Multilateralism, Regionalism, and Bilateralism

Multilateralism, Regionalism, and Bilateralism

Sam Choon Yin (10/2004)

 

In theory, multilateralism is hailed as the first best approach toward trade liberalisation because it minimises complications and trade diversion effects. This is in comparison with regionalism and bilateralism initiatives. Let me explain why.

Complications may arise in regional trade agreements (RTAs) or free trade agreements (FTAs) because members and partners have to cope with the spaghetti bowl problem. It refers to the rules of origin (ROO) agreements which confuse organisations and raise business costs. The ROO identifies the product of origin in the value chain to prevent third parties (firms in non-participating countries in RTAs and FTAs) from ‘entering’ via the member countries. To allow for preferential trade treatment, a substantial part of the production must be done within the member country.

While the ROO is also applicable in the World Trade Organisation (WTO) initiatives (because ROO is not standardised but rather subject to negotiation and bargaining), a country with many RTAs or FTAs tend to face greater complications because of the different sets of ROO, some of which may be overlapping with one another. Accordingly, enforcement of the rules can be a complicated task resulting in more paperwork and higher cost of compliance. Yamazawa and Scollay (2002) suggested that the problem could be minimised if members progressively lower trade barriers with non-members as they proceed to remove trade barriers among themselves. Alternatively, the countries may wish to adopt the open regionalism concept (as in APEC formed in 1989) to extend the preferential trade treatments to non-member countries over time.

             The other problem with multilateralism relates to trade diversion. Trade is said to have diverted if an economy ends up importing from a less efficient producer in the trade bloc as compared to the pre-FTAs or pre-RTAs stage where it imports from a more efficient producer outside the trade bloc. The formation of FTA between the United States and Australia for example may divert trade from the Asian economies (say Indonesia) to US (assuming that Indonesia is the most efficient producer among the three nations). If this is true, Australia’s welfare will deteriorate. The problem could be less severe if, first, trade creation effect outweighs the trade diversion effect. This is the case for the Australian-United States Free Trade Agreement (AUSFTA) signed in February 2004 at least according to the estimates provided by the Centre for International Economies (CIE, 2001). The CIE study has estimated that around US$1.8 billion of net trade creation could be gained from the agreement.

Second, trade diversion effect may be non-dominant if the dynamic benefits of the FTA are taken into consideration. For example, signing of the AUSFTA is expected to attract more investments to Australia. Accordingly, the domestic producers could access to a larger market and reap economies of scale. Furthermore, the domestic producers are able to learn from the US counterpart (hailed as the leader in the technology era) and subsequently enhance Australia’s probability to flourish in the information and technology age. It will be difficult for trade diversion to dominate if the dynamic benefits are considered.

Other reports prepared by the CIE have showed that it is unlikely for trade diversion to dominate in the case of AUSFTA. Two reasons were advanced to explain why this is so. From the US’s perspective, theoretically the country may divert trade from the Asian, European and Latin American countries to Australia. CIE (2004) explains that this should be minimal since both US and Australia are already very open countries. For those relatively heavier protected goods in the US like dairy, sugar and beef products, importing from Australia should not generate much trade diverting effects since Australia is already the least cost (or near least cost) producer. From Australia’s perspective, trade diversion could take place most notably in vehicles and parts industry (instead of importing from Japan and Europe for being more efficient producers than US). But as noted in CIE (2003, p. 11), a ‘US car is not a perfect substitute for a Japanese car. They are different products, albeit with a degree of substitutability’. In other words, product differentiation may cover-up to some extent the negative effects associated with trade diversion.

The Monash study on AUSFTA supported this conclusion. Referring to the Australia-New Zealand Economic Relations Trade Agreement (ANZERTA), the study argued that there is little evidence to suggest that there is trade diversion because ‘both countries unilaterally reduced their trade barriers with other trading partners in parallel with he ANZERTA program to eliminate all trade barriers between the two countries’ (MU, 2991, p. 21). This obviated the risk of trade diversion. MU (2001) also referred to an earlier study by Anne Krueger on the North American Free Trade Area (Krueger, 1999), which suggested that the agreement had expanded not only the volume of trade between US and Mexico but between Mexico and the other countries as well.

