World Trade Report 2011

The WTO and preferential trade agreements: From co-existence to coherence

9 789287 037640

World Trade Report

The ever-growing number of preferential trade agreements (PTAs) is a prominent feature of international trade. The World Trade Report 2011 describes the historical development of PTAs and the current landscape of agreements. It examines why PTAs are established, their economic effects, and the contents of the agreements themselves. Finally it considers the interaction between PTAs and the multilateral trading system.

Accumulated trade opening – at the multilateral, regional and unilateral level – has reduced the scope for offering preferential tariffs under PTAs. As a result, only a small fraction of global merchandise trade receives preferences and preferential tariffs are becoming less important in PTAs.

The report reveals that more and more PTAs are going beyond preferential tariffs, with numerous non-tariff areas of a regulatory nature being included in the agreements.

Global production networks may be prompting the emergence of these “deep” PTAs as good governance on a range of regulatory areas is far more important to these networks than further reductions in already low tariffs. Econometric evidence and case studies support this link between production networks and deep PTAs.

The report ends by examining the challenge that deep PTAs present to the multilateral trading system and proposes a number of options for increasing coherence between these agreements and the trading system regulated by the WTO.

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This report is also available inFrench and Spanish.

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© World Trade Organization 2011

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Cover bottom centre – Christian Lagereek – iStockphotoCover bottom right – René Mansi – iStockphoto

Cover image top right – Heather Sapey-Pertin

The World Trade Report is an annual publication that aims to deepen understanding about trends in trade, trade policy issues and the multilateral trading system.

The 2011 World Trade Report is split into two main parts. The first is a brief summary of the trade situation in 2010. The second part focuses on the special theme of preferential trade agreements.

Website: www.wto.orgGeneral enquiries: enquiries@wto.orgTel: +41 (0)22 739 51 11

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Contents

1

ContentsAcknowledgements and Disclaimer 2

Foreword by the Wto Director-General 3

executive summary 5

I World trade in 2010 18

II The WTO and preferential trade agreements: From co-existence to coherence 40 A Introduction 42

1. PerspectivesandinsightsintheWorldTradeReport2011 44

2. Structureofthereport 45

B Historical background and current trends 46

1. TheformationofPTAs:ahistoricalperspective 48

2. TheevolutionofPTAs:stylizedfacts 54

3. TradeflowsrelatedtoPTAs 63

4. Howpreferentialistrade? 72

5. Conclusions 85

C Causes and effects of PtAs: Is it all about preferences? 92

1. MotivesforPTAs 94

2. ThestandardeconomicsofPTAs 100

3. Goingbeyondthestandardanalysis 109

4. Conclusions 114

TechnicalAppendix:SystemiceffectsofPTAs 118

D Anatomy of preferential trade agreements 122

1. ArelowertariffsstillimportantforPTAs? 124

2. PatternsinthecontentofPTAs 128

3. ProductionnetworksanddeepPTAs 145

4. Africanregionalcooperation:lessonsfromdeepintegration? 151

5. Conclusions 153

Appendixtables 157

e the multilateral trading system and PtAs 164

1. Systemiceffectsofpreferentialtariffliberalization 166

2. DeepPTAprovisionsandthemultilateraltradingsystem 168

3. RegionalismandtheWTO:historicalperspective 182

4. TherelationshipbetweenPTAsandtheWTO 187

F Conclusions 196

statistical appendix 199

Bibliography 228

technical notes 239

Abbreviations and symbols 243

List of figures, tables, boxes and maps 245

Wto members 249

Previous World trade Reports 250

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acknowledgementsTheWorld Trade Report 2011waspreparedunderthegeneral direction of the Deputy Director-GeneralAlejandroJaraandsupervisedbyPatrickLow,DirectoroftheEconomicResearchandStatisticsDivision.Thewritingof thisyear’sreportwascoordinatedbyNadiaRocha and Robert Teh. The principal authors of theReport were Marc Bacchetta, Cosimo Beverelli, JohnHancock, Alexander Keck, Gaurav Nayyar, ColemanNee, Roberta Piermartini, Nadia Rocha, Martin Roy,Michele Ruta, Robert Teh and Alan Yanovich. Otherwritten contributions were provided by Marc Auboin,Manfred Elsig, Trudi Hartzenberg and Roy Santana.Special acknowledgment is owed to Richard Baldwinfor his many suggestions and contributions to thereport.TradestatisticsinformationwasprovidedbytheStatistics Group of the Economic Research andStatistics Division, coordinated by Hubert Escaith,Julia de Verteuil, Andreas Maurer and JurgenRichtering.AishahColauttiassistedinthepreparationof the graphical input and Paulette Planchette,assisted by Véronique Bernard, prepared thebibliography. Research assistance was provided byHans Baumgarten, Pavel Chakraborty, ClaudiaHofmann, Joelle Latina, Alen Mulabdic, AndreasLendle,andGianlucaOrefice.

Other Divisions in the WTO Secretariat providedvaluable comments on drafts at various stages of

preparation. The authors are particularly grateful toseveralindividualsintheLegalAffairsDivision(ValerieHughes, Gabrielle Marceau and Edna Robles), theTrade in Services Division (Rolf Adlung) and TradePolicies Review Division (Rohini Acharya, Jo-AnnCrawford, and Christelle Renard). The followingindividuals from outside the WTO Secretariat alsomade useful comments on earlier drafts: DaleAndrews,AnnCapling,ManfredElsig,GaryHufbauer,Lena Lindberg, Xuepeng Liu, Mark Manger, Jean-ChristopheMaur,AlessandroNicita,EmanuelOrnelas,Joost Pauwelyn, John Ravenhill, Robert Staiger, KatiSuominen, Tania Voon, Peter Williams, and JohnWhalley.

The production of the Report was managed byPaulette Planchette of the Economic Research andStatistics Division in close cooperation with AnthonyMartin,HeatherSapey-PertinandHelenSwainoftheInformation and External Relations Division. Thetranslators in the Languages, Documentation andInformationManagementDivisionworkedhardtomeettight deadlines. This year the WTO Secretariatlaunched a Webpage discussion on the topic of theWorld Trade Report 2011. The Webpage, whichattracted many stimulating contributions, wasmanaged by Joelle Latina, in collaboration withAnthonyMartin.

disclaimerThe World Trade Report and any opinions reflected therein are the sole responsibility of the WTOSecretariat.TheydonotpurporttoreflecttheopinionsorviewsofmembersoftheWTO.Themainauthorsof the Report also wish to exonerate those who have commented upon it from responsibility for anyoutstandingerrorsoromissions.

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Foreword by the WTO director-GeneralThisyear'sWorld Trade Reporttakesanin-depthfreshlook at preferential trade. The choice of this topicreflects two significant trends in international traderelations,bothofwhichcarryfar-reachingimplicationsfor themultilateral tradingsystem.Thefirstandmostreadily evident of these is the continuing growth andincreasing prominence of preferential tradeagreements (PTAs). In the last two decades, thenumberofPTAshasincreasedmorethanfour-fold,toaround 300 active agreements today. There is noreason to assume that PTAs will cease to grow innumberorthattheywillnotformpartofthelong-termtapestryof internationaltraderelations.Secondly, thecontent of PTAs continues to evolve and deepen,reflecting important changes in the world economy.This too raises vital questions about the focus andreach of the WTO, and the value assigned bygovernmentstoglobally-basedtraderelations.

