Regional Trading Arrangements under the Multilateral Trading System Issues for Future Negotiation. Somasri Mukhopadhyay

Transcription

1 Regional Trading Arrangements under the Multilateral Trading System Issues for Future Negotiation Somasri Mukhopadhyay CEA 38th Annual Meetings Ryerson University, Toronto June 2004 Abstract The world trading arena is experiencing two parallel trails of liberalization initiatives, one at the regional level and the other at the multilateral level. With the global experience of increased favoritism for trade liberalization at the regional level even at times of satisfactory progress of the multilateral trade liberalization, doubts have come up regarding the motive behind the formation of RTAs and thus the role of RTAs in aiding multilateral trade liberalization. The in-built discrimination present in RTAs cannot be denied. The existing provisions under the multilateral trading system are designed to minimize the discrimination. But experience has brought out certain limitations of the provisions in producing the desired results. Coupled with this is the inadequate functioning of the multilateral trading system in implementing the provisions for formation of RTAs. As a consequence, members of the multilateral trading system in the Doha Ministerial Meet have agreed to open negotiations on the existing provisions relating to the formation of regional trading arrangements. The above issues needs to be taken up and given due consideration in the proper perspective. Failure to do so might result in the RTAs turning out to be stumbling blocs to a freer and fair global trading regime. Keywords: Regional Trading Arrangement, Trade Liberalization, Trade Negotiation, World Trade Organization Jel Codes: F03, F13, F15

2 1: Introduction The Multilateral Trading System has opened up Regional Trading Arrangement (RTA) issues for negotiation. In the Doha Ministerial (2001) members of the World Trade Organization (WTO) have agreed to go for Article XXIV for re-negotiation. Paragraph 29 of the Doha Ministerial Declaration (2001) reads We also agree to negotiations aimed at clarifying and improving disciplines and procedures under the existing WTO provisions applying to regional trading agreements. The negotiations shall take into account the developmental aspects of the regional trade agreements. That is, members of the multilateral trading system have aimed to improve and clarify the existing provisions relating to forming of regional trading arrangement (RTA). While doing so, due considerations would be given to the developmental aspect of RTA. Right from its inception, the multilateral trading system has allowed the formation of regional trading arrangements as an exception to its principle of non-discrimination. The General Agreement of Tariff and Trade (GATT), 1948 allowed the trade liberalization at the regional level with the presumption that the same would aid trade liberalization at the multilateral level. Both being trade liberalization initiatives, there seems to be no apparent contradiction between regional trade liberalization and multilateral trade liberalization. Moreover, at the time the General Agreement on Tariff and Trade was signed, the theory of RTA has been not fully developed. It is only in the mid 20 th century that we got Jacob Viner s contribution in this field. However, the discriminatory aspect of the RTAs have been acknowledged by the GATT contracting parties. Accordingly, formation of RTAs has been allowed as an exception to the non-discriminatory principle of the multilateral trading system. With the passage of time, the world has experienced increased popularity of trade liberalization at the regional level. This increased popularity has resulted in substantial contribution in the theory of regional trading arrangement. However, trade liberalization at the regional level has gained popularity in spite of the same initiative at the multilateral level progressing quite satisfactorily. This has led to an urge to have a relook at the existing provisions in respect to the formation of RTA. Thus, Para 29 got included in the Doha Ministerial Declaration. This paper aims at discussing the principle issues relating to RTA to be given due consideration in the renegotiation phase. The paper is designed as follows. The next section discusses the trade liberalization processes. Section three describes regional trade liberalization under a rule based multilateral trading system. In section four, a comparative analysis is made to bring out the issues pertaining to RTAs in aiding the creation of a freer and fair global trading regime. Based on the discussion in section three, future negotiating concerns have been presented in section five. Section six is the concluding section. 1

3 2: Trade Liberalization: Regional and Multilateral The world is increasingly experiencing countries going for a liberalized trading regime. This can be cited as the fall out of the trade theories pointing out the gains from trade liberalization. Analyzing the question why do nations trade, trade theories over the decades have discussed the benefits accruing to nations practicing free trade. Simultaneously, with the claim made by the trade theories that free trade is the first best policy any nation can practice, arguments favoring a restrictive external sector policy have also developed over the years. An interesting point to note is that the incentives of protection lie in the theories propounding free trade. Having a re-look at the two most significant and extensively discussed theories of International trade the Ricardian and the Heckscher - Ohlin Theories, one finds the roots of protection embodied. They are in the form of some powerful implications of the theories. The first major implication of free trade is factor price equalization and the second major is the Rybczynski Theorem. With these two implications, we are likely to observe demand for protection from the effects of free trade from precisely those sectors in the economy that are hurt. More important, for an economy in the process of development, an absence of protection might result in creating an adverse environment for industries to develop. This would ultimately affect the economic development of the country. Least but not the last, certain strategic criteria, like developing export sector, sometimes lead to opting for a restrictive trade policy by a country. That is, countries to achieve some domestic economy goals sometimes need to go for a restrictive trade policy. A protectionist trading regime is always welfare decreasing. Realizing this, increasing number of countries have opted for a liberalized trading regime. However, considering the domestic compulsions, one understands that it is not possible or rational for any country to go for an absolute free trade regime overnight. Liberalization of the external sector is thus a gradual process and that is what countries have opted for. This process can be of two broad types. One is gradually decreasing restriction of the external sector, to all the trading partners. The other is liberalizing the trading regime for select group of countries. The first is the multilateral trade liberalization or multilateralism, while the second is regional trade liberalization or regionalism. Turning towards the global developments one finds a highly restrictive trading regime during the early part of the twentieth century. It is a well-recognized fact that high degree of protectionist external sector policy practiced by countries prior to and during the Second World War period resulted in the rethinking of the 2

