PREFERENTIAL TRADE

AGREEMENT

Definition

• A trade pact between countries that reduces tariffs for certain products to the countries who sign the agreement. While the tariffs are not necessarily eliminated, they are lower than countries not party to the agreement.

• A Preferential trade area (also Preferential trade agreement, PTA) is a trading bloc which gives preferential access to certain products from the participating countries. A PTA can be established through a trade pact. It is the first stage of economic integration. The line between a PTA and a Free trade area (FTA) may be blurred, as almost any PTA has a main goal of becoming a FTA in accordance with the General Agreement on Tariffs and Trade.

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• Preferential Trading Agreements– preferential trading agreements under which the

participating countries, lower tariffs with respect to each other but not the rest of the world.

– The GATT-WTO prohibits such agreements.

• The formation of preferential trading agreements is allowed if they lead to free trade between the agreeing countries.

• Are preferential trading agreements good?

• Trade creation – Occurs when the formation of a preferential trading

agreement leads to replacement of high-cost domestic production by low-cost imports from other members.

• Trade diversion – Occurs when the formation of a preferential trading

agreement leads to the replacement of low-cost imports from non members with higher-cost imports from member nations.

– Free trade can be established among several WTO members as follows:

• A free trade area allows free-trade among members, but each member can have its own trade policy towards non-member countries.

– Example: The North American Free Trade Agreement (NAFTA) creates a free trade area.

• A customs union allows free trade among members and requires a common external trade policy towards non-member countries.

– South Africa, Botswana, Lesotho and Swaziland established the Southern African Customs Union (SACU) in 1969 as a continuance of their custom union arrangements, which are in force since 1910.

• A common market is a customs union with free factor movements (especially labor) among members.

– Example: The European Union (EU) is a full customs union.

Trade bloc• A trade bloc is a type of intergovernmental agreement, often part of a

regional intergovernmental organization, where regional barriers to trade (tariffs and non-tariff barriers) are reduced or eliminated among the participating states

• Trade bloc mostly encourages regional trade

• Trade blocs can be stand-alone agreements between several states (such as the North American Free Trade Agreement (NAFTA) or part of a regional organization (such as the European Union).

• Trade blocs can fall into different categories, such as: preferential trading areas, free trade areas, customs unions, common markets and economic and monetary unions.

Economic integration

• Term used to describe how different aspects between economies are integrated.

• As economic integration increases, the barriers of trade between markets diminishes

• The most integrated economy today, between independent nations, is the European Union and its euro zone.

• The degree of economic integration can be categorized into six stages: Preferential trading area Free trade area Customs union Common market Economic and monetary union Complete economic integration

• Levels of integration

• Preferential trade agreement• countries giving reciprocal concessions• - often countries already linked closely• - sometimes for specific goods• e.g. US-Canada auto pact (before NAFTA)

• Free trade area (FTA)• very low internal trade barriers• aim to eliminate all trade restrictions• no unified policy for outside FTA• e.g. NAFTA

• Customs union• similar to FTA, but• - common external tariffs• - joint position in world trade negotiations

• Common market• customs union plus movement of factors• especially labor and capital• e.g. Western Europe in 1970s and 1980s

Free trade• Is a type of trade bloc, a designated group of countries that have agreed to eliminate

tariffs, quotas and preferences on most (if not all) goods and services traded between them.

• It can be considered as second stage of economic integration

• Unlike a customs union, members of a free trade area do not have a common external tariff (same policies with respect to non-members), meaning different quotas and customs

• The aim of a free trade area is to so reduce barriers to easy exchange that trade can grow as a result of specialisation, division of labour, and most importantly via (the

theory and practice of) comparative advantage

• Additional Gains from Free Trade

– Protected markets in small countries do not allow firms to exploit scale economies.

– The presence of scale economies favors free trade that generates more varieties and results in lower prices.

– Free trade, as opposed to “managed” trade, provides a wider range of opportunities and thus a wider scope for innovation.

• Free Trade and Efficiency

– In the case of a small country, free trade is the best policy.

The Case for Free Trade

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EXAMPLES FOR PTA

• the European Union and the ACP countries • India and Afghanistan• India and Mauritius• the North American Free Trade Agreement (NAFTA)• the Generalized System of Preferences• the Cotonou Agreement.

• Venezuela- Preferential trade agreements signed between Chile and Venezuela give the Chilean exporters considerable advantage over U.S. fruit suppliers.

• Bolivia - Bolivia's trade with neighboring countries is growing, in part because of several regional preferential trade agreements it has negotiated.

• • PERU - Some countries (not including the United States) avoid tariffs on a number of

their exports to Peru because of preferential trade agreements.

• Panama - Panama is not a party to any agreements providing completely free trade, but does have bilateral preferential trade agreements with Costa Rica, El Salvador, Honduras, Guatemala, Nicaragua and the Dominican Republic.