TheperennialconcernabouttherelationshipbetweenthemultilateraltradingsystemandPTAshasprovokeddifferentreactionsamongcommentatorsandanalysts.Some would emphasize a clash of systems andinherent inconsistencies between discriminatory andnon-discriminatory approaches to trade relations.OtherswouldpointtothegrowingprominenceofPTAsasareflectionofthedemiseofmultilateralism.Othersstill would assert that regional and multilateralarrangements are in essence complementary andneed to be fashioned accordingly. None of theseperspectives can singly capture the complexity ofinternationaltraderelationsinaglobalizingworld.

Our report seeks to navigate a way through thesecomplexities in bringing new data and analyses tounderstandtheseissues.Itacknowledgesthemultiplemotivations for preferential approaches. At the sametime,thereportidentifiesimportantwaysinwhichthefocus of trade policy, particularly of the preferentialvariety,isbeingreshapedtoreflecttheconsequencesof past policies as well as changes in productionstructuresinternationally.

InearliertimesPTAsweremostlikelytobemotivatedby the desire to avoid relatively high most-favourednation (MFN) tariffs. The theory on free trade areasandcustomsunionsmirroredthisrealitybyplacingthenotions of trade creation and trade diversion centre-stage. At the same time, considerable attention hasbeen paid to the discriminatory effects of rules oforiginonthetradeofthirdparties.Morerecently,thiscontext has lost some of its relevance becauseunderlying realities have changed. As the reportdocuments, average tariffs have fallen markedly inrecent years, making tariff preferences a more minormotivation for entering into PTAs. Furthermore, itseems that where MFN tariffs remain high they arealsoexcludedfrompreferentialreductions,additionallyweakeningthismotivation.

As tariff preferenceshavediminished in importance,non-tariff measures havebecome relatively moresignificantasdeterminantsof market access and theconditions of competition.Non-tariffmeasurescomeinmanyshapes.Theymaybe designed to influencecompetitive conditions inmarkets,justliketariffs,orthey may focus on publicpolicy concerns such ashealth, safety, and theenvironment. These publicpolicyinterventionsalsohavetradeconsequencesandmaybemoreorlessdiscriminatoryintheireffects.

For the most part, it would seem that non-tariffmeasures of the public policy variety have remainedfocused on consumer welfare and not benefits toproducers. However, the fact that interventionsputatively designed to protect consumers may alsofavour producers can lead to concerns over hiddenprotectionandunwarrantedmarketsegmentation. InaworldwheretheWTOishavingdifficultyadvancinganupdated multilateral agenda, the risks of preference-based discrimination and market disintegration builtaroundregulatorydivergenceshouldnotbedisregarded.

An important additional element in the equation,stemming from the emergence of supply chainproduction as a prominent mode of twenty-first-centuryintegration,isthatnewregulatorymattersareincreasingly on PTA agendas. These include issuessuch as investment, competition policy, governmentprocurementandharmonizationormutual recognitionofproductandprocessstandards.Thereportanalysesthe content of a large number of PTAs in terms ofwhether they augment WTO provisions in particularpolicyareasandintroduceentirelynewissues.Bothofthese tendencies are identified in many PTAs,particularly those that have entered into force morerecently.Here,then,isanotherreasonwhyweneedtoremainattentivetopolicyfragmentation.Totheextentthat the desire for deeper integration under PTAs, inbothWTOandnon-WTOareasofregulation,isdrivenby the logic of vertically integrated internationalproduction structures, one is less likely to encounterdiscriminatory intent lurking behind regulatorycooperationinPTAs.Butweshouldbemindfulofthepossibility that even in the absence of intent, marketsegmentation and discriminatory outcomes could beanunavoidableconsequenceofthesearrangements.

The report pays explicit attention to the question ofwhatisneededinamultilateralcontexttoensurethat

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PTAsandtheWTOdonotsimplyrunonparalleltracks,offering plentiful opportunities for inconsistency andconflict. This focusexplains the subtitle of the report–“Fromco-existencetocoherence”.Whatthen,shouldtheWTObedoing? It hasoftenbeensaid that if theWTOmadeprogress inmultilateralnegotiations,bothon market access and rules, this would soften thelikelihood of clashes and inconsistencies with PTAs.Thisisundoubtedlyavalidpoint,buttheexperienceoftheDohaDevelopmentRoundduring the lastdecadehasraisedquestionsabout theabilityandwillingnessofgovernments toadvance themultilateralagenda. Ithas also raised the need to connect the multilateralandbilateral“brains”oftradepolicydriversandactors.We need a better record if we are to attain greatercoherence between the WTO and PTAs throughsuccessfulmultilateralnegotiations.

A second possibility is to continue the quest forgreaterlegalclarityanddetailintheWTOrulesaboutwhat is permissible under PTAs. Progress here couldblunt the likelihood of damaging discriminatoryoutcomes under PTAs, whether intentional orotherwise.Hereagain,however, yearsofeffort in theDoha Round and before to address multilateralprovisionsonPTAshaveyieldedlimitedresults.Itisforgovernments todeterminewhether theyneedgreaterlegal certainty in this domain. If they do, perhaps amorecircuitous route to theobjective isprecisely theone thatmembershave recentlyembarkedupon.Theprovisional establishment of the TransparencyMechanismforRegionalTradeAgreementsmaypavethewayfornon-litigiousdeliberationsthatcouldbuildconfidence and understanding among membersregardingthemotives,contentsandpolicyapproachesunderpinningregionalinitiatives,leadingovertimetoasharedvisionandreinforcedlegalprovisions.

Thirdly, to the extent that PTAs are motivated by adesire for deeper integration rather than marketsegmentation, there could be a role for the WTO topromotegreatercoherenceamongnon-competingbutdivergent regulatory regimes that in practice causegeographical fragmentation or raise trade costs. Thisagenda has been referred to as multilateralizingregionalism. In some cases the multilateralizationeffect occurs de facto because regulatory reformsundertaken in a PTA context are applied in a non-discriminatory manner. This MFN dividend could bebuiltupon inotherpolicyareas.The feasibilityof thisapproachwouldneedtoberesearchedfurther.

Whateverviewonetakesofpreciselyhowtopromoteaglobalorientationintraderelations,thereisnodoubtthat we need to build towards a more stable andhealthier tradingenvironment,wherealternative tradepolicyapproachesaremutuallysupportiveandbalanceequitablytheneedsofallnations.Itistothediscussionof this agenda that this year's World Trade Reportseeks to make a contribution. I hope members willhaveafirstopportunitytoconsidersomeoftheissuesin this report at the upcoming 8th WTO MinisterialConferenceinDecember2011.

Pascal LamyDirector-General

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executive summarySection a: Introduction

The report is divided into four main parts. The firstprovides an historical analysis of preferential tradeagreements (PTAs) and a description of the currentlandscape. It documents the large increase in PTAactivity in recentyears,breaking thisdownby region,levelofeconomicdevelopment,andtypeofintegrationagreement.ItprovidesapreciseestimateofhowmuchtradeinPTAsreceivespreferentialtreatment.

The second section discusses the causes andconsequences of PTAs, focusing on both economicand political factors. A distinction is made betweenshallowanddeep integration inorder tosuggest thattraditional theories do not fully explain the emergingpatternofPTAs.ThereportexaminesinparticulartheroleofinternationalproductionnetworksinpromptingthecreationofdeepPTAs.

