UNIT 6 Regional Trade Agreements

Unit Structure

6.0 Overview
6.1 Learning Objectives
6.2 Definition and Types of RTAs
6.3 Article XXIV
6.4 Benefits of RTAs
6.5 Drawbacks of RTAs
6.6 Exercises
6.7 Summary
6.8 Suggested Readings

3.0 OVERVIEW
Since the 1990’s, there has been a global trend towards bilateral and regional trade
arrangements. The number of such arrangements that have been formed, or are currently
being negotiated, has dramatically increased. Consequently, at present almost all
countries are party to such arrangements. One of the characteristics of recent regional
trade agreements (RTAs) is their comprehensiveness. Not only do they cover the
reduction or elimination of tariffs and other non-tariff barriers on the trade of goods and
services, but also they cover broader elements such as investment rules, intellectual
property rights and so on.

During the second half of the 1990's, trade liberalization and the pursuit of global free
trade underwent a metamorphosis. The political momentum shifted away from what was
seen by some nations as the painstakingly slow process of multilateral tariff negotiations
to smaller regional and bilateral arrangements - the Regional Trade Agreement.

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RTAs are not a new means of trade liberalization; historically, whenever multilateral
trade negotiations broke down, bilateral and multilateral free trade agreements filled the
void. Such strategic trade arrangements have enabled many states to move towards freer
trade at their own pace, and for their own benefits.

3.1 LEARNING OBJECTIVES

By the end of this Unit, you should be able to understand and grasp the following:

 Understand the definition of RTAs;

 Understand Article XXIV which permits the creation of RTAs under the WTO;
 Understand the different types of regional initiatives;
 Discuss the various benefits of RTAs;
 Discuss the various limitations of RTAs.

3.2 Definition and Types of RTAs

RTAs, by definition, are negotiated agreement by which national economies maintain

lower barriers to mutual trade while sustaining relatively higher barriers to third parties.
RTAs can take on several forms, and current theory identifies five different forms of
arrangements. These arrangements include preference areas, free trade areas, customs
unions, common markets and economic unions, with each of them being progressively
more integrated than the preceding arrangement.

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 Free Trade
Areas (FTAs)
Customs
Union
Common
Market
Economic
Union
Political
Union

Level of integration

Key:
Shallow integration
Deep integration

First, at the most basic level, Preferential Trading Agreements (PTAs) lower trade
barriers among members. Such preferential trade is usually limited to the portion of
actual trade flows from LDCs, and is often non-reciprocal. An example of such an
agreement is the Papua New Guinea - Australia Trade and Commercial Relations
Agreement (PATCRA II) that has been in effect since 1977.

Secondly, a Free Trade Agreement/Area (FTA) is a reciprocal arrangement whereby

trade barriers (usually tariffs) between participating nations are abolished. However, each
member determines its external trade policies against non-FTA members independently.
Most commonly, barriers to trade are reduced over time, but in most cases, not all trade is
completely free from national barriers. A prominent example of a FTA is the North
American Free Trade Agreement (NAFTA).

The third level of economic integration is the Customs Union. In a Customs Union, trade
barriers among members are eliminated. Also, the participating nations adopt a common
external trade policy (e.g. common external tariff regime or CET). A Customs Union is

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equivalent to an FTA plus a common external trade policy. The Customs Union of the
Southern Cone -Mercosur-represents such an arrangement.

The fourth level of economic integration is the Common Market. In a Common Market,
countries remove all barriers to movement of both goods and factors, and retain the
common external trade policy. It is equivalent to a customs union plus free mobility of
factors. One example of Common Market is the Common Market for Eastern and
Southern Africa (Comesa).

The fifth level of economic integration is the Economic Union. In an Economic Union,
besides the free goods and factor movements, member countries also adopt common
macroeconomic policies. One example of Economic Union is the European Union (EU).