4 concept that free trade is the first best policy. This led countries deciding the formation of a multilateral trading system to achieve a freer and fair global trading regime. A revival of the belief on the trade theory claim and a reaction to the restrictive trade regime experienced world wide came in the form of signing of the General Agreement of on Tariff and Trade (GATT). This can be considered to be a movement towards initiating regularized multilateralism. Regional Trading Arrangement (RTA) can be said to be the other form of reaction, running parallel to the one described above. Thus, there are two parallel phenomenon taking place in the global trading scenario. One is the emergence of the GATT - a set of multilateral trading rule to discipline the world trading system finally leading to the formation of the World Trade Organization (WTO); the other is the formation of regional trading arrangements, that is, multilateralism and regionalism. Both multilateralism and regionalism call for liberalization of trade. Both are the outcomes of the realization that free trade is the first best policy. The difference between the two is that, one creates a liberalized trading regime at the global level, the other aims at creating the same at the regional level. Following Winters (1996), regionalism can be loosely defined as any policy designed to reduce trade barriers between a subset of countries regardless of their commonality or closeness. Multilateralism on the other hand can be defined as a characteristic of the world economy or world economic system. However it boils down to the behavior of individual countries - the extent to which they behave in a multilateral fashion. Elaborating Winters (1996) definition, multilateralism is a function of:- The degree to which discrimination is absent that is, the proportion of trade partners that receive identical treatment; and The extent to which the country s trading regime approximates free trade. The first condition brings out the non-discriminatory aspect of multilateral trade liberalization. However, it implicitly assumes an worsening of multilateral trade liberalization with formation of a regional trading arrangement. But each and every case of RTA cannot be considered as adversely affecting multilateral trade liberalization. On the contrary the liberalization aspect of and thus the added benefits from an RTA cannot be denied. Also, regional trade liberalization is a higher degree of liberalization, though among a limited number of countries. This missing criterion gets added in the definition through the second condition. According to Yarbrough and Yarbrough, (1992) multilateralism is a process whereby countries solve problems in an interactive and co-operative fashion. This definition appears to be closely associated with professional negotiators and international bureaucrats, and seems to be not quite appropriate in tackling the issue of what purpose the process serves if it is not to generate outcomes. However, this can be used in the following way. Multilateralism can be considered to be a process where countries negotiate market access 3

5 with their trading partners with the objective of creating a freer and fair global trading regime. Keeping in mind the underlying non-discriminatory principle of the multilateral trading system, the market access advanced by each country is similar for all trading partners. Against this, regionalism can be considered to be an arrangement of increased market access among select group of countries. This arrangement running parallel to the process of multilateralism can either re-enforce the latter or might create an opposite wave. In either case, an adjustment process gets initiated for the RTA members and the excluded trading partners. If the increased market access enjoyed by members gradually gets extended to the excluded countries, regionalism might be considered as an aiding force to multilateralism. In the long run thus, multilateralism can be expected to be achieved at the end of the adjustment process. This would happen if the urge for liberalization is the motive behind RTA countries. However, the possibility of an opposite wave cannot be ignored. If the motive behind the formation of RTA is not only attaining a liberalized trading regime, the RTA members can be seen to increase the extent of liberalization among them keeping the trade policy for the ROW unchanged. Then multilateralism cannot be expected to be achieved at the end of the adjustment process. Rather, regionalism might affect the probabilities with which different outcomes occur. That is, whether multilateralism can be reached via regionalism is not certain. This is where the issue of regionalism aiding or adversely affecting multilateralism comes in. Thus, the impact of regional trade liberalization on global trade becomes an important aspect of discussion. The first theoretical work on the aspect of Regional Trading Arrangement is done by Jacob Viner in His theory is known as the theory of Customs union. However, what he has dealt with is basically the concept of a preferential trading arrangement. i With the formation of the Regional Trading Arrangement, the home country reduces tariff on imports from the member country, keeping the tariff on goods from the non-member country unaffected. This, according to Viner, creates trade between member states in response to the mutual elimination of tariffs on each other's goods. On the other hand, another effect, trade diversion also takes place which shifts the trade flows from non-member countries to member countries in response to tariff discrimination produced by the union's formation. That is, with lowering of the tariff on the item imported from the member countries, the price competitiveness increases for that vis-à-vis imports from the rest of the world. This will result in an increase in imports. Thus, according to Viner, with the formation of the PTA, imports into a member country increase. This increase can be broken ion to two aspects. i. An increase in total imports of the commodity, the increase resulting from the increase in imports from the members. ii. The share of the members increases lowering the share of the rest of the world. 4