The third section focuses on the policy content ofPTAs,withparticularreferencetothedepthandscopeofcommitmentscomparedwiththosecontainedintheWTO agreements. It supports the link betweenproduction networks and PTAs with both statisticalevidenceandcasestudies.

The final section identifies areas of synergies andpotential conflicts between PTAs and the multilateraltrading system and examines ways in which the two“tradesystems”canbemademorecoherent.

See page 42

Section B: Historical background and current trends

the formation of trading blocs: a historical perspective

Global trade relations have never been uniform or monolithic and regional trading arrangements have been around for centuries.

Regional trading arrangements have encompassedempires and colonial spheres of influence, bilateralcommercial treaties and, more recently, multilateralagreements. They have often overlapped andinteracted,creatingatradelandscapedefinedlessbyclear-cut choices between regionalism andmultilateralism – or discrimination and non-discrimination – than by the complex interplay, evencompetition,amongmultipletraderegimes.

Despitethiscomplexity,inmorerecenttimestradeco-operation has become broader and more inclusive.Defining landmarks in this trend have been theestablishment of the GATT in 1947 and the WTO in1995.At thesame time, trade relationshavebecomedeeper and more far-reaching, incorporating areassuchasservicestrade,foreigninvestment,intellectualproperty and regulatory regimes. These tendenciesareaclearreflectionofthegrowingintegrationoftheworld economy and the “internationalization” ofpoliciesthatwereonceconsidereddomestic. Insomecases,regionalagreementshaveprogressedfurtherinthis direction than the over-arching multilateralframework.

Progress has not been continuous, and there havebeenmajorset-backsandreversalsalongtheway.Theeconomicdepressionoftheearly1870s,forinstance,effectivelybroughttheexpansionofEurope'sbilateraltradetreatiestoanend,justasthe“GreatDepression”oftheearly1930shelpedfuelthespreadofdefensiveand increasingly hostile trade blocs in the inter-warperiod. Conversely, the push for a more open andinclusive trading order has been strongest duringperiods of economic expansion and internationalpeace.AmainjustificationforcreatingtheGATTinthepost-warperiodwasthewidelyheldbeliefthathostiletrade blocs had contributed directly to the economicchaos of the 1930s and the outbreak of the SecondWorldWar.

the establishment of the post-war multilateral trading system did not diminish the attraction of bilateral or regional approaches to trade arrangements and led instead to a period of creative interaction and sometimes tension between multilateralism and regionalism.

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The first wave of regionalism in the late 1950s and1960s was driven by Western Europe's push forcontinentalintegration,leadingtotheestablishmentofthe European Economic Community (EEC) in 1957and the European Free Trade Agreement (EFTA) in1960.Throughoutthisperiod,GATTtariffcuttingandmembership enlargement moved in tandem, first withtheDillonRound in1960-61and thenwith themuchmore ambitious Kennedy Round between 1964 and1967.

Subsequent waves of regionalism, from around themid-1980s onwards, reflected an increasing embraceofsucharrangementsintheAmericas,AsiaandAfrica,as well as in Europe. The continuing proliferation ofregionalagreementsoverthelast25years involvesawide network of participants – including bilateral,plurilateral and cross-regional initiatives – andencompassescountriesatdifferentlevelsofeconomicdevelopment – including “developed-developed”,“developing-developing”, and “developed-developing”alliances. These newest agreements also oftenaddress WTO+ type issues, suchas services, capitalflows, standards, intellectual property, regulatorysystems (many of which are non-discriminatory) andcommitmentsonlabourandenvironmentissues.

The Uruguay Round (1986-1994) coincided with aperiod of growing regionalism and several issues,including services and intellectual property, wereaddressed for the first time both regionally andmultilaterally. The continuing proliferation of PTAs inparallel with the Doha Round has provoked a debateabout coherence, compatibility and potential conflictbetweenmultilateralandregionalapproachestotradecooperation. Among the questions addressed in thisdebatearewhetherburgeoning regionalismsignals aweakeningofinternationalcommitmenttoopentrade,and foreshadows a return to a more fragmentedtrading system. Alternatively, PTAs may be part of abroad pattern seen since the Second World War –where some countries want to move “further andfaster” in trade rule-making than others, wherebilateralandregionalagreementscanhaveapositive,“domino effect”, encouraging the pace of multilateralcooperation (and vice versa), andwhere regional andmultilateral agreements are becoming coherent, notconflicting, approaches to managing a more complexandintegratedworldtradingorder.

stylized facts about PtAs

PtA participation has accelerated over time and become more widespread.

From the1950sonwards, thenumberofactivePTAsincreased more or less continuously to about 70 in1990.Thereafter,PTAactivityacceleratednoticeably.The number of PTAs in force in 2010 was close to300. The surge in PTA activity is driven both by agrowing number of countries taking an interest in

reciprocal trade opening and by an increase in thenumberofPTAspercountry.AllWTOmembers (withtheexceptionofMongolia)belongtoatleastonePTA.

PtA activity has transcended regional boundaries.

OnehalfofthePTAscurrentlyinforcearenotstrictly“regional”.Theadventofcross-regionalPTAshasbeenparticularlypronounced in the lastdecade.The trendtowardsabroadergeographicalscopeofPTAsisevenmore pronounced for those PTAs that are currentlyunder negotiation or have recently been signed (butarenotyet inforce).Practicallyalloftheseareofthecross-regionaltype.

PtAs have seen opposing trends towards further rationalization on the one hand and a sprawling web of new bilateral and overlapping deals on the other.

Numerous bilateral agreements have beenconsolidated into plurilateral agreements either viaaccessions or negotiations between existing PTAs.Examples include successive EU enlargements, theconsolidation of bilateral pacts between EasternEuropean countries in the context of the CentralEuropean Free Trade Agreement (CEFTA) and theconclusion of a PTA between Mercosur and theAndeanCommunity in theLatinAmerican IntegrationAssociation(LAIA)framework.

Atthesametime,aparalleltrendisdiscernibletowardsbilateral deals across regions. While many of thesebilateral arrangements are between developingcountries,developedcountrieshavealsoplayedapart.A consequence of this trend is an increasedfragmentation of trade relations, with countriesbelongingtomultiple,sometimesoverlappingPTAs.

Free trade agreements are far more prevalent than customs unions and a number of products continue to be excluded from preferential access.

Free trade agreements account for more than three-quarters of all PTAs in force. Although GATTArticle XXIV requires that import duties are to beeliminated on substantially all trade among themembers of customs unions and free trade areas,some products are often excluded. A recent study ofPTAs involving four major trading countries and theirpartnersshowsthatabout7percentof tariff lines inthe sample are excluded, either temporarily orpermanently.Theseproductsaremainlyagriculturalorfood items, and labour-intensive manufacturedproductssuchasfootwearandtextiles.

the coverage of PtAs in terms of policy areas has widened and deepened over time.

Notwithstanding the prevailing pattern of specificproductexclusionsfromtariffelimination,mostrecent

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PTAsgobeyondtraditionaltariff-cuttingexercisesandmay include such policy areas as services trade,investment, intellectual property, technical barriers totradeanddisputesettlement.Forinstance,aboutone-third of PTAs in force today contain servicescommitmentscomparedtolessthanatenthin1990.

stylized facts about trade flows related to PtAs

the value of world trade between members of preferential trade agreements has increased as the number of PtAs has expanded.