3.3 Article XXIV

Under the current legal system of the World Trade Organisation (WTO), there are two
categories of rules on the RTAs in the area of trade in goods: the first is based on the
Article XXIV of the General Agreement on Tariffs and Trade, which generally applies to
all RTAs; the second is based on the so-called Enabling Clause, which in exceptional
circumstances, provide special and differential treatment (SDT) for RTAs among
developing countries.

The General Agreement on Tariffs and Trade (GATT) system was established in order to
prevent the discriminatory trade practices contributed to the development of economic
blocs before the World War II. The GATT, therefore, adopted non-discrimination as a
fundamental principle. An unconditional MFN clause was incorporated into Article I of
the General Agreement, as this was conceived as the most effective measure for applying
the non-discrimination principle to actual trade practices. Thus, the GATT strictly
confined preferences to the practices that existed when it was established, meaning that it
would not in principles permit the creation of any new preferences. However, there are
no principles without exceptions to the MFN obligations under the GATT/WTO system.

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In Article XXIV of the General Agreement, exceptions to the MFN treatment are
provided in three situations: traffic frontiers, Customs Unions (CUs), or free trade areas.
It is the latter two arrangements, which are usually referred to as RTAs.

In 1947, developing countries proposed the initial concept of free trade areas where “two
or more developing countries might be prepared to abolish all trade barriers among
themselves, though not wishing to construct a common tariff towards the rest of the
world” (Haight 1972: 393). Developing countries might have thought that non-
discrimination principles did not always benefit them and a certain degree of preferential
treatment would be necessary in order to promote their economic development.
Moreover they needed schemes more flexible than CUs because they regarded these as
very poor measures for utilising preferential treatment due to their strict conditions. The
concept of a free trade area received support from many participants in the drafting
session.

Free Trade Areas were adopted in Article XXIV so that they could function as a control
valve to reconcile the internal conflict between MFN treatment and reciprocity in the
Fundamental GATT principles.

The provisions of Article XXIV of the General Agreement provide the basic rules on
preferential arrangements covering trade in goods.

Article XXIV stipulates certain criteria for the formation of RTAs:

 A “stand still” condition: duties and other regulations of commerce should not on
the whole be higher or more restrictive than the general incidence of the duties
and regulations such commerce applicable in these countries prior to the
formation of a CU or free trade are
 “A reasonable length of time” condition: any CU or free trade area should be
formed within a “reasonable length of time.” This ambiguous term has lately
been clarified to mean exceeding ten years only in exceptional circumstances.

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  All RTAs and interim agreements must be notified to the Council of Trade in
Goods (CTG) and be examined by the Committee on Regional Trade Agreements
(CRTA) for their conformity to these criteria.
 Because of the use of plural in the phrase “between the constituent territories” in
Article XXIV: 8, all parties should liberalise their trade in products on reciprocal
basis.
 Article XXIV only covers RTAs “between the territories of contracting parties.”
In other words, any RTAs involving a non-contracting party cannot be understood
as an RTA in the terms of Article XXIV and, consequently, cannot be justified as
an exception to the MFN obligations. In order for RTAs involving non-members
to be approved, the procedure is expected to be in accordance with Article XXIV:
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3.4 Benefits of RTAs

Under the current legal system of the World Trade Organisation (WTO), there are two
categories of rules on the RTAs in the area of trade in goods: the first is based on the
Article XXIV of the General Agreement on Tariffs and Trade, which generally applies to
all RTAs; the second is based on the so-called Enabling Clause, which in exceptional
circumstances, provide special and differential treatment (SDT) for RTAs among
developing countries.

3.4.1. Advantages of Regional Initiatives

Regional initiatives have a number of advantages which explain why so many countries
are members of such agreements:

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  Region Specific Issues

Firstly, a regional agreement can help in dealing with region-specific issues, such as
border controls, transit, migration, or movement of labour. Countries recognize that other
more opaque barriers than tariffs can hinder trade. These include border controls,
phytosanitary restrictions, weak transport systems, and regulatory differences. RTAs
therefore increasingly cover some of these issues, which are more suitably addressed at
the regional level. Some RTAs have also included dispute resolution mechanisms, which,
in the implementation phase of the arrangement, have proven to be extremely useful.

