Trade Policy Reforms And Development: Essays in Honour of Peter Lloyd

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Author: Sisira Jayasuriya

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Trade Policy Reforms and Development

Trade Policy Reforms and Development Essays in Honour of Peter Lloyd, Volume II

Edited by

Sisira Jayasuriya Director, Asian Economics Centre, Department of Economics, University of Melbourne, Australia

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Sisira Jayasuriya 2005 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited Glensanda House Montpellier Parade Cheltenham Glos GL50 1UA UK Edward Elgar Publishing, Inc. 136 West Street Suite 202 Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library

ISBN 1 84376 365 6 Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall

Contents List of contributors

vii

Introduction Sisira Jayasuriya

xi

PART ONE 1

Globalization and the political economy of international trade policy Arye L. Hillman

PART TWO 2

3

4

5

POLITICAL ECONOMY

WTO ISSUES AND TRADE NEGOTIATIONS

The economic crisis, labour standards and trade performance in East Asia Keith E. Maskus Challenges facing the WTO: determining its role in international aﬀairs Gary P. Sampson The interaction between trade and competition policy: post-Doha communications to the WTO Working Group Kerrin M. Vautier Choosing formulas for market access negotiations: eﬃciency and market access considerations Joseph Francois, Will Martin and Vlad Manole

PART THREE 6 7 8

3

25

41

68

90

REGIONAL INTEGRATION

Regionalism and bilateralism in ASEAN Chia Siow Yue and Mari Pangestu ANZUS free trade agreements: results from a global model Niven Winchester and Martin Richardson New criteria for optimum currency areas Herbert Grubel

v

121 153 180

vi

Contents

PART FOUR 9

10

Agricultural trade reform and poverty reduction in developing countries Kym Anderson Industrialization, trade policy and poverty reduction: evidence from Asia Peter Warr

PART FIVE 11

TRADE AND POVERTY REDUCTION

239

EMPIRICAL INVESTIGATIONS IN TRADE

The surge in US imports, 1995–2001 Mordechai E. Kreinin

Index

205

261

271

Contributors Kym Anderson Lead Economist Development Research Group World Bank, and Professor of Economics (on leave) University of Adelaide Australia Chia Siow Yue Senior Research Fellow Singapore Institute of International Aﬀairs, and former Director Institute of Southeast Asian Studies Singapore Joseph Francois Professor of Economics Erasmus University Rotterdam Fellow, Tinbergen Institute The Netherlands, and Director of the European Trade Study Group The Netherlands Herbert Grubel Professor of Economics (Emeritus) Simon Fraser University Senior Fellow The Fraser Institute Vancouver, British Columbia Canada Arye L. Hillman William Gittes Chair Professor of Economics Bar-Ilan University Israel

vii

viii

Contributors

Mordechai E. Kreinin University Distinguished Professor Department of Economics Michigan State University East Lansing, Michigan USA Vlad Manole Consultant Development Economics Research Group World Bank Washington, DC USA Will Martin Lead Economist Development Research Group World Bank Washington, DC USA Keith E. Maskus Professor and Chair Department of Economics University of Colorado Boulder, Colorado USA Mari Pangestu Minister of Trade Government of Indonesia, and Member of the Board of Trustees and former Executive Director of the Centre for Strategic and International Studies Jakarta Indonesia Martin Richardson Professor School of Economics Faculty of Economics and Commerce Australian National University Canberra Australia

Contributors

Gary P. Sampson Senior Counsellor World Trade Organization Geneva, and Professorial Fellow Melbourne Business School Melbourne University Australia Kerrin M. Vautier Independent research economist Chair of New Zealand Asia Institute University of Auckland, and Member of the New Zealand High Court under the Commerce Act New Zealand Peter Warr John Crawford Professor of Agricultural Economics, and Director, Poverty Research Centre Division of Economics Research School of Paciﬁc and Asian Studies Australian National University Canberra Australia Niven Winchester Lecturer of Economics University of Otago New Zealand

ix

Introduction Sisira Jayasuriya These two volumes, Trade Theory, Analytical Models and Development and Trade Policy Reforms and Development, bring together papers prepared in honour of Professor Peter Lloyd (Ritchie Professor of Economics at the Department of Economics, University of Melbourne, Australia) on the occasion of his formal retirement after a distinguished career of over four decades in academia. A group of his close friends and collaborators – drawn from four continents – was present to honour him at a Festschrift conference held on 23–24 January 2003 at the University of Melbourne where preliminary versions of most of these chapters were presented. The chapters have been subsequently revised in the light of comments from referees and participants at the workshop. Peter Lloyd, at present one of the most distinguished and internationally renowned Australian economists, started life – in his own words – as a ‘boy from the bush’ in New Zealand, completed his undergraduate and Masters at the Victoria University of Wellington in New Zealand, and did his doctoral studies at Duke University, USA. After graduation he returned to the Victoria University of Wellington to start his university career and subsequently held positions in economics departments at the Michigan State University, the Australian National University and ﬁnally, in 1983, at the University of Melbourne. In between he spent periods at various universities around the world, including a period as Visiting Professor at the National University of Singapore in the early 1980s. The titles of the two volumes and the diversity of topics covered by the contributors reﬂect Peter Lloyd’s core interests as a professional economist: development of rigorous theory and analytical models to understand and elucidate real-world behaviour, and the application of conclusions from theory to inform policy. Peter’s own wide-ranging interests have led him to write not only on international economics, but also on production theory, welfare economics, macroeconomics, health economics, ﬁnance, economic demography, history of economic thought and mathematical economics, though his reputation in international economics perhaps tends to overshadow his important contributions to these other ﬁelds. xi

xii

Introduction

Peter has been – and remains – an ‘old-fashioned’ academic in the best sense of the term, devoted to maintaining the highest standards of academic integrity and scholarly rigour in his own work and within the profession. His research is also driven by a sense of social responsibility, in the best traditions of the classical economists. While strongly believing in ‘the essentiality of theory to understanding the real world and to policy advice’, Peter has consistently resisted the temptation to ‘do theory for its own sake’ (or, for the sake of a ‘good’ journal paper!). With obvious regret, in his introduction to his selected essays (International Trade Opening and the Formation of the Global Economy, Edward Elgar, 2002) he wrote that: an increasing proportion of academic writers devote their eﬀorts to theory which is divorced from any policy advice or even any general interest in policies. There is more interest today in theory for its own sake. This is most notable in the United States but is increasingly true in Australia. Specialization in the activities of economists has produced much higher levels of skills and much inventive theorising but the profession of economics would in my view be more productive as a social instrument if closer links between theory and policy were re-established.

One consequence of this strong interest in real-world economies and policy issues has been Peter’s increasing interest in international policy debates centred around the ongoing process of globalization and international economic integration. Dating from his time in Singapore in the early 1980s, he has become a leading analyst of trade and development issues in Asia. Similarly, the global trading system and the role and nature of the WTO have attracted much of his attention in recent years. Without attempting an exhaustive survey of Peter’s research output – his publications list includes 16 books, nine research monographs, 102 journal publications, and 98 book chapters (the complete list is accessible at www.economics.unimelb.edu.au/staﬀproﬁle/plloyd.htm) – it is worth brieﬂy reviewing some of his writings to illustrate both the signiﬁcance of Peter’s academic contributions and his versatility. Peter Lloyd’s contribution to the study of intra-industry trade is internationally recognized and demonstrates how careful examination of real-world developments paved the way for major advances in theory. His joint paper with Herbert Grubel in 1971 on ‘The empirical measurement of intra-industry trade’ in the Economic Record examined Australian trade data in detail and argued that the phenomenon of intra-industry trade was not a mere statistical artefact but a real phenomenon that demanded more attention from international trade theorists and analysts. The index presented in that paper – later known as the ‘Grubel–Lloyd’ index – remains to this day the most popular measure of intra-industry trade in the empirical literature. This was fol-

Introduction

xiii

lowed by their book Intra-Industry Trade (Macmillan, 1975), which documented in detail that intra-industry trade was indeed an important and increasingly signiﬁcant global phenomenon in international trade. In the light of subsequent developments in international trade theory, particularly the class of models associated with the New Trade Theory pioneered by Paul Krugman and others that combine diﬀerentiated products and imperfectly competitive markets, the concluding paragraph of the 1971 paper makes interesting reading: Diﬀerent actual cases called for diverse explanations in terms of advantages of specialization in narrow product ranges, joint production unmatched by complementarity in demand, and trade across borders in high transportation cost industries. The explanation of other intra-industry trade ﬂows may require consideration of product diﬀerentiation strategies in oligopolistic markets which have been neglected by most international trade theorists. (emphasis added)

The stimulus for rigorous theorizing provided by the requirements of practical policy making is evident in the 1974 Journal of International Economics paper, ‘A more general theory of price distortions in open economies’, which attempted to derive simple policy rules that ensure welfare improvements for the realistic case of partial reforms to trade regimes – piecemeal tariﬀ reforms – which raise the standard second-best problems of moving from one distorted situation to another. The paper examined the even now widely practised policies of reductions in extreme tariﬀs and uniform reductions in all tariﬀ rates. Interest in piecemeal reforms and analytical approaches to dealing with welfare changes in distorted economies led to the paper with Albert Schweinberger on ‘Trade expenditure functions and gains from trade’ in 1988 (Journal of International Economics), enables normative analysis of multi-household economies with distinct preferences and endowments. The basic concept of the trade expenditure function has subsequently been applied – most notably by James Anderson and Peter Neary – to the measurement and analysis of protection in the presence of tariﬀ and non-tariﬀ barriers and to the impact of piecemeal reforms. The ‘33 theory of customs unions’ paper in the Journal of International Economics in 1982 surveyed, consolidated and synthesized the theoretical analysis of customs union models that extended the analysis to three countries and three commodities. This paper demonstrated how diﬀerent assumptions about patterns of trade in the 3 3 model leads to a wide diversity of results. In subsequent work Peter has continued to work on the theoretical (and empirical) analysis issues of regional trade blocs and their policy implications. He has been particularly interested in the ‘deepening’ of regional trade agreements to achieve full economic integration by

xiv

Introduction

extending the scope of such agreements beyond removing barriers to trade at the border to also eliminate other internal barriers hindering market integration, thus enhancing market access to permit the ‘law of one price’ to hold is critical to achieving a fully integrated regional (or a global) economy. This interest is reﬂected in several of his writings on WTO and regional trade integration issues that emphasize the role of harmonization of standards, tax regimes and competition policy. Recognizing the problems posed by increasingly complicated ‘rules of origin’ in regional trade agreements, he has examined alternative policy measures to achieve the desired ends more eﬃciently – see, for example, ‘Country of origin in the global economy’, in World Trade Review (2002). Given this interest in regional and global market integration, it must be gratifying for Peter that his work has clearly had a major impact on policy discussions to move towards a fully integrated economy between New Zealand and Australia – his native and adopted countries. His 1991 study, The Future of CER: A Single Market for Australia and New Zealand, published by CEDA and the Institute of Policy Studies in Wellington, New Zealand, recommended an EU-style single market for the two countries, and ongoing moves to further deepen the Australia–New Zealand Closer Economic Agreement (CER) suggest that this may well become a reality in the foreseeable future. Despite increasing involvement in policy issues in recent years, Peter has not lost his interest in making analytical models more policy relevant. This is nowhere better exempliﬁed than in his 2002 paper ‘Generalising the Stolper–Samuleson theorem: A tale of two matrices’ (Review of International Economics) that extends the celebrated theorem on the distributional eﬀects of relative price changes to the case of many goods and factors with diversiﬁed holding of factors. The paper shows that though diversiﬁed factor ownership by households fundamentally changes the relationships between prices and real incomes, the essential spirit of the theorem can be maintained in a much more general context. (Peter treasures a letter received from Paul Samuelson himself commending this extension of the theorem!) What is truly remarkable is that Peter has maintained this record of consistently high research productivity while carrying a full load of teaching and, particularly in recent years, several heavy administrative responsibilities. As the Dean of the Faculty of Economics and Commerce from 1988 to 1993, he provided leadership and guidance during a diﬃcult transitional period for both the Faculty and the University. He took a leadership role in developing Asia-oriented research in economics at the University of Melbourne and was the founding Director of the Asian Economics Centre and its predecessor, the Asian Business Centre. Peter has always been committed to teaching. Even when teaching was not compulsory, as was the

Introduction

xv

case during his 14 years at the Australian National University, he maintained a regular programme of teaching. He has a well-founded reputation among students fortunate enough to have been taught by him as a brilliant and dedicated teacher, generous with his time and advice as well as sympathy and understanding – as I can attest from my own personal experience. Another facet of his character is revealed by the many co-authored publications: Peter enjoys interaction and collaboration with colleagues. The enthusiastic response to the Festschrift in honour of Peter Lloyd was a reﬂection of the high regard and esteem in which he is held by his friends, colleagues and collaborators, both here in Australia and overseas. John Freebairn, Head of the Department of Economics in 2002, mooted the idea of holding the Festschrift and committed departmental resources. Jeﬀ Borland, who took over as Head in 2003, with the administrative support of Cherie Millerick, Persefoni Gouletas and Colin Newell, ensured that the Festschrift activities ran smoothly. The authors, discussants and other participants at the workshop – some of whom literally travelled around the globe to be present – enabled this published tribute to Peter Lloyd to become a reality. Premachandra Athukorala, Daniel M. Bernhofen, Max Corden, Mark Crosby, Geoﬀ Edwards, Christopher Findlay, John Freebairn, Hal Hill, Patrick Jomini, Stephen King, Jay Menon, Richard Pomfret, David Robertson, John Shannon and Peter Stemp also provided refereeing and other academic assistance. In preparing the manuscript for publication, Lee Smith provided invaluable editorial assistance at short notice. Department of Economics University of Melbourne Melbourne 3010, Victoria Australia

PART ONE

Political Economy

1.

Globalization and the political economy of international trade policy Arye L. Hillman*

INTRODUCTION In the years that have spanned Peter Lloyd’s career, changes have taken place both in the conduct of international trade policy and in the normative views expressed about trade policy. This chapter provides an overview of these changes. In considering the changes (or lack of change), I shall be concerned with political economy, or the interface between economic outcomes and political or collective decisions. Political economy will enter in two parallel ways. As a concept of positive economics, political-economy perspectives describe why governments have chosen policies. Politicaleconomy perspectives are also part of the broad normative theme of why free trade may or may not be regarded as desirable. A consideration of political economy from these perspectives reveals changes that have taken place in the periods before and after globalization, and also sustained consistencies regarding normative views of government. Normative views of government underlie how government is described in economic models, and the expectations we have of government. The normative principle can be that governments are means for social and economic improvement through appropriate policies. Such a normative view can be stated without regard for the limitations that might be present on government. The limitations include information and problems of majority voting or other means of making collective decisions. Electoral objectives and the need for political support also introduce principal–agent problems between government and voters or the public at large. If the limitations on expectations of political decisions are, however, set aside, government comes to be portrayed as the instrument for improving social welfare through correctly specified policies. Returning to our two aspects of political economy, neither political calculations nor private economic self-interest are present in the descriptions of economic policies 3

4

Political economy

(the normatively desirable policy is specified). There is also political economy in the broad normative principle that government can only do social good. My purpose in this chapter is to elaborate on these two themes of political economy as found in pre- and post-globalization attitudes to free trade. Change in the conduct of trade policy has been part of a process described as ‘globalization’. The term globalization refers to the integration of national markets for goods, capital, services, and also to some labour. The integrated global markets have limited governments’ policy discretion. Eﬀectiveness of monetary policy diminishes when interest rates and exchange rates are determined in world markets. Market responses to government budgetary deficits and the composition of public spending limit government discretion in fiscal policy. Social welfare and domestic redistribution policies are constrained by mobile tax bases, and also by adverse selection through migration when people arrive to benefit from social entitlements and others leave because taxes to finance redistribution are regarded as onerous or unjustified. Globalization threatens national institutions, in a limiting example for the same reason that the Soviet system required the economy to be closed to markets and foreign trade to be planned or regulated. That is, when exposed to markets, goods produced with paternalistic institutions cannot withstand competition from goods produced where market institutions prevail. Globalization also has consequences for the poorer countries of the world, through demand for child labour and eﬀects on the environment. Concerns are also expressed that globalization undermines indigenous cultures.1 A substantial literature expresses the concerns that the constraints imposed by globalization limit the benefits achievable from national governments and national institutions, and that globalization in particular does harm in poorer countries.2 The anti-globalization views are accompanied by protests against multinational corporations (which account for substantial parts – perhaps some 80 per cent – of the value of international trade) and against the international agencies (the WTO, the World Bank and the IMF) that are seen to be promoting liberal economic policies and open markets. Of course, there can be substantive critical evaluations of international institutions; see for example Peter Lloyd’s evaluation (2001) of the WTO. What is the relation between pre- and post-globalization views of the merits of free trade and the sources of opposition to free trade? Is there a common theme within the pre- and the post-globalization views, or has there been a discrete change or break with new issues arising in the postglobalization era? In the search for common themes, we can begin with the pre-globalization issues, and thereafter return to the post-globalization concerns.

Globalization and the political economy of international trade policy

5

BEFORE GLOBALIZATION The substantial protectionism in the richer countries of the world when Peter Lloyd began his investigations of international trade contradicted Adam Smith’s message about how markets facilitate benefits from specialization and how the opportunity to engage in voluntary exchange can only be beneficial. The policies also contradicted David Ricardo’s principle of comparative advantage (that people in any country have a comparative advantage in something and can gain from trade no matter how absolutely ineﬃcient they are in production of diﬀerent goods). In the face of these contradictions and more formal proofs that free trade is Pareto-eﬃcient and maximizes national income, the presence of protectionist policies posed a challenge for the principle that free trade is the socially desirable policy – in particular if the normative principle was to be adhered to that government is the instrument of social good or social improvement. The social desirability of free trade is based on the eﬃciency of competitive markets. Besides eﬃciency, governments may also seek social justice, which requires considering how policies aﬀect income distribution. Objectives of eﬃciency and income distribution can conflict, and, as noted in political-economy views of the choice of trade policies, governments can be led by political consequences of income distribution to choose policies that compromise the eﬃciency of free trade.3 Not only political motives might lead governments to be concerned with income distribution and to forgo the eﬃciency of free trade: Max Corden (1974/1997) suggested that governments exhibit a conservative bias in using trade policy to ensure that significant declines do not take places in people’s incomes; that is, trade policy is a form of social insurance. If, however, people are only selectively eligible for the social insurance, and the eligibility is related to the political support that can be provided, then the political-economy view is supported.4 Income-distribution objectives, whether sought for political-support or social-welfare reasons, do not compromise the eﬃciency of free trade when lump-sum taxes and transfers are present to allow income to be redistributed without eﬃciency losses. Such separation between eﬃciency and income-distribution objectives was proposed by Richard Musgrave (1959). The separation allows free trade to maximize national income, and, since free trade is Pareto-eﬃcient, permits government, in a second separate step, to redistribute income to make all inhabitants of a country better oﬀ under free trade than under protection. Through the application of Musgrave’s separation, trade policy thus achieves eﬃciency through free trade, and trade policy is not explained as resulting from income-distribution objectives. The separation implies that market incentives do not aﬀect personal

6

Political economy

behaviour all that much.5 Governments are then free to seek eﬃciency through free trade because redistribution can take place independently through lump-sum taxes and transfers without any (or significant) eﬃciency losses. Why, however, might governments nonetheless choose protectionist policies? A reason may be that governments do not have access to lump-sum taxes and transfers, so income-distribution objectives do after all compromise the eﬃciency of free trade. Whether the incomedistribution objectives reflect need for political support or principles of social justice, we have an explanation for departure from free trade – for income-distribution reasons. However, suppose that Musgrave’s separation is adhered to, and the normative principle is sustained that government is an instrument of social good. Then departure from free trade can only be to improve eﬃciency, since income-distribution objectives are achieved independently of trade policy using the lump-sum taxes and transfers. When Peter Lloyd was beginning his career, the theory of the second-best was the means of reconciling departure from free trade with pursuit by government of eﬃciency objectives.6 Strategic trade policy evolved into the centrepiece of the second-best.7 The second-best was present because international markets were not competitive and there were non-competitive rents or profits. The models of strategic trade policy proposed to governments how, in various ways under diﬀerent circumstances,8 government policies could increase national income (an eﬃciency objective) by directing the rents or profits to domestic industries or ffirms. A principal policy instrument proposed was a subsidy to domestic exporting ffirms.9 Illegality under the GATT (General Agreement on Tariﬀs and Trade) of export subsidies did not deter the proponents of strategic trade policy. Nor did the prospect of countervailing duties or other retaliation by foreign governments, or the observation that domestic benefits to one fi f rm or industry were at the expense of another. Or the possibility that, with many ffirms selling in imperfectly competitive world markets, the favour of export subsidies might be traded for campaign contributions or other forms of political support.10 Since national income was increased (private fi f rms or domestic industries benefited from public policy in the ffirst instance, but the rents or profits secured with government assistance could be transferred to the public at large, presumably through a corporate profits tax), governments in the strategic trade policy models were departing from free trade in the public interest. There was therefore consistency between the observation of departure from free trade and the policy recommendation that departure from free trade has (or can have) social merit. Peter Lloyd, in his research with Herbert Grubel,11 confirmed the substantial presence of intra-industry trade, which was consistent with imperfectly competitive markets. The step

Globalization and the political economy of international trade policy

7

taken in designing and recommending strategic trade policy (in which Peter Lloyd had no part) was to show how socially responsible government could choose to depart from non-interventionist free-trade in pursuit of eﬃciency (not income-distribution) objectives. The conclusion was therefore consistent with the normative principle that government acts in the public interest. Here is an interpretation of the preservation of the normative principle. With Musgrave’s separation ruling out income distribution as the reason for departure from free trade, and with government viewed as acting in a socially responsible manner in the public interest, observed protectionist policies required a normative eﬃciency justification, which the second-best and strategic trade policy provided.12 On the other hand, Musgrave’s separation can be rejected as impractical or not feasible. Empirical studies confirm that taxes, and also transfers, have accompanying eﬃciency losses that appear significant.13 That is, people therefore do not usually contribute according to their ability without regard for their post-tax reward, and the consequence is then a trade-oﬀ between eﬃciency and income-distribution objectives of public policy, since the two objectives are not independently achievable. Protectionist trade polices can now reflect willingness to forgo the eﬃciency of free trade for income-redistribution reasons. There remains the question whether this is social willingness to forgo free trade as suggested by Max Corden or political willingness as proposed by the political economy view of the determination of trade policy. If social willingness, protectionist policies can be described as pursuit of a normative ideal of income distribution or as part of social insurance, and the normative principle of government only doing social good or acting in the public interest is then sustained. Political willingness to compromise eﬃciency for income-distribution objectives suggests, on the contrary, decisions to depart from free trade that are not in the public interest. Political decision makers might be taking advantage of rational ignorance and asymmetric costs and benefits of self-interested collective action, and other sources of political principal–agent problems in representative democracy,14 to choose trade polices to achieve political or personal objectives.15 So, with Musgrave’s separation between eﬃciency and income-distribution objectives not feasible because of the absence of lump-sum taxes and transfers, international trade policy becomes a means of achieving political income-distribution objectives.16 The protection that increases rents or incomes in import-competing industries is then ineﬃcient and reduces national income.17 There have been limited or perhaps no cases of governments following the recommendations of strategic trade policy.18 We might agree that

8

Political economy

‘in the international trade literature we have been explaining unobserved phenomena for over 150 years’ (Richardson, 1996, p. 313). Then the question is why this has been so. The answer may reside in the broad political-economy theme of the view taken of government. In the view provided by strategic trade policy, government takes advantage of pre-existing rents for the social (and national) good. However, the domestic industry-specific rents obtained through protection provide a view of political decision makers as creating ineﬃciency so as to create rents for political and private benefit, which is inconsistent with the normative principle that government seeks the public interest.19 Protectionist policies may be regarded as reflecting lack of knowledge on the part of the political decision makers. The decision makers may have succumbed to short-term populist ideas, such as about the need to protect jobs, and they may not be aware that the market, left to its own designs, would provide jobs and maximize the country’s income through comparative advantage. That is, perhaps political decision makers were not aware of the ‘distortions’ they were creating. Education of policy makers would end the ineﬃcient protectionism and allow a return to the principle that government acts in the public interest. However, then governments should be educated about the social benefits of free trade. The second-best and strategic trade policy proposals provide a normative justification for government pursuing the public interest by departing from free trade. Still, if protectionism persists and if government is viewed as acting in the public interest, the second-best and strategic trade policy show how, with the Musgrave policy separation maintained, government acting in the public interest might depart from free trade. The alternative political-economy view does not seek to educate government. Rather, with the Musgrave policy separation ruled out and free trade taken as eﬃcient, the reason for policies that depart from free trade can only be political self-interest in changing income distribution.20

TRADE LIBERALIZATION Before we consider political economy and free trade in the postglobalization era, we can briefly note why the trade liberalization that underlies globalization occurred. The trade liberalization was not a removal of trade barriers that had been imposed for purposes of corrections of ineﬃciency, but rather appears to have political-economy foundations consistent with the protectionism that was replaced. A number of considerations were associated with the liberalization of trade.21

Globalization and the political economy of international trade policy

9

First, the development of capital or asset markets and trade liberalization are related. Asset markets allow owners of specific factors to diversify sources of incomes, so changing personal preferences to favour more liberal trade policies.22 Second, without necessarily relying on moderation of private protectionist interests through asset markets, trade liberalization occurred through rounds of multilateral negotiations where governments exchanged market access. The view of trade liberalization as exchange of market access is an extension of the political-economy view of protection.23 A government can use protectionist policies unilaterally to benefit importcompeting sectors. Benefiting export sectors requires ffinding means of increasing rents in these sectors. For agriculture, this can be done through state trading24 that purports to maintain ‘orderly marketing or to smooth changes in producers’ incomes’. For industrial goods, subsidies contravene the GATT or WTO and can evoke countervailing duties.25 Benefits to exporters can, however, be provided through foreign market access, which foreign governments may be prepared to provide in exchange for reciprocal domestic market access for foreign producers.26 It is then not the public interest that underlies trade liberalization but the political objective of increasing incomes in export industries.27 Also, when trade liberalization takes place unilaterally, the terms of trade may deteriorate.28 Deterioration of the terms of the trade disadvantages the country in the aggregate, but also, in particular, disadvantages export industries. When trade liberalization takes the form of exchange of market access, terms of trade changes are moderated.29 An explanation for globalization or multilateral liberalization requires additionally the role of the most-favoured-nation (MFN) clause in ensuring that market-access ‘concessions’ granted to one trading partner are also granted to other trading partners with whom a country has entered into trade liberalization agreements. The MFN clause avoids opportunism whereby the value to a trading partner of any market-access agreement could be devalued by a more concessionary agreement with another trading partner.30

POST-GLOBALIZATION INCOME DISTRIBUTION Let us now move to the post-globalization period. Opposition to free trade before globalization involved industry interests.31 With the course of globalization, from a longer-run perspective, we expect the predictions of the Heckscher–Ohlin model to prevail, so that real incomes of countries’ relative abundant factors can be expected to increase and real incomes of

10

Political economy

relatively scarce factors to fall. We also expect tendencies for international equalization of incomes from diﬀerent factors of production. In the richer countries, the wages of unskilled labour can therefore be expected to decline, or there will be unemployment; in poorer countries, the wages of unskilled labour can be expected to increase. Consistently with these predictions, in the United States the skill premium increased and incomes became more unequal.32 In Europe and other locations where labour markets were less flexible, there were high sustained rates of unemployment of unskilled workers. Global product markets, as predicted, appeared to introduce global relations into domestic factor markets by detaching personal incomes from where a person happens to live. That is, before globalization, unskilled workers in richer countries had been at an advantage relative to unskilled workers in poorer countries, through a presumption that unskilled workers merited high incomes only because they happened to live in high-income countries.33 The trade liberalization occurred together with the information revolution. Since the decline in the real incomes of the low-skilled workers in the richer countries could reflect either globalization or new technology, there are therefore two eﬀects to untangle. Identifying the cause will suggest the policy responses that could be proposed. If the predictions of the Heckscher–Ohlin model have been realized, protection could be sought to correct the social inequality due to liberalization.34 There is then, however, a change in the form of the protectionist interest. Sectoral or industry interests are replaced by broad factors of production in the neoclassical (and Marxian) sense. If new technologies are the reason for the declines in incomes of the low-skilled workers, the case for intervention is that of the Luddites.35 An explanation for the changes in income distribution that takes into account interdependencies between globalization and technology is that liberalization of trade exposed industry in the richer countries to import competition from goods produced using unskilled labour in poorer countries. Unable to match the low costs of imports, producers in the richer countries innovated and introduced technologies that increased demand for skilled labour, and competition changed from price to quality. The unskilled workers of the poorer countries could not match the higher quality of the richer countries, which required skilled workers. Workers who could not adapt to the new conditions in richer countries lost through lower incomes, because they were competing with low-cost foreign unskilled labour. Or they lost because of unemployment as their jobs were displaced by the low-cost foreign imports. Both globalization and technology are, according to this view, collectively responsible for the plight of the unskilled workers in the richer countries. Globalization was the catalyst, and the

Globalization and the political economy of international trade policy

11

technology changes were responses that marginalized unskilled workers in richer societies.36

GLOBALIZATION AND STANDARDS The case against globalization has aspects other than income distribution in rich countries. As has been observed, globalization reduces the policy discretion of national governments. If government policy is seen as necessary for social and economic improvement, it follows that globalization is not a desirable phenomenon.37 Globalization of capital markets, for example, diminishes the capability of government to tax because of tax competition, although there is also the opposite case that discipline imposed on governments is beneficial for taxpayers.38 In the context of international trade, issues in particular arise about the environment and labour standards.39 The global environment has been perceived as threatened by globalization because of the concern that the lowest national standards will prevail, that is, that there will be ‘a race to the bottom’ in environmental standards. Since environmental standards determine costs of production, producers in richer countries have reason to seek standards that allow them to have costs similar to foreign producers. Therefore the claim is that globalization will deteriorate environmental conditions in rich countries.40 Environmentalists with broader perspectives who care about global consequences may oppose free trade because they fear that lower environmental standards in poorer countries combined with the increased demand for the output of these countries in world markets will adversely aﬀect the global environment. Globalization also increases the demand for goods produced by workers who do not have the social protection provided to workers in richer countries and can therefore encourage child labour. There are, in particular, biases against educating girls in various poorer countries.41 Where the girls are employed in the production of goods for export, globalization increases the bias against educating girls, by providing demand for the girls’ output. The common source of the problems associated with the environment and labour standards is that globalization increases demand for the output of poorer countries. Generally, economic development is furthered when world demand for a poor country’s output increases. There were complaints that the richer countries, despite programmes such as the Generalized System of Preferences,42 impeded economic development by closing their markets to the goods of developing countries. Poorer countries did not, however, participate to the same extent as richer

12

Political economy

countries in the GATT rounds of reciprocal liberalization. Trade in goods produced by unskilled labour (such as in particular textiles) continued to be regulated. Many of the poorer countries moreover pursued policies of import substitution and were not interested in trade liberalization. The communist countries were also uninterested in trade liberalization. Through the 1990s changes occurred in poorer countries’ receptiveness to trade liberalization. Part of the process of globalization has been the participation of poorer countries in the multilateral trading system so that trade expanded between more dissimilar countries than previously, so introducing income-distribution issues and consequences of trade that had not previously been present.43 Market access for the goods of the developing countries has, however, become the source of complaint of opponents of globalization, albeit indirectly through the consequences of environmental and labour standards. Opponents of globalization indeed might oppose any growth in demand for output of poorer countries’ because of environmental and labour-standards issues. The opposition to globalization has focused on multinational ﬁrms with production facilities in developing countries that pay wages and employ workers according to local conditions and produce output that is sold at world market prices. The multinational ﬁrms often pay wages in excess of the norm in the local labour market and provide better working conditions than local employers. Protests should therefore perhaps be more vehement against local employers in poor countries than against multinational firms. Opponents of globalization perceive direct foreign investment as socially undesirable rather than a means of facilitating growth and technology transfer. Opponents of globalization also have reason to support export cartels because of lower output in poor countries due to collusive monopolistic pricing.44 Stringent environmentalists might find that they have common cause with domestic producer interests. NIMBYs favour free trade when an environmentally unfriendly good is produced abroad. Concern with the global environment, however, results in a position favouring protection, or closing market access to developing countries. If the richer country has a comparative advantage in an environmentally unfriendly good, the NIMBY position45 would favour reduced trade to reduce foreign demand for domestic output. Those concerned with the global environment also favour reduced trade, since world output is lower when protection has reduced world incomes.46 For labour standards, social concerns lead to objectives of reducing output produced by child labour in poor countries. Protection in the richer country achieves this objective by denying market access to output from the

Globalization and the political economy of international trade policy

13

poorer country where child labour is used. Globalization or liberal trade on the contrary increases demand for goods produced by child labour. The pre-globalization opponents of free trade also have an interest in protection, and improving foreign labour standards.47 Socially concerned groups that seek protection in the richer countries (or equivalently withdrawal from free trade in the poorer countries) thus can have allies in local industry in rich countries.48 The socially concerned groups are also allied with post-globalization opponents of free trade because of the consequences for incomes and employment of unskilled workers in the richer countries. Opponents of globalization have consistent objectives that could be achieved by corrective government policies in the poorer countries. The corrections by government would provide incentives to end child labour and in general to improve labour standards. Policies in poor countries could also resolve environmental externalities. We should therefore consider the behaviour of governments in poor countries. The political élites that rule in many poor countries in various cases have incentives to oppose improvement in the conditions of the poor in their countries. William Easterly (2001) has described the behaviour of governments in poor countries that have been recipients of World Bank financial and technical assistance. Easterly points out how living conditions of the poor in developing countries have failed to improve or have deteriorated despite the resources provided to governments to improve living conditions of the poor. The development failures did not stop the aid resources. Easterly notes that resources repeatedly disappear without helping those whom it is intended should be helped. Adjustment loans are given without adjustment, followed by more adjustment loans that are equally ineﬀective in resulting in the change that would open the economies to markets and growth and would raise the incomes of the poor. After debts reach critical levels, the debts are forgiven, and then indebtedness returns to levels where debts are again forgiven. Easterly observes that donors have no choice but to keep giving and to hope for better outcomes, because donors are donors and donors have good intentions. There is therefore a moral hazard problem. Resources are provided to help the poor but, if the development programmes were successful in fostering growth and improving the lot of the poor in poor countries, there would be no more poor, and so no more reason for resources to be provided to help the poor and to be appropriated by the political élites. Improvement in the living standards of the poor in poor countries would, however, increase demand of the population for improved environmental conditions. That is, environmental quality is generally described as a normal good, the demand for which increases with income.

14

Political economy

Growth of income would reduce child labour. Child labour is associated with low levels of family income, although also with social norms.49 Labour standards are part of keeping the poor in poor countries poor. Keeping the poor as poor sustains the incentives for parents to use their children as sources of income rather than sending them to school, because of the opportunity cost of schooling relative to other income-earning opportunities.50 Direct school costs may be too high for parents to pay, or there may be no school because public spending by the government has not provided schools and parents have not organized to self-finance schooling. The quality of the government’s schools may also be so low that parents regard the education provided as not worthwhile given the opportunity or direct supplementary costs. A reason for inadequate resources for schools can be that the country is poor and has insuﬃcient tax revenue to finance public spending on them. Corruption is another reason for inadequate schools: corrupt governments prefer not to spend on education because the opportunities for kickbacks and appropriation are greater from public spending on capital-intensive projects (such as roads and military equipment).51 Resources also may not reach the schools because the political élites who rule may prefer the population to remain uneducated. The middle class that would be created by broad access to educational opportunities would come to threaten the élites’ autocratic hold on power.52 Growth of incomes with more equal income distribution would alleviate or solve the problem of inadequate environmental and labour standards in now poor countries. Sustained poverty, on the other hand, keeps people insensitive to adverse environmental eﬀects and maintains inadequate labour standards. Since the political élites in poor countries have interests in keeping their populations poor,53 the policies and behaviour of governments and political élites in poor countries are suggested as the root cause of the problems that worry socially concerned groups in richer countries who oppose and protest against globalization. The protests, it would appear, should be directed against the governments in poor countries rather than international agencies that encourage open markets, growth, and more equal income distribution in poorer countries. The socially concerned groups that protest against the international agencies divert attention from the governments in poor countries whose policies keep their poor populations poor. Local political élites may also own local industry and so have an interest in local protection. The improvement in local wages and work standards due to multinational firms is not in the interest of the political élites. I oﬀer a personal anecdote. In a poor country a local manager of a multinational’s factory explained that members of the government had complained that wages in the factory were too high, since the salaries paid often exceeded

Globalization and the political economy of international trade policy

15

by a factor of two the salaries of cabinet ministers (still less than US$100 per month). Then, noting the time on his (real) Rolex watch, the minister said it was time for another appointment. We accordingly now confront the question why socially concerned groups in rich countries oppose the open markets made possible through globalization and do not direct their protests against the governments in the poor countries. Diﬀerent answers can be contemplated. It may not be feasible to protest against governments in the poorer countries ruled by political élites. Protests against the government oﬃces or outside rulers’ palaces in poor countries may not be met with the same tolerance and freedom of expression allowed in protests against international agencies. We can also return to the normative principle of government as only doing social good. The principle would be violated (it would be politically incorrect) if the socially concerned in rich countries protested against the policies of governments of poor countries. Yet the protest groups could disseminate information showing the overall level of literacy, the proportion of girls attending school, and the ranking of countries on a corruption index. Information on government policies toward the environment could also be disseminated, including whether members of the government or their families are involved in activities of selling or personally demolishing the rainforests for personal gain or employing child labour.

CULTURAL RELATIVISM Globalization is also criticized on grounds that indigenous cultures are threatened. We here enter the domain of cultural relativism.54 A culture may, for example, subjugate women and place no value on the education of girls since girls are destined to be chattels among their husbands’ many wives. In that case child labour of girls is part of the culture. The protest should be against the lack of freedom of women or the practice of mutilation of pubescent girls (so that a girl will not seek the company of a man other than to whom she has been sold). Cultural relativism and political correctness go hand in hand. The political correctness of cultural relativism would disallow reference to the cultural basis for the treatment of girls that underlies female child labour. Globalization has made the output of young girls more valuable for countries that have a comparative advantage in goods that young girls are adept are producing (following the standard Heckscher–Ohlin endowmentbased proposition). In competitive markets, the incomes of young girls will have increased because of globalization. If markets are not competitive, the exploitation is twofold: the girls should be at school but are not, and they

16

Political economy

are exploited and employed in quasi-slave conditions under which surpluses accrue to the employers.

CONCLUSIONS The political economy of positions regarding free trade and protection has changed during the course of globalization – where political economy has two interpretations, fi f rst that of policies chosen according to self-interest of the political decision makers, and second, a broader normative theme that has been expressed with reference to a principle that government necessarily acts in the public interest. Before globalization, the self-interest theme of political economy was expressed principally through descriptions of industry-specific interests seeking politically provided benefits and oﬀering political support or perhaps personal benefits in return. The theme of opposition to free trade in post-globalization political economy has been based on income distribution aﬀecting broad categories of factors of production rather than industry interests – although industry interests are present through common cause with proponents of social objectives involving the environment and labour standards.55 In the normative theme of political economy specified as how government is viewed, pre-globalization models used Musgrave’s policy separation to describe how decisions by government to depart from free trade had social merit on eﬃciency grounds, thereby sustaining the normative principle of government as acting in the social interest. In the post-globalization era, governments are also protected, by protests directed against markets rather than against the government policies (or absence of policies) that are the sources of the environmental and labour-standard problems that protestors wish to see resolved. The common theme that we identify in the political economy of pre- and post-globalization approaches to government is a normative principle that government acts in the public interest. The pre-globalization second-best and strategic-trade policy views did not address the reality of motives for departure from free trade because of governments’ political support and income distribution concerns. In the post-globalization era, governments in poorer countries are favoured by the absence of critical evaluation of their policies and by the direction of protest toward international agencies. A normative view of a government that only acts in the public interest does not allow questions to be asked that can be the basis for beneficial change. This was the case before globalization and remains the case, albeit with a diﬀerent focus, after globalization.

Globalization and the political economy of international trade policy

17

NOTES * 1. 2. 3. 4.

5. 6.

7. 8.

9. 10.

11. 12. 13. 14. 15.

Kym Anderson and other participants in the Festschrift conference provided helpful observations. I have also benefited from comments from Wilfred Ethier and Martin Richardson. A further problem associated with globalization is the spread of communicable disease. See Arhin-Tenkorang and Conceição (2003). For views of globalization, see for example Hirst and Thompson (1999) and the papers in the edited volume by Chan and Scarritt (2002). See Hillman (1989/2001). The explanations of protectionist trade policies pointing to political economy (or political objectives) and the explanations pointing to social welfare objectives and social insurance can be observationally equivalent. In either case protection can be provided to pre-empt decline in personal incomes or asset values. The diﬀerence is in the motives attributed to political decision makers (see my 1982 paper on protection of declining industries). The diﬀerence is whether we believe that policies are predicated on political support and electoral success. That is, people can be taxed or given government transfers without very much of a substitution eﬀect (in principle none at all) in labour supply or market demand. The theory of the second-best pointed out how, if markets could not achieve eﬃciency (or to use the terminology of the time, if markets were ‘distorted’), and if the ‘distortions’ could not be corrected, departure from free trade could be Pareto-improving and indeed Pareto-eﬃcient (see Bhagwati, 1971). Externalities, binding minimum wages and market power resulted in government acting in the public interest by departing from free trade. See my survey (Hillman, 2003b). In the simplest story a local and foreign firm are Cournot competitors in a third foreign market and the government helps the local firm with a subsidy that credibly allows the local firm to reduce price, and thereby increase market share and profits. If the firms are Bertrand competitors, a tax on the local firm is called for, to make credible an increase in price that provides higher profits. Because firms always seem to look with favour on the subsidy and with disfavour on the tax, some of us observed by an irreverent twist of logic that firms in practice must be Cournot rather than Bertrand competitors; this hinted, of course, at political-economy considerations that were missing. Third markets were not necessary for strategic trade policy. Protectionist policies are part of strategic trade policy recommendations when local and foreign firms compete in local markets. See Brander (1995). When a domestic and a foreign firm compete in a third market, protectionist instruments do not assist the domestic firm but an export subsidy allows an equilibrium to be established where the domestic firm has a larger market share and greater profits. That is, there may be political naïvety in assigning eﬃciency objectives to a political process that determines private benefits from government policy (although the models treat all private benefit as social benefit). We can also observe that strategic trade policy is nationalistic: the objective is to increase ‘home’ income by capturing the rents of the ‘foreigners’. Asset markets, however, blur the distinction between domestic and foreign becomes (see Lee, 1990; Dick, 1992). Furthermore, investors who have spread risk through diversification have no need for government policies that capture the rents of foreign firms (see Feeney and Hillman, 2001). See Lloyd and Grubel (1975). We could be led here into issues of political correctness. See my 1997 presidential address to the European Public Choice Society (Hillman, 1998). See, for example, chs 2 and 7 of Hillman (2003a). See, for example, ch. 6 of Hillman (2003a). The distinction here is in the reason why governments compromise the eﬃciency of free trade, that is, whether the compromise is for benevolent reasons of social welfare or

18

16.

17.

18. 19.

20.

21. 22.

23. 24. 25. 26.

27.

28. 29.

Political economy social insurance, or for political or personal reasons such as the objective of winning elections and remaining in oﬃce. Second-best and strategic trade policy models show how governments can achieve eﬃciency by departing from free trade and so eﬃciency is not compromised. Political support may be provided for contingent protectionist policies that allow trade policies to be used as a form of insurance; but still the political-economy element is that not everybody may be provided ex post with protection, and not with the same levels of protection. The specific-factors model of international trade (see Jones, 1971) sets out the basis for identifying industry interests earning rents as the gainers and losers from trade policies. These domestic industry-specific rents contrast with the rents of strategic trade policy, where the rents are captured from foreigners to increase national income. See my survey (Hillman, 2003b). Another view explains the models that economists choose in terms of self-interest. With personal incentives to publish, second-best opportunities for technical expression of variations on the theme of corrective policies were a boon to academic careers. The alternative of repeating the mantra of the gains from trade would not have provided the same opportunities for varied personal expression, nor for personal professional gain. There is also a view that maximizing income from consulting is facilitated by a complex second-best world where the nuances of discovering and recommending the socially correct policies require specialized professional and technical skills. The political-economy view of international trade policy has become accepted as included along with social objectives in the broad basis for investigating trade policies chosen by political decision makers. The earlier models of trade policy as the outcome of political-economy processes have been refined and expanded through diﬀerent portrayals of the micro-foundations of political behaviour (see, for example, Grossman and Helpman, 2002). For a fuller account, see my survey (Hillman, 2003c). If personal incomes were completely diversified to correspond to the asset composition of the economy, the personal incentives would be to seek free trade, since maximal national income would also provide maximal personal incomes. Schonhardt-Bailey (1991) has demonstrated the role of diversification of personal income sources in the repeal of the Corn Laws. Cassing (1996) has pointed out how management stock-option schemes reinforce protectionist sentiment among managers in contrast to the interests of diversified shareholders. Mayer (1984) has shown that incentives to vote on trade policy issues if trade policy were determined by voting are influenced by personal factor endowments or factor ownership. See also my paper with Feeney (Feeney and Hillman, 2004). See my paper with Moser (Hillman and Moser, 1996). On state trading, see Lloyd (1982). Such outcomes are endogenous to the requisites and restrictions through the GATT and WTO on the use of trade policy. Increasing imports in itself increases exports when a balanced trade constraint is binding. However, subject to balanced trade, imports can only be increased if there is foreign willingness to buy exports. Governments may also (in a mercantilist manner) seek to increase exports without increasing imports. This is not the way that motives for liberalization were generally expressed in economic theory. In a prominently told story, two countries’ governments have levied optimum tariﬀs through a process of retaliation and both are worse oﬀ than they could be back on the contract curve with free trade. That is, the governments are in a Nash equilibrium and would be mutually better oﬀ returning to free trade. Hence they negotiate free-trade agreements. For a focus on the terms of trade consequences of trade liberalization, see Bagwell and Staiger (2003). By mutually removing tariﬀs, governments forgo tariﬀ revenue but the tariﬀ revenue is converted to increased incomes for export-sector interests.

Globalization and the political economy of international trade policy 30.

31. 32. 33.

34. 35. 36. 37. 38. 39. 40. 41. 42. 43.

44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55.

19

See Ethier (2001). Opportunities for protectionist responses have been retained in postglobalization policy possibilities. The protectionism included under the GATT and then WTO rules facilitated trade liberalization by oﬀering insurance for political decision makers against changes in comparative advantage (see Ethier, 2002). Anti-dumping and escape clause provisions allow contingent protectionist recourses. International trade negotiations that liberalized international trade would have required contingency provisions that would have increased the transactions costs associated with reaching agreement, or may have made agreement not feasible. Globalization thus comes with an insurance contract for domestic producers and compensation for foreign producers. See Ethier (2002). As also do the insurance provisions of protection in the post-globalization era. See Ethier (2002). See, for example, Burtless (1995), Freeman (1995). The unskilled or unemployed in a rich country could benefit from domestic social policies, if adverse selection through migration allowed generous social policies to be sustained. On the relation between globalization and social transfer policies, see Rodrik (1998). For example, for a concept of fair wages in the post-globalization era, see Agel and Lundborg (1995). If the technology is the problem, there is also an age dimension, since older workers have a smaller interest in investing in the new technologies because of their limited time horizons. On age and resistance to new technology, see Canton et al. (2002). See Wood (1994). See Hirst and Thompson (1999). See Hillman (2003a, ch. 7). See, for example, Bhagwati and Hudec (1996) and Anderson (1997). In the case of NAFTA, trade liberalization accordingly included provisions regarding the environment. See Bommer and Schultze (1999). On the diﬀerent aspects of international environmental issues, see Schultze and Ursprung (2001). See my paper with Jenkner (Hillman and Jenkner, 2002) for data and references. On political elements in the GSP, see Ray (1987). Governments of richer countries were, for example, concerned whether producers in poorer countries would respect intellectual property rights. The poorer countries’ concerns with market access were reflected in emphasis on eliminating the multi-fibre agreement (MFA) that restricted trade in textiles. Agreement on intellectual property rights could be exchanged for agreement to end the MFA. For example, Rauscher (1990) asks whether cartels might alleviate the deforestation problem. NIMBY is the acronym for ‘not in my backyard’. See my paper with Ursprung (Hillman and Ursprung, 1992). See Hefeker and Wunner (2002). An example suggesting capture of socially concerned groups by narrow protectionist interests is the case of dolphin-friendly tuna. See Körber (1998). See Basu and Hoang (1998). On social norms, see Katav-Herz (2001). See my paper with Jenkner (2004). See Mauro (1997), Gupta et al. (2001). See Easterly (2001). An alternative view involving hostages is that globalization results in ‘political elites being held hostage to market forces in a competitive “race to the bottom” regarding policies on taxes, labour, and social welfare’ (Richards and Gelleny, 2002, p. 66). See, for example, Etounga-Managuelle (2000) and Shweder (2000). The process of trade liberalization that was a component of globalization also had a political-economy dimension, as governments entered into agreements that exchanged market access, which compromised interests of import-competing sectors and advantaged export sectors.

20

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Feeney, J. and A.L. Hillman (2001), ‘Privatization and the political economy of strategic trade policy’, International Economic Review, 42, 535–56. Feeney, J. and A.L. Hillman (2004), ‘Trade liberalization through asset markets’, Journal of International Economics, 64, 151–67. Freeman, R.B. (1995), ‘Are your wages being set in Beijing?’, Journal of Economic Perspectives, 9, 15–32. Grossman, G.M. and E. Helpman (2002), Interest Groups and Trade Policy, Princeton, NJ: Princeton University Press. Gupta, S., L. de Mello and R. Sharan (2001), ‘Corruption and military spending’, European Journal of Political Economy, 17, 749–77. Hefeker, C. and N. Wunner (2002), ‘The producer interest in foreign labour standards’, European Journal of Political Economy, 18, 429–47. Hillman, A.L. (1982), ‘Declining industries and political-support protectionist motives’, American Economic Review, 72, 1180–87. Hillman, A.L. (1989), The Political Economy of Protection, Chur: Harwood Academic Publishers, 3rd printing 2001, London: Routledge. Hillman, A.L. (1998), ‘Political economy and political correctness’, Public Choice, 96, 219–39 (Presidential Address, European Public Choice Society, Prague, April 1997). Hillman, A.L. (2003a), Public Finance and Public Policy: Responsibilities and Limitations of Government, New York: Cambridge University Press. Hillman, A.L. (2003b), ‘International trade policy: explaining departure from Free Trade’, in C. Rowley and F. Schneider (eds), Encyclopedia of Public Choice, Dordrecht: Kluwer (CEPR Discussion Paper 3707), pp. 129–38. Hillman, A.L. (2003c), ‘International trade policy: Globalisation and trade liberalization’, in C. Rowley and F. Schneider (eds), Encyclopedia of Public Choice, Dordrecht: Kluwer (CEPR Discussion Paper 3845), pp. 312–20. Hillman, A.L. and E. Jenkner (2004), ‘User payments for basic education in low-income countries’, in S. Gupta, B. Clements and G. Inchauste (eds), Helping Countries Develop: The Role of Fiscal Policy, Washington DC: International Monetary Fund, pp. 233–64. Hillman, A.L. and P. Moser (1996), ‘Trade liberalization as a politically optimal exchange of market access’, in M. Canzoneri, W.J. Ethier and V. Grilli (eds), The New Transatlantic Economy, New York: Cambridge University Press, pp. 295–312, reprinted 2002 in K. Anderson and B. Hoekman (eds), The Global Trading System, vol. 2, Core Rules and Procedures, London and New York: I.B. Tauris and Co Ltd. Hillman, A.L. and H.W. Ursprung (1992), ‘The influence of environmental concerns on the political determination of international trade policy’, in R. Blackhurst and K. Anderson (eds), The Greening of World Trade Issues, Brighton: Harvester Wheatsheaf, pp. 195–220. Hirst, P. and G. Thompson (1999), Globalization in Question, 2nd edn, Cambridge: Polity Press. Jones, R.W. (1971), ‘A three-factor model in theory, trade, and history’, in J.N. Bhagwati, R.W. Jones, R.A. Mundell and J. Vanek (eds), Trade, the Balance of Payments, and Growth: Essays in Honor of Charles B. Kindleberger, Amsterdam: North-Holland, pp. 3–21. Katav-Herz, S. (2001), ‘Social conformity and child labour’, paper presented at European Public Choice Society Conference, Paris.

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Körber, A. (1998), ‘Why everybody loves Flipper: The political economy of the U.S. dolphin-safe laws’, European Journal of Political Economy, 14, 475–509. Lee, S. (1990), ‘International equity markets and trade policy’, Journal of International Economics, 29, 173–84. Lloyd, P.J. (1982), ‘State trading and the theory of international trade’, in M.M. Kostecki (ed.), State Trading in International Markets, London: Macmillan. Lloyd, P.J. (2001), ‘The architecture of the WTO’, European Journal of Political Economy, 17, 327–53. Lloyd, P.J. and H. Grubel (1975), Intra-Industry Trade: The Theory and Measurement of International Trade in Diﬀerentiated Products, London: Macmillan. Mauro, P. (1997), ‘The eﬀects of corruption on growth, investment, and government expenditure: a cross country analysis’, in K. Elliot (ed.), Corruption and the Global Economy, Washington, DC: Institute for International Economics. Mayer, W. (1984), ‘Endogenous tariﬀ formation’, American Economic Review, 74, 970–85, reprinted 2004 in J.N. Bhagwati and B.P. Rosendorﬀ (eds), Readings in the Political Economy of Trade Policy, Cambridge, MA: MIT Press. Musgrave, R. (1959), The Theory of Public Finance, New York: McGraw-Hill. Rauscher, M. (1990), ‘Can cartelization solve the problem of tropical deforestation?’, Weltwirtschaftliches Archiv, 126, 378–87. Ray, E. (1987), ‘The impact of special interests on preferential trade concessions by the U.S.’, Review of Economics and Statistics, 69, 187–95. Richards, D.L. and R.D. Gelleny (2002), ‘Is it a small world after all?: Globalisation and government respect for human rights in developing countries’, in S. Chan and J.R. Scarritt (eds), Coping with Globalisation, London: Frank Cass, pp. 56–88. Richardson, M. (1996), ‘Comment’ in M. Canzoneri, W.J. Ethier and V. Grilli (eds), The New Transatlantic Economy, New York: Cambridge University Press, pp. 312–16. Rodrik, D. (1998), ‘Why do more open economies have bigger governments?’, Journal of Political Economy, 106, 997–1032. Schonhardt-Bailey, C. (1991), ‘Specific factors, capital markets, portfolio diversification, and free trade: Domestic determinants of repeal of the Corn Laws’, World Politics, 43, 545–69. Schultze, G. and H.W. Ursprung (eds) (2001), Globalization and the Environment, Oxford: Oxford University Press. Shweder, R.A. (2000), ‘Moral maps, first-world conceits, and the new evangelists’, in L.E. Harrison and S.P. Huntington (eds), Culture Matters, New York: Basic Books, pp. 158–72. Wood, A. (1994), North–South Trade, Employment, and Inequality: Changing Fortunes in a Skill-Driven World, Oxford: Clarendon Press.

PART TWO

WTO Issues and Trade Negotiations

2.

The economic crisis, labour standards and trade performance in East Asia Keith E. Maskus*

1.

INTRODUCTION

It is a pleasure to honour Peter Lloyd, who for decades has been at the top rank of applied international trade economists. Peter has made fundamental contributions in trade measurement, in the theory of trade policy, and in empirical analysis of trade restrictions. He has also been intimately involved in considering the role of trade in the development of East Asian economies. In that context, I am delighted to oﬀer this chapter. In this chapter I analyse a question that is both straightforward and diﬃcult to answer: ‘Did the economic crisis in East Asia of the late 1990s have the eﬀect of weakening labour rights in those countries, with a consequent increase in export performance of labour-intensive manufacturing goods?’ The question seems straightforward because, as has been suggested in the popular literature, collapsing economic conditions would be expected to diminish social protection and because, as civil society would have it, such diminution would expand export competitiveness. It is diﬃcult to answer both because the logic is far more complex and because available data are poorly suited to the task. Despite these diﬃculties the question is of considerable interest and deserves analytical attention. To this end I review available evidence on relationships between labour standards and trade, then go on to an empirical analysis of the recent East Asian experience. The data suggest that exports of labour-intensive goods may have increased in those countries that were hit hardest by the crisis. The econometric analysis, however, finds no indication of a negative relationship between labour rights and export performance. Indeed, the data are consistent with a positive impact of labour rights on exports, even in the crisis period. In the next section I discuss why the relationship between labour standards and trade is complex and also theoretically ambiguous. In Section 3 25

26

WTO issues and trade negotiations

I describe recent regulatory experience in East Asia and in Section 4 I provide an empirical analysis of the crisis period. In Section 5 I make brief concluding comments.

2.

DO WEAK LABOUR STANDARDS REDUCE COSTS AND ENHANCE COMPETITIVENESS?

It is intuitive that weak protection of workers’ rights and inadequate working conditions reduce the costs of hiring a worker and therefore may increase international price competitiveness and exports. For example, the ability of firms to require employees to work long hours without a premium for overtime payments, or the willingness of firms to discharge workers with little notice or severance pay, presumably reduces their labour costs per unit of output, which may be significant in labour-intensive products. However, this basic proposition is not necessarily correct. The idea that exports are promoted by weak labour standards rests on the presumption that labour standards act as an ineﬃcient tax on labour use – and thus that weakening such standards would diminish this tax and output and exports would expand.1 The diﬃculty is that this view presumes that labour and product markets are otherwise undistorted. In reality the link between weak labour rights and trade is more complicated.2 Consider, for example, an economy in which firms are permitted to discriminate against women or ethnic groups by paying them wages below marginal revenue products. Firms may achieve cost savings directly on these workers but forgo potential profits by failing to hire more of them at higher wages. Put diﬀerently, in a discrimination equilibrium, firms hire fewer workers than optimal, making output (and exports) lower than would be the case in the non-discriminatory (and eﬃcient) equilibrium. In brief, discrimination can be an obstacle to both economic eﬃciency and social development.3 Similarly, if a single firm hires workers in a monopsonistic fashion because of restraints on the ability of workers to organize and bargain collectively, that firm will hire fewer workers, albeit at a lower wage, than would be the case in a competitive labour market. As a result, output and exports would be diminished again. The introduction of freedom of association and bargaining rights would raise wages but could actually increase exports, depending on the union’s bargaining strategy.4 As a final example, consider the failure of firms to provide their workers with information about the inherent occupational hazards of their jobs. Without such information, workers may accept wages that are too low to compensate them for uncertainty about accidents and may take excessive

The economic crisis, labour standards and trade performance in East Asia

27

risks on the job site. Here is a case where price competitiveness is probably enhanced by weak labour rights, at least in the short run, particularly if employers do not need to cover accident compensation costs. Over time, as workers come to understand these hazards, their wage–risk profile would reflect them more eﬃciently, unless employers can sustain the asymmetric information through hiring from an uninformed labour pool (for example, new workers coming from the countryside). Employers would then expose themselves to additional training costs and to reduced attachment of workers to the firm, making the net long-term impact on competitiveness ambiguous. These examples presume that standards are weak in the export sectors, which may be true in the case of labour-intensive manufactures, mining and forestry. However, if poor working conditions exist predominantly in import sectors, non-traded goods and services, and the informal economy, and if this situation reduced costs and attracted labour, general-equilibrium pressures would end up reducing exports under many circumstances.5 Some mixture of these conditions exists in most poor countries, implying that the implications for trade of strengthening labour rights are generally ambiguous. A final relevant observation is that, empirically, countries in which labour standards are poorly developed and working conditions are abhorrent tend also to be countries in which democratic processes, transparency, openness and clean governance are in short supply.6 In this context, even if weak labour rights were thought to lower costs and improve competitiveness, it would be diﬃcult to isolate these eﬀects because the other problems could dominate. For many reasons, therefore, the empirical problem is diﬃcult, even in theory.

3.

LABOUR STANDARDS IN INDIVIDUAL EAST ASIAN ECONOMIES7

It is interesting to compare key East Asian economies in their policies regarding worker rights and support programmes in recent years. Table 2.1 provides information on the decisions of ten economies regarding ratification of the eight ‘fundamental’ conventions of the International Labour Organization (ILO), which cover core labour standards. Many of the ratifications have taken place since 1996 and the table lists such cases in bold. On this evidence, worker protection standards have actually improved since the economic crisis. However, countries diﬀer in their ratification decisions. China has ratified two of the eight conventions. Hong Kong (China) is not a member of the ILO but complies with five of

28

Yes Yes Yes Yes Yes Yes Yes

Yes Yes Yes Yes No No No

Yes No Yes* Yes No Noa Yes Noa Yes No

Yes No Yes No Yes Yes No

Abolition of forced labour (105)

Yes No Yes*

Forced labour (29)

Yes Yes Yes Yes Yes Yes Yes

Yes Yes No

Equal remuneration (100)

Yes Yes No Yes No No Yes

Yes No No

Nondiscrimination (111)

Sources:

OECD (2000) and ILO website www.ilo.org.

Notes: * Hong Kong (China) is not a member of ILO but has issued its intention to comply with the conventions indicated. a Malaysia and Singapore have denounced Convention 105. Words in bold indicate ratiﬁcation decisions since 1996.

No No n.a.

