Costs and Benefits of Preferential Trade Agreements

In this comment on Martin Wolf's column on the costs of preferential trading agreements (PTAs), Robert Wade notes that there is an additional cost imposed on undeveloped countries in many of these agreements, constraints on their development path that are built into the agreements.

Why would developing countries accept constraints on development as a condition of these agreements? One reason, of course, is to enhance trade but another is that trading agreements with the U.S. come with a large positive insurance externality, military protection from the U.S.:

Robert Wade: A comment on Martin’s general assessment of bilateral-regional trade agreements as compared with WTO agreements...

Like most economists assessing bilateral-regional trade agreements, Martin assesses them on the assumption that the objective of trade policy is to maximize trade... Hence the central issue is “trade creation vs. trade diversion”.... Martin rightly extends this standard framework of efficiency costs and benefits to include also the effects on inter-state competition and conflict.

But one should also assess trade agreements in terms of their impact on ... the diversification and upgrading of production over time, especially in the case of the “southern” partners. Different rules ... governing tariffs, foreign direct investment, intellectual property, the mobility of financial capital, public procurement, and the like - have different impacts on a country’s development trajectory, some being more constraining, more “locking in to existing comparative advantage”, than others.

As Kenneth Shadlen shows in an important article (“Exchanging development for market access?...”, Rev. Int. Pol. Econ. 12 (5), 2005, 750-75), preferential trade agreements involve the southern partner receiving better market access for existing exports, in return for “reforms” deep within its borders ... “Reforms” mean putting the government under new constraints not to use industrial policy instruments to accelerate production diversification and upgrading – instruments of the kind that most of the now developed countries used during their rapid development phase. Hence the risk of freezing the existing division of labour between the trade partners.

On the other hand [under] the WTO’s multilateral rules ... ... the powerful northern countries are a bit less able to close down this policy space and neutralize the competition from southern producers than they are in bilateral or regional agreements. This is one very good reason for supporting the WTO and discouraging the proliferation of PTAs. ...

If PTAs typically shrink policy space even more than the WTO agreements why are many governments rushing to sign such agreements with the US? In the case of the Singapore-US PTA the negotiations almost broke down over ... the US’s insistence that Singapore commit to never applying restrictions on the mobility of financial capital. In the end the Singapore government more or less acceded to the US demand, for the reason (so I was told by a leading Singapore participant) that Singapore’s prime concern was less with the economics ... than with the military-security impact: the government calculated that the agreement would help to tie the US into the region militarily. Presumably the South Korean government has been making a similar calculation ... as North Korea could explode on its doorstep and China-Taiwan could explode to the south. Also, of course, Korea ... has built up a highly competitive set of industries and world-spanning firms, with a huge R&D capability; so is much less likely to experience a freezing of existing comparative advantage than most developing countries.

A final point. Arguably the single biggest threat to the stability of the world trade system comes not from within the trade system (e.g. proliferation of preferential trade agreements) but from the lack of multilateral disciplines over the exchange rates and macroeconomic policies of the major economic states (G3)... I’ll elaborate at a later time.