 Reinforcement Of Internal Regulatory Or Structural Reforms

Secondly, RTAs can reinforce internal regulatory or structural reforms. This can be done
through external treaty obligations and visible political commitments. Often, small
countries participating in a RTA have just made, or are trying to push ahead, major
reforms.

 Liberalization Of Services

Turning to large industrial countries, trade in goods as such no longer appears to be the
dominant factor for participating in RTAs. A growing number of RTAs includes
provisions on liberalizing services (including financial), investment, protecting
intellectual property rights, labour and environmental standards, and dispute resolution.
Industrial countries are keen to include such issues to counter what they regard as unfair
competition due to, for example, piracy or poor labour standards. They also desire to
open up markets for their services sectors, where they have a comparative advantage.

 Political Objectives

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Leaving aside economic goals for a moment, for some countries, political objectives are
another important reason to enter into a RTA. Countries that may have far-reaching
integration as a goal typically start out with trade agreements as a first step toward a
deepening of political relationship. For e.g. initial agreements can cover trade and
investment, then member countries later form an economic and monetary union, and then
enhance the process towards a fully-fledged political union with a common constitution.
Similarly, forging bilateral and regional trade ties is often linked to geopolitical and
security considerations. Trade policy is a key instrument of foreign policy to secure
regional stability by promoting the development of participating countries. In addition,
political cooperation can reduce the potential for military conflicts among member
nations.

 Defensive Motive

A last reason to enter into regional agreements may be defensive. As more and more
countries enter into regional agreements, the cost of non participation rises. While some
countries may prefer the multilateral route, they may also feel that not entering into
regional agreements can lead to a competitive disadvantage relative to countries that have
entered into RTAs.

 Greater Consensus

The benefits of trying to eliminate trade barriers in smaller groups of countries is

facilitated through RTAs i.e. it can be easier to gain consensus among the relatively few
members of a regional agreement as opposed to among all the member countries in the
WTO.

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While RTAs are signed for a variety of reasons, the impact on trade, growth, and
employment seems crucial in determining the extent to which broader objectives are
achieved. It is difficult to identify arrangements that have advanced wider political
objectives, without having first achieved progress in enhancing trade, and having this
seen reflected in higher rates of sustainable growth and employment creation. Thus, it
appears that the willingness to accept trade liberalization and the accompanying
economic adjustments is a first step that may be indicative of progress than can be made
in other areas.

 Economies of scale

Economies of scale are one of the most important aspects of regional integration in
regards to development. In economic theory, economy of scale gains can be achieved
when cost of producing one unit declines as the number of units increases. Economies of
scale gains can be realized in regional integration agreements between developing nations
because of the size of their combined markets and lower capital costs. Before regional
integration, both country A and B will produce a certain good. Because of economies of
scale, the country with the cheapest production costs will be able to provide the good for
the entire region at a lower cost and to the benefit of entire region.

 Trade Creation

Trade creation is another aspect of regional integration that can also be achieved through
RTAs. A RTA effectively expands the market in which a producer can sell a good by
making goods both available and at a cheaper price to new markets. Under a RTA,
countries will turn to partner nations for cheaper products. Thus, production can shift to
nations with the greatest comparative advantage, resulting in greater exports and imports
within the region under the agreement along with greater efficiency in the allocation of
resources.

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  Bargaining Power

Increased bargaining power is another major reason for developing nations to pursue
RTAs. Economies within developing nations are in almost all cases small in comparison
to developed nations, and are often in danger of being left out of global economy as a
result of size. Under RTA, a group of nations can in effect gain greater visibility and
influence within the international community. Increased bargaining power within the
International community can have effects on a number of different aspects; cooperating
members are able to share in the high fixed of negotiation. This power of integration has
been seen in various RTAs, including CARICOM’s success in international
policymaking, and perhaps even more clearly with ‘Group 20’ in the Doha round of
WTO trade talks. As confirmed by several conversations with experts in the international
community, increased bargaining power is a political goal sought after RTAs.