Intra-PTAtraderepresentedabout35percentoftotalworld merchandise trade in 2008, compared with 18per cent in 1990.1 Preferential trade – that is, tradeactually receiving preferential tariff treatment –represents a much smaller share of world trade.However,itisstillworthconsideringtotaltradeamongPTAmembersbecause the latestgenerationof tradeagreements may be motivated by a broader set ofconsiderationsthanjusttariffreductions,includingthedevelopmentandmaintenanceofsupplychains.

The share of manufactured goods in total intra-PTAexports is the same as the share of manufacturedgoodsinworldtrade(65percent),andthissharedoesnotvarymuchacrossPTAs.However, intra-PTAtradeinpartsandcomponentsdoesvarysignificantlyacrosstrade agreements, suggesting a link between somePTAsandverticallyintegratedproductionstructures.

Plurilateral trade agreements accounted for half ofglobal intra-PTA trade in 2008, while bilateral tradeagreements(includingthosewhereonepartyisaPTA)accountedfortheotherhalf.

If many recent PtAs were designed to support production networks, we might expect to see greater geographic concentration of trade over time, since many production networks are regional in nature. evidence of this exists only for certain regions.

The share of intra-regional trade in Europe's totalexports remained roughly constant at around 73 percent from 1990 to 2009. Asia's intra-regional tradeshare increased from 42 per cent to 52 per cent oftotalexportsduringthesameperiod.NorthAmerica’sintra-regional trade share rose from 41 per cent in1990 to 56 per cent in 2000, but then fell back to48percentin2009,sothereappearstobenoglobalpattern that applies to all industrialized regions.Developing regions that predominantly export naturalresourceshaveseen theshareof intra-regional tradeintheirtotalexportssharesrisesubstantiallyoverthepast20yearsorso,buttheyremainquitesmall.

The extent to which trade has become moregeographicallyconcentrateddiffersdependingonthe

typeofgoodsbeingtraded.Theshareofintra-regionaltrade in world exports of manufactured goods wasquite stable between 1990 and 2009, fluctuatingbetween56and59percent,but theshareforofficeand telecom equipment jumped from 41 per cent to58 per cent. Taken together, these results suggestthatsupplychainsmaybeanimportantcomponentofrecent PTA activity in Asia and in the electronicssector,butnotsomuch inother regionsoreconomicsectors.

How preferential is trade?

trade among PtA members is not all preferential on account of the fact that a significant portion of intra-PtA trade is mFn duty-free.

In a sample covering imports of the 20 largestimporters from all their trading partner countries –accountingfor90percentofworldmerchandisetradein 2008 – only 16 per cent qualified as preferentialtrade,assumingfullutilizationofpreferences.2Inotherwords,despite theexplosionofPTAs in recentyears,84 per cent of world merchandise trade still takesplace on a non-discriminatory most-favoured nation(MFN)basis.Thisisfirstlybecausehalfofworldtradeis already subject to zero MFN tariff rates. Secondly,PTAs tend to exempt high MFN-tariff items frompreferential treatment and continue to trade theseproductsatMFNrates.

Existing preferential tariffs reduce the global trade-weightedaverage tariffbyonepercentagepoint, and90 per cent of this reduction (i.e. 0.9 percentagepoints) is due to reciprocal preference regimes. Only2percentofglobalimportsareeligibleforpreferentialtariffs where preference margins are 10 per cent ormore. For most large exporters, preferential tariffsmatter little for the bulk of their exports. This is notalwaystruefor individualsectorsespecially incertainsmaller economies exporting a narrow set ofcommodities (mainly sugar, rice, bananas, fish andgarments), where preference margins may be moresubstantial. There is a possibility though that thesepreferenceswillbeerodedover timeasthecountriestowhichtheyexportenterintomorePTAs.

Data from some customs administrations suggest a high rate of preference utilization.

Information on the value of imports under differentpreferential regimes from the EU and US revealpreference utilization rates of 87 and 92 per centrespectively.Preferenceutilizationratesareuniformlyhighformostexportingcountries,preferentialregimesand types of products. Analysis shows that bothpreferencemarginsand importvalueshaveapositiveand statistically significant impact on preferenceutilization.Surprisingly,however,manyindividualitemsfacing tariffs below 1 per cent still exhibit highutilization rates. This might suggest either that the

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cost of using preferential tariffs in certain cases isnegligible or that other benefits are linked to usingthese preferences, perhaps related to privilegedcustoms clearance, qualification under specificsecuritymeasuresoradvantages incaseofre-exporttootherPTApartners.

Data from firm surveys offer a more detailed and mixed picture of preference utilization rates.

Firm surveys carried out in 2007-08 by the AsianDevelopment Bank (ADB) and the Inter-AmericanDevelopment Bank (IDB) in six East Asian countriesandfourLatinAmericancountries respectively revealthattheuseofPTApreferentialtariffsisnotuniformlyhigh. For instance, the ADB survey shows that onlyaround one-quarter of firms in the sample currentlyusedthesepreferences.However,thisnumberdoubledwhen plans for using PTA preferences in the futurewere factored in. The IDB survey shows that only20 per cent of the firms in the sample did not makeanyuseofPTApreferences.

Complications and costs involved in complying withrulesoforiginwerecitedasconsiderationsinfluencingpreference utilization, especially where preferencemargins were low. The surveys also cited other firm-specific factors that influenced preference utilization.For instance, larger, more experienced firms, withhigherforeignequityandmoreinformationaboutPTAprovisions,weremore likelytousepreferential tariffs.Firms inanumberofcountriessuggested thata lackof informationonPTAswasthemajorexplanationforthenon-useofthesepreferences.

See page 46

Section C: Causes and effects of pTas: is it all about preferences?

motives for PtAs

economic and political science theories provide various explanations for why countries establish preferential trade agreements.

Unilateral trade policy choices can have “beggar-thy-neighbour” consequences, such as unfavourablyaffectingtheratioofimporttoexportprices(terms-of-tradeeffect)oraproductionrelocationeffect.Countriesmight be stuck in a situation characterized by highrestrictionsandinefficientlylowlevelsoftrade.Atradeagreementcouldneutralizethesebeggar-thy-neighboureffects and achieve higher welfare. Economic theorysuggests,however,thatamultilateralagreementratherthanaPTAisthebestwaytoaddresstheproblem.

Gains in credibility suggest a second reason forsigning a PTA. A government may choose to “tie itshands”throughaninternationalagreementinordertoprevent future policy reversals that would beconvenient in theshort-run,but inefficient in the longterm.APTAmayprovideastrongercommitmentthana multilateral agreement when a country is small inworldmarkets.

"Non-traditional”reasonsforwhycountriesformPTAsinclude accessing a larger market, ensuring againstpreference erosion, increasing predictability of futuretrade policy, signalling stability to investors, andachievingdeeperpolicycommitments.

The creation of PTAs cannot be understood withouttaking account of political circumstances. Politicalscience explanations of PTA formation focus on therole of political integration, the role of domesticpolitical considerations, the formofgovernmentsandinstitutions,diplomacy,andtheroleofpowerrelations.

Changes in trade relationships may explain the growth of PtAs over time. together with certain country characteristics, they may also explain the timing of PtA formation and enlargement.

