1.1.3 Trends in “New Regionalism”

Diversity of RTAs: From Shallow to Deep Integration

“Regional trade agreement” is a general term that refers to a whole spectrum of levels of economic integration. The lowest level of integration is represented by trade preferences, or partial scope agreements, which liberalize trade in specific commodities or sectors. This type of agreement, with its selective liberalization, does not conform to GATT/WTO rules on RTAs, which under Article 24 require that preferential arrangements for trade in goods meet two criteria:¹⁴

• “substantially all trade” must be included, and

• the “general incidence of duties and other regulations of commerce” must not

on the whole be higher or more restrictive against third parties than before the

formation of the RTA.

The reasoning behind the requirement for substantial inclusion is to prevent

members from taking a mercantilist approach to liberalization, and including only those sectors in which they anticipate export growth. Such agreements would likely be crafted to carve export growth out of non-members’ market shares, and hence be essentially protectionist and trade-diverting in character.¹⁵

The most common type of RTA is a free trade area in which members liberalize internal trade but retain their independent external tariffs. Seventy percent of the RTAs that have been notified to the WTO, are free trade agreements. Examples of free trade agreements include NAFTA, and U.S. agreements with Israel, Jordan, Singapore, and Chile. Since free trade agreements allow members to retain different tariffs against the rest of the world, they must include detailed rules of origin (ROOs). ROOs prevent goods that enter the member country with the lower external tariff from being transshipped duty free to members with higher tariffs. ROOs require that some proportion of products traded within the free trade area be of domestic content. ROOs can become complex because they can specify domestic content thresholds on a commodity basis and can in themselves become a focus of market access negotiations.

The GATT/WTO does not place any discipline on the rules of origin used in free trade areas. These are being increasingly recognized as an insidious form of trade protection. By increasing the domestic content requirement, ROOs can increase demand for local inputs, and divert trade from lower-cost, non-member suppliers. Krueger (1995) has argued that special interest pressures on the content requirements in ROOs gives them the potential to be used as non-tariff barriers on imported intermediates, causing them to become an important but hidden source of trade diversion in RTAs.

Customs unions liberalize internal trade and its members adopt common external tariffs against the rest of the world, eliminating the need for ROOs. About 8 percent of the RTAs currently in force are customs unions, including MERCOSUR, the Andean Pact, and the Central American Common Market (CACM). This is the type of RTA at which the second criteria of GATT article 24 is aimed. The prohibition against RTA’s raising their common external tariff is, like the first criteria, an attempt to minimize trade diversion. Low external tariffs reduce the margin of preference offered to pact members, and therefore the price incentives that lead to trade diversion. Kemp and Wan (1976) showed that it is possible to eliminate trade diversion entirely if a customs union adopts a sufficiently low set of common external tariffs at the same time that they liberalize

internal trade.¹⁶

In a common market, members move beyond a customs union, and beyond

shallow integration or commodity trade reforms, to allow the free movement of labor and capital within the union. The European Economic Community (EEC) by the early 1990’s had achieved a common market. With the decision to become the European Union, in which members adopted compatible fiscal and monetary policies, and (many) a common currency (the Euro), the Europeans are achieving full economic or deep integration, or an economic union. New regionalism can be characterized as involving many of the elements found in the deepest level of integration, or the achievement of full economic (and monetary) union, and may include (in rough order of increasing depth):

• facilitating financial and foreign direct investment flows (real and financial

capital mobility) by establishing investment protocols and protections;

• liberalizing movement of labor within the RTA;

• harmonizing domestic tax and subsidy policies, especially those that affect

production and trade incentives;

• harmonizing macro policies, including fiscal and monetary policy, to achieve

a stable macroeconomic environment within the RTA, including coordinated

exchange rate policy;

• establishing institutions to manage and facilitate integration (e.g., regional

development funds, institutions to set standards, dispute resolution

mechanisms);

• improvements of communications and transportation infrastructure to

facilitate increased trade and factor mobility;

• harmonizing legal regulation of product and factor markets (e.g., anti-trust

law, commercial law, labor relations, financial institutions); and

• monetary union—establishment of a common currency and completely

integrated monetary and exchange rate policy.¹⁷