World Bank Analysis of Regional Economic Integration and Trade Facilitation:

An Evaluative Review of Selected Documents

Julio J. Nogués∗ and John Eriksson

November 2006

∗ Consultant and Professor, Universidad Di Tella: Buenos Aires. I appreciate several insightful comments by Pablo Garcia and John Eriksson to a preliminary draft of this report. Nevertheless, I remain solely responsible for its contents. E-mail: jnogues@infovia.com.ar .

Table of Contents Acronyms...............................................................................................................................iii I. Introduction ......................................................................................................................... 1 II. The Evaluation Criteria and Approach .............................................................................. 1 III. Summary Assessment by Quantitative Ratings................................................................ 2 IV. The Quality of the Analytical Work................................................................................. 4 V. Scope for Scaling-up: Multilateralism, Regionalism and the World Bank ..................... 13

a. Distribution of gains and compensating arrangements................................................. 13 b. Erosion of the benefits of regional trade agreements ................................................... 14

VI. Conclusions .................................................................................................................... 17 Annex A. List of Documents Reviewed.............................................................................. 18 Annex B. References ............................................................................................................ 20

Acronyms AAA Analytical and Advisory Activities AFTA ASEAN Free Trade Area CAFTA Central America Free Trade Agreement CEMAC Economic and Monetary Community of Central Africa CGE Computable General Equilibrium DR-CAFTA Dominican Republic - Central America Free Trade Agreement EAC East African Community EC European Community EU European Union FTAA Free Trade Area of the Americas GDP Gross Domestic Product IEG Independent Evaluation Group ISO International Organization for Standardization LAC Latin America and the Caribbean Region MFN Most Favored Nation NAFTA North American Free Trade Area SADC Southern Africa Development Community WP Working Paper WTO World Trade Organization

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I. Introduction

As part of an evaluation by the World Bank’s Independent Evaluation Group (IEG) of World Bank support for multicountry, regional programs, this paper reviews a selection of regional analytic work supported by the Bank over the period FY95-05.2 While the main focus of IEG’s evaluation is on regional investment projects and partnerships, which account for the bulk of the Bank’s support, the number of analytical and advisory services (AAA) far exceeds the number of projects and partnerships (as shown in Table 1). Table 1: The Amount of World Bank Support for Regional Activities (FY95-05)

Level of Support US$ (billion) Number of Activities

Regional Programs and Partnerships 1.3 109

Regional Analytical and Advisory Services

0.2

3,167

This report, on the regional analytical work, deals specifically with studies on

regional economic integration and trade facilitation. There are two reasons for this concentration: 1) the predominance of the two issues in multicountry interactions in all developing country regions and 2) the heavy emphasis on analytical work as the Bank’s mode of support on these issues.

The remainder of the report is organized as follows. Section II presents the

evaluation criteria and approach used in the selection and review of individual studies. Sections III and IV provide, respectively, a summary assessment of the studies in terms of quantitative ratings by evaluation criteria and a qualitative assessment of key issues addressed. Section V makes some suggestions for future Bank work on regional integration; and, lastly, Section VI provides a summary of findings and conclusions. Annexes A and B present, respectively, a list of documents reviewed and other references used in assessing the quality and scope of the Bank’s analytical work.

II. The Evaluation Criteria and Approach

The report analyzes the relevance, efficacy, and efficiency of a selection of 24 out of a total of 62 studies released since 1995 dealing with regional integration and trade

2 Regional programs are defined as projects and partnerships that aim to accomplish development objectives in three or more countries in the same Bank region or contiguous regions and that involve some degree of interaction among participating countries.

facilitation. The selection is based on considerations of regional balance, availability of documents, and sufficient information in each document to reach conclusions with regard to the specific evaluation criteria employed.

The criteria are as follows:

1. Rationale: Is there a strong rationale for undertaking the analytical and advisory

work on a regional level? 2. Relevance: Has the work addressed the regional trade objective or issue in a

relevant and appropriately comprehensive way?

3. State of the art: Has the Bank provided state-of-art knowledge validated by experience (including from sources outside the Bank)?

4. Practicality: Has the knowledge provided been practical from the vantage point of

policy-makers or other key stakeholders in the countries in the relevant region?

5. Objectivity: Has the knowledge been presented in a suitably objective way?

6. Candidness: Have significant differences with regard to existing ideas and approaches been conveyed?

In order to compare results, the extent to which each study meets each criterion is

numerically scored, using a rising scale of 1 to 5, and those ratings are taken together to give an overall rating. This means, for example, that a study of the highest technical standard might fall short of the highest overall rating because of a lack of practicality in the analysis provided or candor in discussing alternative views. III. Summary Assessment by Quantitative Ratings

The large majority of the studies rate quite highly, between 4.0 and 5.0 (on a 5-point scale). Figure 1 below presents the aggregate results by evaluation criteria. The studies were rated highest in terms of rationale (criterion 1) and objectivity (criterion 5); and weakest in terms of their practicality (criterion 4) and candidness in discussion of their differences with other existing views (criterion 6).3

3 It should be noted that the relatively low score for candidness is influenced by ratings associated with just a few documents, so any generalization should be made cautiously.