6 The first effect is trade creation. The second one is trade diversion. Trade creation represents the substitution of inefficient (higher-cost) domestic production by efficient regional partner-country production. This raises the welfare of the members and the world as a whole. However trade diversion has a welfare cost since it involves inefficient regional partner-country production substituting for efficient third-country production. That is, Regional Trading Arrangements remove the discrimination between partner countries and domestic firms, and hence, home and partner country prices of tradable tend to be equalized as barriers to trade fall. Relatively inefficient domestic production therefore contracts ("trade creation") in favor of partner-country production. However, RTAs create a new form of discrimination, that is, between partner and non-partner country exports. Partner-country exports will displace more efficient non-partner exports in the home market if the degree of preferential access is sufficient ("trade diversion"). It is argued that so long as trade creation is greater than trade diversion, the RTA is net welfare enhancing. But the point which needs to be highlighted here is that comparing trade creation and trade diversion to judge the impact leaves out one important issue, that of the third country. The comparison brings out the overall effect; one s losses more than compensated by somebody else s gains giving a positive effect at the aggregate. But, the one who is suffering the losses, through the trade diversion is not getting compensated. This loss is arising because of the discriminatory environment created by the formation of an RTA. Under such a situation, would it be appropriate to expect that the regional trade liberalization running parallel to the process of multilateralism would work hand in hand to create a freer and fair global trading regime? 3: Regional Trade Liberalization Under the Multilateral Trading System From the last century, multilateralism has been pursued through multilateral trade negotiations under the auspices of the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO). This multilateralism practiced under GATT/WTO rests on the principles of nondiscrimination in trade. This principle of non-discrimination has two pillars The Most Favored Nation Treatment and the National Treatment. They are enunciated in article I ("General Most Favored Nation Treatment, or MFN) and article III ("National Treatment on Internal Taxation and Regulation," or NT) of GATT. The most favored nation treatment ensures equal treatment to all the member countries of WTO. Regional trading arrangement goes for liberalization of trade within a group of countries - a discriminating policy towards the rest of the world. This appears to be against the most favored nation treatment of WTO, which says that a country cannot discriminate among its trading partners. The WTO rules contains exceptions to the MFN principle; one such being the scope for the formation of Free Trade Areas and Customs Union. 5

7 In the first place, way back in 1947, when GATT was signed, there already existed certain bilateral trading arrangements. These could not be terminated. These bilateral arrangements basically implied preferential treatment to some countries leading to a scenario of discrimination. To make these arrangements GATT compatible, the founder contracting parties to GATT provided the "Grand Father Clause". This basically recognized the "historical preferences", that is, the bilateral/plurilateral trading arrangements already existing were exempted from the MFN obligations. The clause that the countries which already had some form of regional trading arrangement before GATT was formed would get MFN exemptions is given in Paragraph 3 of Article I and the RTAs are listed in Annexes A-F to the Agreement. That is, GATT recognized the existence of certain preferential arrangements at the time it was established. These provisions allowed the pre-existing agreements to stand without subjecting preferences accorded under them to the MFN obligation. Moreover, the Contracting Parties may also agree to exempt an existing regional agreement at the time that one of its members joins the GATT. However, the "Grandfather Clause" got terminated in Not only recognizing the already existing bilateral/plurilateral trading arrangements, the GATT contracting parties, based on the ideology that liberalizing trade even at the regional level would help liberalization of global trade, incorporated provisions for future establishment of regional integration agreements, otherwise inconsistent with MFN obligation. The provisions were designed to minimize the in-built discriminatory aspect of RTA so that the basic theme of GATT does not get eroded away. Initially, article XXIV formed the main basis of contracting parties entering into regional integration agreements with select countries. Later, the enabling clause (1979) was introduced into GATT having the same objectives but less rigid than Article XXIV to promote trade and development of the less-developed countries. Further down the line, with WTO coming into existence and services getting included under its gamut, Article V of GATS introduces such waiver for trade in services. An elaborate discussion of the existing provisions would aid identifying the issues for future negotiation. Article XXIV of the General Agreement on Tariff and Trade GATT Article XXIV is the central GATT provision on regional integration. It deals explicitly with customs unions and free-trade areas as well as with interim agreements leading to both. The primary objective for allowing the formation of regional trading arrangement has been incorporated in Paragraph 4 of Article XXIV of GATT It reads as under. The contracting parties recognize the desirability of increasing freedom of trade by the development, through voluntary agreements, of closer integration between the economies of the countries parties to such agreements. 6