Worst forms of child labour (182)

Yes Yes Yes*

Minimum age (138)

Ratiﬁcations of fundamental ILO conventions covering worker rights

Cambodia China Hong Kong (China) Indonesia Rep. of Korea Malaysia Philippines Singapore Thailand Vietnam

Table 2.1

Yes No No Yes No No No

Yes No Yes*

Freedom of association (87)

Yes No Yes Yes Yes No No

Yes No Yes*

Collective bargaining (98)

The economic crisis, labour standards and trade performance in East Asia

29

the conventions. Indonesia has ratified all eight conventions, while the Philippines has ratified seven. The Republic of Korea has ratified those covering child labour and discrimination but has chosen not to ratify those covering union rights and forced labour. Malaysia and Singapore have ratified the fewest conventions and both have taken exception to the provisions of Convention 105 on the Abolition of Forced Labour. The number of ILO convention ratifications cannot be taken as a reliable measure of worker protection. Ratification indicates only an intention to comply with a convention and may in some instances not reflect actual labour market policies, for the ILO has little scope for enforcing these rights. Turn now to recent legislative history in key countries. China has ratified ILO Convention 138, calling for a minimum age at which work may be undertaken full time. China’s law bans work for children under age 16 and there are particular provisions regulating work by those aged 16 or 17. China has ratified ILO Convention 100 calling for equal remuneration for equal work between men and women. However, China has not ratified other fundamental conventions. Overall, China maintains an approach that is not particularly supportive of union rights. It has only one oﬃcially recognized national union and applications to establish a union at the enterprise or professional level are denied. Because such unions are not recognized, their operations are illegal and leaders have at times been detained. China does not recognize the right to strike, though strikes do occur. Collective bargaining is not permitted within state-owned enterprises and the negotiation of collective agreements in other enterprises seems to be restricted. Hong Kong (China) has long recognized the right to form and join unions, but the government does not encourage the use of collective bargaining. Employers may be fined if they prevent a worker from joining a union. There is a significant restriction on the right to strike, for employers may summarily discharge an employee who is absent from work for this reason. However, if such discharges are seen as intimidating, the employers may be fined and subject to criminal proceedings. Indonesia traditionally has recognized the right to form a union but placed significant conditions on unions, such as minimum number of workers per plant, number of provinces represented, and the like, before certification could be issued. Before President Suharto’s resignation in 1998, only one trade union federation was recognized and the government heavily interfered in its activities. Since 1998, many such restrictions have been relaxed and numerous new unions and trade union confederations have been certified, though there remain problems with registration of workplace-level units. The unionization rate is still low at around 5 per cent.

30

WTO issues and trade negotiations

The rights to strike are strongly limited by mediation and notification requirements, which prevent most strikes from being declared legal. Leaders of illegal strikes have often been detained. Despite a more prolabour environment since 1998, there remain allegations of discrimination against union members and interference by employers with union activities. Finally, discharges from employment require approval by a committee of workers, employers and government oﬃcials, and there are mandatory severance payments. Korea’s labour laws have become markedly friendlier to organized worker interests, in part to become more consistent with OECD practices.8 Before 1997, the law in Korea permitted only one labour union per company and there were strict restraints on the formation of national confederations. New legislation in 1997 and 2002 established a more liberal environment in which labour union pluralism is recognized and a number of national federations have emerged. Public workers have rights, though limited, to form representative associations. The rights to strike remain prohibited for government workers and are restricted for workers in essential services. In other areas the rights to strike are recognized, subject to notification requirements and cooling-oﬀ periods. Collective bargaining rights are now respected in the law and there is legal protection against retribution for participating in strikes. Korea implemented a law protecting workers from arbitrary dismissal in 1999 and there are mandatory severance payments for fi f red workers. For its part, the ILO (1998) described Korea’s changes as a comprehensive set of economic and social measures to cope with the ffinancial crisis. Malaysia retains significant restraints on union formation. Unions can be denied legal recognition if authorities think they may be used for ‘unlawful purposes or other reasons’. Unions can only represent workers in similar industries or professions, precluding the emergence of national unions. These restrictions keep unionization low at around 9 per cent. The right to strike is heavily restricted by requirements for compulsory arbitration and government authorities can take disputes to court, an act that delays the onset of strikes. Strikes in a comprehensive set of essential services are illegal. Laws that protect unions from discrimination protect collective bargaining, but enforcement is alleged to be weak. Workers in ‘pioneer’ industries do not have full collective bargaining rights. Malaysia requires employers to give advance notification before ffiring workers, and mandatory severance payments, though this latter requirement has a relatively low compliance rate. The Philippines has a high rate of unionization, at around 27 per cent of the workforce. To be registered, a union must represent at least 20 per cent of the workers in a bargaining class, and there also are minimum representation requirements for establishing a national federation, but these restrictions do not seem particularly onerous. For a strike to be legal, there must be

The economic crisis, labour standards and trade performance in East Asia

31

majority approval among workers, prior notification and a cooling-oﬀ period, while authorities can declare strikes illegal in a broad set of strategic industries. Finally, legislation gives employees protection from arbitrary dismissal, though anti-union practices persist in an environment of weak enforcement. There are prior notification requirements and mandated severance payments. It is noteworthy that there have been marked improvements in labour relations within publicly managed export processing zones since the mid-1990s.9 Thailand permits freedom of association in order to establish unions in the private sector but the government retains restrictions on organization rights within large state-owned enterprises. The level of unionization is quite low at around 2 per cent. Authorities can prohibit strikes in the private sector, while strikes by workers in state companies are illegal and are prohibited in essential services. The government sets wages in state enterprises, thereby significantly restricting collective bargaining. Anti-union discrimination is illegal in the private sector but encounters weak enforcement. To summarize, legislated labour standards have not been reduced in the East Asian region since 1997. There is some evidence of a general trend toward raising them, at least as indicated by ratification of fundamental ILO conventions. However, only Korea has significantly strengthened its regulatory framework for labour protection and China has done little to improve its formal recognition and protection of union rights. Meanwhile, allegations persist that governments raise roadblocks to union activities while the enforcement of labour laws is often thought to be weak.10 It is important to note that these regulations have little direct relevance for labour conditions in the informal sectors of East Asian economies. Workers in the informal economy have few rights and may work in conditions that are less sanitary and more dangerous than those in formal employment.11 Moreover, child labour tends to be concentrated in informal sectors. Employment in the informal economy depends on many factors, including the cost impacts of labour regulations in the formal economy. The strongest short-run determinant of changes in informal employment is overall growth in the economy. In this regard, one impact of the Asian crisis was a temporary shift toward informal employment in many East Asian economies,12 which suggests that working conditions on average have deteriorated.

4.

CHANGES IN LABOUR-INTENSIVE MANUFACTURED EXPORTS

Despite the numerous diﬃculties in interpreting such exercises, it is illustrative to look at some simple indicators of export performance in East

32

WTO issues and trade negotiations

Asian developing economies since the onset of the financial crisis. Presumably weak labour standards are capable of expanding exports most readily in such labour-intensive goods as apparel, textiles, footwear and miscellaneous manufactures (for example, toys and sporting goods). It is interesting to examine changes in these impacts over the crisis period. There are several reasons why the financial crisis may have reduced relative costs of production in labour-intensive exports. Even if legislated labour standards were not diminished in this period, it is conceivable that authorities signalled a reduced commitment to enforcement of labour rights within labour-intensive goods. Another possible reason is that the costs of acquiring inputs from subcontractors may have fallen relatively sharply during the crisis if wages fell in those firms. A third is that exchange-rate changes may pass through more quickly to competitive sectors. Under such circumstances, one would anticipate that eﬀectively weaker standards would have raised the share of labour-intensive manufactures in total exports between 1995 (pre-crisis) and 1999 in East Asia. Figure 2.1 shows the shares of labour-intensive products – textiles, apparel, footwear and miscellaneous goods – in total manufactured exports for eight economies. In the relatively high-income economies, the crisis did not shift resources into export production of labour-intensive goods. Rather than rise, China’s share of labour-intensive manufactured exports fell in all export markets over the period as a whole, though it rose in 1999 to Japan. These shares fell in Hong Kong (China) as well, though less dramatically to the EU and the United States. Korea’s labour-intensive export share also fell in all markets over the period, as did Malaysia’s and Taiwan (China)’s. Indonesia is unusual among the economies illustrated, for its share of labour-intensive exports to all markets rose between 1997 and 1998 (data were not yet available for 1999). Specialization therefore moved marginally in Indonesia toward labour-intensive goods, while Thailand’s shares fell marginally. These results cannot reveal much about how labour standards aﬀected changes in trade shares, because numerous other factors could have driven these changes. Most obviously, each of these economies, except perhaps China and Indonesia, has seen its output mix shift away from labourintensive goods over time because of shifts in comparative advantage. Another factor is that exports of apparel and textiles to key markets may be constrained by quotas not to increase beyond certain annual growth rates in volume terms. At best, the results simply do not support the notion that weaker eﬀective labour conditions during the crisis accommodated an increase in the relative export performance of labour-intensive goods.13

The economic crisis, labour standards and trade performance in East Asia China

45 43 41 39 37 35 33 31 29 27 25

1995 1996 1997 1998 1999

Total

EU

Japan

Malaysia

9 8 7 6 5 4 3 2 1 0

1995 1996 1997 1998 1999

Total

USA

33

Hong Kong (China)

EU

Japan

USA

Philippines

50

30

45

25 1995 1996 1997 1998 1999

40 35 30

1995 1996 1997 1998 1999

20 15 10 5

25

0 Total

EU

Japan

Total

USA

Indonesia

50 45 40 35 30 25 20 15 10 5 0

EU

Japan

USA

Taiwan (China)

19 17 1995 1996 1997 1998

1995 1996 1997 1998 1999

15 13 11 9 7 5

Total

EU

Japan

USA

Total

Korea

23 21 19 17 15 13 11 9 7 5

EU

Japan

USA

Thailand

35 30 1995 1996 1997 1998 1999

1995 1996 1997 1998 1999

25 20 15 10 5

Total

EU

Japan

USA

Total

EU

Japan

USA

Note: The calculations are made for total exports and for exports to the EU, Japan and the USA. They are based on data from the World Bank’s Production and Trade Database. Labour-intensive manufactures are deﬁned as ISIC categories 321, 322, 323, 324, 325, and 390. These comprise textiles, apparel, footwear and miscellaneous manufactures.

Figure 2.1 Shares of labour-intensive manufactured exports, 1995–99 (per cent)

34

5.

WTO issues and trade negotiations

ECONOMETRIC ANALYSIS: LABOUR STANDARDS AND LABOUR-INTENSIVE EXPORTS

I undertake an econometric analysis to test the hypothesis that labour standards aﬀected East Asian exports of labour-intensive goods, and did so more strongly after the onset of the crisis. For this purpose, bilateral exports data from 17 developing-country exporters to 20 OECD importers were assembled. Three measures of labour standards are selected, corresponding to Models 1 through 3 below. The first (Model 1) is an index of the strength of freedom of association rights (FA rights) in exporting nations in 1996 (applied to the 1995 data here) and 2000 (applied to the 1999 data here), developed by the OECD (2000). This index takes on the values 1, 2 or 3 in our sample of exporters. In those countries with index value 1, such rights are ‘practically non-existent’ (China, Indonesia and Egypt in 1995 among the exporters included here). In those countries with index value 2, restrictions on FA rights are significant or it is diﬃcult to form union confederations (Colombia, South Korea, Malaysia, Pakistan, the Philippines and Thailand in 1995).14 In those countries with index value 3, some restrictions exist but it is possible to establish confederations (Argentina, Brazil, Chile, India, South Korea, Mexico, Peru, Venezuela and South Africa).15 The 2000 index values were the same as the 1995 values except that Korea and Indonesia were moved up one category. This suggests that measured freedom of association rights were not endogenous to the crisis in the sense of being weakened. The second measure (Model 2) is an index of four labour standards developed by Verite (2002). A single value of this index (VERLS) exists only for each country in the late 1990s and is applied in both the 1995 and 1999 regression equations. The third measure (Model 3) is the number of the eight fundamental ILO conventions (ILO–F) that were ratified by the exporting countries by 1995 or 1999. It should be noted that number of ratifications is a questionable indicator of a country’s actual commitment to strong labour rights, but these measures have been commonly used in the literature. Very few countries reduced the number of conventions they had ratified, though a number did ratify more during the crisis period, as noted earlier in this chapter. Again, these changes suggest that labour rights were not weakened by the crisis. Since there were very few legislated changes in labour rights and no useful data are available on enforcement, available data do not permit us to track the dynamics of changes in trade and labour standards over the crisis period. Rather, the intention underlying the regressions is to determine whether relative diﬀerences in the strength of labour standards

The economic crisis, labour standards and trade performance in East Asia

35

across exporting nations generated stronger impacts on trade in 1999 than in 1995. Table 2.2 presents results for all variables used to augment the basic gravity equation.16 Interestingly, Mexico’s membership in NAFTA increased its labour-intensive exports above anticipated levels and this eﬀect increased between 1995 and 1999. The regional dummies are generally significant and positive except in Model 3, where labour standards are measured by ratification decisions on fundamental ILO conventions. The analysis incorporates an index of political freedoms in the exporting countries in order to control for the fact that diﬀerential labour standards may simply reflect weaknesses in the broader policy environment. As may be seen, an increase in the political freedom index exerted a significantly negative eﬀect on bilateral exports of labour-intensive products in each model. This seems surprising, given that the equations control for market size and distance. It may well be that the index is picking up the influence of comparative advantage; as economies become richer (and political freedoms tend to improve) their export bundles shift away from labour-intensive goods. Looking next at the results for freedom of association rights in Model 1, across all developing countries in the sample, the average coeﬃcient is positive and significant in both years. Thus, rather than finding that weak labour standards increase export performance, the opposite seems true. Note that because the dependent variable is the log of bilateral exports and the independent variable is an index in levels, the coeﬃcient is not an elasticity. Accordingly, below each coeﬃcient the table reports the associated elasticity computed at the sample mean for FA rights. These figures suggest that bilateral exports of labour-intensive goods respond elastically to marginal improvements in labour rights. To isolate the impacts of freedom of association rights in East Asia, I include interaction terms for three regions. In 1995 the interaction coeﬃcient for East Asia was significantly positive, suggesting that the direct response of exports from increased labour rights was even stronger in East Asia than on average. Indeed, the elasticity is 2.13, suggesting that a 1 per cent increase in union rights would expand the average bilateral export flow of East Asian developing countries by more than 2 per cent.17 However, this eﬀect was smaller in 1999 and the East Asian coeﬃcient is not significantly diﬀerent from the average. This may provide some indication that stronger labour rights had a relatively smaller positive impact on exports of labour-intensive goods by the later year. However, it hardly supports a claim that weak labour protection was a source of export competitiveness. The coeﬃcient estimates on the South Asian and Latin American

36

WTO issues and trade negotiations

Table 2.2 Impacts of labour standards on labour-intensive exports from developing countries Variable NAFTA Political freedom East Asia South Asia Latin America FA rights

Model 1 (1995)

Model 2 (1995)

Model 2 (1999)

Model 3 (1995)

Model 3 (1999)

2.37*** 3.53*** 2.52*** 3.62*** 2.07*** 2.86*** 0.30*** 0.19*** 0.82*** 0.91*** 0.27*** 0.11**

1.05* 8.18*** 2.37** 0.60*** (1.37) FA rights 0.94*** East Asia (2.13) FA rights 2.42*** South Asia (0.71) FA rights 1.18** Latin America (0.27) VERLS VERLS East Asia VERLS South Asia VERLS Latin America ILO–F ILO–F East Asia ILO–F South Asia ILO–F Latin America No. of obs. R2

Model 1 (1999)

1700 0.74

3.13*** 2.80*** 5.46*** 16.9*** 1.34 1.55* 0.66*** (1.59) 0.32 (1.32) 1.52*** (1.15) 1.03** (0.57) 0.09*** (5.28) 0.01 (5.41) 0.21*** (3.31) 0.03** (4.56)

1700 0.76

1700 0.75

4.28*** 1.59*** 0.05 6.11*** 0.09 1.56 6.18*** 0.69 0.72

0.14*** (8.22) 0.02 (7.81) 0.04 (7.94) 0.11*** (5.57)

1700 0.77

0.16** 0.52*** (0.62) (2.69) 0.38*** 0.42** (0.10) (1.93) 0.85*** 0.71*** (0.23) (2.25) 0.19** 0.27 (0.92) (3.27) 1700 1700 0.74 0.77

Notes: The coeﬃcients come from gravity models of bilateral exports of labour-intensive industries from 17 developing countries to 20 OECD importers listed below. Each equation is estimated as an augmented gravity model with controls for importer and exporter GDP, importer and exporter population, bilateral distance, and industry ﬁxed eﬀects. Standard errors are robust to heteroscedasticity. *** indicates signiﬁcantly diﬀerent from zero at 1% level, ** at the 5% level, and * at the 10% level.

The economic crisis, labour standards and trade performance in East Asia

37

Figures in parentheses are elasticities calculated at sample means. Data on GDP (in billions of dollars in purchasing power parity terms) and population (in millions) are from the World Development Indicators (2001). Distance is the number of kilometres (in thousands) between capital cities. The index of political freedoms is the simple average of the ‘political freedom’ and ‘civil liberties’ indicators from Freedom House (www.freedomhouse.org), re-scaled so that an increase in the index here signiﬁes an increase in political rights. Labour-intensive industries are deﬁned as ISIC 321, 322, 323, 324 and 390. Exporters are Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela (Latin America); India, Pakistan (South Asia); China, Indonesia, South Korea, Malaysia, the Philippines, Thailand (East Asia); Egypt and South Africa. Importers are Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Japan, Ireland, Italy, Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Turkey, the UK and the USA.

dummies are negative and significant, suggesting that lower labour standards were more positively associated with labour-intensive exports than average. However, to make a proper comparison across groups requires calculating the associated elasticities, which depend on the share of these countries in the sample of exporters.18 As may be seen, these elasticities are positive for both South Asia and Latin America, suggesting that in all three regions an improvement in labour rights actually expands labourintensive exports. However, while the elasticity estimates for South Asia are significantly bigger than zero, those for Latin America are not.19 Interestingly, unlike the East Asian case, in both of these regions the elasticities became higher in 1999. Across the whole sample, the coeﬃcient of the second measure of labour standards is significantly positive in both years, again suggesting that higher standards are associated with greater exports of labour-intensive goods. In this case the estimated elasticities are quite high. The coeﬃcients on the East Asian interaction term are zero, meaning that countries in that region do not behave diﬀerently from average. Finally, while the marginal coeﬃcients on South Asia and Latin America are negative and usually significant, the estimated elasticities remain significantly positive. Again, using this measure there is no evidence that weak labour standards provide an advantage in labour-intensive exports. The third measure of labour rights, the number of fundamental ILO conventions (of a maximum of eight) that a country has ratified, tells a diﬀerent story. On average, the coeﬃcients are negative and significant, suggesting that countries that have ratified more conventions tend to export a smaller volume of labour-intensive products. It happens that those countries with higher ratification numbers tend to be among the smaller exporters of manufactured goods (Argentina, Colombia, Peru, Venezuela and Egypt).20 With respect to East Asia, it is interesting that the coeﬃcients on the

38

WTO issues and trade negotiations

interaction terms are positive, suggesting that this inverse relationship is weaker in that region. In fact, the elasticity of exports with respect to ILO ratifications is not significantly diﬀerent from zero in 1995 for East Asia, though it is in 1999. Why do the results using the third measure diﬀer from those using the first and second? Close consideration of the three measures provides insight. The OECD measure of FA rights is directly keyed on a central and fundamental basic labour right. The Verite index combines four approaches but its incorporation of enforcement and eﬀective recognition of four core labour standards makes it also focused on basic rights. Thus, both these measures are suited to analyse the impacts of core labour protection on export performance. These impacts appear to be positive. On its face, the third measure – the number of ILO ratifications – should also be an indicator of core labour rights. However, as explained earlier, it is a questionable measure of actual commitment to improved working conditions. Indeed, in the present sample of developing-country exporters, it may proxy for inflexibility in labour markets, since the highest ratification numbers exist in countries that have the strongest security and survival rights in the formal sector. Forteza and Rama (2001) developed an index of labour-market rigidity and found that among developing countries the average index was 0.18 in East Asia, 0.32 in Latin America and the Caribbean, and 0.27 in South Asia. Meanwhile, the total number of ILO conventions ratified (as opposed to the eight basic ones) on average was 9.35 in East Asia, 37.65 in Latin America and the Caribbean, and 23.71 in South Asia.21

6.

CONCLUDING REMARKS

To summarize the econometric results, two of our three measures of labour standards suggest that bilateral export volumes in labour-intensive goods actually rise as worker protection is increased, a finding that is particularly true within East Asia. The balance of evidence does not support the view that weak labour rights promote exports in these goods, nor does it suggest decisively that during the economic crisis weak labour rights translated into stronger labour-intensive exports. On these grounds, an appropriate policy message is that East Asian developing countries need not delay the introduction of core labour standards, for doing so will not reduce their competitiveness in labour-intensive manufactured exports and could well increase it. However, caution might be urged in terms of implementing stronger measures that could limit flexibility in formal labour markets.22

The economic crisis, labour standards and trade performance in East Asia

39

NOTES * 1.

2. 3. 4.

5. 6. 7. 8. 9. 10.

11. 12. 13.

14. 15.

16.

17.

18.

This chapter draws on an extensive report the author prepared for the World Bank, an abridged version of which was published in World Bank (2004). Brown et al. (1996). Note that this view suggests that countries with weak labour standards suﬀer a terms of trade loss on their exports or, put diﬀerently, that they choose unilaterally to adopt regulations that are weaker than nationally optimal. See also Bagwell and Staiger (1999). Here is an initial reason to doubt that poor standards are economically eﬃcient. Maskus (1997); Martin and Maskus (2001). Some argue that improved worker rights can raise productivity by raising the ‘buy-in’ of employees to firm goals, and that collective bargaining encourages innovation and attracts FDI (ILO, 1998–99). OECD (2000). Trade economists often assume that labour unions will act to restrict employment and generate rents for those who retain jobs, in which case the interjection of union rights could increase ineﬃciency. However, there is little systematic evidence on this point in developing countries. Maskus (1997). Moran (2002); OECD (2000). See OECD (2000) and Betcherman and Islam (2001). I was unable to find information on Cambodia and Vietnam. Cambodia adopted a general law governing labour relations in 1997. OECD (2000). ILO (1998–99). According to information on the ILO website, between 1997 and 2001 there were two complaints by unions against government practices in China, one in Hong Kong, China, one in Cambodia, one in Indonesia, two in Korea, one in the Philippines, one in Thailand, and none in Malaysia, Singapore or Vietnam. Maskus (1997). Betcherman and Islam (2001). Further basic evidence may be garnered from data in ILO (2001). Despite the large increases in unemployment between 1995 and 1999 in Hong Kong, Indonesia, Korea, Malaysia, the Philippines and Thailand, there was virtually no change in reported hours worked per week. Moreover, in those countries reporting these figures, the number of reported injuries per 100 000 fell sharply from 1995 to 1999. At least on these simple indicators, firms (in the formal sector) were not pressuring workers to work harder or more dangerously. Indonesia was raised to level 2 and South Korea to level 3 in the 1999 data. An index value of 4 exists for countries with strong FA rights. Because it applies to all the importers in this sample except Turkey, it could not provide much statistical discrimination among those countries in terms of how their labour standards aﬀect trade. Thus, FA rights in the importer are excluded. Coeﬃcients for the gravity equation variables (importer and exporter GDP, importer and exporter population, and bilateral distance) are available on request. These coeﬃcients were consistent with standard gravity equation results. In some cases reported exports were zero, so I added the value one to all export fflows before taking logs. Treat this result with caution, as a ‘1 per cent’ change in a discrete index is not a readily interpretable experiment, while to claim that a doubling of this index (say from 1 to 2) would expand exports by 213 per cent is not very sensible. Such elasticities relate to marginal changes in policy. Specifically, if log (exports) G (FA rights) (FA rights DREG), where DREG is the regional dummy variable, then the elasticity of exports with respect to FA rights is ( DREG BAR) (FA rights BAR), where DREG BAR and FA rights BAR are sample means.

40 19. 20. 21. 22.

WTO issues and trade negotiations These inferences come from t-tests using the standard errors of the relevant regression coeﬃcients and of the dummy variables. These are approximate tests for I assumed all covariances to be zero. The correlation between exports and ratifications is 0.44 in 1995 and 0.55 in 1999. Hasan and Quibria (2002). Hasan and Quibria (2002) reach a similar conclusion though their focus is on determinants of poverty reduction rather than trade competitiveness.

REFERENCES Bagwell, Kyle and Robert W. Staiger (1999), ‘The simple economics of labour standards and the GATT’, in Alan V. Deardorﬀ and Robert M. Stern (eds), Social Dimensions of U.S. Trade Policies, Ann Arbor: University of Michigan Press. Betcherman, Gordon and Rizwanul Islam (eds) (2001), East Asian Labour Markets and the Economic Crisis, Washington, DC: World Bank. Brown, Drusilla, Alan Deardorﬀ and Robert Stern (1996), ‘International labour standards and trade: a theoretical analysis’, in Jagdish Bhagwati and Robert Hudec (eds), Fair Trade and Harmonization: Prerequisites for Free Trade?, Vol. 1, Cambridge, MA: The MIT Press. Forteza, A. and M. Rama (2001), ‘Labour market rigidity and the success of economic reforms across more than 100 countries’, The World Bank, Working Paper no. 2521. International Labour Organization (1998), Labour and Social Issues Relating to Export Processing Zones, Geneva: ILO. International Labour Organization (1998–99), Country Studies on the Social Impact of Globalization, Geneva: ILO. International Labour Organization (2001), Yearbook of International Labour Statistics, Geneva: ILO. Martin, William J. and Keith E. Maskus (2001), ‘The economics of core labour standards: Implications for international trade policy’, Review of International Economics, 9, 317–28. Maskus, Keith E. (1997), ‘Should Core Labour Standards be Imposed through Trade Policy?’, World Bank, Policy Research Working Paper no. 1817. Moran, Theodore H. (2002), Beyond Sweatshops: Foreign Direct Investment and Globalization in Developing Countries, Washington, DC: Brookings Institution. Organization for Economic Cooperation and Development (2000), International Trade and Core Labour Standards, Paris: OECD. Verite (2002), ‘Report to California Public Employees Retirement System (CalPERS): Emerging markets research project’, manuscript (available at [email protected]). World Bank (2004), East Asia Integrates: A Trade Policy Agenda for Shared Growth, Kathie Krumm and Homi Kharas (eds), Washington, DC: World Bank.

3.

Challenges facing the WTO: determining its role in international aﬀairs Gary P. Sampson*

INTRODUCTION For international trade economists, the General Agreement on Tariﬀs and Trade (GATT) was the institution that dealt with international trade policy from a multilateral perspective. If multilateral trade policy is what the World Trade Organization (WTO) occupies itself with – and indeed it is – then trade policy today extends its influence well beyond the subject matter that traditionally has been the grist of international trade economists. These expanding boundaries of the responsibilities of the WTO have increasingly become the subject of heated public debates and academic inquiry, and have manifested themselves under a variety of headings. Rules relating to intellectual property rights and trade in services were added to the WTO agenda as a result of the Uruguay Round, and competition policy, investment, government procurement and trade facilitation have emerged as prime candidates for new WTO Agreement.1 The declaration launching the Doha Development Round not only called for modalities for negotiations in all these areas but also launched negotiations in the very controversial area of trade and environment. This has raised the fury of some, while others have lamented the fact that human rights and labour standards were not included also. The controversy turns on whether the WTO is the appropriate body to deal with these matters, and if it is, whether it has the capacity to do so given what is considered by some to be both an overloaded and inappropriate agenda. Elements of this debate have led to inquiries by international lawyers into the extent to which there should be formal ‘linkages’ between WTO rules and domestic policies, particularly those relating to competition policy, environmental management and other socially oriented matters such as labour standards and human rights.2 The legal questions surrounding such 41

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possible formal linkages are complex and the subject of considerable debate among both international lawyers and economists.3 In two excellent volumes edited by Jagdish Bhagwati and Robert Hudec,4 the topic of linkages was addressed by both international economists and lawyers in terms of whether free trade necessitates the harmonization of standards. It is reasoned that as barriers to trade are removed, the relative competitiveness of countries in international trade is influenced by the diﬀerence in their regulatory regimes. On one side of the coin is the fact that diﬀerent environmental and labour standards, as well as diﬀerent competition policies, aﬀect the competitiveness of traded products and beg the question of whether free trade and regulatory autonomy are compatible. The other side of the coin is whether trade policy can be used as an instrument to ‘level the playing ﬁeld’ and oblige countries to adopt harmonized labour, environment and social standards to compete in international trade.5 To my mind, the question can be couched in most general terms as: what should be the role of the WTO in global governance?6 In whatever form it is presented, however, any discussion of the boundaries of the responsibilities of the WTO quickly raises emotions. The WTO is ﬁercely criticized by those who argue that its rules constitute an unwanted intrusion into the domestic aﬀairs of sovereign states; that they impede the proper workings of democratically elected governments by denying them, for example, the possibility to restrict imports of goods produced in an environmentally unfriendly manner or without respecting core labour standards. The reach and power of the WTO should therefore be ‘shrunk’. On the other hand, there are those who argue that the multilateral trading system at the beginning of the twenty-first century is the most remarkable achievement in institutionalized global economic cooperation that there has ever been. It does not intrude on national sovereignty and should maintain its current role intact.7 Others think that the very success of the WTO means that its reach should be extended. This would involve an acceptance on the part of the trade community that those responsible for trade policy should recognize that social norms are inextricably linked with the international economic system, and provide the common moral and legal underpinnings for the global economy. Integrating social norms into all aspects of economic policy making – including trade policy – would ensure that markets are not only open and eﬃcient, but also fair and just. It is clearly important that WTO member governments8 retain the policy autonomy to implement whatever measures are necessary to meet their national objectives; they should be free to adopt standards as high or as low as they wish, and market-access rights obtained through bound

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43

liberalization commitments should not be undermined by so-called ‘legitimate’ policy choices introduced as disguised restrictions on trade. However, what is legitimate in terms of policy choices is very much a matter of the interpretation of a number of WTO obligations relating to domestic regulations. It is precisely with respect to this interpretation that the greatest pressure is felt in the WTO in regard to creating linkages with non-traditional trade areas. In the following, I argue that a change in the existing interpretations would change radically the role of the WTO and move it further away from the role ascribed to it by its creators. This chapter has four objectives. The ffirst is to discuss the changing role of the WTO in international aﬀairs, and the manner in which it now extends its reach well beyond what could be considered as the traditional concerns of international economists. The second objective is to examine how the interpretation of key concepts in the WTO Agreement9 can have important implications for the relationship between trade policy and that relating to protection of the environment, enforcement of labour standards and areas that have not in the past been considered to be at the core of international economics. What emerges is that the interpretation of non-discrimination in the WTO Agreement is critical. Interpretations can change in diﬀerent ways; for example, there can be negotiated undertakings by WTO members or there can be practices built up through resort to the dispute settlement mechanism. The third section examines the relationship of the rules of the WTO and how they interface with those of the Multilateral Environment Agreements that contain trade provisions. The fourth section discusses the policy implications of the earlier sections of the chapter. In general terms it cautions against extending the reach of the WTO further without seriously considering the role of the WTO in the broader context of global governance.

CHANGING ROLE OF THE WTO Given the ambitious objectives of the WTO it is not surprising that it finds itself at centre stage in a number of areas.10 The WTO is mandated to raise standards of living, achieve full employment along with a large and steadily growing volume of real income. It is also to develop the full use of the world’s resources while expanding the production and exchange of goods. Ambitious as these goals are, they are also the goals of the General Agreement on Tariﬀs and Trade (GATT) that remained largely unknown except for those with a very specialized trade interest. In fact, the only addition to the objectives of the GATT are that the WTO is to allow for the ‘optimal use of the world’s resources in accordance with the objective of

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sustainable development’. Important as the addition of the goal of sustainable development may be, it does not go far in explaining the increased prominence of the WTO. The reasons for this are complex, with some being more evident than others. One obvious reason is the dramatic expansion of the coverage of WTO rules. This results from the increase in both the value and volume of world trade since the creation of GATT.11 World trade has grown more rapidly that world production in every year since the Second World War; the result being that the share of world production that is traded – and subject to WTO rules – has grown greatly. At the same time, the original 23 members of the GATT have expanded to almost 150 WTO members with another 25 countries in the process of accession. Also the breadth of application of multilateral trade rules has increased significantly. With the WTO Agreement being a ‘single undertaking’, unlike the Tokyo Round Codes, members are required to be parties to all the WTO agreements. A further consideration relates to the sectoral coverage of the WTO Agreement. Textiles and agriculture – formerly outside the ambit of the regular trade rules – are now addressed through specific agreements in the WTO.12 New additions to the coverage of trade rules are trade in services and traderelated intellectual property rights, both characterized by enormous commercial and political importance. Further, the nature of trade rules has become far more exigent. Domestic regulations relating to sensitive areas such as ffinancial services, environmental subsidies and support measures for agriculture are all subject to WTO disciplines. These rules extend well beyond border measures and reach deep into domestic regulatory structures of the member countries. The TRIPs (Trade-related Aspects of Intellectual Property Rights) Agreement, for example, raises a number of ethical questions. These include those relating to the appropriateness of patenting life forms, benefit sharing with indigenous people for the exploitation of local genetic resources, lack of access to essential medicines for the poor, and the potential for conflict between the rights and obligations of WTO rules and the cross-border movement of living modified organisms. Quite apart from the agreements themselves, recent disputes have raised fundamental questions about the appropriateness of standards to protect health (the asbestos case), the role of science in the management of healthrelated risks (the hormones case), the conservation of endangered species (Shrimp–Turtle case) and the legitimacy of corporate tax subsidies (US tax case). Unlike the GATT, the WTO dispute settlement process moves forward automatically with panel and appellate body reports adopted unless there is a consensus against them. The rule of negative consensus backed up by a mechanism providing for compensation and sanctions in

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the case of non-compliance – sometimes involving hundreds of millions of dollars – has greatly increased the public awareness of the process. The enforceable nature of decisions and the automaticity of the process also set it apart from the compliance mechanisms of other international treaties. These features, coupled with the fact that the dispute proceedings are closed to the public, has heightened the sense of exclusion and resentment of those outside the process. While the creation of an Appellate Body in the WTO has been important in adding balance to the automaticity of the decision taking, it has left some with the view that it has extended its authority beyond that granted to it by member governments at the time of its creation. The Dispute Settlement Understanding limited its jurisdiction to issues of law covered in panel reports and to legal interpretations developed by panels. It was prohibited from adding to, or diminishing, the rights and obligations provided in the WTO Agreement. It has been argued that some Appellate Body reports seem to indicate a new concept of evolutionary policy formulation through litigation – something that is very diﬀerent from consensus decision taking after a debate by all members in the WTO General Council. A further consideration is that there have been a number of developments – technological and otherwise – that were not foreseen some years ago but have had important implications for the implementation of some of the agreements. One example relates to recent developments in biotechnology. Genetic engineering now permits the characteristics of living organisms to be changed by transferring the genetic information from one organism across species boundaries into one that is too distantly related to permit natural cross-breeding. It is this transfer of genetic information across the boundaries of species that has contributed to the most vocal public reactions and the call for its regulation. The TRIPs Agreement obligation to provide for the patenting of microbiological processes has not only enormous commercial implications but also raises significant ethical concerns. The Technical Barriers to Trade Agreement places disciplines on the labelling of products derived from genetically modified organisms and the TRIPs Agreement has implications for rewarding indigenous people for their own genetic resources. At the time of writing the most recently notified dispute relates to WTO obligations that bear on genetically modified organisms and the products derived from them. The manner in which the WTO functions compared to the GATT has also changed due to the fact that two-thirds of WTO members are now developing countries. With many of the most successful having adopted outward-oriented development strategies, the importance of the WTO for developing countries, as well as their interest and weight within it, has increased considerably. They have, for example, locked in domestic policy

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reforms through adopting legally binding WTO obligations. They also look to assured market access through bound tariﬀs and commitments in the services sectors to continue their export-led growth strategies. Their legitimate expectation is that the WTO will provide a forum where their views can be eﬀectively expressed and their concerns adequately dealt with without disguised restrictions being introduced in the form of labour standards or environmental regulations relating to their imports. Developing countries are therefore far more active in the WTO than in earlier times, and have higher expectations as to what the institution can and should do for them. Another reason for the heightened interest in the WTO is that it came into being against the backdrop of an incredible revolution in the cost and speed with which information can be communicated. Non-governmental organizations are now linked to one another through broad networks and coalitions that render them more eﬀective and sophisticated than their earlier counterparts. The result is that the public image of the WTO is greatly influenced by the information conveyed through these electronic means and public pressure is on the WTO in terms of transparency and accountability. While many of these groups are not against trade per se, others are unabatedly protectionist, putting them on a collision course in terms of ideology with supporters of an open and liberal trading system. The events in Seattle, fuelled by coalitions of non-governmental organizations built on the World Wide Web, placed the public for the first time at the centre of a vital public policy discussion that was traditionally dominated by governmental representatives in closed meetings. One way or another all these considerations bear on the relationship between WTO rules and domestic regulation that is discussed below. The automaticity of the dispute settlement mechanism – in particular with respect to the adoption of their reports – ensures the implementation of their decisions and the greater public exposure of the WTO adds to the pressure of being seen as sympathetic to environmental and other causes. The increased importance of developing countries in the WTO adds to the resistance of imposing conditions relating to production processes (for example, labour standards) on their imports and the depth of regulation raises concerns about national sovereignty. While the above paragraphs enumerate some of the reasons why the WTO has increased its importance, an additional development may have served to reduce it, in particular the extraordinary proliferation of regional trade agreements.13 While the expectation of some was that the growth in numbers of regional trade agreements in the early 1990s was a response to the possibility of a failed Uruguay Round of negotiations, the numbers have continued to accelerate.14 Indeed, 125 new regional trade

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agreements have been notified to the WTO since its creation, with an average of 15 notifications per year.15 During the four- and a half decades of the GATT the annual average was less than three. The WTO Secretariat has estimated that 243 regional trade agreements were in force in 2002. The end result is that all but two of the almost 150 members of the WTO are parties to at least one – and some as many as 26 – preferential trading arrangements. One salient feature of these agreements is that many go well beyond addressing traditional border measures, and extend their reach to the liberalization, elimination and harmonization of trade-impeding regulatory policies. This has sparked a new interest not only in the motivation for the continuing proliferation of regional trade agreements, but also in the extent to which they promote deeper integration in the regulatory structures of the countries concerned. An important question, then, is whether these trading arrangements are supportive of the multilateral trading system or not. As the various regional trading agreements are very diﬀerent in their nature and intent, the answer requires a close analysis on a case-by-case basis. Here important work by Peter Lloyd has provided insights into the Closer Economic Relations (CER) Agreement between Australia and New Zealand.16 At the time of signing, the two countries had the highest average tariﬀ protection of all OECD countries. The first years of the agreement saw the emphasis being placed on reductions in border protection: tariﬀs and quantitative restrictions on goods were quickly eliminated. The depth of integration was broadened with agreement to liberalize trade in services and remove a range of non-tariﬀ measures. In fact, Lloyd has shown that the CER Agreement has greatly deepened the integration of the economies of the two countries through, inter alia, agreements relating to harmonization of standards, mutual recognition and conformity assessment procedures. The conclusion is that the CER Agreement has led to trading relations between the two countries that have not undermined their commitment to the multilateral trading system. In fact, the CER Agreement made an important contribution to the broader process of liberalization in both countries by constituting a trial run for subsequent multilateral trade reforms.17 Lloyd concludes that the ‘CER is the cleanest regional trading arrangement in the world, with virtually no exceptions to free trade in goods and services and an absence of bureaucracy. Both countries are now a model for members of the WTO in terms of their observance of both its rules and spirit’.18 More generally, however, detailed case studies reveal that the recent agreements diﬀer considerably in scope and level of ambition, with the diﬀerences being apparent in the nature of the rights, obligations and processes that they establish.19 In particular, the case studies reveal that the

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impact of regional agreements has been broadly consistent with the substantive multilateral principles governing regulatory barriers in the WTO. Indeed, most agreements restate the parties’ obligations contained in the various WTO agreements. In this sense, the WTO rules constitute a floor that underpins additional commitments in the regional agreements.

INTERPRETING THE KEY RULES Discrimination, Products and Processes One starting point from which to look at the linkages between trade and non-traditional areas is the proposition that in well-functioning marketbased economies, prices register the relative scarcity of resources and consumer preferences; their role is, inter alia, to allocate resources eﬃciently. The welfare of society can be undermined, however, when market prices fail to capture the eﬀects of certain activities and therefore send misleading signals relating to the optimal use of resources. In the case of the environment, resource misallocation undermines eﬀective environmental management and retards the economic growth that could generate resources for improved environmental management programmes. Distorted prices can obscure the abundance of under-utilized environmental resources, contribute to the excessive depletion of exhaustible resources, generate new environmental problems, and contribute to the excessive use of environmentally damaging inputs. In such instances there is a hierarchy of instruments available to deal with environmental problems, and trade instruments are certainly not the ffirst-best among them.20 The reasoning follows that when adverse production and consumption externalities are adequately integrated into decision-making processes, trade and the attainment of environment objectives can be mutually supportive.21 Not surprisingly, taxes and charges are increasingly used for the pursuit of national policy objectives involving the correction of market failures. This means the application of taxes, subsidies and other charges that will vary across countries and aﬀect the international competitiveness of tradable products. There are good reasons why these taxes and subsidies will diﬀer across countries. There may be diﬀerent physical conditions across countries with, for example, diﬀerent pollution absorption capacities. However, even if the physical conditions are the same, not only is the utility function defined on income and pollution not identical and homothetic, but also societal choices relating to risk management may diﬀer.22 In short, costs will be internalized diﬀerently (or not at all) in diﬀerent countries for good reasons. An important question for present purposes is whether WTO

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rules inhibit countries from taxing as they wish and adjusting domestically taxes and other charges in order to maintain international competitiveness. According to WTO rules, governments are free to adjust domestic taxes and charges at the border on goods traded internationally. They can impose domestic taxes and charges on imported goods, and exempt or reimburse them on exported goods.23 In the absence of a harmonized taxation system between trading partners, border tax adjustment aims at ensuring trade neutrality of domestic taxation and preserving the competitive equality between domestic and imported products.24 While this appears to be a straightforward exercise, there remains considerable controversy in the WTO as to which taxes can be imposed or rebated as well as under what circumstances.25 An important distinction in this context is between indirect taxes imposed directly or indirectly on products,26 and direct taxes imposed on the producer.27 According to WTO practice, indirect taxes are eligible for tax adjustment, and direct taxes are not. The preference granted to indirect taxes relies on the assumption that indirect taxes are shifted completely ‘forward’ by the taxpayer, are eventually reflected in the ﬁnal price of the product, and directly aﬀect the international competitiveness of the product. On the contrary, it is assumed that direct taxes are shifted ‘backward’: they are ﬁnally borne by the manufacturer of the product, may not be reflected in the ﬁnal price and may not aﬀect international competitiveness.28,29 The above rules apply to taxes on tradable products. As countries develop their national response strategies to environmental problems, environmental taxes that apply directly to production processes are likely to play an increasingly important role. Under existing GATT rules and jurisprudence, while it is clear that border tax adjustment is possible for indirect taxes levied on products, the extent to which indirect taxes on inputs, incorporated or exhausted in the production process, to the ffinal product can be adjusted at the border, whether on exports or on imports, is open to interpretation.30 Since environmental taxes and charges are at least as much process-oriented as product-oriented, the interpretation of the WTO rules will have significant implications for competitiveness of a variety of industries.31 What this translates into is that equivalent domestic taxes can be imposed on imported ‘like’ products; domestic taxes, for example, on the same imported coal and petroleum. As far as exports are concerned, taxes could be rebated if they were levied on the product at the domestic level; rebates of domestic taxes on exported coal and petroleum. This same understanding does not, however, extend to taxes paid in the process of producing the good; for example, rebating domestic taxes applied to processes, such as indirect taxes levied on the energy consumed

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or the carbon emitted in the production process.32 Thus, a domestic tax can be applied legitimately to imported fuel, but a tax cannot be applied on the energy consumed in producing a ton of steel. The question of interpretation relating to taxes on production processes as distinct from products underlies much of the debate about the role of the WTO in constraining domestic regulation. The more general policy issue is to what extent should the processes whereby goods are produced enter into the rule making of the WTO, and can goods that are ‘alike’ in their physical characteristics be legally discriminated against on the grounds of some policy objective relating to how they were produced. The principle of non-discrimination underpins the rules-based multilateral trading system. It has two components: the most-favoured-nation (MFN) clause contained in Article I of GATT 1994 and national treatment which is contained in Article III of GATT 1994. MFN treatment stipulates that WTO members are bound to grant to the products of other members treatment no less favourable than that accorded to the like products of any other country. Thus, no member is to give special trading advantages to another, or to discriminate against a particular product because of the manner in which it was produced, or because of the country of origin of the product. The rules for border tax adjustment discussed above are addressed in Article III of GATT 1994 dealing with national treatment. National treatment stipulates that once goods have entered a market, they must be treated no less favourably with respect to taxes and other charges than domestically produced like goods.33 Both taxes and regulations (that is, all laws, regulations and requirements aﬀecting the internal sale and distribution accorded to imported products) should not be applied to imported products so as to aﬀord protection,34 and imported products shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of laws, regulations and so on.35 While one of the basic purposes of the national treatment provision is to ensure that internal charges and regulations are not such as to frustrate the eﬀect of tariﬀ concessions, the disciplines apply whether or not the product concerned is subject to a tariﬀ concession, and whether or not adverse trade eﬀects occurred. The manner in which a number of concepts in the definition of national treatment are interpreted has important implications with respect to the flexibility of governments in formulating domestic policy.36 The determination of a discriminatory tax for the purposes of border tax adjustment, for example, is made by comparing domestic and imported like products. It has been the practice for panels first to determine whether imported and domestic products are ‘like’ before examining whether the measure is discriminatory. The notion of ‘like product’ has

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been analysed on a case-by-case basis in a number of GATT/WTO dispute settlement panels. The term appears some 16 times throughout the GATT 1994 and is interpreted on a case-by-case basis depending on the context in which it is used.37 Clearly, its interpretation is of primary importance for determining the boundaries of WTO rules. From an environmentalist perspective, regulation can be important with respect to the manner in which a good is produced, consumed and disposed of. Thus, a biodegradable product produced in an environmentally friendly way is not like an identical product produced in an environmentally unfriendly manner. Two hand-knotted carpets may be alike in physical terms and classified for tariﬀ purposes in the same tariﬀ classification, but for a human rights activist they are very diﬀerent products if one was made with child labour. How likeness is to be interpreted is in the hands of the dispute settlement process of the WTO, and it is done with a great deal of acknowledged discretion. According to the Appellate Body, there can be no one precise and absolute definition of what is ‘like’. The concept of ‘likeness’ is a relative one that evokes the image of an accordion. The accordion of ‘likeness’ stretches and squeezes in diﬀerent places as diﬀerent provisions of the WTO Agreement are applied. The width of the accordion in any one of those places must be determined by the particular provision in which the term ‘like’ is encountered as well as by the context and the circumstances that prevail in any given case to which that provision may apply.38

According to the Oxford Dictionary, ‘like’ means: having the same characteristics or qualities as some other . . . thing; of approximately identical shape, size, etc., with something else; similar.39 As the Appellate Body has observed, this meaning suggests that ‘like’ products are products that share a number of identical or similar characteristics or qualities. However, ‘dictionary meanings leave many interpretive questions open’. In particular, the dictionary definition of ‘like’ does not indicate which characteristics or qualities are important in assessing the ‘likeness’ of products. Second, the definition provides no guidance in determining the degree or extent to which products must share qualities or characteristics in order to be ‘like products’. Third, the Oxford Dictionary definition of ‘like’ does not indicate from whose perspective ‘likeness’ should be judged.40 From an economic perspective it would seem reasonable that like products should share essentially the same physical characteristics and commonality of end uses. They should also be examined in light of their cross-elasticity of demand to determine if they are directly competitive or substitutable in the marketplace. The traditional approach in the GATT and WTO has been to adopt this basic approach (also in the Working

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Party on Border Tax Adjustments) by taking into account the product’s end-uses in a given market; consumers’ tastes and habits, which change from country to country; and the product’s properties, nature and quality. What if products are like in the sense described above, but governments wish to regulate them diﬀerently? Can they be discriminated against on grounds of the intent of the regulation? The answer to this question has far-reaching implications for the role of the WTO in domestic regulatory autonomy. A recent WTO case relating to trade in asbestos products is insightful in this respect. Asbestos is generally considered to be a highly toxic material, the exposure to which poses significant threats to human health. However, due to its resistance to high temperatures and chemical attack, it has found wide use in industrial and other commercial applications. The French government, which had previously imported large amounts of asbestos, adopted a decree that provided for a ban on asbestos ffibres and products containing them. Canada, the largest exporter of asbestos in the world, argued that the decree imposed less favourable treatment to imported asbestos as compared to domestic substitutes for asbestos such as fi f bro-cement products, and brought the dispute to the WTO.41 The Panel established to deal with the case ruled that asbestos-fibre products and fibro-cement products were like products within the meaning of the national treatment provisions of the GATT 1994 (Article III:4), and that the decree relating to the prohibiting of the marketing of asbestos fibres and products violated the national treatment obligation. Their view was that it is not appropriate to take into consideration the health risks associated with asbestos fibres in examining the ‘likeness’ of products. The Panel did not dispute the health risks associated with asbestos fibres. In fact, the risks had been confirmed by the experts they consulted. The Panel held that while the products in question were like products – and could not be diﬀerentiated on the grounds of the policy objective – the complaining party should seek an exception for a non-conforming measure as provided for in the relevant provision (discussed below) of the GATT 1994 and seek an exception for a non-conforming measure that violated its GATT obligations. The Panel ruled that the measures fell within the range of policies designed to protect human life or health, and that the violation of national treatment was justified as an exception. The Appellate Body reversed the ffinding and concluded that Canada had not satisfied its burden of proving that these ffibres are ‘like products’ under the national treatment provision. It overruled the panel ffinding that resort to the exceptions provisions was necessary, reasoning that the products could be diﬀerentiated on the grounds of the health risks. The important question in the context of the fl f exibility in domestic regulation is if products

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compete on the market and are considered like products in this context, can they be distinguished according to some criterion relating to policy objectives and thereby legitimately discriminated against? The Panel said no and the Appellate Body said yes. In examining the measure in the context of the exceptions provision, the Appellate Body noted that the more vital the policy pursued, the easier it would be to prove that a measure was necessary to meet the objectives of the policy, and therefore provided the grounds for discrimination. In this case, the objective pursued (health) was characterized as ‘vital and important in the highest degree’.42 This then begs the question as to whose responsibility is it to decide whether the objective pursued is vital and important in the highest degree. If it is to be the Panel or the Appellate Body, this ascribes a great deal of importance to what the legal process in the WTO considers to be a ‘vital and important’ regulatory objective across 140-plus countries with very diﬀerent levels of economic development, social norms and priorities with respect to the environment and public health. A concomitant question is whether importance should be ascribed to the fact that the health risk was evident in the product itself. Could the policy choice be related to the production process that produced the good even it was not a characteristic of the final product? Here lies the critical distinction between products where their ‘diﬀerence’ lies not in their competitiveness in the market, but rather in the manner in which they were produced. If the production process that produced the good is apparent in the good itself, then it is a product-related production process (PPM). If the production process is not apparent, then it is a non-product-related production process (NPPM). Thus cotton that is produced with chemical fertilizers is not like cotton produced organically, providing there is a chemical residue in the cotton. Permitting products to be discriminated against on the grounds of how they were produced would have far-reaching implications for ethical considerations that many feel passionately about. Imported eggs could be banned if they were laid by hens kept in battery cages rather than free ranging, imported fur products banned because the animals were caught in steel-jawed leg traps, and food products derived from genetically modified organisms could be banned even if the genetic modification was not apparent in the product. Two points are important for what follows. Does the answer not lie in labelling products according to how they were produced and letting the consumer decide how to weigh the implications in light of her ethical preferences? The answer to this question turns out to be complicated as it also depends on the extent to which non-product-related production processes can be legally identified under WTO rules in labelling schemes. Second,

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if there is to be discrimination solely on the grounds of how goods are produced, is this not the domain of those institutions that have the expertise and mandate to deal with these considerations? The answer to this question should be yes. A limited number of Multilateral Environment Agreements (MEAs) do invoke non-conforming WTO measures to resolve product- and process-related environmental problems. But here too there are important considerations relating to the relationship of MEA rules to WTO rules. This too will be discussed below. Exceptions What if the imported product does not itself – unlike the asbestos case – contain the health or environment risk? Imported shrimp may well be like domestic shrimp in terms of competing in the domestic marketplace; the question is whether they can be legitimately discriminated against vis-à-vis shrimp imported from other countries on the grounds that the importing country considers they were caught in a manner that endangers turtles. If the answer is yes, the implications are far-reaching. The imposition of sanctions to enforce preferred standards extraterritorially presents a number of problems with respect to WTO rules. There is a prohibition of quantitative restrictions under Article XI of GATT 1994, and since WTO members are bound to grant to the products of other members treatment no less favourable than that accorded to the like products of any other country, there would also be a violation of MFN. It would have to be demonstrated that the product facing the quantitative restriction was not like another imported like product. Thus the question is whether MFN treatment can be violated in order for one country to achieve some objective relating to the environment that is beyond its own borders. In such instances, the likeness of products is not in question; the non-product-related production process is. If a WTO obligation is breached, as noted above, recourse can be sought to the ‘General Exceptions’ Article XX of GATT 1994. This provides that under exceptional circumstances, governments may need to apply and enforce measures – such as quantitative restrictions – to protect public morals, human, animal or plant life or health (Article XXb) or relating to the conservation of exhaustible natural resources (Article XXg).43 The measures for which an exception is sought are subject to the requirements that they do not constitute a means of arbitrary or unjustifiable discrimination and that they do not represent disguised restrictions on international trade. Under the GATT, there were six panel proceedings under Article XX involving an examination of environmental measures or human-healthrelated measures. In no instance was the policy objective of the governments

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questioned; it was the discriminatory nature of the restriction that was under challenge. Out of the six reports, three remained unadopted while so far, under the WTO, three disputes have led to the adoption of Panel and Appellate Body reports. Only on the occasion of the asbestos case did the ruling accept the legitimacy of invoking the measure (a health measure in this instance) as an exception.44 As a result, a great deal of animosity has been directed towards the WTO on the part of public interest groups who firmly believe that trade sanctions are an acceptable means to enforce preferred standards universally. However, the issues surrounding the extra-territorial application of preferred standards are complex from a trade policy point of view, as legal proceedings in the WTO make clear. The landmark dispute between Mexico and the USA regarding a US embargo on the import of tuna from Mexico is particularly illustrative. It was the first time in the history of the GATT that a government had argued that the provisions of the GATT should be interpreted to permit actions against other governments with diﬀerent domestic policies. In this case it was claimed by the USA that the Mexican tuna caught using purse seine nets resulted in the incidental kill of dolphins. Mexico appealed to GATT on the grounds that the embargo applied by the USA was a violation of the prohibition on quantitative restrictions. The Panel ruled in favour of Mexico, based on a number of diﬀerent arguments. These included the fact that the US embargo was aimed at regulating not the sale of a product, but rather its process of production (the mode of harvesting in this case). Under GATT rules, the Panel argued, the USA was obliged to provide Mexican tuna (as a product) with a treatment no less favourable to that accorded to US tuna (also as a product), regardless of how the tuna itself was harvested. The tuna caught by Mexican fishermen was tuna caught by other means. The Panel also observed that whilst GATT Contracting Parties could adopt GATT-inconsistent measures (falling under the ‘General Exceptions’ clause of GATT Article XX) for the protection of the environment or the conservation of exhaustible natural resources, it was not clearly spelled out in the Agreement whether the resources being protected could fall outside the jurisdiction of the party adopting the environmental controls. To address this issue, the Panel inspected the drafting history of the relevant section of Article XX, and came to the conclusion that drafters only intended it to apply to the jurisdiction of the country taking the action.45 Whilst the report of the Panel was not adopted by GATT member countries, its ruling was nevertheless heavily criticized by environmental groups that felt that trade rules were an obstacle to environmental protection. As a result, the call has come from a number of environmental

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groups for the WTO to modify its interpretation of like products to permit discrimination against products that have not met certain environmental standards. The so-called Shrimp–Turtle case was the first environment case dealt with by a WTO Panel and then appealed through the Appellate Body.46 The Appellate Body was required to determine if a measure related to protection of turtles was a measure to conserve an exhaustible natural resource and qualified for justification under the exceptions article. Tuna was not an endangered species and this question never arose. At issue was whether a living creature should be considered to be an exhaustible natural resource. The Appellate Body ruled that in the light of contemporary international law, living species, which are in principle renewable, ‘are in certain circumstances indeed susceptible of depletion, exhaustion and extinction, frequently because of human activities’.47 The Preamble to the Agreement Establishing the WTO was also considered to be relevant in this respect, and the Appellate Body was further influenced by existing agreements dealing with the environment. The WTO preamble is, according to the Appellate Body, to give ‘colour, texture and shading to the rights and obligations of Members under the WTO Agreement’. In this ‘colouring-in’ exercise, the Appellate Body clearly considers that it has the possibility to interpret the preamble language of the WTO Agreement. Thus, the preservation of turtles was, on the basis of the facts of this case, an acceptable measure for which to seek an exception. Notwithstanding that, the Appellate Body did not rule directly on the question of extraterritoriality and there is considerable confusion as to where matters now stand.48 One view is that by ruling on the case without addressing this issue, the Appellate Body had not accepted the complainants’ argument that some sort of jurisdictional limitations would prevent the use of Article XXg with respect to the measures in question. For others, if this was the case, this was a fundamental and impermissible alteration of the present balance of the rights and obligations of members under the WTO Agreement, as this could open the door to unilateral measures aimed at discrimination based on non-product-related process and production methods. The complaining countries had all agreed that turtles were an endangered species, that they should be protected, and therefore had their national conservation strategies in place. They argued that it is their sovereign right to decide on the optimal conservation strategy in the light of what is the most appropriate approach given their national circumstances. For example, should national conservation strategies depend on nesting problems of turtles, avoiding the pollution of local beaches or changing local habits relating to the human consumption of turtles and the marketing of turtle shells?