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Figure 1. Reports Rate Highly Across Criteria (on an increasing scale of 1-5)

3.6 3.8

4 4.2 4.4 4.6 4.8

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1. Rationale for undertaking the advisory work

2. Relevancy andcomprehensiveness

3. State-of-the-artknowledge

4. Practicality forpolicy-makers andkey stakeholders

5. Knowledgeprovided in a suitable and objective way

6. CandidnessIn discussion of existing views

Criteria

Ave

rage

s

Aggregated by region, the five Latin American and Caribbean studies and two

South Asia studies show the highest average ratings across all criteria, but the differences among regions is quite marginal as shown below in Table 2. The seven studies on Africa have the lowest average score, but this is due mainly to a couple of studies that scored low on several of the criteria. Otherwise, the great majority of the Africa-related studies also meet the criteria with high marks. All but one document dealing with Europe and Central Asia also received high ratings. Table 2: Average Ratings are Similar Across All Regions

(on an increasing scale of 1-5)

Africa Caribbean East Asia & Pacific

Europe & Central Asia

Latin America

Middle East & North Africa

South Asia Average

Rationale for understanding the advisory work 4.9 5.0 5.0 4.3 5.0 4.3 5.0 4.8Relevancy and comprehensiveness 4.3 4.5 5.0 4.3 4.0 4.7 5.0 4.5State-of-the-art knowledge 3.9 4.5 5.0 3.7 5.0 4.7 4.5 4.5Practicality for policy-makers and stakeholders 3.9 4.5 4.0 4.0 4.0 4.7 5.0 4.3Knowledge provided in a suitable and objective way 4.4 4.5 4.7 4.7 4.7 4.7 4.5 4.6

Candidness in discussion of differences with existing ideas and approaches 3.9 5.0 3.7 4.0 4.7 3.7 4.0 4.1Average 4.2 4.7 4.6 4.2 4.6 4.4 4.7 4.5Number of studies evaluated 7 2 3 3 3 3 2

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IV. The Quality of the Analytical Work Overview

Viewed qualitatively, the analytical work shows considerable strength in the treatment of most, though not all, of the key issues addressed in the sample of reports. But the quality of the data and quantitative methods used is mixed, and several reports fail to explain changes in Bank policy advice on specific issues over time. The analytic rigor and policy relevance of the key topics addressed in the reports

Five substantive issues dominate the focus of the 25 reports reviewed: • The general costs and benefits of regional trade and integration; • Policy and structural impediments to trade growth;

• Commodity export dependence;

• Strengthening country positions in North-South trade negotiations; and

• The political economy of trade reform.

While the first four issues are well addressed in most individual reports, the fifth issue on the political economy of trade reform is insufficiently covered and sometimes poorly analyzed.

The costs and benefits of regional trade and integration. The largest number of documents, twelve, deal largely with the pros, cons, and risks of regional economic integration and trade. They all present clear analyses of the benefits and costs, but very general policy recommendations (as indicated in Table 3 below).

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Table 3: The Costs and Benefits of Regional Trade and Integration Study Key Findings and Issues

Free Trade Agreements and the Southern African Development Community (SADC) Economies, Africa Regional Working Paper (WP) No. 27 (2002) Regional Integration in Central Africa, WP No.52 (2003) Regional Trade Integration in East Africa, WP No. 72 (2004) Reform and Opportunity: the Changing Role and Patterns of Trade in South Africa and SADC, WP No. 14 (2001) Risks and Rewards of Regional Trading Arrangements in Africa (2005) Salient Features of Trade Performance in Eastern and Southern Africa, WP No. 76 (2004)

Makes strong case for deeper integration among SADC countries and highlights trade and infrastructure barriers. Relevant but very general policy recommendations, whose practicality is unclear. Clear presentation of pros and cons of regional integration. Relevant but very general policy recommendations, whose practicality is unclear. Clear analysis of benefits and risks of the integration strategy underlying Economic Partnership Agreements with EU countries. Relevant but very general policy recommendations, whose practicality is unclear.

Pangestu and Gooptu in East Asia Integrates: A Trade Policy Agenda for Shared Growth, World Bank (2004)

Presents regional trade arrangements as more fundamental than financial arrangements for regional economic cooperation

East Asia: Recovery and Beyond, World Bank (2000)

Explains region’s poor trade performance during early years of recovery. Identifies several cyclical and structural factors that caused unit prices of the region’s main exports to plummet while import prices remained high. Notes that harmful effects of regionalism elsewhere can be used to justify regional integration;

A Time to Choose: Caribbean Development in the 21st Century ( )

Provides a comprehensive strategic analysis and identification of restrictions to growth, notably: erosion of trade preferences, precipitous decline in productivity, and growing risks of macroeconomic instabilities. Recommends deepening integration policies within the Caribbean Community.

Towards a New Agenda for Growth: Organization of Eastern Caribbean States

Makes specific short and long term recommendations for policy reform in the Eastern Caribbean. Ireland is used as a successful island economy benchmark.

DR-Central American Free Trade Agreement (CAFTA): Challenges and Opportunities for Central America (2005)

Lessons from North American Free Trade Agreement (NAFTA) for Latin America and the Caribbean Countries (2003)

Notes that trade diversion effects of regional integration can be important; the “hub & spoke” strategy practiced by the U.S. after the failure of the Uruguay Round has an adverse impact on non-participants; the administrative and standards measures required to expand exports to the U.S. are costly; and other significant non-trade reforms (such as education) are required to reap the growth benefits of trade reform.

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Policy and structural impediments to trade growth. Ten studies focus primarily on

structural constraints to trade growth and policy measures required to reap the benefits of trade liberalization and regional integration. These studies stress such impediments as: infrastructure constraints, especially in transport and energy; lack of border controls; trade barriers and trade agreements in other regions or third countries that influence trade integration through, for example, trade diversion; behind-the-border obstacles; and, in one study, the importance of exchange rate policies. Two Africa documents also identify similarity of factor endowments as associated with poor trade performance.