8 However it has been re-asserted that RTAs are not to be designed for creating barriers for the rest of the world. Paragraph 4 thus, further reads They also recognize that the purpose of a customs union or of a free-trade area should be to facilitate trade between the constituent territories and not to raise barriers to the trade of other contracting parties with such territories. Acknowledging the discriminatory aspect of regional trading arrangements, certain conditions have been imposed by the GATT contracting parties while allowing trade liberalization at the regional level. Paragraph 5 of Article XXIV of GATT 1994 reads Accordingly, the provisions of this Agreement shall not prevent, as between the territories of contracting parties, the formation of a customs union or of a free-trade area or the adoption of an interim agreement necessary for the formation of a customs union or of a free-trade area; Provided that: with respect to a customs union, or an interim agreement leading to a formation of a customs union, the duties and other regulations of commerce imposed at the institution of any such union or interim agreement in respect of trade with contracting parties not parties to such union or agreement shall not on the whole be higher or more restrictive than the general incidence of the duties and regulations of commerce applicable in the constituent territories prior to the formation of such union or the adoption of such interim agreement, as the case may be; with respect to a free-trade area, or an interim agreement leading to the formation of a freetrade area, the duties and other regulations of commerce maintained in each if the constituent territories and applicable at the formation of such free-trade area or the adoption of such interim agreement to the trade of contracting parties not included in such area or not parties to such agreement shall not be higher or more restrictive than the corresponding duties and other regulations of commerce existing in the same constituent territories prior to the formation of the free-trade area, or interim agreement as the case may be; and any interim agreement referred to in sub-paragraphs (a) and (b) shall include a plan and schedule for the formation of such a customs union or of such a free-trade area within a reasonable length of time. To bring out the net welfare enhancing and multilateralism aiding properties of the RTA, Paragraph 8 of Article XXIV of GATT 1994 reads For the purposes of this Agreement: 7

9 A customs union shall be understood to mean the substitution of a single customs territory for two or more customs territories, (i) so that duties and other restrictive regulations of commerce (except, where necessary, those permitted under Articles XI, XII, XIII, XIV, XV and XX) are eliminated with respect to substantially all the trade between the constituent territories of the union or at least with respect to substantially all the trade in products originating in such territories, and, (ii) subject to the provisions of paragraph 9, substantially the same duties and other regulations of commerce are applied by each of the members of the union to the trade of territories not included in the union; A free-trade area shall be understood to mean a group of two or more customs territories in which the duties and other restrictive regulations of commerce (except, where necessary, those permitted under Articles XI, XII, XIII, XIV, XV and XX) are eliminated on substantially all the trade between the constituent territories in products originating in such territories. So, Article XXIV allows countries to enter regional trading arrangements as an exception to the nondiscriminatory principle of the multilateral trading system. While doing so, it explicitly assumes a tradefacilitating role to RTAs. Along with that, the provision lays down certain conditions for countries going for regional trade liberalization in an attempt to minimize the discrimination inherent in RTAs. They can be summarized as follows. Free Trade Areas and Customs Unions should 1. Cover "substantially all trade" 2. Not raise the average level of protection against excluded countries In case of an interim arrangement, the member countries should 3. Reduce internal tariffs to zero and remove internal quantitative restrictions other than those justified by other GATT articles within a reasonable time frame. The first condition tries to ensure minimization of trade diversion. It says that all trade or at least a substantial amount of trade has to be covered. This, to certain extent ensures that interest groups would not drive a RTA. Trade diversion unambiguously generates gains for partner exporters so when two countries swap tradediverting concessions, both sets of producers gain. On the other hand, if they swap creating concessions, producers lose some sales in their home markets and may or may not gain overall. Condition 1 implies that governments cannot select only commodities that are likely to feature trade diversion, and this in turn seems likely to encourage more efficient free trade areas and customs unions. 8