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While failing to rule on the extraterritoriality question, the Appellate Body noted that the most conspicuous flaw in the application of the trade sanction related to its intended and actual coercive eﬀect on the specific policy decisions made by foreign governments. It considered that it is not acceptable, in international trade relations, for one WTO Member to use an economic embargo to require other Members to adopt essentially the same comprehensive regulatory programme, to achieve a certain policy goal, as that in force within that Member’s territory, without taking into consideration diﬀerent conditions which may occur in the territories of those other Members.49

Thus the question of extraterritorial application of domestic process standards appears to be left open to further interpretation. The important point is that providing for the legal discrimination among imports on the basis of production methods would profoundly change the role of non-discrimination that lies at the heart of the WTO legal system.50 More particularly, the question is who sets the environmental, labour, or any other standards, who enforces them and is there to be a role for the WTO in legitimizing the imposition of discriminatory trade measures through litigation. Answering this question also goes a long way to defining the future limits of the WTO in global environmental governance. Agreements on Standards The plurilateral 1979 Agreement on Technical Barriers to Trade (TBT Agreement), also called the ‘Standards Code’, was an important step in dealing with diﬀerent perceptions as to what are legitimate standards. It was one of the outcomes of the Tokyo Round of multilateral negotiations. This Code permitted its limited number of signatories to introduce potentially trade-restrictive technical or sanitary and phytosanitary regulations in the pursuit of ‘legitimate’ objectives by invoking as justifications the protection of human, animal or plant health, the protection of the environment, animal welfare, religious considerations and national security motives. It was, however, thought important to refine the TBT Agreement in the Uruguay Round and introduce a special agreement to deal with sanitary and phytosanitary measures in order to provide an expanded and clearer set of rules and principles regulating the application of standards. While under Article XX, ‘General Exceptions’, a measure could be exempt from other GATT provisions, Article XX is only invoked if there is a breach of WTO obligations. It was thought that clearer and more detailed rules on the scope of measures permitted in terms of standards that governments

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could impose was important to avoid unnecessary obstacles to trade while recognizing the sovereign right of governments to adopt whatever standards are appropriate to fulfil legitimate objectives, taking into account the risks that non-fulfilment would create. But fulfilling these both objectives simultaneously is not a simple task. Before the entry into force of the SPS Agreement in January 1995, as long as both domestic and imported goods were treated as ‘like products’ and the treatment was equal, the scientific justification for such measures was not called into question. With the coming of the WTO, the legal framework for dealing with SPS measures changed. Governments can now challenge regulations based on food safety even when there is no discrimination between imported and domestic food substances.51 In one high-profile case, the European Union placed a ban on meat products containing hormones that went into eﬀect in 1989; it applied to animals treated with hormones in order to promote growth, as the EU maintained that there was a carcinogenic eﬀect associated with human consumption of the hormone-treated beef. European measures could not be challenged by the USA under GATT as the only applicable GATT clause at that stage was the national treatment obligation, which required that imported products be treated no diﬀerently from domestic ones. As meat products containing hormones were also banned domestically, there was no violation of the GATT non-discrimination principle.52 When the case was dealt with by a WTO panel, the panellists rejected the EU arguments due to a lack of scientific evidence of a health and safety risk. They concluded this after consulting scientific experts who reached a general agreement that the hormones posed no risk. Thus, according to the Sanitary and Phytosanitary Agreement, WTO members should be guided by scientific principles when deciding the appropriate level of protection for plants, animals and humans. In this manner, the decisions are to be neither arbitrary nor protectionist, as the accepted level of risk should be a reflection of environmental, health and safety protection, not a means to protect domestic producers from competition. The SPS Agreement defers to recognized international agreements (for example, Codex Alimentarius) in setting acceptable standards for the application of SPS measures. While governments are free to set their standards at higher or lower levels than the international standards, scientific evidence and risk assessment are required to justify higher levels. Risk assessment is a necessary part of departing legally from the international standards set by Codex or the equivalent for plants and animals.53 However, notwithstanding the importance of scientific evidence, diﬃcult questions of interpretation quickly emerge. What is the minimum degree of scientific validation required for a trading partner to be obliged to accept a standard adopted by another trading partner as being legitimate and not a

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disguised restriction on trade? What is the role of ‘precaution’ if there is insuﬃcient scientific evidence to justify a standard (which may be restricting imports) but substantial potential consequences to society of not setting such a standard? Who has the burden of proof in demonstrating that there is – or is not – a real risk? Further, even where the scientific evidence is conclusive, public perceptions of the associated risks and how they should be managed diﬀers considerably among WTO members. The consumption of food derived from genetically modified organisms provides an excellent example. The Uruguay Round Agreement on Technical Barriers to Trade addresses mandatory regulations and voluntary standards and establishes obligations to ensure that voluntary standards, mandatory regulations and conformity assessment procedures do not have as their objective the restriction of trade.54 Determining the desired level of health, environmental or consumer protection is the starting point for regulatory or standards-setting processes. In this respect, there are a number of similarities with the SPS Agreement; the TBT Agreement encourages WTO members to use, whenever appropriate, relevant standards or conformity assessment guides or recommendations issued by international standardizing bodies as a basis for their own regulations and procedures. The use of internationally recognized standards is presumed not to constitute an unnecessary barrier to trade. Nevertheless, like the SPS Agreement, it acknowledges that there are good reasons for mandatory regulations and voluntary standards to diﬀer between countries. It states that: ‘no country should be prevented from taking measures necessary to ensure the quality of its exports, or for the protection of human, animal, and plant life or health, of the environment, or for the prevention of deceptive practices, at the levels it considers appropriate’.55 The Agreement also states that standards may diﬀer between countries due to diﬀerences in taste or levels of income, as well as geographic and other factors. Although this oﬀers a high degree of flexibility in the preparation, adoption and application of national technical regulations, it also raises the questions of which diﬀerences are ‘legitimate’, what is the criterion that establishes legitimacy and which standards create unnecessary obstacles to trade. This question of legitimacy is compounded by disagreement about whether the coverage of the Agreement encompasses standards that relate to the production methods as well as products themselves. The TBT Agreement requires that in respect of technical regulations and voluntary standards, products imported from any member are to be accorded treatment no less favourable than that accorded to like products of national origin and to like products originating in any other country. This means that imported products have to meet the same technical requirements as a

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domestic product. Domestic requirements, however, may well apply to both the product and the manner in which it was produced. If process regulations and standards (such as labelling relating to the manner in which a good was produced) are covered by the Agreement, then the disciplines of the Agreement apply.56 There are very diﬀering views in the WTO Technical Barriers to Trade Committee and the Committee on Trade and Environment (CTE) on this matter. Many developing countries, for example, argue that the requirement to meet standards based on production and process methods that are not incorporated into the fi f nal product are not consistent with the GATT/WTO interpretation of ‘like products’. Their concern is a systemic one. If processbased standards are considered covered by the TBT Agreement – although it has advantages, such as greater transparency of the schemes and their notification – it creates a precedent for the acceptability of non-productrelated production methods from a WTO perspective. This is something that most – if not all – developing countries wish to avoid.57 It would mean, for example, the imposition of the environmental standards of importing countries via labelling requirements indicating if the good was produced in an environmentally friendly manner. For environmentalists, the very raison d’être of many labelling schemes is to distinguish between products according to the manner in which they have been produced. An ongoing and important practical manifestation of the potential problems relating to interpretation has emerged in recent meetings of the TBT Committee, where it has been argued that labelling products derived from genetically modified is inconsistent with the WTO interpretation of like product. The USA and Canada have expressed concern over the EU regulation on the labelling of products containing genetically modified soya or maize. The EU requires foodstuﬀs and food ingredients containing traces of modified DNA or protein to be labelled as ‘produced with genetically modified soya/maize’. The USA and Canada argued that such labels were unnecessary technical barriers to trade since no scientific reason existed to diﬀerentiate between foodstuﬀs produced with genetically modified crops. The USA also questioned the feasibility of developing reliable and commercially practical tests for detecting DNA or protein resulting from genetic modification. This will certainly be a major issue in the current dispute on this matter before the WTO.

STANDARDS, THE WTO AND MEAs Since its establishment, one of the most actively discussed topics in the WTO has been the relationship between WTO provisions and the use of

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trade measures in Multilateral Environmental Agreements (MEAs). The debate has centred on the possibility of a conflict arising over trade-related measures contained in MEAs: namely, their potential inconsistency with WTO rules, and how conflict in these rules could be avoided or dealt with. What is clear is that just as the TBT and SPS Agreements defer to international standards which are not considered as barriers to trade, multilaterally agreed standards more generally could fill an important gap in the avoidance of barriers to trade – particularly when there are crossborder implications of the standards adopted. While there is no agreement about how to settle the debate on these matters, there is no disagreement between WTO members that MEAs are the best way to coordinate policy action to tackle global and transboundary environmental problems. WTO member governments do not want the WTO to become an environment policy-making organization or environmental standards enforcement agency. Indeed, it is agreed among members that WTO rules provide for governments to adopt whatever trade measures they wish to protect their domestic environment. When it comes to environmental problems beyond their borders, the expectation is that governments will agree to – and enforce – environmental regulations through regional or international environment agreements and not unilateral coercion through WTO-inconsistent measures. Most troubling, however, is whether, and to what extent WTO law should permit trade measures authorized by environmental agreements to be imposed against another GATT member country that is not a signatory to the environmental agreement. In the conventional principles of treaty interpretation, the international environment agreement would trump the GATT obligations in those cases where both governments have signed both treaties. In a case where a GATT member has not signed the environmental agreement, the agreement cannot displace the member’s rights unless it is given some higher status in international law. This latter issue captures one of the major themes in the trade and environment debate – the contention that environmental goals are more important than GATT goals and that GATT should therefore give way in the conflict.58 As the WTO and MEAs represent two diﬀerent bodies of international law, the relationship between them should be coherent and fully understood by all concerned. This is not – it is argued – the case at the moment. MEAs do – and should – have the possibility for parties to the agreements to legally invoke WTO-inconsistent measures to achieve their goals.59 Given the importance of the global trade and environment regimes, any clash over the application of rules agreed to among nations would have unfortunate ramifications for both regimes. To remove this possibility, and to avoid the WTO being the arbiter of environmental disputes, any WTO-inconsistent

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measures should be clearly spelled out and agreed to by the parties to a broad-based Multilateral Environment Agreement. Disagreement as to the legality of MEA measures in any MEA should then be dealt with by the compliance mechanism in the MEA itself and should not be left to interpretation by a WTO dispute panel or appellate body report as has been the case recently. This course of action requires eﬀective MEAs, characterized by clearly specified trade measures that may be taken for environmental purposes, broad-based support in terms of country membership and a robust dispute settlement system. The conclusion is that eﬀective MEAs are critical to avoid environmental disputes gravitating towards the WTO and inhibiting the smooth functioning of the WTO itself.

POLICY IMPLICATIONS It has been argued that it is the combination of rigid market-access rules with flexible safeguards and impairment procedures that has permitted the multilateral trade liberalization to proceed without the harmonization of policies across GATT/WTO member countries. It is this subtle compromise that has permitted two opposing principles, domestic policy autonomy and trade cooperation, to coexist.60 The WTO has a much more important role to play in international aﬀairs than did the GATT, and a legitimate question appears to be how much should be left to future interpretation of negotiated texts through litigation. One argument is that the inexact status of the final actions taken by WTO members represents a practical answer to policy issues on which it is not possible to reach total agreement. But the argument continues that public interest groups resist the common WTO pragmatic solutions to the interpretation of rules – for example, constructive ambiguity in the formulation of text to keep negotiations proceeding – believing that trade ministries do not share the same ultimate values as they do. They are therefore not prepared to trust the WTO to achieve a solution for them over the long run. The conclusion is that the WTO’s aﬃnity for ambiguous solutions to legal issues does not provide a solution to the trade linkages debate.61 In reality, the alternatives to addressing the problems that public interest groups have with WTO rules have been couched in terms of two rather rigid alternatives: the need for formal decisions involving amendments or waivers, or changes and interpretation to the rules through the dispute settlement procedures. It would seem, however, that a realistic alternative is for governments to discuss and negotiate the manner in which they intend to deal with the important policy issues that are gravitating towards the WTO. In launching the Doha Development Round, governments negotiated and agreed

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to texts relating to how to deal with access to essential medicines and the TRIPs provisions relating to compulsory licensing and patents. Similarly, how to approach the phasing out of environmentally harmful fishing subsidies was negotiated along with the process to be followed in clarifying the relationship between WTO rules and conflicting trade rules in Multilateral Environment Agreements. In the absence of these negotiations in the context of the Doha Ministerial Meeting, all these topics would be candidates for dispute settlement action.

NOTES * 1. 2. 3. 4. 5.

6.

7. 8.

9.

10.

11. 12.

The views expressed in this chapter are my own. I would like to thank an anonymous referee for most helpful comments. Peter Lloyd has argued that the enthusiasm of some to extend the reach of the WTO, in particular, to labour standards, the environment and competition policy is misplaced. See Lloyd (1997a, 2001). For a sceptical approach to the inclusion of competition policy in the WTO see Lloyd and Sampson (1995). In fact, the American Journal of International Law (2002), devoted a full issue to the implications of increasing the linkages between these specific issues (including competition policy) and the WTO. Bhagwati and Hudec (1997). To some extent, these issues are being raised in a very uncoordinated manner. With some justification, Bhagwati, in commenting on the papers in the American Journal of International Law (2002), scolded the contributors for neglecting the contributions in the volumes edited by himself and Hudec. See Bhagwati (2002). Some support for this view is given by Jackson (2002). With these issues in mind I invited a number of prominent people who are all influential in their respective areas of international relations and asked them to contribute a chapter to a volume addressing what they thought to be the ‘Role of the WTO in Global Governance’. Very diﬀerent views emerged. See Sampson (2000). See Wolf (2000). There are almost 150 governments that constitute the membership of the WTO. In what follows, these will be referred to as the WTO members. While the 15 countries of the European Union are individual members, they are represented at WTO meetings (with the exception of the WTO Budget Committee) by the European Commission which speaks on behalf of the 15 member states. All the multilateral trade agreements relating to services, agriculture, intellectual property and so on which emerged from the Uruguay Round are annexed to the Agreement Establishing the World Trade Organization. In the following, the expression ‘the WTO Agreement’ is understood to cover the totality of all the Uruguay Round agreements. These texts are to be found in WTO (1995). The Preamble to the Agreement Establishing the World Trade Organization (WTO) states that members recognize ‘that their relations in the field of trade and economic endeavor should be conducted with a view to raising standards of living . . . while allowing for the optimal use of the world’s resources in accordance with the objective of sustainable development, seeking both to protect and preserve the environment and to enhance the means for doing so’. See WTO (1995). GATT had an original membership of 23 countries. See WTO (2003), ch.1. It should be mentioned, however, that while the Agreement on Agriculture has as its objective creating a less market-distorting approach to world trade in agriculture

64

13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23.

24.

25. 26. 27. 28.

29. 30. 31.

WTO issues and trade negotiations products, the options that remain available to policy-makers are far removed from what the economist would consider to be the optimal policy choice. The term ‘regional’ is used to describe these preferential trading agreements, even though many are not regional in nature (for example, European Union–Mexico Free Trade Agreement or the USA–Singapore Free Trade Agreement). Even 30 years ago John Jackson predicted that ‘as the general incidence of all tariﬀ and other trade barriers declined world wide, assuming the trend of past twenty years continues, the problem of preferential arrangements may fade away’. See Jackson (1969). Members of the WTO are obliged to notify their regional trade agreements to the WTO Committee on Regional Trade Agreements (CRTA). The figures cited here are drawn from the WTO (2002). See, for example, Lloyd (1998). See Lloyd (1997). Lloyd (1998). See Sampson and Woolcock (2003). See Lloyd (1992). Dan Esty puts a high priority on ‘internalizing the externalities’ as a means of solving the trade and environment debate, but severely questions the political reality of all countries pursuing this route. See Esty (1994). The reasons why are dealt with comprehensively in Bhagwati and Srinivasin (1997). This so-called destination principle is to be distinguished from the origin principle, whereby the products are taxed in the country of production. Under the origin principle, there would be no need for border tax adjustment, since all products would be taxed at their point of origin. In 1968, a Working Party on Border Tax Adjustments was established in GATT to examine the provisions of the General Agreement relevant to border tax adjustments, the practices of contracting parties in relation to such adjustments, as well as their possible eﬀects on international trade. See GATT (1970). For a comprehensive discussion see WTO (1997). Such as sales, excise, turnover, value added, franchise, stamp, transfer, inventory and equipment taxes. Such as taxes on wages, profits, interests, rents, royalties, and other forms of income, and taxes on the ownership of real property. As such, WTO provisions on border tax adjustment follow the destination principle for indirect taxes, and the origin principle for direct taxes. The distinction between direct and indirect taxes, and the assumptions which underlie it, have been questioned at times. Some governments have argued that the assumption of full shifting of direct taxes is not a reflection of economic reality and favours countries which rely heavily on indirect taxes and discriminates against countries which rely predominantly on direct taxes. As such, the conclusion they draw is that the current GATT provisions and tax practices are not trade-neutral. While these are the working assumptions, the reality of whether taxes are passed on depends very much on the market structure. For a discussion see WTO (1996), Report (1996) of the Committee on Trade and Environment (Report of CTE to Singapore Ministerial Conference), WT/CTE/1, 12 November 1996. The 1970 Working Party noted that there was a divergence of views with regard to the eligibility for adjustment of certain categories of tax, such as those which encompass consumption taxes on capital equipment auxiliary materials and services used in the transportation and production of other taxable goods, as well as taxes on advertising, energy, machinery and transport. The Working Party did not investigate the matter for it felt that while this area of taxation was unclear, its importance – as indicated by the scarcity of complaints reported in this connection – was not such as to justify further examination. (GATT, 1970, para. 15)

Challenges facing the WTO: determining its role in international aﬀairs 32. 33. 34. 35. 36. 37.

38.

39. 40. 41. 42. 43.

65

Such taxes include consumption taxes on capital equipment, auxiliary materials, and services used in the transportation and production of other taxable goods (for example, taxes on advertising, energy, machinery and transport). GATT 1994 Article III:2. See WTO (1995). GATT 1994 Article III:1. See WTO (1995). GATT 1994 Article III:4. See WTO (1995). Frieder Roessler identifies ‘treatment no less favourable’, ‘so as to aﬀord protection’ and ‘like products’ and discusses them in Roessler (1997). This section will concentrate on ‘like products’. In the Antidumping Agreement, for example, like product is defined as ‘a product which is identical, that is, alike in all respects to the product under consideration or, in the absence of such a product, another product which, although not alike in all respects, has characteristics closely resembling those of the product under consideration’. Appellate Body Report, Japan – Taxes on Alcoholic Beverages, (WTO DOC. WT/DS 8, 10 and 11/AB/R of 4 October 1996), Geneva: WTO. The Appellate Body also cautioned against the automatic transposition of the interpretation of ‘likeness’ under the first sentence of Article III:2 to other provisions where the phrase ‘like products’ is used (p. 113). The New Shorter Oxford English Dictionary (Oxford: Clarendon Press, 1993), Vol. I, p. 1588. These observations were made by the Appellate Body. See WTO (2001). Ibid. The asbestos referred to in this case is chrysotile asbestos. Ibid., para. 172. The relevant text of Article XX of GATT 1994 reads as follows: Subject to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade, nothing in this Agreement shall be construed to prevent the adoption or enforcement by any Member of measures: (b) necessary to protect human, animal or plant life or health; . . . (d) necessary to secure compliance with laws or regulations which are not inconsistent with the provisions of this Agreement, including those relating to customs enforcement, the enforcement of monopolies operated under paragraph 4 of Article II and Article XVII, the protection of patents, trade marks and copyrights, and the prevention of deceptive practices; . . . and (g) relating to the conservation of exhaustible natural resources if such measures are made eﬀective in conjunction with restrictions on domestic production or consumption . . . .

44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54.

For a useful description of these cases see WTO (2000b). For a summary see ibid. The relevant aspects of the Panel Report can be found in the Appellate Body Report. See WTO (1998a). See ibid., para. 128. The following views are all expressed by national delegations in WTO (1998b). See WTO (1998a), para. 161. The resistance on the part of developing countries to a change in this direction cannot be overstated. See the remarks by of a number of developing countries in WTO (1998b). It has been argued that one of the main US motivations for negotiating the SPS Agreement in the Uruguay Round was to have the means to tackle the European Union on hormone regulations. See Echols (1996). Charnovitz (1998). See WTO (1995), 5(1) p. 72 and Annex A:3, p. 79. The TBT Agreement covers all technical regulations, voluntary standards and the procedures except when these are sanitary or phytosanitary measures as defined by the SPS Agreement.

66 55. 56.

57. 58. 59. 60. 61.

WTO issues and trade negotiations WTO (1995), p. 138. Thus a standard relating to fuel for a motor vehicle would not take into account the process used to produce the fuel unless the quality of the product were aﬀected. Mineral fuels and ethanol can have the same standards with respect to chemical composition. The fact that one is the product of a biological process is only relevant if the chemical composition of the fuel is aﬀected. For a discussion of these points and other aspects of the relationship of ecolabelling to the TBT Agreement, see Motaal (2002). This view is expressed in Hudec (1996). Sampson (2001). Frieder Roessler, former Head of the GATT Legal Oﬃce, also draws attention to the importance of flexibility (see Roessler, 1997). Hudec, 1996).

REFERENCES American Journal of International Law (2002), special issue on ‘The boundaries of the WTO’, 96 (1). Bhagwati, Jagdish (2002), ‘Afterword: the question of linkage’, American Journal of International Law, 96 (1), 126–34. Bhagwati, Jagdish and Robert H. Hudec (1997), Fair Trade and Harmonization, Vol. 1, Cambridge, MA: MIT Press. Bhagwati, Jagdish and T.N. Srinivasin (1997), ‘Trade and environment: Does environmental diversity detract from the case for free trade?’, in J. Bhagwati and R.H. Hudec (eds), Fair Trade and Harmonization, Cambridge, MA: MIT Press, ch. 4. Charnovitz, Steve (1998), ‘The World Trade Organization, meat hormones and food safety’, International Trade Reporter, 15 October. Echols, Marsha A. (1996), ‘Sanitary and phytosanitary measures’, in Terence P. Steward (ed.), The World Trade Organization: Multilateral Trade Framework for the 21st Century and U.S. Implementing Legislation, Washington, DC: American Bar Association, Section on International Law and Practice. Esty, Dan (1994), Greening the GATT, Washington, DC: International Institute for Economics. GATT (1970), Working Party Report, ‘Border tax adjustments’, L/3464, adopted on 2 December, 18S/97. Hudec, Robert (1996), ‘The GATT/WTO dispute settlement process: Can it reconcile trade rules and environment needs?’, in Rudiger Wolfrum (ed.), Enforcing Environmental Standards: Economic Mechanisms as Viable Means, Berlin: Springer Verlag, pp. 123–64. Jackson, John (1969), World Trade and the Law of GATT, New York: Bobbs-Merrill. Jackson, John H. (2002), ‘After word: the linkage problem – comments on five texts in symposium’, American Journal of International Law, 96 (1), 118–25. Lloyd, Peter (1992), ‘The problem of optimal environmental policy choice’, in K. Anderson and R. Blackhurst (eds), The Greening of World Trade Issues, Brighton: Harvester Wheatsheaf, pp. 49–72. Lloyd, Peter (1997a), ‘The Singapore Ministerial Conference: an overview’, Australian Economic Review, 30 (1), 71–4. Lloyd, Peter (1997b), ‘Completing the CER’, Committee for Economic Development of Australia (CEDA) Working Paper, Melbourne, April.

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Lloyd, Peter (1998), ‘Unilateral and regional trade policies of the CER countries’, in J.J. Piggott and A.D. Woodlands (eds), International Trade Policy and the Paciﬁc Rim, Basingstoke: Macmillan. Lloyd, Peter (2001), ‘The architecture of the WTO’, European Journal of Political Economy, 17, 327–53. Lloyd, Peter and Gary P. Sampson (1995), ‘Competition and trade policy: identifying the issues after the Uruguay Round’, World Economy, 18 (5), 681–705. Motall, Doaa Abdel (2002), ‘Ecolabelling and the World Trade Organization’, in Gary P. Sampson and W. Bradnee Chambers (eds), Trade, Environment and the Millennium, 2nd edn, Tokyo: United Nations University Press. Roessler, Frieder (1997), ‘Diverging domestic policies and trade integration’, in J. Bhagwati and R.H. Hudec (eds), Fair Trade and Harmonization, Cambridge, MA: MIT Press (1997), ch. 1. Sampson, Gary P. (ed.) (2000), The Role of the WTO in Global Governance, Tokyo: United Nations University Press. Sampson, Gary P. (2001), ‘Eﬀective multilateral environment agreements and why the WTO needs them’, World Economy, 24 (9), 1097–108. Sampson, Gary P. and Stephen Woolcock (eds) (2003), Regionalism, Multilateralism and Economic Integration: the Recent Experience, Tokyo: United Nations University Press. Wolf, Martin (2000), ‘What the world needs from the multilateral trading system’, in G.P. Sampson (ed.), The Role of the WTO in Global Governance, Tokyo: United Nations University Press, pp. 183–208. WTO (1995), The Results of the Uruguay Round Negotiations: the Legal Texts, Geneva: WTO Secretariat. WTO (1996), ‘Report of the Committee on Trade and Environment’ (Report of CTE to Singapore Ministerial Conference), WT/CTE/1, 12 November. WTO (1997), ‘Taxes and charges for environmental purposes: Border tax adjustment’, WT/CTE/W/47, 2 May. WTO (1998a), United States – Import Prohibition of Certain Shrimp and Shrimp Products, Appellate Body Report, WT/DS58/AB/R, 12 October. WTO (1998b), Minutes of Meeting of the Dispute Settlement Body, WT/DSB/M/50, 14 December. WTO (2001), European Communities – Measures Aﬀecting Asbestos and AsbestosContaining Products, Appellate Body Report and Panel Report, adopted 5 April, WT/DS135. WTO (2002a), ‘Regional trade integration under transformation’, document presented at a WTO seminar, 26 April, and available at www.WTO.org. WTO (2002b), ‘GATT/WTO dispute settlement practice relating to GATT Article XX paragraphs (b), (d) and (g)’, Note by the WTO Secretariat, WT/CTE/ W/203, 8 March. WTO (2003), Understanding the WTO, Geneva: WTO Secretariat.

4.

The interaction between trade and competition policy: post-Doha communications to the WTO Working Group Kerrin M. Vautier

1.

THE CONTEXT: PROMOTING EFFICIENT COMPETITION IN GLOBAL MARKETS

In 1996, Peter Lloyd and I began extensive collaborative research on ‘competition policy’ and international trade at bilateral, regional, plurilateral and multilateral levels. This was against a background of growing international interest in policies to promote or defend competitive and eﬃcient markets. Our research showed that issues were being confused by the common proposition that ‘competition policy’, and competition law in particular, warranted attention because this was a new trade-related area. We determined that there was a stand-alone case for policies to promote competition, the objective of which was neither to maximize a country’s trade nor to prevent nullification or impairment of benefits from negotiated trade concessions. We went on to advocate a coherent framework, based on pro-competition principles, for guiding policy direction in national and multi-national fora and for guiding the resolution of economic conﬂict within and between governments. In so doing, we acknowledged the prima facie appeal of the WTO as the institutional location for addressing emerging competition issues, pointing to its breadth of membership and its positioning as a multilateral organization that could, at least in principle, correct policy distortions aﬀecting global markets. However, the focus of the WTO was on rules for world trade, government measures, and a market access/trade-driven approach to international competition issues. We very much doubted that solutions to the emerging competition issues (particularly anti-trust) would emanate from the WTO, especially in view of the following considerations:

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69

the fact that an important competition principle – comprehensiveness – was not a WTO principle; the trend away from per se prohibitions of business conduct; the analytical complexities of competition (as distinct from trade) analysis under a rule-of-reason approach; and the practical diﬃculty of securing agreement on competition rules among so many members, given their diﬀerent stages of development and institutional capacity.

We did not intend, however, that these various constraints be construed as a recipe for the status quo. To the contrary, we strongly supported what we termed ‘positive unilateralism’, stimulated by multinational support for intra- and inter-country cooperation in applying competition principles. We also maintained that continuing reductions in border barriers to trade would be the WTO’s main strategy for promoting competition in globalizing markets and, as developing members argue, for facilitating their trade relationships. Further, we urged, the WTO could ● ● ●

● ● ●

enforce non-discrimination in international trade; address specific competition issues within WTO agreements or GATT articles; encourage members to accede to and give eﬀect to explicit competition provisions relating to services, intellectual property and state trading enterprises; ensure that anti-dumping measures are not used as a form of contingent protection; prohibit export and import cartels; and generally promote national policies in support of the competitive process and a culture of competition.

In short: The approach of the WTO should be as comprehensive, coherent and credible as possible within its constitution and mandate. . . . But it is important that . . . competition principles not be undermined by individual economies’ trade maximization objectives or by specific concerns about trade nullification and impairment for which WTO remedies exist.1

If necessary, the WTO’s nullification and impairment provisions should be strengthened. I have continued to study the deliberations of the WTO Working Group on the interaction between trade and competition policy (the Working Group) and, for the purposes of this chapter, have analysed all the

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written communications from individual members and institutions to the Working Group during 2002, that is, the formal responses to the competition policy section (paragraphs 23–5) of the 2001 Ministerial Declaration (reproduced in Appendix 1).2 It is to this section of the Doha Declaration that the chapter now turns.

2.

THE DOHA MINISTERIAL DECLARATION 2001

WTO ministers in the Doha Declaration picked up from where the Working Group had left oﬀ after five years of deliberations, which began after the 1996 Singapore Ministerial. The Statement from that meeting directed that a newly constituted Working Group would ‘study issues raised by Members relating to the interaction between trade and competition policy, including anti-competitive practices, in order to identify any areas that may merit further consideration in the WTO framework’. The notion of a ‘multilateral framework’ for competition policy started to develop in 19993 and paved the way for ministerial recognition at Doha of ‘the case for’ such a framework. Despite the lack of clarity and coherence in the framework’s rationale and elements – which remains a concern of some members – much of the Working Group’s discussion related to implementation and institutional issues and, in 2000, the emphasis was clearly on the goals and elements of cooperation. In 2001 there was a narrowing of focus towards national competition laws and to anti-cartel provisions in particular. In addition, the main proponents of a WTO framework softened their position with assurances that they were not calling for: ● ● ● ● ●

a one-size-fits-all approach; the adoption of general domestic rules relating to competition law or enforcement; harmonized competition laws; necessarily, a positive comity requirement for cooperation; nor recourse to the WTO’s dispute settlement procedures.

This left the following elements of the proponents’ case: ● ● ●

a prohibition on hardcore cartels (because of their impact on international trade); voluntary cooperation amongst competition agencies that exist in member countries; the application of fundamental WTO principles to national competition laws;

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provision for exceptions and exemptions, provided these are transparent; technical assistance for capacity building in developing countries.

Unfortunately, none of the representations to the Working Group about the broader scope and role of competition policies found expression in the emerging ‘competition policy’ framework, nor in the ministers’ instructions for the Working Group’s 2002–03 agenda. As a result, the agenda was substantially curtailed. In the Doha Declaration, WTO ministers explicitly acknowledged: (i) (ii)

the case for a multilateral framework to enhance the contribution of competition policy to international trade and development; and the need for associated and enhanced technical assistance and capacity building, including in respect of policy analysis and development.

A significant feature of ‘the case’ is that competition policy is specifically linked to international trade rather than to competition–eﬃciency–welfare (a paradigm which the author, Peter Lloyd and some members would prefer). This created no surprise, however, given a prevalent view in the Working Group that ‘competition policy’ is to be valued primarily for the role it could play in maximizing a country’s trade or the potential benefits from trade – a view inﬂuenced more by country access and trade objectives than by competition and market eﬃciency objectives. The analytics thus become skewed towards impediments to trade alone, rather than detriments to the overall competitive process. Either way, short- and long-term delivery of technical assistance and capacity building to developing and least-developed member countries would appear to be a prerequisite for any explicit consensus on negotiation modalities, especially as a big issue for at least some of these members is how a multilateral competition policy framework might aﬀect their development policies and objectives. It is not surprising that the Singapore issues have been described as ‘development issues’ in the context of the Doha Development Agenda and that an aim of capacity building and technical assistance for competition policy is to deepen understanding of this area among both recipients and providers of assistance.

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3.

THE WTO WORKING GROUP AGENDA 2002

Ministers instructed that the Working Group’s 2002–03 agenda would focus on: ● ● ● ●

technical assistance and capacity building; modalities for voluntary cooperation; clarification of provisions on hardcore cartels; and clarification of core principles, including transparency, nondiscrimination and procedural fairness.

Working Group meetings on each of these topics were held during 2002, culminating in the Working Group’s 2002 Report to the General Council.4 The table in Appendix 2 sets out the member and institutional communications that were submitted to each of the three meetings on a no-commitment basis. Analysis of these underpins the discussion in Sections 3.1 to 3.4 below, which follow the order of the Working Group agenda. While competition policy was not defined by ministers solely in terms of competition law – in fact it was not defined at all – their scoping of the term mirrored the narrowing-down process in the Working Group. Not surprisingly therefore, the formal post-Doha Communications also concentrated on competition law. The principles discussed were also generally confined to the three specified in the Doha Declaration, although that text left open the possibility of including and clarifying others. 3.1

Technical Assistance and Capacity Building

Developing-member perspectives Capacity building and technical assistance have been propelled by the Doha Development Agenda to the forefront of the competition policy work programme for the period up to the Fifth Ministerial Session. At least as far as developing countries are concerned, capacity building and technical assistance need to acknowledge ﬂexibility (to reﬂect inter-country diﬀerences) and progressivity (to reﬂect a phased approach to any new competition legislation), and to involve long-term commitments to the ‘building’ elements of both human and institutional capacity. In support, there needs to be decentralized and ex ante competition advocacy (not just at government level) and a demonstration that the benefits of any competition regime exceed the costs. Technical cooperation can assist with understanding and implementing agreed international economic rules and should have urgent regard to the

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design of transparent and fair procedures and to the autonomy of a competition authority within government. Capacity building and technical assistance also need to extend to sector-specific regulatory bodies, to ensure consistency in a competition regime. Comments While there was strong acceptance within the developing economy group of the positive contribution that competition policies, including competition law, could make to (international) market orientation and (national) development, specific suggestions for assistance were generally tied to the process of building and sustaining competencies in the development and implementation of competition law, with particular emphasis on the importance of an autonomous and transparent competition institution in each country with suﬃcient authority to conduct the necessary advocacy role. The underlying intent varies among both developed and developing countries. Appropriately, communications from five developed members reinforced the link between the economic underpinnings of competition law/policy and the various forms of technical assistance. The purpose of technical assistance and capacity building for the delivery of ‘competition policy’ is equally important as the purpose of ‘competition policy’ itself. The EC, in promoting technical assistance for case-related enforcement, where trade interests are aﬀected, was endeavouring to export its objective function for competition law into a WTO framework – ‘convergence of approach’ being its longer-term game. But its trade-related/market access approach stood apart from the emphasis on competition and eﬃciency evidenced in some other communications. And there was resistance, including by the USA, to the notion of a single model.5 The importance of tailoring technical assistance to specific circumstances, needs and diﬀerent national approaches was stressed. 3.2

Modalities for Voluntary Cooperation

Introduction The underlying rationale for voluntary cooperation arises from a combination of globalization, anti-competitive business activities (cartels, mergers and abuse of dominant positions, in particular) that cross national boundaries/jurisdictions, and adverse impacts from these activities on plural (national) markets. A multilateral framework would enable the spread of cooperation in relation to business conduct that does not fall within bilateral agreements, and would supplement such agreements.

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WTO Secretariat The scope of voluntary cooperation among competition regulators is a well-established issue within the Working Group. The WTO Secretariat6 was alert to the broad and narrow use of the term ‘cooperation’ and, for the purposes of a Background Note, adopted the latter, describing its two main elements as: (i) (ii)

provisions to facilitate case-specific cooperation on anti-competitive practices having an impact on international trade; and provisions relating to general exchanges of information and experiences and joint analysis of global trade-related competition issues, to be conducted by a WTO Competition Policy Committee.7

Cooperation in a WTO context would tend to be incremental, with the first phase being largely educational in respect of developing enforcement capacity. Notification procedures, coordination of enforcement actions against international cartels, and the development of common merger review procedures would follow.8 At the same time, the WTO Secretariat recorded resistance among members to pressure for harmonization and the view that harmonization of substantive laws and enforcement policies was not a prerequisite for eﬀective cooperation. However, over time, cooperation would tend to foster a degree of ‘soft’ convergence.9 UNCTAD The support within UNCTAD for a multilateral cooperation framework seems to derive, at least in part, from recognition that members’ interests could be adversely aﬀected by international cartel and merger activity, and from the fact that these members tend not to be participants in bilateral cooperation agreements. The tone of the post-Doha UNCTAD meetings suggests that developing economies are shaping their responses to the prospect of a multilateral framework around, inter alia, provisions for comity and special and diﬀerential treatment. This approach seems likely to represent a source of tension with developed WTO members who, as the OECD noted, are resistant even to voluntary positive comity. Comments While the seven member communications on modalities for voluntary cooperation were all supportive of the notion of ‘voluntary cooperation’, diﬀerent dimensions emerged – depending on whether the term was interpreted solely as anti-trust case-specific enforcement cooperation,

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or was more generally linked to the building of capacity and mutual understanding among all members. Any multilateral role in respect of voluntary cooperation was seen as supplementing, not substituting for, the ‘deeper’ and potentially more intensive cooperation potential of bilateral (and regional) competition cooperation agreements. Bilateral cooperation was considered not to be suﬃcient for protecting developing economies against international cartels. However, while a multilateral framework might be more inclusive, it would not necessarily be able to satisfy demands for positive comity nor for principles for addressing jurisdictional issues. Both hardcore cartels (including export and import cartels) and business acquisitions featured prominently in the underlying rationale for international cooperation and led to a focus on the corresponding individual and collective enforcement capability of national competition agencies. But the objective function was again biased towards protecting trade interests, with no attempt to reconcile this with the primary objective of competition law. Further, despite the increasing ability of businesses to export their conduct across borders into enlarging markets, adverse impacts were considered in the context of a country’s trade and national markets. This apparent contradiction is being sustained by national laws and their enforcement where markets continue to be defined in geographic and jurisdictional terms rather than in economic terms. 3.3

Clarification of Provisions on Hardcore Cartels

Introduction The topic of ‘hardcore’ cartels is one in which both developed and developing countries clearly have an interest. The Communications to the July 2002 meeting were rich with examples of prosecuted domestic cartels as well as cartels that were international in scope, in terms of both the diversity of their membership and the geographic spread of their adverse impacts. These cartels have also aﬀected important products that are used and consumed globally.10 The ‘hardcore’ qualifier is intended by its authors to underscore the harm caused by certain horizontal agreements – variously described as the ‘most egregious’, ‘insidious’, ‘unequivocally pernicious’ and ‘unambiguously harmful’ form of conduct – and to distinguish these agreements from other inter-firm collaborations that have welfare-enhancing potential.11 WTO Secretariat The WTO Secretariat cited statutory exemptions or protective regulatory regimes as contributors to the harmful eﬀects of hardcore cartels.12 It also

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recorded that a distinction should be made between international hardcore cartels and export/import cartels,13 notwithstanding submissions that: ● ● ●

export cartels are a clear example of an anti-competitive practice that potentially distorts the terms of trade; the victims of export cartels often include developing country importers, of machinery and consumer products, for example; registration of export cartels is not necessarily required, in which case their prevalence may be greater than presently thought.

On the other hand, the WTO Secretariat noted suggestions that: ● ● ●

the harm caused by export cartels may be less than thought, in that not all fix prices or exercise market power; in any event, the concern is less than situations where both export and domestic markets are subject to cartelization; even without exemptions, cartels that only impact export markets might be outside the jurisdiction of the source country.

Strongest advocate The European Community, which is the strongest advocate for an inclusive multilateral response that unequivocally condemns and bans hardcore cartels and that provides for voluntary cooperation to that end, sees these cartels as contradicting the proper functioning of a competitive marketplace and adversely impacting international trade.14 It submitted that any multilateral ban on hardcore cartels would not be eﬀective in the absence of a commitment by WTO members to provide for deterrent sanctions in their domestic regimes.15 Comments A multilateral response along these lines would raise important questions as to conduct definition and the extent of corresponding support provided by domestic prohibitions, sanctions and possible leniency programmes (modelled on the EC Competition Commission and supported by the OECD).16 The fact that the international trend in competition law is away from per se rules, in favour of rule-of-reason/case-by-case analysis, suggests that any outright prohibitions of particular forms of business conduct – whether in national or international law – will (and should) be limited. At least from an economic perspective, per se rules only have a place where the purpose or eﬀect of clearly defined conduct is unequivocally harmful to the eﬃciency of the competitive process in most if not all circumstances. That such conduct may also distort international trade or undermine the

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potential benefits from trade provides additional grounds for concern. But trade/access eﬀects, on their own, may not justify intervention on competition grounds, having regard to positive as well as negative implications for competition in the relevant market. If ‘egregious’ and ‘pernicious’ hardcore cartel conduct is to be the target of multilateral discipline, there is a major question over the extent to which exemptions and exceptions can justifiably be accommodated, especially in developed countries. Arguably, the exclusions envisaged in the OECD definition – notably agreements that are exempted or authorized by members17 – are far too broad as a starting point; and the EC, for one, appears quite sanguine about the possible range of exclusions and exemptions from any international ban on hardcore cartels, provided these are transparent. Given the reasons advanced for explicit multilateral condemnation of hardcore cartels, periodic review in addition to transparency would seem necessary – while noting that this, in turn, would require agreement on the competition principles/standards to be applied in any review. The fact that the title of the EC’s Communication on hardcore cartels was confined to ‘International Hardcore Cartels’ suggests that the EC has either bought into or is responsible for the (somewhat legalistic) distinction used by the WTO Secretariat to separate ‘trade cartels’ from ‘international cartels’. At the same time, the USA specifically identified export cartels – in that they fall outside the reach of domestic anti-trust – as one of the more complex issues arising in the context of a multilateral approach to ‘hardcore cartels’. And Canada’s question as to the value of a WTO cartel agreement becomes particularly pertinent if exceptions and exemptions are to be accommodated and in eﬀect condoned by members from the outset, irrespective of the level of adherence to competition principles. While ministers at Doha sought clarification of provisions on hardcore cartels, the deliberations on this topic have not yet delivered. The Communications did, however, reveal a strong anti-cartel thrust and accepted the underlying presumption that hardcore cartels with crossborder eﬀects are either increasing in absolute or proportional terms or having wider adverse impacts than previously thought. This is despite the proposition that the risk of cartel arrangements is inversely proportional to the level of competition18 that, generally, would be expected to increase as globalization proceeds. 3.4

Clariﬁcation of Core Principles

Introduction The Doha Declaration reflected the prior discussions of the Working Group that core/fundamental WTO principles were a desirable feature of

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any multilateral competition policy framework and that these included transparency (of all relevant laws, regulations, decisions and notifications); procedural fairness (execution of decisions in a uniform, impartial and reasonable manner); and non-discrimination (in terms of MFN and national treatment). The WTO Secretariat would also include ‘special and diﬀerential treatment’ as a fundamental principle, embodying progressivity, flexibility and capacity building as integral elements.19 It is noted that the WTO’s core principles are already cited in relation to internal measures as well as border measures and that no examples of discrimination on the basis of corporate nationality have been placed before the Working Group. Comments The main proponent of a multilateral framework agreement, the EC, has in eﬀect argued that a set of binding and unambiguously defined core principles should substitute for any commitment to the harmonization of members’ competition laws, for which it recognizes there is no present mandate. But, while there is some overlap, these core principles are trade principles, not competition principles – a distinction that takes on more significance if, as foreshadowed, the reach of these principles were to go beyond hardcore cartels. Generally during 2002, the focus was on the three principles specified in the Doha Declaration rather than on other principles that might be relevant to a multilateral competition policy framework. The starting point of trade (and ‘development’), not competition (and welfare), helps explain why so little cross-reference was made to APEC’s Competition Principles.20 The limited exploration of the relevance of these Principles – ‘accountability’ was picked up by Australia and ‘comprehensiveness’ by New Zealand – was disappointing, especially in view of the seeming promise conveyed in Japan’s Communication on technical assistance/capacity building which stated that the APEC Principles ‘will be very important as a reference point for discussing elements of core principles in the WTO Working Group’.21 When it came to principles, however, Japan was reticent about any explicit competition dimension. Overall, the following ‘clarifications’ in relation to core principles have emerged: ● ●

the three principles specified in the Doha Declaration are indeed ‘core’ (binding?) principles; special and diﬀerential treatment for developing countries is another relevant principle;

The interaction between trade and competition policy ● ● ● ● ●

●

●

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the core principles could apply beyond any multilateral rule on hardcore cartels; core principles would not be applied in a mechanical or uniform way; flexibility would be permissive of sectoral exclusions from national competition laws for developed as well as developing members; an MFN exemption could apply to bilateral/regional competition cooperation agreements; the non-discrimination principle could apply to national rules (de jure discrimination) but not to de facto discrimination in enforcement; a transparency obligation could be confined to national laws, regulations and guidelines, in view of the potential cost burden and capacity limitations on the ability of developing members to comply with a wider obligation; the procedural fairness principle would necessarily be expressed in somewhat general terms, even though there was some interest in promulgating minimum standards.

Some members argued that as the core WTO principles presently extend to internal measures, they would already reach existing competition law regimes. Thus competition law policy would already be subject to (geographic) non-discrimination, transparency and procedural fairness – although their inclusion in a WTO competition policy agreement would be reinforcing, especially in resisting pressures for discriminatory treatment from domestic sources.22 Others argued that these WTO principles required tailoring to competition law. But this could divert members in their negotiations from competition principles to the tailoring of trade principles to competition law regimes. The relatively narrow approach that has emerged would suit some members as it avoids explicit display of competition issues in the WTO beyond a specified category of ‘egregious’ anti-competitive business practices. It avoids the articulation and application of competition principles to present rules and practices within the WTO. It avoids interference with the status quo as far as developed countries are concerned and limits international guidance for overall competition policy processes in member economies. One could infer from the US Communications that adoption of core WTO principles for a multilateral competition framework is all too hard and will depend in large part on how generality is balanced with specificity in determining negotiation modalities. General principles (for example, in respect of procedural fairness) may give insuﬃcient guidance, especially for developing countries where guidance on minimum standards might be

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sought, whereas too much operational detail would threaten to compromise national policy discretion and flexibility. The perceived risk for developing economies is that the competition law preferences and experiences of developed economies are foisted inappropriately or prematurely upon them. Developing countries are clearly alert to the inconsistencies and limitations of a multilateral approach to ‘competition policy’ that is far from comprehensive, even in its application to trade measures.23 Consequently, developed countries are becoming rather more exposed when they seek to exclude, from the start, such sensitive cross-border practices as trade cartels and anti-dumping. These areas are very much at the interface between trade and competition and their exclusion must weaken any ‘case for a multilateral framework to enhance the contribution of competition policy to international trade and development’.24 There is clearly a reluctance on the part of developed and developing countries to relinquish existing exceptions/exemptions,25 despite their possible implications for trade and competition. At the same time, each group is sceptical that the other can justifiably retain these. On the positive side, emphasis was placed on transparency and peer review – although, generally, the importance of transparency was promoted more for reasons of predictability, for firms, than for reasons of accountability of governments and regulators.

4.

OVERALL ASSESSMENT

4.1

Competition and Development

A major issue for developing members (and NGOs) 26 is the interaction between competition and development policies. Competition law, primarily associated with developed countries, is a relatively sophisticated policy instrument in legal, economic, institutional and jurisprudential terms. Some countries will put competition law behind more immediate ‘competition policy’ priorities of trade liberalization and regulatory reform. And potential recipients of capacity building and technical assistance can be expected to seek tangible responses to the development thrust of the Doha Agenda. Developing members have also signalled concerns over the barriers to their competitiveness and development being maintained by developed countries. It can be argued that there is no a priori contradiction or incompatibility between competition policy and industrial policy, especially if the former underpins overall growth and development via open and competitive

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markets. But this perception is not necessarily shared by those developing countries facing the initial stages of structural transformation and who fear the displacement of relatively small local players by relatively powerful foreign firms. There is a big step between member acceptance of the mutual benefits of freer trade, and member support for a multilateral competition framework. 4.2

Elements of a Multilateral Framework

While members could be forgiven for thinking that the sine qua non of the EC’s approach is that each WTO member should have a competition law, the EC appears to have accepted that such a commitment cannot realistically be included in the initial elements of any multilateral framework. In its Communications, the EC has demonstrated a preparedness to make ‘concessions’, presumably for the purpose of facilitating consensus around the negotiating modalities. In addition to accepting that neither competition law nor its harmonization would be an obligation for WTO members, the EC has: ● ● ●

placed a limit on the scope of the transparency principle; agreed to an MFN exemption for bilateral cooperation agreements; confined the application of the proposed core principles to competition law (as distinct from its enforcement).

The EC also clarified that no additional market access would be secured under the framework. Its argument was that not only is there an existing link between the WTO’s trade principles and internal measures, but also the intended focus of the framework is on ensuring equality of opportunities for members as distinct from specific results in terms of access. Despite some convergence of view on competition law priorities, an important theme of the Working Group deliberations is that no single model for national competition law and enforcement is appropriate. Japan and Hong Kong, to name but two, do not consider that this precludes cooperation on competition matters. As depicted in Figure 4.1, the emerging multilateral competition policy framework is built around four key elements: (i) technical assistance for capacity building in the short and longer term; (ii) voluntary cooperation between competition agencies; (iii) a rule to prohibit hardcore cartels, enforceable at national level;

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(iv) core principles (possibly binding) for governing national competition (i.e. anti-trust) rules. As it stands, the framework does not: ● ● ●

● ●

go beyond competition law; articulate competition principles either for competition law or competition policy; in particular, take the non-discrimination principle beyond discrimination on the basis of nationality to protect trade, to nondiscrimination in respect of all modes of supply to protect competition; provide a basis for conflict resolution; provide a broad basis for a competition culture or competition advocacy.

Further, the issue of sector and conduct exemptions/exceptions from national laws has become embedded as a critical issue. The scope for permissive decisions by members on public benefit/net national welfare grounds does not get to grips with cross-border competition issues in markets that are not jurisdictionally bound. Overall, what has evolved is a soft and narrow framework, suggesting minimal impact either on attitudes or competitive processes in globalizing markets. Guidance for resolving cross-border competition conflicts remains limited. In eﬀect, the WTO might simply be engineering a political gesture towards ‘reining in’ multinational enterprises and increasing capacity building for developing members.

Exclusions

Exemptions/ exceptions

Hardcore cartel prohibition

Capacity building and technical assistance

National competition rule

Nondiscrimination Bilateral (MFN cooperation Exception national agreements treatment)

Transparency

Competition agency

Voluntary cooperation

Competition agency

Procedural fairness

Enforcement

Exemptions/ authorizations

Binding WTO principles with special and diﬀerential treatment for developing members

Figure 4.1

Multilateral competition policy framework

The interaction between trade and competition policy

4.3

83

Capacity Building

If assistance programmes are not designed to reflect a common approach to national competition laws and related institutional arrangements – because providers cannot agree on what that approach ought to be – then providers will need to be responsive to the specific circumstances and needs of recipient countries, noting the important distinction between: (i)

(ii)

short-term priorities covering policy analysis/development – so that developing members ‘may better evaluate the implications of closer multilateral cooperation for their development policies and objectives’;27 and long-term priorities in respect of human and institutional development – the technical assistance for which needs to be incremental and sustainable.

While much inter-country cooperation and agency support is already in evidence, the volume of assistance is not necessarily a good measure of its economic value to recipient countries. 4.4

Hardcore Cartels

Developing countries in particular want to be clear on the costs/benefits of any multilateral competition rules and commitments. They are being invited to accept the somewhat counter-intuitive proposition that as the volume of cross-border trade increases, so does the risk of hardcore cartels. This needs to be weighed alongside another proposition that, as firms face less protection through progressive reductions in trade and regulatory barriers, they might be incentivized to seek protection through private cooperative or coercive activities as a substitute for (less profitable) competitive conduct. The Communications reveal general acceptance that both the sources and impacts of hardcore cartels can be ubiquitous, and an emerging view that these cartels should be a primary target for any multilateral framework, even though they are not easily defined. The OECD definition,28 for example, could capture far more than completely indefensible inter-firm arrangements. This definitional question becomes especially important in the context of any per se rule, as members would need to agree on what conduct should be prohibited in all circumstances. The broader the definition, the stronger the argument for enforcement discretion at the national level under a rule-of-reason approach. However, if multilateral competition principles are not pressing down on members’ national rules

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and their enforcement, the WTO’s contribution to the promotion of interfirm competition and eﬀective anti-cartel enforcement will be very limited. 4.5

Principles

The proposed core principles are trade principles for competition law, not competition principles for trade. Neither are they competition principles for competition policy or trade policy. But trade eﬀects of business behaviour do not provide a suﬃcient basis for government intervention under the umbrella of competition law.29 If the principles were to apply beyond hardcore cartels, which appears to be the intention of some countries, the eﬀect would be to increase member commitments, in respect of transparency for example, as well as indirectly to import wider aspects of competition law into the multilateral framework. The distinction between applying the core principles to national rules (de jure) or to both rules and their enforcement (de jure and de facto) is not an insignificant one. In addition to limiting application of the nondiscrimination principle, a de jure approach would limit application of the transparency principle, even though the proponents of transparency mostly argue that this should cover exemptions and exceptions (subject to protection of information for confidentiality reasons). A focus only on the rules would also limit application of the principle of procedural fairness, which is really about non-discrimination with respect to actual procedures and processes, including equal access by all parties. The inclusion of special and diﬀerential treatment in a competition framework might suggest that eligible members will find it no more diﬃcult to obtain such treatment than elsewhere in the WTO. In any event, the important distinction between transitional provisions and opt-out provisions should be kept to the fore. An MFN exception for bilateral cooperation agreements would be on the basis that these are complementary to a multilateral approach and that they provide opportunity for deeper levels of cooperation between two parties on competition issues than is possible under a multi-party cooperation framework. However, having closely studied the bilateral form of competition agreement, Peter Lloyd and I found its potential for deep cooperation is also limited, especially absent positive comity provisions.

5.

CONCLUDING REMARKS

While the Working Group has been attempting to clarify the shape and scope of a multilateral competition framework, fundamental questions

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remain: has the case for a multilateral framework to enhance the contribution of competition policy (= competition law) to international trade and development been convincingly and coherently made? Is this ‘case’ the right one? Will the various elements that now feature in the framework make a credible diﬀerence to trade, eﬃcient markets or development? The areas which logically fit at the interface between trade and competition policy, that is, those that clearly have a trade and competition dimension, such as export and import cartels, parallel importing, antidumping and subsidies, have eﬀectively been carved out of the proposed framework – a framework that is heavily compromised by vastly diﬀerent member interests in a very complex area. While these diﬀerent interests will – appropriately – halt the EC’s grand plan of exporting its competition law model to all WTO members, they are likely also to prevent the importation into the WTO of competition principles that could serve to enhance competition as well as trade and welfare. The WTO Working Group has been emphasizing rules for trade rather than principles for competition. But, as Peter Lloyd and I have previously concluded, any multilateral competition framework should have something to oﬀer beyond the application of trade principles to national anti-trust rules (where these exist). If, because of its over-arching mandate, the WTO should appropriately limit itself to fundamental trade principles, then there should be no pretence that the proposed multilateral competition framework is anything other than a token buttress to trade liberalization. The promise that was available in the words of the Singapore Declaration has all but dissipated and what is left is that part of competition promotion that the WTO is least equipped to deal with – competition law. The narrowness of the framework that is evolving does nothing to bolster the credibility of the WTO as an agent for comprehensively promoting competition in global markets.30 Neither the Doha Declaration nor the diﬀerent member and institutional reactions to it suggest that the requisite consensus on negotiation modalities will be easily reached.

NOTES 1. 2. 3. 4. 5. 6.

Vautier et al. (2003). Most of the country-specific and institution-specific analyses that appeared in the original paper for the Festschrift have been removed from the published chapter but can be obtained from the author on request. WTO (1999). WTO (2002). US, WT/WGTCP/W/185, p. 2. WTO Secretariat, WT/WGTCP/W/192 ‘Background Note’.

86 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.

17. 18. 19. 20. 21. 22. 23.

24. 25.

26.

27. 28.

29. 30.

WTO issues and trade negotiations Ibid., para. 5. Ibid., para. 21. Ibid., para. 32. These include vitamins, carbonless paper, graphite electrodes, citric acid, sodium gluconate, lysine. WTO Secretariat, WT/WGTCP/W/191, para. 3. Ibid., para. 13. Ibid., para. 5. EC, WT/WGTCP/W/193, para. 4. Ibid., para. 21. A leniency programme oﬀers amnesty from punishment or sanctions to the first cartel participant who whistleblows. Interestingly, leniency grants to cartel whistleblowers were made in each of the five international cases referred to in the Annex to the EC Communication/193. OECD, Recommendation of the Council concerning Eﬀective Action against Hard Core Cartels. Argentina, WT/WGTCP/W/206, p. 2. WTO Secretariat, WT/WGTCP/W/209, ‘Background Note’, para. 17. APEC (1999), Attachment to APEC Economic Leaders’ Declaration, Auckland, New Zealand, 13 September. Japan, WT/WGTCP/W/186, III. WTO (2002), para. 13. The membership of the ‘anti-dumping’ group that has formed within the WTO appears to be testimony to this: Brazil, Chile, Colombia, Costa Rica, Hong Kong, China, Israel, Japan, Korea, Mexico, Norway, Chinese Taipei, Singapore, Switzerland, Thailand, Turkey. Source: Appendix 1. It should be borne in mind, however, that a country’s exemptions/exceptions/ authorizations do not necessarily warrant condemnation as they may well be justified in competition and welfare terms, especially if they are derogations from per se prohibitions. Typically, competition law jurisdictions (including Australia and New Zealand) maintain statutory and enforcement flexibility to accommodate ‘anti-competitive’ conduct on grounds of countervailing (national) public benefit, including net eﬃciency (which, from an economics perspective, is the appropriate emphasis). NGOs opposing competition policy in the WTO have expressed concerns about the burden of adjustment to new regulations and enforcement mechanisms; the unfairness, to companies of developing countries, of conferring national treatment upon transnational companies; the need for ‘development strategy’ to take precedence; and the likely exclusion of export cartels involving developed countries. They do not regard the WTO as the appropriate forum for negotiating competition or for arranging cooperation among competition authorities. ‘Investment and competition negotiations in the WTO – What’s wrong with it and what are the alternatives?’ http://www.s 2bnetwork.org Source: Appendix 1. ‘Anti-competitive agreement, anti-competitive concerted practice, or anti-competitive arrangement by competitors to fix prices, make rigged bids (collusive tenders), establish output restrictions or quotas, or share or divide markets by allocating customers, suppliers, territories, or lines of commerce.’ The wording of the Japan/Singapore Agreement is relevant in this regard: cooperation is directed at practices which adversely impact a country’s trade and which are ‘anticompetitive’ because they fail a competition standard in the relevant market. It is noted that APEC started modestly with its fostering of information/experience sharing, and the building of a common language and understanding, which culminated in the formulation of a strategic framework of principles for enhancing competition amongst its diverse member economies.

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REFERENCES Asia Pacific Economic Cooperation (APEC) (1999), Principles to Enhance Competition and Regulatory Reform. Lloyd, P.J. and Kerrin M. Vautier (1999), Promoting Competition in Global Markets: A Multi-National Approach, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Vautier, Kerrin M. (2002), Competition Policy and the Doha Development Agenda, Wellington: NZ Trade Consortium in association with the NZIER, June. Vautier, K.M., P.J. Lloyd and I-Wen Tsai (2003), ‘Competition Policy, Developing Countries, and the World Trade Organization’, in Will Martin and Mari Pangestu (eds), Options for Global Trade Reform – a view from the Asia-Paciﬁc, Cambridge: Cambridge University Press. Vautier, Kerrin M. and P.J. Lloyd (1997), International Trade and Competition Policy: CER, APEC and the WTO, Wellington: Institute of Policy Studies. World Trade Organization (1999), Report of the Working Group on the Interaction between Trade and Competition Policy to the General Council, WT/WGTCP/3. World Trade Organization (2002), Report of the Working Group on the Interaction between Trade and Competition Policy to the General Council, WT/WGTCP/6.

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APPENDIX 1

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EXTRACT FROM MINISTERIAL DECLARATION, MINISTERIAL CONFERENCE, FOURTH SESSION, DOHA, 9–14 NOVEMBER 2001

Interaction between Trade and Competition Policy 23. Recognizing the case for a multilateral framework to enhance the contribution of competition policy to international trade and development, and the need for enhanced technical assistance and capacity building in this area as referred to in paragraph 24, we agree that negotiations will take place after the Fifth Session of the Ministerial Conference on the basis of a decision to be taken, by explicit consensus, at that Session on modalities of negotiations. 24. We recognize the needs of developing and least-developed countries for enhanced support for technical assistance and capacity building in this area, including policy analysis and development so that they may better evaluate the implications of closer multilateral cooperation for their development policies and objectives, and human and institutional development. To this end, we shall work in cooperation with other relevant intergovernmental organisations, including UNCTAD, and through appropriate regional and bilateral channels, to provide strengthened and adequately resourced assistance to respond to these needs. 25. In the period until the Fifth Session, further work in the Working Group on the Interaction between Trade and Competition Policy will focus on the clarification of: core principles, including transparency, non-discrimination and procedural fairness, and provisions on hardcore cartels; modalities for voluntary cooperation; and support for progressive reinforcement of competition institutions in developing countries through capacity building. Full account shall be taken of the needs of developing and least-developed country participants and appropriate flexibility provided to address them.

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APPENDIX 2

THE WTO WORKING GROUP AGENDA 2002 – MEMBER1 AND INSTITUTIONAL2 COMMUNICATIONS3

Capacity building/Technical assistance (23–4 April)

Modalities for voluntary cooperation (1–2 July)

Clarification of provisions on hardcore cartels (1–2 July)

Clarification of core principles (26–7 September)

Australia Canada Egypt* EU

Australia Canada

Argentina Australia Canada

Australia

EU

EU

Japan† Korea†

Japan† Korea†

Korea† Mexico†

EU India* Japan† Korea† New Zealand

Romania Switzerland† Thailand† USA

WTO Secretariat

Thailand† USA OECD UNCTAD WTO Secretariat

USA OECD WTO Secretariat

South Africa Switzerland† Thailand† USA

WTO Secretariat

*Members of ‘like-minded group’ of 15 countries that is targeting procedural issues in the WTO, especially transparency. † Members of the (anti-dumping) ‘Reform Group’. 1 Only Australia, Korea and the USA issued Communications for each of the four topics. Of the 15 member countries which made formal contributions, eight were developing countries. 2 While APEC was not included amongst the Communications of observer intergovernmental organizations, five or six individual APEC economics made submissions on each of the four topics. 3 The Working Group Report (2002) also lists members/observers who made oral statements or posed questions at the meetings.

5.

Choosing formulas for market access negotiations: eﬃciency and market access considerations Joseph Francois, Will Martin and Vlad Manole*

1.