Several reports deal with the importance of liberalizing trade and improving the provision of infrastructure services. Unlike goods, a regional agreement for liberalizing trade in services is less likely to create diversion effects as important as those for trade in goods. Liberalizing services even if only regionally, is likely to reduce trading costs not only with member countries but also more generally, with trade in all directions. Better transportation, new and improved roads, better ports and transport systems, stronger banking and insurance markets, that can be the scope of regional negotiations, will reduce costs for the benefit of trade with all WTO members. Because measuring the height of protection in service industries remains more of an art, there have been relatively few attempts to measure gains from their liberalization. Nevertheless, the few Bank documents that have addressed this topic in terms of world trade, have uncovered important potential gains (World Bank 2002, Mattoo et. al. 2001 and Mattoo 2006). In south-south agreements, opportunities for reducing trading costs through more efficient provision of services remain under-exploited, at least in relation to trade in goods.

One regional study, World Bank Framework for Development of Regional Energy Trade in South East Europe, proposes a set of actions that would unlock the potential benefits of this market, estimating that it could reduce power costs by an amount that ranges between 11% and 15%. There are several sources of potential benefits arising from regional integration of power markets. For example, some countries in a region may enjoy lower fuel costs than others, something that can justify the construction of thermal power plants geared towards exporting to neighboring countries. Second, acceptable levels of supply reliability can be achieved with lower capacity margins when networks are interconnected than when operating independently. Third, peak loads among neighboring countries can take place at different times and in these instances, the output of power plants activated at peak times, can be shared. According to this document, such markets are under development in Southern Africa, Indochina, and Central American countries (Sistema de Interconexión Eléctrica para los Países de América Central, SEPAC). Similar discussions are under way in South America and it is probably the case that there are several other plans under consideration or implementation regarding regional integration of gas and power markets.

Other regional studies show that transport systems provide an essential input to

commerce and international trade. Transport regulations and their administrative mechanisms can generate undue costs and reduce trade in some cases, significantly. In such instances, reform will strengthen supply networks and productive systems thus helping to diversify economies as trade costs decline. The few documents on transport costs included

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in this review are clear in pointing towards the need for reform in these areas. Some of them present evidence of the room that exists for achieving important cost savings. For example, Trade and Trade Facilitation in the South Caucasus shows that of the aggregate logistical costs of transporting a container from Rotterdam to Yerevan, between 20% and 25% goes to unofficial payments. Maghreb Transport and Trade Facilitation Study is a good example of the role that future Bank documents can play to show the general and regional effects that transport policies can have in raising costs and reducing trade flows. This document illustrates well how the Maghreb countries suffer from relatively high transport costs. Based on these estimates and on several country-specific surveys the analysis estimates the impact of policy-induced distortions on excessive transport costs.

Under any program of trade liberalization, the role to be played by the exchange rate

policy should be a major consideration and yet, only a few of the documents that have been reviewed pay attention to this issue. Trade Policies in South Asia is one exception to this omission. This document recalls how in the past, some countries in the region had to reverse their liberalization policies when their domestic currencies became clearly overvalued. Countries that are considering joining a regional agreement that has important trade liberalization measures have to consider the role that the exchange rate will play during implementation and after. This is particularly important under WTO (World Trade Organization) rules, where members have limited instruments to soften the impact of the program for sectors that may come under particular stress. There is a corresponding need to study the role if any that a regional safeguard can play during the transition period.

Trade and Investment Integration of the Maghreb also stresses the fact that very few of firms in the region have quality management systems at an international level, reflected by the relatively small number holding the ISO 9000 standard. This fact, the study argues, puts an important barrier to exporting manufactures to the EU. Although the NAFTA and CAFTA reports describe the demands put forward by the US in several behind-the-border areas, in most cases, they fail to quantify their impacts. Table 4 summarizes the key findings and issues from reports dealing with transport and other structural and policy constraints.

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Table 4: Policy and Structural Impediments to Trade Growth Study Key Findings and Issues

Trade and Transport Facilitation in the South Caucasus (2003)

Shows that up to 25% of total logistical costs of transporting a container from Rotterdam to Yerevan goes to unofficial payments.

World Bank Framework for Development of Regional Energy Trade in South East Europe (2004)

Shows trade constraints from high energy costs and identifies multiple, substantial benefits from integration of energy markets.

Maghreb Transport and Trade Facilitation Study (1995)

Illustrates how Maghreb countries suffer from relatively high transport costs and the impact of policy-induced distortions on excessive transport costs.

DR-CAFTA: Challenges and Opportunities for Central America (2005)

Lessons from NAFTA for Latin America and the Caribbean Countries (2003)

Complementary measures –e.g., customs, patent, and copyright reforms; sanitary and phytosanitary modernization are also needed along with regional integration

Comparative Advantage in International Trade for Central Asia (2005)

“Behind-the-border” obstacles to regional trade are identified, including cumbersome regulations for business entry and exit, weak domestic financial markets, and pernicious government problems, but not analyzed, in spite of their importance.

Trade and Investment Integration of the Maghreb (2005)

Firms in the region lack quality management systems that constitute a barrier to exports, but labor adjustment in the Maghreb is touched on only marginally.

Maghreb Transport and Trade Facilitation Study (1995)

The impact of policy distortions on transport costs in the Maghreb is estimated to be very substantial.

Trade Policies in South Asia: An Overview, World Bank (2004)

One of the few studies that stresses the importance of exchange rate policies in trade liberalization

Preferential Trading in South Asia (2004) Gains from regional agreements are contingent on complementary policies for education & the business environment.