10 The second condition can be viewed as an attempt to preserve the sanctity of tariff bindings. It ensures that the formation of any regional trading arrangement is not accompanied with dilution of pre-committed increased market access to the other trading partners. It has to be remembered that the basic advantage from a regional trading arrangement comes from the discriminatory treatment between the members of the group and the non-members. With this, it also needs to be kept in mind that the RTAs are believed to be facilitating the creation of a liberalized multilateral trading regime. To move towards a liberalized trading regime negotiations are carried out at the multilateral level. If a regional trading arrangement were accompanied with increase in trade restriction for other WTO members, then it would be a movement away from the objective that would erode the sanctity of the multilateral trading system. On the contrary, the expectation out of these regional trading arrangements is that they would start with an increased liberalization among a group that will gradually get extended to the remaining members of the multilateral trading system. Thus, the second condition is primarily to ensure that the non-members do not face increased trade restrictions in the RTA countries markets after the formation of the same; they continue to enjoy the previous commitments given by the member countries in terms of market access. In the next place, the condition can also be viewed as one ensuring the minimal amount of trade diversion. It is well recognized that formation of a regional trading arrangement leads to trade diversion because of the discriminatory situation created out of the same. In addition to that, if after the formation, the trade barriers for the non-members get increased, that results in an increased amount of trade diversion. So, it indirectly acts as a check to the increase in trade diversion. So, the two conditions together, offer reasonable assurances about the barriers facing non-members in the member country markets after the formation of the regional trading arrangement. Condition 3 ensures that the basic rationale behind granting the MFN exception does not get diluted. That is, the driving force behind the urge to liberalize the claim made by the trade theories that free trade is the most beneficial external policy should be given due importance. So, within a reasonable time frame an interim arrangement should finally materialize into a free trade arrangement or customs union, thereby enhancing the trade creation aspect. Apart from the three conditions discussed above, it has also been specified in Article XXIV of GATT 1994 that the multilateral trading system should be notified regarding the formation of such arrangements if the countries happens to be GATT contracting parties and now WTO members. Paragraph 7 of Article XXIV of GATT 1994 reads a) Any contracting party deciding to enter into a customs union or free-trade area, or an interim agreement leading to the formation of such a union or area, shall promptly notify the CONTRACTING PARTIES and shall make available to them such information regarding the proposed union or area as 9

11 will enable them to make such reports and recommendations to contracting parties as they may deem appropriate. b) If, after having studied the plan and schedule included in an interim agreement referred to in paragraph 5 in consultation with the parties to that agreement and taking due account of the information made available in accordance with the provisions of subparagraph (a), the CONTRACTING PARTIES find that such agreement is not likely to result in the formation of a customs union or of a free-trade area within the period contemplated by the parties to the agreement or that such period is not a reasonable one, the CONTRACTING PARTIES shall make recommendations to the parties to the agreement. The parties shall not maintain or put into force, as the case may be, such agreement if they are not prepared to modify it in accordance with these recommendations. The multilateral body retains the right to judge the compatibility of the RTA; in case it is found incompatible to Article XXIV, recommended changes have to get incorporated into the regional trading agreements. The Enabling Clause The Enabling Clause is the other provision incorporated later into the multilateral trading system that allows the formation of regional trading arrangements. That provision got included under the multilateral trading system under the Enabling Clause (1979). This is the decision on Differential and More Favorable Treatment, Reciprocity, and Fuller Participation of Developing Countries, a result of the Tokyo Round of GATT negotiations ( ). It was incorporated into the GATT system with the intent to promoting the trade and development of less-developed countries. Under this clause allows Contracting Parties grant preferential treatment to developing countries on a non- MFN basis. This significantly relaxes the conditions for creating free trade area or customs unions that include only developing countries. It drops condition 1, on the coverage of trade, and relaxes condition 3, allowing developing countries to reduce tariffs on mutual trade in any way they wish and NTMs in accordance with criteria which may be prescribed by the CONTRACTING PARTIES. It then supplements condition 2 by requiring that the arrangement does not constitute a barrier to MFN tariff reductions or cause undue difficulties for other contracting parties. Article V of the General Agreement of Trade in Services With WTO coming into operation on Jan 1 st 1995, trade in services came under the rule based multilateral trading arrangement. The General Agreement on Trade in Services (GATS) negotiated under the Uruguay Round of Trade Negotiations is also based on the principle of non-discrimination. Thus, it is also built on the two basic pillars, that is the most favored nation treatment and the national treatment. However, the approach 10