INTRODUCTION

There is a now a clear understanding that there are wide divergences between the broad approaches to tariﬀ reduction initially proposed by diﬀerent participants in the Doha Development Agenda. In his overview of the agricultural negotiations, Stuart Harbinson (WTO, 2003a) emphasized the wide divergence between the Uruguay Round approach to tariﬀ reduction favoured by Switzerland, Europe and Japan, and the more strongly top-down Swiss formula favoured by Uruguay, other Cairns Group members and the USA. He asked whether there were alternative views that might be used to form a basis for a compromise between the two approaches. In the negotiations on non-agricultural market access, the draft declaration for the ill-fated Cancun Ministerial moved away from earlier proposals involving a Swiss formula for non-agricultural market access, instead calling for delegates to seek a ‘non-linear’ tariﬀ reduction formula to be determined (WTO, 2003d). There seems to be broad agreement in the Doha Development Agenda negotiations on the desirability of a formula-based approach to tariﬀ reductions, and many diﬀerent formulas have been proposed. Some of these approaches – such as the Uruguay Round approach to agricultural tariﬀ reduction – allow discretion in assigning tariﬀ cuts at the individual tariﬀ-line level. Others are specified on a line-by-line basis, removing policy makers’ discretion at the individual product level. A major diﬃculty in comparing the diﬀerent formulas under consideration is that they diﬀer in many key respects, including the extent to which they reduce average tariﬀs and the extent to which they are top-down in reducing high tariﬀs relative to lower rates. Our objective in this chapter is to provide a framework for evaluating the trade-oﬀs between approaches 90

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91

such as the Swiss formula that are sharply top-down and approaches such as the proportional cuts approach that are less targeted to reducing peak tariﬀs. The potential benefits from use of a formula approach are large. If a suitable top-down formula can be identified and implemented, we can be relatively sure that it will lead to a global welfare gain, since the social costs of tariﬀs generally rise more rapidly than the rates themselves.1 By contrast, approaches that focus on reducing relatively low, ‘nuisance’, tariﬀs face the risk of reducing economic welfare and tariﬀ revenues by diverting imports away from higher-tariﬀ items (see Martin, 1997). An important message from analysis of actual tariﬀ data appears to be that the critical feature of a formula approach for welfare in the importing countries is not so much the flexibility of the formula (i.e. its willingness to go soft on peak tariﬀs) but rather the specification of a targeted reduction in the average rate. In other words, as long as a reduction in the average is still met, introducing some added flexibility by moving closer to proportional tariﬀ cuts may not greatly reduce the importing country’s gains from a top-down approach. However, moving away from a strict top-down approach in the industrial countries does seem to reduce the market access gains for low-income countries in industrial country markets. This chapter is organized as follows. In Section 2, we first provide some detail on the current market access landscape. This highlights important issues related to tariﬀ peaks, unbound tariﬀs, and gaps between bound and applied rates that will be important determinants of success for any formula approach. In Section 3, we then consider some formula-based approaches. In Section 4, we set out the concept of ‘flexible formula’ approaches. In Section 5, we consider some practical implementation issues. For illustration, and to assess the quantitative implications of alternative formulas, we examine an initial sample of three industrial countries and three developing countries in Section 6. In Section 7, we consider the trade-oﬀs between increasing flexibility and two dimensions of the cost of doing so – the reductions in eﬃciency in the importing country, and reductions in the cuts in average tariﬀs facing developing countries.

2.

A QUICK TOUR OF THE MARKET ACCESS LANDSCAPE

Tariﬀ negotiations in the multilateral trading system have generally been based on tariﬀ bindings, or schedules of concessions tabled under GATT rules, and the coverage and level of these bindings is an important element of the initial conditions for negotiation. Table 5.1 provides information on

92

Table 5.1

WTO issues and trade negotiations

Industrial tariﬀ rates and bindings – post UR and ITA Per cent of MFN imports that are subject to:

Argentina Australia Brazil Canada Chile Colombia El Salvador European Union Hungary India Indonesia Japan Korea Malaysia Mexico New Zealand Norway Peru Philippines Poland Singapore Sri Lanka Thailand Tunisia Turkey United States Uruguay Venezuela Zimbabwe

Tariﬀ lines

bound tariﬀs

unbound tariﬀs

tariﬀs bound above applied rates

tariﬀs unbound or bound above applied rates

Share of bound duty free tariﬀ lines to total tar. lines

Total tariﬀ lines

100.0 96.9 100.0 99.8 100.0 100.0 97.1 100.0

0.0 3.1 0.0 0.2 0.0 0.0 2.9 0.0

99.9 31.7 91.0 45.7 99.7 97.7 96.0 17.7

99.9 34.8 91.0 45.9 99.7 97.7 98.9 17.7

0.0 17.7 0.5 34.5 0.0 0.0 0.0 26.9

10 530 5 520 10 860 6 261 5 055 6 145 4 922 7 635

93.6 69.3 92.3 95.9 89.8 79.3 100.0 100.0 100.0 100.0 67.4 92.8 36.5 9.2 67.4 67.9 49.3 100.0 100.0 100.0 13.6

6.4 30.7 7.7 4.1 10.2 20.7 0.0 0.0 0.0 0.0 32.6 7.2 63.5 90.8 32.6 32.1 50.7 0.0 0.0 0.0 86.4

3.3 14.8 86.6 0.1 3.4 31.0 98.4 46.5 36.5 98.5 15.5 44.6 11.7 1.4 8.9 41.5 0.0 14.0 96.3 90.3 3.9

9.7 45.5 94.3 4.2 13.6 51.7 98.4 46.5 36.5 98.5 48.1 51.8 75.2 92.2 41.5 73.6 50.7 14.0 96.3 90.3 90.3

10.4 0.0 0.0 47.4 11.6 1.6 0.0 39.5 46.6 0.0 0.0 2.2 15.2 0.1 0.0 0.0 1.4 39.4 0.0 0.0 3.0

5 896 4 354 7 735 7 339 8 882 10 832 11 255 5 894 5 326 4 545 5 387 4 354 4 963 5 933 5 244 5 087 15 479 7 872 10 530 5 974 1 929

Source: Francois (2001), based on WTO and World Bank data on Uruguay Round and post-Information Technology Agreement schedules.

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93

the share of industrial-product tariﬀs (on a trade-weighted basis) that remains either unbound or bound above applied rates. While tariﬀs in the OECD (and Latin America) are generally bound, many Asian and African economy tariﬀs remain unbound despite more than a fourfold increase in the coverage of developing-country tariﬀ bindings in the Uruguay Round (Abreu, 1996). For almost all developing countries, existing bindings are, on average, well above applied rates, reflecting a combination of relatively high initial bindings and the subsequent sharp wave of reductions in applied rates (see Blackhurst et al., 1996; Francois, 2001; World Bank, 2001). In addition to general Uruguay Round commitments, some important sectoral ‘zero-for-zero’ agreements are reflected in the next-to-last column of Table 5.1. OECD economies have between roughly 10 per cent and 30 per cent of tariﬀ lines bound at 0 per cent. Laird (1998) estimates that zero-for-zero increased developed-country duty-free imports to 43 per cent of total imports. With the implementation of Uruguay Round commitments, average ad valorem tariﬀs on non-agricultural products in the industrial countries generally are around 3 per cent. This is reflected in the ﬁrst columns of Table 5.2. However, there are important exceptions such as textiles and clothing, where the average rate is roughly three times the overall average. This is reflected in the standard deviation and maximum tariﬀ columns. With full implementation of current commitments, we estimate a simple average industrial tariﬀ in the USA of 3.2 per cent, a standard deviation of 4.3, and a maximum tariﬀ of 37.5 per cent. The European Union has a higher average, but less dispersion. We estimate an EU average of 3.7 per cent, a standard deviation of 3.6 per cent, and a maximum tariﬀ of 17 per cent. For the developing countries in Table 5.1, average industrial tariﬀs range from a low of 3 to 4 per cent to a high of more than 20 per cent, estimates that are biased downwards by the omission of specific, compound and mixed tariﬀs from the data we utilized.2 Table 5.2 presents detailed data for three developing countries: Brazil, India and Thailand. These countries span the spectrum of developing country bindings as reflected in Table 5.1. Brazil’s tariﬀs are all bound, though the average rate for industrial products is 14.9 percentage points above the current applied rate. We refer to this gap below as ‘binding overhang’. India and Thailand’s tariﬀs are partially covered by bindings, again with significant binding overhang. As in the case of industrial tariﬀs, the stage for the agricultural negotiations was largely set by the Uruguay Round. One key diﬀerence from industrial products is that essentially all agricultural tariﬀs are bound. However, in both industrial and developing countries, there is a large degree

94

5.9 6.2 3.5 12.9 31.0 26.5

Simple average

European Union Japan USA Brazil India Thailand

3.7 2.3 3.2 15.9 19.2 10.5

Simple average

(b) Non-agriculture

European Union Japan USA Brazil India Thailand

(a) Agriculture

74.9 43.3 90.0 27.0 150.0 65.0

Maximum tariﬀ

3.6 3.4 4.3 6.0 16.5 10.8

Standard deviation 17.0 30.9 37.5 35.0 40.0 80.0

Maximum tariﬀ

Post-UR and ITA tariﬀs

7.5 8.1 7.4 5.1 20.8 14.4

Standard deviation

Post-UR and ITA tariﬀs

0.4 0.1 0.2 14.9 3.9 7.8

Binding overhang

0.3 1.2 0.5 22.6 90.7 7.1

Binding overhang 2.9 3.7 2.4 4.6 14.9 6.3

Standard deviation 10.9 13.9 11.5 22.3 70.8 30.1

Maximum tariﬀ 0.1 0.2 0.1 5.3 31.3 1.7

Binding overhang

1.9 1.2 1.7 13.5 11.3 7.2

Simple average

1.4 1.4 1.6 4.2 9.2 6.1

Standard deviation

5.0 5.6 6.1 16.7 30.5 20.7

Maximum tariﬀ

0.1 0.0 0.0 1.9 0.3 2.0

Binding overhang

Eﬀect of basic formula application on tariﬀs

3.0 3.5 1.9 12.4 29.5 15.1

Simple average

Eﬀect of basic formula application on tariﬀs

47.7 48.5 48.3 15.4 41.3 31.6

% reduction in average

48.6 43.0 46.6 3.7 4.8 43.0

% reduction in average

Table 5.2 Summary of the eﬀects of basic Swiss-formula reductions: applied tariﬀs before and after a 50 per cent cut in average tariﬀ bindings

Choosing formulas for market access negotiations

95

of binding overhang resulting from ‘dirty tariﬃcation’ or the use of ‘ceiling bindings’ (Hathaway and Ingco, 1996).

3.

SOME TARIFF REDUCTION FORMULAS

A range of tariﬀ-cutting formulas has been considered or implemented under GATT and regional trade arrangements. In this section, we focus on formulas implemented on a line-by-line basis, leaving discussion of discretionary approaches to Section 5. Stern (1976), Laird (1998), Laird and Yeats (1987) and Panagariya (2002), WTO (2003c) and World Bank (2003) survey a range of alternative line-by-line formulas. The first is a simple proportional cut, frequently described as a linear cut in policy discussions: t1 ct0,

(5.1)

where t0 is the initial tariﬀ (which may be an MFN applied rate; a preferential rate in a regional negotiation; or a tariﬀ binding in the WTO context), t1 the rate after application of the formula and c is the constant proportion of their original rate to which tariﬀs are to be reduced. After years of negotiations aiming to accommodate diﬀerences in countries’ initial tariﬀ rates (Preeg, 1970), a 50 per cent proportional cut formula was used in the Kennedy Round (1963–67). In the end, some products were exempted from this approach and permitted smaller tariﬀ reductions on the grounds of their sensitivity. Since the products exempted had much higher than average tariﬀs, these exemptions substantially reduced the cut in the overall average tariﬀ. Baldwin (1987, p. 43) estimates that, despite these exceptions, the reduction in average tariﬀs on industrial products was 35 per cent. This compared extremely favourably with the average of 2.5 per cent achieved in the second through the fifth rounds of GATT tariﬀ negotiations, generally conducted under the request-andoﬀer approach. An alternative proposal considered in the Tokyo Round negotiations, and suggested in a diﬀerent form in the Doha negotiations by Konandreas (2003) was a general linear reduction approach: t1 dft0,

(5.2)

where d is a positive constant and f is a number between zero and one. As with equation (5.1), this formula may be written with tariﬀs in percentage or proportional terms by making an appropriate adjustment to the parameter d.

96

WTO issues and trade negotiations

Formula (5.2) suﬀers, however, from a potentially serious problem with low tariﬀ rates. If the parameter d exceeds zero – which it must to yield larger percentage reductions in higher rates – this formula will lead to increases in lower rates. While there may be a case for some such increases in tariﬀs as a way of reducing the variation in tariﬀ rates and hence the cost of protection, such increases in tariﬀs do not sit easily with the trade-liberalizing raison d’être of the WTO. To deal with this problem, the proponents of this approach during the Tokyo Round advocated that it be applied only for tariﬀs greater than 5 per cent (Laird and Yeats, 1987). The formula accepted in the Tokyo Round was the Swiss formula: t1

a·t0 , a t0

(5.3)

where a is a positive tariﬀ rate that becomes a ceiling on tariﬀ rates. If tariﬀs are expressed in proportional terms, then the Tokyo Round value of this parameter was in the range from 0.14 to 0.16. For tariﬀs in percentage terms, the corresponding parameter values are 14 to 16. In the Doha negotiations, the USA and the Cairns Group proposed use of the Swiss formula with a coeﬃcient of 0.25 for agriculture. The Swiss formula has a number of desirable features for tariﬀ negotiations. The concavity of (5.3) in the initial tariﬀ rate means it has the desirable feature of reducing higher tariﬀ rates by more, in both absolute and relative terms, than lower tariﬀ rates. It is particularly eﬀective in reducing peak tariﬀs, since even the very highest tariﬀs are reduced below the value a. From the importers’ point of view, top-down approaches tend to reduce the economic eﬃciency losses associated with high and widely dispersed tariﬀs, and to preserve revenues, since import volumes tend to increase more on the higher-tariﬀ goods. From the point of view of developing-country exporters, top-down approaches like the Swiss formula might also be expected to lead to greater market access gains to developing countries given the existence of industrial-country tariﬀ peaks in agriculture, textiles and clothing. To understand the Swiss formula it is useful to examine particular cases. For an extremely small initial tariﬀ, say one tenth of 1 per cent, the coeﬃcient by which t0 is multiplied in equation (5.3) (a/(at0)) is essentially one, so there is essentially no reduction in the tariﬀ. For an initial tariﬀ rate of a, the final tariﬀ rate is a half of a, implying a 50 per cent reduction from the initial tariﬀ. For a very high initial tariﬀ, t0 /(at0) approaches one and the tariﬀ rate is eﬀectively reduced to a. A very stylized comparison of the proportional tariﬀ cut of 0.5 used in the Kennedy Round with a Swiss formula using the parameter 0.16 from the Tokyo Round is given in Figure 5.1. The diagram shows that the cuts in

Choosing formulas for market access negotiations

97

t1

0.32

t10.5t0

0.16

t10.16t0 /(0.16t0)

0

0.16 t0

0.32

Figure 5.1 Impacts of a proportional and a Swiss formula for tariﬀ cutting low tariﬀs are smaller using the Swiss formula than using the proportional cut formula, but that the cuts for tariﬀs above 0.16 are larger with the Swiss formula. While the figure does not make this clear, no tariﬀ would remain above 0.16 following application of this formula. A number of other formula-type approaches to structuring market access expansion have been proposed. Josling and Rae (2004) consider alternatives including reduction of bound rates to applied rates; the introduction of ceilings on tariﬀs; and ‘cocktail’ approaches with diﬀerent formulas, such as reductions to a ceiling rate, proportional cuts and Swiss-formula cuts over diﬀerent ranges of tariﬀs. Hoekman and Olarreaga (2002) examine the introduction of a limit on the ratio of the highest tariﬀs to the average as a means of dealing with tariﬀ peaks. The proposal by China, and the subsequent proposal by the Chair of the Market Access Committee in the Doha negotiations (World Bank, 2003) on non-agricultural market access introduced a Swiss formula with an a coeﬃcient based on each country’s initial average tariﬀ.

4.

INTRODUCING SOME FLEXIBILITY TO LINE-BY-LINE FORMULA CUTS

There are good reasons to question whether a pure Swiss formula, with a common upper limit of around 0.15 as used in the Tokyo Round, would provide suﬃcient fl f exibility for all WTO members to reach agreement on

98

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tariﬀ reductions in agriculture or non-agriculture in the Doha negotiations. In fact, it seems very possible that the lack of fl f exibility of the Swiss formula contributed to the exclusion of large numbers of products with high tariﬀs from the formula in the Tokyo Round. Unfortunately, many of these products were items such as agricultural products, textiles and clothing that are of particular interest to developing countries, which were not active participants in the exchange of market access concessions at that point. Hoekman and Olarreaga (2002) note that peak applied tariﬀs in the industrial countries are now around 50 times as high as the average rate. This contrasts with a ratio of ffive in the developing countries of sub-Saharan Africa, six in Latin America, seven in the Middle East and North Africa, nine in South Asia, and 28 in East Asia. Clearly, the widespread use in developingcountry trade reforms of top-down liberalization approaches noted by López and Panagariya (1992) has had a profound impact on the distribution of developing-country tariﬀs. The combination of quite large diﬀerences in the means and the variances of tariﬀs across countries seems likely to create a need for a formula that could encompass the entire distribution of tariﬀ rates while minimizing pressure for exceptions and special cases. One possible approach to dealing with this problem involves application of a Swiss-type tariﬀ reduction, with a ceiling based on the individual country’s initial average tariﬀ rather than a common Swiss-formula parameter a. In eﬀect, this combines the targeting of the distribution of tariﬀs under the pure Swiss formula with the targeting of a reduction in the average tariﬀ. This targeted formula approach reduces the ‘one-size-fits-all’ problem of a common a parameter. However, it still leaves potential political problems created by the very sharp top-down nature of the pure Swiss formula. To address the flexibility problem, one might generalize the Swiss formula to allow more flexibility in dealing with diﬀerent tariﬀ profiles, as suggested in Francois and Martin (2003). Under this flexible formula approach, the idea is to allow greater flexibility of approach to accommodate diﬀerent preferences over tariﬀ maxima and rates of reduction. One way to provide some additional flexibility is to modify the original Swiss formula by introducing an additional parameter, b, into equation (5.3) to obtain: t1

a · t0 1 1 . a · b t0 a b · t01

(5.4)

We call parameter b a flexibility parameter as it allows the shape of the relationship between the initial and final tariﬀs to change.3 As can be seen from the second term in equation (5.4), the original Swiss formula is a

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Choosing formulas for market access negotiations

special case of equation (5.4), with b1. As will become evident, the impact of tariﬀ reductions on peak tariﬀs can be softened by raising the a parameter. As b increases, the formula tends to increase the reduction in the lower tariﬀs, allowing for higher maximum rates with the same target reduction in the average tariﬀ. Clearly, there is an entire family of ﬂexible Swiss formulas, distinguished by their b values.4 Comparing these formulas directly is diﬃcult since changing b changes both the curvature of the line and the average depth of cut. Readily available programs like Microsoft Excel can be used to find the combinations of a and b consistent with the targeted reduction in average tariﬀs and hence allow formulas with diﬀerent curvature, but the same depth of cut in average tariﬀs, to be compared. To avoid formulas that increase the value of some tariﬀs, the flexibility parameter, b, should be one or above. This extended Swiss formula retains the key feature of the original Swiss formula that all tariﬀs are reduced below a ceiling given by a. Figure 5.2 illustrates, for an example with tariﬀs ranging from 0 per cent to 90 per cent, the percentage reduction in each tariﬀ rate needed given a target of a 50 per cent reduction in the average tariﬀ. As shown, there is some scope for trading oﬀ cuts 0.0

50.0

100.0

150.0

0.0 10.0

t1: b1.0 t1: b1.2 t1: b1.4 t1: b1.6 t1: b1.8 t1: b2.0

% reduction in tarff

20.0 30.0 40.0 50.0 60.0 70.0 80.0

Figure 5.2

Original tariff

Flexibility and Swiss formula-based tariﬀ reductions

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WTO issues and trade negotiations

in higher tariﬀs with cuts in lower tariﬀs through adjustments to the compensation parameter. This family of curves clearly provides much greater ﬂexibility to negotiators who had, hitherto, to choose one or the other approach. There is a limit to the flexibility we can obtain using the compensation parameter. As we raise b, we are substituting larger cuts in smaller tariﬀs for smaller cuts in higher tariﬀs. Beyond some point, it becomes infeasible to meet the required reduction in average tariﬀs. As shown in Francois and Martin (2003), adopting a combined targeted and flexible Swiss-formula approach guarantees that peak rates will be cut by at least the cut in the average, even with flexibility.

5.

SOME PRACTICAL ISSUES

Several practical issues arise in the implementation of formula cuts. These include the specification of the goal in terms of the depth of cut; the choice of the base rate to be cut; and the potential need for additional flexibility in the negotiations. 5.1

Average Cuts or Cuts in the Average?

One fundamental parameter in negotiations is the objective of tariﬀ reduction to be specified. Should it be specified in terms of a percentage reduction in average tariﬀs (simple or weighted); or in terms of an average tariﬀ cut; or in terms of a ceiling tariﬀ like the 0.15 used in the Swiss formula during the Tokyo Round; or as an average reduction in the price of imports?5 One widely advocated approach to tariﬀ reduction, the Uruguay Round approach to agricultural trade liberalization, specifies its objective in terms of an average cut in tariﬀs, and leaves countries free to choose the reductions at a tariﬀ-line level, perhaps subject to a minimum cut requirement. The diﬀerence between a cut in average tariﬀs and an average cut in tariﬀs seems minor, but is actually fundamental. Both in line-by-line approaches, and in those involving discretion at the tariﬀ-line level, a cut in average tariﬀs is an appealing organizing objective in that it provides a measure of progress from the initial regime towards complete free trade. By contrast, an average-cut criterion is always close to meaningless since it does not take into account whether the cuts take place in high or low tariﬀs. Under discretionary approaches, an average-cut criterion encourages large percentage cuts in low tariﬀ-rate commodities, as was evident in the Uruguay Round agreement on agriculture (Hathaway and Ingco, 1996),

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and may lead to little or no reduction in average tariﬀs. By leaving peak rates relatively unscathed, it may also exacerbate tariﬀ escalation. Proposals to use the Uruguay Round approach of a 36 per cent average cut in tariﬀs, with a minimum cut of 15 per cent in each tariﬀ line, seem likely to result in much less liberalization than the ‘headline’ 36 per cent cut. Since members would be able to choose the tariﬀ lines on which they make larger or smaller cuts, it would be feasible to make a reduction in the average tariﬀ rate of little over 15 per cent. Consider, for example, a case where a country has just two tariﬀ rates, 1 per cent and 100 per cent, and policy makers want to minimize the change associated with this approach. The result is likely to be as shown in Table 5.3. As is evident from the table, the 36 per cent average tariﬀ cut can be achieved with a reduction in average tariﬀs of only 15.5 per cent, less than half the specified goal. And virtually all of this is the result of the totally inflexible minimum-cut requirement. Since higher tariﬀs are typically those that are most politically sensitive, there is every reason to expect countries to behave like the hypothetical country in the table. In this case, the result will be limited overall liberalization, and particularly small reductions in the peak tariﬀs that are of greatest concern to developing countries. With relatively large reductions in low tariﬀs and limited reductions in high tariﬀs, tariﬀ escalation may even become worse. With all countries keenly aware of the option to minimize liberalization, and expecting other countries to take advantage of this opportunity, the pressure on policy makers to minimize the extent of their liberalization would be intense. It seems likely that the outcome would be reductions of 15 per cent in almost all tariﬀ lines with significantly trade-restricting tariﬀs. This approach has been described by the World Bank (2003) as ‘the cut you have when you are not having a cut’. If a discretionary approach is adopted, it would seem more logical to specify a target cut in average tariﬀs rather than an average cut in tariﬀs. While preserving the discretion that advocates of discretionary approaches demand, a reduction-in-the-average criterion does impose some realistic discipline. An average-cut criterion imposes essentially no Table 5.3 Large diﬀerences between average cuts in the tariﬀ and cuts in the average tariﬀ

Initial tariﬀ rate Tariﬀ cut New tariﬀ

Good 1 %

Good 2 %

Average %

1 57 0.43

100 15 85

50.5 36 42.7

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discipline, and hence provides no basis for an exchange of market access ‘concessions’. 5.2

Choice of Base Rate

A key issue in implementing any formula-based approach is the base rate to which the formula should be applied. In a regional negotiation context, this rate will generally be the preferential applied rate. Countries using a formula approach to reform their own tariﬀs would generally use the applied MFN rate as the base. Traditional GATT practice has been to focus on the bound rates contained in countries’ schedules of concessions. This has the important advantage of creating no disincentive for individual countries to undertake unilateral reductions in applied rates of the type that have so sharply reduced protection in developing countries during the past 20 years (World Bank, 2001). In addition, this approach might be viewed as providing credit for unilateral liberalization in the sense that a prior unilateral reduction of applied rates reduces one for one the cut in applied rates required in subsequent negotiations. Clearly, the choice of bound rates as the base would mean that some countries would have to make only small, or no, reductions in applied rates. Since WTO negotiations depend on meeting the needs of all participants, the approach to be adopted must meet the needs of participants. At the end of the day, countries will consider whether the reductions in their partners’ applied rates, and the increases in the security of their market access, resulting from the chosen base and reduction formula (or other approach) are suﬃcient to make the resulting package worthwhile. Historical applied rates, such as the rates applying at the end of a previous negotiation, would give credit for autonomous liberalization since that time, but perhaps create some disincentive for future liberalization. 5.3

Additional Flexibility

Even with the additional flexibility allowed by the extension of the Swiss formula oﬀered in this chapter, there is a risk that it would not be suﬃciently general to meet the political constraints of all countries on all products. One way to deal with the problem of exceptions while allowing additional flexibility would be to make a formula cut first, and to allow for renegotiations with compensation from this new base. This approach shifts the onus in making exceptions from the country to its trading partners, and seems much less likely to lead to fewer and smaller exceptions than the traditional discretionary approaches. Clearly, it would ensure the

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maintenance of a balance of concessions – the perceived lack of which created such diﬃculties in the Kennedy and Tokyo Rounds. 5.4

Non Ad Valorem Tariﬀs

Another potentially serious problem is created by specific, mixed and compound tariﬀs. Top-down formulas such as the Swiss formula cannot be directly applied to these tariﬀs, since it is not possible to know which are the high and low tariﬀs without knowledge of the value of the goods. One option would be to convert all specific tariﬀs to ad valorem form before applying the formula, as is specified for non-agricultural goods in the Cancun Ministerial Declaration (WTO, 2003d). Whether the approaches outlined in this section and the previous section have any chance of being acceptable depends heavily on the nature of the distributions of applied tariﬀs and tariﬀ bindings in member countries. The next section provides a very brief initial empirical assessment of the implications of formula approaches for a range of countries, taking into account the current distribution of their tariﬀs and tariﬀ bindings.

6.

SOME EXAMPLES

A simple, hypothetical analysis can illustrate some of the key implications of the approaches we discuss, including the implications of binding overhang. For concreteness, we specify: ● ● ● ●

A target for reduction in simple average tariﬀ bindings of 50 per cent. Unbound tariﬀs are initially bound at 150 per cent of applied MFN rates. The parameter b is initially set to 1.0 and is increased to 2.0. Agricultural and non-agricultural tariﬀs were treated separately.

Tables 5.2, 5.4(a–c) and 5.5(a–c) present the eﬀect of formula-based reductions on the tariﬀ schedules of the EU, Japan, the USA (industrial countries) and Brazil, India, and Thailand (developing countries). Table 5.2 summarizes results for the basic Swiss formula, while Tables 5.4 and 5.5 illustrate the eﬀect of adding flexibility while maintaining the same reduction in average bindings. These results are summarized in Figure 5.3. For the USA, bound rates generally are very close to applied rates. This is reflected in low initial binding overhang (the gap between average bound and applied rates shown as a percentage of the average applied rate). This also means that all formulas considered lead to significant cuts. The result

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Table 5.4 EU, Japan and the USA: eﬀects of a 50 per cent reduction in average bound rates (a) European Union a Compen- Simple Standard Maximum para- sation (b) average error tariﬀ (%) meter paratariﬀ meter (%) *Ag. *Non-ag. Ag. Non-ag. Ag. Non-ag. Ag. Non-ag.

1 1 12.7 6.4 16.5 8.2 27.9 13.7

0 0 1.0 1.0 1.2 1.2 1.5 1.5

5.9 3.7 3.0 1.9 3.0 1.9 3.0 1.9

7.5 3.6 2.9 1.4 3.0 1.5 3.2 1.6

74.9 17.0 10.9 5.0 13.0 5.7 17.9 7.1

Simple % average reduction binding in average overhang tariﬀ (pct points) 0.3 0.4 0.1 0.1 0.1 0.1 0.1 0.1

N/A N/A 48.6 47.7 48.5 47.6 48.4 47.5

Per cent of industrial tariﬀ lines currently unbound: 0% *Notes: a1, b 0 corresponds to zero cuts. The ﬁrst two rows therefore represent post-Uruguay Round (or base) rates of tariﬀs. Agricultural tariﬀs are limited to ad valorem tariﬀs. Other speciﬁc tariﬀs may be applied to excluded tariﬀ lines, typically at higher ad valorem rates than averages shown.

(b) Japan a Compen- Simple Standard Maximum para- sation (b) average error tariﬀ (%) meter paratariﬀ meter (%) *Ag. *Non-ag. Ag. Non-ag. Ag. Non-ag. Ag. Non-ag.

1 1 17.1 6.3 22.7 8.1 39.6 13.9

0 0 1.0 1.0 1.2 1.2 1.5 1.5

6.2 2.3 3.5 1.2 3.5 1.2 3.5 1.2

8.1 3.4 3.7 1.4 3.9 1.5 4.2 1.6

43.3 30.9 13.9 5.6 16.6 6.8 21.3 9.7

Per cent of industrial tariﬀ lines currently unbound: 0.84% Notes: as for panel (a).

Simple % average reduction binding in average overhang tariﬀ (pct points) 1.2 0.1 0.2 0.0 0.2 0.0 0.2 0.0

N/A N/A 43.0 48.5 43.2 48.4 43.7 48.4

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Table 5.4 (continued) (c) USA a Compen- Simple Standard Maximum para- sation (b) average error tariﬀ (%) meter paratariﬀ meter (%) *Ag. *Non-ag.

1 1

Ag. Non-ag.

Simple % average reduction binding in average overhang tariﬀ (pct points)

0 0

3.5 3.2

7.4 4.3

90.0 37.5

0.5 0.2

N/A N/A

12.4 7.2

1.0 1.0

1.9 1.7

2.4 1.6

11.5 6.1

0.1 0.0

46.6 48.3

Ag. Non-ag.

17.4 9.5

1.2 1.2

1.9 1.7

2.6 1.7

15.3 7.3

0.1 0.0

46.2 48.2

Ag. Non-ag.

34.7 16.2

1.5 1.5

1.9 1.7

3.0 1.9

26.0 9.9

0.1 0.0

45.9 48.1

Per cent of industrial tariﬀ lines currently unbound: 0% Notes: as for panel (a).

Table 5.5 Brazil, India, Thailand: eﬀects of a 50 per cent reduction in average bound rates (a) Brazil a Compen- Simple Standard Maximum para- sation (b) average error tariﬀ (%) meter paratariﬀ meter (%)

Simple % average reduction binding in average overhang tariﬀ (pct points)

*Ag. *Non-ag.

1 1

0 0

12.9 15.9

5.1 6.0

27.0 35.0

22.6 14.9

N/A N/A

Ag. Non-ag.

37.4 31.8

1 1

12.4 13.5

4.6 4.2

22.3 16.7

5.3 1.9

3.7 15.4

Ag. Non-ag.

47.0 39.8

1.2 1.2

12.4 13.5

4.6 4.3

23.2 16.8

5.3 1.9

4.0 15.3

Ag. Non-ag.

75.8 64.3

1.5 1.5

12.3 13.5

4.6 4.4

24.7 17.1

5.4 1.9

4.5 15.1

Per cent of industrial tariﬀ lines currently unbound: 0% Notes:

as for Table 5.4(a).

106

Table 5.5

WTO issues and trade negotiations

(continued)

(b) India a Compen- Simple Standard Maximum para- sation (b) average error tariﬀ (%) meter paratariﬀ meter (%) *Ag. *Non-ag. Ag. Non-ag. Ag. Non-ag. Ag. Non-ag.

1 1 134.2 38.3 169.9 48.1 277.2 77.6

0 0 1 1 1.2 1.2 1.5 1.5

31.0 19.2 29.5 11.3 29.5 11.3 29.4 11.2

20.8 16.5 14.9 9.2 15.0 9.3 15.1 9.3

150.0 40.0 70.8 30.5 72.0 34.7 73.5 35.0

Simple % average reduction binding in average overhang tariﬀ (pct points) 90.7 3.9 31.3 0.3 31.4 0.3 31.4 0.3

N/A N/A 4.8 41.3 4.9 41.3 5.0 41.3

Per cent of industrial tariﬀ lines currently unbound: 38% Notes: as for Table 5.4(a).

(c) Thailand a Compen- Simple Standard Maximum para- sation (b) average error tariﬀ (%) meter paratariﬀ meter (%) *Ag. *Non-ag. Ag. Non-ag. Ag. Non-ag. Ag. Non-ag.

1 1 38.2 27.8 48.9 35.0 81.5 56.5

0 0 1.0 1.0 1.2 1.2 1.5 1.5

26.5 10.5 15.1 7.2 15.1 7.2 15.1 7.2

14.4 10.8 6.3 6.1 6.6 6.1 7.2 6.2

65.0 80.0 30.1 20.7 34.6 23.0 43.8 27.4

Per cent of industrial tariﬀ lines currently unbound: 32% Notes: as for Table 5.4(a).

Simple % average reduction binding in average overhang tariﬀ (pct points) 7.1 7.8 1.7 2.0 1.7 2.0 1.7 1.9

N/A N/A 43.0 31.6 42.9 31.4 42.9 31.1

107

Choosing formulas for market access negotiations 0.0

100.0 90.0 80.0

Binding overhang as % of average % reduction in average applied rate

10.0

70.0

20.0

60.0 30.0

50.0 40.0

40.0

30.0 20.0

50.0

10.0 60.0

0.0 EU

Japan

USA

Brazil

India

Thailand

Figure 5.3 Binding overhang in industry: the impact of a 50% reduction in bound rate average on applied rate average is a reduction in maximum rates, variance and average rates. Notice from Table 5.4 that peak rates are not reduced as much when the flexibility parameter b is raised above 1. In particular, while still achieving a 50 per cent reduction in the average bound rate, the USA would be able to keep its highest ad valorem applied rates on industrial goods in the range from 7.3 to 9.9 per cent, depending on the selection of the b parameter. Similarly, the EU would be able to keep some peak industrial rates at up to 4.5 times the average tariﬀ. In Brazil, by contrast, average bound rates are well above applied rates. This is reflected in Table 5.2, as well as Table 5.5 and Figure 5.3. With a 50 per cent reduction in average bindings, Brazil’s industrial average applied rate falls by 15.4 per cent of its base value. While smaller than the proportional cut in average tariﬀs in the industrial countries, this translates into a larger percentage reduction in the cost of imports than those observed in the industrial countries. In agriculture, the binding overhang is so great that almost nothing happens to applied rates (a 50 per cent reduction in bindings yields only a 3.7 per cent reduction in applied rates). However, the binding overhang would be reduced suﬃciently to ensure real liberalization in subsequent negotiations, and to constrain potential future increases in tariﬀs. India realizes a similar (that is, very small) cut in applied agricultural tariﬀs, again reflecting high binding overhang in both developed and developing countries. The reduction in the average industrial tariﬀs is greater than in the case of Brazil. This reduction of eight percentage points in the average tariﬀ on industrial products implies a much larger reduction in the price of imports than in the case of the industrial countries.

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Thailand, with less binding overhang, realizes greater reductions in agricultural tariﬀs, with these tariﬀs reduced by over 40 per cent relative to their initial average level. In the industrial sector, Thailand’s reduction in applied rates is just over 30 per cent, which necessitates a reduction in applied tariﬀs of around three percentage points. This generates a reduction in the price of imports that is larger than in the industrial-country cases considered. In agriculture, the extent of binding overhang is much greater. Even with a large cut, such as the 50 per cent cut in bindings considered here, we see only small reductions in applied rates on agricultural goods in Brazil and India. In Thailand, by contrast, we see sharp reductions in agricultural tariﬀs because of the limited binding overhang in this case.

7.

WELFARE IMPLICATIONS OF INTRODUCING FLEXIBILITY

When considering an approach that would increase the political fflexibility of negotiating modalities, it is important to have some idea of the potential economic costs of allowing such fl f exibility. One consideration is for eﬃciency in the importing country. For the single-country case, economic theory tells us that top-down reductions in protection are likely to lead to greater welfare gains in the importing country than proportional cuts or, a fortiori, approaches that allow high tariﬀs to be reduced by less than low tariﬀs. A second consideration is the potential distribution of market access gains between countries. Given the preponderance of tariﬀ peaks in the products exported by developing countries to the industrial world, topdown approaches seem more likely to reduce the tariﬀs that are of greatest concern to developing countries, and hence to increase their market access gains. This potential diﬀerence can be measured by examining the impacts of diﬀerent approaches on the average tariﬀs facing developing countries. 7.1

Eﬃciency Eﬀects on the Importer

Economic theory provides two classic rules of thumb for piecemeal tariﬀ reduction in a single, small country: (i) that a proportional reduction in all tariﬀs will increase welfare, and (ii) that a reduction in the highest tariﬀ will increase welfare as long as this good is a net substitute for all other goods (Vousden, 1990, ch. 9). Vousden also shows that these welfare-improving conditions apply to multilateral, as distinct from unilateral, trade reforms as long as compensation is allowed. These rules, and the simple intuition given above, are strongly suggestive that a formula, such as the Swiss formula, that is strongly top-down will be welfare-improving – and more

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109

strongly welfare-improving than a proportional cut. The actual diﬀerence between a Swiss-formula-type cut and a proportional cut, though, is ultimately an empirical question. Theory tells us the direction of the diﬀerence (‘Swiss is better than proportional’), but not the magnitude. A simple approach to investigating whether use of greater flexibility, and hence a move away from strongly top-down to a more proportional cut, will have major welfare implications is to draw on the distorted trade expenditure function introduced by Lloyd and Schweinberger (1988), and further developed by Anderson and Neary (1992). While we could take a computable general equilibrium (CGE) modelling approach, this would require considerable aggregation of the tariﬀ data, which might cause us to lose information in the dispersion of tariﬀs within the twenty or so aggregates routinely used in CGE analysis. Instead, we have used a more disaggregated, but simpler, model with around 5000 tariﬀ lines identified separately, and identified as substituting in Armington fashion relative to a single, domestically produced good.6 We begin by representing the relevant features of the economic structure with the welfare evaluation approach that Lloyd and Schweinberger developed 15 years ago – a distorted trade expenditure function: Be( p, v)g( p, v)zp( p, v, u)( pp*),

(5.5)

where B is the balance of trade, e is the expenditure function in a vector of domestic prices and total utility, u; g is revenue from production as a function of domestic prices and a vector, v, of resources (we might generalize this by using a profit function with variable intermediate inputs); zp is the derivative of (eg) and equal to net imports of each good; and p* is a vector of world prices. If we assume a standard Armington-type structure in a small economy, with imports diﬀerentiated from domestic goods, but domestic goods perfectly substitutable with exports, then we can simplify the analysis of tariﬀ changes by focusing only on e( p, u) and the tariﬀ revenue function. When tariﬀs change, there will be no change in the realized value of g( p, v) and it can be ignored, unless there are distortions such as export taxes. To make the approach easy to apply, we write the expenditure and revenue functions using a constant-elasticity of substitution functional form for the expenditure function and a tariﬀ revenue function based on the import demand functions derived from the fi f rst derivatives of this function with respect to prices. In this situation, for a single economy, the relevant elements of the distorted trade expenditure can be written: B [jj ( pj*(1tj))(1 )]1/(1 ) u j pj*j [ pj(1tj)/P] u,

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WTO issues and trade negotiations

where P [jj ( pj*(1tj))(1 )]1/(1 ), is the elasticity of substitution, and the js are the distribution parameters of the CES expenditure function. We calibrate this function using data on imports from the UNCTAD TRAINS database, and data on consumption of domestically produced goods from the World Bank’s World Development Indicators. In line with standard practice in the CGE literature, all domestic prices were initially set to unity to allow decomposition of value data into prices and quantities. This allowed the coeﬃcients to be determined from the value share data at domestic prices. A value of 4 was assigned, raising the elasticity of substitution above that in most empirical estimates of import demand functions on the grounds that we are dealing with very ffinely disaggregated trade data for which relatively high elasticities of substitution might be expected. While the analysis in the earlier sections of this chapter was undertaken for agriculture and for industrial products separately, in line with the negotiations at WTO, this approach would not be satisfactory for our welfare analysis. Second-best eﬀects associated with reducing one set of tariﬀs, while leaving another set unchanged, might overwhelm the welfare eﬀects of interest to us – those associated with diﬀerent degrees of progressiveness in the reduction of high tariﬀs.7 Finally, the goal of this section is primarily illustration. Therefore, we repeated the analysis using the extended Swiss formulas to reduce all tariﬀs in each sample country. The tariﬀ schedules of USA and the European Union have been analysed for the case of a 50 per cent reduction in simple average tariﬀs. These results are presented in Table 5.6 for the three diﬀerent values of the b parameter identified in the earlier tables. The gains are, as might be expected, very small, given the very low levels of the ad valorem tariﬀs included in the database. As might also be expected, the gains from reform for the USA rise as the tariﬀ reduction formulas are made more strongly top-down. However, the diﬀerences between the gains with diﬀerent degrees of flexibility are quite small. A similar pattern emerges for the European Union. In both cases, moving from the standard Swiss formula Table 5.6 Welfare implications of a 50 per cent reduction in bound tariﬀs under diﬀerent degrees of ﬂexibility

b 1 b 1.2 b 1.5

USA % of GDP

EU % of GDP

0.0548 0.0535 0.0508

0.0463 0.0455 0.0440

Note: For the impact on tariﬀ structures, see Table 5.5.

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111

to a Swiss formula with a flexibility parameter of 1.5 causes only a very small reduction in the welfare gains from liberalization. What do these results suggest? The results are of course very partial, reflecting only the eﬃciency gains from own-country liberalization. Further, they are based on tariﬀ information that excludes the eﬀects of specific, compound and mixed tariﬀs, and other charges such as antidumping duties. However, they are based on very widely dispersed real-world tariﬀ data collected at a fine level of disaggregation, and probably do have some relevance for inferences about national and global eﬃciency gains from trade reform. We would draw the following conclusion. Whether and how we add flexibility is second order, and should not be a roadblock to achieving a reduction in the average. This means that the selection of which formula to choose, at least among the top-down options spanned by the flexible Swiss formula, is nowhere near as important as the more basic issue of simply selecting and imposing a targeted reduction in the average.8 It may be better to simply focus on achieving large reductions in average tariﬀs, even if the price is acceptance of an approach, such as a pure proportional cut, that allows some tariﬀs to remain relatively high. This result may not, of course, be acceptable, particular if such approaches are found not to achieve needed reductions in some of the key tariﬀ peaks restricting global market access, and particularly market access by developing countries. 7.2

Market Access Gains to Developing Countries

A key empirical issue is the extent to which changing the dispersion of overall protection, for a given average cut in tariﬀs, aﬀects the average reduction in protection facing developing countries. In contrast with the eﬃciency issue addressed in Section 7.1, there is little that theory can say to guide whether top-down cuts will be more successful in reducing the barriers facing developing countries. However, we do know that developing countries generally face higher MFN tariﬀ barriers against their exports than do industrial countries (World Bank, 2003, ch. 2). Many have concluded that this diﬀerence reflects to a significant degree the limited presence before the Uruguay Round of developing countries in the ‘main game’ of multilateral negotiations – the exchange of market access concessions. Whatever the cause of this discrepancy, it implies that approaches that attack tariﬀ peaks more aggressively are more likely to be beneficial to developing countries, the greater the extent that developing countries face disproportionately high tariﬀs. To examine this issue, we increase the b parameter in equation (5.4) to reduce the concavity of the tariﬀ-cutting formula. At one extreme, we

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WTO issues and trade negotiations

consider the classic Swiss formula set in such a way that it brings about a 50 per cent reduction in tariﬀs with the greatest reductions, by far, in the highest tariﬀs. Then, we allow for increasing degrees of flexibility up to the point where all tariﬀs are reduced by a flat 50 per cent. This is done by increasing the flexibility parameter in the extended Swiss formula from 1.0 to 2.0. The results of this analysis are presented in Figure 5.4 for EU tariﬀs faced by exports from low-income countries, and in Figure 5.5 for US tariﬀs faced by the same countries. In each case, the values of the flexibility formula are shown on the horizontal axis and the proportional reduction in tariﬀs on the vertical axis. We find that a classic Swiss formula used to target a 50 per cent cut in the simple average tariﬀ on imports into these two large economies does indeed lead to larger reductions in the weighted average tariﬀs facing low-income countries. In the case of the USA, the reduction in tariﬀs is 56 per cent, while in the European Union, the reduction is 55 per cent. Then, as the flexibility of the cuts is increased, the reductions in average tariﬀs faced by the low-income countries fall progressively, to 50 per cent when tariﬀs are cut proportionately. Clearly, this simple, exploratory analysis confirms our initial hypothesis that top-down approaches produce larger reductions in tariﬀs facing lowincome countries for any given reduction in the importers’ average tariﬀ. This gain is an important equity reason to favour strongly top-down approaches to tariﬀ cutting – such as the Swiss formula – over more flexi0.56 0.55 0.54 0.53 0.52 0.51 0.50 0.49 0.48 0.47 1.0

1.2

1.5

2.0

Note: average tariﬀs are shown on the vertical axis.

Figure 5.4 Implications of alternative tariﬀ-cutting rules for EU tariﬀs facing low-income developing countries

Choosing formulas for market access negotiations

113

0.56 0.55 0.54 0.53 0.52 0.51 0.50 0.49 0.48 0.47 1.0

1.2

1.5

2.0

Note: average tariﬀs are shown on the vertical axis.

Figure 5.5 Implications of alternative tariﬀ-cutting rules for US tariﬀs facing low-income developing countries ble, and perhaps more politically saleable, alternatives such as a proportional cut. It seems likely that approaches that allowed peaks to be retained, such as an average-cuts rule, would further reduce the market access gains for poor countries.

8.

CONCLUSIONS

In this chapter, we first considered the advantages of formula approaches to trade negotiations, and noted the apparently widespread acceptance of these advantages in the current WTO negotiations under the Doha agenda. An important feature of these negotiations is the search for compromises between those seeking aggressive top-down market liberalization and those seeking more limited liberalization, or seeking to avoid reform altogether. We then examined the key features of the market access landscape that will aﬀect the choice of approaches to negotiations. These features include the large dispersion of average tariﬀs among the active participants in the negotiations, and the large gaps between applied and bound tariﬀ rates in many countries and sectors. In implementing a formula approach, one key practical issue is whether countries are to have discretion in the depth of cuts on individual tariﬀ lines. Where countries have discretion, an average-cuts criterion was shown

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to provide essentially no discipline. A seemingly similar, but in fact fundamentally diﬀerent, criterion of a required reduction in the average tariﬀ rate would potentially introduce some discipline by requiring cuts in at least some high tariﬀs. Our review of potential approaches to tariﬀ reduction covers a range of line-by-line tariﬀ formulas. The Swiss-formula approach used in the Tokyo Round is seen as particularly desirable because of its ability to introduce a tariﬀ rate ceiling, and to bring about larger reductions in the highest tariﬀ rates. Unfortunately, it may be too restrictive to be fully applied in its original form, particularly because of the large dispersion in the average and dispersion of countries’ tariﬀ rates, and the presence of binding overhang in many countries. To overcome, or at least reduce, this restrictiveness, we examined the implications of targeted and flexible Swiss-formula approaches. The first is a simple adaptation of the Swiss formula that is targeted to a specific reduction in average tariﬀs for particular country and commodity groups (for example, agricultural and non-agricultural). The second is a more flexible version of the Swiss formula that would allow the same cut in the average tariﬀ to be achieved with somewhat smaller reductions in peak tariﬀs. Essentially, this increase in flexibility would allow larger cuts in smaller tariﬀ rates to be used to compensate for smaller reductions in higher tariﬀs. While such a change would almost certainly reduce economic eﬃciency, it may ultimately be preferable to a retreat into exceptions as a way of reaching a politically acceptable agreement. This flexible formula approach potentially allows for a Swiss family of formulas, or a Swiss-Army-knife type collection of instruments, with diﬀerent trade-oﬀs between tariﬀ cuts on higher and lower tariﬀ rates. We examine the potential outcomes of applying this family of formulas in three industrial country markets – Europe, Japan and the USA – and three developing-country markets – Brazil, India and Thailand. As an illustration, we target cuts in average bound tariﬀ rates in each country, considering agricultural and industrial products separately. Preliminary analysis suggests that, in this situation, only a bold cut, such as the 50 per cent target used in the Kennedy Round, would make substantial progress in increasing market access in both developing and developed countries. In the final section of the chapter, we develop two simple methodologies for evaluating the consequences of diﬀerent tariﬀ formulas. The first approach evaluates the welfare consequences for the importer of diﬀerent tariﬀ reductions. When the welfare implications of diﬀerent versions of the flexible Swiss formula are considered over the range from the Swiss formula to a proportional cut, we find that the gains are very similar for diﬀerent degrees of flexibility. This is illustrated with data for the USA and the

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115

European Union. The basic qualitative message is the same in both cases. Increasing flexibility appears to have only a small impact on the eﬃciency gains accruing from a 50 per cent tariﬀ cut. From the point of view of economic eﬃciency in the importing country, this result suggests that the depth of cut in the average tariﬀ may be more important than the extent to which this reduction is brought about by reducing tariﬀ peaks. The extent to which the formula used succeeds in bringing down high tariﬀ rates relative to others seems to matter more for developing countries’ market access. Because many of the exports of developing countries face high tariﬀs in the industrial countries, we anticipated that top-down approaches might be more eﬀective in increasing the market access of developing countries. This expectation was borne out – formulas that reduced peak tariﬀs in the industrial countries more sharply gave developing countries greater increases in the market access of low-income countries for any given reduction in average tariﬀs.

NOTES *

1. 2.

3. 4. 5. 6. 7. 8.

This chapter reflects the personal views of the authors only and not those of any institution with which they are aﬃliated. We would like to thank numerous friends and colleagues, and particularly Elwyn Grainger-Jones, Bernard Hoekman, Richard Newfarmer, Marcelo Olarreaga, Ernie Preeg and Alan Winters for valuable comments. All remaining errors are, of course, our own. Correspondence addresses: J.F. Francois, Burg Oudlaan 50-H8-18, Erasmus University Rotterdam, 3000DR Rotterdam NL, [email protected]; Will Martin, World Bank, 1818 H St NW, Washington DC 20433, USA, wmartin1@world bank.org; Vlad Manole, World Bank, 1818 H St NW, Washington DC 20433, USA, [email protected] See Vousden (1990), p. 233. López and Panagariya (1992) point out that the presence of non-produced intermediates weakens this general proposition. This omission has recently been remedied for applied rates in a few countries in the WTO’s Integrated Database and the UNCTAD TRAINS database available through the World Bank’s World Integrated Trade Solutions (WITS) program, and in data compiled by the International Trade Centre and CEPII. The first expression in (5.4) shows its similarity to the original Swiss formula. The second shows the source of the asymptotic feature of the formula – division by a rectangular hyperbola in the tariﬀ rate. This might be called a Swiss-Army-knife approach to tariﬀ reduction. This measure, defined for a small country by t/(1 t), where t is the change in the tariﬀ rate, is an important determinant of the increase in market access resulting from a negotiation. A better longer-term solution to this problem would be to utilize a two-stage aggregation approach like that proposed by Bach and Martin (2001). The importance of this problem can readily be overstated. At least at the level of aggregation used in a CGE model, Hertel and Martin (2001) found that these second-best welfare impacts were very small in a prospective new round of WTO negotiations. Of course, if escalation-increasing approaches such as that of the Uruguay Round are considered, it may well be important to look at more than the resulting reduction in the average.

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REFERENCES Abreu, M. (1996), ‘Trade in manufactures, the outcome of the Uruguay Round, and developing country interests’, in W. Martin and L.A. Winters (eds), The Uruguay Round and the Developing Countries, Cambridge: Cambridge University Press. Anderson, J. and P. Neary (1992), ‘Trade reform with quotas, partial rent retention, and tariﬀs’, Econometrica, 60, 57–62. Bach, C. and W. Martin (2001), ‘Will the right tariﬀ aggregator for policy analysis please stand up?’, Journal of Policy Modeling, 23, 611–35. Baldwin, R.E. (1987), ‘Multilateral liberalization’, in J.M. Finger and A. Olechowski (eds), The Uruguay Round: A Handbook for the Multilateral Trade Negotiations, Washington, DC: World Bank. Blackhurst, R., A. Enders and J.F. Francois (1996), ‘The Uruguay Round and market access: opportunities and challenges for developing countries’, in W. Martin and A. Winters (eds), The Uruguay Round and Developing Countries, Cambridge: Cambridge University Press. Francois, J.F. (2001), The Next WTO Round: North–South Stakes in New Market Access Negotiations, CIES Adelaide and the Tinbergen Institute, Adelaide: CIES. Francois, J.F. and W. Martin (2003), ‘Formula approaches to tariﬀ negotiations’, World Economy, 26 (1), 1–28. Francois, J.F. and W. Martin (2004), ‘Commercial policy variability, bindings, and market access’, European Economic Review, 48, 665. Hathaway, D. and M. Ingco (1996), ‘Agricultural liberalization and the Uruguay Round’, in W. Martin and L.A. Winters (eds), The Uruguay Round and the Developing Countries, Cambridge: Cambridge University Press. Hertel, T. and W. Martin (2001), ‘Second-best linkages and the gains from global reform of manufactures trade’, Review of International Economics, 9 (2), 215–32. Hoekman, B. and M. Olarreaga (2002), ‘Une proposition pour l’OMC: La “super” clause de nation plus favourisée’, mimeo, Washington, DC: World Bank. Hoekman, B., F. Ng and M. Olarreaga (2002), ‘Eliminating excessive tariﬀs on exports of least developed countries’, Policy Research Working Paper 2604, Washington, DC: World Bank. Josling, T. and A. Rae (2004), ‘Options for enhancing market access a new round’, in M. Ingco and L.A. Winters (eds), Agriculture and the New Trade Agenda: Creating a Global Trade Environment for Development, Cambridge: Cambridge University Press. Konandreas, P. (2003), ‘A compromise formula for tariﬀ cuts in agriculture’, Food Policy, 28, 1–11. Laird, S. (1998), ‘Multilateral approaches to market access negotiations’, WTO–TPRD Staﬀ Working Paper TPRD-98-02, Geneva. Laird, S. and A. Yeats (1987), ‘Tariﬀ cutting formulas – and complications’, in J.M. Finger and A. Olechowski (eds), The Uruguay Round: A Handbook for the Multilateral Trade Negotiations, Washington, DC: World Bank. Lloyd, P. and A. Schweinberger (1988), ‘Trade expenditure functions and the gains from trade’, Journal of International Economics, 24, 275–97. López, R. and A. Panagariya (1992), ‘On the theory of piecemeal tariﬀ reform: the case of pure imported intermediate inputs’, American Economic Review, 82 (3), 615–25.

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Martin, W. (1997), ‘Measuring welfare changes with distortions’, in J. Francois and K. Reinert (eds), Applied Methods for Trade Policy Analysis, Cambridge: Cambridge University Press. Panagariya, A. (2002), ‘Formula approaches to reciprocal tariﬀ liberalization’ in B. Hoekman, A. Mattoo and P. English (eds), Development, Trade and the WTO, Washington, DC: World Bank. Preeg, E. (1970), Traders and Diplomats: An Analysis of the Kennedy Round of Negotiations under the General Agreement of Tariﬀs and Trade, Washington, DC: Brookings Institution. Stern, R.M. (1976), ‘Evaluating alternative formulas for reducing industrial tariﬀs’, Journal of World Trade Law, 10, 50–64. Vousden, N. (1990), The Economics of Trade Protection, Cambridge: Cambridge University Press. World Bank (2001), Global Economic Prospects and the Developing Countries 2001, Washington, DC: World Bank. World Bank (2003), Global Economic Prospects and the Developing Countries 2004, Washington, DC: World Bank. WTO (2001), ‘Ministerial Declaration’, Ministerial Conference, Fourth Session, Doha, 9–14 November 2001, WT/MIN(01)/DEC/1, World Trade Organization, Geneva. WTO (2002), ‘Negotiations on agriculture: Overview’, Committee on Agriculture, Special Session, World Trade Organization, Geneva, 18 December, TN/AG/6. WTO (2003a), ‘Negotiations on agriculture: first draft of modalities for the further commitments, Revision’, Committee on Agriculture, Special Session, World Trade Organization, 18 March, TN/AG/W/1/Rev. 1. WTO (2003b), ‘Draft elements of modalities for negotiations on non-agricultural market access’, Negotiating Group on Market Access, World Trade Organization, 19 August, TN/MA/W/35/Rev. 1. WTO (2003c), ‘Formula approaches to tariﬀ negotiations: Revision’, Note by the Secretariat, World Trade Organization, 11 April, TN/MA/W/35. WTO (2003d), ‘Draft Cancun Ministerial Text’, Ministerial Conference, Fifth Session, Cancun, 10–14 September, World Trade Organization, Geneva.

PART THREE

Regional Integration

6.

Regionalism and bilateralism in ASEAN Chia Siow Yue and Mari Pangestu

INTRODUCTION The Association of Southeast Asian Nations (ASEAN) was formed by Indonesia, Malaysia, the Philippines, Thailand and Singapore (ASEAN-5), with the Bangkok Declaration signed in August 1967. ASEAN was founded for strategic and security reasons, to prevent interstate conflicts and to respond to the communist threat in Southeast Asia. During the cold war era, ASEAN was a bastion of anti-communism and actively wooed by the Western powers. Brunei joined ASEAN in the 1980s and Cambodia, Laos, Myanmar and Vietnam (CLMV) in the 1990s after the ending of the cold war, expanding the grouping into the ASEAN-10. Before the outbreak of the Asian financial crisis in mid-1997, ASEAN was much lauded as a dynamic and cohesive organization, able to achieve regional peace and security and, together with the political stability of individual member states, provide the underpinning for the dynamic economic growth of the region. The crisis devastated several ASEAN economies. Preoccupations with domestic financial, economic, political and social problems have sidelined eﬀorts at regional economic cooperation. ASEAN has been increasingly perceived as lacking in political will to move forward in regional economic cooperation and integration. The ASEAN countries individually and collectively are facing several tough challenges. The first is to ensure sustained economic recovery. In the short term, this depends on cyclical recovery of domestic consumption and investment demand and export demand. For the longer term, ASEAN has to meet the challenges of economic competitiveness, particularly with the economic rise of China. The second is to manage globalization so as to maximize the benefits and minimize the vulnerabilities. ASEAN countries have by and large benefited from trade globalization in the 1980s and first half of the 1990s but have suﬀered severely from the downside of financial globalization in 1997–98. The third is to narrow the economic and digital divide following the extension of ASEAN membership to include the 121

122

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CLMV countries, so that a two-tier ASEAN will not hinder the process of economic integration. The fourth is to manage the democratic transition under way in some countries. The process is sometimes disruptive and, when accompanied by ineﬀective and incoherent government decision making, as in Indonesia, can sideline both national economic development and regional economic integration. This chapter focuses on ASEAN economic integration in the context of the broader emerging East Asian regionalism. It examines the progress of ASEAN and the obstacles to the deepening of economic integration. It also examines the trend of East Asian regionalism, of which ASEAN is emerging as a key player by default rather than by design. It explores the various options open for ASEAN – the pursuit of multilateralism, the deepening of ASEAN integration, the broadening of ASEAN integration to include other countries of East Asia, and entering into bilateral agreements.

ASEAN ECONOMIC INTEGRATION The ASEAN-10 is a grouping of countries diverse in size and resource endowments, levels of economic development and technological capability, and social and cultural institutions and practices. Table 6.1 shows the diﬀerences in size, level of economic development and trade volume. ASEAN diversity, together with the reluctance to cede national sovereignty, has determined the form and pace of economic integration. ASEAN members opted for minimal institutionalization and kept the ASEAN Secretariat small. Decision making is undertaken based largely on the principle of consensus forged through numerous and multi-layered dialogues and meetings of political leaders, ministers and senior oﬃcials. Thus the outcome was often that of the lowest common denominator. There were only half-hearted eﬀorts at economic integration before 1992. The Preferential Trading Arrangement (PTA) was implemented only in 1977 but became bogged down by exclusion of export items of major interest to member states and inclusion of irrelevant items such as snowploughs. Eﬀorts at industrial cooperation and complementation were characterized by bickering over industrial location (Chia, 1995; Pangestu et al., 1992). There was a clear lack of political will to integrate national markets, as individual ASEAN countries, excepting Singapore, were still pursuing import substitution strategies and creating and protecting national ‘strategic’ industries and projects.

123

GNP – PPP adjusted

537.5 575.0

5.2 144.7 86.5 80.8 99.4 120.9 3.3 1.6 n.a. 32.6 1 414 1 094

15 000 680 3 640 1 050 24 740 1 970 270 310 n.a. 410 628 198 336 100 401 19 9 n.a. 169

2 940 8 340 4 360 24 910 6 550 1 520 1 610 n.a. 2 130

3.8 6.5 3.3 7.8 3.8 4.8 6.4 n.a. 7.6 364 780 383 491

56 716 88 521 33 589 121 731 64 223 1 531 320 1 760 15 100

313 078 333 452

31 170 74 384 31 373 115 961 60 190 1 476 437 2 461 16 000

677 858 716 943

87 886 162 905 64 962 237 692 124 413 3 007 757 4 221 31 100

GDP, Merchandise trade av. annual Total Per Total Per Exports Imports Total growth, capita capita 1990–2001 (%) 2001 2001 2001 2001 2001 2001 2001 (US$ billion) (US$) (US$ billion) (US$) (US$ million) (US$ million) (US$ million)

GNP

World Development Report, 2003.