Reducing commodity export dependence: Two studies are concerned with the high degree of export concentration in a few primary commodities characterized by volatile prices and a declining trend. The traditional advice that the Bank has offered to overcome this characteristic has been to deepen liberalization and remove structural barriers. Countries have negotiated and implemented regional trade agreements that seek to diversify exports. Despite the time that has elapsed since implementing these measures, most developing countries continue to be characterized by exports that show a high degree of concentration in primary products. A Latin America (LAC) study explores how to move away from comparative advantage in natural resources to a more knowledge-based economic structure with higher growth potential. Two of the major questions addressed in this report are: 1) is a rich endowment of natural resources a curse for growth and

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development and 2) can LAC economies move to more knowledge-based and dynamic productive systems. The answers given are no and yes, respectively. These conclusions are well-supported, drawing on the realities and history of the region and also on the experience of specific countries. The questions raised by this report are relevant for other regions although specific policy recommendations may vary from region to region. Table 5 identifies the studies and summarizes the key findings. Table 5: Reducing Commodity Export Dependence Study Key Findings and Issues

Trade Performance and Regional Integration in the CIS Countries (2004)

Despite policy reforms, most countries show a high concentration of primary exports (findings caveated by significant concern about quality of the data)

From Natural Resources to the Knowledge Economy (2002)

With the right set of policies some Latin American countries have shown that they can move from natural resource based economies to dynamic, knowledge based systems.

Strengthening countries’ positions in North-South trade negotiations: Several studies provide information that could help countries strengthen their position in north-south trade arrangements (as shown in Table 6). One study shows that concessions given in areas such as intellectual property rights, government procurement, and customs reform can turn out to be quite costly and have important economic effects (Hoekman and Maskus 2005). Other studies show the importance of understanding the distribution of gains and losses among participating countries and agreeing on compensation measures. For example, two reports that analyze the experience of integrating with the U.S. conclude that: a) NAFTA has helped Mexico and DR-CAFTA will help Central America get closer to the levels of development of its partners, but by themselves these agreements are not enough to ensure a significant amount of convergence of per capita GDP of Latin American countries with the US and b) to ensure maximum benefits, other significant policy reforms will have to accompany implementation of an FTAA (Free Trade Agreement of the Americas) in areas such as education, institutional reform, and the deepening of trade liberalization through unilateral measures and multilateral negotiations. (Lessons from NAFTA for Latin America and the Caribbean Countries, 2003; DR-CAFTA: Challenges and Opportunities for Central America, 2005).

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Table 6: Strengthening Countries’ Positions in North-South Negotiations Study Key Findings and Issues

Regional Integration in Central Africa, WP No.52 (2003)

Poor compliance with trade agreements, owing to excessive obligations in the agreements, resulting from pressure groups.

Regional Trade Integration in East Africa, WP No. 72 (2004)

Identifies unequal distribution of gains among participating countries and lack of agreement on compensation measures.

Lessons from NAFTA for Latin America and the Caribbean Countries (2003)

DR-CAFTA: Challenges and Opportunities for Central America (2005)

Trade diversion effects of regional integration can be important; the “hub & spoke” strategy practiced by the U.S. after the failure of the Uruguay Round, has an adverse impact on non-participants; other significant non-trade reforms (e.g. education) are required to reap the growth benefits of trade reform; the administrative and standards measures required to expand exports to the U.S. are costly

Maskus in East Asia Integrates: A Trade Policy Agenda for Shared Growth, World Bank (2004)

Trade-offs are identified between higher IPR standards and adverse development impacts in the short run.

Hoekman and Maskus, The WTO, Intellectual Property Rights, and the Knowledge Economy (Elgar, 2004)

Data effectively employed to show that trade concessions made by developing countries for intellectual property rights, government procurement, and customs reform are costly.

Political economy dimensions of trade reform: In spite of its relevance, the

political economy of trade reforms is addressed in only a couple of documents. The study Regional Trade Integration in East Africa concludes that the past failure of the East African Community (EAC) was associated with the unequal distribution of the gains from this regional agreement and the impossibility of arriving at an agreement on compensation. A second study, Trade, Investment, and Development in the Middle East and North Africa, includes an insightful analysis of the political economy aspects of efforts to liberalize an economy. It suggests that the degree of liberalization of an economy is at least in part the result of the interplay between two groups of opposing political forces: those that favor protection, and those that favor openness. In this setting, the winner is usually the most concentrated and powerful group as measured for example, by its greater share of GDP. The capacity to implement trade reform is also affected by institutional constraints. While the report Regional Integration in Central Africa cited the “good institutional basis” of the Economic and Monetary Community of Central Africa (CEMAC) it also signaled the lack of commitment by member countries to comply with agreements. This stems in part from the overloading of obligations with which many countries do not comply by default or because of the pressure of powerful interest groups. This record suggests the need for regional agreements to be more realistic about what obligations countries are likely to meet and which they are not. Table 7 summarizes the key findings from reports that touched on these political economy issues. On the whole, the role played by power groups in opposing trade liberalization, including implementation of agreed measures, could be stressed more emphatically in future reports.

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Table 7: Political Economy Dimensions of Trade Reform Study Key Findings and Issues

Reform and Opportunity: The Changing Role and Patterns of Trade in South Africa and SADC, WP No. 14 (2001)

Regional Trade Integration in East Africa, WP No. 72 (2004)

These studies Identify unequal distribution of gains among participating countries and lack of agreement on compensation measures.