 Market Attractiveness

Increased market attractiveness has played a major role in the RTAs especially in the case
of Africa. Similar to the goal of increased bargaining power, RTAs provide increased
market attractiveness for FDI and trade relations with the developed world because of the
clarity of rules and the stability than an RTA brings to a region. As a region becomes
unified under standard trade measures and investment law, it is easier for outside nations
to invest in and do business with the developing nations under RTA. This in turn can
bring increased financial and capital flows, infrastructure, and ultimately wealth to the
region. Increased FDI after formation of the RTAs has been researched extensively by
organizations such as World Bank, and various situations point to the effectiveness of
regional integration as a positive for FDI. The investment situation within European
community and the NAFTA all showed significantly increases in FDI after negotiations
were concluded.

Another aspect of increased market attractiveness is the idea of conflict resolution within
developing nations. Under some RTAs, conflict resolution boards have been put into

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place that have increased the legality of agreements and increased attractiveness for
foreign investors and export purchasers. One of the boards includes the peer review
system used by the New Partnership for African Development (NEPAD) that has been
viewed favourably by various developed nations and groups including the US and EU.

 Cooperation in public goods

This also assists national economies in their development. By cooperating on

infrastructure projects the whole region can benefit and money can be saved through
economies of scale gains in regards to investment in public goods. This cooperation can
also be beneficial for environmental reasons. Railroads, public utilities projects, and
power plant initiatives (with the case of SADC power pooling project) are only a few
examples of how regional integration can increase efficiently and save money for
member nations.

3.5 Drawbacks of RTAs

Disadvantages Of Regional Initiatives

While there are many obvious benefits for countries to join in RTA, as evidence by their
popularity, there are some negative aspects associated with the RTAs. It is important to
know these drawbacks in order to make RTA work as well as to formulate policy as
regards to new RTAs.

 Trade Diversion

As mentioned above, Trade Creation is one of the benefits of RTA, but trade creation
however is not the entire picture. A negative aspect, called trade diversion can occur

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when the partners divert away products that may be more cheaply produced in favour of
products from the RTA partner, even if these products are produced at a higher cost, thus
resulting in inefficiency. In the case of trade diversion, regional suppliers have an
advantage as a result of preferential treatment rather than an actual comparative
advantage. The latter stems from sales won at the expense of third country suppliers,
which become less competitive purely because they face a tariff barrier that does not
apply to suppliers within the new free trade area. Such increased trade actually reduces
the economy’s overall efficiency. It results in lowered welfare for the importing nation
as tariff revenues are lost and not replaced by gains from trade when trade creation
cannot outweigh trade diversion.

 Delocalisation Of Labour Market

Another negative consequence of RTA is that it leads to shift in employment. Since the
formation of trading blocs significantly reduces or eliminates barriers to trade, the
producer of a particular good or service will more often be decided by relative
productivity. With trade agreements, labour market is dislocated, i.e., there are some jobs
that are loss while others are gained. An example will be the loss of between 32000 and
100000 of manufacturing jobs as a direct result of the NAFTA between Canada, Mexico
and United States. But evidence also suggests that between 90,000 and 160,000 jobs tied
to exports to Mexico were also created by NAFTA. Dislocation allows a nation to
upgrade their economy toward higher-wage-paying industries.

 Increase In The Complexity Of International Trading System

FTAs also increase the complexity of the international trading system and can raise
transaction costs for business. For example, complicated rules of origin are required to
prevent third countries product entering via the other party. With different rules
negotiated under different agreements, enforcement of these rules and compliance with
them by business can be a complicated task. Businesses have to take into account the

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different dispute settlement mechanisms as well as different standards regimes and other
harmonization arrangements.

 Unequal Bargaining Power

In a RTA between a developed country and a developing country or countries, the latter
are usually in a weaker bargaining position due to the lack of capacity of their economies,
their weaker political situation and their weaker negotiating resources. The result of such
unequal bargaining power can be that significant trade restrictions by large countries
remain in place instead of being eliminated under circumstances of more equal
negotiating power.
 Distortion In Production

Additionally RTAs may negatively impact on global trade because regional preferences
and rules of origin distort production by making location of production or source of raw
materials the driving incentive.