12 is a bit different because of the inherent nature of trade in services, discussion of which is beyond the scope of this thesis. To incorporate the provisions for MFN exemptions in trade in services in line with Article XXIV in GATT, we have Article V of GATS. This allows for the liberalization of trade in services among a group of countries, with similar conditions of Article XXIV under GATT attached. The conditions talk about the coverage of all or substantial service sectors and gradually going towards total elimination of restrictions. In line with enabling clause, Article V of GATS includes the provision for liberalizing service trade on regional level among developing countries. 4: Regional Trading Arrangement Under the Multilateral Trading System: The Issues Trade liberalization implies increased market access, and thus expanded market for participating countries. More the number of participating countries, larger is the market available. As such, it is expected that multilateral trade liberalization would be more attractive than regional trade liberalization initiative. But, global experience reveals that there has been a spurt of regional trading arrangements in recent days. This increased popularity of RTAs has led to serious concern by economists and negotiators. One of the concerns is regarding the impact of trade liberalization at the regional level on trade liberalization at the multilateral level. Another concern, or rather a related concern is the rationale behind this increased popularity for RTAs. The point that cannot be denied is that a multilateral initiative for trade liberalization through a negotiation process among a large number of countries is expected to achieve a lower degree of liberalization as compared to a regional initiative over the same time frame. This might be a valid point for countries to go for trade liberalization at the regional level, simultaneously with trade liberalization at the multilateral level. Moreover, though countries are interested in a liberalized trading regime, yet there exist certain domestic compulsions. One might be the existence of a strong producers lobby, arguing against liberalization, as that would expose them to foreign competition. As such, the country might not give a high degree of market access at the multilateral level. But, it might be a viable option for it to gradually open up the market. Moreover, it is also true that a liberalized policy regime should not lead to de-industrialization of the economy. Keeping this in mind, it seems quite logical for a country to first open up its domestic market to few countries and get prepared to face global competition. Placing this against the backdrop of the global trend in RTAs, it might be quite consistent to claim that the fast pace of global liberalization urged nations to get prepared to face global competition. 11

13 This to certain extent matches with the trend of increase in the number of regional trading arrangement at times when the trade liberalization initiative at the multilateral level also reveals quite impressive progress. If this is the motive behind the formation of RTAs, then at least theoretically it can be claimed that they would not act as stumbling blocs. The underlying reason is that with this motive, it is expected that the member countries would gradually go for higher degree of liberalization at the multilateral level. Such a situation matches exactly with the objective of the multilateral trading system granting this exception under Article XXIV of GATT and the Enabling Clause Decision. Regionalism is not so old a phenomenon in the global trading arena. In its proper framework, the world experienced the first form of regional grouping in the twentieth century. As pointed out by Viner Regional Trading Agreement among group of countries is a feature of the early post World War II period. Data reveal that from the seventies there has been an increased number of RTAs coming up in the global trading arena. (Exhibit 1). This trend appears to have got strengthened during the nineties. In fact, the post-war trade liberalization at the multilateral level has been paralleled by the same initiative at the regional level through the regional trading arrangements. Breaking the period, two distinct sub-periods can be seen to reveal increased popularity of the regional trading arrangements. One is the seventies and the other during the nineties. (Exhibit 1). Exhibit 1: Regional Trading Arrangements Notified Under the GATT/ WTO No. of RTAs Source: WTO Secretariat Year There is a claim that the slow progress of the multilateral initiative led to the increased popularity of the RTAs. There is no doubt that a trade liberalization initiative at the multilateral level, involving quite a large number of countries is expected to take comparatively longer time compared to the relatively less complex and diverse negotiating issue of an RTA. In fact the number of countries joining the multilateral trading 12

14 system is increasing with the passage of time, making the negotiating process more complex with divergent issues, and thus increasing the expected time of the liberalization process. The countries, quite eager to achieve a liberalized trade regime prefer to go via the faster and easier process of regional trade liberalization. This popular claim demands verification from the data relating to the multilateral trading system negotiating process. Considering the two distinct periods of increased popularity of RTAs, it can be seen that multilateralism made quite satisfactory progress during the two periods. The two periods that reveal a phenomenal increase in the number of regional trading arrangements coincide with the periods when the multilateral trading system was also revealing quite remarkable pace of liberalization, along with disciplining the multilateral trading system. During the seventies the different non-tariff GATT/ WTO Chronology in Brief Year The Event 1947 Birth of GATT on 30 th October at the Palais des Nations, Geneva 1948 GATT comes into Force. First Meeting of its Members in Havana Club 1949 Second Round of Talks at Annecy, France Tariff Cuts Agreed to Ten New Countries Admitted Third Round at Torquay, England 8700 Trade Concessions Exchanged Four New Countries Admitted 1956 Fourth Round at Geneva. Tariff Cuts worth $1.3 trillion at todays price agreed upon The Dhillon Round 4400 Tariff Cuts agreed to The Kennedy Round Many Industrial Tariffs Halved Membership increased to Fifty Code on Dumping Agreed to The Tokyo Round Membership increased to 99 First Serious Discussion on Non-Tarifff Barriers (Ex Subsidies & Licensing Requirements) Average Tariff on manufactured goods in the 9 biggest markets cut from 7% to 4% The Uruguay Round Further Cuts in Tariffs, Export Subsidies, Licensing and Customs Valuation First Agreement on Trade in Services and Intellectual Property Rights 1995 Formation of the World Trade Organisation Till 2004 Ministerial Conferences and certain sectoral negotiation Source: The Economist, 16 May 1998 and WTO Documents measures eroding the benefits of the multilateral trade liberalization gained attention in the negotiating forum. As such, the global trading system was expecting the emergence of a more disciplined trading environment aiding fair trade. Moreover, disciplining the non-tariff measures in turn implies removing unnecessary restrictions on trade and thus can be interpreted as a movement towards liberalization. The late eighties and early nineties witnessed Uruguay Round approaching a successful conclusion with a much wider framework of trade liberalization under the aegis of the World Trade Organization. This contradicts the popular claim that the slow progress of the multilateral trade liberalization led to the increased interest in the regional trading arrangements. It appears that the urge for liberalization was not the only criteria driving nations to form regional trading arrangements. From 1947 to 1994, 109 regional trading agreements were notified under GATT. Out of these 109, 98 were notified under Article XXIV of GATT and 11 under the Enabling Clause. ii The total number of regional trading arrangements increased to 240 in out of this 240 were already negotiated while 68 were still in the negotiating process as of July (Exhibit 2). However, to certain extent this is an 13