Regional Integration in Central Africa, WP No.52 (2003)

Poor compliance with trade agreements, owing to excessive obligations in the agreements, resulting from pressure groups.

Trade, Investment, and Development in the Middle East and North Africa (2003)

Rare instance of a political economy analysis of winners and losers in trade liberalization

Preferential Trading in South Asia (2004) Importance of strengthening peace & democratic institutions is mentioned; this is rarely mentioned in most studies and is poorly analyzed when it is.

The adequacy of the data and quantitative methods used

Several reports utilized quantitative models or other quantitative approaches—some more successfully than others. One significant determinant of the effectiveness of a quantitative approach was the reliability and relevance of the available empirical data. In one case, Free Trade Agreements and the SADC Economies, a relatively sophisticated Computable General Equilibrium Model (CGE) employed irrelevant and out-dated data. The results in this case are bound to be suspect and likely in error. In some cases, more sophistication might be preferable to less while in others, the converse might be true. The worst of worlds occurs when a high level of sophistication is applied to data that are second or third rate. What informational content do the numbers crunched in this way have? For example, analysis of the impact of different integration alternatives by SADC countries is based on simulations with a CGE (computable general equilibrium) model that in some cases, rely on old input-output matrices and furthermore, the data on the crucial agricultural sector are too aggregative for the results to have concrete meaning. In contrast, the analysis offered in the working paper, How Far Did Africa’s First Generation Trade Reforms Go?, uses a methodology of intermediate sophistication that given the data shortcomings is more appropriate than running CGE simulations. Similarly, the study Maghreb Transport and Trade Facilitation Study used a method of analysis of transport costs and policy distortions appropriate for the available data.

A second methodological issue relates to the comparability of findings across studies. Two documents, one on Africa (How Far Did Africa’s First Generation Trade Reforms Go, 2003) and the other on South Asia (Trade Policies in South Asia: an Overview, 2004), answer an important question regarding the extent to which reforms in these regions liberalized several economies. In addition, the South Asia report offers concrete suggestions for policy reform of specific trade instruments. It is unfortunate that the two studies did not follow the same approach to measuring the extent of trade

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liberalization. Had they done so, the Bank and the research community generally, could compare between regions and countries the extent to which these most recent liberalizers had in fact liberalized trade. This indicates that without sacrificing intellectual creativity, in some topics there remains room to unify methodological approaches, thus increasing the degree of comparability4

Inconsistent advice A couple of reports failed to adequately discuss significant differences in views on contentious issues by key stakeholders, including within the Bank and among other observers. Challenging the political decision of the time, the earliest dated document included in this review, Should East Asia Go Regional: No, No, and Maybe, reflected a clear opposition to the formation of the Asean Free Trade Area (AFTA) in 1992. The author presents several arguments against this strategy, notably: a) the small size of the market; b) low levels of intra-regional trade; c) relatively high levels of protection in the bigger countries where removal of trade barriers will be slower; d) concentration of gains in countries that have the lowest levels of protection; and e) the difficulties and discretion associated with negotiating compensation agreements, especially among a relatively large number of countries, some of whom were historic rivals. According to the author, these difficulties are illustrated by the lengthy and frustrating experience of member countries during the formation of Asean. This document failed to signal with clarity the underlying differences in ideas and approaches between those who had decided to form the AFTA, and those like the author who opposed it. Approaching the realities of regional politics and departing from these earlier views, a more recent Bank document, East Asia: Recovery and Beyond, supports the AFTA and other agreements between countries in this region. For example, it asserts that AFTA “...may be a useful stepping stone to further liberalization because it exposes domestic industry to more competition...” (page 55).5 Yet, this document fails to offer a candid discussion of the significant differences in recommendations that exists between this new assessment and the Bank’s older policy advice.

4 In this specific example, this would have been possible as the more unified methodology used in the Africa study was developed in the 70s. 5 This support contrasts with the earlier agnosticism expressed by Panagariya (1993). Interestingly, this paper is not included in the references of this document.

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V. Scope for Scaling-up: Multilateralism, Regionalism and the World Bank What does this assessment imply about plans for future policy-oriented research on regionalism? During the last decade, the number of trade agreements has exploded and today most regions of the world are characterized by what has been called a spaghetti bowl of accords. There remains hardly any country that does not belong to at least one agreement. Things were not like that some fifteen years ago when multilateralism remained the preferred trade strategy of the world and particularly, of industrial countries (World Bank 2006, chapter 2).

The results of the negotiations at the Hong Kong Ministerial Meeting of the WTO in early 2006 were insignificant. Therefore, the Bank will have to pay much closer attention to trade diversion effects of the regional agreements which it has supported with its advice. This will be the case particularly if a multilateral trading system over which agnosticism prevails triggers resistance to further unilateral liberalization policies. If in the future, countries oppose implementing unilateral liberalization that usually has accompanied policy advice on regionalism, then the Bank will have to be extremely careful on how far it can promote additional regional policies and agreements. In particular, future work by the Bank on regionalism will have to be more watchful about two effects: distribution of the gains and costs among countries in specific agreements and erosion of the benefits of regional trade agreements. a. Distribution of gains and compensating arrangements The traditional argument, by which trade agreements are evaluated, was originally developed by Viner (1950). This framework distinguishes between the trade creation and trade diversion effects of an agreement. Trade creation occurs when higher cost domestic production is replaced with efficiently produced imports from the other member countries. Trade diversion takes place when imports that are efficiently produced in third countries, are substituted with higher cost imports from partners. The most visible impact of trade diversion effects is noticed in lost government revenues. If member A applies an MFN (most-favored nation) tariff of 10% on TV sets that are imported at $100 dollars CIF from the most efficient third-country producer, the treasury collects $10 dollars for each unit that is imported. Assume that after formation of the agreement, country A substitutes imports from third countries with imports from its partner who sells the TV sets at $105 CIF. Because of free intra-regional trade, now country A collects zero tariffs while its consumers pay $105 per unit, which puts the net loss to country A at $5 per unit.