The multilateral efforts are spearheaded by the WTO. Formed in 1995, the WTO took over the works of the General Agreements on Tariffs and Trade (GATT) in Geneva ‘with the authority not only in trade in industrial products but also in agricultural products and services’ (Salvatore, 2001, p. 310). The GATT/WTO had completed several trade rounds notably Geneva (completed in 1947), Annecy (1949), Torquay (1951), Geneva (1956), Dillon (1961), Kennedy (1967), Tokyo (1979) and Uruguay (1994). The Uruguay Round, which ran from 1986 to 1994, led to the formation of the WTO. The current Doha Round is scheduled to complete by January 2005.

Credit should be given to GATT/WTO for providing an avenue to discuss trade issues in a collective manner and settle trade disputes (trade rules are established to minimise complications and promote certainty in business transactions). However, multilateral trade discussions are slow and difficult, not surprisingly since more than 140 countries are involved in the negotiating process, with each one of them having a veto power. More issues are usually covered in the negotiation including sensitive ones like intellectual property rights, human rights and liberalisation of the agriculture sector. Reaching a consensus on these issues is particularly problematic and time consuming. The WTO’s progress is further slowed down by the Asian financial crisis which hit the Asian region in 1997 and the September 11, 2001 terrorist attack on the US, as nations become more sceptical about integration and globalisation, particularly in connection with the US (a possible result of growing anti-Americanism).

This problem is further compounded by the fact that the developed countries have not completely free up their sectors particularly the agriculture sector. For example, it has been estimated that as much as USD360-USD400 billion was spent per year in the form of subsidies on farmers in the OECD countries. While these subsidies accounted for only 2-3 percent of US’s GDP, they accounted for more than 50 percent of India’s GDP. Essentially, with the subsidies, farmers in US could export their farm products much lower than the cost of production resulting in the loss of income and employment in the poorer countries. Such developments worried representatives from the developing countries. The developing countries were also worried about ‘dumping’ from developed countries. Excess agricultural goods from the developed countries were sold below costs of production in the poorer countries thus undermining the producers there to compete fairly with their counterparts.

In addition to the above problems, Baldwin (1993) has blamed the declining GATT/WTO power to the loss of ‘hegemonic’ power of the US. GATT was more successful in the past because the US was more willing to liberalise trade without demanding immediate reciprocity as it ‘placed a high priority on the goal of rebuilding these (Europe and Japan) economies as a means of promoting peaceful relationships and, after the expansionary behavior of Soviet Union, of strengthening the so-called free world economically so the leaders of the countries in this group could better resist the threat be being absorbed into the communist group of nations’ (Baldwin, 1993, p. 391). The US reduced its tariffs and provided large amounts of foreign aids to attain these objectives.  Because these measures were so successful, Japan, Western Europe and Newly Industrialising Countries have strengthened and subsequently threatened the economic position of the US, causing the latter to be more protective than before. Consequently, the loss of US’s hegemonic power reduced the GATT’s power to facilitate and increase world trade.

In fact, the argument that the WTO increases trade has been questioned. In a recent article, Andrew Rose (2003) has shown econometrically that membership in the GATT and WTO (since 1995) is not associated with increase trade. The member countries did not seem to have a significantly different trade patterns as compared to non-members. Two reasons were advanced to explain why this is so. First, the GATT/WTO did not enforce members to lower trade barriers particularly so for developing countries which received special and differential treatments. Second, the members were already extending most favoured nation status unilaterally to countries outside the system, although they were not obligated to do so. Hence, the notion that WTO increases trade has to be re-evaluated. Nevertheless, the author recognises that the WTO could, over time, expand the volume of trade for it (1) provides a useful platform to discuss and settle trade-related issues and (2) is more willing to discuss sensitive topics like liberalisation of services and agriculture sectors in the negotiations.