380.0 525.5

ASEAN-6 ASEAN-10

Source:

0.3 213.6 23.8 77.0 4.1 61.2 12.3 5.4 48.3 79.5

Popln, 2001 (million)

ASEAN economic indicators

Brunei Indonesia Malaysia Philippines Singapore Thailand Cambodia Laos Myanmar Vietnam

Table 6.1

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Regional integration

The Creation of the ASEAN Free Trade Area In 1992 the ASEAN-6 agreed to form a free trade area (AFTA). A customs union was ruled out in view of the sharp diﬀerences in external tariﬀ levels among the member countries and the reluctance of the high-tariﬀ countries to lower external tariﬀs on an MFN (most-favoured-nation) basis. The decision to form AFTA was in response to several developments. First, the emerging North American Free Trade Area (NAFTA) and the Single European Market were deemed to pose serious challenges to ASEAN’s attractiveness for foreign investors and for market access. There was growing recognition that ASEAN countries were individually too small and needed to cooperate for economic growth and negotiating leverage vis-à-vis major trading partners and investing countries. Second, many argued that with the end of the cold war, ASEAN members were in need of a ‘new glue’ to keep ASEAN together. This led to the establishment of the ASEAN Regional Forum in 1993 but also gave impetus to economic cooperation. Finally, since the mid-1980s, the ASEAN economies had been abandoning import substitution strategies and adopting more open trade and investment regimes. In particular, Indonesia, the biggest ASEAN country and de facto leader, was more ready to open up to regional free trade and competition. The AFTA mainly focused on preferential tariﬀ reductions and removal of non-tariﬀ barriers on intra-ASEAN trade in goods. To prevent trade deflection, the rule of origin was set at 40 per cent of ASEAN content. The 1992 Agreement had an original timeframe of 15 years for tariﬀs to reach the 0–5 per cent level, with general and sensitive exclusion lists. At the time members were not prepared to bring tariﬀs down to zero level. Subsequently, the end-date was advanced to 2002 for the ASEAN-6. The newer members were given later end-dates in recognition of their late entry into ASEAN and AFTA, with 2006 for Vietnam, 2008 for Laos and Myanmar, and 2010 for Cambodia. ASEAN also agreed to bring intraASEAN tariﬀs down to zero level by 2010 for ASEAN-6 and 2015 for Cambodia, Laos, Myanmar and Vietnam (CLMV) countries. By January 2002, or six years earlier than the original target of 2008, the original six ASEAN members had reached the 0–5 per cent target for intra-ASEAN trade for 90 per cent of their tariﬀ lines. The average tariﬀ rate fell from 11.4 per cent at the start of the AFTA process in January 1993 to 3.2 per cent in January 2002. A noted and much-publicized exception in the tariﬀ-reduction schedule was Malaysia’s decision to delay the opening up of its automotive market, citing the need for more time because of the eﬀects of the Asian financial crisis. Table 6.2 shows the extent to which intra-ASEAN trade has grown – from US$82 billion in 1993 to US$152 billion in 2001, excluding trade with

125

487 0 4 997 12 987 0 795 18 406 6 008 43 680

886 0 2 659 8 904 0 1 883 18 760 5 671 38 763

Intra-ASEAN imports Brunei Darussalam Cambodia Indonesia Malaysia Myanmar Philippines Singapore Thailand TOTAL

1993

983 0 3 271 10 948 0 2 464 22 167 7 079 46 912

468 0 5 867 15 257 0 1 426 27 562 7 991 58 571

1994

1 013 0 4 219 13 523 0 2 489 24 537 8 821 54 602

530 0 6 476 18 436 0 2 358 31 771 10 610 70 181

1995

2 849 0 5 549 14 682 0 1 012 27 362 9 757 61 211

446 0 8 310 22 694 0 2 970 34 441 12 112 80 973

1996

Intra-ASEAN trade, 1993–2001 (US$ million)

Intra-ASEAN exports Brunei Darussalam Cambodia Indonesia Malaysia Myanmar Philippines Singapore Thailand TOTAL

Table 6.2

977 0 5 413 14 840 0 4 873 30 397 8 122 64 622

496 0 8 851 23 249 0 3 436 35 794 13 526 85 352

1997

591 0 4 559 12 940 0 4 429 23 647 5 438 51 604

221 0 9 347 21 611 0 3 821 25 998 8 315 69 313

1998

896 0 4 784 12 413 1 039 4 461 26 241 7 987 57 821

375 0 8 278 21 885 237 4 989 29 269 9 902 74 935

1999

534 549 6 781 15 935 1 113 4 955 33 291 10 476 73 634

639 76 10 884 24 409 393 5 982 37 784 15 100 95 267

2000

545 1 092 5 727 15 254 1 319 4 665 28 991 10 047 67 640

775 73 9 507 21 024 951 4 986 32 815 14 357 84 488

2001

0.81 1.61 8.47 22.55 1.95 6.90 42.86 14.85 100.00

0.92 0.09 11.25 24.88 1.13 5.90 38.84 16.99 100.00

2001, % share

126

(continued)

1993

Source:

ASEAN Secretariat.

Intra-ASEAN exports and imports Brunei Darussalam 1 373 Cambodia 0 Indonesia 7 656 Malaysia 21 891 Myanmar 0 Philippines 2 678 Singapore 37 166 Thailand 11 679 TOTAL 82 443

Table 6.2

1 451 0 9 138 26 205 0 3 890 49 729 15 070 105 483

1994 1 543 0 10 695 31 959 0 4 847 56 308 19 431 124 783

1995 3 295 0 13 859 37 376 0 3 982 61 803 21 869 142 184

1996 1 473 0 14 264 38 089 0 8 309 66 191 21 648 149 974

1997 812 0 13 906 34 551 0 8 250 49 645 13 753 120 917

1998 1 271 0 13 062 34 298 1 276 9 450 55 510 17 889 132 756

1999 1 173 625 17 665 40 344 1 506 10 937 71 075 25 576 168 901

2000

1 320 1 165 15 234 36 278 2 270 9 651 61 806 24 404 152 128

2001

0.87 0.77 10.01 23.85 1.49 6.34 40.63 16.04 100.00

2001, % share

Regionalism and bilateralism in ASEAN

127

Laos and Vietnam, for which data are not available. Singapore alone accounts for some 40 per cent of trade among the ASEAN-8, reflecting its position as the largest trading nation in ASEAN and its entrepôt role. Malaysia ranked second with a 24 per cent share. Brunei, Cambodia and Myanmar account for a very small share of intra-ASEAN trade. Eﬀorts to accelerate tariﬀ reduction were in response to the emerging competitive pressures posed by globalization, and rapid developments in Latin America, Eastern Europe, India and China. However, these eﬀorts are still not enough, as ASEAN will achieve a zero-tariﬀ internal market only in 2015. More importantly, ASEAN also accelerated the elimination of non-tariﬀ barriers, which usually pose more serious barriers to crossborder trade than tariﬀs, and promoted trade facilitation measures. Such measures included harmonization of tariﬀ nomenclatures, reforming and streamlining of customs procedures and valuation practices, harmonization or mutual recognition of product standards, and improved physical transportation links. Broadening of ASEAN Economic Integration AFTA initially covered only preferential tariﬀ reductions under the Common Eﬀective Protective Tariﬀs (CEPT) scheme and services and investment were only added later with the 1995 ASEAN Framework Agreement on Services (AFAS) and the 1998 Framework Agreement on the ASEAN Investment Area (AIA). The 1990s also saw ASEAN promoting the development of trans-border investment zones known as ‘growth triangles’ (see Chia, 1997 for discussion). However ASEAN has also only made limited headway in implementing the liberalization of services under AFAS. As services are generally perceived to have dynamic growth potential and the eﬃcient provision of services is crucial to competitiveness in goods production and trade, the slow pace is a matter of concern. Likewise, ASEAN is not moving fast enough on investment liberalization under AIA. Non-ASEAN investors account for the bulk of foreign investments in ASEAN, yet these investors will have to wait until 2020 to be accorded national treatment. In the aftermath of the Asian financial crisis, ASEAN also stepped up financial cooperation, with bilateral currency swap arrangements and a monitoring and surveillance process. ASEAN in Crisis and the Way Forward? Two developments in the 1990s have slowed the deeper economic integration of ASEAN. The first is membership expansion to include

128

Regional integration

CLMV countries. There are strong political reasons for their inclusion. However, as these new members are the least developed in Southeast Asia and are still undergoing economic transformation from command to market-based economies, they could move only at a slower pace than the ASEAN-6. This has created a two-tier ASEAN. There are ongoing eﬀorts to narrow the development gap. One major measure proposed in 2000 is the Initiative for ASEAN Integration (IAI) that emphasizes training and capacity building for the CLMV countries, with resources drawn from among the more developed ASEAN members as well as from outside ASEAN. In the short term, ASEAN may have to increasingly adopt the ‘10-minus’ formula or ‘coalition of the willing’ in order to move forward. A delicate balance will have to be struck between ASEAN solidarity and cohesiveness on the one hand and allowing a slower pace of cooperation and integration for those unable and unwilling. Second, governments have been preoccupied with the aftermath of the 1997 Asian financial crisis and with domestic political changes. The crisis had severely damaged several ASEAN economies and governments were pressured to protect vulnerable sectors rather than pushing for further trade and investment liberalization. There were also tumultuous political changes in a number of countries, particularly in Indonesia. Furthermore, the changes in political leaderships have also led to the loss of the togetherness and familiarity built over the years. Obviously the informal consensual ‘ASEAN way’ of reaching agreements and decisions has to be replaced by greater institutionalization of the ASEAN process to push ASEAN forward. The Asian financial crisis gave impetus to closer financial cooperation among ASEAN countries. The ASEAN Swap Arrangement was first established in 1977 among ASEAN central banks to provide short-term swap facilities for member countries with temporary liquidity problems. The facility was little used until the 1997 Asian financial crisis. Also, ASEAN finance ministers met in 1998 and established the ASEAN Surveillance Process to monitor exchange rates, macroeconomic aggregates and sectoral and social policies. The Asian Development Bank provides technical support. Since the crisis, the ASEAN ministers have been meeting twice a year. However, the traditional ASEAN practice of non-interference and informality has restricted the eﬀectiveness of this peer review process. On the 30th anniversary of ASEAN in December 1997, the political leaders adopted the ASEAN Vision 2020 to build an ASEAN community. On the economic front, Vision 2020 seeks to create a ‘stable, prosperous and highly competitive ASEAN economic region in which there is a free flow of goods, services and investment, a freer flow of capital, equitable economic development, and reduced poverty and socio-economic disparities’

Regionalism and bilateralism in ASEAN

129

(ASEAN Secretariat, December 1997). Proposals to achieve this vision included advancing economic integration and cooperation under AFTA, AFAS, AIA and subregional growth areas; closer consultation in macroeconomic and financial policies; cooperation in the development of small and medium enterprise sectors, science and technology, energy and water, food security, human resource development. After the vision a number of moves were made, such as accelerating the timetable to achieve AFTA, the zero target, and trade facilitation measures. However, progress toward real economic integration was slow and, concerned over the slow progress of ASEAN economic integration, Singapore Prime Minister Goh Chok Tong proposed at the 8th ASEAN Summit in November 2002 that ASEAN should agree on an ASEAN Economic Community (AEC) with free flow of goods, services, investments, technologies and skilled manpower within the region. The AEC will be the end-goal for a road map for integrating ASEAN and its 2020 Vision. At the last ASEAN Summit at the end of 2003, the ASEAN members agreed to achieve an ASEAN community, which included economic, security and social aspects, by 2020 or earlier. The essence of the AEC is broadening ASEAN economic schemes, especially in the 11 priority sectors.

ECONOMIC INTEGRATION BEYOND ASEAN ASEAN is now facing yet another challenge, that of responding to the rise of regionalism in East Asia that has seen ASEAN being wooed into economic cooperation arrangements by China and Japan, followed by the USA and India. Apart from initiatives at the regional level, individual ASEAN countries have also become increasingly engaged in bilateral agreements. ASEAN is clearly in danger of being overtaken by events. It clearly lacks a concerted strategy to achieve Vision 2020 and to respond to the various regional and bilateral initiatives. A crucial question is whether these regional and bilateral initiatives will strengthen ASEAN or reduce it to irrelevance. Also, some trade economists are concerned that the proliferation of RTAs (regional trade agreements) would give rise to ‘spaghetti-bowl’ and ‘hub-and-spoke’ eﬀects (Pangestu and Findlay, 2001). This section will examine what drives the new East Asian regionalism and what are its features and then proceeds to survey the major initiatives. Driving Forces and Features of East Asian Regionalism Both political and economic forces have been driving the proliferation of regional, subregional and bilateral trading arrangements in East Asia since the mid-1990s (Chia, 2002a).

130

Regional integration

First, the cold war that has divided East Asian countries ideologically along communist and anti-communist lines for decades has ended. With the tumbling of political barriers, political and economic relations among East Asian countries improved. In Southeast Asia, ASEAN expanded to incorporate the socialist countries of Cambodia, Laos, Myanmar and Vietnam. In Northeast Asia, countries are slowly coming to terms with historical animosities and rivalries in the face of economic realities. In particular, the region’s relations with China have improved dramatically. Second, countries in East Asia have been watching with concern the establishment of continental economic blocs in the Americas and Europe and an emerging free trade area of the Americas (FTAA) and a transAtlantic economic bloc. East Asia’s economies and exporters are increasingly vulnerable to the discriminatory practices of NAFTA and the expanded EU. Also, investors are flocking to Mexico to serve the NAFTA market and to Central and Eastern European countries to serve the EU market. At the same time, the failure to launch a new WTO Round at Seattle in 1999 created uncertainties over prospects of improving global freer and fairer trade. Although the Doha Development Round was finally launched in December 2002, success is not guaranteed and the momentum for regionalism in diﬀerent regions of the world has already been set. Third, the Asian financial crisis of 1997–8 served as catalyst for the change in attitude towards regionalism in East Asia. The crisis clearly demonstrated the high level of economic and financial interdependence and interconnectivity among East Asian economies. Further, the crisisaﬃliated economies (Thailand, Indonesia, Malaysia, the Philippines, South Korea) were disillusioned with the assistance provided by the IMF, the USA and the EU. Japan was more forthcoming with assistance but some of its initiatives met with strong objections from the IMF and the USA. The crisis brought together the leaders and oﬃcials of Southeast Asia and Northeast Asia in the ASEAN3 meetings that led to regional financial cooperation to avert another financial crisis. Regional economic cooperation and integration could help improve regional economic stability and resilience. Also, in the strive for economic recovery, RTAs look an increasingly attractive option as they provide security of market access, additional investment resources, and better resource allocation and economic eﬃciency. Fourth, the economic rise of China added another impetus to East Asian regionalism. The adoption of economic reforms and the open-door policy since the late 1970s has led to three decades of meteoric economic growth of China. This rise of China and its entry into the WTO in 2002 is posing severe adjustment and competitive problems for neighbouring economies. Having secured its WTO membership, China is entering into

Regionalism and bilateralism in ASEAN

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regional economic cooperation and integration with its Southeast Asian neighbours, in part to allay ASEAN concerns. There is also growing realization among East Asian economies that the region could form a large and dynamic economic bloc, able to harness regional resources and eﬀorts to resolve regional problems, meet common challenges of globalization and of regionalism in the Americas and Europe, and seek a more eﬀective voice in the global arena hitherto dominated by Western interests. After all, East Asia has one-third of the world’s population, one-quarter of the world’s GDP and two-fifths of the world’s foreign reserves. An earlier proposal in 1990 by the Malaysian Prime Minister Mahathir for the establishment of an East Asia Economic Group (later changed to East Asia Economic Caucus) to counter regionalism in North America and Europe failed to take oﬀ because of US opposition and the lack of commitment of a number of core East Asian governments. Fifth is the changed trade and foreign policy position of Japan and South Korea. Until the mid-1990s, Japan and South Korea had chosen to remain committed to multilateralism and had not entered into preferential trade agreements. However, after a decade of economic stagnation, Japan is increasingly challenged to remain internationally competitive and Japanese businessmen actively lobby for better access to overseas markets. Japan has since signed and implemented an economic partnership agreement with Singapore and is pursuing various RTA initiatives with ASEAN, South Korea and across the Pacific. So as not to be isolated, South Korea has also been pursuing regionalism aggressively since the fi f nancial crisis, including proposing that East Asia embark on a free trade area and eventual economic community. Table 6.3 shows the bilateral and regional agreements that have been concluded, are under negotiation or are proposed. A survey of the various regional and bilateral RTAs shows the following features. The first is that countries that have in the past been staunchly against the preferential approach such as Japan and South Korea are involved in a number of RTAs. Second, most of these eﬀorts began after 2000, and especially beginning 2001. The timing reflects the driving forces discussed above. Third, there is a large number of bilateral agreements, with Singapore being the clear forerunner, having already signed four agreement and negotiating others. Thailand is also clearly following the same path. Fourth, out of the initiatives that involve regional agreements, ASEAN emerges as a hub, perhaps more by default rather than design as these are being initiated by the extraregional partners rather than by ASEAN. Fifth, these are mostly ‘new age’ FTAs, which extend beyond traditional liberalization of trade in goods and services and in investment, to include trade and investment facilitation and development

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Table 6.3

Regional integration

Regional trading arrangements in East Asia

Bilateral: ASEAN Malaysia–Japan Malaysia–US Philippines–US Thailand–Australia Thailand–Bahrain Thailand–Chile Thailand–China

Type of agreement

Status

Start Signed year

Compreh. EP TIFA, explore FTA FTA FTA

Under discussion Under discussion Proposal MOU to neg. FTA by 2005 Signed Proposal Signed

2003 2003 2002 2003

2001 2001 2001

2003 2003

Closer EP, 2010 FTA PTA fruits & veg.

Thailand–Croatia FTA Thailand–Czech Rep. FTA Thailand–India FTA by 2010

2002 2001 2003

Thailand–Japan

CEP

Thailand–Mexico Thailand– New Zealand Thailand–Peru Thailand– South Africa Thailand– South Korea Thailand–USA Singapore–Australia Singapore–Canada Singapore–Chile Singapore–India Singapore–Japan Singapore–Mexico Singapore– New Zealand Singapore– South Korea Singapore–US

FTA FTA

Proposal Proposal Under discussion/neg. Under discussion/neg. Proposal Under discussion

FTA FTA

Proposal Proposal

2003 2003

FTA

Under study

2003

TIFA, explore FTA FTA FTA FTA FTA New age EP FTA Closer EP, 2010

Under discussion Signed Under negotiations Under negotiations Under discussions Signed Under negotiations Signed

2003 2000 2001 2000 2002 2000 1999 1999

FTA

Proposal

2002

FTA

Signed

2001

FTA

Oﬃcial discussions

2000

FTA

Proposal/study

Bilateral: other Asia South Korea– Australia South Korea–China

2003 June 2003

2002

2002

2002 2001

2003

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Regionalism and bilateralism in ASEAN

Table 6.3

(continued)

South Korea–Chile South Korea–Japan

Type of agreement

Status

Start Signed year

FTA FTA

Under negotiations Oﬃcial discussions/study Oﬃcial discussions/study Oﬃcial discussions/study Under negotiations Proposal/study Oﬃcial discussions/study Oﬃcial discussions/study Oﬃcial discussions

1998 1998

South Korea–Mexico FTA South Korea–NZ

FTA

South Korea–US Japan–Canada Japan–Chile

FTA FTA FTA

Japan–Mexico

FTA

Hongkong– New Zealand

Closer EP

Regional plus AFTA AFTACER ASEANChina ASEANJapan ASEAN South Korea ASEANIndia SingaporeEFTA ASEAN3

FTA Closer economic relations FTA

Implemented Oﬃcial discussions/study Oﬃcial study/ negotiations Comprehensive EP Oﬃcial discussions FTA Oﬃcial discussions FTA FTA FTA

New regional Japan–South Korea– FTA China Pacific 5 FTA

2000 2000 2001 2002 2000 1998 2001

1993 1999 2001 2002* 2002 2002

Oﬃcial discussions 2002 Signed, implem. ’03 2002 Oﬃcial 2000 discussions/study Oﬃcial 2000 discussions/study Proposal 1998

Notes: *The Framework Agreement was signed end of 2002 and negotiations on early-harvest component almost completed; rest of agreement still being negotiated. ASEAN3: ASEAN plus Japan, South Korea and China. Pacific 5: Singapore, Australia, New Zealand, USA and Chile. Source: Austria (2003); Montreevat (2003); Low (2002) and other media sources.

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cooperation in a wide range of areas. East Asia has also been exploring initiatives for monetary cooperation and integration ahead of initiatives in trade integration. Summary of ASEAN-based Agreements ASEAN–CER Closer Economic Partnership ASEAN’s ffirst external agreement is with the Australia–New Zealand Closer Economic Relations (CER). First informal consultations began in 1995 with agreement to establish interregional FTAs. At the ministerial meeting in October 1999, it was agreed that a high-level task force be formed to look into the feasibility of an AFTA–CER FTA. Agreement to negotiate on an FTA failed to materialize, in part reflecting some political sensitivities in bilateral relations. Eventually the AFTA–CER Closer Economic Partnership agreement was signed in September 2002 without the liberalizing or FTA features. The focus of the agreement is on trade and investment facilitation (including cooperation in infrastructure); trade and investment promotion; capacity building; and cooperation on new economy issues including communications technology and information as well as e-commerce. This interregional partnership is in addition to the Singapore– New Zealand and Singapore–Australia FTAs already concluded. ASEAN–China Comprehensive Economic Cooperation China first proposed an FTA with ASEAN at the November 2000 Summit. This led quickly to the formation of the ASEAN–China Expert Group and its submission of the report on Forging Closer ASEAN–China Economic Relations in the Twenty-First Century in November 2001. Key proposals of the Expert Group Report are: establishment of an ASEAN–China FTA within ten years; trade and investment facilitation measures; technical assistance and capacity building for ASEAN members; and cooperation in areas such as finance, tourism, agriculture, human resource development, small and medium enterprises, industrial cooperation, intellectual property rights, environment, forestry and forestry products, energy and subregional development. The FTA will create a huge economic region of 1.7 billion people, GDP of US$2 trillion and trade of US$1.2 trillion. It will increase intraregional trade and investment and attract investments from the USA, EU and Japan. It will provide for special and diﬀerential treatment and flexibility for CLMV countries and also for an ‘early-harvest’ package of mutually agreed list of goods to be liberalized without having to wait for a full FTA to be finalized. The Report cited a simulation study by the ASEAN Secretariat that shows that the ASEAN–China FTA will increase ASEAN’s exports to China by 48 per cent and its GDP by 0.9 per cent,

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while China’s exports to ASEAN will increase by 55.1 per cent and its GDP by 0.3 per cent. The Framework Agreement on ASEAN–China Comprehensive Economic Cooperation was signed at the ASEAN–China Summit in November 2002 and broadly adopted the recommendations of the Expert Group Report. It commits ASEAN and China to start negotiations on an FTA that will cover trade in goods and services and investment liberalization and facilitation, as well as other areas of cooperation. The target is to establish the FTA by 2010 for ASEAN-6 and 2015 for CLMV, with fflexibility on sensitive sectors as well as taking into consideration the lower development levels of CLMV countries. In the meanwhile, an ‘earlyharvest’ package of tariﬀ reductions was negotiated in 2003 comprising HS1–HS8 for all ASEAN members and China, and in addition a separate bilateral list between each ASEAN country and China. Due to longer than anticipated negotiations on the rules of origin and the sensitive list of exceptions, the early-harvest package was not ready in 2003. Thailand has been the most aggressive and has completed a bilateral zero tariﬀ agreement with China on 188 fruits and vegetable products, implemented in the ffirst half of 2004. One-third of China’s fruit imports come from Thailand and before this agreement, faced a 30 per cent tariﬀ (www.chinafruitnews.com/ news/20030828). There have been some negative responses from Thai farmers after its implementation due to the fl f ood of Chinese fruits into the Thai market. Whereas negotiations on the broader programme of tariﬀ reduction in the FTA and rules of origin began in 2003, planned tariﬀ reductions are scheduled to begin in 2005. ASEAN and China comprise primarily developing economies with comparative advantages in similar product categories. Negotiations could prove diﬃcult in sectors where their agriculture and industries compete rather than complement. However, development cooperation in areas such as tourism, human resource development and education, information technology, and the Mekong Basin development could proceed much more quickly. Negotiations on other elements of the FTA such as services and investment have not yet begun, although there is reference to a need to have deadlines for the completion of the negotiations. What motivates the ASEAN–China FTA? China’s motivations are both political and economic. Politically, China seeks to allay ASEAN concerns over its economic ascendance and to contain the influences of Japan and the USA in Southeast Asia. Economically, China is eyeing the ASEAN region for both its market and its raw materials, especially energy sources and minerals. ASEAN governments readily welcomed the China initiative. China is a rapidly growing market for ASEAN products and services

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and could serve as a new engine of growth as the decade-long Japanese economic stagnation continues. China’s WTO entry will also mean an economic partnership underpinned by WTO rules and disciplines. Furthermore, ASEAN could attract FDI (foreign direct investment) to produce for the China market and attract Chinese FDI as well. At the same time, ASEAN countries are concerned over China’s competitive strengths and advantages, particularly competition in labour-intensive products in domestic and third-country markets and competition for FDI. Individually and collectively, ASEAN countries need to improve economic competitiveness so as to minimize the competitive eﬀects as well as to exploit the opportunities of preferential access to the China market. ASEAN–Japan Comprehensive Economic Partnership China’s oﬀer of an FTA with ASEAN triggered a response from Japan, with Japanese Prime Minister Koizumi proposing an ASEAN–Japan economic partnership agreement in January 2002, immediately after the signing of the Japan–Singapore Economic Partnership Agreement (JSEPA). This led to the Joint Declaration on ASEAN and Japan Comprehensive Economic Partnership in November 2002, at the same time that the Framework Agreement on ASEAN–China Comprehensive Economic Cooperation Agreement was signed. The Declaration provides for the development of a framework agreement and bilateral economic partnerships covering a possible free trade area to be completed within ten years, and ‘trade and investment promotion and facilitation measures . . . and co-operation in other areas such as ffinancial services, information and communication technology, science and technology, human resource development, small and medium enterprises, tourism, transport, energy and food security’ (ASEAN Secretariat Website, aseansec.org). The Declaration proposes the following guiding principles: comprehensiveness of countries and sectors; reciprocity and mutual benefits; special and diﬀerential treatment to ASEAN developing countries in accordance with WTO; and additional flexibility for the CLMV countries. The CEP could begin in areas where implementation is feasible and could be accelerated to provide immediate benefits, as in technical assistance and capacity building, trade and investment promotion and facilitation measures, trade policy dialogue, business sector dialogue, and facilitation of mobility of business people. The CEP is expected to expand ASEAN trade to Japan by 44.2 per cent and Japan trade to ASEAN by 27.5 per cent in 2020 from the base year of 1997. At the time of writing there has not been much progress in developing a framework for an ASEAN–Japan FTA; however, bilateral negotiations have begun between Japan and Thailand, the Philippines and Malaysia.

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At the same time, the bilateral agreement between Japan and Singapore has already been signed and implemented (2002). Bilateral discussions are ongoing with Malaysia, the Philippines, Thailand and Vietnam. It would appear that Japan’s preference is to create a network of bilateral agreements under a general ASEAN–Japan Framework Agreement since it clearly recognized the diﬃculty of negotiating one comprehensive package. ASEAN countries have diverse economic levels and bilateral agreements would allow for diﬀerent time frames and treatment of sensitive sectors. In particular, it would enable Japan to negotiate on agriculture with each country separately, given the political and economic sensitivity of agriculture in Japan and the competitiveness of several ASEAN countries in agricultural exports. Obviously, the bilateral approach has implications for ASEAN cohesiveness and negotiating leverage, as Japan ‘cherry-picks’. It also raises the issue of defining the WTO rule of ‘substantially all sectors’. What motivates the ASEAN–Japan economic partnership? Japan is increasingly concerned over the economic ascendance of China and its growing influence in Southeast Asia. Japan’s proposal to ASEAN, particularly its timing, is obviously a reaction to the ASEAN–China FTA proposal and an eﬀort to ensure that Japan is not upstaged by China. Also, an economically strong ASEAN will mean Japan can diversify investments between ASEAN and China. ASEAN, on the other hand, also sees a role for Japan to balance a rapidly emerging China. ASEAN–US Partnership In the late 1980s there was a proposal for formal and closer economic ties between ASEAN and the USA under the ASEAN–US Initiative (see Naya et al., 1989). However, this initiative was never developed further, as the USA had other interests. Then in October 2002, President Bush announced the Enterprise for ASEAN Initiative (EAI) on the periphery of the APEC meeting in Los Cabos. Two factors appear to be driving the new American initiative. The first is American geo-strategic interest in dominantly Muslim Southeast Asia following the 11 September 2001 terrorist attacks in New York and Washington, DC. The second is the rapidly emerging RTAs within East Asia. The ASEAN–US Business Council is reported to favour such an agreement to keep their country engaged in the region as China’s regional influence grows. The EAI is intended to involve bilateral free trade agreements (FTA) between the USA and ASEAN countries. The precursor to the bilateral free trade agreement is the bilateral Trade and Investment Facilitation Agreement (TIFA), which a number of ASEAN member countries already have with the USA. Of course Vietnam has a special agreement under the PNTR (Permanent Normal Trade Relations) arrangement. From the

138

Regional integration

perspective of the USA, the objective of the EAI is to create a network of bilateral FTAs which will increase trade and investment, and the USA and each ASEAN country will jointly determine if and when they are ready to launch FTA negotiations, thus each moving at its own pace. It is likely that the basis of the FTAs with the ASEAN countries will be modelled after the completed US–Singapore FTA. However, it would appear that ASEAN prefers to have an ASEAN-wide TIFA, although the form and implementation of such a TIFA is still being studied and is likely to be diﬃcult to formulate to the mutual acceptance by all. Therefore, it is likely that a number of ASEAN countries will continue to enter into bilateral negotiations to create a bilateral free trade area with the USA. ASEAN–India In the wake of China’s proposal, India also proposed a Framework Agreement on Economic Cooperation between ASEAN and India. A Framework Agreement was signed by leaders from ASEAN and India at the ASEAN Summit in October 2003. The Framework Agreement includes a free trade area in goods, as well as other aspects such as investment, services, trade facilitation and promotion, and functional cooperation in various sectors such as agriculture, automotive, science and technology, and tourism. Discussions and negotiations continued in 2004, and it was agreed that the end-goal was 2011 for ASEAN 6 and 2016 for the CLMV countries. The framework also includes an early-harvest component that was hoped to begin in 2004, but looks like only beginning in January 2005, and to reach zero tariﬀs by 2007, and negotiations are ongoing to finalize the early-harvest list which apparently includes unprocessed agriculture products, chemical and manufactured products. It was hoped that the list would be approved at the ASEAN Leaders summit in November 2004.

TOWARDS EAST ASIAN ECONOMIC INTEGRATION The renewed East Asian regionalism has also led to increased acceptance of economic cooperation at the East Asia level. In the aftermath of the crisis, the cooperation began in the monetary and financial sectors, before even thinking about trade. ASEAN3 Monetary and Financial Cooperation An important configuration is the ASEAN3 group, comprising the ASEAN-10, China, Japan and Korea. Initiated by ASEAN, it was initially

Regionalism and bilateralism in ASEAN

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an informal gathering of foreign ministers of the 13 countries on the sidelines of the main ASEAN Ministerial Meetings. It provided the ffirst forum for Southeast and Northeast Asian policy makers to meet. Following the outbreak of the Asian ffinancial crisis, the ffirst ASEAN3 Summit of Heads was convened in December 1997 to discuss the modalities for ffinancial cooperation. An earlier proposal by Japan for an Asian Monetary Fund failed to take oﬀ, due to IMF and US concerns that it might undermine the role of the IMF and give rise to a moral hazard problem. Instead, the ASEAN3 ffinance ministers adopted the Chiang Mai Initiative with two components that built on existing arrangements at the ASEAN level. First the ASEAN swap arrangement was expanded to include Japan, China and South Korea in a network of bilateral swap and repurchase agreement facilities. Several bilateral swap arrangements have been signed between the Northeast Asian and ASEAN countries. Critics argue that the swaps are too small to be eﬀective in warding oﬀ any large speculative currency attack. Second, the ASEAN surveillance process was extended to include Japan, China and South Korea with the finance ministers of the 13 countries meeting regularly on monitoring and surveillance. The ASEAN3 process started with financial cooperation and appears to be moving towards broader and deeper economic cooperation and integration. There have been several ASEAN3 Summits of Leaders as well as ministerial meetings on finance, economics and trade, labour, agriculture and forestry, tourism, energy and environment. The East Asia Vision Group that was created had proposed the creation of an East Asia FTA or East Asian community, and these issues were discussed at the ASEAN3 summits. There are also eﬀorts to widen and deepen the scope of financial cooperation beyond surveillance and swaps, with the resurfacing of the Asian Monetary Fund proposal and discussions of an eventual common currency (see Wang, 2002). Proposals for an East Asia Free Trade Area South Korea mooted the idea of an East Asian Community at the ASEAN3 Summit in November 1998. This led to the establishment of the East Asia Vision Group (EAVG) and its report on Towards an East Asian Community in November 2001. A group of oﬃcials was then tasked with evaluating the EAVG report. The November 2002 Final Report of the East Asia Study Group identified both concrete short-term measures and medium- to long-term measures to push forward East Asian cooperation. The short-term measures for possible immediate implementation include formation of an East Asia Forum, an East Asia Business Council, and a network of East Asian eminent intellectuals, and the promotion of East

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Regional integration

Asian studies. The medium and long-term measures, requiring further studies, include an East Asia Summit, and an East Asia FTA. The report proposes that the East Asia Summit evolve from the ASEAN3 process so as to reach a level comfortable to all member countries, to address concerns that ASEAN may be marginalized if the pace is too fast and to nurture a greater sense of ownership among the Northeast Asian countries. Since the November 2002 Summit, there has been talk about developing a regular East Asian Summit and the formation of an East Asian FTA. These ideas have not been able to go far at this time of writing. A political issue that has to be resolved is that of membership. Oﬃcial proposals have so far focused on the ASEAN3 membership of 13 countries, namely the ASEAN-10, China, Japan and Korea. Inclusion of Hong Kong, Taiwan or even Australia and New Zealand is a thorny political issue that divides many countries in the region. And whether the ASEAN-10 will join the grouping as one entity or ten individual entities, with implications for ASEAN unity and relevance, has also to be resolved. There is ASEAN concern that an East Asia grouping could undermine ASEAN and make it irrelevant. A more diﬃcult issue is that of leadership between Japan and China.

NEW BILATERALISM As already noted, bilateral FTAs are also on the rise. There are agreements between ASEAN countries and those of Northeast Asia. There are also agreements with countries beyond East Asia, including those in North America, Latin America, Europe, India, Australia and New Zealand (see Table 6.3). Singapore has been the spearhead in entering into bilateral FTA. To date Singapore has signed FTAs with New Zealand, Japan, the European Free Trade Area (EFTA), Australia and the USA, and is in various stages of negotiations with Mexico, Canada, South Korea and India. The negotiations have usually been concluded in record time, reflecting that bilateral agreements between ‘like-minded countries’ are much easier to conclude than regional and multilateral agreements, and that Singapore has a highly open economy with very few sensitive products or services. These bilaterals extend beyond traditional liberalization of trade in goods and services and of investment, making them WTO-plus and AFTA-plus in scope, coverage and liberalization time frames. Singapore also intended its bilaterals to be the forerunners of similar agreements for its ASEAN partners. The Singapore–New Zealand Close Economic Partnership was first proposed by the two prime ministers on the side of the APEC Summit in

Regionalism and bilateralism in ASEAN

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New Zealand in September 1999, and publicized as a partnership of like-minded economies and a catalyst for APEC trade liberalization. The CEP was concluded a year later and implemented by early 2001. This first bilateral has drawn much criticism from some ASEAN partners concerned with the undermining of ASEAN solidarity and the possibility that New Zealand goods would enter other ASEAN countries through Singapore. It should be noted, however, that ASEAN has refused to enter into a free trade agreement with the CER. Also, rules of origin have been put in place precisely to handle the problem of trade deflection in FTAs. Of greater economic importance to Singapore are the bilateral agreements with Japan and the USA, as these are its major trade and investment partners. The Japan–Singapore partnership was proposed in December 1999, negotiations began in October 2000 and the Japan–Singapore Economic Partnership Agreement (JSEPA) was signed in January 2002 and implemented later in the year. Both Japan and Singapore see JSEPA as the forerunner of closer partnership agreements between Japan and ASEAN. JSEPA is not a traditional FTA but an ‘FTA-plus’ or ‘New Age Economic Partnership’, as it goes beyond trade and investment liberalization and facilitation to include an enlarged agenda of development cooperation in key areas such as information and communications technology, science and technology, financial services, tourism and human resource development. On trade liberalization, JSEPA removes tariﬀs on 94 per cent of Singapore’s exports to Japan up from the pre-agreement level of 84 per cent; Singapore will remove all remaining tariﬀs on goods imported from Japan, namely on four types of alcoholic beverages. In turn, Japan agreed to apply looser rules of origin (ROO) to 264 product items, mostly petrochemical products, to allow them to qualify for preferential tariﬀ treatment in Japan. Singapore expects the FTA to benefit its electronics and petrochemical exports to Japan. Agriculture proved a thorny negotiating issue for Japan, and while agreeing to open up substantially all agricultural imports, Japan stopped short of allowing free market access for Singapore exports of orchids and tropical fish. What motivates JSEPA? Singapore and Japan enjoy close economic relations and the two countries share many economic and strategic interests and work closely in many regional and international fora. JSEPA will strengthen bilateral ties and promote greater trade, investment and economic cooperation. As a new age FTA, JSEPA can generate significant opportunities for the public and private sectors of both countries in key growth industries. JSEPA also goes beyond economic benefits for the two signatory countries. It strategically anchors Japanese presence in Southeast Asia and can serve as a catalyst for bilateral agreements between Japan and the rest of ASEAN. Critics point out, however, that JSEPA has

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Regional integration

set a precedent for Japan to exclude sensitive agricultural products in its bilaterals with other countries in the region. The US–Singapore FTA (USSFTA) was first announced by Singapore Prime Minister Goh Chok Tong and US President Bill Clinton on the sidelines of the APEC Leaders’ meeting in November 2000. Negotiations began in December 2000 and were delayed by the change of presidency in the USA. It was finally concluded and signed in January 2003, with signing scheduled for May 2003 and subsequent US Congressional approval. USSFTA contains features that its negotiators have described as WTO-plus as well as NAFTA-plus. A key feature is the rules of origin (ROO) that recognizes outward processing and cumulative value added, to reflect the reality of modern manufacturing process with components and intermediate goods sourced from diﬀerent countries. NAFTA does not allow cumulative value added, but USSFTA will enable inputs sourced from neighbouring ASEAN countries to be included in Singapore’s cumulative value added to satisfy ROO requirements for entry into the USA, and would thus give a boost to outward processing FDI in Singapore’s neighbouring countries. USSFTA will also strengthen bilateral customs cooperation to prevent transhipment of goods posing as of Singapore origin to circumvent US textile quotas. In services, the USSFTA has adopted a negative list approach, that is, all services sectors will be automatically liberalized unless specifically reserved, which goes far beyond GATS. What motivates the US–Singapore FTA? First, it will further strengthen the existing trade and investment bilateral relations. The USA is Singapore’s leading trade partner, while Singapore is one of the USA’s top export markets, surpassing US exports to China. There are more than 1400 US companies operating in Singapore. Second, USSFTA is trans-Pacific. It is the ffirst bilateral that the USA has entered into with an Asian country. The bilateral could be the forerunner to bilateral FTAs between the USA and other countries in East Asia. What motivates Singapore to engage in a growing number of bilateral FTAs? Its bilateral initiatives should be seen in the context of its overall trade and investment regimes. Singapore is a small island nation of about 650 km2 and 3 million citizens. It practises free trade in goods and free flow of investments, with only a few minor exceptions. Its trade in goods and services is more than triple its GNP in size. It has also one of the most liberal FDI regimes in the world and plays host to several thousand foreign multinational corporations and international companies. Restrictions on trade in services are progressively being liberalized, particularly in financial services, telecommunications and professional services, some of them undertaken unilaterally while others are in response to GATS and the

Regionalism and bilateralism in ASEAN

143

ASEAN Framework Agreement on Services, and yet others are oﬀers in bilateral agreements. Ready access to overseas markets and attracting high-tech inward FDI are the life-blood of Singapore. The Singapore government is concerned over the slow pace of trade and investment liberalization under the WTO, APEC and ASEAN. Bilateral FTAs with selected and like-minded partners enable Singapore to achieve faster results. It is also expected that such bilaterals will act as catalysts to hasten the liberalization process in ASEAN and APEC. The bilaterals are WTO-consistent in that each agreement covers substantially all sectors and does not raise barriers against non-partners. In fact, the agreements are WTO-plus as they include trade and investment liberalizations beyond GATT and GATS agreements and are FTA-plus as they include many facilitation measures and cooperation eﬀorts in areas such as research and development and human resource development and information technology. A number of other ASEAN countries, particularly Thailand and Malaysia, are also actively engaged in exploring and negotiating bilaterals. Under the Chuan government, Thailand proposed a number of bilateral free trade areas with small countries like Croatia and the Czech Republic. However, under Prime Minister Thaksin, who came into power in February 2001, Thailand is aggressively pursuing the bilateral track with major trading partners (Nagai, 2002; Montreevat, 2003). It is discussing and planning to negotiate bilateral free trade areas with the large trading partners Japan and the USA, the large Asian markets such as China and India, and a number of other countries such as Australia, New Zealand and some Latin American countries (Table 6.3). Some see Thailand’s drive towards FTAs as being generated by politicians and the foreign ministry bureaucracy in order to have deliverables and as a ‘me-too reaction’ for fear of being left behind by other countries negotiating similar agreements. The Thaksin government’s FTA initiatives appear also to be a strategy to attract foreign investment and position Thailand as a strategic hub in aviation and transportation, air servicing, automotive (‘Detroit of the East’), tourism and training and human resource development. It has also promoted its access to around 520 million people in ASEAN and access to South China (Team Thailand Road Show, www.international.utah.gov/pptThailand-utah.pdf; Nagai, 2002, p. 19). At the APEC Summit in Los Cabos, in October 2002, Thailand and the USA signed a bilateral agreement to promote liberalization and investment. In a switch of strategy, Malaysia is also beginning on a dual-track approach and is discussing with Japan and the USA the possibility of a bilateral free trade area. This dual-track approach has already become

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Regional integration

oﬃcial policy and ‘RTA can complement the greater multilateral processes’ (Keynote Speech, Deputy Prime Minister Datuk Seri Abdullah Ahmad Badawi, 15th PECC General Meeting, Brunei, 3 September 2003). The other ASEAN economies, namely Brunei, Indonesia, the Philippines and Vietnam, also have trade and investment agreements with the USA. Under a Trade and Investment Framework Agreement (TIFA), a Joint Council has been created to further facilitate and liberalize trade and investment, including such areas as intellectual property rights, information technology, biotechnology policy, and capacity building as well as coordination in APEC and WTO. TIFA is seen as the precursor to more serious negotiations for an RTA. Vietnam has had a special bilateral agreement with the USA1 since June 2001. The agreement is a comprehensive trade agreement providing MFN status in trade in goods, intellectual property, trade in services, investment, business facilitation and transparency measures.

ISSUES AND IMPLICATIONS It would appear that the region is at present in a state of flux, with a number of countries pursuing bilateral FTA with its major partners; it is under pressure to broaden, widen and accelerate intra-ASEAN economic integration while at the same time pursuing ASEAN1 RTA; and an East Asia level of cooperation and integration is also evolving. What are the main issues arising from the proliferation of RTAs for the ASEAN region and the future of ASEAN economic cooperation? What are the implications and what are the possible approaches that ASEAN or ASEAN countries should adopt? The Issues and Risks There is consensus in the literature that liberalization under a multilateral framework is the first-best solution; preferential trading agreements do not necessarily benefit their members and have potential adverse eﬀects on excluded countries. The empirical evidence on the benefits of the RTA to its members and, even worse, the potential trade diversion eﬀects on excluded members, are admittedly inconclusive, but nevertheless show that whether or not members of a preferential trade agreement benefit is an empirical question and subject to many provisos. Despite this, RTAs are likely to continue to proliferate. Countries will adopt a multi-track approach to opening up their economies. Continued uncertainty over the progress in the WTO is evident from the WTO list of RTAs concluded in the 1990s (WTO, 2003). The ongoing Doha Round is also not expected to

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see any diminished interest in RTAs. This seems to indicate that countries are choosing second-best or even third-best options as compared to the first-best option of multilateralism, because RTAs are achieving economic as well as political objectives that a multilateral round is unable to achieve or producing speedier and more focused results. As discussed above, the ASEAN region is no longer the exception as it was in the past. ASEAN and the wider East Asia are also pursuing regionalism in a defensive response to regionalism in the Americas and Europe, and as a response to the competitive challenge and risks of globalization. Having said that, the economies are still pursuing a multi-tier track approach, with continuing unilateral reforms and liberalization and support for the multilateralism of WTO, in addition to the regional, subregional and bilateral initiatives. In principle this ‘competitive liberalization’ model that the USA is also promoting, with one path contributing and being compatible with other paths, could also work for the ASEAN region. Despite the inevitability of this trend, one must be aware of the costs and potential downside risks. Some of the major risks are as follows. The first is the traditional risk of trade diversion whereby trade is diverted from the more eﬃcient non-member to the less eﬃcient member in the preferential RTA. The negative diversion eﬀect is potentially larger for services than goods because, given the nature of competition in services, the strong position acquired by ‘first movers’ will mean participating economies are locked into second-rate suppliers (Pangestu and Findlay, 2001, p. 7). The second risk relates to whether the RTA will undermine the multilateral trading system and not converge to the multilateral trading system. Once an RTA is formed involving major trading partners, there is little incentive for existing members to enlarge its market by adding new members and expanding the RTA because it would lead to dilution of their preferences. Furthermore, a new set of interests benefiting from the preferential agreement will resist further reform of expanding members, and multilateralizing the liberalization in the WTO. For non-members the trade-oﬀ is between increased competition from the existence of the RTA and joining the RTA to get preferential access. If there is no open membership, then excluded countries will have an incentive to create their own preferential agreement. In addition, RTAs often have carve-outs of sensitive sectors. Third, multiple and overlapping RTAs give rise to diﬀering tariﬀ reduction schedules and regulations including a complex matrix of rules of origin also known as the ‘spaghetti bowl’ eﬀect. Obviously the impact of diverse rules of origin on trade deflection and on the transaction costs of cross-border business deserves closer study. Significant diﬀerences in rules of origin will distort the decision to locate production in the most eﬃcient

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location, aﬀect decisions to obtain inputs from the cheapest source, and can also aﬀect economies of scale as production for the same good can be subject to diﬀerent content requirements and processes of production. These factors will adversely aﬀect the essence of intra-ASEAN economic cooperation, which is to create an ASEAN regional production centre, which in turn is linked to China. Complex rules of origin also impose a greater burden for compliance and monitoring on smaller and mediumsized companies, and lesser developed countries (Brenton, 2003). Fourth, the proliferation of overlapping RTAs has also given rise to the hub-and-spoke eﬀect. Some trade economists have criticized hubs for reaping more benefits than spokes, since a hub has free access to all the spokes while each spoke has market access to the hub only. The USA has become an FTA hub with its FTA arrangements not only in NAFTA but also its involvement in various bilateral FTAs. As its NAFTA partners, Canada and Mexico, are also in the process of signing up to other regional and bilateral RTAs, they have also become hubs and the US hub advantage is correspondingly diminished. In East Asia, Singapore, Japan and ASEAN have become hubs. But the early movers may have their hub positions eroded when other countries in East Asia also sign up to multiple RTAs. Fifth, for countries with limited financial and human negotiating resources, engagement in negotiating RTAs will no doubt divert resources that could be devoted to the Doha Round. For countries that are better endowed, it would not necessarily be the case of either/or. In fact, there could be advantages – participation in RTAs could prepare countries to accept global liberalization under the WTO; and the negotiating experience gained with RTAs could be usefully deployed in the Doha negotiations. Sixth, it could be a back door to sensitive issues such as labour and environment, which it was not possible to introduce in the multilateral agenda. The Singapore–US agreement has an environment and labour component, for instance. The seventh risk relates to the creation of conflicts and tensions in the region. As more advanced members enter into bilateral agreements with major trading partners, tensions and conflicts could arise with other members in the original regional grouping. This is evident in the case of Singapore and Thailand and the other ASEAN member countries. Implications A number of implications arise from the emerging issues that ASEAN and ASEAN member nations face in the current state of proliferation of RTAs. As already noted, ASEAN is emerging as a hub by default rather than by design in the approaches made by major trading partners to form

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RTAs. The optimal benefits to ASEAN will only be maximized if ASEAN can emerge as a hub and establish a consolidated regional approach (Pangestu and Findlay, 2001). Unless ASEAN can strengthen its own framework for regional cooperation and develop a common framework on which the RTA that ASEAN enters into should be designed, negotiated, coordinated and sequenced, then the partner economy is likely to emerge as the hub. The pattern will be more that of a series of diﬀerent bilateral agreements between the partner economy and ASEAN member economies, with the partner economy emerging as the hub and reaping more of the benefits. Take the potential ASEAN China RTA that ASEAN sees as increasing the attractiveness of ASEAN as an investment location with access to the China market. If China emerges as the hub and each ASEAN country as spokes in a series of bilateral agreements, then location in the hub is more attractive because of greater market access and unrestricted sourcing with each spoke, while location in the spoke provides less coverage. If indeed the strategy of ASEAN and individual ASEAN nations to enter into bilaterals and RTA is to increase the attractiveness of ASEAN as location for investment, to be considered as a hub and to create an ASEAN regional production centre, then it is important for ASEAN to emerge as the hub. To do so it will need to strengthen itself as an economically integrated unit and develop a common vision and strategy vis-à-vis external partners to avoid the above-mentioned ‘spaghetti bowl’ eﬀect and regional tensions between ASEAN members. A common strategy can then still be used to negotiate bilaterally. Whither ASEAN? ASEAN is again being challenged to broaden and accelerate the process of intra-ASEAN economic integration. During 2003, there was renewed discussion as to just how this challenge is to be met and there was wide agreement that economic integration in ASEAN must go beyond tariﬀs and goods. It must include non-tariﬀ barriers, deeper commitments in services and investment compared to the current ASEAN agreements, facilitation measures and regional institutional mechanisms, especially a dispute settlement mechanism. There was less agreement on whether an AFTA-plus approach or a common market-minus approach (Soesastro, 2003) would be more viable for ASEAN. Under the latter approach common external tariﬀs would be achieved by 2020, as well as other possible policies.2 The main argument for adopting a common market approach is that this sets a clear goal to achieve rather than leaving the process to oﬃcials and ministers. A modified approach is to adopt both an

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AFTA-plus and common external tariﬀ approach for a number of priority sectors,3 rather than a comprehensive common market. The final decision made at the summit in October 2003 was to achieve an ASEAN Economic Community (AEC) by 2020 or earlier. An agreement was reached to liberalize trade in goods and services, as well as address investment, and other issues to realize ASEAN as a single production centre. However, a blueprint to achieve the AEC is still missing, despite adopting an AFTA-like approach of deep and broad integration for 11 priority sectors and agreeing on the setting up of regional institutions such as the dispute settlement process. Road maps for achieving broad and deep integration that goes beyond tariﬀ reductions were being prepared throughout the course of 2004. Diﬀerent countries have been tasked with championing the sectors. The 11 priority sectors comprise four services sectors (airline, health, tourism and e-commerce) and seven manufacturing sectors (automotive, rubber products, wood products, textiles, electronics, food products and agribusiness). However, it is not clear whether the road maps are being prepared with a conceptual framework in mind and with clear time lines and goals. As progress is made on the AEC, ASEAN and individual ASEAN countries are entering into bilateral RTAs, and as such ASEAN should also develop a framework that would guide such RTAs and that could be used by ASEAN or individual ASEAN members when negotiating. The vision should be linked to the AEC framework and blueprint to ensure that there will be no inconsistencies or unintended eﬀects. This would not only ensure the emergence of ASEAN as a hub, but also increase the likelihood that the diﬀerent bilaterals and RTAs will converge on a wider regional agreement and eventually on the multilateral trading system. A common framework will also benefit the smaller and less developed members of ASEAN who have limited negotiating capacity and resources. What should be the elements of such a common framework? One view is that since Singapore has already entered into bilateral agreements with the major trading partners, this could be used as a model. The Singapore bilateral agreements have many of the ideal elements such as comprehensive coverage, diﬀerent but innovative rules of origin and clear timetables and deadlines. However, it is diﬃcult to replicate because Singapore does not have an agriculture sector, which is normally the sensitive sector. Even so, orchids and ornamental fish have been excluded from the Singapore and Japan RTA. A common framework will need to have guidelines on how to deal with sensitive sectors to ensure comprehensive coverage and a process of eventual inclusion. Furthermore, Singapore has the resources and capacity to enter into all areas of the RTA simultaneously, whilst the smaller and less developed ASEAN economies would not be able to do this.

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Following the discussions that have taken place in various fora and the spirit of WTO consistency, the following features and architecture are suggested as elements of a common framework.4 First, there should be comprehensiveness of scope, covering goods and services (and in turn covering all modes of supply), investment, technical barriers to trade and mutual recognition agreements. Trade and investment facilitation should be pursued continuously. Second, there should be a common approach to the rules and regulations governing diﬀerent RTAs even though they will be negotiated bilaterally. This is important in the case of rules of origin, which should be kept simple and neutral. Other specific guidelines are to allow alternative rules of calculation and not require all rules to be satisfied; allow for full cumulation; and not use restrictive rules of origin for sensitive sectors.5 Innovations such as the Singaporean rule of outward processing, which recognizes the prevalence of manufacturing chain and outsourcing, and the integrated sourcing initiative for IT components could also be considered. Third, agreeing to a common framework is important, but it does not mean that all members should enter into an RTA that includes all the components in the framework. Given the diversity of the ASEAN members, not all members have the same level of capacity and readiness. Furthermore, including all the elements of an RTA would involve protracted negotiations. Therefore, there should be a principle of flexibility that allows for ‘unbundling’, that is, negotiations could begin with facilitation measures, and those in trade in goods and even in services could be undertaken with an ‘early-harvest’ approach whereby reductions of impediments of mutual interest to all parties are undertaken first. However, most importantly, the early harvest should also be made available to all other trading partners, even if it is with a longer time frame. Fourth, capacity building should be an integral part of the RTA. The less developed countries will need capacity building from the more developed members in the RTA. Fifth, up to now ASEAN members have opted for minimal institutionalization and kept the ASEAN Secretariat small. Decision making is undertaken by the political leaders, ministers and senior oﬃcials, based on the principle of consensus, and forged through frequent and multilayered meetings and dialogues. However, agreement to come to a common framework, monitoring adherence and discipline to the framework, and enforcing parts of the agreement such as dispute settlement will require greater institutionalization. Some steps in this direction have already been taken at the ASEAN Summit in 2003 with regard to the creation of a regional dispute settlement mechanism within the ASEAN Secretariat; however, implementation remains to be seen. The issue of whether to strengthen the

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Secretariat or create independent regional units with special functions and authorities will also need to continue to be considered. A final component is WTO consistency in covering substantially all trade and in not raising barriers against non-member countries. However, as many have argued, these WTO consistency principles are not stringent enough and only two RTAs have been declared WTO-consistent by the WTO Committee on RTA, the main reason being the ambiguity over the interpretation of ‘substantially all trade’ for goods as well as services. Multilateralizing the agreement by multilateralizing the preferences given to members within a predetermined time frame would provide a stronger condition for WTO consistency. In the case of tariﬀs this could be achieved, for instance, by lowering MFN tariﬀs at the same time as preferential rates are coming down. Sequencing Finally, the rapid development of financial cooperation in East Asia under the ASEAN3 framework has raised the issue of sequencing of monetary integration and trade integration. The theory of economic integration has traditionally focused on trade, starting with sectoral trade arrangements and moving to free trade areas, customs unions, common market, economic and monetary union. These are the building blocks of the European Union, whose early stages were characterized by a world with limited cross-border capital flows. The East Asian experience has been diﬀerent. Financial cooperation has been spurred by the Asian financial crisis, with trade integration lagging. Obviously stable exchange rates and common currencies facilitate trade. But how far can monetary integration proceed without more integrated trade flows? Protagonists argue that monetary cooperation and integration may be easier to achieve than trade integration. This is not necessarily true. While surveillance and swap arrangements were readily put in place to meet the needs created by the regional financial crisis, deeper monetary integration with pooling of foreign reserves and a common currency is likely to meet strong resistance from East Asian countries sensitive to the issues of national identity and national sovereignty.

NOTES 1. Agreement between the USA and the Socialist Republic of Vietnam on Trade Relations. 2. The common-market-minus approach comes from the recommendations made by the ASEAN ISIS (2003).

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3. This approach was recommended by a study undertaken by McKinsey, which was commissioned by the ASEAN Ministers. In an informal AEM meeting in July 2003, the Ministers announced that a number of priority sectors had been chosen although it is not clear what elements of the AFTA-plus or common market will be adopted in each of these sectors. The priority sectors included textiles and garments, wood-based products, automotive, rubber-based products, agro-based products and fisheries, electronics, e-ASEAN, healthcare, airlines and tourism. 4. The PECC Trade Forum has been conducting work in this area since 2001 and a number of references can be found on this subject on the PECC Website, ranging from an inventory of RTAs in the region and what constitutes a good design for RTAs to minimize any potential adverse eﬀects (www.pecc.org). (See Scollay, 2001 for a detailed analysis of some of the guidelines for good RTAs.) 5. Sensitive sectors are better dealt with by having longer transition periods and suitably designed safeguards.

REFERENCES ASEAN Economic Forum (2003), ‘Towards a common framework for ASEAN extra regional co-operation’, presentation to the ASEAN SEOM 3/34, Yangon, 11 June. ASEAN Secretariat (1997), ASEAN Vision 2020, Jakarta: ASEAN Secretariat, December. ASEAN–China Expert Group on Economic Co-operation (2001), Forging Closer ASEAN–China Economic Relations in the Twenty-First Century, Jakarta: ASEAN Secretariat, October. ASEAN ISIS (2003), Towards an ASEAN Economic Community – A Track Two Report to ASEAN Policy Makers, Jakarta, April. Austria, Myrna S. (2003), ‘East Asian regional co-operation: Approaches and Process’, in Zhang Yunling (ed.), East Asian Co-operation: Progress and Future, Beijing: World Aﬀairs Press. Brenton, Paul (2003), Notes on Rules of Origin with Implications for Regional Integration in South East Asia, World Bank, July. Chia Siow Yue (1995), ‘Progress and issues in ASEAN economic integration’, in Toshihiko Kawagoe and Sueo Sekiguchi (eds), East Asian Economies: Transformation and Challenges, Singapore: Institute of Southeast Asian Studies, pp. 265–304. Chia Siow Yue (1997), ‘Regionalism and subregionalism in ASEAN: The free trade area and growth triangle models’, in Takatoshi Ito and Anne O. Krueger (eds), Regionalism Versus Multilateral Trade Arrangement, Chicago: University of Chicago Press. Chia Siow Yue (1998), ‘The ASEAN Free Trade Area’, Paciﬁc Review, 11 (2), 213–32. Chia Siow Yue (2002a), ‘ASEAN and emerging East Asian regionalism’, conference paper, May. Chia Siow Yue (2002b), ‘Regional economic co-operation in East Asia: modalities and approaches’, conference paper, August. East Asia Study Group (2002), Final Report of the East Asia Study Group, Jakarta: ASEAN Secretariat, November. East Asia Vision Group (2001), Towards an East Asian Community: Region of Peace, Prosperity and Progress, Jakarta: ASEAN Secretariat, October.

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Low, Linda (2002), ‘Singapore’s bilateral free trade agreements: institutional and architectural issues’, paper prepared for the PECC Trade Forum, Joint Meeting with PECC and Inter-American Development Bank, 23 April, Washington, DC. Montreevat, Sakulrat (2003), ‘Thailand toward bilateral free trade arena, viewpoints’, Institute of Southeast Asian Studies, 24 June (http://www.iseas.edu.sg/). Nagai, Fumio (2002), ‘Thailand’s trade policy: WTO plus FTA?’, IDE APEC Study Center, Working Paper Series 01/02, No. 6, March (www.ide.go.jp). Naya, Seiji, Kernial S. Sandhu, Michael Plummer and Narongchai Akrasanee (co-ordinators) (1989), ASEAN–US Initiative: Assessment and Recommendations for Improved Economic Relations, Honolulu and Singapore: East–West Center and Institute of Southeast Asian Studies. Pangestu, Mari and Christopher Findlay (2001), ‘Regional trading arrangements in Asia Pacific: where are they taking us?’, paper presented at the PECC, Trade Policy Forum, Regional Trading Arrangements: stocktake and next steps, Bangkok, 12–13 June. Pangestu, Mari, Hadi Soesastro and Mubariq Ahmad (1992), ‘A new perspective on ASEAN economic cooperation’, ASEAN Economic Bulletin, March. Scollay, Robert and John Gilbert (2001), New Subregional Trading Arrangements in the Asia-Paciﬁc, Washington, DC: Institute for International Economics. Soesastro, Hadi (2003), ‘ASEAN Economic Community: concepts, costs and benefits’, paper presented at the ASEAN Roundtable 2003, Roadmap to an ASEAN Economic Community, 20–21 August. Wang Yunjong (2002), ‘Monetary and financial co-operation in East Asia: future direction for institutional arrangements of monitoring and surveillance’, conference paper, April. World Trade Organization (2003), ‘RTAs notified to GATT/WTO and in force by date of entry into force’, March (www.wto.org).

7.