Note that under some circumstances the exporters from the partner country could wipe out the gain enjoyed by consumers in country A. This would occur if the high cost

exporters can collude and take advantage of the tariff preferences and charge country A consumers $110 CIF per unit. In this case, government revenues of this country continue to be zero but consumers pay the same price as before the agreement came into force. The agreement has left country A with a net loss of $10 per TV set while producers and exporters from the partner country have internalized the profits associated with a price hike of 10%.

Under what circumstances is country A less likely to be overtaken by the

agreement? If country A had zero tariffs, then it would be impossible for its partners to take any advantage from it while this country would profit from exporting those goods that are protected by its partner. More generally, among the members of an agreement, those that are likely to profit the most are those that have the lowest average protection, the lowest tariff dispersion, and exporters with sufficient power to charge higher prices by an amount equal to the preference margins.

This simple example raises the important questions of gainers and losers to an agreement and whether a compensating mechanism can be instituted. Several documents considered in this review either sidestep the issue of gainers and losers totally or make a marginal reference to the issue.6 Unfortunately, the evidence points in the direction of agnosticism if not outright pessimism about the likelihood that in the future gainers will agree to negotiate fair compensations to the losers in an agreement. There is little evidence that countries have reached agreement on compensation, and less that the compensation has been substantive and not window-dressing when it has occurred. (See for example, the discussion in Schiff and Winters 2003, page 94).

Summing-up, trade liberalization through regional integration is a quite different proposition from unilateral measures or multilateral agreements. Regional integration can and may have produced net losses to some members who most likely have not been and will never be compensated. The contributions reviewed for this review indicate that there have been few efforts to estimate winners and losers from trade agreements. The Bank can, and perhaps should, do more to raise awareness among its staff that their enthusiastic support for specific regional agreements can end up hurting some of the same participating countries that they are attempting to help. b. Erosion of the benefits of regional trade agreements In the real world where the great majority of countries apply protection policies, the probability that a regional trade agreement will not produce trade diversion (low cost imports from the rest of the world being replaced by higher cost products from partner countries) is nil. This trade diversion not only implies real economic losses to the member countries suffering them but also discriminates against exports from efficient non-members. How serious is this discrimination effect of regional trade agreements?

The higher the level of protection that member countries apply against imports from non-members, and the lower the impact that the agreement has on growth rates, the more 6 To be sure, there are exceptions and one of them is Panagariya (1993).

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serious the trade diversion effects and the negative economic consequences on non-members’ exports. Yet, despite these well-known consequences of regional agreements on third countries, few of the documents reviewed for this review show any real concern about it.

In most of the documents that have been reviewed, the usual Bank recommendation

is that regional agreements can and should be strengthened and deepened for the benefits of the member countries.7 Is the discrimination against third countries that is created by regional agreements of economic importance? If it were not, then a Bank characterized by regions operating as independent islands would be of no great concern. On the other hand, if this discrimination is important, then the Bank as a multilateral institution can be traveling a dangerous road that does more harm than good to developing countries and the trading system.

As noted above, the higher the level of tariffs applied to imports from non-members, the higher the likelihood that a trade agreement will produce trade diversion and discrimination. Most developing countries still have relatively high average tariffs and therefore, trade agreements that include them most usually harm non-members (World Bank 2006). Likewise, it is well known that some industrial countries still apply highly protectionist policies on agricultural and agro-industrial products. Trade agreements that increase the size of markets for these highly protected goods discriminate against exports from efficient producers that generally are developing countries. How serious are these diversion effects?

One estimate provided by an often-cited study by Bayoumi and Eichengreen (1997) found that the formation of the EC (European Community) countries reduced the annual growth of members’ trade with other industrial countries by 1.7 percentage points per year. Cumulating the decline over the period 1957-1973 puts the loss to the rest of the world exports at $24 billion dollars in the latest year.8

Researchers have also uncovered several cases of discrimination against developing countries’ exports from integration agreements of industrial countries. Goto (1996) for example, analyzed the accession of Greece, Spain and Portugal to the EC to determine whether there had been changing patterns of agricultural and manufactured trade flows before and after enlargement. He found that in all three cases, there was an important increase in regional agricultural trade but at best minor changes in the patterns of manufactured trade flows. He concluded that these differences should be attributed to the

7 Recommendations for strengthening integration are less harmful when member countries also reduce protection with third countries. Although most of the documents offer this suggestion, I doubt the extent to which in today’s world, developing countries are as enthusiastic in reducing protection with third countries as they are in strengthening integration. Most likely, integration agreements are being created with minimal if any reduction of trade barriers against imports from third countries but this is a hypothesis that requires an evaluation. 8 Cited in Schiff and Winters (2003) page 212.

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EC´s structure of protection that is heavily biased towards agriculture increasing trade diversion effects when enlargement to new countries was agreed9.