• Hungary has concluded a number of preferential trade agreements, including the Europe Agreement between Hungary and the European Community and their Member States (December 1991). In June 1993, the EU agreed to accelerate the agreement's provisions and reaffirmed its commitment to Hungary's full membership.

• France and other EU member states have a network of preferential trade agreements that is expanding rapidly.

NAFTA

• is an agreement signed by the governments of the United States, Canada, and Mexico creating a trilateral trade bloc in North America.

• The goal of NAFTA was to eliminate barriers to trade and investment between the USA, Canada and Mexico.

• agreement December 1992,ratified 1993,implementation 1994-2008• US proponents of NAFTA

- trade benefits - reduce immigration pressures- prosperity, stability, democracy for Mexico

• General features• elimination of trade barriers• - in 10 years• - 15 for special products (e.g. agriculture)• no common external tariff• restrictive rules of origin• - goods must have “a substantial transformation”• - e.g. 60% of autos must be locally made• - e.g. textiles must be made from NAFTA yarn

• Specific features

investment• national treatment• dispute settlement by international tribunals• exempt – Canadian cultural industries

Environment• Commission on Environmental Cooperation• has country enforced its environmental policy?• fines or trade sanctions can be imposed

Safety valve• pre-NAFTA measures allowed if import surge

Transportation• no barriers eventually

No permanent independent organization• NAFTA functions through meetings• of country officials

EUROPEAN UNION

formerly European Common Market,European Community (EC)

• fifteen members, 370 million people• eleven official languages• 10 new members in May 2004• 3 more applicants negotiating for membership History• origins - Europe's devastation after 1939-45• economic integration as political move• 1951, 6 countries in “Coal and Steel Community”• Treaty of Rome, 1957

- European Economic Community- customs union- UK rejects

• 1950's – 1980's - success- new European political institutions- 6 new members (UK in 1973)- increased trade, capital, labor flows

• Common market + positive measures to

• reduce market frictions

• transactions costs

• ▫ legal rules coordinated

• ▫ common standards, financial regulations, etc

• transportation problems

• ▫ coordinate roads, rail, etc

• ▫ no border checkpoints

• exchange rate uncertainty

• ▫ coordination of macro policies

• ▫ possibly single currency

• Success reveals three problem areas

• microeconomic – natural and administrative barriers

• Macroeconomic- different currencies, instability

• politics – conflicts between "Europe" and countries

Evolution

• Traced back to 1500s in Europe when mercantilism developed• Mercantilism -Mercantilism is an economic theory that holds that the prosperity of a

nation is dependent upon its supply of capital, and that the global volume of international trade is "unchangeable." 

• Prosperity of Britain Union, Free trade thoughts of Netherlands etc paved way• GATT article XXIV sanctioned free trade areas and custom unions• Jacob Viner performed static analysis of PTA in 1950• Vinerian approach said PTA could be trade diverting or trade creating• 1957- evolution of European union and EFTA enhanced PTA• Vinerian approach reworked by Paul Wannacott & Mark hutz-1989• By Lawrence Summers in 1991• World Banks Export- oriented industrialisation policy also promoted PTA

Preferential rules of origin

• Countries use the system of certification of origin most commonly called rules of origin, where there is a requirement for the minimum extent of local material inputs and local transformations adding value to the goods

• Establish criteria for determining the country or customs territory from which a product originates

• Allow customs authorities to distinguish between goods that are and that are not eligilble for preferential treatement

• Rules determine the eligibility of products for tariff preferences under various types of trade agreements

• PTA s could alter global trade patterns in textiles and apparels significantly to the advantage of members and dis advantage of non –members

• New PTA rules that US and EU follow, allow some flexibility• Administering of rules of origin will impose costs on firms and governments,

so economic cost factor should be considered• Simplification and harmonization of rules of origin is part of the future

program of work for the WTO

PREFERNTIAL TRADE AGREEMENTS IN ASIA AND PACIFIC

REGION

REASONS FOR ESTABLISHMENT OF PTAs

• (a) recognition of the political needs of member nations;

• (b) geographic proximity of the partners;

• (c) dissatisfaction with the GATT/WTO process for trade liberalization;

• (d) the opportunity to address issues not addressed by WTO or not effectively addressed, such as barriers to services trade, foreign investment flows, various non-tariff barriers and labour, and

• environmental standards; and

• (e) a response to regional trade agreements formed or forming elsewhere, including a reflection of the fear of exclusion from major markets. This “domino” effect (Baldwin, 1996) is clearly evident in the Asian and Pacific region, with the Association of Southeast Asian Nations (ASEAN), Japan, the Republic of Korea, Singapore, Chile and New Zealand showing initial interest in PTAs in the 1990s. By 2000,the United States of America, Australia, individual ASEAN members such as Thailand, and China had joined the trend, and the momentum has since continued.