Thepotentiallossofmarketsharefornon-membersofanexistingPTAinducesthemtoformnewPTAsorjoinexistingones.ThesedominoeffectsofPTAformationcan be further strengthened with multilateral tradeopening.

Among the factorsaccounting for thepatternofPTAformationandenlargementover timearethephysicaldistance between countries, economic size, similarityineconomicsize,proximityofapotentialentranttoanexistingPTA,theextentofexistingagreementsfacingacountrypair,andtheexistingnumberofmembersinaPTA.

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the standard economics of PtAs

the standard theory on the effects of PtAs suggests that preferential trade agreements increase trade between member countries and reduce trade with third-countries, leading to negative welfare effects for non-members of PtAs.

APTA increases tradeamongmembersasexportersbenefit from the elimination of tariffs in partnermarkets. Non-member countries suffer from areduction of exports to member countries and adecline in the price of their exports in internationalmarkets.

In the traditional Vinerian analysis, preferential tradeopening allows some domestic production to bereplacedby imports frommoreefficientfirms locatedin preference-receiving countries, leading to welfaregains (trade creation). At the same time PTAs mayreduce imports from more efficient non-membercountries,implyingawelfareloss(tradediversion).Thenet welfare effect of PTAs depends on the relativemagnitudeoftheseopposingeffects.

supply chain or vertical production arrangements may change the welfare calculus.

The possibility of trading components used in theproductionoffinalgoodsaltersthecalculationoftradecreationandtradediversion.Althoughtheoutcomeisstill uncertain, welfare-reducing PTAs trading only infinal goods could become welfare-improving oncemembers trade in parts and components along asupply chain. In this way, international productionnetworks can mitigate the trade diversion effects ofPTAs,althoughthisisbynomeansguaranteed.

the trade effects of a preferential agreement depend on the economic characteristics of PtA members.

The “natural trading partners” hypothesis suggeststhat trade agreements among countries which tradeintensively are more likely to be trade-creating.Preferentialtradeagreementsmayalsohavedynamiceffects,forinstancedrivenbyeconomiesofscale,andeffectsonthelocationofproduction.

Severalstudieshavetestedthetraditionaltheoriesontradecreationandtradediversion.Whilethisliteratureisnotconclusive, itsuggeststhattradediversionmayplaya role in someagreementsand in somesectors,but itdoesnotemergeasakeyeffectofpreferentialagreements.

When governments have political economy reasons for signing a PtA, the question arises whether trade-diverting or trade-creating agreements are more politically viable and

whether a PtA reduces or increases the incentive to set inefficiently high external tariffs.

In shaping their PTAs, governments may not beinfluenced exclusively by the welfare implications ofagreements.Iforganizedlobbygroupscarrysufficientweight in the political preferences of governments,trade-divertingPTAscouldbepoliticallyviableinsomecircumstances.

Moreover,conflictingpoliticaleconomyforcesmayactupon external tariffs agreed in a PTA. On the onehand, PTAs destroy protectionist benefits and lowerthe demand for high external tariffs. On the otherhand, high external tariffs can be used in PTAs tosustaincooperationonnon-tradeissues.Theempiricalliteraturefindsevidenceofbotheffects.

Restrictive rules of origin (Roos) in PtAs may divert or suppress trade in intermediate goods.

RestrictiveRoOsmaymake itprofitable forfirms inacountrytoengagein“supplyswitching”–replacinganefficientnon-membersupplierofanintermediategoodwithalessefficientone,eitherfromapartnercountry(tradediversion)oradomesticfirm(tradecontractionor suppression). Furthermore, by influencing thesourcing of intermediate goods, RoOs are likely toincreasefirms'costsandhencehaveanadverseeffectonfinalgoodstrade.

This discrimination, which leads to trade diversion byprotecting the exports of certain industries in PTAmember countries, can be resolved through the“diagonal cumulation” of RoOs. Under thisarrangement, participating countries agree that in allPTAs concluded among themselves, materialsoriginating in one country can be considered to bematerialsoriginatinginanyoftheothercountries.

Going beyond the standard analysis

the concept of deep integration is widely used to refer to any arrangement that goes beyond a simple free trade area.

Trade agreements that mostly deal with bordermeasuresareoftendefinedas “shallow”agreements.Incontrast,preferentialagreementsthatincluderuleson other domestic policies are referred to as “deep”agreements.

Two distinct dimensions of deep integration are the“extensive” and the “intensive” margin. The extensivemargin refers to an increase in the policy areascovered by an agreement, while the intensive marginreferstotheinstitutionaldepthoftheagreement.Theextensive and intensive dimensions of deepagreements may be related, as an extension of thecoverageofanagreementmayrequirethecreationofcommoninstitutionsforitsproperfunctioning.

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Deep integration and trade are intimately related.

Deep arrangements may be necessary to promotetradeincertainsectorsandeconomicintegrationmorebroadly. For instance, harmonization or mutualrecognition of certain regulations may be a pre-requisite for trade in services, or competition policyrulesmayberequiredtoallowcomparativeadvantagetomaterialize.

Economic theory also suggests that the degree oftradeopennessisadeterminantofdeepagreements.In this respect, shallow and deep integration may beseen as complementary where the first generates ademandforgovernancethatthesecondcanprovide.

An institutional challenge for the WTO is to find anapproachthatfacilitatesdeeper integrationsoughtbyits members while maintaining compatibility with thenon-discriminationprinciple.

the rise in international production networks illustrates the complementarity between trade and governance which is at the core of successful deep agreements.

In order for cross-border production networks tooperatesmoothly,certainnationalpoliciesneedtobeharmonized or rendered mutually compatible tofacilitate business activities in several countries. Thisgeneratesademandfordeepformsofintegration.

Developed countries were the first movers in theattempt toprovidesome international rules to furtherencourage international fragmentation of production.AgreementssuchastheEUSingleMarketProgrammeortheUS-Canadafreetradeareacanbeexplained(atleast in part) in terms of increased demand for deepintegration generated by the needs of internationalproductionsharingarrangements.

The continuous expansion of production sharingbetweendevelopedanddevelopingcountriesrequiresdeeperagreementstofillthegovernancegapbetweencountries.AnagreementsuchastheNorthAmericanFree Trade Agreement, for example, includesdisciplines going beyond preferential tariffs that arerequired to facilitate production sharing between theUnited States and Mexico. In Europe the Euro-Mediterraneanagreementsfulfilthesameobjective.

The recent wave of preferential agreements may (atleast in part) be an institutional response to newcircumstancescreatedby thegrowth inoffshoring. Inthissense,PTAsareefficiency-enhancingratherthanbeggar-thy-neighbour(trade-diverting)agreements.

Deep integration may involve several trade-offs that need to be addressed.

A basic trade-off arises between the benefits ofcommonpoliciesandthecostsofharmonizationwhenpolicypreferencesdifferamongmembercountries.

Deep integration lowers trade costs and providesshared benefits, such as common rules and a stablemonetary system, that the market or nationalgovernmentsfailtooffer.However,nounifyinganalysisispossibleoftheeconomiceffectsofdeepintegration,as these effects depend on the specific form thatarrangementstake.

Deepintegrationwithadvancedeconomiesmaycreateadvantages for developing countries from importingbest-practice institutions. However, costs may beinvolvedifthecommonrulesaredistantfromnationalpreferencesandtheneedsofdevelopingcountries.