ANZUS free trade agreements: results from a global model Niven Winchester and Martin Richardson*

INTRODUCTION When President George W. Bush received ‘fast-track’ trade promotion authority (TPA) in 2002 that, in essence, gives him much greater power to pursue trade negotiations, many economists looked with interest to see where this power would be applied. One optimistic perspective on recent US trade policy is that TPA was purchased at the considerable cost of US steel tariﬀs and the bloated Farm Bill – necessary quos for the quid of domestic political support for TPA – so it must be highly valued by the Bush administration and therefore would be used extensively and wisely to promote trade agreements. The particular hope of many economists was that it would signal a renewed US commitment to multilateralism and decreased emphasis on preferential trading deals. This was especially the hope in New Zealand (NZ), an exporter of products in the world’s most protected sector, agriculture, and a miniscule one at that, with little power in bilateral settings. While it is perhaps too early to assess the US commitment to multilateralism – a less optimistic view of the steel tariﬀs and Farm Bill is that they represent a total capitulation of US international economic interests to domestic political interests – it does seem that the TPA has triggered a rash of negotiations for bilateral preferential trading arrangements. So the USA is in the ffinal stages of preparing a deal with Singapore, another with Chile is the ffirst of a planned series of dominoes in South America. The US Trade Representative (USTR) has also notified Congress of its intentions to open negotiations with the countries of the South African Customs Union (Botswana, Lesotho, Namibia, South Africa and Swaziland), with those of the Central American Integration System (Costa Rico, El Salvador, Nicaragua, Honduras and Guatemala) and with Morocco. From an NZ perspective perhaps the most significant deal the USA has indicated it will start to negotiate is that with Australia. The significance of this lies not just in its immediate impact on NZ, as an exporter competing with Australia in many markets and product lines, but also in its impacts 153

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on the dynamic political economy of NZ’s own trade relations. Given the close economic relations between Australia and NZ, as represented by the eponymous free trade area Closer Economic Relations, would a USA– Australia deal make the addition of NZ a fairly straightforward step? Would it be easier, in fact, than creating a USA–NZ deal directly in that the major barrier to such a deal is very likely the US farm lobby and that would have to have been overcome for a USA–Australia deal to go ahead? Or would it make a USA–NZ deal more diﬃcult – would the US farm lobby draw the line at favourable treatment for even more eﬃcient farmers or would Australian interests oppose the inclusion of competing NZ farmers in a deal giving preferential access to US markets? Great interest was stimulated in NZ in November 2002 when the US Trade Representative, Robert Zoellick, notified Congress of his oﬃce’s intention to initiate negotiations with Australia, as required by the US Trade Act. The interest came from the following two sentences at the close of the seven-page letter: Given the integration of the economies of Australia and New Zealand, New Zealand has been advocating its case to the Administration, as well as to Congress, that an FTA with New Zealand would complement our FTAs with Singapore and Australia. We will be soliciting the views of the Congress on this matter as we move forward with the Australia FTA. (USTR, 2002, p. 7)

While one can hardly conclude from this that a USA–NZ FTA is imminent, nevertheless the possibility has at least been raised and it reinforces the potential significance of the questions raised above. While we do not purport to answer these questions in this chapter, they do provide some of the rationale for the exercises we do conduct here. We evaluate USA–Australia, USA–New Zealand and USA–Australia– New Zealand free trade agreements using computable general equilibrium modelling. The comparative statics exercise we consider involves removing import tariﬀs, export subsidies (both positive and negative) and transport costs on trade in all commodities between nations in the free trade area. Hence our calculations are likely to represent the upper limit of changes due to the proposed trade agreements.

MODEL STRUCTURE AND DATA SOURCE We use Version 5 of the Global Trade Analysis Project (GTAP) Database (Betina and McDougall, 2002), which is a representation of the world economy in 1997. The database ‘combines detailed bilateral trade, transport and protection data characterising economic linkages among regions,

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together with individual country input–output databases which account for inter-sectoral linkages within regions’ (Hertel, 2002, pp. 1–2). Five primary factors, 57 sectors and 66 regions are identified. We operationalize the database using the GTAP5inGAMS model. GTAP5inGAMS is a static, multiregional CGE model that determines the production and allocation of goods. Rutherford and Paltsev (2000) outline the model in detail. We confine our discussion of GTAP5inGAMS to its salient features, which are listed in Box 7.1.

BOX 7.1

MODEL STRUCTURE

Imports Using the Armington assumption (Armington, 1969), imports are differentiated by source and composite imports are differentiated from domestic production. The regional composition of imports is the same in public, private and intermediate demand, but the aggregate share of imports may differ across demands. Following Scollay and Gilbert (2000) we double all Armington elasticities generated from the GTAP Database, so as to focus on long-run changes. Production Goods and services are produced by perfectly competitive firms under constant returns to scale technologies. Leontief nests of value added and a composite of intermediate inputs produce outputs. At a lower level of the production nest, a Cobb–Douglas aggregation of primary factors produces value added in each sector, and a further Leontief nest of intermediate inputs by product type produces an intermediate composite for each sector. Expenditure on final goods A utility-maximizing representative agent determines private, public and investment demand in each region. Public and investment expenditures are fixed in absolute value, so only the value of private expenditure changes with income. Private and public expenditures are Cobb–Douglas functions of domestic-import composites by product category. Primary factors Factors are perfectly mobile intersectorally but immobile internationally. Land and natural resources are specific to agriculture and mining respectively.

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Our aggregation of the GTAP Database, for most of our simulations, is displayed in Table 7.1. The USA, Australia and New Zealand enter as separate regions, while all other nations enter in a composite region. We identify 15 regions and five factors of production. To give some idea of the regions we are modelling here, Table 7.2 shows each region’s share of global trade and the importance of trade in the region (as a percentage of regional GDP). As is common, the smaller the country or region, the more significant is trade as a proportion of national income. Further details of the regions are provided in Appendix Tables 7A.1– 7A.4, which detail NZ exports, Australian exports, NZ imports and US imports respectively, all by sector and trading partner as described in Table 7.1. The most notable features are how much more important a market is Australia for NZ than vice versa; the much greater importance of Table 7.1

Model aggregation

REGIONS New Zealand (NZ) Australia (AUS) United States (USA) Rest of world (ROW) FACTORS Land Skilled labour Unskilled labour Capital Natural resources

SECTORS Livestock Wool Forestry and fishing Other agriculture Dairy products Meat products Other food products Minerals and energy Textiles and wearing apparel Wood and paper Chemicals and plastics Transport equipment Electronic and machinery equipment Other manufacturing Services

Table 7.2 Global trade share and trade as a percentage of GDP Region

NZ

AUS

USA

ROW

Global trade share Trade/GDP

0.29 0.67

1.18 0.45

14.66 0.25

83.88 0.62

Source: GTAP Version 5 Database (Betina and McDougall, 2002).

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agricultural exports to NZ than to Australia (the latter dominated, unsurprisingly, by mineral exports); and the utter insignificance of both Australia and NZ as sources of imports into the USA, except in the sectors of meat products (where Australia and NZ combined provide about a third of US imports), dairy products (about a fifth) and wool (almost all). In all of these tables it is well to remember that Australia has a population some five times that of NZ and a GDP some seven times greater. Table 7.3 presents the GTAP Database’s ad valorem tariﬀ equivalents of tariﬀ and non-tariﬀ barriers to trade among the countries of interest. Notable features here1 are the surprisingly high implicit tariﬀs on US primary exports to NZ, the lack of data on services protection and the diﬀerences between US tariﬀs on both ‘other food products’ and ‘forestry and fishing’ imports from Australia and NZ. So Australian forestry and fishing exports to the USA face nearly four times the implicit tariﬀ faced by NZ exports, and ‘other food’ exports face almost double the tariﬀ facing their NZ counterparts. Much of this is probably due to the aggregation used – ‘other food’ includes rice, wheat, sugar, some cereals, grains and other crops and so on and if it includes products that Australia exports Table 7.3 Ad valorem tariﬀ equivalents of tariﬀ and non-tariﬀ barriers in US–NZ and US–Australia trade, 1997, % Sector

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services

NZ–USA trade, tariﬀ imposed by:

AUS–USA trade, tariﬀ imposed by:

NZ

USA

Australia

USA

0.17 – 0.36 2.56 11.25 9.77 9.08 0.77 8.15 6.29 3.52 2.10 4.04 5.42 –

0.62 0.92 0.33 7.61 42.49 5.21 10.83 0.00 4.24 0.25 2.55 1.26 1.96 3.32 –

0.66 3.17 0.21 2.10 7.35 3.18 5.85 0.07 14.41 3.20 3.40 4.24 2.98 4.56 –

0.63 0.92 1.19 9.50 42.49 5.24 18.66 0.28 9.00 0.88 3.17 1.69 2.53 0.92 –

Source: GTAP Version 5 Database (Betina and McDougall, 2002).

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to the USA but NZ does not, then that could explain this diﬀerence. Regarding services, the current version of the GTAP Database has little data on services protection, a restriction that is unavoidable but that might be quite significant in the context of these simulations, as a large part of the FTA negotiations between Australia and the USA involves services.

THE SIMULATIONS We now turn to our simulations. The basic exercise we consider is to abolish all trade interventions among FTA members while maintaining barriers against non-members at their initial levels. However, as FTAs invariably involve more than simple trade barrier reductions, frequently introducing standards harmonization and the like, we attempt to capture these gains by abolishing transport costs between participating countries as well. Table 7.4 presents the basic welfare consequences of assorted ANZUS FTAs in our simulations. From an NZ perspective, an FTA excluding NZ is (very slightly) harmful, a three-way FTA is beneficial but an exclusive FTA between the USA and NZ is the best possible outcome. None of the eﬀects is particularly massive, however, with the annual benefit of a USA–NZ deal adding only three-quarters of a percentage point to GDP, or less than US$0.5 billion. The same qualitative results hold for Australia – it would prefer an exclusive FTA with the USA to a three-way arrangement but that is preferred to a USA–NZ FTA and none of them is a particularly big deal. The USA gains from any FTA with the threeway being most attractive, a deal with NZ alone next most appealing and an exclusive deal with Australia being only barely profitable. Finally, the rest of the world loses most from a three-way deal and least from a USA– Australia deal. Table 7.4 Welfare eﬀects under alternative FTAs (equivalent variation as a percentage of GDP and US$, 1997 million) FTA

NZ %

AUS $

%

USA $

%

ROW $

%

$

USA–AUS 0.015 8.7 0.146 516.0 0.007 592.7 0.003 524.4 USA–NZ 0.751 429.8 0.011 38.2 0.021 1691.0 0.010 1886.0 USA–AUS–NZ 0.707 404.9 0.128 453.8 0.029 2280.3 0.013 2324.9 Note: Shock removes import tariﬀs, export subsidies and transport costs on trade in all commodities among FTA members.

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159

What to make of these results? First, the losses to the non-member country in the two-country FTAs are for standard trade diversion reasons, as the USA switches its import source towards its partner country. Indeed, this mitigates some of the negative eﬀects on the non-member country as shown in Appendix Table 7A.5, where the consequences for NZ exports of a USA–Australia and three-way FTA are shown. In a USA–Australia FTA, NZ exports to the rest of the world increase in most significant sectors but in a three-way FTA those exports to non-members decrease. Also, in a USA–Australia FTA, NZ agricultural exports to Australia increase significantly, presumably replacing Australian products now sold into the USA: NZ exports to the USA of dairy and wool decline significantly in such an FTA. In a three-way FTA NZ exports to the USA of dairy products and ‘other food products’ increase very dramatically (as do Australian exports in those categories, as shown in Appendix Table 7A.6), although wool exports decline, more than replaced by Australian export increases. In the domestic market, a USA–Australia FTA has very little impact on NZ imports (see Appendix Table 7A.7), with a slight decline in some agricultural imports from Australia. In the three-way FTA, however, there are substantial increases in imports from the USA in many sectors (and overall) and a slight decrease in imports from Australia (driven largely by decreased imports of transport equipment and other equipment, all more than replaced by imports from the USA). Not surprisingly, overall NZ imports of all agricultural products increase in the three-way FTA, presumably as NZ domestic sales are diverted to the more lucrative US market and replaced by imports from other sources. Finally, Appendix Table 7A.8 shows that, from an NZ perspective, a USA–Australia FTA leads to a very small decline in every product price (relative to the model’s numeraire, the price of services in the USA) and small, mostly negative, output eﬀects whereas a three-way deal increases all prices and has large positive eﬀects on dairy and ‘other agricultural’ outputs and significant negative eﬀects on most manufacturing output levels. We turn next to the consequences of these FTAs for real factor returns in our countries of interest. Table 7.5 shows the consequences for factor owners of a USA–Australia FTA. The general eﬀect in NZ is a small decline in factor returns, corresponding to the small negative eﬀect on NZ welfare of such a deal. The greatest beneficiaries in Australia of such a deal are landowners – land is specific to agriculture in this model, recall, and the biggest impact of such a deal is on Australian agricultural exports. One curious result here is that the returns to Australian natural resources – specific to mining in the model – decline following a USA– Australia FTA, despite the increased volume of Australian exports to the

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Regional integration

Table 7.5 Simulated changes in real unit factor returns under a USA–Australia free trade agreement, % Factor Land Skilled labour Unskilled labour Capital Natural resources

NZ

AUS

USA

ROW

0.020 0.011 0.021 0.010 0.123

2.441 0.266 0.418 0.312 0.835

0.215 0.020 0.018 0.008 0.133

0.004 0.002 0.003 0.002 0.026

Note: As for Table 7.4.

Table 7.6 Simulated changes in real unit factor returns under a USA–Australia–New Zealand free trade agreement, % Factor Land Skilled labour Unskilled labour Capital Natural resources

NZ

AUS

USA

ROW

10.799 0.098 1.026 0.370 3.427

2.310 0.260 0.404 0.294 0.746

0.526 0.035 0.026 0.015 0.148

0.003 0.004 0.004 0.004 0.028

Note: As for Table 7.4.

US in minerals and energy. However, as shown in Appendix Table 7A.6, overall Australian exports in these sectors decline in the two-way FTA. The US tariﬀ against Australia on this sector is very low and the formation of an FTA consequently has little trade creation eﬀect. But the expansion of other sectors comes at the overall expense of this sector; hence the declining return to its specific factor. Turning to the three-way FTA, Table 7.6 shows the consequences for factor returns here. Little is aﬀected in the initial FTA members (except that the negative consequences for US landowners increase to half a percentage point or so) but there is a very significant increase in the return to NZ landowners (and a less significant increase in return to unskilled labour).2

SENSITIVITY ANALYSIS We double elasticity parameters governing substitution possibilities between imports by source and between composite imports and domestic

161

ANZUS free trade agreements

Table 7.7 Welfare eﬀects under alternative liberalization scenarios when Armington elasticities are doubled (equivalent variations as a percentage of GDP and in US$, 1997 million) FTA

NZ %

AUS $

%

USA $

%

ROW $

%

$

USA–AUS 0.024 13.7 0.173 613.7 0.007 558.7 0.007 1363.4 USA–NZ 1.808 1035.4 0.011 39.6 0.039 3097.9 0.020 3607.3 USA–AUS– 1.624 929.6 0.127 451.1 0.045 3604.7 0.025 4641.4 NZ Note: As for Table 7.4.

production to examine the sensitivity of our results to the assigned values of these parameters. Table 7.7 reports welfare changes for such an experiment. Our results are qualitatively similar under the two import specifications, although gains to the USA and NZ from trade liberalization involving the two countries are significantly larger when substitution possibilities in the import specification are increased, particularly so for NZ. For instance, comparing Tables 7.4 and 7.7 shows that the gain to NZ from a three-way FTA in the latter case is over double that in the former. Additionally, welfare reductions in the rest of the world from all of the FTAs are roughly twice as large when Armington elasticity parameters are increased. The change in Australian welfare is not significantly aﬀected by changes in import specification.

ALTERNATIVE TRADE LIBERALIZATION SHOCKS We conclude our analysis by considering a number of alternative scenarios for trade liberalization that might occur under the aegis of a free trade area. First we turn to scenarios involving less liberalization than that considered so far. Suppose we simply abolished tariﬀs alone, leaving export interventions and transport costs unaﬀected. Table 7.8 shows the eﬀects of this shock. Interestingly, the negative consequences of being left out of an FTA are greater in this case than in the more extensive liberalization summarized in Table 7.4. Of course, the gains from membership are reduced in this exercise; so much so, in fact, that Australia actually loses from a three-way FTA. Presumably these are the standard losses from trade diversion.

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Regional integration

Table 7.8 Welfare eﬀects under alternative liberalization scenarios when only tariﬀs are removed (equivalent variations as a percentage of GDP and US$, 1997 million) FTA

NZ %

AUS $

%

USA $

%

ROW $

%

$

USA–AUS 0.042 23.8 0.013 44.6 0.002 179.0 0.003 491.3 USA–NZ 0.586 335.5 0.014 48.5 0.019 1499.2 0.01 1845.5 USA–AUS– 0.507 290.4 0.008 27.3 0.021 1652.3 0.012 2224.0 NZ

Table 7.9 Welfare eﬀects under alternative liberalization scenarios when tariﬀs and export subsidies are removed (equivalent variations as a percentage of GDP and US$, 1997 million) FTA

NZ %

AUS $

%

USA $

%

ROW $

%

$

USA–AUS 0.042 24.0 0.006 19.6 0.003 238.8 0.003 557.0 USA–NZ 0.581 332.4 0.014 49.9 0.020 1585.1 0.011 1943.9 USA–AUS– 0.505 280.0 0.016 56.7 0.023 1802.4 0.013 2397.8 NZ

If we consider a more intermediate case in which both import restrictions and export interventions are removed, then Australian losses from exclusion or a three-way deal are even greater (and Australian gains from an exclusive deal even smaller), as shown in Table 7.9. Two possible reasons for this are that Australia benefits either from importing goods subsidized through US export subsidies or from any terms-of-trade eﬀects of its own export taxes. The database reveals that US export subsidies on trade with Australia are negligible, however, so the first of these explanations is unlikely. But Australia does impose export taxes on some of its trade with the USA – most notably in wool (9.4 per cent) – so one explanation for this observation is that Australia derives terms-oftrade benefits from those export restrictions that are lost under complete liberalization. To investigate this we consider a number of exercises in which we remove Australian export interventions one at a time. Appendix Table 7A.9 shows one of these – all subsidies and taxes are removed except the Australian tax on wool exports (to the relevant FTA partners). Comparing the results of these exercises to those in Tables 7.8 and 7.9

163

ANZUS free trade agreements

reveals that these taxes are, indeed, the source of some of Australia’s gains from trade. Compared to the status quo benchmark, for instance, Table 7.8 shows that Australia gains US$44.6 million from an exclusive deal with the USA when only tariﬀs are removed but, from Table 7.9, gains only US$19.6 million when import and export interventions are removed. If Australia retained its wool tax, however, its gain would be US$25.67 million (from Table 7A.9); other exercises (not shown) demonstrate that if Australia also retained its tax in the ‘other food’ category its gain would be US$31.55 million; if it also retained the tax on lumber its gain would be US$31.77 million and so on. One other point that arises from these alternative simulations is that the eﬀects of transport costs are quite asymmetric across countries here, impinging most severely on Australian gains from trade. Recall that our argument for including their reduction in our initial scenario was that FTAs frequently cover more than simply trade barriers and, to the extent that they ease trade between member countries in other ways, that could be best captured by a reduction in non-trade-barrier trade costs. The asymmetric significance of those costs in this context, however, suggests that reducing transport costs is not the best way to capture those eﬀects here. A further issue we can consider is to ask what might happen if the US agricultural lobby were to assert itself and get special treatment for agriculture in an FTA. We consider first the most extreme case in which they are completely successful and agricultural trade restrictions post-FTA are maintained at their pre-FTA levels. Table 7.10 shows the welfare results here and comparison with Table 7.4 shows, unsurprisingly, dramatically lower gains for all countries – particularly NZ – from any FTA. We also see that the USA actually loses from an FTA with NZ in such a setting, emphasizing that the gains to the USA from a full FTA with NZ are Table 7.10 Welfare eﬀects under alternative liberalization scenarios with agriculture excluded (equivalent variations as a percentage of GDP and US$, 1997 million) FTA

NZ %

AUS $

%

USA $

%

ROW $

%

$

USA–AUS 0.011 6.4 0.072 256.4 0.007 531.6 0.002 300.4 USA–NZ 0.077 44.0 0.002 8.1 0.001 81.1 0.001 154.8 USA–AUS– 0.067 38.4 0.070 249.2 0.006 451.8 0.001 147.5 NZ Note: As for Table 7.4.

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Regional integration

largely from consumption and production eﬃciencies in the agricultural sector. A more limited restriction on agricultural exemptions is modelled in Table 7.11, wherein only meat and dairy products – two of the most important of NZ’s export sectors in its trade with the USA – are exempted. A convex combination of the liberalizations in Tables 7.4 and 7.10, the results are a convex combination of the results in those tables too. A further exercise we consider is shown in Table 7.12 and involves only the dairy sector being exempted from any FTA. The gains to the USA from a US–NZ deal are still substantially lower here than in a full FTA (at around US$441 million versus US$1691 million) but its gains from an FTA with Australia are actually higher than in the full FTA case. Indeed, aggregate world welfare increases by more in a USA–Australia FTA that excludes dairy (a gain of around US$585 million) than in a comprehensive Table 7.11 Welfare eﬀects under alternative liberalization scenarios with dairy products and meat products excluded (equivalent variations as a percentage of GDP and US$, 1997 million) FTA

NZ %

AUS $

%

USA $

%

ROW $

%

$

USA–AUS 0.012 6.9 0.120 425.4 0.007 584.2 0.003 473.0 USA–NZ 0.161 92.1 0.004 13.4 0.002 186.0 0.001 128.08 USA–AUS– 0.148 85.0 0.116 0 0.010 767.0 0.003 594.4 NZ Note: As for Table 7.4.

Table 7.12 Welfare eﬀects under alternative liberalization scenarios when dairy products are excluded (equivalent variations as a percentage of GDP and US$, 1997 million) FTA

NZ %

AUS $

%

USA $

%

ROW $

%

$

USA–AUS 0.006 3.5 0.128 454.4 0.008 657.8 0.003 523.6 USA–NZ 0.232 133.1 0.004 15.2 0.006 440.9 0.002 376.9 USA–AUS– 0.229 131.2 0.124 440.0 0.014 1112.2 0.005 908.1 NZ Note: As for Table 7.4.

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ANZUS free trade agreements

one (around US$576 million). The reason for this is presumably the trade diversion eﬀect of an FTA that includes dairy but excludes the world’s lowest-cost producer, NZ, an interpretation that is reinforced by observing the substantial increase in gains to the importing country (the USA) when a three-way FTA is comprehensive (giving a US gain from the FTA of US$2280 million) versus one that excludes dairy products (giving a US gain from the FTA of only US$1112 million). We also determine the consequences of these assorted FTAs on the assumption that the USA’s other negotiations would proceed successfully and result in FTAs with Chile, Singapore, Morocco and the South African Customs Union. The results are reported in Appendix Table 7A.10 and are broadly as one would expect: exclusion from a deal with the USA is now more costly (NZ would lose US$37.2 million from being left out, versus US$24.0 million in Table 7.9) and inclusion more valuable, particularly for NZ who would gain US$415.4 million from inclusion in such a deal, versus US$280.0 million in Table 7.9. Nevertheless, the numbers here are still not particularly large and we have run another simulation exercise to consider an alternative benchmark: global free trade. Table 7.13 shows the results of this and demonstrates the far more substantial gains to be had, to all participating countries, from such a global deal. One final exercise we consider follows from the discussion, at least in Australia, of the consequences of an FTA with the USA for relationships with Asia. Accordingly, we have looked at the consequences of a USA–Australia FTA with East Asian countries separated out so that we can observe the eﬀects on Australian trade with these countries. Appendix Table 7A.11 shows the welfare eﬀects of our assorted FTAs on NZ, Australia, the USA, East Asia and the rest of the world (with only tariﬀs and export subsidies removed so the results are directly comparable with those in Table 7.9). Appendix Table 7A.12 shows the eﬀects of a USA–Australia FTA on Australian exports to these groups of countries. Table 7.13 Welfare eﬀects under global trade liberalization (equivalent variations as a percentage of GDP and US$, 1997 million) FTA

Global

NZ

AUS

USA

ROW

%

$

%

$

%

$

%

$

6.922

3963.4

1.473

5219.5

0.497

39 385.4

0.305

55 592.2

Note: Shock removes import tariﬀs and export subsidies on trade in all commodities between all regions and should be compared with Table 7.9.

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Regional integration

Interestingly, both tables show that the eﬀects on East Asian countries (China, Hong Kong, Japan, South Korea, Taiwan, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam) are broadly similar to those on the rest of the world in our other simulations. While East Asia is more sensitive than the rest of the world to all of the ANZUS FTAs we consider, the most notable impacts are those of a USA–NZ FTA and a three-way deal which both have a substantially larger negative welfare eﬀect on East Asia than on the rest of the world as a whole. As far as Australian trade is concerned, Appendix Table 7A.12 does not suggest that East Asian trade would be aﬀected particularly unusually compared to that of other non-members of a USA–Australia FTA (across all sectors we find a 2.09 per cent fall in Australian exports to East Asia versus a 2.35 per cent fall in exports to the rest of the world, and remarkably little diﬀerence sector by sector). All in all, we do not find much evidence to support the notion that a USA–Australia FTA, in particular, would have substantial negative consequences in East Asia. The political signal sent by signing such an agreement is another matter entirely, however.

SUMMARY AND CONCLUSION In this chapter we have considered a number of FTA permutations involving Australia, NZ and the USA using the GTAP Database and static computable general equilibrium model GTAP5inGAMS. One of the most obvious features of the results is that the welfare consequences are not particularly large, even for a small country such as NZ in an extensive three-way FTA – an extra three-quarters of a percentage point on national income is not trivial, but it is still only a little over NZ$200 per capita. It might be argued that the downside of this is that these FTAs have little to oﬀer; the upside is that exclusion from them is not costly – even if the alternative for NZ is to be left out of a bilateral USA–Australia deal, that only adds less than an extra two-hundredths of a percentage point of national income to the cost. A recent CIE paper (CIE, 2001) also analyses the impact of an Australian–US free trade area using two models: the Asia Pacific G-Cubed model and the GEMPACK version of the GTAP model. Its simulated increases in real GDP for included countries are greater than ours using both models and, using the Asia Pacific G-Cubed model, it finds that New Zealand gains (marginally) from a USA–Australia free trade area, an eﬀect we do not reproduce. Using the Asia Pacific G-Cubed model, the authors observe increases in real GDP of 0.33 per cent, 0.02 per cent and 0.03 per cent in Australia, the USA and New Zealand respectively. They

ANZUS free trade agreements

167

attribute the gain to New Zealand to a larger Australian economy and the diversion of Australian dairy products from East Asia to the USA, although our results suggest that East Asia is not atypical vis-à-vis the rest of the world in this respect. There are many diﬀerences between the Asia-Pacific G-Cubed and GTAP5inGAMS models. Most significantly, the former is dynamic and the latter is static. There are, however, also dissimilarities between these authors’ GTAP simulations and ours: (a) they use Version 4 of the GTAP Database, updated to 1998–99 using their own adjustments, while we use Version 5 of the database; (b) they employ the GEMPACK version of the GTAP model, while we employ the GAMS version, and (c) aggregations diﬀer in the two models. While our results and theirs do diﬀer, nevertheless both studies indicate that the formation of a USA–Australia free trade area will only marginally influence national welfare in the three countries of concern. What does this chapter imply for our earlier questions concerning the dynamics of trade negotiations? Our numbers suggest that the addition of NZ to a USA–Australia deal should meet with relatively strong support from the USA and little opposition from Australia but, of course, they must be read subject to the vital caveat that the political economy of trade policy often has little to do with national welfare as economists usually measure it. Reading the USTR’s letter to the Senate notifying of the intention to negotiate with Australia (USTR, 2002) it is diﬃcult to find much discussion of the gains to US consumers from lower import prices in their trade with Australia.3 And nor do the press in Australia and NZ typically trumpet the potential of a deal with the USA as lying in the wealth of cheap imports that will follow. While trade policy has always been a strict subset of foreign policy, it does appear that this is more explicitly the case with the USA under the current Bush administration than it has been in the past (not explicitly in terms of stated policy, where the separation of ‘pure’ foreign policy and trade policy is still insisted upon, but de facto, it seems, in the practice of trade policy where the choice of trading partners is clearly not independent of foreign policy goals).4 Our own conclusion drawn from this exercise is that our priors are confirmed: the best hope for NZ and Australia is multilateralism and negotiation capital is probably best devoted to the pursuit of trade eﬀorts through the WTO. Finally, it should be stressed that our results are subject to all of the usual caveats surrounding CGE modelling and to the particular caveats that follow from our use of the GTAP Database. As noted earlier, the absence of comprehensive data on services protection is a significant shortcoming of the database, especially in the context of analysing FTAs in which services feature prominently. Furthermore, we have noted that our baseline

168

Regional integration

simulations, using transport cost reductions as a proxy for non-tradebarrier-related liberalizations associated with an FTA, perhaps do not capture this perfectly and it would be an interesting topic for future study to find a more suitable means of representing such eﬀects in a static model such as that used here.

NOTES *

1.

2. 3. 4.

We are grateful to Sisira Jayasuriya for all his eﬀorts in organizing Peter Lloyd’s Festschrift and for his editorial assistance in preparing this chapter. We are also grateful to Peter Lloyd and Festschrift participants for useful discussion of this chapter and, particularly, to Don McLaren and an anonymous referee for very helpful suggestions and comments. All remaining errors, of course, are ours. Since 1997, perhaps the most significant trade policy reform in NZ has been the abolition in 1998 of auto tariﬀs (previously at 22.5 per cent) and the consequent disappearance of the auto assembly industry. Scollay (2002) allows for this by recalibrating the baseline with zero auto tariﬀs. This adjustment makes no significant diﬀerence to our results, however, and is not done here. Other diﬀerences between our approach and Scollay’s include our adjustment of the GTAP elasticities to better approximate long-run eﬀects and the fact that we abolish all trade restrictions, including export subsidies and transport costs, in contrast to Scollay’s exercise of removing only tariﬀs. This is an interesting feature of NZ trade that has shown up elsewhere – that, for Stolper–Samuelson reasons, trade liberalization benefits unskilled labour. See Cagatay and Lattimore (1999). Actually, it is impossible. Indeed, many NZ commentators have suggested that NZ’s anti-nuclear stance has been an albatross around the neck of any aspirations to entering serious negotiations with the USA towards forming an FTA, as has its non-committal position on the war in Iraq.

REFERENCES Armington, P.S. (1969), ‘A theory of demand for products distinguished by place of production’, IMF Staﬀ Papers, 16, 159–76. Betina, D.V. and R.A. McDougall (2002), Global Trade Assistance and Protection: The GTAP 5 Database, Purdue University: Center for Global Trade Analysis. Cagatay, S. and R. Lattimore (1999), ‘NZ trade liberalisation, unemployment and real wages’, mimeo, Lincoln University. CIE (2001), Economic Impacts of an Australia–United States Free Trade Area, Canberra and Sydney: Centre for International Economics. Hertel, T.W. (2002), ‘Introduction to the GTAP Database’, in D.V. Betina and R.A. McDougall (eds), Global Trade Assistance and Protection: the GTAP 5 Database, Purdue University: Center for Global Trade Analysis, ch. 1. Rutherford, T.F. and S.V. Paltsev (2000), ‘GTAPinGAMS and GTAP-EG: Global datasets for economic research and illustrative models, the dataset and static model’, University of Colorado.

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169

Scollay, R. (2002), ‘The impact on New Zealand of a FTA between Australia and the United States’, mimeo, APEC Study Centre, University of Auckland. Scollay, R. and J. Gilbert (2000), ‘Measuring the gains from APEC trade liberalisation: An overview of CGE assessments’, World Economy, 23 (2), 175–97. USTR (2002), ‘Notification to Congress of intent to initiate FTA negotiations with Australia’. Available at http://www.ustr.gov/releases/2002/11/2002-11-13australia-byrd.PDF.

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APPENDIX:

Regional integration

TABLES OF FURTHER RESULTS

Table 7A.1 New Zealand exports by sector and trading partner (expressed as a proportion of total exports), 1997 Sector Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services All sectors

AUS

USA

ROW

All regions

0.31 0.02 0.09 0.19 0.47 0.07 0.93 1.02 1.46 2.20 1.52 0.22 2.22 2.27 0.25

0.18 0.09 0.08 0.38 1.24 2.24 0.88 0.03 0.22 0.55 0.53 0.17 0.61 0.54 3.22

2.24 0.80 2.97 3.00 18.33 12.44 4.29 0.52 3.12 3.46 3.05 0.32 2.56 3.97 14.77

2.72 0.90 3.13 3.57 20.04 14.75 6.10 1.56 4.80 6.21 5.10 0.71 5.39 6.77 18.24

13.24

10.95

75.81

100.00

Source: GTAP Version 5 Database (Betina and McDougall, 2002).

Table 7A.2 Australian exports by sector and trading partner (expressed as a proportion of total exports), 1997 Sector

NZ

USA

ROW

All regions

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment

0.02 0.00 0.00 0.04 0.02 0.02 0.38 0.13 0.25 0.39 0.66 0.83

0.03 0.11 0.01 0.08 0.08 0.63 0.48 0.56 0.32 0.11 0.38 0.80

1.58 2.35 0.54 7.83 2.98 4.05 4.44 16.41 2.59 1.29 2.72 2.20

1.62 2.46 0.55 7.95 3.08 4.70 5.30 17.09 3.16 1.78 3.76 3.83

171

ANZUS free trade agreements

Table 7A.2 (continued) Sector

NZ

USA

ROW

All regions

Electronic & machinery equip. Other manufacturing Services

0.62 0.82 0.08

0.72 1.41 4.74

5.07 14.10 17.17

6.40 16.33 21.99

All sectors

4.27

10.44

85.29

100.00

Source: As for Table 7A.1.

Table 7A.3 New Zealand imports by sector and trading partner (expressed as a proportion of total imports), 1997 Sector

AUS

USA

ROW

All regions

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services

0.08 – – 0.21 0.13 0.08 1.78 0.61 1.15 1.78 3.00 3.76 2.81 3.80 0.37

0.11 – 0.01 0.21 0.01 0.02 0.47 0.01 0.31 0.61 1.78 2.57 4.54 1.00 5.00

0.04 – 0.03 0.54 0.04 0.10 1.37 2.98 4.51 2.27 6.34 7.38 14.38 5.54 18.31

0.23 – 0.04 0.95 0.17 0.20 3.61 3.59 5.98 4.66 11.11 13.71 21.73 10.34 23.68

19.55

16.62

63.83

100.00

All sectors Source: As for Table 7A.1.

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Regional integration

Table 7A.4 US imports by sector and trading partner (expressed as a proportion of total imports), 1997 Sector

NZ

AUS

ROW

All regions

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services

0.004 0.002 0.002 0.009 0.025 0.049 0.018 0.001 0.004 0.012 0.011 0.003 0.012 0.011 0.062

0.002 0.008 0.001 0.007 0.006 0.052 0.038 0.044 0.025 0.008 0.029 0.060 0.054 0.109 0.346

0.244 0.002 0.162 1.511 0.117 0.205 2.545 6.643 8.641 4.183 6.701 12.388 29.645 11.401 14.591

0.25 0.01 0.16 1.53 0.15 0.31 2.60 6.69 8.67 4.20 6.74 12.45 29.71 11.52 15.00

All sectors

0.22

0.79

98.98

99.99

Source: As for Table 7A.1.

173 0.23

0.42 2.11 0.08 0.21 0.25 0.25 0.16 0.06 0.26 0.15 0.13 0.35 0.23 0.13 0.19

ROW

0.18

1.42 0.83 0.18 0.81 0.82 0.98 0.16 0.09 3.41 0.88 0.32 5.97 2.31 0.21 0.21

All

130.77

9.81 32.86 1.46 62.15 878.76 55.45 184.04 1.33 51.77 5.74 14.90 19.27 14.44 30.49 3.00

2.72 3.11 2.10 4.33 2.84 7.02 6.27 3.59 23.57 5.27 6.45 26.46 13.56 6.85 6.41 9.23

USA

AUS

8.64

15.16 10.67 5.19 11.17 9.67 8.89 8.19 3.11 12.96 6.92 4.82 7.89 7.82 7.04 7.41

ROW

USA–AUS–NZ FTA

Shock removes import tariﬀs, export subsidies and transport costs on trade in all commodities among FTA members.

1.44

1.52

All sectors

Note:

0.23 29.44 0.44 0.05 19.34 5.01 2.20 0.21 0.19 0.27 0.23 0.31 0.28 0.37 0.23

USA

9.41 4.79 3.10 12.19 6.70 2.42 2.36 0.17 11.79 2.19 1.39 19.75 5.95 0.32 1.37

AUS

USA–AUS FTA

Simulated changes in New Zealand exports, per cent, in baseline simulation (Table 7.4)

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services

Sector

Table 7A.5

6.55

13.41 12.61 5.01 3.02 45.58 0.89 19.80 3.35 13.21 6.23 3.27 7.18 7.65 4.00 6.62

All

174 56.21

0.49

All sectors

As for Table 7A.5.

7.29 60.75 19.54 115.97 1436.25 66.57 464.58 3.16 225.21 17.97 29.98 36.60 52.35 15.29 4.48

4.38 0.96 0.31 3.68 1.73 2.56 1.44 0.79 0.01 1.06 0.22 0.11 0.24 1.14 2.25

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services

Note:

USA

1.62

4.81 2.24 0.03 3.88 2.79 3.03 1.83 0.79 0.52 1.03 0.38 0.31 0.36 1.39 2.15

ROW

USA–AUS FTA

4.47

4.62 0.58 0.38 2.64 32.26 6.29 40.58 0.66 23.30 0.11 3.37 7.82 6.16 0.06 0.72

All

1.60

14.43 8.62 11.48 28.25 13.46 0.24 0.26 2.40 1.43 0.84 1.51 7.06 5.56 0.23 2.44

NZ

52.70

8.01 63.44 20.82 116.74 835.55 76.39 463.37 3.28 225.86 18.32 30.16 37.16 52.66 15.52 4.70

USA

1.40

4.28 1.54 0.20 3.63 1.94 2.63 1.65 0.72 0.68 0.91 0.49 0.71 0.53 1.24 1.97

ROW

USA–AUS–NZ FTA

Simulated changes in Australian exports, per cent, in baseline simulation (Table 7.4)

NZ

Sector

Table 7A.6

4.24

3.90 1.37 0.58 2.23 18.58 7.96 40.75 0.60 23.38 0.63 3.69 6.60 5.77 0.26 0.52

All

175 0.34

0.50

All sectors

As for Table 7A.5.

0.80 0.00 0.14 0.19 1.11 0.91 0.32 0.14 0.83 0.06 0.37 0.66 0.41 0.08 0.32

4.38 0.96 0.31 3.68 1.73 2.56 1.44 0.79 0.01 1.06 0.22 0.11 0.24 1.14 2.25

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services

Note:

USA

0.08

0.71 3.20 0.25 0.17 1.00 0.74 0.43 0.13 0.59 0.30 0.19 0.18 0.12 0.25 0.08

ROW

USA–AUS FTA

0.21

1.03 3.20 0.24 0.66 0.97 0.56 0.50 0.02 0.49 0.25 0.11 0.19 0.14 0.28 0.17

All

1.54

14.43 8.62 11.48 28.25 13.46 0.24 0.26 2.40 1.43 0.84 1.51 7.06 5.56 0.23 2.44

AUS

34.67

22.70 0.00 15.32 62.48 28.64 113.65 115.14 6.41 161.77 65.78 26.60 38.36 40.22 65.46 4.21

USA

0.57

20.07 12.83 11.33 32.99 16.41 2.94 1.96 1.59 2.18 2.06 0.98 7.68 6.06 1.01 4.52

ROW

USA–AUS–NZ FTA

Simulated changes in New Zealand imports, per cent, in baseline simulation (Table 7.4)

AUS

Sector

Table 7A.7

5.10

19.31 12.83 11.90 38.32 11.42 12.14 15.76 1.71 6.55 9.87 5.22 1.12 3.68 6.77 4.42

All

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Regional integration

Table 7A.8 Changes in NZ product prices and output under alternative liberalization scenarios, per cent Sector

US–AUS FTA

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services

USA–AUS–NZ FTA

Price

Output

Price

Output

0.06 0.06 0.05 0.07 0.06 0.06 0.06 0.04 0.06 0.06 0.06 0.05 0.06 0.05 0.06

0.27 0.18 0.15 0.07 0.64 0.73 0.11 0.06 1.40 0.26 0.08 0.50 0.73 0.11 0.02

1.69 1.79 0.60 2.03 1.51 1.35 1.03 0.34 1.13 1.01 0.77 0.39 0.79 0.77 1.13

2.72 1.77 1.81 14.24 38.14 1.87 4.32 3.70 9.30 2.52 3.25 3.86 8.11 4.34 0.32

Note: Shock removes import tariﬀs, export subsidies and transport costs on trade in all commodities among FTA members. All price changes are relative to the model’s numeraire, the price of services in the USA.

Table 7A.9 Welfare eﬀects under alternative liberalization scenarios when tariﬀs and export subsidies are removed except for the Australian export tax on wool (equivalent variations as a percentage of GDP and US$, 1997 millions) FTA

NZ %

AUS $

%

USA $

%

ROW $

%

$

USA–AUS 0.041 23.5 0.007 25.7 0.003 234.4 0.003 556.8 USA–NZ 0.581 332.4 0.014 49.9 0.020 1585.1 0.011 1943.9 USA– 0.506 289.5 0.014 50.6 0.023 1797.6 0.013 2397.3 AUS–NZ

177

$ 24.0 332.5 8.5 289.1 37.2 502.7 415.4

%

0.042 0.581 0.015 0.505 0.065 0.878 0.762

NZ

0.006 0.014 0.006 0.016 0.074 0.026 0.041

%

$ 19.6 49.8 19.8 56.6 263.1 93.0 144.3

AUS

0.003 0.020 0.007 0.023 0.009 0.038 0.038

%

$ 238.5 1585.4 547.1 1802.3 748.7 2998.7 2987.0

USA

0.009 0.011 0.112 0.001 0.144 0.142 0.179

%

27.3 32.2 335.5 3.1 433.1 427.2 438.1

$

Other USTR

0.003 0.011 0.007 0.013 0.012 0.024 0.029

%

$ 532.6 1978.5 1310.0 2406.0 2184.4 4339.4 4861.1

ROW

Note: ‘OTH’ refers to countries other than Australia and New Zealand that the USTR has indicated it will negotiate preferential trading agreements with (Chile, Singapore, Morocco, and the South African Customs Union). Countries in the Central American Integration System are not included as the GTAP 5 Database includes these nations in a composite region with other nations. Shock removes import tariﬀs and export subsidies on trade in all commodities between all regions.

USA–AUS USA–NZ USA–OTH USA–AUS–NZ USA–AUS–OTH USA–NZ–OTH USA–AUS–NZ–OTH

FTA

Table 7A.10 Welfare eﬀects under alternative liberalization scenarios when tariﬀs and export subsidies are removed, all countries currently considered by the USTR (equivalent variation as a percentage of GDP and US$, 1997 millions)

178

$

23.3 334.0 291.1

%

0.041 0.583 0.508

NZ

0.006 0.014 0.015

%

$ 22.0 48.4 53.1

AUS

0.003 0.020 0.023

%

$ 249.4 1597.6 1824.5

USA

0.005 0.026 0.029

%

$ 272.79 1485.6 1663.2

East Asia

0.002 0.003 0.005

%

$ 239.3 367.0 605.2

ROW

Note: East Asia includes China, Hong Kong, Japan, South Korea, Taiwan, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam.

USA–AUS USA–NZ USA–AUS–NZ

FTA

Table 7A.11 Welfare eﬀects under alternative liberalization scenarios when tariﬀs and export subsidies are removed and East Asia enters as separate region (equivalent variation as a percentage of GDP and US$, 1997 millions)

179

ANZUS free trade agreements

Table 7A.12 Simulated changes in Australian exports, per cent, USA–AUS FTA NZ

USA

East Asia

ROW

All nations

Livestock Wool Forestry & fishing Other agriculture Dairy products Meat products Other food products Minerals & energy Textiles & wearing apparel Wood & paper Chemicals & plastics Transport equipment Electronic & machinery equip. Other manufacturing Services

5.21 1.76 0.87 4.09 2.23 3.33 2.28 1.30 1.05 1.94 1.07 2.03 1.40 1.93 2.68

6.80 47.89 17.38 115.78 1415.96 50.83 452.15 2.68 221.62 16.44 27.98 32.85 49.19 13.89 4.25

5.03 2.13 0.86 3.93 2.94 3.10 2.61 1.07 0.49 1.57 1.04 2.48 1.36 2.18 2.39

5.31 2.51 0.91 4.32 3.33 3.44 2.69 1.13 0.43 2.18 1.04 2.48 1.32 2.17 2.37

4.99 0.11 0.53 2.82 31.50 4.02 38.72 0.96 22.04 0.66 1.91 4.97 4.30 0.78 0.95

All sectors

1.75

53.38

2.09

2.35

3.63

Note: Shock removes import tariﬀs and export subsidies on trade in all commodities. East Asia includes China, Hong Kong, Japan, South Korea, Taiwan, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam.

8.

New criteria for optimum currency areas Herbert Grubel*

Peter Lloyd’s wide range of interest in economic theory and policy has always included the links between his native New Zealand and his adopted Australia. For this reason, it is appropriate for me to contribute a chapter that concerns the economic and political issues surrounding a possible monetary union between the two countries. The subject in the context of North America also happens to have been one of my research priorities during the last four years. The topic of monetary union has attracted much attention by economists as a result of the currency upheavals in Asia and South America in the 1990s, which suggests that the benefits from the traditional ffixing of exchange rates by independent central banks can easily be lost by the problems created by speculative attacks on currencies. The interest of economists was also aroused by the fact that at the beginning of 2001 members of the European Monetary Union ffinalized the process by the highly symbolic replacement of national currencies by euro notes and coins. Many economists, who had predicted that this event would never take place, were prompted to repeat their arguments why the union made no sense economically and why therefore it was doomed to failure. Economists also turned their attention to the issues surrounding the possible creation of a North American monetary union.1 This attention was driven by two additional motives. First, the North American Free Trade Agreement between Canada, Mexico and the USA signed in the early 1990s had been a great success by almost all standards. Since this success matched the success of free trade in the European Community, it was natural to ask whether North America should not follow up its own free trade agreement by copying Europe’s creation of a monetary union. Second, Canadians’ interest in a North American Monetary Union was driven by their country’s poor economic performance during the 1990s. The exchange rate against the US dollar dropped by nearly a third. Figure 8.1 shows the postwar history of this exchange rate, which fluctuated around 180

New criteria for optimum currency areas

181

1.15 1.05 0.95 0.85 0.75 0.65 0.55 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001

Figure 8.1

The Canadian/US dollar exchange rate

a distinct downward trend after the middle 1970s. In addition, Canada’s productivity growth lagged and resulted in a growing gap in real per capita income between Canada and the USA. It is interesting to note that New Zealand is in much the same relationship with Australia as Canada is with the USA. In 2000, as a percentage of the USA, Canada’s population was 10.9 per cent, GDP was 7.0 per cent and real per capita income measured in purchasing power parity was 79.8 per cent. The ffigures for New Zealand relative to Australia are 20 per cent for population, 12.8 per cent for GDP and 74.2 per cent for per capita income. On the other hand, the trade relationships between the two pairs of neighbouring countries are very diﬀerent. Of Canada’s total exports, 85.1 per cent go to the USA and 73.7 per cent of imports come from that country. In contrast, New Zealand’s trade with Australia represents only 20.4 per cent of exports and 22.5 per cent of imports.2 There are many other important diﬀerences in the economies of the two pairs of countries, which are relevant to the analysis of the benefits and costs of monetary union. However, this is not the place to go into such institutional details. The main purpose of this chapter is to set out briefly the traditional theory and some empirical evidence on optimum currency area criteria, which will always be linked to Robert Mundell. This analysis sets the stage for the presentation of some new criteria that I think should replace the traditional approach. Naturally, many of my empirical and institutional references are to conditions in Canada and the country’s relationships to the USA. I hope that my analysis will stimulate others, more familiar with New Zealand and Australia than I am, to see the relevance of my analysis to these two countries.

182

1.

Regional integration

TRADITIONAL BENEFITS

Most studies of currency unions and textbook discussions emphasize the costs of monetary union. Benefits are given short shrift, if they are mentioned at all. This treatment of benefits was justified in the past since no empirical estimates existed. However, since the early 1990s estimates of savings in transactions costs are found in Michael Emerson et al. (1992), a study entitled European Economy: One Market, One Money.3 Using data from a special survey of firms, banks and foreign exchange dealers, the savings were estimated to about 0.3 and 0.4 per cent of national income for the average of the European Economic Community. A consideration of economic diﬀerences between Europe and North America implies that the savings for Canada would be near those in Europe while they would be much smaller for Mexico and the USA with their less open economies. It is tempting to dismiss these savings in transactions costs as trivial since they are at best equal to about 20 to 40 per cent of an average annual growth in real national income of the most favourably aﬀected countries. However, this conclusion is misleading in the light of modern theories of trade and protection. The reduction in transactions costs of trade is equivalent to a lowering of tariﬀs, which leads to the expansion of intra-industry trade and the creation of scale economies. These scale economies are responsible for empirical estimates of gains from trade due to lower protection using the new international trade theory,4 which are much greater than estimates made using the traditional Heckscher–Ohlin model with its assumption of constant returns to scale.5 A second benefit from monetary union stems from the narrowing of interest rate diﬀerentials between the smaller and the dominant countries in the union. This proposition is illustrated in Figure 8.2, which shows a recent history of Canadian and US interest rates. As can be seen, the Canadian has been above the US rate for all of the period 1950–2000, except for a few quarters at the end. In December 2002 the historic gap has been restored. What is remarkable about this persistent premium of Canadian rates is that over the period cumulative increases in consumer prices have been virtually identical. As a result, the average diﬀerence in nominal rates was 1.17 points and in real rates it was 0.97 points. The diﬀerence in domestic inflation rates, the dominant textbook explanation of the Canada–USA nominal interest rate diﬀerential, clearly is not relevant. The theoretical explanation of the interest rate diﬀerential is that the higher Canadian interest rate average is due to the liquidity, sovereign and exchange risk attached to the holding of government bonds denominated

183

New criteria for optimum currency areas 16 Canada

14

Yield to maturity, %

12 10 8 USA 6 4 2

Figure 8.2

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

1968

1966

1964

1962

1960

1958

1956

1954

1952

1950

0

Long-term government bond yields: Canada and the USA

in Canadian dollars.6 The diﬀerence in sovereign and liquidity risks associated with holding assets in Canadian rather than US dollars is relatively small. Canada has a record of political and ffiscal stability nearly equal to that of the USA. The outstanding debt in Canadian dollars is large enough to provide reasonable liquidity. Clearly, the bulk of the interest rate diﬀerential must be due to the risk that the Canadian dollar continues its past fluctuations and historic decline against the US dollar. It does not matter to investors whether the latter is due to the extrapolation of divergent trends in domestic inflation rates (which it is not, as the data show) or due to some other factors to be discussed below. In this context it is interesting to note that over the past 30 years or so the annual risk premium almost completely compensated bond holders for the 30 per cent depreciation of the Canadian dollar. Is this a coincidence or more evidence on the rationality of investors? To support futher the view that the interest rate diﬀerential is due mainly to exchange risk it is useful to consider what happened in Europe during the 1990s when the implementation of the European Monetary Agreement progressively increased the link of national exchange rates. As can be seen from Figure 8.3, this linking gradually eliminated the gap between the higher interest rates of Spain and Italy relative to those of Germany. In decades preceding 1990 the currencies of these countries had been highly unstable and falling in value. With the currency risk eliminated through membership in the currency union, the premium was eliminated almost completely. The remaining gaps reflect the sovereign and liquidity risks of Spain and Italy relative to those of Germany.

184

Regional integration 16

Spain

14

Italy

Yield to maturity, %

12 10 Netherlands

8 6

Germany

4 2 0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Figure 8.3

Long-term government bond yields – European countries

Figure 8.3 also shows that the interest rate gap between the Netherlands and Germany during the 1990s was virtually zero. This record is due to the fact that the Netherlands entered the period with a long-standing commitment to keep its exchange rate fixed to that of Germany. This policy was credible by the fact that the Central Bank of the Netherlands formally surrendered its traditional interest rate setting sovereignty and simply let German interest rates prevail in the country. There will always remain diﬀerences in interest rates on the securities issued by diﬀerent governments in the European Community, just as bonds issued by individual US states carry rates greater than those of the federal government. But as the evidence of recent years in Figure 8.3 shows, this diﬀerence is likely to be small. Additional evidence on the eﬀects of monetary union on capital markets is found in the study by Bris et al. (2002) in which the authors used business data to measure the eﬀect of membership in the European Monetary Union on corporate valuations, investments and ffinancing choices. The study compared corporations located inside the European Monetary Union with those EEC member countries outside it, that is, the United Kingdom, Greece, Denmark, Norway and Switzerland. The study concludes: ‘The evidence provided supports the view that the introduction of the euro has lowered ffirms’ cost of capital by eliminating currency risks among the countries that have adopted the common currency, and by further increasing the capital market integration in Europe’(from the abstract of the paper). Lower interest rates will have a range of beneficial consequences for economic growth. First, payments on government debt will be lower,

New criteria for optimum currency areas

185

permitting tax reductions or higher spending. Supply-side economics has documented the eﬀect on economic growth resulting from lower taxes and some new spending projects may have high economic or social returns. Second, lower interest rates will decrease the debt burden of consumers, whose welfare will be increased as they apply the money saved to investment or spending of their choice.7 However, the eﬀects of lower interest rates on aggregate demand stemming from tax reductions (or increased government spending) and from more disposable income of private debtors will be oﬀset to some degree by the lower income received by the holders of public and private debt. For this reason, the third and most important benefit of lower interest rates will come from the reduced cost of capital for firms, which can aﬀord to make more investment. The resultant increased use of capital per worker will raise labour productivity and national income, which are the ultimate determinants of prosperity and living standards.

2.

TRADITIONAL COSTS

The views of the general public and policy makers on the merit of a monetary union are dominated by the proposition that it involves the costly surrender of national monetary sovereignty. Unexpected shocks to aggregate demand and supply coming from developments abroad, as well as purely domestically caused fluctuations in aggregate demand, are considered to impose losses in employment and output since interest and exchange rate adjustments can no longer be used to restore equilibrium.8 Consider a hypothetical example. If Australia were self-suﬃcient in oil, an increase in world oil prices would result in an economic boom and inflationary pressures and therefore the need for higher interest rates. If New Zealand had no domestic production of oil, the higher oil prices would result in unemployment and the appropriate monetary policy would be lower interest rates. Under these conditions, one interest rate would not meet the need of both countries. By these criteria, New Zealand and Australia are not an optimum currency area that would benefit from one central bank serving both countries. Crosby and Otto (2000) in their study of a possible monetary union between New Zealand and Australia point out that there are no objective criteria by which to decide at what level of similarity in economic structure two countries would or would not benefit from a union. Moreover, such studies show that existing countries always are better oﬀ having their own central bank because no pairs of countries have identical mixes of industries producing services, manufactures, natural resources and agricultural

186

Regional integration

products. Therefore, any given external shocks must of necessity aﬀect each country diﬀerently. Nor does the record show that internally caused business cycles of individual countries are synchronized perfectly. As a result, most studies in this tradition conclude that all existing countries are best served by retaining their national monetary sovereignty.9 Robert Mundell often sheds doubt on the merit of such studies of the cost of monetary union by pointing to the fact that all subregions of existing countries have diﬀerent industry mixes and that therefore by the criteria of the traditional macro models, they should all have their own currencies and fflexible exchange rates. Most of the traditional studies of optimum currency areas are deficient because they do not include the fact that unions produce the microeconomic benefits discussed in Section 1 above. The proper question such studies should raise is whether a proposed union results in microeconomic benefits that are larger or smaller than the macroeconomic costs. The costs tend to be discussed at length and the former most of the time are mentioned cursorily, if at all. And most important, neither the costs nor the benefits are ever quantified empirically, mostly because existing models are not up to the task and relevant data are not available.

3.

TRADITIONAL MODIFICATIONS

The literature contains some extensions of the basic Keynesian model of the cost of monetary union. The first of these involves the flexibility of labour markets and domestic prices. The greater this flexibility, the smaller are the eﬀects of external shocks on unemployment and output. In the limit of perfect wage and price flexibility, external economic shocks would not require the use of any accommodating monetary policy, nor would there be any business cycle unemployment. Second, adjustment costs are reduced if labour market disequilibria can be resolved by external migration. Analysts like Eichengreen (1992) note that such mobility exists in the USA between individual states, which he cites as one reason why the USA is an optimum currency area and Europe is not. In Europe, language, cultural and other institutional diﬀerences stand in the way of free migration in spite of increasing economic integration in other dimensions. Third, Eichengreen also makes much of the fact that the large federal government in the USA has in place automatic transfer programmes, which come to the assistance of regions suﬀering from the adverse consequences of economic shocks. Such fiscal transfers are much smaller in Europe and are another reason why it does not constitute an optimum currency area.

New criteria for optimum currency areas

187

Fourth, Ingram (1973) argued that private capital markets enable countries aﬀected by an economic shock to borrow funds, which can be used to finance domestic adjustments. Monetary union increases the integration of capital markets and the elimination of exchange risk. The macroeconomic costs of a union therefore are reduced correspondingly. The problem with the influences on the macroeconomic costs of instability just discussed is that they make it even more diﬃcult to measure the overall costs of instability and to put them into a cost–benefit analysis that includes the microeconomic benefits noted above.

4.

FUNDAMENTAL NEW MODIFICATIONS: MONETARISM AND ENDOGENEITY OF CHARACTERISTICS

The bulk of the theoretical literature on optimum currency areas was developed during the 1960s and 1970s. It was based on a widespread consensus that Keynesian monetary and fiscal policies could be used successfully to stabilize economies disequilibrated by external shocks and endogenous business cycles. Ronald McKinnon (1963) was the first to point out a fundamental flaw in these models. He noted that under the Keynesian paradigm, the restoration of full employment requires deliberate inflationary policies. This inflation allows policy makers to impose cuts in real wages without the need to reduce nominal wages, which workers are unwilling to accept. The success of such inflationary policies depends on the exploitation of workers’ money illusion in the wage-setting process. The experience of the 1970s showed that inflation did not facilitate labour market adjustment. Used for prolonged period of time, it produced instead simultaneously high inflation and high unemployment. In the light of this experience and other developments the consensus on Keynesian economics crumbled and was replaced by models based on rational expectations. Robert Lucas received a Nobel Prize for his work in this field. A pragmatic approach to monetary policy has replaced the one based on Keynesian ideas. Under this new approach the longer-run focus of policy is on the need to maintain price stability in the longer run and to vary interest rates in the short term to respond to external shocks and endogenous business cycles. This pragmatic approach has been considered successful, but it remains to be seen how it fares in the longer run, and there is no scarcity of economists criticizing it. Thus Milton Friedman is convinced that lags in monetary policy are so variable and unpredictable that this pragmatism will fail. There is the risk

188

Regional integration

that even pragmatic monetary policy will eventually make mistakes or that it is determined by political factors. If this happens, we will see a repeat of history, which shows that monetary policy itself has caused much economic instability, including the Great Depression of the 1930s. The demise of the Keynesian paradigm and remaining questions about the success of discretionary monetary policy have fundamental implications for the theory of optimum currency areas. If discretionary policy can do little to stabilize economies or even causes instabilities to develop, then the loss of national monetary sovereignty is almost certainly much smaller than is assumed in the traditional literature and may even be zero. There is, of course, the problem that the central bank of a currency area will similarly use its power to create monetary mischief. To prevent this problem, the creators of the European Central Bank have given it a constitution, which makes it responsible only for the maintenance of price stability, not the pursuit of full employment, which had been the mandate of most national central banks in the past. While this new constitution does not guarantee price stability or the avoidance of mistakes in the execution of monetary policy, at least it provides the European Central Bank with the ability to minimize political influence and to use pragmatism to guide its policies. Endogeneity of Economic Characteristics One of the most important new criticisms of the Keynesian approach to measuring the cost of monetary union is that several of the economic characteristics of an economy are endogenous to the existing exchange rate regime. It has already been mentioned that past macroeconomic instabilities have been caused by faulty and politically motivated monetary policy adventures made possible by the existence of a national central bank operating without a balance of payments constraint. Another endogenous characteristic involves labour market flexibility. This point has been made in the report by Emerson et al. (1992) and more generally by Frankel and Rose (1997), whose study is appropriately entitled ‘The endogeneity of the optimum currency area criteria’. The endogeneity of labour market characteristics is very important and it will now be illustrated by reference to the recent experiences of two jurisdictions, California and Canada’s British Columbia. In the early 1990s California suﬀered a severe exogenous shock when the end of the cold war resulted in a strong downturn in the state’s defence industry. There was no exchange rate depreciation and expansionary monetary policy to cushion the blow. Labour knew that it had to adjust to the new reality.

