at least one such trade bloc, and many countries belong to several. More than one-third of all global trade takes place within the framework of a regional pact. That figure jumps to two-thirds of all trade if you include the Asia-Pacific Economic Cooperation (APEC) agreement.
Eight Rules for Negotiation
The authors provide eight rules for officials in developing countries who are involved in negotiating such treaties. Above all, the book reminds officials that they need to use pacts as a tool for increasing their country’s competitiveness. “It means minimizing the extent to which you discriminate against the rest of the world; that is, against countries that are excluded from your pacts. This takes place unilaterally as in the case of Chile, which has very low tariffs. Clearly, the goal is to open up the country to worldwide competition,” said Schiff, when he introduced the book in Santiago, Chile recently.
To apply this key rule effectively, you cannot allow pressure groups from various sectors to introduce specific preferences that detract from free trade. On the contrary, you have to minimize exceptions to the scope of your regional free trade pact. As much as possible, the service sector should be included in these treaties. “Often, parties to these negotiations trade away exceptions in sectors that are not competitive. However, this is precisely where you can generate most of the benefits of creating a free-trade pact,” Schiff emphasized. “This increases competitiveness, and improves the way resources are allocated.” Instead of exchanging exceptions, Schiff suggests that countries negotiate mutual deregulation measures. “In other words, you say, ‘I am ready to open this sector where I am not very competitive, if you open that sector where you aren’t [very competitive.]’”
Both economists contend that the cost of diverting trade is borne largely by trading partners who must pay more for their imports. “But this cost can also weigh on countries excluded from a pact, because they lose export markets.” The book argues that the nations of Latin America and the Caribbean, as elsewhere, could derive more significant long-term benefits from the multilateral deregulation of trade in goods and services than from the current combination of agreements.
To achieve greater competitiveness, the book also suggests that trade pacts guarantee non-discriminatory treatment for foreign direct investors, including investors in the service sector.
Integration with Rich Neighbors of the North
Another key rule in the new book: Regional integration pacts between developing countries and higher-income countries – known as “North-South” pacts – usually generate more significant gains for developing countries than pacts forged between various groups of poorer countries. Thanks to their huge size, richer Northern partners usually boost the internal competitiveness of poorer countries. Moreover, North-South pacts enhance the credibility of developing nations’ trade policy.
“We saw the impact on productivity and growth that comes from trading more with countries that manufacture more technology; countries that make higher-quality components, capital goods and information technology,” Schiff noted in his presentation. One exception to this rule could be MERCOSUR, Schiff added, which is a South-South pact. However, MERCOSUR, which comprises Argentina, Brazil, Uruguay and Paraguay, encompasses a large economy (Brazil).
Another basic rule: Agreements with explicit terms and mechanisms for compliance improve the credibility of political and economic reforms undertaken by developing countries. “When Mexico signs an agreement with the United States or the European Union, it shows everyone that [Mexico’s] policies are credible; people know that they can be sanctioned. Moreover, the large countries also want to impose this sense of responsibility” in their partners, noted Schiff.
Moreover, the new book suggests that regional integration pacts can contribute to achieving political goals such as national security. However, this happens only when governments are efficient; not when governments spend recklessly or pursue policies that are “divisive from an economic point of view,” the book says. This kind of pact can also provide additional support for democracy and human rights. Schiff noted, “For example, in MERCOSUR, a condition for being a full-fledged or associate member is to be a democratic nation. In another example, the European Union warned Baltic nations with ethnic Russian minorities that they could not join the EU if they did not make changes” in the way they treated the ethnic Russians living in the Baltic States.
The authors advise developing countries not to depend on the World Trade Organization to monitor the impact of regional integration pacts. The WTO has a supervisory role over trade agreements signed by its 145 member-states. “You must evaluate regional integration pacts – whether you belong to them or other countries do – on the basis of their goals, as well as your criteria for national development. You should not evaluate them by whether or not they comply with details in relevant articles of the WTO,” the book asserts. The WTO manages a combination of behavioral norms “but not the results [of pacts]; the WTO watches whether members comply with obligations of their trade agreements – because they have conceded that right to the WTO. But the WTO does not monitor the economic results [of trade pacts], per se.”
Nevertheless, the authors recognize that countries that do not belong to any integration pact – and whose trade is negatively affected by such a pact – must resort to the WTO’s procedures for taking action against the protectionist impact of such pacts.
Governments should focus on more than simply providing preferential trade to trading partners, the authors suggest. They must look for ways to minimize the costs of transacting and implementing regional trade agreements. After all, trade pacts can have important fiscal consequences for those countries that depend on import duties and tariffs. However, those countries can take advantage of the opportunity provided by trade pacts to reform their tax structure.
Evidence from Chileand MERCOSUR
While acknowledging that not everyone can apply these rules, Schiff says they have “a broad application, and they provide a good reference point for measuring specific plans.” Clear examples can be found in such case studies as Chile and MERCOSUR.
In the case of Chile, which has duties that are low and flat (6%), the redirection of trade is going to be relatively small. In the worst-case scenario, Chile can buy something from a trading partner, although not something with more than a 6% [price] difference. If the cost exceeds that percentage, Chile would be better off continuing to import from the rest of the world and pay duties. Then, the amount of redirected trade and its cost are both much lower. For example, the United States has average tariffs that are very high, and it does not derive any important pricing advantages (from the US-Chile Free Trade Agreement). However, the U.S. is a huge market. Opening this market will have very significant benefits by creating trade and improving access [for Chile] – while little trade will be redirected [away from Chile]. This won’t happen right away, but after a transition period of at least eight years.”
Although there is a lot of debate about whether MERCOSUR generates benefits for its members, some positive aspects of that South-South pact cannot be overlooked, according to Schiff. “They say, if MERCOSUR didn’t exist, Argentina’s tariffs would have been raised a great deal more, to brake [Argentina’s] imports during the debt crisis. What happened, instead, was that Argentina had to negotiate with Brazil at every opportunity.” During the latest MERCOSUR-related rounds, Argentina and Brazil negotiated a significant deregulation of such sectors as automobiles and sugar.
When it comes to global trade policy, every country can do what it wants, says Schiff. However, within a customs union, every country must maintain discipline. “According to one study, when Brazil lowered its tariffs from Argentina, and it was able to become more competitive in the Brazilian market, the prices Brazil paid for imports from the U.S. — and from the rest of Latin America, Europe and Japan — all dropped. Those countries all saw evidence of Argentina’s greater competitiveness in their domestic markets. This happened because MERCOSUR is quite large, but everything would improve even more if they were a common external tariff,” Schiff asserts.
The authors warn against the negative impact of “domino regionalism.” After the failure of global trade negotiations at last September’s WTO ministerial meeting in Cancún, several countries anxiously sought to establish a series of bilateral and regional trade agreements. Although the growth of regional agreements could heighten incentives for new countries to join a pact, this trend does not necessarily improve the incentives for old members of a pact. Achieving that goal requires carefully following the rules outlined in this book.
In Latin America, unilateral trade liberalization came first; trade blocs came later, this book argues. “For example, Argentina, Brazil, Mexico and Chile carried out reforms – including trade deregulation – before enacting integration pacts,” the study says.
In a definitive way, Regional Integration and Development brings us closer to the dynamics of regional integration in Latin America and elsewhere. The book comes during a year that is pivotal for negotiations on the Free Trade Area of the Americas, which culminate in December. According to Schiff and Winters, the litmus test for the FTAA will be if it “enables a more profound integration by establishing as general principles both free trade and unrestricted investment in services.”