Deep integration also has systemic effects. Deepagreements may impose costs on non-membercountries.Ontheotherhand,deepregionalintegrationcould provide an appropriate intermediate level ofintegration(e.g.commonrules)betweennationstatesand the global level in different behind-the-borderareas.

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Section d: anatomy of preferential trade agreements

Preferential tariffs and PtAs

Preference margins are small and market access is unlikely in many cases to be an important reason for creating new PtAs.

The estimated average applied tariff across allproducts and countries was 4 per cent in 2009, andthescopeforexchangingpreferentialmarketaccessisthereforelimited.Significanttariffbarriersstillexistinsomesectors,however,suchasagricultureandlabour-intensivemanufacturedgoods.However,PTAsdonotappear tobeabout theremovalof tariffpeakseither.Most sensitive sectors remain sensitive (subject tohigher tariffs) in PTAs. Approximately 66 per cent oftarifflineswithMFNratesabove15percentagepointshavenotbeenreducedinPTAs.

Whentheadvantageconferredbyprovidingpreferentialaccesstoanexporter iscalculatedwithrespecttotheaverageappliedtarifffacedbyallexporterstothesamemarketratherthanrelativetotheMFNrate,theshareofglobal trade for which preferential market accessmattersislessthan13percent.

Patterns in the content of PtAs

PtAs cover many more policy areas than tariffs and frequently entail legally enforceable commitments.

In a sample of almost 100 PTAs, deep integrationelementswereclassifiedintoWTO+areasandWTO-Xareas. WTO+ refers to deeper integration in areascoveredbytheWTOandWTO-XreferstopolicyareasnotcoveredinWTOagreements.Theanalysisconfirmsthat many PTAs go beyond the WTO and these deepintegrationprovisionsarefrequentlyenforceablelegally.

As expected, WTO+ provisions universally includeindustrial and agricultural tariffs. An increasingly largenumberofPTAsnowalsoincludeprovisionsontechnicalbarriers to trade, services, intellectual property andtrade-related investment measures. WTO-X provisionscommonly include competition policy, investment andthemovementofcapital.Aboutone-thirdofthePTAsinthe sample also include environmental laws, labourmarketregulationsandmeasuresonvisaandasylum.

Compared with PTAs between trading partners withsimilarlevelsofincome,thosebetweendevelopedanddeveloping countries contain a higher number ofWTO+ provisions on average. WTO-X provisions areencountered most frequently in agreements betweendeveloped countries, followed by those betweendevelopedanddevelopingcountries,andfinally thosebetweendevelopingcountries.

overall, services commitments in PtAs have gone well beyond commitments in the General Agreement on trade in services (GAts) as well as Doha Round offers in services.

Services obligations typically form part ofcomprehensivePTAscovering“newgeneration”issuessuch as investment, intellectual property, ore-commerce.Outof85notificationsunderArticleVoftheGATS,3a littlemore thana third relyonaGATS-typelistingofareaswherespecificcommitmentsapply(positive list), almost half rely on the morecomprehensive approach of indicating where specificcommitments do not apply (negative list) and theremainderadoptamixtureofthetwoapproaches.

Despite innovations in their structure, most servicesPTAs share a broad commonality with the GATS interms of the basic set of disciplines, although somePTAs have gone beyond GATS with respect todisciplinesondomesticregulationortransparency,forexample.

the investment chapters in PtAs contain many provisions and guarantees that are important to international production networks.

Since firm-specific assets such as human capital(management or technical experts) and intellectualproperty(patents,blueprints)giveinternationalfirmsacompetitive edge, protecting these assets againstexpropriationwillencouragemoreproductionsharing.Allowing freer movement of corporate personnel isanother critical requirement. Investor confidence willbe further improved through access to a disputesettlementmechanism.

FromthesampleofinvestmentchaptersinPTAsusedfor this report, it appears that a large proportion ofagreementshaveadoptedanegativelistandhenceamoreambitiousapproachtoinvestmentopening.TheytypicallyextendMFNandnationaltreatmenttoforeigninvestors, provide guarantees of investor protectionand grant private investors the right to disputesettlement. In general, the investment provisions inthesePTAsareaccommodating,althoughnoattempthas been made to test how much these provisionsactuallyaffectflowsofforeigndirectinvestment.Morerecent PTAs appear more open on the investmentfrontthanearlierones.

As tariff barriers have progressively been reduced, non-tariff barriers have acquired increasing weight. over time, more and more PtAs have included provisions regarding technical barriers to trade (tBts).

TheinclusionofspecificprovisionsinPTAsappearstofollowahubandspokestructure,withalargerpartnerrepresenting the hub to whose standards the spokeswill conform. For example, while the agreements

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signed by the EU typically include harmonizationprovisions, North American agreements that embodyTBT provisions tend to prefer mutual recognition. Inaddition, North American, East Asian and South-CentralAmericanTBTprovisionsinPTAsmainlyfocuson introducing transparency requirements anddeveloping institutional bodies, while EU and Africanagreementsbarelyconsidertheseissues.

the risk of a lock-in effect exists in regional provisions on tBts.

Harmonizationtoaregionalstandardmayincreasethecostsforfurthermultilateralliberalization.Ifadoptingacertainstandardinvolvesthepaymentofsomeformoffixedcosts,theriskexiststhatregionalprovisionsmayworkasastumblingblockinmultilateralcooperation.

Competition policy complements the reduction of trade barriers.

TheadoptionofcompetitionpolicyinPTAsisinmanywaysanatural complement to the reductionof trade,investment and services barriers. In evaluatingcompetitionrulesinPTAs,oneneedstogobeyondthecompetition policy chapter of PTAs to includecompetition-related provisions that appear in otherchaptersoftradeagreements.Competitiondisciplinesappear in the chapters on investment, services (intelecommunications, maritime transport and financialservices), government procurement and intellectualproperty.

Sector-specific competition provisions may havestronger pro-competitive effects than the articles inthecompetitionpolicychapteritself,assumingthatthetrade agreement has one. Principles in PTAs relatingto non-discrimination, procedural fairness andtransparency can also have a strong bearing oncompetitionlawandpolicy.

many elements of competition rules in PtAs are characterized by non-discrimination.

Competition disciplines usually operate through theuseofdomesticregulations.Whileitisnotimpossiblefor these regulations to be tailored to favourenterprises originating from PTA partners, it may becostly to do so. To the extent that enforcement ofcompetitionlawreducesthemarketpowerofdomesticincumbents, theprospectsof foreignenterprises thatalreadyoperateinthemarketareimproved,whetherornottheyarefromaPTAmember.

Competition provisions in regional agreements maycarry other external benefits, such as economies ofscale from the creation of a regional competitionauthority. Even if no centralized authority isestablished,benefitscanflowfrominformationsharingand cooperation among enforcement authorities.Demonstration effects may also apply when a

competitionauthorityinonePTAmembertakesactionagainstanti-competitivebehaviour.

Production networks and deep PtAs

empirical analysis confirms the positive association between deep integration and production networks.

Lackofdataposessomedifficulties inassessingtheinternational fragmentation of production, forcingempirical studies to rely on proxy measures forproductionnetworks.Thisanalysisusestradeinpartsandcomponentstoproxyforglobalproductionsharing.