New criteria for optimum currency areas

189

Few workers exercised the emigration option. During the crisis there were no empty houses in California or any other signs of large-scale emigration. Workers were willing instead to retrain and find jobs in other industries in the region. Successful firms expanded, employing the highly skilled and experienced labour. New firms were drawn to California to take advantage of this productive labour force and the state’s superb infrastructure. The eﬀect of California’s economic shock wore oﬀ quickly and economic growth and prosperity returned promptly. Around the same time of the events in California, British Columbia suﬀered the consequences of an exogenous shock in the form of lower prices of and demand for its main exports produced in the forest, mining and fishing industries. Workers in British Columbia did not have to face reality to the same degree as California workers did. The depreciation of the currency insulated them from the full eﬀects of the shock by keeping up the Canadian dollar prices of their output, even though the US dollar prices for their products declined. They did not have to retrain or work in diﬀerent industries. The falling exchange rate was equivalent to a tariﬀ.10 In my view, the observed diﬀerences in the labour market characteristics of California and British Columbia are due to their long experiences with exchange rates. The fixed rates of California have forced labour to adjust quickly and realistically to changes in economic conditions. In British Columbia, labour is protected by the falling exchange rates and can aﬀord to be less flexible. We may expect that the adoption of a common currency for North America will teach Canadian labour markets to become more like those in California. In this sense, labour market conditions are endogenous to the exchange rate system and traditional, static Keynesian estimates of the cost of monetary union are biased upward since they do not reflect the benefits of permanently fixed exchange rates. However, there is no guarantee that a common currency for California (the USA) and British Columbia (Canada) will produce the predicted increases in labour market flexibility quickly enough to prevent the development of severe unemployment and other economic dislocations in British Columbia. If this happens, the political system may well be forced into the abandonment of the experiment with monetary union. The same empirical questions arise in the context of other attempts to eliminate a country’s central bank and leave monetary policy to another institution, as has happened in Ecuador with dollarization and in some other countries with currency boards.11

190

Regional integration

5.

THE COST OF FLEXIBLE EXCHANGE RATES

The cost of flexible exchange rates has traditionally been considered to consist of transactions costs and higher interest rates, as was discussed above. The present section considers a diﬀerent cost in the form of slower real economic growth and lower real per capita incomes. This cost has not been recognized in the traditional literature on flexible exchange rates, which to the contrary claims that flexible rates increase economic eﬃciency and incomes. For this reason, the following analysis is very controversial. It is suggestive and does not take the form of a rigorous analytical model needed to clinch the case, though in this sense it is much like the entire theory of optimum currency areas. To facilitate exposition, the analysis is carried out in the context of conditions in Canada, which throughout its history has been a major exporter of commodities – the output of industries exploiting natural resource endowments in forests, agricultural land, the oceans, energy and minerals. The share of commodities in Canadian exports still is over 50 per cent, though it has been falling steadily over the last 50 years because developing countries have increased their output and put downward pressures on prices. In addition, the exploitation of Canadian resources has become more costly because of diminishing returns and the imposition of regulations to protect the environment. The decline in the prices, production and export of commodities has not been steady. Superimposed on the trend have been cycles in prices and demand. Regressions that have the Canada/US exchange rate as the dependent variable show that commodity prices are the major determinant of the exchange rates. For this reason, the Bank of Canada argues that exchange rate fl f exibility is required to absorb the shock of ffluctuating commodity prices and that any ffixing of the exchange rate would be costly to the Canadian economy.12 The model implies that over the full cycle of ffluctuations the commodity prices and exchange rate return to their initial level. The following analysis is designed to show that in a world of limited wage and price flexibility and of union power, the exchange rate is unlikely to return to its initial level even if commodity prices recover fully over the normal cycle. The flexibility of the rate thus can explain the downward bias observed in Figure 8.1, which as noted above is not justified by divergent rates of inflation in Canada and the USA. The most fundamental observation about secular commodity price declines is that they do not necessarily result in a declining exchange rate. A country or region with a ffixed exchange rate that experiences decreased demand for its exports simply cannot have a declining exchange rate. Instead, it has to deal with the problem through changes in its industrial mix.

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In a free market, labour and capital move out of the less profitable into more profitable industries, sometimes into industries subject to higher rates of return because of externalities like agglomeration eﬀects and the dynamics of high-tech industrial activities aﬀecting productivity in non-related industries. A flexible exchange rate system prevents or at least delays this reallocation of resources. By doing so, the system reduces the eﬃciency of the economy for a prolonged period of time. I will argue that this avoidance or delay of economic adjustment is responsible for a large part for the gap in Canadian and US productivity which occurred during the period under observation. The dynamic process leading to these conclusions may be illustrated by the use of stylized facts as they occurred in Canada in recent decades. Consider the Canadian economy in equilibrium with domestic and world price stability, full employment and foreign payments in balance at the given initial exchange rates and world commodity prices. Now assume that these commodity prices fall and that the exchange rate falls in response. The currency depreciation protects the commodity sector and has the desirable and beneficial eﬀect that output, employment and profits remain higher than they would if the exchange rate had remained unchanged. However, at the same time that the lower exchange rate helps the commodity-producing sector, almost by definition, it disequilibrates other industries. Thus ffirms exporting or competing with imported manufactures and services enjoy higher revenues in terms of Canadian dollars. Rationally, these higher revenues should be considered to be temporary and set aside to pay dividends, maintain wages and market shares during periods when commodity prices are high and the corresponding exchange rate appreciation reduces revenues. However, this theory does not necessarily hold in the real world, where future prices and revenues are uncertain and unions play a major role in the setting of wages. Thus consider that the Canadian automobile industry is a major player in the economy. It is highly unionized and higher profits are routinely used to justify demands for higher wages in the next round of bargaining. Employers tend to resist these demands because they are not matched by real increases in labour productivity and an appreciated future exchange rate will wipe out present profits. However, the unions tend to get what they want because employers give in to their demands, knowing from experience that the exchange rate will not return to its old level in the future along with the recovery in the world prices of commodities. This expected permanent lowering of the exchange rate is a self-fulfilling prophecy. The higher wages and costs in the automobile sector come up against higher exchange rates when commodity

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prices recover. The loss of competitiveness caused by the rising exchange rate eventually reduces automobile exports and the old level and equilibrium are reached before the exchange rate reaches its pre-cycle level. Similar developments take place not just in exporting industries other than automobiles but also in import-competing industries that benefit from the original depreciation of the currency. Even in the commodityproducing sector wages are often increased to maintain parity with those in the rest of the economy. The total eﬀect of this dynamic process involving the endogeneity of wage demands is a ratchet eﬀect on the exchange rate, which depreciates in response to lower commodity prices but never returns fully to the level warranted by their recovery. The secular depreciation of the Canadian dollar has several important real eﬀects on the economy. First, the currency’s reduced purchasing power translates into lower real incomes for consumers of tradable goods and, most obviously, Canadians who travel to the USA as tourists or on business. Second, Tom Courchene and Rick Harris (1999) note that Canadian industry relies heavily on imported machinery for its capital-deepening investments. The cost of this machinery is raised by the depreciation of the Canadian dollar, which in turn reduces the incentives to use more capital per worker. Competing US manufacturers do not suﬀer from this same change in the relative price of capital. As a result, gains in labour productivity in Canada have been lagging behind those in the USA, especially so during the 1990s when the exchange rate depreciated by about 25 per cent. Third, as already mentioned above, the decline in the value of the Canadian dollar is equivalent to the existence of a tariﬀ on imports and a subsidy on exports. It has been well documented that such protection reduces the eﬃciency of resource use. The fact that the commodity-producing sector has been declining both absolutely and relative to other sectors in the Canadian economy in recent decades does not invalidate the proposition that the sector would have shrunk even more rapidly if the declining exchange rate had not artificially maintained its profitability. The main implication of the preceding analysis is that the fflexible exchange rate system operating in Canada introduces a downward bias into the exchange rate. More important, it causes overall productivity in Canada to be lower than it would have been if the exchange rate had been fi f xed. Price Stability McKinnon (2002) oﬀers another argument about the cost of flexible exchange rates. He suggests that there are two Mundell models of optimum currency area economics. The first is found in his 1961 article, which gave

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rise to the large literature mentioned above and which is based on the Keynesian paradigm. The second is found in a paper presented at a conference in Madrid in 1970. The paper has the title ‘Uncommon arguments for common currencies’ (Mundell, 1973) and embodies a radical departure from his first contribution. In the first paper Mundell’s main conclusion was that two countries with dissimilar industrial structures are better oﬀ with flexible exchange rates to deal with external shocks. In the second paper, Mundell points to the fact that if two countries with such dissimilar industrial structures adopt a common currency, external shocks allow one to prosper while the other one suﬀers. As a result, economic activity and prices of the region as a whole are more stable than are those of the two countries operating under flexible rates.13 Greater income stability has positive eﬀects on welfare in its own right. It increases the usefulness of money and makes the economy more eﬃcient as it moves closer to the optimal exchange economy along a spectrum, which at one end is the barter economy without money.14 In sum, the preceding analysis implies that the traditional optimum currency area literature needs to be expanded to include the fact that a country with a flexible exchange rate system suﬀers reduced economic growth and income because the system has a built-in bias towards currency depreciation, which in turn distorts the dynamics of the adjustment process in the wake of technical changes and external shocks. In addition, the larger a currency area is, the more the eﬀects of positive and negative shocks are oﬀsetting so that income, employment and prices are more stable in the union than on the average of member countries under flexible rates. Some Caveats The preceding analysis represents a rather radical change from the traditional models, which have praised the ability of countries with flexible exchange rates to deal with exogenous shocks and secular changes in the economic environment. In the remainder of this section I respond to three diﬀerent criticisms of my model. First, Bank of Canada economists argue that my analysis of the eﬀects of flexible exchange rates on productivity is false because a lower exchange rate increases returns to investment symmetrically in both the commodityproducing and other industrial sectors. As a result, a lower exchange rate does not keep resources in the former and prevent the expansion of the latter sectors. In my view, this argument neglects a proposition well known from the theory of the firm. Existing firms unable to meet average costs continue to

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operate as long as they cover marginal costs. New firms, on the other hand, are established only if prices cover capital and marginal costs. Second, the Australian economist Mark Crosby sent me his personal comments on the first draft of the present chapter. He has found that in Australia, which like Canada has faced declining world commodity prices and a falling exchange rate, overall productivity gains have been among the highest in the world. I am not in a position to know what factors could explain the observed diﬀerences between Canada and Australia. Moreover, my professional skills are not up to the task of providing more solid empirical and theoretical support for my basic model even in the Canadian context alone. However, studies by Canadian experts in the study of productivity Richard Harris (2002) and Don Daly (2002) support my model and its conclusions. Nevertheless, the ffinal word is not in on this issue and it will take much more eﬀort to persuade economists in the Bank of Canada and other institutions that fl f exible exchange rates have a negative eﬀect on productivity growth. Third, Max Corden, one of Australia’s best-known economists, in his comments on my paper during the conference, raised important questions about the link that I argued exists between falling commodity prices, the depreciation of the exchange rate, higher profits in manufacturing and the subsequent increase in wages that are not matched by productivity gains. Corden argues that if wages are raised without matching productivity gains, competitiveness is reduced, the balance of trade deteriorates, the currency is depreciated and the prices of tradable goods increase. The resultant inflation lowers real wages and restores the balance of payments to its initial level. Rigorous models of this process imply that in the new equilibrium domestic inflation and the currency depreciate by an equal percentage. All real economic conditions – income, employment and the real terms of trade – return to the level that existed before the economically unjustified wage increase. The crucial point is that in Canada during the period to which my analysis applies, there has been no inflation. Therefore, my model is inconsistent with basic trade theory. My response to this criticism focuses on the nature and measurement of inflation. First, there has in fact been inflation in Canada during this period. While it was somewhat less than the inflation rate in the USA, during the crucial 1990s it would have been even higher if unemployment had not been above its long-run equilibrium and economic growth had not been depressed. Second, during the last 20 years many studies have shown that currency depreciation does not necessarily lead to an increase in domestic prices of equal proportions. There is much speculation about this result, which is inconsistent with the functioning of international arbitrage in goods markets. The most important of these explanations is based on the existence

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of market separation, which is maintained by government regulations concerning health, safety and labelling. Thus, it is known that identical pharmaceuticals sell for less in Canada than in the USA. This marketing strategy is profitable for the producers of such drugs because their marginal costs of production are low and they attempt to maximize revenue in each separate market, setting prices higher the higher is the country’s per capita income. Arbitrage of such drugs is prevented because wholesalers in each country sell them with diﬀerent labels and often diﬀerent dosages, as is required by law. Arbitrage at the retail level by individual consumers has recently been on the increase, but it remains insignificant given the size of the market. An almost identical situation occurs in the market for automobiles. To prevent even retail arbitrage, sellers of cars in Canada now require customers to sign contracts which prohibit them from reselling their cars in the USA. Violation of this contract results in the loss of new car warranties that have been made valid only in Canada. Finally, even simple consumer goods like food and textiles cannot be arbitraged at the wholesale level because of diﬀerent labelling requirements in the two countries. Canadian labels have to be in English as well as French. In addition, the health and safety information printed on the labels is diﬀerent. As a result, wholesalers wishing to arbitrage diﬀerent prices face often prohibitively high costs of relabelling. Manufacturers of such products in turn tend to fi f nd it in their interest to retain segmented markets for the same reasons, as do the producers of drugs. In sum, the price increases in Canada that are predicted by economic theory to follow the depreciation of the currency have not been observed as expected theoretically because government regulations prevent complete goods arbitrage. My model is consistent with basic economic theory if the latter is expanded to include the real-world existence of government regulations and firms’ pricing strategies in regulated markets.

6.

EMPIRICAL EVIDENCE

As noted above, no studies have produced empirical measures of the macroeconomic costs and microeconomic benefits of monetary union. Responsible are the absence of the proper quantifiable models and needed data. However, recently a number of economists have used a novel, indirect way to assess empirically the eﬀect of monetary unions on economic growth and incomes. Andrew Rose and a number of co-authors15 have assembled a database on the economic performance of countries, including those that were linked

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by a common currency. The authors use regressions to estimate the level of bilateral trade between pairs of countries as the dependent variable. The income per capita, size of population, geographic distance, the existence of sea ports, common language and culture and similar variables are used as independent variables. Many studies using such so-called gravity models of the determinants of bilateral trade exist and have documented that most of the variables listed have some influence on countries’ foreign trade. The innovation introduced by Rose and his co-authors is the use of a dummy variable reflecting the presence or absence of a common currency. As it turns out, there are about 200 bilateral trade relationships between countries or dependencies that have common currencies. Examples of these relationships are the USA and Panama, France and Monaco and Switzerland and Liechtenstein. Some of France’s former colonies in West Africa have used the French franc and retained their essential link through the adoption of the euro. Some countries of the British Commonwealth continue to use the pound sterling. In some studies Rose and other authors have augmented the database by including countries with currency boards, which resemble monetary unions by taking away all powers for setting monetary policy from the country’s central bank. Countries operating currency boards have been Hong Kong, Argentina, Lithuania and others.16 One of the earliest papers using gravity models and the database on monetary unions is by Rose and Wincoop (2001). The paper’s title is instructive: ‘National money as a barrier to international trade: the real case for currency union’. The abstract of the paper summarizes its ffindings as follows: National money is a barrier to international trade. Accordingly, currency unions have lower trade barriers, more trade and higher welfare. This paper uses empirical gravity models to quantify these eﬀects, using a large panel data set. We estimate that trade barriers associated with national borders are halved when countries join a currency union, significantly raising trade and welfare.

In another paper Rose (2002) looks at 19 recent studies by other authors considering the same question but using slightly diﬀerent data and statistical techniques. The database for Rose’s meta-analysis consisted of 383 point estimates and had as its main conclusion ‘currency union approximately doubles trade’.17 In yet another paper Reuven Glick and Andrew Rose (2002) take a slightly diﬀerent approach to the issue by studying what eﬀect leaving a monetary union has on the level of the country’s trade. Using a data set covering 217 countries from 1948 through 1997, they found that ‘a large number of countries left currency unions; they experienced economically and statistically significant declines in bilateral trade, after accounting for other factors. Assuming symmetry, we estimate that a pair of countries

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that starts to use a common currency experiences a near doubling in bilateral trade’.18 In a jointly published study Jeﬀrey Frankel and Andrew Rose (2002) found that belonging to a currency union or using a currency board increases trade between pairs of countries three times above the level that would exist otherwise. While this result is even larger than that found in other papers by Rose and in the meta-analysis just referred to, the paper by Frankel and Rose is especially notable because it extends the analysis by considering the eﬀect this higher level of trade has on per capita incomes. To make this estimate, the authors ffirst calculate the extent to which countries’ trade levels (exports plus imports) relative to GDP are associated with higher per capita income. They found that every 1 per cent increase in the levels of trade raises income per capital by at least one-third of a per cent over 20 years. They then calculate what a tripling of a country’s trade implies in terms of per capital income. Applied to Canada, they found that a monetary union with the USA would increase Canada’s trade by 184 per cent and its GDP per capita by 37 per cent. However, these beneficial eﬀects would tend to appear slowly and be completed only with a lag of 40 years. The release of these findings by Frankel and Rose was greeted with much interest in the Canadian media. Upon questioning, the authors admitted to being sceptical about the reliability of their estimates, the size of which surprised them. However, they noted that they had tried to bias downward their findings at every step of their empirical analysis. But these attempts to minimize the estimate of gains still produced the contentious 37 per cent figure. These estimates seem to be high by any standards but they do imply that, on balance, monetary union has a significant, positive eﬀect on economic prosperity and living standards in the countries that are members of the union. It is important to note that these benefits do not occur at the cost of other countries. Frankel and Rose note that the higher trade levels among members of the union are not associated with trade diversion. In sum, empirical studies of the determinants of trade between pairs of countries show clearly that a common currency or otherwise credibly fixed exchange rate between them has a considerable, positive eﬀect on the level of trade. The higher trade levels in turn imply significantly higher productivity and living standards for these countries.

7.

SUMMARY AND CONCLUSION

Most of the past and even current literature on the eﬀects of monetary union is dominated by a paradigm that has its origins in Mundell’s famous

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article on optimum currency areas published in 1961. The conclusions of this literature depend crucially on the assumption that Keynesian monetary and fiscal policies can be used to stabilize unemployment and output. The demise of the consensus on the usefulness of the Keynesian paradigm implies that most of the literature and even textbook accounts of optimum currency area policies are irrelevant. At the very least, the rational expectations and monetarist theories that replaced the Keynesian paradigm imply that the macroeconomic costs of joining a monetary union are much smaller than has been suggested by past studies. At the same time, the traditional literature on optimum currency areas tends to disregard or minimize estimates of the microeconomic benefits of lower transactions costs and interest rates. New empirical evidence suggests that this approach leads to biased results. These are substantial and are likely to have a significant impact through mechanisms spelled out by the new international trade theory and its assumption that trade gives rise to economies of scale. Two important new theoretical ideas have recently been introduced into the discussion of the merit of monetary unions. The first involves the notion that many economic characteristics determining the cost of losing monetary sovereignty are in fact endogenous to the existing exchange rate regime. The most important of these, labour market flexibility, is a function of the way in which currency depreciation has been used historically to correct excessive wage increases and to deal with external shocks. The second new idea involves the view that in a world of imperfect labour markets and union power, flexible exchange rates result in a downward bias of currency values, which in turn retards economic adjustments needed in the wake of economic shocks and longer-run trends. The resultant slower economic growth is a cost endogenous to the use of flexible exchange rates. Empirical studies of the eﬀects of monetary union based on gravity models show that it has very significant positive eﬀects on levels of trade and income. While the database used in these studies limits their implications for countries of the size of Canada, Australia and New Zealand, they do suggest that past results of studies of the merit of a New Zealand–Australia union should be re-examined with the help of new models found in the literature.

NOTES *

I gratefully acknowledge useful comments on the first draft of this chapter made by Max Corden and Mark Crosby and participants at the conference honouring Peter Lloyd’s contributions to economics and the University of Melbourne.

New criteria for optimum currency areas 1. 2. 3.

4. 5.

6. 7.

8. 9.

10.

11.

199

See Courchene and Harris (1999) and Grubel (1999, 2000). The present chapter draws heavily on the second edition of my study published in 1999, which is expected to be completed in 2005. These numbers are from World in Figures, 2003 Pocket Edition (London: The Economist, 2002). This study was sponsored by the Commission of the European Communities and its authors are mostly academic economists. It followed the Delors Commission Report (1989), which involved more political considerations and which was designed to set out the blueprint for the creation of the monetary union. See for example Harris and Cox (1983), who used a dynamic general equilibrium model to estimate the gains for the Canadian economy due to the reduction in tariﬀs under the North American Free Trade Agreement. The new trade theory used in Harris and Cox (1983) and similar studies is based on the empirical phenomenon of intra-industry trade (IIT), which Peter Lloyd and I documented in our study published in 1975. Peter was responsible for the chapter on measurement theory, which undoubtedly resulted in the present, widespread use of the Grubel–Lloyd index in the economics literature. Our book is widely cited but has been read by few. Otherwise we would have given more credit for presenting in that book all of the explanations of the causes and eﬀects of IIT that years later were turned into the new international trade theory by Paul Krugman and others who were highly skilled in mathematical modelling. In my, totally unbiased, view this mathematical modelling helped bring tenure and promotion to a number of economists, but it has limited access by the general public and policymakers to the important empirical and policy implications of intra-industry trade. Kevin Clinton (1998) presents the theory with appropriate references to the literature. Economic instability in Mexico in recent decades has been so high that capital markets are underdeveloped and interest rates very high. For this reason it is diﬃcult to find Mexican interest rates in the financial statistics published by the IMF and OECD. Several audiences I spoke to in that country greeted the idea that interest rates on consumer loans might be reduced by membership in a North American monetary union with great enthusiasm. For representative samples of analysis in this tradition see Murray (2000) and Eichengreen and Bayoumi (1997). Dominick Salvatore is the editor a special issue of the Journal of Policy Modeling, published in 2000, which contains papers by such distinguished economists as Martin Feldstein, Rudiger Dornbusch, Barry Eichengreen, Michael Mussa and Ron McKinnon. The majority of the authors predicted that the European Monetary Union would fail, mainly because member countries would encounter excessive costs due to the loss of national monetary sovereignty. It is worth noting that these papers were written several years before the final stage of the union, the elimination of national currency notes and coins, went into eﬀect. See also Bayoumi and Eichengreen (1993) and Feldstein (2000). It is tempting to argue that the BC industries acted rationally in the expectation that the commodity prices would eventually return to their normal levels whereas the California shock involved irreversible and permanent changes requiring a diﬀerent form of adjustment. The fact is that during the last few decades, commodity prices never returned to their previous highs. Competition from many developing countries has greatly diminished Canada’s comparative advantage in these industries. At the same time, the tanking of the California defence industry could also be interpreted as a temporary setback, much like others in history. In addition, if a depreciating California dollar had allowed it, the industry would have been able to increase its world share by oﬀering lower prices in the currencies of buyers. Space limitations prevent an adequate discussion of the problems encountered by Argentina after it had adopted a currency board. Hanke (2002) argues persuasively that the country had not adopted a genuine currency board but left too much discretionary power with its central bank in the setting of monetary policy. Most important,

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12.

13.

14.

15. 16. 17. 18.

Regional integration Argentina’s problems were more political than economic. It is almost certain that the return to flexible rates will mean simply that the country will once again experience the problems that existed before the adoption of the currency board – high inflation, interest rates and unemployment, large budget deficits, slow growth and continuous devaluations. Ireland’s hard currency fix through membership in the European Monetary Union has similarly been blamed for the country’s inflation. This blame is not warranted. The inflation was due to the increase in prices of non-trade goods, especially housing, which was caused by the very large rate of income growth that propelled Ireland ahead of Britain in per capita income levels. Such asset price increases are the cost of success and cannot be avoided except through policies that end the prosperity deliberately. Tight monetary policy and a currency appreciation would have killed the boom but left in place the relative increases in the prices of non-tradables. Walsh and Thom (2002) oﬀer a detailed analysis of the Irish experience. See John Murray (2000) for further references and the argument. The econometric modelling has been criticized for its reliance of the lagged dependent variable as one of the main explanatory variables in the equation. The model also excludes energy from the commodity price index, even though coal, gas, electricity and petroleum represent an important share of all commodity exports. Peter Kenen in a private comment on another paper in which I present this analysis argues that this analysis was first presented by him in Kenen (1969) and that Mundell’s paper focuses on the eﬀect of monetary union on the usefulness of its international reserve holdings and confidence in its own currency. Interested readers are invited to reach their own conclusions on the proper attribution of the basic idea that flexible exchange rates result in greater price and income fluctuations for the average of countries than exists if these same countries are members of a currency union and price-level stability is measure for the entire union. The argument about the increased usefulness of money and eﬃciency gains from the formation of a monetary union was presented in Grubel (1970). My analysis draws on Klein (1977), who found that the use of money and economic growth in US history were greater the more stable the price level was around zero or some other trend. References to some of the relevant studies are provided below. For a complete list of published and unpublished papers on the subject see the website of Rose: www.hass.berkeley.edu/~arose See Hanke (2002) for a full discussion of the theory of currency boards and a list of countries where they exist and an analysis of their performance. The quote is from the abstract of the paper released on the Internet in draft form on 8 April 2002. The quote is from the abstract of the published paper.

REFERENCES Bayoumi, Tamim and Barry Eichengreen (1997), ‘Ever closer to Heaven: An optimal currency area index for European countries’, European Economic Journal (Papers and Proceedings of the Eleventh Annual Congress of the European Economic Association), 41 (3–5), 761–70. Bris, Arturo, Yrjo Koskinen and Mattias Nilsson (2002), ‘The euro is good after all: Corporate evidence’, Yale ICF Working Paper No. 02-26. (found on http://papers.ssrn.com/so13/papers.cfm?abstract_id=321260). Clinton, Kevin (1998), ‘Canada–U.S. long-term interest rate diﬀerentials in the 1990s’, Bank of Canada Review, Spring, 17–38.

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Courchene, Thomas J. and Richard G. Harris (1999), ‘From fixing to monetary union: Options for North American currency integration’, C.D. Howe Commentary, June. Crosby, Mark and Glenn Otto (2000), ‘An Australia–New Zealand currency union?’, paper prepared for Financial Markets and Policies in East Asia Conference at the Australian National University, 4–5 September. Daly, Donald J. (2002), ‘Capital inflows, exchange rates and Canadian manufacturing productivity performance’, Discussion Paper, Schulich School of Business, York University, April. Delors Commission Report (1989), Report on Economic and Monetary Union in the European Community, Brussels: Commission of the European Communities, Committee for the Study of Economic and Monetary Union. Eichengreen, Barry (1992), ‘Is Europe an optimum currency area?’, in Sylvio Borner and Herbert Grubel (eds), The European Community after 1992, London: Macmillan, pp. 138–61. Eichengreen, Barry and Tamim Bayoumi (1993), ‘Shocking aspects of European monetary unification’, in F. Torres and F. Giavazzi (eds), Growth and Adjustment in the European Monetary Union, Cambridge: Cambridge University Press. Emerson, Michael, Daniel Gros, Alexander Italianer, Jean Pisani-Ferry and Horst Reichenbach (1992), One Market One Money: An Evaluation of the Potential Beneﬁts and Costs of Forming an Economic and Monetary Union, Oxford: Oxford University Press. Feldstein, Martin (2000), ‘Europe can’t handle the euro’, Wall Street Journal, 8 February. Frankel, Jeﬀrey and Andrew Rose (1997), ‘The endogeneity of the optimum currency area criteria’, Economic Journal, 108 (July), 449. Frankel, Jeﬀrey and Andrew Rose (2002), ‘An estimate of the eﬀect of common currencies on trade and income’, Quarterly Journal of Economics, 117 (2), 437–66. Glick, Reuven and Andrew K. Rose (2002), ‘Does a currency union aﬀect trade? The time series evidence’, European Economic Review, 46 (6), 1125–51. Grubel, Herbert (1970), ‘The theory of optimum currency areas’, Canadian Journal of Economics, 3 (2), 318–24. Grubel, Herbert (1999), ‘The case for the amero: The economics and politics of a North American monetary union’, Critical Issues Bulletin, Vancouver: The Fraser Institute. Grubel, Herbert (2000), ‘The merit of a North American monetary union’, Journal of North American Economics and Finance, 11, 19–40. Hanke, Steven H. (2002), ‘Currency boards’, Annals of the American Academy, 579 (January), 87–105. Harris, Richard G. (2002), ‘Asymmetric shocks and productivity dynamics in a core–periphery integration’, Discussion Paper (unpublished draft) found on website sfu.ca/~rharris Harris, Richard G. and David Cox (1983), Trade, Industrial Policy and Canadian Manufacturing, Toronto: Ontario Economic Council. Ingram, James (1973), The Case for European Monetary Integration, Princeton Essays in International Finance 98, Princeton, NJ: Princeton University Press. Kenen, Peter (1969), ‘The theory of optimum currency areas: An eclectic view’, in Robert Mundell and Alexander Swoboda (eds), Monetary Problems of the International Economy, Chicago: University of Chicago Press, pp. 41–60.

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Klein, Benjamin (1977), ‘The demand for quality-adjusted cash balances: Price uncertainty in the US demand for money function’, Journal of Political Economy, 84 (July), 691–715. McKinnon, Ronald (1963), ‘Optimum currency areas’, American Economic Review, 53, 717–25. McKinnon, Ronald (2002), ‘Optimum currency areas and the European experience’, Economics in Transition, 10 (2), 343–64. Mundell, Robert (1961), ‘A theory of optimum currency areas’, American Economic Review, 51 (4), 657–65. Mundell, Robert (1973), ‘Uncommon arguments for common currencies’, in Harry G. Johnson and Alexander K. Swodoba (eds), The Economics of Common Currencies, London: George Allen & Unwin, pp. 114–32. Murray, John (2000), ‘Why Canada needs a flexible exchange rate’, North American Journal of Economics and Finance, 11 (1), 41–60. Rose, Andrew K. (2002), ‘The Eﬀect of Common Currencies on International Trade: A Meta-Analysis’, unpublished manuscript found at Rose’s personal website. Rose, Andrew K. and Eric van Wincoop (2001), ‘National money as a barrier to international trade: the real case for currency union’, American Economic Review, 91 (2), 386–90. Walsh, Brendan and Rodney Thom (2002), ‘The eﬀects of a common currency on trade: Lessons from the Irish experience’, European Economic Review, 46, 1111–23.

PART FOUR

Trade and Poverty Reduction

9.

Agricultural trade reform and poverty reduction in developing countries Kym Anderson*

The ffirst of the eight Millennium Development Goals articulated at the UN General Assembly in 2000 was to halve by 2015 the proportion of people in absolute poverty, that is, those living on less than US$1 per day and suﬀering from hunger. Throughout most of the nineteenth and twentieth centuries, the number of people in the world that were poverty stricken to that extent had been increasing almost continually (Bouguignon and Morrisson, 2002). Since the late 1970s, however, the number has declined by more than 200 million (Sala-i-Martin, 2002). Remarkable though that recent achievement has been in such a short period, the World Bank estimates that there were still as many as one in ffive people, or 1.2 billion, below that poverty line in 2000 (for example, Collier and Dollar, 2002, Figure 3).1 Eﬀorts to alleviate poverty for those remaining poor people, if they are to be successful, need to be based on a clear understanding of the reasons behind successful alleviation to date. The evidence presented by Salai-Martin suggests that aggregate economic growth diﬀerences have been largely responsible for the diﬀerences in poverty alleviation across regions, a finding supported by numerous other studies (for example, Dollar and Kraay, 2002). Initiatives that boost economic growth are therefore likely to be helpful in the fight against absolute poverty. Trade liberalization is such an initiative that tends to boost economic growth.2 But it also alters relative product prices, which in turn aﬀect factor prices (Lloyd, 2000; Ruﬃn and Jones, 1977, 2004). Hence its net eﬀects on poverty and hunger reduction depend also on the signs of those domestic product price changes and how they aﬀect domestic factor prices, on the price and quantity of food available for consumption, and hence on real individual and household incomes. If the price changes (whether due to own-country reforms and/or those of other countries) are pro-poor, then they will tend to reinforce any positive growth eﬀects of trade reform on the poor, although the outcome depends also on 205

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the extent to which changes in border measures and complementary domestic policies 1. 2. 3. 4. 5. 6.

create new markets that are pro-poor; stimulate the poor to respond to altered prices and new market opportunities; provide second-round spillover eﬀects that are pro-poor; minimize any transitional unemployment that is concentrated on the poor; raise government revenue that leads to pro-poor public expenditure; and reduce the vulnerability of the poor.

The present chapter explores the potential poverty implications of one aspect of the current Doha Development Agenda of the World Trade Organization (WTO) trade liberalization agenda. At the WTO Ministerial in Doha in November 2001, members agreed, in launching the next comprehensive round of multilateral trade negotiations (MTNs), that there would be a substantial focus on development concerns (see the Doha Ministerial Declaration in WTO, 2001a). Even so, numerous people in developing countries remain sceptical that they will receive suﬃcient gains from that MTN to warrant the inevitable costs of negotiations and adjustments.3 They (and some in the donor community) are sceptical not least because they perceive the OECD countries as unwilling to provide developing countries access to highly protected agricultural and textile markets. Some of them also are yet to be convinced that reducing distortions in world food markets would alleviate rather than add to poverty and food insecurity in developing countries. For example, those in net food-importing developing countries worry that, because of a higher food import bill, their economies will be worse oﬀ because of agricultural trade reform which raises international food prices. Yet two-thirds of the world’s poor live in rural areas and, in least-developed countries, the proportion is as high as 90 per cent (OECD, 2003, p. 3). If those poor rural households are net sellers of food, an alternative prior is that agricultural trade liberalization abroad would favour most poor households in countries where the boost to international food prices is transmitted to those food-surplus households. The issue becomes more complex for developing countries that also reduce their own distortionary trade policies, the poverty outcome of which depends heavily on whether that own-country reform raises or lowers the relative price of food domestically. Given these diﬀering priors, the aspect of the WTO negotiations focused on in this chapter is the poverty impact of agricultural policy reform relative to liberalizing trade in other goods.4

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The chapter addresses the eﬀects of trade reform on global poverty at three levels: ffirst on developing countries as a group; then on diﬀerent types of developing countries; and ffinally on diﬀerent types of households within developing countries. We begin by summarizing global economic modelling results showing the eﬀects of goods trade distortions expected to still be in place in 2005 (that is, post-Uruguay Round). Those results support the view that agricultural trade policies remain by far the most costly of all goods market distortions in world trade. What also becomes clear from those results is that if developing countries want to maximize their benefits from the Doha MTN Round, they need also to free up their own agricultural (and other) markets so that their producers are better able to take advantage of new market-opening opportunities abroad. The chapter then addresses such questions as whether some developing countries would be made worse oﬀ through tariﬀ preference erosion, whether net food-importing developing economies would suﬀer from higher food prices in international markets, and whether Doha would worsen food security for the urban poor of developing countries. To help answer those questions by way of example, the chapter also examines China’s accession to the WTO, which involves altering relative prices in China to a much larger extent than the Doha Round is likely to impose on WTO member countries. While the conventional wisdom has been that WTO accession for China will exacerbate poverty in that country, the results summarized below oﬀer a somewhat more optimistic view, particularly if mooted reforms to domestic policies are implemented. The chapter concludes with suggestions on ways to increase the prospects of a pro-poor reform outcome from the Doha Round, including changes needed to the domestic and trade policies of developing countries themselves to enhance their food security.

ESTIMATING NATIONAL AND GLOBAL WELFARE GAINS FROM WTO TRADE REFORM Which Sectors and Regions Oﬀer the Biggest Potential Global Gains? What is the potential for welfare gains from the WTO’s Doha Development Agenda? This question was addressed in an empirical study (Anderson et al., 2001), using an applied general equilibrium model of the global economy known as GTAP.5 According to that study, of all the economic gains to be had in 2005 from removing the barriers to trade in goods that will still be in place after all Uruguay Round commitments are implemented, almost half (48 per cent) would come from agricultural and processed food policy reform in OECD countries (Table 9.1) – even though such products

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in those countries contribute only 4 per cent of global GDP. But notice also that another one-sixth of the welfare gains would come from reform of farm and food policies of developing countries. Textiles and clothing reforms would be the next biggest contributor, although they appear small by comparison with agricultural reform: their potential global welfare contribution is only one-ninth that of agriculture’s (7 per cent compared with 65 per cent). This big diﬀerence reflects two facts. One is that projected distortions to prices for agriculture are more than twice those for textiles and clothing in 2005. The other is that textiles and clothing contribute only 1.5 per cent to the value of world production and 5 per cent to the value of world trade, half or less the shares for farm products.6 Which Sectors Oﬀer the Biggest Potential Gains to Developing Countries as a Group? The distribution of the gains across regions that would result from full trade liberalization is clear from the upper half (a) of Table 9.1. As always, most of the gains accrue to the liberalizing region. For example, all but one-tenth (11.6/122.1) of the gains from high-income countries removing distortions to their trade in farm and food products accrues to those countries. Even so, that farm trade reform contributes more than one-quarter of the total welfare gains to developing countries from developed countries liberalizing their merchandise trade (11.6/43.1). As for developing countries liberalizing their own farm and food policies, three-quarters of the benefits there from stay with the developing countries themselves (31.4/42.6), and those policies contribute almost half of the gains from those countries’ overall merchandise trade reform (31.4/65.1). In total, 26 per cent (43.0/164.7) of the gains from global agricultural trade liberalization would accrue to developing countries.7 Clearly, developing countries as a group have a major stake in the process of farm policy reform continuing: according to the model results in Table 9.1, farm and food policies globally contribute 40 per cent (43.0/108.1) of the cost to developing economies of global goods trade distortions. Textile and clothing policies also harm them greatly, but barely one-third as much as farm policies.8 Table 9.1 shows that 57 per cent (25.6/45.1) of the potential welfare contribution to developing countries from global merchandise trade liberalization – and 74 per cent (12.3/16.7) of that from just farm trade liberalization – would come from reforms by developing countries themselves. This reflects the importance not only of own-country reform but also of expanding South–South trade: between the 1980s and 2001, the share of developing countries’ agricultural exports going to

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209

Table 9.1 Sectoral and regional contributions to economic welfare gains a from completely removing trade barriers globally, post-Uruguay Round, 2005 (a) in 1995 US$ billions Liberalizing regionb

Beneﬁting regionb

Agriculture Other Textiles & Other Total and food primary clothing manufactures

High-income High-income Low-income Total

110.5 11.6 122.1

0.0 0.1 0.0

5.7 9.0 3.3

8.1 22.3 14.2

96.6 43.1 139.7

High-income Low-income Total

11.2 31.4 42.6

0.2 2.5 2.7

10.5 3.6 14.1

27.7 27.6 55.3

49.6 65.1 114.7

High-income Low-income Total

121.7 43.0 164.7

0.1 2.7 2.8

4.8 12.6 17.4

19.6 49.9 69.5

146.2 108.1 254.3

Low-income

All countries

(b) in % of total global gains Liberalizing region

Beneﬁting region

Agriculture Other Textiles & Other Total and food primary clothing manufactures

High-income High-income Low-income Total

43.4 4.6 48.0

0.0 0.1 0.0

2.3 3.5 1.3

3.2 8.8 5.6

38.0 16.9 54.9

High-income Low-income Total

4.4 12.3 16.7

0.1 1.0 1.1

4.1 1.4 5.5

10.9 10.9 21.7

19.5 25.6 45.1

High-income Low-income Total

47.9 16.9 64.8

0.1 1.0 1.1

1.9 4.9 6.8

7.7 19.6 27.3

57.5 42.5 100.0

Low-income

All countries

Notes: a No account is taken in these calculations of the welfare eﬀects of environmental changes associated with trade liberalization, which could be positive or negative depending in part on how environmental policies are adjusted following trade reforms. b High- and low-income here are shorthand for developed and developing countries. Source: Anderson et al. (2001).

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other developing countries rose from 28 per cent to 37 per cent (World Bank, 2003, Table 3.6). What Would Be the Impact of Trade Reform on International Food Prices? The above GTAP modelling study found that full liberalization of OECD farm policies would boost the volume of global agricultural trade by more than 50 per cent, but would cause real international food prices to rise by only 5 per cent on average.9 For the subset of low-income countries that would remain net food-importing economies after such a reform and thereby suﬀer a deterioration in their terms of trade, the extent of the rise in their food import prices from a phased and partial reform (as distinct from the instantaneous and complete reform modelled above) would be indiscernible from other changes in terms of trade due to such things as exchange rate movements. Even the complete reform generates estimated losses for only two of the food-importing countries/country groups shown in the disaggregated Table 9.2, namely China and Middle East/ North Africa.10 Would Rich Countries Gain More Than Developing Countries from Trade Reform? The final two columns of Table 9.2 reveal that, even though developing countries would gain slightly less than rich countries in aggregate dollar terms from a move to global free trade in merchandise, they would gain much more as a percentage of GDP: 1.9 per cent, which is more than three times the percentage for rich countries. For sub-Saharan Africa (other than South Africa) the gain would be 1.4 per cent of its GDP. Furthermore, those developing countries would gain less if they abstained from reforming their own policies. To illustrate the point, the eﬀects on low-income countries in sub-Saharan Africa and South Asia have been examined first without and then with those economies participating in reform (Anderson and Yao, 2003b). If all regions other than South Asia and sub-Saharan Africa were to remove their trade distortions remaining after the end of 2004 when all Uruguay Round commitments are to have been implemented, the world economy would structurally adjust to allow each region to exploit even more its comparative advantages. Sub-Saharan Africa and South Asia would have to undertake some structural changes within and between key sectors even if they chose not to join in such a trade reform (Table 9.3(a)). In particular, agriculture would expand at the expense of labour-intensive manufacturing in those low-income countries.

211

Source:

Anderson et al. (2001).

North America Western Europe Australia/New Zealand Japan China HKong, Korea, Taiwan Indonesia Other Southeast Asia India Other South Asia Brazil Other Latin America Turkey Middle East & N. Africa Economies in transition South African CU Other sub-Saharan Africa Rest of world Low-income High-income Total

3 50 8 36 5 4 1 0 4 1 3 15 0 1 4 1 2 4 43 97 140

Total ($ bn)

11 61 8 30 5 1 0 1 1 0 1 14 1 3 1 1 2 3 12 110 122

Agric. ($ bn)

Total ($ bn)

19 21 2 8 11 24 1 10 5 5 13 4 2 1 2 1 1 7 65 50 115

9 11 1 6 10 6 0 1 3 1 2 1 1 2 3 0 0 1 31 14 17 9 2 1 0 4 12 0 6 2 3 5 3 1 0 2 0 1 3 34 11 45

Agric. ($ bn)

11 19 1 8 7 12 1 5 3 2 9 2 1 0 0 0 0 4 31 38 69

Manuf. ($ bn)

Developing-country liberalization

Manuf. ($ bn)

Rich-country liberalization

22 71 10 44 6 28 2 11 9 7 16 19 2 2 6 1 3 11 108 146 254

$ bil

0.2 0.7 2.0 0.8 0.4 2.3 0.9 2.6 1.8 4.6 2.0 2.4 0.9 0.2 0.7 0.9 1.4 3.0 1.9 0.6 0.8

% of GDP

All merchandise

Global liberalization

Table 9.2 Disaggregation of sectoral and regional contributions to economic welfare gains a from completely removing trade barriers globally, post-Uruguay Round, 2005 (1995 US$ billion)

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However, sub-Saharan Africa would expand its agricultural output more, and contract its manufacturing more, if it also undertakes reforms itself than if it stands aside from reform. The trade balance for the diﬀerent product groups is aﬀected by the above production eﬀects plus changes in consumption, following relative price and income changes. By comparing Tables 9.3(a) and 9.3(b) it is evident that net food imports are less for subSaharan Africa and South Asia following the removal of remaining trade barriers in 2005, but more when those developing countries participate in the reform. Would Poor African Countries Gain More from Doha if they Abstained from Reform? The results in Anderson and Yao (2003b) suggest that sub-Saharan Africa’s aggregate economic welfare gain is twice as great from participating in than from standing aside from further trade liberalization. However, most of that greater gain goes to the South African Customs Union. The reason Table 9.3 Percentage diﬀerence in sectoral output when all merchandise trade distortions remaining post-Uruguay Round are removed, 2005 (a) Reform in all regions except sub-Saharan Africa and South Asia

Rice Wheat Other cereal grain Veg, fruit, nuts Oilseeds Other crops Plant ﬁbre Livestock Other food prod. Meat & dairy prod. Forestry & ﬁsh Energy & minerals Veg. oils, fats Textiles & clothing Other manuf. Services

South Africa

Other sub-Saharan Africa

India

Other South Asia

6 18 114 1 2 43 12 28 28 38 2 2 0 8 7 0

1 2 85 0 3 8 11 15 2 14 0 0 0 2 0 0

12 6 1 1 1 2 2 0 2 1 0 1 4 10 3 0

9 6 1 1 2 1 0 1 29 3 1 2 5 16 11 0

Agricultural trade reform and poverty reduction in developing countries

213

Table 9.3 (continued) (b) Reform in all regions including sub-Saharan Africa and South Asia

Rice Wheat Other cereal grain Veg, fruit, nuts Oilseeds Other crops Plant fibre Livestock Other food prod. Meat & dairy prod. Forestry & fish Energy & minerals Veg. oils, fats Textiles & clothing Other manuf. Services

South Africa

Other sub-Saharan Africa

India

Other South Asia

4 3 171 1 5 61 10 6 22 6 7 29 0 1 8 1

1 6 90 9 1 9 1 54 3 0 4 7 2 13 5 0

19 15 1 0 0 2 2 0 1 2 0 6 15 5 19 2

18 7 2 3 7 4 1 6 38 8 3 3 17 29 60 4

Source: Anderson and Yao (2003b).

that other sub-Saharan Africa as an aggregate does not gain more is that the very considerable gains from more eﬃcient resource use there would be oﬀset by an adverse change in the region’s terms of trade when all of those countries expand their primary product exports simultaneously. That raises the question: would the economy of each sub-Saharan African country be better oﬀ if its government did not participate in the next WTO round? The answer is: certainly not. On the contrary, their economy’s welfare would be even worse if their government did not participate, for several reasons. One is that it would forgo the economic eﬃciency gains from reforming its own policies while still suﬀering the terms-of-trade loss from others’ reforms (since any one of those countries is too small for its own policy choice to alter the terms of trade significantly).11 Second, it would forgo the opportunity to seek through thenegotiations greater market access for its particular exports to other countries. And third, there is the promise in this next round that any participating poor economies that lose from taking part in the multilateral liberalization could secure much more compensation than in previous rounds, in the form of technical assistance and funds for trade policy capacity building (WTO, 2001a).

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Trade and poverty reduction

It is thus in the national economic interest of such countries to be pressured from abroad to commit to such reform, painful though that may be politically for its government. The political pain tends to be less, and the prospect for a net economic gain greater, the more sectors the country involves in the reform. The economic gain is prospectively greater the more sectors it involves because a wider net reduces the possibility that reform is confined to a subset of sectors that are not the most distorted. (When so confined, resources might move from the reformed sector to even more ineﬃcient uses, thereby reducing rather than improving the eﬃciency of national resource use – see Lloyd, 1974.) Qualiﬁcations to the Global Modelling Results There are three other important sources of gains from trade reform that are not captured in the above results, namely, gains from reform to trade in services, gains from increasing competition and economies of scale, and dynamic gains. The nature of service sector policies makes estimating their eﬀects much more diﬃcult than is the case for goods barriers to trade. None the less, preliminary empirical attempts suggest restrictions on services trade and investment flows are very substantial, particularly by developing countries (Findlay and Warren, 2000). Moreover, the GATS (General Agreement on Trade in Services) negotiations during the Uruguay Round resulted in almost no commitments to lowering those impediments (Hoekman, 1996). During that round many developing countries considered the negotiations that led to the GATS as something they had to put up with in order to get agriculture and textiles ‘concessions’. Yet the gains to developing countries from opening up their services markets, as for developed countries, would be enormous. Those gains would come not just directly to consumers but also to producers who purchase services as intermediate inputs into their goods production. Farmers in particular would benefit from services reform because they depend heavily on such things as transport services to get their produce to domestic and overseas markets (Anderson and Hoekman, 2000). While measuring distortions to services trade and mark-ups by imperfectly competitive firms is fraught with diﬃculty, initial attempts are beginning to bear fruit. A study by Francois (2001) includes one set of estimates of the tariﬀ equivalent of those distortions in a version of the GTAP model that also incorporates imperfect competition and scale economies. Specifically, that study assumes that monopolistic competition exists in the non-primary sectors involving economies of scale that are internal to each ﬁrm. These modifications amplify the estimated gains

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215

from trade considerably. For example, that study finds that if applied tariﬀ rates for both goods and services were to be cut in half, the global gains would be US$385 billion, of which 51 per cent would be due to services reform. The 49 per cent due to halving tariﬀs on goods trade ($192 billion) in the Francois study compares with the above estimate (where no imperfect competition is assumed) of around $250 billion from totally removing all tariﬀs on merchandise trade. The key point to draw from this comparison is that the gains from trade reported above should be interpreted as lower-bound estimates for at least two reasons: because they apply only to goods trade, leaving aside the important distortions prevalent in services markets; and because they are based on the assumption that there are no economies of scale and that perfect competition prevails in all sectors. None of the studies reported above draws on a truly dynamic economic model. They measure well the eﬀects of producers reallocating their resources and consumers adjusting their purchases when relative product prices change with trade reform, but they do not measure the impact of such reform on investment behaviour. Yet we know from experience that when markets are freed up, investors divert their funds towards expanding the now-more-profitable activities and away from the now-less-profitable ones. They are also willing to invest more in aggregate, because of the reduced uncertainty associated with binding the reforms in WTO schedules. That boost to investment applies even more following the reductions in barriers to foreign investment and hence international technology transfers of the past two decades. Thus economic growth is boosted by that diversion and by expansion of investment funds, over and above the boost in output from reallocating existing resource endowments. This additional eﬀect is omitted from most empirical modelling eﬀorts for two reasons: because it takes much longer for analysts to build and to run dynamic models than comparative static ones, and because the extent to which investors respond to changing incentives is less well understood and hence cannot be included with as much certainty as the other behavioural characteristics that are common to both comparative static and dynamic models. Keeping that in mind, it is none the less instructive to note the results of a recent study that examines the range of outcomes generated as the responsiveness of productivity to openness is varied. The World Bank (2002, ch. 6) conducted a study very similar to the one reported above, and obtained very similar results when its version of the GTAP model was in comparative static mode (a global welfare gain from complete liberalization of merchandise trade of $355 billion per year by 2015, compared with the present study’s estimate of $254 billion as early as 2005 when the world economy would be somewhat smaller, and with

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agricultural policies still responsible for about two-thirds of that gain). When their same model was switched into dynamic mode, however, that global gain increased two- to threefold over reasonable ranges of productivity responsiveness parameters. This adds further weight to the claim that the earlier welfare results should be considered as very much lower-bound estimates of the gains from trade liberalization.12 In short, developing countries as a group have much to gain economically from taking part in the next round of WTO negotiations to liberalize trade, and more so the more they are willing to embrace reform at home so as to enable their ffirms to take greatest advantage of the opportunities provided by the opening up of markets abroad. And this applies especially to agricultural trade reform.

IMPACTS OF FURTHER TRADE REFORM ON VARIOUS TYPES OF DEVELOPING COUNTRIES In thinking about the impacts that further trade reform could have on developing countries, it is helpful to recognize that developing countries are quite heterogeneous in their degree of nutrition and in their production and trade specialization patterns. This is evident, for example, in the sample of 23 countries included in a recent FAO study on the impact of the Uruguay Round (Matthews, 2002). Table 9.4 shows that the proportion of the population that is undernourished is not highly correlated with the income grouping of countries. Also clear from that table is that not all low-income countries are classified as LDCs (least developed countries), nor is the subset of those that are net importers of food defined on a calorie basis highly correlated with the WTO’s list of so-called NFIDCs (net foodimporting developing countries). And the countries shown vary hugely in the value of their food imports when expressed as a percentage of either total exports or just exports of agricultural products, with again not a high correlation between those indicators and the food-deficit status of countries. Given that heterogeneity, it is helpful for present purposes to categorize developing countries as follows: 1. 2. 3.

net exporters of foods protected by OECD countries (grains, meats, dairy products, oilseed products, sugar, fruits and vegetables); those suﬃciently close to self-suﬃcient in protected OECD products as to be likely net exporters under global free trade; those net food importers that would remain so under free trade at home and abroad and are net exporters of: – tropical agricultural products (for example, beverages)

Agricultural trade reform and poverty reduction in developing countries

– –

217

non-agricultural primary products (for example, petroleum) non-primary products (for example, textiles and clothing).

With those categories in mind, we turn to some of the concerns raised in the chapter’s introduction. Does it Matter that Global Trade Reform Erodes Tariﬀ Preferences? Among the net exporters of foods protected by OECD countries are developing countries that receive some form of preferential access to OECD country markets. Such countries typically have put their negotiating eﬀorts more into seeking extensions of preferential trading schemes than into cuts to remaining most-favoured-nation (MFN) barriers to trade in agricultural, textiles or other products. While that option is currently still before them, it is worth considering whether it is wise to take it up. There are several types of preferential access schemes that have been designed to mitigate the eﬀects of high tariﬀs on exports from developing countries to advanced economies. They range from very broad ones with minor tariﬀ concessions, such as the Generalized System of Preferences (GSP), to market-specific ones such as the European Union’s provision of duty-free access for certain volumes of certain products from certain developing countries (mostly former colonies of EU member states) in Africa, the Caribbean and the Pacific (ACP – formerly the Lomé Convention, now the Cotonou Agreement), to the new EU proposal for duty- and quota-free access for most exports from the least developed countries (LDCs, as classified by the United Nations). To what extent are these arrangements stepping stones or stumbling blocks in respect of better market access abroad for poor countries? In particular, how eﬀective are these arrangements as compared with MFN liberalizations under the WTO in delivering benefits to poorer economies (as distinct from just being easier politically for national governments to sign)? African, Caribbean and Pacific (ACP) developing countries that have been granted preferential access to European Union markets for some of their exports typically consider themselves privileged, believing that it better enables them to compete in those markets. Not only do they not have to pay the same import duty as other foreign suppliers, but also they receive the EU domestic price, which is higher than the international price to the extent of the protection aﬀorded by the tariﬀ and other restrictions such as quotas on non-ACP imports. Beneficial though this might sound, five important points need to be borne in mind. First, many other equally poor but non-ACP developing countries are harmed by the ACP preferences. This was made abundantly

218

Bangladesh Botswana Brazil Costa Rica Côte d’Ivoire Egypt Fiji Guyana Honduras India Indonesia Jamaica Kenya Malawi Morocco

35 25 10 5 15 4 n.a. n.a. 21 24 6 9 44 33 7

% of population undernourished, 1998–2000 LI UMI UMI UMI LI LMI LMI LMI LMI LI LI LMI LI LI LMI

World Bank

LDC

LDC

UN

NFIDC

LIFDC LIFDC LIFDC

LIFDC LIFDC LIFDC

NFIDC

NFIDC NFIDC

LIFDC LIFDC

LIFDC

FAO

NFIDC NFIDC

NFIDC

WTO

Income/food-trade status groupings

21 14 7 6 9 20 9 7 13 5 6 12 13 13 12

Food imports as % of total exports, 1995–99

Table 9.4 Income category and food-trade status of a sample of developing countries

829 256 30 19 17 542 52 23 48 42 56 111 32 16 146

Food imports as % of agric. exports, 1995–2000

219

19 11 23 25 23 18 21 38

LI LMI LMI LI LMI LMI LI LI LDC

LDC NFIDC

NFIDC NFIDC

LIFDC

LIFDC LIFDC LIFDC

LIFDC

15 14 6 26 12 2 20 5

134 152 123 357 68 14 41 13

Source:

Compiled from data in Matthews (2002) and the FAO’s State of Food Insecurity 2002, Rome.

Notes: LI, LMI and UMI refer to the World Bank classiﬁcations of low-income, lower middle-income and upper middle-income countries; LDCs are least developed countries, as recognized by the UN; NFIDCs are net food-importing developing countries, as deﬁned by the WTO Committee on Agriculture; LIFDCs are low-income food-deﬁcit countries, deﬁned by the FAO as those countries with a GNP per capita less than $1445 in 2000 and which are net importers of food deﬁned on a calorie basis.

Pakistan Peru Philippines Senegal Sri Lanka Thailand Uganda Zimbabwe

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Trade and poverty reduction

clear in the 1990s during the infamous dispute settlement case that was brought to the WTO concerning the EU’s banana import regime. One background study showed that for every dollar of benefit that the banana policy brought to producers in ACP countries, the regime harmed nonACP developing-country producers by almost exactly one dollar – and in the process harmed EU consumers by more than 13 dollars (Borrell, 1999a). It is diﬃcult to imagine a more ineﬃcient way of transferring welfare to poor countries, since EU citizens could have, through direct payments, been 13 times as eﬀective in helping ACP banana producers and not hurt non-ACP banana producers at all. Such wasteful trade diversion is avoided under non-discriminatory, MFN liberalizations that result from multilateral trade negotiations under WTO. Second, the additional production that is encouraged in those ACP countries when they get privileged access to the high-priced EU market is not internationally competitive at current prices (otherwise it would have been produced before getting that preferential treatment). Indeed the industry as a whole may not have existed in the ACP country had the preference scheme not been introduced.13 In that case, its profits are likely to be lean despite the scheme, and would disappear if and when the scheme is dismantled. Eﬀorts to learn the skills needed, and the sunk capital invested in that industry rather than in ones in which the country has a natural comparative advantage, would then earn no further rewards. Third, the ACP preferential access scheme under the Lomé Convention has not been a reciprocal agreement; that is, the developing countries were not required to open their markets to EU products. While that makes life easy for ACP politicians, it contributes nothing to the removal of the wasteful trade-restrictive policies of the ACP countries. This contrasts with market access negotiations under WTO, which are characterized by reciprocity: you receive greater access to my markets (on an MFN basis) on the condition that your trading partner receives a similar degree of improvement in access to your markets. Fourth, in so far as a developing country sells only part of its exports into a protected market to which it has preferential access, it receives a lower price for the rest of its exports than would be the case under free trade because of the price-depressing eﬀect of that OECD protection on the free international market. It is therefore conceivable that the weighted average price for its exports is lower than what it would be under free trade, notwithstanding the benefit of preferential access for some of its exports. Fifth, and perhaps most important, the ACP preference scheme reduces very substantially the capacity for developing countries as a group to press for more access to EU markets. It does this in two ways: by reducing the

Agricultural trade reform and poverty reduction in developing countries

221

number of such countries arguing against protection, and by creating a subset of developing countries supporting the EU’s protectionist stance (in order to continue to receive the high domestic prices in the EU market). This point is crucial, and yet it is often not appreciated. Perhaps if these preferences had not been oﬀered in the first place, developing countries would have negotiated much more vigorously in previous GATT rounds for lower tariﬀs on agricultural and other imports into the EU. That in turn would have placed greater pressure on Japan and others to reduce their agricultural protectionism also. The end result would have been higher international prices for agricultural products that, for developingcountry producers as a group, may have been more than suﬃcient to oﬀset the lower prices received in the EU market for a favoured subset of those producers. A similar set of provisos can be made about the EU’s recent proposal to extend preferences for UN-designated ‘least developed countries’ (LDCs). That initiative would provide duty-and quota-free access to the EU for exports of all merchandise except arms. It received in-principle, bestendeavours endorsement at the WTO Ministerial in Doha in November 2001, but without any specific timetable.14 Liberal though that proposal sounds, note that it does not include trade in services (of which the most important for LDCs would be movement of natural persons, that is, freedom for LDC labourers to work in the EU or other high-wage countries).15 Also, a number of safeguard provisions are included in addition to the EU’s normal anti-dumping measures. Furthermore, access to three politically sensitive agricultural markets, bananas, rice and sugar, would be phased in by the EU only gradually over the next eight years (and would be subject to stricter safeguards). Several empirical studies of the proposal have already appeared. A World Bank study by Ianchovichina et al. (2001) compares the EU proposal, from the viewpoint of sub-Saharan Africa (SSA), with recent initiatives of the USA and Japan. Their GTAP modelling results suggest that even the most generous interpretation of the USA’s Africa Growth and Opportunity Act (which they model as unrestricted access to the USA for all SSA exports) would benefit SSA very little because the US economy is already very open and, in the products where it is not (for example, textiles and clothing), SSA countries have little comparative advantage. Likewise they ffind the Japanese proposal of free access to Japan’s market for industrial products helps SSA hardly at all, since the region exports few industrial products. By contrast, the EU proposal, especially if it were to apply to all Quad countries (the EU, the USA, Canada and Japan), would have a sizeable eﬀect on SSA trade and welfare – provided agriculture is included in the deal. Just from EU access alone, SSA exports would be raised by more than

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Trade and poverty reduction

US$0.5 billion and SSA economic welfare would increase by $0.3 billion per year (a 0.2 per cent boost). This is very similar to a recent estimate by UNCTAD/ Commonwealth Secretariat (2001, ch. 3). The estimated benefits are not surprising given that agriculture and food products account for more than half SSA exports. These items are highly protected in the EU and other Quad countries, and little is provided for them in the way of preferential access under the GSP. The results overstate the benefits of the EU proposal, however, as this World Bank study assumes all SSA countries (excluding relatively wealthy South Africa and Mauritius), not just the LDCs among them, would get duty- and quota-free access. Another World Bank study, by Hoekman et al. (2002), uses a partial equilibrium approach and looks at the benefit of the EU initiative for LCDs not just in SSA but globally. It finds that trade of LDCs would increase by US$2.5 billion per year if all Quad countries provided them dutyand quota-free access on all merchandise.16 However, almost half of that increase would come as a result of trade diversion from other developing countries. The authors suggest that this is trivial because it represents less than 0.1 per cent of other developing countries’ exports (about $1.1 billion).17 That misses a similar point to the one made above, however. It is that if the 48 LDCs are given such preferences, they will become advocates for rather than against the continuation of MFN tariﬀ peaks for agriculture and textiles – diminishing considerably the number of WTO members negotiating for their reduction. It may be true that reductions in agricultural and textile tariﬀs would help LDCs much less than they would help other developing countries, as the study by Hoekman et al. (2002) finds; but the gains to consumers in the Quad would be more than suﬃcient to allow them to increase their aid to LDCs to compensate for the loss of income from preference erosion. To put the point in a blunter but more general way, trade can be worse than direct aid if the trade is preferential and thereby distortionary. Wouldn’t Net Food-importing Developing Countries Lose from Higher Food Import Bills? Among the net food-importing developing countries (NFIDCs), some fear agricultural protection cuts by OECD countries will lead to an unaﬀordably higher international food import bill. Yet even those developing countries – which may be part of one of the country aggregates in Table 9.2 – need not lose out from farm support cuts abroad. If, for example, they are close to self-suﬃcient in food without price supports (as many net food-importing developing countries are), and reform abroad raises the international price

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of food, they may switch to become suﬃciently export-oriented that their net national economic welfare rises. A second possibility is that the developing country’s own policies are suﬃciently biased against food production that the country is a net importer, despite having a comparative advantage in food. In that case, the international price rise can improve national economic welfare even if the price change is insuﬃcient to turn that distorted economy into a net food exporter (Anderson and Tyers, 1993). That comes about because the higher price of food attracts mobile resources away from more-distorted sectors, thereby improving the eﬃciency of national resource allocation. Because of these two possibilities, the number of poor countries for which a rise in international food prices might cause some hardship is much smaller than the number that are currently not net exporters of agricultural products. What about the other NFIDCs? Some are exporters of tropical agricultural products such as beverages, while others export energy raw materials or other mining products. They would be less concerned about a higher food import bill if they received in return better access to OECD markets for more-processed versions of their primary products. Tariﬀ escalation in many instances makes access diﬃcult through raising the eﬀective protection to processors in OECD countries, which crowd out potential exports from developing-country processors. What about those developing countries whose comparative advantage is gradually moving from primary products to (initially unskilled) labourintensive manufactures, as in much of Asia? While that industrialization lowers their direct interest in agricultural trade reform abroad, it heightens their keenness to see barriers to exports of textiles and clothing lowered. That interest of theirs in textile trade expansion should be shared by agricultural-exporting developing countries, for if the former group could export more manufactures, it would tend to become a larger net importer of agricultural products. Conversely, lowered industrial-country barriers to agricultural trade would reduce the need for the more landabundant developing countries to move into manufactures in competition with the newly industrializing ones. Scope clearly exists for the two groups to band together and negotiate as a single voice calling for barriers to both farm and textile trade to be lowered, so that each group can better exploit its comparative advantage to the direct benefit of the vast majority of poor people in both. If that means lowering protected domestic food prices, some farm labourers will find jobs in the expanding light industrial sector where wages will have risen. Even those staying in agriculture need not lose, if savings from cuts in price supports were used to reduce underinvestment in such areas as agricultural R&D and rural roads, education and health.