 Prevents Complete Liberalisation In Multilateral Arena

RTA may also prevent complete liberalization in multilateral arena. Countries that benefit
from regional trade agreements may be reluctant to expose themselves to the risks of
opening their markets on a multilateral level, if they expect relatively insignificant
returns.

 Loss Of Technology And R&D Transfer

One of the negative consequences of RTA is the loss of technology and R&D transfers
from developed countries. Technology and ‘Know How’ transfers from developed
countries are viewed as the major benefits from RTAs. Unfortunately, as intra-regional
trade begins to dominate a trading bloc, these technology and R&D transfers can be lost.

 Loss Of National Sovereignty

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Successive levels of integration require that nations surrender more of their national
sovereignty. For this reason, the higher levels of integration are more difficult to achieve.

3.6 EXERCISES

1. ‘Countries have joined one regional integration group or another with the hope of
addressing common problems in a collective and coordinated manner. One objective has
been the enhancement of growth and development through a collective effort. Regional
economic cooperation has been considered as a means of promoting increased intra-
regional trade and economies of scale by pooling small and fragmented domestic markets
to support industrialization strategies’.

Discuss.

2. ‘The Sub-Saharan African countries have joined one regional integration group or
another with the hope of addressing common problems in a collective and coordinated
manner. One objective has been the enhancement of growth and development through a
collective effort. Regional economic cooperation has been considered as a means of
promoting increased intra-regional trade and economies of scale by pooling small and
fragmented domestic markets to support industrialization strategies’. Discuss.

3.7 SUMMARY

 Since the 1990’s, there has been a global trend towards bilateral and regional
trade arrangements. The number of such arrangements that have been formed, or
are currently being negotiated, has dramatically increased. Consequently, at
present almost all countries are party to such arrangements.

14
  RTAs, by definition, are negotiated agreement by which national economies
maintain lower barriers to mutual trade while sustaining relatively higher barriers
to third parties. RTAs can take on several forms, and current theory identifies five
different forms of arrangements. These arrangements include preference areas,
free trade areas, customs unions, common markets and economic unions, with
each of them being progressively more integrated than the preceding arrangement.
 Under the current legal system of the World Trade Organisation (WTO), there are
two categories of rules on the RTAs in the area of trade in goods: the first is based
on the Article XXIV of the General Agreement on Tariffs and Trade, which
generally applies to all RTAs; the second is based on the so-called Enabling
Clause, which in exceptional circumstances, provide special and differential
treatment (SDT) for RTAs among developing countries.
 Under the current legal system of the World Trade Organisation (WTO), there are
two categories of rules on the RTAs in the area of trade in goods: the first is based
on the Article XXIV of the General Agreement on Tariffs and Trade, which
generally applies to all RTAs; the second is based on the so-called Enabling
Clause, which in exceptional circumstances, provide special and differential
treatment (SDT) for RTAs among developing countries.
 While there are many obvious benefits for countries to join in RTA, as evidence
by their popularity, there are some negative aspects associated with the RTAs. It
is important to know these drawbacks in order to make RTA work as well as to
formulate policy as regards to new RTAs. These include amongst others trade
diversion, loss of national sovereignty and unequal bargaining power.

3.8 SUGGESTED READINGS

Rhee, Y.W., Katterbach, K. and White, J. (1990). ‘Free Trade Zones in Export
Strategies’, Industry Series Paper, No.36, World Bank: Washington.

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Chen, C. (1996). ‘Regional Determinants of Foreign Direct Investment in Mainland
China’, Journal of Economic studies, 23(2), pp. 339-62.
WTO. (1999). ‘Developing Countries and the Multilateral Trading System: Past and
Present’ Development Division, Background Document Prepared for the High Level
Symposium on Trade and Development, Geneva, 17-18 March.

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