CONCERNS ASSOCIATED WITH PTAs

Various concerns can be mentioned in association with PTAs, including the well-known possibilities of :

• trade diversion rather than creation,

• concentration on regional arrangements diverting scarce negotiating resources away from multilateral negotiations,

• the administrative costs and confusion that could result from a plethora of overlapping trade agreements (Hilaire and Yang, 2003).

• there is clearly the risk that a hub-and-spoke system will dominate, with these leading economies as the hubs.

• Zhai (2006) considered the possibility of China or Japan being regional hubs.

• Agriculture, of course, is the problematic sensitive sector in many of the completed agreements as well as in ongoing negotiations. Asia-Pacific PTAs have followed a variety of approaches in incorporating agricultural preferences, and the agreements range from quite comprehensive to very restrictive coverage.

MOTIVATION AND METHODOLOGY

• This study is motivated by the many PTAs that are being simultaneously negotiated and implemented in the Asian and Pacific region with potential to interact and change outcomes, perhaps in ways that may not have been anticipated.

• China is involved in a range of agreements; those already in force include agreements with ASEAN, Chile, New Zealand, Pakistan, Hong Kong, China, and Macao, China (from 1 October 2008), while other partner countries now at the study, consultation, negotiation or ratification stage include Australia and the Republic of Korea.

• ASEAN has agreements or negotiations with Australia and New Zealand, Japan, the Republic of Korea and the European Union. The web of agreements becomes even more tangled when considering those agreements involving individual ASEAN member countries.

• The Global Trade Analysis Project (GTAP) dynamic model is applied to bilateral and regional trade analyses in the Asian and Pacific region. In particular, a number of China’s possible preferential agreements are examined, the implications of these trading partners also liberalizing among themselves are considered.

Model and baseline

• The GTAP-Dyn model permits capital accumulation, together with international mobility and foreign ownership of capital

• Under this model-Five primary factors of production (land, natural resources, physical capital, and unskilled and skilled labour) combine with intermediate inputs, including imports, to produce final output.

• The current study uses version 6 of the GTAP database, comprising 87 economic regions, and 57 sectors (Dimaranan, 2006), extended to facilitate analysis of dynamic capital accumulation.

• First a baseline model is developed, up to 2020, from the benchmark GTAP 6 dynamic database projection.

• The baseline simulation captures some of the significant ways in which the structure of the world economy is anticipated to change by 2020. Changes in the structure of production for each region are driven by differences in the relative rates of factor accumulation, including endogenous capital growth. These combine with different factor intensities in each sector, as well as price and income elasticities

Liberalization scenariois• 1.Bilateral agreements (hub-and-spoke)• All bilateral tariffs are removed between China (the hub) and three regions:

Australia and New Zealand in 2009; ASEAN countries in 2010 (new ASEAN countries in 2015);a and the Republic of Korea in 2012.

• 2. Regional free trade area (RFTA)• All bilateral tariffs are removed within an FTA comprising China, ASEAN,

the Republic of Korea, Australia and New Zealand. The timing of liberalization is as for scenario 1, but now also liberalizing trade between ASEAN, Australia and New Zealand and the Republic of Korea in 2013 (extended to 2017 for tariffs imposed by new ASEAN countries).

• 3. Regional free trade area with sensitive products (RFTA-Sensitive)• As for scenario 2, but with sensitive sectors not liberalized. For Asian

countries, sensitive products are assumed to be the rice, cattle and sheep meat, and dairy product sectors. For Australia and New Zealand, the sectors assumed to be sensitive are textiles, wearing apparel and leather products.

• 4. APEC• Developed APEC countries are assumed to fully liberalize their tariffs by

2010, and developing countries by 2020.• a Intra-ASEAN tariffs are also eliminated.

Determinants of successful PTAs

Preferential agreements that are most likely to produce benefits are those with the following characteristics:

(i) large and diverse membership;

(ii) low external MFN tariffs;

(iii) comprehensive coverage in terms of measures, sectors and products, with few exemptions;

(iv) liberal rules of origin; and

(v) inclusion of measures to facilitate trade and to promote cross-border competition.

• In addition, well-designed agreements also need to be supported by effective monitoring and enforcement mechanisms to ensure consistent implementation.

Effects of PTA s• Inclusion of sensitive sectors and the provisions on services ,investment, and

trade facilitation• Some PTAs, such as ASEAN-China CEC, include agriculture, and consistent

implementation of these agreements could create a momentum for further agricultural liberalisation

• Most PTAs include provisions on services, investment, and trade facilitation, although the provisions generally lack specifics and a time table for implementation.

• The proliferation of Asia Pacific PTAs increases the bias toward intraregional trade and raises the risk of trade diversion, especially because the MFN tariff rates in some countries are high and strongly dispersed.

• Administrative complications could severely diminish any potential benefits of PTAs and further accentuate trade diversion.

• Preferential agreements could potentially inhibit the processes of cross-border production networking which has been central to the region’s successful integration.

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