The creation of NAFTA also offers examples of export losses by third countries. Nogués (2004) shows several product-specific examples of how creation of this agreement in 1994 was followed by declining import shares from Argentina and Brazil in Mexico that were compensated by higher shares from Canada and the US. For example, one case of loss from the formation of NAFTA is that of sunflower oil exports from Argentina to Mexico. As compared with 1991, Mexico’s imports from Argentina reached a peak and thereafter declined rapidly from $ 82.4 million dollars, to only $3.6 millions dollars in 2000. The figures also show Mexico’s imports from the US increasing fast to more than double the value registered in 1991.10

There are two other ways by which trade agreements can harm non-members: through price effects and terms of trade deterioration, and by reducing the likelihood of making progress in multilateral trade negotiations. Both of these factors have been found to produce worrying negative effects (Schiff and Winters 2003), which are not well reflected in several of the documents that have been reviewed. The picture that emerges from this review is one where each regional vice-presidency in the Bank tends to protect and promote trade agreements among the countries that they supervise with little or any concern for the negative consequences on the countries that the vice-president sitting next door is trying to assist. Summing up, regional agreements produce trade discrimination and this should be of concern to a multilateral institution like the Bank that should continue to strive for a stronger multilateral trading system. Yet, adding the bits and pieces of advice offered by the Bank’s regions to the countries that fall under its purview may be producing the opposite effect: a world that facilitates discriminatory regional agreements overtaking multilateralism and some countries gaining at the expense of others. The recommendation that stems from this finding is that the Bank should assess the extent to which this concern is real and has a negative impact on the world economy. Another suggestion is to create greater awareness among regional staff that their advice in favor of specific regional agreements has negative economic consequences on non-members, in much the same way

9 Other examples of discrimination against agricultural exports from developing countries were also triggered by the enlargement of the EU to Austria, Finland and Sweden in 1995 (Nogués 2004). 10 Note that although the discrimination against Argentina has been disentangled through analysis of disaggregated trade data, more aggregate techniques may indicate that an agreement like NAFTA has not produced trade diversion effects (World Bank 2003). This suggests that in the future, the Bank should consider finer methods for analyzing this topic. More generally, when facing a choice between reading a sophisticated quantitative analysis, and a document that holds a storyline and uses data wisely, I believe that most policymakers would choose the second. Nevertheless, in some parts of the Bank it has become fashionable to use sophisticated modeling approaches for the analysis of integration agreements. Unfortunately, this tradition has even been exported to developing countries and today, if a Foreign Affairs Ministry does not have a toy like a CGE model (Computable General Equilibrium), then it is considered not to have the right technology and analytical capacity for leading the trade negotiations. This is wrong. This comment is not geared at downgrading CGE models and similar sophisticated methodologies, but simply to point out that there are few observers who really understand the CGE black box and even less, those that can use the information that it generates with wisdom and prudence.

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that similar advice by staff operating in other regions has negative effects on their own countries. VI. Conclusions

Except for a few outliers, the documents included in this review have received high marks for their relevance, quality of analysis on specific topics, new knowledge generated, and accessibility to a broad audience of policymakers and other stakeholders. The one criterion where several documents are wanting is in signaling differences with existing ideas and approaches. Some have done an excellent job in pointing to them, but others only mention the issue in passing, or not at all. There are even documents that fail to make any reference to earlier Bank contributions on the same region but offer differing policy recommendations. For example, while some documents have opposed specific agreements, others addressing the same region have favored them. In some cases, the documents offering these differing recommendations have not been cross-referenced.

The evidence suggests several areas where further work by the Bank can serve to strengthen regional ties and facilitate trade overall and not just intra-regional integration. Work covered by this review in the areas of transport and trade facilitation as well as in energy, point in the direction of economy-wide cost savings. Additional analysis financed by the Bank in these and other service topics such as banking and insurance, could serve to illustrate the extent of cost reductions for intra-regional trade as well as for trade with third countries.

Finally, regional integration in trade in goods has apparently produced net losses (or

highly skewed distribution of the gains) to some members who will never be compensated. Likewise, given its apparently small effect on growth, regional agreements are more than likely to be harming non-members. The contributions reviewed for this evaluation indicate that there have been few efforts to identify the losers from specific trade agreements.

This assessment suggests that regional analysis has been undertaken in a

compartmentalized way: each of the Bank's regions supporting formal integration among the countries they cover and disregarding the effects on others. The Bank should do more to raise awareness among its regional staff that its enthusiastic support for specific agreements can end up hurting some of the same countries that they are attempting to help, as well as third countries. The Bank remains a multilateral institution and should continue to push for a strengthened multilateral system. In this regard, the documents addressed by this review indicate that its advice on regional policies can be strengthened.

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Annex A. List of Documents Reviewed Africa Regional Integration in Central Africa: Key Issues, Africa Regional Working Paper Series No. 52, June 2003. How Far Did Africa's First Generation Trade Reforms Go? An Intermediate Methodology for Comparative Analysis of Trade Policies, Africa Region Working Paper Series No. 58a and 58b, June 2003. Salient Features of Trade Performance in Eastern and Southern Africa, Africa Regional Working Paper Series No. 76, October 2004. Regional Trade Integration in East Africa: Trade and Revenue Impacts of the Planned East African Community Custom Union, African Region Working Paper Series No. 72. August 2004. Reform and Opportunity: The Changing Role and Patterns of Trade in South Africa and SADC, Africa Working Paper Series No. 14. Free Trade Agreements and the SADC Economies, Africa Region Working Paper Series No. 27, February 2002. Risks and Rewards of Regional Trading Arrangements in Africa: Economic Partnership Agreements (EPAs) Between the EU and SSA, Draft dated June 15, 2005. Caribbean Towards a New Agenda for Growth: Organization of Eastern Caribbean States, prepared by Caribbean Country Management Unit. World Bank: Washington DC. A Time to Choose: Caribbean Development in the 21st. Century, prepared by Caribbean Country Management Unit. World Bank: Washington DC. East Asia and Pacific Should East Asia Go Regional: No, No, and Maybe, Policy Research Working Paper No. 1209, 1993. East Asia: Recovery and Beyond, Prepared by the East Asia and Pacific Region of the World Bank, 2000. East Asia Integrates: A Trade Policy Agenda for Shared Growth, East Asia and Pacific Region, 2003.