Results show that greater trade in parts andcomponents increases the depth of newly signedagreementsamongPTAmembers.PTAsalsoincreasetradeinpartsandcomponentsby35percentamongmembers. In addition, the greater the depth of anagreement, the bigger the increase in trade in partsand components among member countries. Theestimationresultsshowthatonaverage,signingdeepagreements increases trade in production networksbetween member countries by almost 8 percentagepoints.

the case of AseAn: from regionalization to regionalism.

ASEAN was established in 1967 largely to deal withrisingterritorial tensionsamongsomeof itsmembers(the original signatories were Indonesia, Malaysia,Philippines,SingaporeandThailand)andwithpossiblespilloversfromtheconflictinIndochina.Inthequarterof a century that spanned the creation of theassociationand thedecision formally toestablish theASEAN free trade area (AFTA), there was a shift ineconomicpolicyfromtraditionalimportsubstitutiontoexport promotion and openness to foreign directinvestment.

This led to a huge increase in total merchandiseexports of the five original members. In particular,exportsofpartsandcomponentsbecameincreasinglyimportant, rising from just about 2 per cent of totalexports in the year of the association's founding to17percentbythetimethefreetradeagreementwassigned. Equally telling was the increased prominenceofpartsandcomponentstradeinintra-regionaltrade.

While the increased regionalization of trade in partsandcomponentstradeinASEANwouldnothavebeenpossiblewithoutthecountries'opennesstotradeandforeigninvestment,itmaynothavebeensufficientforproductionnetworks tocontinue toflourish.Thismayexplain AFTA's evolution beyond a free trade area.Services and intellectual property agreements weresignedin1995,aninvestmentagreementanddisputesettlement mechanism in 1996, and a frameworkagreement for mutual recognition arrangements in

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1998.RecentstudiesdocumenthowAFTAsucceededinreducingtradecosts,not throughpreferential tariffliberalization but through concerted trade facilitationinitiatives,andhowthiswasmotivatedbyparticipationininternationalproductionnetworks.

Production networks may explain some PtAs in Latin America too: the case of Costa Rica.

As a result of its policies of trade and investmentopening, Costa Rica has experienced a significantchangeinitstradestructure,withasubstantialriseintheshareofmanufacturingexportsaswellastradeinservices in total exports. Over the last decade, thecountry has become more integrated with globalproduction networks in such sectors as electronics,medical devices, automotive, aeronautic/aerospace,andfilm/broadcastingdevices.

The link between production networks and PTAsseems apparent in Costa Rica's agreements with theUnited States (US-CAFTA-DR agreement) and withChina.WhileoveralltradewiththeUnitedStatesgrewby about 11 per cent annually from 1995, parts andcomponentstradegrewatabouttwicethatrate.Morethan25percentofCostaRica'stotalgoodsexportsin2009weredirectly related toproductionnetworks inelectronics,withChinabeingthemaintradingpartner.Overall, trade in parts and components makes upabouthalfofCostaRica'scurrenttradewithChina.

not all integration experiences conform to this pattern: the case of Africa.

The roots of African integration lay in the effort tocorrectthegeographicalfragmentationbequeathedbycolonialism. Fragmentation resulted in small markets,land-locked economies, and limited developmentoptions. In the 1980s, the Lagos Plan of Actionproposed the division of the continent into regionalintegration areas that would eventually constitute aunitedAfricaneconomy.

For themostpart,African integrationhasfocusedonimport tariffs. The inclusion of services and otherbehind-the-border issues, such as investment,competition policy and government procurement, hasproved contentious. A major limitation to Africanintegration progress has been its adherence to a“linear” integration model. This process is marked bythe stepwise integration of goods, labour and capitalmarkets, and eventually monetary and fiscalintegration.

Deep integration could improve Africa's record on regional cooperation.

Border measures are likely to represent a minorconstraint to regional trade in Africa compared withstructural economic shortcomings, such as a lack ofinfrastructure, an institutional framework, skills, and

economic diversification. Enhanced market accesswithoutthecapacitytoproducegoodsandservicestobenefit from those opportunities will fail to producehigher economic growth. At a regional level thesesupply-sideconstraintscouldbeaddressed inpartbya regional integration agenda that includes services,investment, competition policy and other behind-the-border issues. In short, a deep integration agendacouldaddresssupply-sideconstraintsmoreeffectivelythan an agenda that focuses almost exclusively onbordermeasures.

See page 122

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Section e: The multilateral trading system and pTas

systemic effects of preferential tariff liberalization

A number of different mechanisms have been identified through which PtAs could foster or hinder multilateral trade opening.

Theprospectofpreferenceerosioncanbeaforceforsupporting further multilateral tariff reduction or forresisting it. The presence of political-economymotivations behind tariff reductions is another factorthat can either foster or slow down the diminution ofpreferential tariffs through trade-openingonanMFNbasis.

Opposition to further multilateral tariff reductionsmightalsoariseinthecaseofPTAsthatareconcludedto foster mutual cooperation on non-trade issues, orwhenPTAs increasetheadjustmentcostsassociatedwith multilateral opening, or when the PTA is trade-creatingfromtheperspectiveofexcludedcountries.

evidence on the systemic effects of regionalism on multilateral tariff reductions is inconclusive.

The literature that considers whether MFN andpreferential tariffscomplementorcompetewitheachother finds opposite results for developing anddevelopedcountries.Mostof thecontributions to thisliterature, however, do not distinguish between MFNtariffs that have been negotiated at the multilaterallevelandunilateraltariffreductions.

ExaminationofthecorrelationbetweenPTAformationandmultilateralismcannotproduceconclusive resultsbecause multilateral trade rounds are rare events,wheremoreorlessambitioustradeopeningscenariosarenegotiated.Multilateral tradenegotiationsarenotstructured to contemplate either full or zero tradeopening.Anecdotalevidencecanbefoundtosupporttheview thatPTAs facilitate furthermultilateral tradeopeningandtheoppositeviewthattheyhinderit.

Deep PtA provisions and the multilateral trading system

so far not much research has been conducted on the systemic effects of deep-integration provisions. the existing literature suggests that deep integration is often non-discriminatory.

Bytheirverynature,somedeepintegrationprovisionsarede facto extended tonon-membersbecause theyare embedded in broader regulatory frameworks thatapplytoalltradingpartners.Insuchcases,multilateralregulation may not be necessary. PTAs may also

directly refer to WTO rules on deep integrationmeasures, automatically supporting the multilateraltradingsystem.

Severalmechanismssupportingfurthertradeopeningare found in PTAs. These include “non-party” MFNclauses, a tendency to use template approaches thatreplicate trade rules, and domino effects pointing inthe direction of the progressive extension ofpreferentialmarketaccess.

Production chains can alter political-economy forces in favour of the adoption of trade measures that comply with the principle of non-discrimination.

Final good producers sourcing their imports throughinternational value chains are likely to support theharmonization of rules of origin across PTAs, forinstancethroughtheadoptionofrulesofcumulation.

The international fragmentation of production mayalsobeadriverofdeepintegrationprovisionsthatareconsistentwiththeprinciplesofthemultilateraltradingsystem, such as international standards andmultilateralrulesontraderemedies.

some deep provisions in PtAs can, however, contain discriminatory aspects, creating a tension with the multilateral trading system.

