Friday, July 25, 2008

Is Preferential Trade Freer Trade?

Not everything with the word "free trade" in it really represents genuine trade liberalization. In particular, regional (or "preferential") trade agreements among pairs or small groups of countries, like NAFTA or the pending deals between the US and Colombia and Korea are criticized by some true free traders.

Some see these deals as distractions from the multilateral WTO negotiations (which currently continue to be very much bogged down), and, in theory, they can reduce economic efficiency through trade diversion (e.g. if Taiwan is a more efficient producer of monitors than Korea, if our tariff treatment of the two countries is the same, we will import monitors from Taiwan, but if we lower trade barriers preferentially with Korea, they may end up producing our monitors). One of the leading critics of preferential trade agreements from a free trade perspective is Jagdish Bhagwati - see this Economists' View post about his book "Termites in the Trading System." On the other hand, Richard Baldwin has argued that the WTO needs to embrace the "spaghetti bowl" of regional trade agreements (see also, this Economist article).

Perhaps free traders should not worry too much. At VoxEU, Antoni Estevadeoral, Caroline Freund and Emanuel Ornelas summarize their recent research on preferential trade agreements. They find that:
Our results imply that regionalism is a building bloc to free trade. There is no clear evidence that trade preferences lead to higher tariffs or smaller tariff cuts. There is strong evidence that preferences induce a faster decline in external tariffs in free trade areas. For example, if a country that follows a strict policy of non-discrimination offers free access to another country in a sector where it applies a 15% multilateral tariff, the country would tend to subsequently reduce that external tariff by over 3 percentage points. This complementarity effect is stronger in sectors where trade bloc partners are more important suppliers, precisely where trade discrimination would be more disrupting.

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