Europe and Central Asia World Bank Framework for Development of Regional Energy Trade in South East Europe, Energy and Mining Sector Board Discussion Paper No. 12, March 2004. Trade and Transport Facilitation in the South Caucasus, 2003 Trade Performance and Regional Integration in the CIS Countries, Staff Working Paper No. 38, 2004. Comparative Advantage in International Trade for Central Asia, 2005. Latin America From Natural Resources to the Knowledge Economy, 2002. Lessons from NAFTA for Latin America and the Caribbean Countries, 2003. DR- CAFTA: Challenges and Opportunities for Central America, 2005. Middle East and North Africa Maghreb Transport and Trade Facilitation Study, Report No. 13908-MNA prepared by the Middle East and North Africa Regional Project, 1995. Trade, Investment and Development in the Middle East and North Africa: Engaging With the World, Prepared by the Middle East and North Africa Region (2003). Trade and Investment Integration of the Maghreb, 2005. South Asia Trade Policies in South Asia: An Overview, Prepared by the Poverty Reduction and Economic Management Unit, South Asia Region, 2004. Preferential Trading in South Asia, 2004.

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Annex B. References Bhagwati, J. and A. Panagariya. 1996. Preferential Trading Areas: Strangers, Friends or

Foes? in J. Bhagwati and A. Panagariya (eds.), The Economics of Preferential Trading Agreements, AEI Press: Washington DC.

Bayoumi, T. and B. Eichengreen. 1997. Is Regionalism Simply a Diversion? Evidence from

the Evolution of the EC and EFTA, in T. Ito and A. Krueger (eds.), Regionalism versus Multilateral Trade Agreements, NBER-East Asia Seminar on Economics, Vol. 6, University of Chicago Press.

FAO. 2004. The State of Agricultural Commodity Markets, FAO: Rome. Finger, J. and P. Schuler 1999. Implementation of Uruguay Round Commitments: The

Development Perspective, Policy Research Working Paper No. 2215, World Bank: Washington DC.

Finger, J. and J. Nogués 2002. The Unbalanced Uruguay Round Outcome: The New Areas

in Future WTO Negotiations, in The World Economy, March. Finger, J. and P. Schuler 2004. Poor People's Knowledge: Promoting Intellectual Property

in Developing Countries, World Bank and Oxford University Press. Goto, J. 1996. Regional Integration and Agricultural Trade, Policy Research Working

Paper No. 1805, The World Bank: Washington DC. Hoekman, B. and K. Maskus. 2004. The WTO, Intellectual Property Rights and the

Knowledge Economy, Edward Elgar ltd. Maskus, K. 2000. Intellectual Property Rights in the Global Economy, Institute for

International Economics: Washington DC. _______. (2004). Protecting Industrial Inventions, Author's Rights and Traditional

Knowledge, chapter 6 in East Asia Integrates: A Trade Policy Agenda for Shared Growth, The World Bank: Washington DC.

Mattoo, A., R. Rathindran and A. Subramanian (2001), Measuring Services Trade

Liberalization and its Impact on Economic Growth: An Illustration, Policy Research Working Paper No. 2655, World Bank: Washington DC.

Mattoo, A. 2006. Services in a Development Round: Proposals for Overcoming Inertia, in

Newfarmer (ed.). Newfarmer, R. ed. 2006. Trade, Doha, and Development: A Window into the Issues, The

World Bank: Washington DC.

Nogués, J. 2004. Agricultural Exporters in a Protectionist World: Review and Policy Implications of Barriers Against Mercosur, INTAL-ITD Working Paper No. 16, Inter-American Development Bank: Washington DC.

Panagariya, A. 1993. Should East Asia Go Regional? No, No, and Maybe, Policy Research

Working Paper No. 1209, World Bank: Washington DC. Pangestu, M. and S. Gooptu. 2004. New Regionalism: Options for East Asia, chapter 3 in

East Asia Integrates: A Trade Policy Agenda for Shared Growth, The World Bank: Washington DC.

Roggoff, K. and C. Reinhardt. 2002. Foreign Direct Investment in Africa: The Role of

Price Stability and Currency Instability, in B. Pleskovic and N. Stern (eds.), Annual World Bank Conference on Development Economics: A New Reform Agenda, World Bank and Oxford University Press.

Schiff, M., and L.A. Winters. 2003. Regional Integration and Development, World Bank

and Oxford University Press. Viner, J. 1950. The Customs Union Issue, Carnegie Endowment for International Peace:

New York. World Bank. 2006. Global Economic Prospects, World Bank: Washington DC. __________. 2004. East Asia Integrates: A Trade Policy Agenda for Shared Growth, East

Asia and Pacific Region, World Bank: Washington DC. __________. 2003. Lessons from NAFTA for Latin America and the Caribbean Countries,

World Bank: Washington DC. __________. 2002. Global Economic Prospects and the Developing Countries, World

Bank: Washington DC. __________. 2000. East Asia: Recovery and Beyond, prepared by the East Asia and Pacific

Region of the World Bank: Washington DC. __________. 1993. The East Asian Miracle: Economic Growth and Public Policy, World

Bank: Washington DC.

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