15 underestimation as it includes the Free Trade Agreements and customs Unions and the PTAs that aim to become so. iii Exhibit 2: RTAs in Force and Under Negotiation (as of July 2000) FTAs Under Negotiations CUs Under Negotiation CUs in Force FTAs in Force Source: WTO Secretariat The interesting point that gets revealed by desegregating the data is that the level of economic integration achieved among the members of such agreements varies among agreements. Most of the RTAs are in the form of free trade areas; very few customs unions have been notified to the multilateral trading system. (Exhibit 2). The important custom unions notified are the European Community, CARICOM and MERCOSUR. In the year RTAs as of July 2000 RTA Status Number Free Trade Area 148 Customs Union 24 Free Trade Area Under Negotiation 67 Customs Union Under negotiation 1 Source: WTO 2000, more than 85 per cent per cent of the 172 existing regional trading arrangements are seen to be in the form of free trade area; only one out of the 68 negotiating RTAs are in the form of Customs Union, remaining 67 being in the form of Free Trade Areas. Area-wise break up of the data reveals that RTAs have been primarily centered around Western Europe. Among the 109 regional trading agreements notified under GATT between 1948 to 1994, 76 are between Western European countries. The trend continues and going by the latest data available, around 50 per cent of the RTAs currently in force are situated in the Euro-Mediterranean region. (Exhibit 3). However, at present, it is worth noting that the number of RTAs coming up in America is not far behind that of the European region. 14

16 Even for non-european countries, preferential trading arrangements featured in their trade policy. Consequently, when the World Trade Organization came into operation on January 1995, majority of its members was parties to at least one regional trading arrangement notified under GATT. The notable exception turned out to be Japan. Exhibit 3: Geographical Distribution Of RTAs, Both In Force And Under Negotiation FTAs under negotiation CUs under negotiation FTAs in force CUs in f orce Number of RTAs 100% 80% 60% 40% 20% 0% Americas Asia Pacific Eastern Europe & Euro- Mediterranea Sub-Saharan Cross Regional FTAs under negotiation CUs under negotiation 1 FTAs in force CUs in force Region Source: WTO Report The WTO Report (1995) adds that very few RTAs agreements among developing countries have met their original timetables for the establishment of a free trade area or a customs union. Coupled with this is the absence of wide sectoral coverage and this has resulted in limiting the potential gains to the members from liberalization. The composition of RTA also varies; on one extreme there is a simple bilateral RTA composed of two parties; on the other extreme there is an RTA in which all parties are themselves distinct RTAs. Bilateral RTAs account for 98, or almost 60 per cent, of the 172 RTAs in force, and for half of all RTAs under negotiation. Plurilateral RTAs account for 16 per cent of all RTAs currently in force, but make up less than ten per cent of RTAs under negotiation. The percentage of RTAs where at least one party is an RTA itself is about 30 per cent of both the RTAs under negotiation and those in force. iv The most noteworthy development expected in the coming years is the emergence of a new category, namely RTAs where each party is a distinct RTA itself. v These account for 9 of the 68 RTAs under negotiation and are composed of both regional and 15

17 cross-regional initiatives. (Exhibit 4). This is a new trend that is a reflection of the growing consolidation of established regional trading arrangements. Exhibit 4: Composition of RTAs 200 Number of RTAs All Parties are distinct RTAs At least one party is an RTA itself Plurilateral Bilateral In Force Under Negotiation All Parties are distinct RTAs 0 9 At least one party is an RTA itself Plurilateral 27 5 Bilateral Source: WTO Report The above data bring out certain issues for consideration. In the first place, there is a larger number of Free Trade Areas than Customs Union. A Free Trade Area is trade liberalization, or basically creating free trade within the region, without affecting the individual member country s trade policy with the rest of the world. In case of customs union it is free trade within the region, similar to a free trade area, along with harmonization of trade policy for the rest of the world. Looking purely from theory angle, there is not much to gain in terms of increased market access for non-members; the only advantage is that they face similar market entering conditions for the whole region. In fact, the issue, looking purely from theory side is more important for the members. In case of a customs union, each member having similar trade policy for the rest of the world, the non-member can enter the regions market through any country without having any extra advantage. But in case of a free trade area, the non-members can take the advantage of choosing to enter through the member-country having the minimum tariff and thus catering to the regions market. To ensure that this does not happen, it is necessary for the RTA to have strict Rules of Origin. Thus a customs union appears to be a less complex form of RTA to handle vis-à-vis free trade area. Moreover, the condition that no RTA members can increase the market entry barrier for the rest of the world 16