Theriskof tradediversionmayextendbeyondtariffs,forexampletotheareaofanti-dumping.Anti-dumpingprovisionsinPTAsmayresultinmembersbeingsparedfromanti-dumpingactionsandanincreasedfrequencyof anti-dumping actions against non-members.Moreover, many PTAs exclude the imports of PTApartnersfromglobalsafeguardactions.

Lock-in effects of regulatory harmonization within a given PtA may have negative systemic effects.

Competing PTAs with incompatible regulatorystructures and standards may lock in members to aparticular regime, undermining the principles oftransparency and predictability of regulatory regimesand making movement towards multilateral tradeopeningcostly.

the non-discriminatory nature of deep provisions might in principle create political-economy and third-country resistance to further multilateral opening.

If preferential liberalization is non-discriminatory innature, it might be opposed by political-economyforces because higher market shares (and profits) intheothermember’smarketmightbemorethanoffsetby the loss of domestic profits vis-à-vis firms frompartnersandnon-members.

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Concerns over overlapping jurisdiction between the Wto dispute settlement system and the dispute settlement mechanisms of PtAs have received considerable attention in the academic literature.

The possibility that dispute settlement procedures inmore than one forum can give rise to conflictingjudgementshasbeendiscussedasapotentialsourceofconcern.TheissuehasbeenraisedonlyinahandfulofWTOdisputes.Areviewof thedisputesbrought tothe WTO reveals that members continue to use theWTO dispute settlement system to resolvedisagreementswiththeirPTApartners.

seeking coherence between PtAs and the Wto

GAtt/Wto provisions provide exemptions under certain circumstances from the mFn principle for PtAs.

Surveysoftheapplicationoftheseprovisionssuggesta relatively tolerant attitude towards PTAs. Theprovisions themselves are widely regarded asincomplete and lacking in clarity. Recently, attentionhasfocusedon improvingtransparencyandtheDohaRound negotiations have resulted in the introductionon a provisional basis of a new transparencymechanism.

The fact that the Transparency Mechanism forRegional Trade Agreements is the only result of theDohanegotiationsthathasbeenallowedsofar togoforwardindependentlyofthefullresultsoftheRoundsuggeststhatWTOmembersareawareoftheneedtobetterunderstandwhatregionaltradeagreementsareabout.

the quest for coherence between regionalism and multilateralism is nothing new.

Until recently, ensuring coherence was broadlyunderstoodasacceptingthatPTAsandthemultilateralsystem could complement each other while imposingdisciplines aimed at minimizing the negative effectsthat PTAs could have. Approaches to improvingcoherencefocusedontheweaknessesofmultilateraldisciplinesandhowtheycouldbefixed.

RecentdevelopmentsinPTAactivitymaywellchangethe perspective on coherence. Beyond the fact thatPTA activity has accelerated noticeably since 1990,what may challenge the current thinking is that thenewPTAs, or at least someof them, are qualitativelydifferentfromtheoldones.

Some of the new PTAs focus more on reducingbehind-the-border barriers than on extendingpreferentialtariffs.Giventhatpreferentialagreements

involvingsuchmeasuresdonot typically induce tradediversion, their systemic implications cannot beanalysed using the traditional stumbling blocks/building blocks framework. Moreover, the politicaleconomy of new PTAs is different from that ofpreferentialtariffs.

new international trade rules are being developed outside the Wto, with attendant risks of exclusion and additional trade costs arising from overlapping and possibly competing regulatory structures.

Whether and how these new challenges might beaddressed is an open question. The principle ofsubsidiarity, which states that regulatory regimesshouldbeasdecentralizedaspossible,couldbeusedtoassesswhethermeasuresagreedatthebilateralorregionallevelneedtobeincorporatedinamultilateralsetting.

A number of different approaches have been proposed for improving coherence between PtAs and the multilateral trading system.

Theremaybeacaseformaintainingseparateregimesfor regional and multilateral cooperation whereparticulartypesofcooperationaremoreappropriatelymanaged at the regional rather than the multilaterallevel.Bythesametoken,thereareissuesthatcannotbe addressed adequately at the regional level. Inbetweenthesetwoextremes,thecoherencequestionarises.

Proposals can be grouped under four headings:accelerating multilateral trade opening; fixing thedeficiencies in the WTO legal framework; adopting asofterapproachasacomplementtotheexistinglegalframework; multilateralizing regionalism (extendingexisting preferential arrangements in a non-discriminatory manner to additional parties). Theseapproachesarenotmutuallyexclusive.TheyallaimatmakingsurethatPTAscontributetotradecooperationandopeninginanon-discriminatorymanner.

LoweringMFNtariffswouldreducediscriminationandthereby blunt the adverse effects of PTAs. However,reducing all tariffs to zero does not seem to bepolitically feasible in thepresentcontextand itwouldnoteliminateallpotentiallyadverseeffectsofdeeperintegration measures. Moreover, the scope for far-reaching action in this domain is limited by the lowaveragelevelofexistingpreferentialtariffs.

TheDohaRoundincludesamandatetonegotiatewitha view to “clarifying and improving disciplines andprocedures under the existing WTO provisionsapplying to regional trade agreements”. Whilenegotiationsontheproceduralissueshaveresultedinthe adoption on a provisional basis of the newtransparency mechanism for regional trade

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agreements,negotiationsonruleshavenotadvanced.These difficulties conform to a long-standing patternoflimitedprogress.

Therationaleforusinga“softlaw”approachwouldbeto allow WTO members to better understand theirrespective priorities and interests, with a vieweventually to unblocking progress towards legalinterpretations of particular provisions that wouldensure coherence.However, the soft lawapproach isnotwithoutriskassoftlawandhardlawcouldbecomeantagonistictooneanotheriftheunderlyingconditionsforcooperationareabsent.

As a result of global production sharing, new forcesfavourabletothemultilateralizationofregionalismmayhave emerged. The extent to which deep integrationmeasures inPTAshave thepotential togenerate thesame sort of costly spaghetti/noodle bowl aspreferentialtariffsisstillamatterfordebate,buttheremaybearolefortheWTOtoreducethesetransactioncosts.

See page 164

Conclusions

An over-arching conclusion of this report is thatregional and multilateral approaches to tradecooperationneednotbeincompatible,butneithercanthey be seen simply as arrangements that serve thesamepurposeorsatisfy thesameneeds.Support foran increasingly outward-looking and inclusive globaltradingorderhasbeenstrong in theperiodsince theendof theSecondWorldWar,and thisgrowingtrendtowards openness has manifested itself throughunilateral, bilateral, regional and multilateralapproaches.

The spread of deep PTAs and the weightier role ofnon-tariff commitments have important implicationsfor how to evaluate the role of PTAs and how theyinteractwiththemultilateraltradingsystem.Thesheernumber of PTAs and continuing momentum towardsestablishingmoreof themsuggest that theyarehereto stay. They respond to a range of economic andpolitical needs. Governments will need to find acoherentwayoffashioningtradepolicyattheregionalandmultilateral level. Thismeansensuring thatPTAsand the multilateral system complement each otherandthatmultilateraldisciplinesminimizeanynegativeeffectsfromPTAs.

See page 196

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Endnotes1 Thesefigureshavebeencalculatedexcludingintra-EUtrade.

2 Ifintra-EUtradeisincluded,30percentofworldtradeispreferential.

3 Thisfigureiscurrentasof1March2011,countingnotificationsforagreementsthatarecurrentlyinforce.