There is generally a fear that trade liberalisation process will go back wards or side ways as a result of the problems noted above. As such, some countries have chosen the other path toward trade liberalisation, via the RTAs and FTAs. As Low (2004) writes, ‘….an enlarged WTO with a disproportionate member of developing economies and vastly different economic growth capacities has become a victim of its own success’ (p. 240). Faltering of the Uruguay Round in the 1980s saw the US embracing FTAs with Israel and Canada (in 1988), and later with Mexico to form the NAFTA, while Asian countries initiated the AFTA in 1992, APEC in 1989 and East Asian Economic Caucus in 1990 (now renamed as ASEAN + China, South Korea and Japan or ASEAN + 3). FTAs and RTAs are favoured because they are relatively less complicated and time consuming in reaching a consensus. This is not surprising since they involve smaller number of nations. They are also more flexible as the negotiators could choose what to include and exclude (for example, the Singapore-Japan FTA has excluded the agriculture sector). Moreover, FTAs and RTAs are favoured because they could bring about a complete elimination of tariffs (and lowering of non-tariff barriers) within finite periods, as opposed to multilaterialism efforts which usually have more modest aims like reducing, rather than eliminating tariffs.

However, it is useful to note that RTAs and FTAs are complimenting rather than replacing multilateral negotiations. They are tapped when there is a possibility of the trading system falling side ways and backwards (the realisation of the bicycle theory). Fred Bergsten (1996) from the International for International Economics has pointed out that contemporary regionalism and bilateralism initiatives were necessary to keep up with the momentum of trade liberalisation after the conclusion of the Uruguay Round.[1]

Furthermore, contemporary RTAs and FTAs are welcomed for they respond to the process of competitive liberalisation (a term coined by Fred Bergsten (1996)). More countries are essentially moving towards regional and bilateral trade negotiations because of their desire to attract investments, jobs and technology so as to perform economically better than others. This appears to be true if one is look at Mexico’s experience. For instance, in view of the positive prospect of NAFTA, leaders of Singapore and Malaysia had led government and business delegations to Mexico in early 1992 to discuss cooperative opportunities in trade and investment while Japanese, Korean and Taiwanese investors announced plans to locate new production facilities in Mexico (Snape, Adams and Morgan, 1993, p. 167).

In the process of competitive liberalisation, more countries would be pressured to liberalise trade further so as to avoid being left behind by others who had gone ahead with trade liberalisation either bilaterally or regionally. Andrew Stoler (2003) provided an example. He credited the NAFTA for helping to push the Uruguay Round toward a successful conclusion. In arguing for AUSFTA, both the Canberra and Washington offices had also used the term ‘competitive liberalisation’ to explain the demonstration effect of the FTA in helping achieving the WTO objectives. This is pointed out in Stoler (2003, p. 25) in response to an argument put forward in the ACIL report (prepared for Australia’s Rural Industries Research and Development Corporation). The ACIL report had argued that the US might feel that it had done enough in meeting Australia’s demand in the AUSFTA such that it became ‘less interested in meeting those demands in the WTO context’ (ACIL, 2003, p. vii).[2]

A similar conclusion is reached in Baldwin (1997). He had argued that growing interests to pursue RTAs and FTAs were not so much because they were easier to negotiate than multilateral negotiations. Instead, signing RTAs and FTAs is deemed essential to move toward multilateral liberalisation for they help to enhance the power of pro-trade in the multilateral negotiation process. According to Baldwin (1997), in a country with the exporters as pro-traders while those who compete with imported products trying to erect trade barriers, any liberalisation efforts via RTAs and FTAs will tend to enhance the influence of the exporters and weaken the protectionists. He wrote:

‘Announcement of a reciprocal trade talk multiplies the ranks of pro-trade forces by making exporters – normally indifferent to domestic protection – opponents of domestic import barriers. The same goes on in other nations, so the resulting political equilibrium involves liberalised domestic and foreign markets. While the liberalisations are phased in, export interests get stronger as they expand output and employment. Import competitors get weaker as they scale back or shutdown’ (Baldwin, 1997, p. 885).