18 after the formation of the RTA imposes a binding on members external trade policy. Also, members having higher entry barrier vis-à-vis other members have to accept a decrease in the external barrier as a result of the same clause. But the fact that there appears to be greater preference for free trade areas than customs union puts a question mark on the motive of the members behind formation of the RTAs. Under a free trade area, member countries can retain their individual trade policies for the rest of the world. Thus, each country joining an RTA in the form of free trade area can continue a quite restrictive trade policy for the rest of the world while giving zero duty market access to the RTA members. By doing so, the country continues to protect the domestic producers from global competition. In case of a customs union to set in the common external trade policy member countries having comparatively more restricted trading regime have to bring down the level of the restriction for the rest of the world because of the condition of non-increase of trade restriction for the rest of the world. Otherwise, the condition of non-increase of trade restriction would get violated for the members having lower trade restriction for the rest of the world. Moreover, agreeing to a common external trade policy, no individual members can unilaterally take an external trade policy decision. Thus, even though the discrimination cannot be wiped out, yet, customs union appears to be a better option than free trade areas. Under free trade area, with each country retaining quite restrictive trade policy for the rest of the world, the extent of discrimination is expected to be more complex and hence more problematic against the backdrop of global trade liberalization. In this case, there is no binding on the individual members external trade policy coming from the RTA. The RTA in this case can be considered to be more focussed on the welfare implications of the members rather than any motive of global liberalization. Secondly, there is relatively higher number of RTAs formed among the developed countries. If we consider the argument that domestic compulsions force countries to enter a moderate level of liberalized trading regime through RTAs, then the trend should have been more RTAs among developing countries. However, at this point it needs mentioning that very recently an increased number of RTAs among developing countries is reported. But lack of authentic data bars detailed discussion. Turning to the global trading arena and the developments in the multilateral trading system, one can very easily find a trace of protectionist agenda practiced, not only by the developing but also for the developed countries. In fact, the fear of competition from newly industrializing countries led to the emergence of various NTMs in the global trading arena. In the context of these RTAs, keeping these aspects in mind, can it be claimed that to certain extent the creation of a safe heaven for the member countries urge nations to go for RTAs? 17

19 The third issue crops up from the fact that data reveal that the RTAs among developing countries, using the Enabling Clause have not yet reached the stage of Free Trade Area or Customs Union. They are still in the PTA stage. This in turn implies that the domestic producers in the member countries continue to enjoy some form of protection, at least for the select sectors thereby not achieving the extent of welfare maximization possible. Moreover, being notified under the Enabling Clause, the PTAs might be selective in choosing the different sectors to be covered under the RTA, thus not allowing the maximum extent of trade creation possible. Under this situation then, can it be argued that the liberalization zeal played a major role in urging nations to enter into regional trading arrangements? So, the data on one hand data reveal an increased dependence of countries on regional trade liberalization. On the other hand it raises doubt regarding the motive of the countries behind the formation of RTAs. Even if it is assumed for the time being that the motive is trade liberalization, the in-built discriminatory mechanism of a regional trading arrangement operating under the multilateral trading system cannot be denied. As has already been mentioned, the multilateral trading system ruled by the World Trade Organization is based on the principle of non-discrimination, embodied in the Most Favored Nation Treatment and National Treatment. The Most Favored Nation prohibits member countries of the multilateral trading system to discriminate among members. Concentrating on the issue of market access, it can be said that countries are required to open up the market to the same extent to all members of WTO. Few WTO members coming together to sign a regional trading arrangement, implies increased market access for the RTA members as compared to other WTO members. Thus, a discriminatory scenario between RTA members and the excluded WTO members emerges. This discrimination turns out as a restriction for non-members of RTA to enter the regions market. The process is as follows. Negotiations at the multilateral level ensure certain extent of market access in each of the WTO member country market. This increased market access mainly comes through decreased tariff (considering the case of goods only). This decrease in tariff results in decrease in protection to the domestic industry. The very fact of tariff existence reveals uncompetitiveness on part of the domestic producers vis-à-vis foreign producers. The decrease in protection level allows foreign players to enter. But, some extent of protection still exists for domestic producers. This in turn implies an artificial competitiveness for domestic producers; but when it is the competition among foreign players in the domestic country market, everybody is at par. With few countries coming together to form a regional trading agreement, the countries entering a members market are no longer at par. The RTA members enjoy increased market access vis-à-vis non-members 18