This short essay has argued that despite being the first best policy, multilateralism seems to have been overshadowed by regionalism and bilateralism initiatives in recent years for reasons that I have noted above. However, the RTAs and FTAs should not be viewed negatively. They play the role of rejuvenating multilateral liberalisation (to delay the bicycle theory from realising). Through competitive liberalisation, they exert pressure on countries to liberalise and proceed with the WTO trade rounds. Multilateralism thus is not totally ignored (the fact that the WTO has more than 140 members with 30 more wanting to join testifies the perceived strength of the international institution). Countries like the US, Australia and Singapore have expressed their strong commitment toward realising the WTO initiatives despite having individually signed FTAs and RTAs. 

 

References

ACIL, 2003, A Bridge Too Far? An Australian Agricultural Perspective on the Australia/United States Free Trade Area Idea, a report for the Rural Industries Research and Development Cooperation (February 2003) (http://www.rirdc.gov.au/reports/GLC/ ACIL-ABridgeTooFar.pdf).   

Baldwin, Richard, 1993, Adapting the GATT to a More Regionalised World: A Political Economy Perspective, in Anderson, et al (editors) Regional Integration and the Global Trading System, Wheatsheaf, Sydney.

Baldwin, Richard, 1997, The Causes of Regionalism, The World Economy, 20, pp. 865-888.

Bergsten, Fred, 1996, Competitive Liberalization and Global Free Trade: A Vision for the Early 21st Century, Working Paper 96-15, Institute for International Economies (http://www.iie.com/publications/wp/1996/96-15.htm)

CIE, 2001, Economic Impacts of an Australian-United States Free Trade Area, Centre for International Economics, Australia (June 2001) (http://www.intecon.com.au/).  

CIE, 2003, Australia-United States Free Trade Agreement: Comments on the ACIL Report, Centre for International Economics, Australia (March 2003) (http://www.intecon.com.au/). 

CIE, 2004, Economic Analysis of AUSFTA: Impact of the Bilateral Free Trade Agreement with the United States, Centre for International Economics, Australia (April 2004) (http://www.intecon.com.au/).

Krueger, Anne, 1999, Trade Creation and Trade Diversion Under NAFTA, Baldwin Conference, National Bureau of Economic Resources, August 15, 1999.

Low, Linda, 2004, Singapore’s Bilateral Trading Arrangements in the Context of East Asian Regionalism, Southeast Asian Affairs 2004, Institute of Southeast Asian Studies, Singapore.

Monash University (The Australian APEC Study Centre), 2001, An Australia-USA Free Trade Agreement: Issues and Implications, Monash University, Australia (http://www.dfat.gov.au/publications/aus_us_fta_mon/). 

Rose, Andrew, 2003, Do We Really Know that the WTO Increases Trade?, paper presented at the Singapore Management University, Distinguished Lecture Series 2004 (http://www.sess.smu.edu.sg/events/economics_stats_2004.htm).

Salvatore, Dominick, 2001, International Economics, Seventh Edition, John Wiley & Sons, Inc, United States.

Snape, R.H.; J. Adams and D. Morgan, 1993, Regional Trade Agreements: Implications and Options for Australia, Canberra.

Stoler, Andrew, 2003, Australia-USA Free Trade: Benefits and Costs of an Agreement, paper presented for a conference on Free Trade Agreement and US trade Policy, Institute for International Economics, Washington D.C., May 7-8 2003.

Yamazawa, Ippei and Robert Scollay, 2003, Towards An Assessment of APEC Trade Liberalization and Facilitation, in Richard Feinberg (editor) APEC as an Institution: Multilateral Governance in the Asia Pacific, Institute of Southeast Asian Studies, Singapore.



[1] The fear of the bicycle theory realising is indeed very real as can be seen from the failure of trade talks in Cancun in September 2003. Recent success in Geneva (July 2004) was thus very welcome.

[2] ACIL (2003) and MU (2003) had also expressed concern that the AUSFTA might have taken so much of the governments’ resources and time that they could be ‘distracted’ from meeting the WTO’s objectives. MU (2001) for example has noted that the negotiations of FTAs is resource intensive and involves high opportunity cost as opposed to multilateral negotiation (it cited the example of the NAFTA where over a thousand pages were included in the agreement, involving more than two dozen committees and working groups) (MU, 2001, p. 23). The Australian government reassures the public than it would not ignore the WTO initiative for it sees the WTO as the best hope for major gains in trade to be reaped not only by Australia but all participating economies.