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IMPACTS OF FURTHER REFORM ON DIFFERENT HOUSEHOLDS WITHIN DEVELOPING COUNTRIES Another important distinction is that between various types of households within each developing country. For present purposes the key household types to distinguish are net sellers of food, landless farm labourers, and non-farm low-skilled labourers (including under-employed workers). Those households mainly supplying non-farm skilled labour and/or capital typically are not poor and so are of less concern here. Bearing this in mind, we turn to two additional questions raised in the introduction. Wouldn’t Higher International Food Prices Increase Poverty and Food Insecurity for Poor Households? The impact of trade liberalization on income distribution and thereby on poverty at the household level is not always clear: even though the eﬀects of trade policies on capital owners and workers have been studied by trade theorists for centuries, applying that theory to the real world turns out to be a complex empirical task (Winters, 2002; McCulloch et al., 2001; Hoekman et al., 2001). This is because the economy-wide eﬀects depend (a) on the shares of households’ income from diﬀerent productive factors such as labour and land, whose prices will have changed (depending on the size of the changes in relative producer prices, factor substitutability, factor intensities, and factor mobility between sectors), (b) on their expenditure shares on diﬀerent products (whose consumer prices also will have changed and not necessarily to the same extent as producer prices not least because of marketing margins), and (c) on any changes in net transfers to them (for example, increased handouts, reduced taxation, more remittances from urban relatives). Those complexities make it diﬃcult to generalize a priori, or even in the face of empirical modelling studies when they report eﬀects of reform just on production, trade, product prices and aggregate economic welfare. Even so, some observations are worth making about the eﬀects on poverty and food security of reducing agricultural protectionism globally. Most low-income countries have not propped up the producer price of food. In so far as an international food price rise is transmitted domestically,18 the vast majority of the poor would benefit directly. This is because they are in farm households and are net sellers of food. Even poor landless farm labourers who are net buyers of food would benefit indirectly from agricultural trade liberalization via a rise in the demand for their unskilled farm labour, assuming that raises their wage suﬃcient to more than oﬀset the rise in food prices in rural areas. Since the more aﬄuent people in cities

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would find it relatively easy to pay a little extra for food, the only other major vulnerable group is the under-employed urban poor. But even that group may not be worse oﬀ in so far as trade reform generates a morethan-oﬀsetting increase in the demand for (often informal sector) services that use that group’s labour relatively intensively. What about the impact of reform on food price variability and other aspects of food security, especially as it aﬀects the poorest households? Contrary to popular belief, trade liberalization is much more likely to reduce than raise food insecurity for the vast majority of the world’s poor. Food security means always having access to the minimum supply of basic food necessary for survival. The key to that, in addition to peace and greater eﬃciency in the functioning of staple food markets, is strengthened purchasing power of the poor. That is, enhancing food security is mainly about alleviating poverty. The rate of food self-suﬃciency is at most only a supplementary indicator, and only while there remains a perception that food insecurity rises when the level of food self-suﬃciency in basic foods falls much below 100 per cent. Eliminating all agricultural policy distortions in developed countries would raise international prices for agricultural products on average, and reduce their variance by ‘thickening’ the market, which would stimulate production in non-protected countries.19 According to one recent study (Diao et al., 2001), that would boost the value of agricultural exports of developing countries by 24 per cent and dampen their agricultural imports by 2 per cent. This suggests that food self-suﬃciency in many low-income countries would rise. As well, since a high proportion of the poorest households in developing countries are producers and net sellers of food, they would benefit from such reform. In both respects, therefore, food security for the vast majority of households in low-income countries should be enhanced on average. Those same households would be helped even further if agricultural price-depressing policies were in place domestically and these are removed. The latter reform also boosts self-suﬃciency in agricultural products and thereby boosts even further perceived food security in those economies. The Diao et al. (2001) study estimates that eliminating developing countries’ own agricultural price distortions would boost their farm export value by a further 6 per cent. True, the households that are net buyers of food in such economies will face higher food prices; but whether they become less food secure depends also on what happens to their earnings (and/or transfers). If they are landless rural poor, their earning prospects will have risen along with the growth in demand for farm labour, or for labour in local enterprises that grow as farmers spend their enhanced income on simple manufactures and services produced nearby. As for

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urban households, the vast majority of them are more aﬄuent than those in rural households and so can well aﬀord to pay higher market prices for food. This suggests that only a small proportion of households in lowincome economies would be net food buyers at risk of becoming more food insecure as a result of rising domestic food prices following trade liberalization. Even that group could be better oﬀ if developed countries were also to reduce their barriers to imports of textiles and clothing, since that would expand the demand for unskilled labour in the apparel industry of developing countries. What about in developing countries where agricultural trade liberalization means lower domestic prices for agricultural products because such countries have kept domestic food prices above international levels via import restrictions? It is true that removing those distortions will reduce farm incomes in those countries (but by more for larger than smaller farms), and urban households will benefit from lower food prices. However, food self-suﬃciency will fall – and it is the fall in both farm earnings and food selfsuﬃciency that focuses the attention of those who argue that agricultural trade liberalization is bad for poor households. Focusing on just the direct eﬀects of agricultural trade policy reform can be misleading, however, not least because it does not take account of the fact that such reform is typically done in the context of multilateral, economy-wide liberalization. Being multilateral means that other countries’ farm protection cuts raise international food prices, and so less of a price fall occurs than when a country cuts it agricultural protection unilaterally. And being economy-wide means the decline in demand for farm labour is more or less than oﬀset by a growth in demand for labour in expanding non-farm industries. In short, at least two points are worth stressing.20 First, reducing agricultural policy distortions in developed countries would increase the mean and reduce the variance of international prices for agricultural products, which would stimulate production in other countries. This suggests that food self-suﬃciency would rise in those developing countries that transmit international prices to their domestic market. Second, since a high proportion of the poorest households in low-income countries are producers and net sellers of food, they would be key beneficiaries of such reform. In both respects, therefore, food security for the vast majority of households in lowincome countries should be enhanced on average. Those same households would be helped even further by the reduction/removal of any policies that are depressing farmers’ returns (for example, directly via agricultural export taxes or indirectly via import protection for non-agricultural sectors or an overvalued currency). The latter reform also boosts self-suﬃciency in agricultural products and thereby boosts perceived food security even further in those economies.

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What About Lowering Domestic Food Prices in Protective Developing Countries, as with China’s Accession to the WTO? Those food-importing developing countries that currently protect their farmers have a diﬀerent set of concerns. The case of China’s accession to the WTO illustrates the situation. That accession, which will be ongoing until the latter part of the present decade, involves a decline in the domestic price of some farm products. Because farm households in China are among the country’s poorest, that trade reform is often pointed to as an example of one that will exacerbate poverty. To explore that possibility, a set of empirical studies was commissioned recently by the World Bank. A global economy-wide numerical simulation model was used to generate the changes in product and factor prices expected from the commitments to reform that China made in its accession negotiations. These were then mapped on to the earning and spending patterns of various household types and regions in China as revealed in China’s rural and urban household surveys. The conventional wisdom that China’s WTO accession will impoverish its rural people, via greater import competition in its agricultural markets, need not prevail. One needs to keep in mind that, even if prices of some (land-intensive) farm products fall, those for other (labour-intensive) farm products could rise. Also, the removal of restrictions on China’s exports of textiles and clothing will boost town and village enterprises, so demand for non-farm workers in rural areas may grow even if demand for farm labour in aggregate falls. New estimates of the likely changes in agricultural prices as a result of WTO accession are drawn on to examine the factor reward implications of China’s WTO accession empirically using the GTAP model. Results reported in Anderson et al. (2004) suggest that farm–non-farm and Western–Eastern income inequality may well rise, but rural–urban income inequality need not. That conclusion is supported by a more detailed study of households by Chen and Ravallion (2004). They fi f nd negligible impacts on inequality and a small reduction in poverty in aggregate, but some variance across households and regions. Farm households tend to lose, especially those highly dependent on feed grain production (in Northeastern China) and in hinterland regions with weak links to the booming non-farm sectors and eastern provinces. But the losses are at most very small, amounting to less than 5 per cent of household income. Facilitating the transfer of some labour from less lucrative farm activities to now-more-lucrative non-farm work could be suﬃcient (with the usual remittances back to the farm household) to ensure that all gain from China’s WTO accession. A companion study by Ianchovichina and Martin (2004) also examines how much diﬀerence it could make if the hukou system that restricts

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rural-to-urban migration were to be abolished. Their results suggest that the sign of the eﬀects could be switched to favour the poorer farm households – albeit at the expense of the richer non-farm ones – if the remaining WTO accession-related reforms were to be accompanied by reform of the hukou system that allowed some members of those households to obtain higher-paying non-farm employment and repatriate earnings back to their farm family. And of course aggregate national economic welfare would be enhanced by that labour market reform as well. This illustrates the general point that gains from trade reform will be greater, the more liberal are domestic product and factor markets. A summary of these modelling results can be seen in Table 9.5. Without labour market reform, WTO accession for China would slightly reduce rewards to unskilled farm labour and to agricultural land while raising rewards to all other factors of production. This suggests that farm households earning less than 60 per cent of their income from unskilled non-farm Table 9.5 Changes in China’s real factor prices and national economic welfare due to WTO accession, 2001 to 2007 (% and, for national welfare, 1997 US$ billions) Core WTO accession scenario

Alternative scenario: core case plus also removing labour market distortion

Factor rewards Farm unskilled wages Rental price of land Non-farm unskilled wages Skilled labour wages Rental price of capital

0.7 5.5 1.2 0.8 1.3

16.8 9.7 3.8 1.7 1.4

Farm household incomea Farm household type A Farm household type B Farm household type C

1.6 0.8 0.1

6.8 3.6 0.4

Note: a Farm income from agriculture is made up of 57 per cent from unskilled farm labour, 26 per cent from agricultural land and 17 per cent from farm capital, according to the GTAP database. In 1999 on average 51 per cent of rural household income in China was earned outside agriculture, mostly from unskilled labour. Therefore, to illustrate the importance of those oﬀ-farm earnings for farm families, three types of farm households are shown in this table: it is assumed that non-farm unskilled labour contributes 0 per cent of total farm household income for type A, 30 per cent for type B, and 60 per cent for type C. Source: Anderson et al. (2004) and Ianchovichina and Martin (2004).

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work could be harmed (albeit only slightly) from WTO accession. If complete abolition of restrictions to oﬀ-farm migration accompanied WTO accession reforms, however, the final column of Table 9.5 suggests that all types of farm households could be better oﬀ as more family members are attracted to higher-paying oﬀ-farm work. In so far as China’s WTO accession puts upward pressure on international farm product prices, that would have the same pro-poor consequences in other developing countries as the multilateral farm trade reform discussed above. However, the extent of that price rise and the associated increase in China’s imports of farm products is going to be minor, and certainly will not, as implied by the title of Lester Brown’s 1995 book, ‘Starve the World’ (see the empirical results in Anderson et al., 1997).

WHAT ARE THE RISKS OF RE-INSTRUMENTATION OF AGRICULTURAL PROTECTION? If increasing market access in OECD countries through reducing farm production and export subsidies and agricultural protection is able to contribute to poverty alleviation in developing countries, then to what extent would that objective be compromised by eﬀorts to substitute new forms of assistance to farmers as traditional protective instruments are phased out? The imposition of tariﬀ rate quotas accompanied by very high outof-quota tariﬀs, and the administration of quotas so as to ensure less than full usage of them, were two ways in which agricultural protection changes following the Uruguay Round were minimized – to the point that many developing countries struggled to identify any significant growth in agricultural export earnings resulting from the UR Agreement on Agriculture (Matthews, 2002).21 There are at least two ways in which cuts in assistance to developedcountry farmers may be minimized following the Doha Round too. One is via an expansion of exempt support measures to satisfy so-called non-trade concerns related to the alleged ‘multifunctionality’ of agriculture – even though those concerns can readily be met much more directly and hence in less trade-distorting ways than is being proposed (Anderson, 2000; Paarlberg et al., 2002). While the multifunctionality concept originated in the richest, most protective economies, it is now being embraced by farmer groups in numerous developing countries as well. More than 20 such countries’ farm groups plus the EU met in Geneva on 23–25 October 2002 and signed a declaration calling on WTO members to acknowledge that ‘agriculture cannot be treated in the same way as industrial sectors’ because farming ‘fulfils a multitude of functions . . .’. Since then, however, some

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developing countries have been at pains to stress that their concerns are very diﬀerent from those emphasized by rich countries. The other likely form of re-instrumentation is via the adoption of stricter standards that then act as technical barriers to trade. Quarantine measures are an obvious case in point. They often add relatively large cost burdens to exporters from poorer countries because those countries do not have the same capability as developed countries to meet high standards, nor the same imperative to impose them to satisfy domestic consumers (Wilson, 2002).22 Numerous developing countries have cited examples of SPS measures of OECD countries that are already significantly hindering their exports (Matthews, 2002). Another is the increasing use of geographical indications and traditional expressions aimed at diﬀerentiating rich-country products, which eﬀectively reduces the demand for more-standard substitute products from other countries.23 A third and less obvious possibility is the restriction of imports of food products containing genetically modified organisms (GMOs). The direct, short-term eﬀects of a ban on GMOs could help exports from developing countries that choose not to adopt GMOs, even though it harms those who have already adopted them (Nielsen and Anderson, 2001; Anderson and Yao, 2003a; Anderson and Jackson, 2003). But the indirect, longer-term, and potentially much larger eﬀects are adverse for the world’s poor, namely, the disincentive eﬀect of such restrictions on investment in agricultural biotechnologies that could lower food prices and/or raise the nutritional attributes of foods available in developing countries (not to mention the potential damage a GMO trade dispute could inflict on the global trading system – see Isaac and Kerr, 2003).

MOVING FORWARD How Can the Prospects for and Beneﬁts from Reform be Maximized? Consumers in developed countries are more concerned with food safety and the environment than with the price-raising eﬀect of agricultural protection. They are therefore not a force for reform except perhaps for switching support to payments tied to better environmental or food safety outcomes. So the political force for agricultural (and textiles and clothing) reform in developed countries has to come from those countries’ exporters of other industrial goods and of services. This requires that developing countries provide increased access to those producers’ exports as a quid pro quo. Such reform would provide additional benefits to the farm sector of poor countries, both directly through lower-cost inputs and indirectly through the currency devaluation that would accompany it. While the farm

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sector is typically a weak lobbying force in poor countries, membership of or association with a coalition such as the Cairns Group could enhance its lobbying skills.24 So too could support from the more enlightened non-government development agencies that realize how damaging OECD farm policies are to sustainable development in poorer countries (see, for example, Oxfam, 2002). As mentioned above, textile and clothing exporters have an indirect interest in seeing agricultural protection reductions in their own country as well as in the OECD, so that potential food-exporting countries can access those markets instead of competing with them by turning to manufacturing. An alliance between those two types of developing countries would allow them to jointly push for greater agricultural and textile market access in rich countries. People in developing countries also need to recognize that while so-called special and diﬀerential treatment (such as slower reform for developing countries, as in the Harbinson proposal for the Doha Round) may be what their governments prefer for political reasons, it is not in the economic interests of developing-country citizens. Faster and larger reforms bestow greater national economic gains from trade liberalization. To maximize the gains from trade reform, however, developing countries need to have well-functioning domestic economies. If factor markets are inflexible, or public infrastructures are in poor shape, only a fraction (and possibly a small fraction) of the potential gains from trade reform will be realized. How Best to Deal with Residual Concerns About Food Security If a society would feel too food-insecure under laissez-faire, then what needs to be determined is a sense of (a) its willingness to pay for more security by various means, and (b) the costs of those insurance measures. One such measure involves encouraging the holding of food stocks above those that would be commercially viable – a public good that is explicitly allowed for in Annex 2 of the WTO’s Agreement on Agriculture. The optimal level of encouragement is that which boosts stocks so that the marginal social benefit in terms of food security equals the marginal social cost of that intervention. Costs are non-trivial, however. Storage and interest costs and the costs of spoilage and quality deterioration can amount to more than 20 per cent per year. The cost part of the calculation also would need to include the risk of government failure if stocks were to be managed by an ineﬃcient (or corrupt) public agency. If greater domestic production capability is considered by society to be one of the desirable means of boosting food security (because of a

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perception that food import dependence is too unreliable), there are far less costly ways of achieving that than via farm product price supports and import protection. For example, boosting production alone, rather than also taxing consumption as with an import barrier, would be a lower-cost and less trade-distorting means of achieving that end. Even more eﬀective could be improvements in land tenure and more investment in the stocks of primary factors used in food production: agricultural research,25 rural human capital, and rural infrastructure (Otsuka, 2002). That would provide an especially high payoﬀ in situations where, as in so many countries, there has been gross under-investment in these activities in the past. Simultaneously, production could be boosted in many low-income countries simply by better clarifying and enforcing land rights, since they are a key source of collateral for securing loans for productive investments by farm households. Where targeted programmes to boost the earning capacity of the poverty-stricken (for example, via basic education/training) are still not enough to boost their food security in the short term, targeted consumer subsidies to provide that core group with food staples are much less costly than general subsidies to all food consumers via price-depressing agricultural policies. Food aid that is targeted to just that group could be readily provided by the international community without depressing very much the prices received by farmers in recipient countries.26 And greater technical and economic cooperation in the areas of agricultural research, rural education and health, and rural infrastructure may be important co-requisites of trade policy reform if developing countries are to be convinced that they would gain unequivocally from the Doha Round.

NOTES *

Thanks are due to university seminar participants in Melbourne, Yale and Trinity College Dublin (TCD) for helpful comments and to the Asian Development Bank, the World Bank, IIIS at TCD and the University of Adelaide for financial support. The first draft was first presented at the ADB/World Bank Fourth Asian Development Forum on Trade and Poverty Reduction, Seoul, 4–5 November 2002. Views expressed and any remaining errors are the author’s alone. 1. Sala-i-Martin’s data suggest that the number has fallen to 350 million, at least in 1985 PPP terms. Even if that lower figure is correct, it is an unacceptable number of people in extreme poverty. 2. The link between openness and economic growth, while not completely unambiguous and universal, is strong, and there is no evidence that openness is harmful to growth (see the discussion in McCulloch et al., 2001, ch. 2). Trade’s impact on growth can be much reduced in the absence of liberal domestic markets, macro stability, and appropriate institutions and infrastructure, however, since those are all necessary to enable producers to respond to changes in international market signals (Hoekman et al., 2001). For

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3. 4.

5.

6.

7. 8. 9.

10.

11. 12.

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a comprehensive survey of the links between trade, growth and poverty, see Berg and Krueger (2002). The theory is also covered succinctly in Winters (2002), while a survey of the empirical evidence (at least for own-country liberalization) is available in Winters et al. (2002). Their scepticism is supported by recent reviews of the benefits to date to developing countries from the Uruguay Round. On the UR Agreement on Agriculture, for example, see Matthews (2002). An additional reason for focusing on agriculture is that – contrary to conventional wisdom – productivity growth in agriculture historically has outpaced that in manufacturing, including in developing countries (Martin and Mitra, 2001). That empirical evidence suggests that liberalizing markets for farm products could provide an aboveaverage boost to economic growth in poor countries, ceteris paribus, which would add further to poverty alleviation. In so far as new agricultural technologies tend to have a labour-saving bias, however, maximizing the benefits from agricultural productivity growth requires fflexible labour markets so that displaced farm workers can ffind employment readily in non-farm sectors. The GTAP (Global Trade Analysis Project) model is based in Purdue University (see Hertel, 1997). It is a standard, multi-region model based on neoclassical assumptions of perfect competition, constant returns to scale and full employment. Currently it is in use by several hundred researchers in scores of countries on five continents. The database builds on contributions from many of these individuals, as well as the national and international agencies in the GTAP Consortium. Two assumptions are crucial in generating the results reported in Table 9.1, however. One is that China and Taiwan, having joined the WTO at the end of 2001/start of 2002, enjoy the same accelerated access to OECD markets under the Uruguay Round Agreement on Textiles and Clothing (ATC) as other developing countries that were already WTO members. The other crucial assumption is that OECD countries fully implement the spirit of the ATC by the end of 2004, that is, they remove remaining import quotas and do not replace them with similarly protective instruments such as safeguard measures. Dropping either of those assumptions reduces very substantially the estimated gains from Uruguay Round implementation (Anderson et al., 1997), and therefore would raise the potential gains from textile and clothing reform in the next and subsequent WTO rounds above those reflected in Table 9.1. This compares with an estimate for 2015 of 32 per cent in a study that examined just agricultural trade reform alone (Beghin et al., 2003). It should be recognized that these results ignore the eﬀect of tariﬀ preference erosion. In so far as a developing country receives such preferences at present in OECD markets, the above results overstate the potential gains from their reforms. This point is taken up below. Beghin et al. (2003) estimate a slightly higher price rise for numerous agricultural commodities (but close to zero for others), but their study does not include reform to non-farm trade and so overstates what the relative price change would be in a multisector agreement. This result from sector-wide multilateral reform is to be contrasted with that from reform of trade taxes on a single primary commodity that is grown by a few developing countries and whose demand is price-inelastic. In the latter case it is conceivable that the optimal export tax for those few countries is greater than zero if they were to cartelize, in which case reform could harm their economies while benefiting consumers globally. See, for example, the empirical study of West African cocoa by Gilbert and Varangis (2003). For empirical support for this proposition, see for example Anderson and Strutt (1999) with respect to Indonesia. The point is made strongly also in the volume on the Uruguay Round edited by Martin and Winters (1996). An important caveat to all these studies is they assume the aggregate levels of employment of existing resources including labour remain unchanged during the period of adjustment to the reforms. In so far as there is some temporary unemployment and some

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13.

14. 15. 16.

17.

18.

19.

20. 21.

22. 23. 24.

25. 26.

Trade and poverty reduction loss of industry-specific human capital, those costs would need to be subtracted from the amortized value of the flow of benefits as estimated in the simulation studies. Alternatively, the ACP scheme may have caused an existing industry to become less competitive. An extreme example of an industry that has ossified as a consequence of regulations introduced to share the expected benefits of EU preferences is sugar in Mauritius (Borrell, 1999b). In Paragraph 42 of the Ministerial Declaration (WTO, 2001a) it simply says: ‘We commit ourselves to the objective of duty-free, quota-free market access for products originating from LDCs.’ On the potential gains from freeing the temporary movement of unskilled labour services globally, see Winters et al. (2003). This and other estimates of gains from preferential market access provisions need to be discounted to the extent that rules of origin, sanitary and phytosanitary barriers, anti-dumping duties and the like limit the actual trade allowed. For a detailed analysis of these types of restrictions on EU imports from Bangladesh in recent years, see UNCTAD/Commonwealth Secretariat (2001, ch. 5). The impact outside the LDC group would be far from trivial for Mauritius, however, since the vast bulk of its exports are quota-restricted sales of clothing and sugar to the EU and USA. See the discussion in UNCTAD/Commonwealth Secretariat (2001, ch. 6). The elasticity of price transmission is usually less than one for importing countries, especially in the short run where governments intervene at the border in an attempt to cushion the domestic market from international price fluctuations (Tyers and Anderson, 1992; Sharma, 2003). And it is typically much lower in remote rural locations than in urban settings close to the nation’s border. Unfortunately ‘dirty’ tariﬃcation and the continuing use of specific tariﬀs by developed countries, the setting of high ceiling bindings by developing countries, and the introduction of tariﬀ rate quotas greatly weakened (relative to pure ad valorem tariﬃcation) the extent to which the Uruguay Round Agreement on Agriculture raised the mean and lowered the variance of international food prices during the past seven years. For a more in-depth analysis of the food security aspects of WTO farm trade reform, see Diaz-Bonilla et al. (2003). There may have been some as-yet-unmeasured benefits to the extent developing countries were granted the rents from tariﬀ rate quotas imposed by developed countries (which would make their eﬀects similar to the voluntary export restraints imposed on textile exports from developing countries). Quarantine barriers are also more costly than equivalently trade-restrictive import tariﬀs or quotas for the imposing countries, since the latter generate tariﬀ revenue or quota rents whereas for the former that revenue is absorbed in costs of compliance. See, for example, the concerns raised by Cairns Group members in WTO (2001b). An analysis of the prospects for producers in developing countries also harnessing geographical indications as a marketing tool is provided in Maskus (2003). Within agriculture, developing countries’ interests in Doha agenda items align closely with those of the Cairns Group of non-subsidizing agricultural-exporting countries (Bjornskov and Lind, 2002). See Cairns Group (2002) for its proposal on market access in the Doha Round. To many people’s surprise a group of 20 developing countries led by Brazil, China and India did coalesce at the Trade Ministerial meeting of WTO members in Cancun, Mexico in September 2003 and eﬀectively brought the meeting to a close by demanding more agricultural reform in OECD countries than the EU and USA were willing to oﬀer at the time. For recent reviews of the substantial contribution that a further boost to agricultural research could do for poverty alleviation in low-income countries, see Hazell and Haddad (2001) and Runge et al. (2003). If such subsidies are only paid in the towns and cities, however, this increases the risk of excessive, socially costly migration out of agriculture as analysed by Harris and Todaro (1970).

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REFERENCES Anderson, K. (2000), ‘Agriculture’s multifunctionality and the WTO’, Australian Journal of Agricultural and Resource Economics, 44 (3), 475–94. Anderson, K. and B. Hoekman (2000), ‘Developing country agriculture and the new trade agenda’, Economic Development and Cultural Change, 49 (1), 171–80. Anderson, K. and L.A. Jackson (2003), ‘Standards, trade and protection: The case of GMOs’, paper presented at a seminar at the World Bank, Washington, DC, 2 October. Anderson, K. and A. Strutt (1999), ‘Impact of East Asia’s growth interruption and policy responses: The case of Indonesia’, Asian Economic Journal, 13 (2), 205–18. Anderson, K. and R. Tyers (1993), ‘More on welfare gains to developing countries from liberalising world food trade’, Journal of Agricultural Economics, 44 (2), 189–204. Anderson, K. and S. Yao (2003a), ‘China, GMOs and world trade in agricultural and textile products’, Paciﬁc Economic Review, 8 (2), 157–69. Anderson, K. and S. Yao (2003b), ‘How can South Asia and Sub-Saharan Africa gain from the next WTO Round?’, Journal of Economic Integration, 18 (3), 466–81. Anderson, K., E. Ianchovichina and J. Huang (2004), ‘Impacts of WTO accession on Chinese agriculture and rural poverty’, in D. Bhattasali, S. Li and W. Martin (eds), China and the WTO: Accession, Policy Reform, and Poverty Reduction Strategies, London and New York: Oxford University Press, ch. 7. Anderson, K., B. Dimaranan, T. Hertel and W. Martin (1997), ‘Economic growth and policy reforms in the APEC region: Trade and welfare implications by 2005’, Asia-Paciﬁc Economic Review, 3 (1), 1–18. Anderson, K., B. Dimaranan, J. Francois, T. Hertel, B. Hoekman and W. Martin (2001), ‘The cost of rich (and poor) country protection to developing countries’, Journal of African Economies, 10 (3), 227–57. Beghin, J.C., D. Roland-Holst and D. van der Mensbrugghe (2003), ‘How will agricultural trade reforms in high-income countries aﬀect the trading relationships of developing countries?’, in OECD Agricultural Trade and Poverty: Making Policy Analysis Count, Paris: OECD, pp. 39–58. Berg, A. and A.O. Krueger (2002), ‘Trade, growth and poverty’, paper presented at the Annual World Bank Conference on Development Economics, Washington, DC. Bjornskov, C. and K.M. Lind (2002), ‘Where do developing countries go after Doha? An analysis of WTO positions and potential alliances’, Journal of World Trade, 36 (3), 543–62. Borrell, B. (1999a), ‘Bananas: Straightening out bent ideas on trade as aid’, paper presented at the World Bank/WTO Conference on Agriculture and the New Trade Agenda from a Development Perspective, Geneva, 1–2 October. Borrell, B. (1999b), ‘Sugar: The taste test of trade liberalization’, paper presented at the World Bank/WTO Conference on Agriculture and the New Trade Agenda from a Development Perspective, Geneva, 1–2 October. Bouguignon, F. and C. Morrisson (2002), ‘Inequality among world citizens: 1820–1992’, American Economic Review, 92 (4), 727–44. Brown, L.R. (1995), Who Will Feed China? Wake-up Call for a Small Planet, Washington, DC: Worldwatch Institute. Cairns Group (2002), ‘Negotiating proposal on market access’, submission to

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the Committee on Agriculture Special Session, JOB(02)/1126, WTO, Geneva, September. Chen, S. and M. Ravallion (2004), ‘Household welfare impacts of China’s accession to the WTO’, in D. Bhattasali, S. Li and W. Martin (eds), China and the WTO: Accession, Policy Reform, and Poverty Reduction Strategies, London and New York: Oxford University Press. Collier, P. and D. Dollar (2002), Globalization, Growth, and Poverty, New York: Oxford University Press for the World Bank. Diao, X, A. Somwaru and T. Roe (2001), ‘A global analysis of agricultural reform in WTO member countries’, background paper for a USDA project on Agricultural Policy Reform in the WTO: The Road Ahead, ERS-E01-001, Washington, DC: US Department of Agriculture. Diaz-Bonilla, E., M. Thomas and S. Robinson (2003), ‘Trade, food security and WTO negotiations: Some reflections on boxes and their content’, in OECD Agricultural Trade and Poverty: Making Policy Analysis Count, Paris: OECD, pp. 59–104. Dollar, D. and A. Kraay (2002), ‘Growth is good for the poor’, Journal of Economic Growth, 7 (3), 195–225. Findlay, C.C. and A. Warren (eds) (2000), Impediments to Trade in Services: Measurement and Policy Implications, London: Routledge. Francois, J. (2001), The Next WTO Round: North–South Stakes in New Market Access Negotiations, Adelaide: Centre for International Economic Studies, and Rotterdam: Tinbergen Institute. Gilbert, C.L. and P. Varangis (2003), ‘Globalization and international commodity trade with specific reference to the West African cocoa producers’, NBER Working Paper 9668, Cambridge, MA, April. Harris, J.R. and M.P. Todaro (1970), ‘Migration, unemployment and development: A two-sector analysis’, American Economic Review, 60 (1), 126–42. Hazell, P. and L. Haddad (2001), ‘Agricultural research and poverty reduction’, IFPRI Discussion Paper 34, Washington, DC: International Food Policy Research Institute, August. Hertel, T.W. (ed.) (1997), Global Trade Analysis: Modeling and Applications, Cambridge and New York: Cambridge University Press. Hoekman, B. (1996), ‘Assessing the General Agreement on Trade in Services’, in W. Martin and L.A. Winters (eds), The Uruguay Round and the Developing Countries, Cambridge and New York: Cambridge University Press, ch. 4. Hoekman, B., F. Ng and M. Olarreaga (2002), ‘Eliminating excess tariﬀs on exports of least developed countries’, World Bank Economic Review, 16, 1–21. Hoekman, B., C. Michalopoulos, M. Schiﬀ and D. Tarr (2001), ‘Trade Policy Reform and Poverty Alleviation’, World Bank Trade Working Paper No. 2773, Washington, DC, December. Ianchovichina, E. and W. Martin (2004), ‘Economic Impacts of China’s Accession to the WTO’, in D. Bhattasali, S. Li and W. Martin (eds), China and the WTO: Accession, Policy Reform, and Poverty Reduction Strategies, London and New York: Oxford University Press. Ianchovichina, E., A. Mattoo and M. Olarreaga (2001), ‘Unrestricted Market Access for Sub-Saharan Africa: How Much is it Worth and Who Pays?’, CEPR Discussion Paper No. 2820, London: Centre for Economic Policy Research, June. Isaac, G.E. and W.A. Kerr (2003), ‘Genetically modified organisms and trade rules:

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Identifying important challenges for the WTO’, The World Economy, 26 (1), 29–43. Lloyd, P.J. (1974), ‘A more general theory of price distortions in open economies’, Journal of International Economics, 4, 365–86. Lloyd, P.J. (2000), ‘Generalizing the Stolper–Samuelson theorem: A tale of two matrices’, Review of International Economics, 8 (4), 597–613. Martin, W. and D. Mitra (2001), ‘Productivity growth in agriculture and manufacturing’, Economic Development and Cultural Change, 49 (2), 403–23. Martin, W. and L.A. Winters (eds) (1996), The Uruguay Round and the Developing Countries, Cambridge and New York: Cambridge University Press. Maskus, K. (2003), ‘Observations on the development potential of geographical indications’, background paper prepared for the 2nd meeting of the Task Force on Trade and Finance of the UN Millennium Development Goals Project, Yale University, New Haven, 1–3 April. Matthews, A. (2002), ‘Developing country experience with the implementation of the Uruguay Round Agreement on Agriculture: Synthesis of the findings of 23 country case studies’, FAO Geneva Symposium on Implementing the WTO’s URAA, 2 October. McCulloch, N., L.A. Winters and X. Cirera (2001), Trade Liberalization and Poverty: A Handbook, London: Centre for Economic Policy Research. Nielsen, C. and K. Anderson (2001), ‘Global market eﬀects of European responses to genetically modified organisms’, Weltwirtschaftliches Archiv, 137 (2), 320–46. OECD (2003), Agricultural Trade and Poverty: Making Policy Analysis Count, Paris: OECD. Otsuka, K. (2002), ‘Poverty reduction issues: Village economy perspective’, Asian Development Review, 19 (1), 98–116. Oxfam (2002), ‘Boxing match in agricultural trade: Will WTO negotiations knock out the world’s poorest farmers?’, Briefing Paper 32, Brussels: Oxfam International. Paarlberg, P.L., M. Bredahl and J.G. Lee (2002), ‘Multifunctionality and agricultural trade negotiations’, Review of Agricultural Economics, 24 (2), 322–35. Ruﬃn, R.J. and R.W. Jones (1977), ‘Protection and real wages: The neoclassical ambiguity’, Journal of Economic Theory, 14, 337–48. Ruﬃn, R.J. and R.W. Jones (2004), ‘Real wages and trade: Insights from extreme examples’, in S. Jayasuriya and P.J. Lloyd (eds), International Trade and Development: Essays in Honour of Peter Lloyd, Cheltenham, UK and Northampton, MA, USA: Edward Elgar (forthcoming). Runge, C.F., B. Senauer, P.G. Pardey and M.W. Rosegrant (2003), Ending Hunger in Our Lifetime: Food Security and Globalization, Baltimore, MD: Johns Hopkins University Press. Sala-i-Martin, X. (2002), ‘The world distribution of income (estimated from individual country distributions)’, NBER Working Paper 8933, Cambridge, MA, May. Sharma, R. (2003), ‘The Transmission of World Price Signals: The Concept, Issues, and Some Evidence from Asian Cereal Markets’, in OECD Agricultural Trade and Poverty: Making Policy Analysis Count, Paris: OECD, pp. 141–60. Tyers, R. and K. Anderson (1992), Disarray in World Food Markets: A Quantitative Assessment, Cambridge and New York: Cambridge University Press. UNCTAD/Commonwealth Secretariat (2001), Duty and Quota Free Market Access for LDCs: An Analysis of Quad Initiatives, Geneva: UNCTAD and London: Commonwealth Secretariat.

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Wilson, J.S. (2002), ‘Standards, trade and development: What is known and what do we need to know?’, paper presented at the Roundtable on Informing the Doha Process: New Research for Developing Countries, Cairo, 20–21 May. Winters, L.A. (2002), ‘Trade liberalisation and poverty: What are the links?’, World Economy, 25 (9), 1339–68. Winters, L.A., N. McCulloch and A. McKay (2002), ‘Trade liberalization and poverty: The empirical evidence’, mimeo, University of Sussex, September. Winters, L.A., T. Walmsley, Z.K. Wang and R. Grynberg (2003), ‘Liberalizing temporary movement of natural persons: An agenda for the Development Round’, World Economy, 26 (8), 1137–61. World Bank (2002), Global Economic Prospects and the Developing Countries: Making World Trade for the World’s Poor, Washington, DC: World Bank. World Bank (2003), Global Economic Prospects 2004: Realizing the Development Promise of the Doha Agenda, Washington, DC: World Bank, September. WTO (2001a), Doha WTO Ministerial 2001: Ministerial Declaration, WT/MIN(01)/ DEC/1, Geneva: World Trade Organization, 14 November. WTO (2001b), ‘Extension of the protection of geographical indications for wines and spirits to GIs for all products: Potential costs and implications’, IP/C/ W/289, Geneva: World Trade Organization, 29 June.

10.

Industrialization, trade policy and poverty reduction: evidence from Asia Peter Warr*

1.

INTRODUCTION

Among economists, the presumption that economic growth reduces poverty is relatively uncontroversial.1 This expectation is based on the statistical definition of absolute poverty incidence and two empirical observations. Absolute poverty incidence is defined as the proportion of the population whose incomes or expenditures fall below a given threshold, the ‘poverty line’, a level of income or expenditure whose nominal value is adjusted over time to hold its real purchasing power constant.2 The level of real income represented by this threshold is essentially arbitrary, but once it is determined, poverty incidence depends simply on the size of the economic pie and its distribution. The two empirical observations are: (i) whereas the size of the pie (real national income) can change considerably over time, the degree of inequality generally changes only slowly; and (ii) changes in inequality are not systematically related to the rate of growth. Changes in poverty incidence must therefore normally be closely related to changes in the size of the pie – via economic growth or its reversal. Exceptions should be rare, but they are possible. The available empirical evidence strongly supports this expectation: on average, the faster the growth, the greater the reduction in absolute poverty. Nevertheless, while diﬀerences in aggregate rates of growth explain many of the observed diﬀerences in rates of poverty reduction, they do not explain all of them. Obviously, distributive policies, technological change and changes in the international environment may all aﬀect poverty incidence, but the nature of the growth itself may also be important. The literature on economic development has emphasized the sectoral composition of growth as a possible determinant of its distributional implications, although this emphasis has been based primarily on a priori theorizing, rather than empirical analysis. The most obvious argument is 239

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that in most poor countries a majority of the poor live in rural areas and are employed in agriculture. From this it has seemed probable that growth of agriculture is more important for poverty reduction than growth of industry or services. Many authors in the development economics field have taken this view, but the conclusion does not necessarily follow. People are potentially mobile. Given suﬃcient time, even poor people can presumably move to whichever sector is generating the growth and thereby generating incomes. Rural poverty may therefore be reduced by urban-based growth, drawing the poor away from rural areas at a rate that depends on the degree of labour mobility (Chenery and Syrquin, 1986; Fields, 1980). When intersectoral factor mobility is taken into account, it is not obvious that the sectoral composition of growth is important for poverty reduction. Of course, labour may not be fully mobile, even in the long run. Moreover, even if labour were fully and instantaneously mobile, poverty incidence could still be aﬀected by the sectoral composition of growth. To a first order of approximation, the level of absolute poverty incidence depends on the incomes of the poor, which presumably depends on the demand for the factors of production that they own – especially unskilled labour and agricultural land. Growth in diﬀerent sectors has diﬀerential eﬀects on the demands for these factors, depending on these sectors’ factor intensities, and may therefore have diﬀerent eﬀects on poverty. Finally, it is important that the distinction rural/urban is not synonymous with the distinction agriculture/non-agriculture. Much agricultural production may occur in full- or part-time farming on the fringes of urban areas and much industrial and services activity may actually occur in rural areas. This chapter explores these issues for three regions of Asia: South Asia, represented by India; East Asia, represented by Taiwan; and Southeast Asia, represented by Thailand, Indonesia, Malaysia and the Philippines. These six economies were chosen for their wide geographical coverage and for the availability of data on aggregate poverty incidence covering a significant number of years in each case.3 The analysis explores the role of the sectoral composition of economic growth in explaining diﬀerences in poverty reduction outcomes in these six economies and the way these eﬀects may depend on the policy environment within which the growth occurs. The limited availability of data that may support statistical analysis has been an impediment to the systematic study of poverty incidence. Some recent studies have attempted to explore the relationships involved by analysing cross-sectional data sets across countries, or across regions or households for individual countries, while others have attempted to assemble long-term time series data sets on poverty incidence for individual countries. The time series approach is generally preferable, in that it makes

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possible a direct study of the determinants of changes in poverty at an aggregate level. Unfortunately, in most developing countries, the consumer income and expenditure surveys on which studies of poverty incidence must be based are conducted only intermittently. Data are thus generally available at most only with intervals of several years between observations. India and Taiwan are two notable exceptions. For India 29 observations can be assembled for the years 1957 to 1997 and for Taiwan 24 observations are available for the years 1964 to 1995. For the countries of Southeast Asia data have been assembled for Thailand and the Philippines since the 1960s and for Indonesia and Malaysia since the 1970s, but the intervals between observations vary from two years to five or even more. When all available time series observations on poverty incidence at a national level are assembled for Thailand, the total number is only ten. For Indonesia it is nine, for the Philippines seven and for Malaysia five. This chapter uses the time series approach and does so via three case studies: South Asia (India), East Asia (Taiwan) and Southeast Asia (Thailand, Indonesia, Malaysia and the Philippines). The Southeast Asia case study is necessarily based upon a pooling of data for the four countries listed because the number of observations listed above for each one individually is insuﬃcient to sustain formal statistical analysis for that country alone. But when all four countries are pooled, the total number of observations is 31. The present study thus pools the data for these four Southeast Asian countries, while still recognizing the possible diﬀerences between them. The justification for pooling data for these four countries is as follows. First, these countries have roughly similar economic structures. All four are market-oriented economies with agricultural sectors which consist primarily of small farming units and which dominate total employment, but not national output. In all four, industrial production has combined exportoriented production with protected production for domestic markets. All four have large services sectors that provide residual employment opportunities for those not employed in agriculture or industry. In all four, the rural populations dominate the total numbers of poor people, but rural-tourban migration has been a prominent feature of the long-term development process. These facts suggest that the underlying relationship between sectoral growth and poverty reduction might be similar among these four countries, whereas this may not apply within groups of countries whose structural features diﬀer widely. Second, despite their structural similarities these countries have somewhat diﬀerent economic histories. Except for the Philippines, all four experienced growth rates above their long-term historical norms during

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the boom decade from the mid-1980s to the mid-1990s, during which aggregate poverty incidence declined, followed by deep recessions from 1997 onwards, during which poverty incidence increased. But aside from this similarity their detailed experiences have been quite diﬀerent. Thailand has grown most rapidly in all three sectors than the other three countries and the Philippines the least rapidly. The rates at which agriculture has contracted as a share of GDP during the process of long-term economic growth have diﬀered, along with rates of industrialization. The above facts suggest that these countries provide four diﬀerent sets of empirical experience around a similar underlying structure, the circumstances in which pooling data is most likely to be appropriate. Section 2 reviews the data to be studied and Section 3 summarizes the analytical approach to be used. Section 4 discusses the results and Section 5 concludes.

2.

POVERTY AND GROWTH IN INDIA, TAIWAN AND SOUTHEAST ASIA

We begin with the time series data for each economy. Figures 10.1 to 10.6 summarize the available data on poverty incidence in the six Asian economies listed above. The data are presented as aggregate poverty incidence and its rural and urban components. The data are summarized in Table 10.1, which shows the mean values of annual rates of change of % 70.00 60.00 50.00 40.00 30.00 20.00 National poverty Rural poverty Urban poverty

10.00

Figure 10.1

Poverty incidence: India, 1957–97

1997

1995

1993

1991

1989

1987

1978

1973

1970

1968

1966

1964

1961

1959

1957

0

Industrialization, trade policy and poverty reduction

243

% 60

50

40

30

20 National poverty Rural poverty Urban poverty

10

0 64 68 72 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95

Figure 10.2

Poverty incidence: Taiwan, 1964–95

% 50 45 40 35 30

National poverty Rural poverty Urban poverty

25 20 15 10 5 0

1969 1975 1981 1986 1988 1990 1992 1994 1996 1999

Figure 10.3

Poverty incidence: Thailand, 1969–99

aggregate, rural and urban poverty incidence. The relationships between these aggregates may be understood as follows. We shall write N, NR and NU for the total, rural and urban populations, respectively, where NNR NU. We write R NR/N and U NU/N for the rural and urban shares of the total population, respectively, where

244

Trade and poverty reduction % 60

50

40 National poverty Rural poverty Urban poverty

30

20

10

0 1976

Figure 10.4

1978

1980

1984

1987

1990

1993

1996

1999

Poverty incidence: Indonesia, 1976–99

% 60

50

40 National poverty Rural poverty Urban poverty

30

20

10

0 1976

Figure 10.5

1984

1990

1993

1995

Poverty incidence: Malaysia, 1976–95

U R U 1. The total number of people in poverty is given by NPNR P NP , U denote the number in poverty in rural and urban areas, N where NR and P P respectively. Aggregate poverty incidence is given by U R R U U P NP N (NR P NP )N P P ,

(10.1)

245

Industrialization, trade policy and poverty reduction % 80 70 60 50 40 30 20

National poverty Rural poverty Urban poverty

10 0 1965

Figure 10.6

1971

1985

1988

1991

1994

1997

Poverty incidence: the Philippines, 1976–99

Table 10.1 Data decomposition: annual rate of change of poverty incidence a Actual India Taiwan 1957–92 1964–95 Aggregateb Ruralc Urband Migratione

0.665 0.320 0.369 0.033

1.573 1.120 0.454 0.001

Aggregateb Ruralc Urband Migratione

100.0 48.1 46.9 5.0

100.0 71.2 28.9 0.1

Thailand 1969–99

Indonesia 1976–99

Malaysia 1976–95

Philippines 1965–97

1.862 1.043 0.187 0.632

1.414 0.582 0.262 0.570

1.589 1.094 0.298 0.197

0.941 0.484 0.369 0.088

Normalized (aggregate 100) 100.0 100.0 100.0 56.0 41.2 68.8 10.0 18.5 18.8 33.9 40.3 12.4

100.0 51.4 39.2 9.4

Notes: a The decomposition relates to the terms of equation (10.2). Aggregate rural urban migration. b Mean annual value of dP, the year-on-year change in aggregate poverty incidence. c Mean annual value of RdPR, the year-on-year population share-weighted change in rural poverty incidence. d Mean annual value of UdPU, the year-on-year population share-weighted change in urban poverty incidence. e Mean annual value of (PR PU )dR, the year-on-year migration-induced change in poverty incidence.

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R where PR NR P N denotes the proportion of the rural population that is U U in poverty and P NU P N the corresponding incidence of poverty in urban areas. Now, diﬀerentiating (10.1) totally, we obtain a key relationship,

dP RdPRUdPU(PRPU )dR.

(10.2)

From (10.2), the change in poverty incidence may be decomposed into three parts: (i) the change in rural poverty incidence weighted by the rural population share, (ii) the change in urban poverty incidence weighted by the urban population share, and (iii) the movement of populations from rural to urban areas weighted by the diﬀerence in poverty incidence between these two areas. The last of these terms is described by Anand and Kanbur (1985) and by Ravallion and Datt (1996) as the ‘Kuznets eﬀect’. As the population moves from rural to urban areas, a change in aggregate poverty incidence will occur even at constant levels of rural and urban poverty incidence, provided that the levels of poverty incidence in these two sectors are diﬀerent. In growing economies, we expect to find that the rural population share is falling (dR 0) and that the incidence of poverty in rural areas typically exceeds that in urban areas ((PR PU ) 0). Thus the expected sign of (PR PU )dR is negative. How important the Kuznets eﬀect is as a determinant of overall poverty reduction is, of course, an empirical matter. Table 10.1 shows that significant poverty reduction was achieved in all six economies but the rate of reduction in Taiwan and in each of the four countries of Southeast Asia was larger than that in India. In India the incidence of absolute poverty declined from 60 per cent of the total population in 1957 to 41 per cent in 1992, an average annual rate of reduction of 0.67 per cent. This means that over this 35-year period the proportion of the population deemed to be poor declined by an average of two-thirds of 1 per cent per year. The comparable rate of reduction for Taiwan was 1.57 per cent per year and for the countries of Southeast Asia the average rate was 1.45 per cent (Thailand 1.86, Indonesia 1.41, Malaysia 1.59 and the Philippines 0.94 per cent). First, we discuss the decomposition of the data on poverty incidence themselves. Table 10.1 shows the results of this decomposition. All results shown in this table are evaluated at the mean values of the data set. For example, the mean annual change in the aggregate level of poverty incidence for Thailand was 1.86 percentage points per year (that is, an annual reduction, on average, from numbers like 20 per cent to numbers like 18.14 per cent). Equation (10.2), above, is an identity and must apply at all points in the data set. It must therefore apply at the means of the data.

Industrialization, trade policy and poverty reduction

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The equation shows that this mean aggregate change in poverty incidence can be decomposed into three components: average poverty reduction in urban areas, average poverty reduction in rural areas, and the movement of population between these two areas. The second half of the table normalizes the decomposition by dividing all values by this mean change in aggregate poverty (1.86 for Thailand, for example) and multiplying by 100. For Thailand reductions in rural poverty accounted for 56 per cent of the overall reduction in poverty, reduced urban poverty for 10 per cent and migration for 34 per cent. Migration eﬀects were even more important for Indonesia, but for all six economies reductions in rural poverty account for more than 40 per cent of the total reduction in poverty incidence that occurred. The above calculations are, of course, merely descriptions of the data. We wish to know what caused these observed changes in poverty incidence to occur and, in particular, what caused the diﬀerences across countries. Poverty incidence and its changes over time obviously depend on many factors, of which economic variables are only part of the story, and among the economic variables many issues aside from simply the overall rate of growth will be relevant. Changes in commodity prices will play a role, along with tax policies. The sectoral composition of growth and the degree to which it is directed towards export markets or domestic markets may also be important. Nevertheless, the data suggest superficially that the overall rate of growth may be an important part of the story. The data on real GDP growth per person are summarized in Table 10.2, covering the same time periods as the poverty data reviewed above. The growth of real GDP per person followed a pattern roughly similar to these data on poverty incidence. The growth rates of real GDP per person, covering the same periods as the poverty data above, were: India 1.91, Taiwan 6.88, and Southeast Asia 3.46 per cent (Thailand 4.19, Indonesia 4.25, Malaysia 4.32, and the Philippines 1.09 per cent). India’s rate of GDP growth was the second lowest of these six economies (after the Philippines), Table 10.2 Annual rates of growth of real GDP per person and its components

Total Agriculture Industry Services

India 1957–92

Taiwan 1964–95

Thailand 1969–99

Indonesia 1976–99

Malaysia 1976–95

Philippines 1965–97

1.91 0.39 4.41 4.26

6.88 0.10 7.61 7.50

4.19 2.01 8.04 5.33

4.25 1.84 6.56 5.17

4.32 1.29 6.37 4.96

1.09 0.29 1.94 1.64

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and its rate of poverty reduction the lowest. Taiwan’s rate of economic growth was the highest and its rate of poverty reduction the third highest, after Thailand and Malaysia, and higher than the average for Southeast Asia. Among the Southeast Asian countries, reductions in poverty have been achieved in each of the four countries but the rate of reduction was lowest in the Philippines, where the average rate of growth was also lowest. At the level of individual economies, a relationship between the rate of poverty reduction over time and the rate of growth over time also seems possible. For example, in Thailand poverty incidence fell throughout the period indicated except for the recession period of the early 1980s, when measured poverty incidence increased and again in the Asian crisis period of the late 1990s when it increased again. Of course, crude correlations between average GDP growth rates and average rates of poverty reduction, extending over long periods of time, do not necessarily indicate that the diﬀerences in GDP growth rates caused the diﬀerences in rates of poverty reduction.

3.

ANALYTICAL FRAMEWORK

We now turn to the manner in which poverty incidence is aﬀected by economic growth. A central conceptual issue must be discussed first. Drawing a causal connection between economic growth and poverty reduction may seem strained because economic growth is not in itself a policy instrument, nor is it exogenous to the economic system. Economic growth is an outcome, determined by policy, external forces and the way market participants respond to them. Poverty reduction is similarly an outcome of the economic system. Drawing a causal connection between the two may thus appear to be an example of attempting to find stable relationships among endogenous variables of a causal system. In general, such relationships do not exist. The conceptual basis for relating poverty to economic growth is summarized in Figure 10.7. The assumption being made is that one of the ways in which economic policies and other variables inﬂuence poverty is via their eﬀects on output. That is, output is a conduit through which these variables act on poverty. They may aﬀect it additionally through other channels as well, as indicated by the box ‘redistributional eﬀects’ in the figure, but these eﬀects are assumed to be minor. We do not expect that all changes in poverty can be attributed to changes in output, but it is being assumed that one significant channel through which policy inﬂuences poverty is through its eﬀect on output. This is the channel between policy and poverty that is studied by looking at the statistical relationship between poverty and growth.

249

Industrialization, trade policy and poverty reduction

Economic policy

Economic growth Poverty reduction

External factors Figure 10.7

Redistributional eﬀects Conceptual framework: growth and poverty

In this framework, the possibility that changes in poverty incidence could have causal feedback eﬀects on the rate of growth is explicitly excluded. Likewise, we exclude the possibility that the source of growth significantly inﬂuences its ultimate impact on poverty incidence. In this system, GDP and its sectoral components are (causally) an intermediate outcome of policy, as well as other factors, and poverty is a subsequent outcome. By studying the causal link between output (growth) and poverty, we are thus studying one component of the link between policy and external shocks, on the one hand, and poverty incidence, on the other. Poverty and Aggregate Growth For simplicity of exposition it is convenient to hypothesize initially that the total number of households in poverty, NP, depends on the aggregate level of real income, Y, and the size of the population, N. The sectoral composition of the growth will be introduced later. We now turn to the manner in which poverty incidence is aﬀected by economic growth and, for simplicity, we hypothesize initially that the total number of households in poverty, NP, depends on the aggregate level of real income, Y, and the size of the population, N. Thus NP (Y, N ).

(10.3)

P NP N (Y, N)N.

(10.4)

Poverty incidence is thus

Totally diﬀerentiating this equation, dP (YYN)y (N N)n,

(10.5)

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where lower-case Roman letters represent the proportional changes of variables represented in levels by upper-case Roman letters. Thus ydY/Y and n dN/N are the growth rates of aggregate real income and of population, respectively. In the special case where the function () is homogeneous of degree one in Y and N, (10.3) may be written NP YYNN and (10.5) reduces to dP(YYN)(yn).

(10.6)

In this case the change in poverty incidence depends on the growth of per capita income. If this assumption is not imposed, then we can estimate relationships of the kind dPa1b1yc1n,

(10.7)

and test whether the coeﬃcient b1 is significantly greater than zero. We could also test whether b1 c1, that is, whether the growth of per capita income is the determinant of the change in poverty incidence, as in (10.6), or whether population growth aﬀects the reduction in poverty incidence in some other way. We wish to study the way economic growth aﬀects each of the components of the change in aggregate poverty incidence, as given by (10.2). Ravallion and Datt apply an ingenious method for estimating decomposed equations systems of this kind. We have a four-equation system, consisting of (10.7) and: RdPRa2b2yc2n UdPUa3b3yc3n R (P PU )dRa4b4yc4n.

(10.8) (10.9) (10.10)

But from the identity given by (10.2), these equations are linearly dependent. Equation (10.7) is identically the sum of equations (10.8), (10.9) and (10.10). Of these four equations, only three need to be estimated. The parameters of the fourth can be computed from (10.2), using the identities a4 a1 a2 a3, b4 b1 b2 b3 and c4 c1 c2 c3. Poverty and Sectoral Growth Whether the sectoral composition of economic growth aﬀects poverty reduction can now be investigated as follows. The level of real GDP is given

Industrialization, trade policy and poverty reduction

251

by YYa Yi Ys, where Ya, Yi and Ys denote value-added (contribution to GDP) at constant prices in agriculture, industry and services, respectively. The overall rate of growth can be decomposed into its sectoral components from yHayaHiyiHsys,

(10.11)

where Hk Yk /Y, k(a, i, s) denotes the share of sector k in GDP. The eﬀect of sectoral growth can now be studied by substituting (10.11) into equations (10.7), (10.8) and (10.9). By estimating the equation dPa1b1aHa yab1i Hi yib1s Hs ysc1n

(10.12)

and testing whether b1ab1i b1s , we may test directly whether the sectoral composition of growth aﬀects the rate of poverty reduction. An alternative way of viewing this relationship is to decompose equation (10.12) into a component depending on the aggregate rate of growth and a component depending on changes in its composition. Noting that Ya (Ya /Y )Y HaY, ya yha,

(10.13)

where ha dHa /Ha denotes the proportional change in agriculture’s sectoral share of GDP. It follows that b1aHa yab1i Hi yib1s Hs ys(b1aHab1i Hib1s Hs)y b1aHa hab1i Hi hib1s Hs hs.

(10.14)

The impact of sectoral growth can be broken into two parts: one involving the aggregate rate of growth (with the coeﬃcient in parentheses), and a second involving changes in its composition (the final three terms). Clearly, this expression reduces to a term in y alone if and only if the final three terms sum to zero. Now, by diﬀerentiating the identity Ha Hi Hs 1, we see that Ha ha Hi hi Hs hs 0.

(10.15)

Therefore, a suﬃcient condition for the final three terms of (10.14) to vanish is that b1 b2 b3, as discussed in relation to equation (10.12) above. Clearly, to apply this decomposition, no additional econometrics is necessary beyond the estimation of equations such as (10.12). Estimation of the parameters of (10.12) is suﬃcient to support the decomposition represented by (10.14).

252

Trade and poverty reduction

Applying the method of equations (10.7), (10.8) and (10.9) above, we estimate the system dPa1b1aHa ya b1i Hi yib1s Hs ysc1n RdPRa2 b2aHa ya b2i Hi yib2s Hs ysc2n UdPUa3b3aHa ya b3i Hi yib3s Hs ysc3n

(10.16) (10.17) (10.18)

The parameters of the fourth equation of the system (PRPU )dRa4b4aHayab4i Hiyib4s Hsysc4n

(10.19)

are then computed using identities derived from (10.2), as before: a4 a1 a2 a3, b4ab1ab2ab3a, and so forth.

4.

RESULTS4

The regression results are summarized in Tables 10.3 to 10.6. For expositional reasons it will be convenient to present the results for Taiwan first, followed by Southeast Asia and then India. The statistical analyses for Table 10.3

Results: Taiwan Change in total poverty

Change in rural poverty

Change in urban poverty

Coeﬃcient t-statistic Coeﬃcient t-statistic Coeﬃcient t-statistic Constant Agriculture growth Industry growth Services growth Population growth R2 Adjusted R2 F-statistic Durbin– Watson

0.1256 0.6115

1.31 0.35

0.1421 0.4501

0.18 0.41

0.0498 0.8349

0.22 2.68

0.4683

3.25

0.2835

3.18

0.0674

2.65

0.1498

0.52

0.1270

0.71

0.0219

0.43

2.0687

3.64

1.3602

4.00

0.3834

3.13

0.547 0.456 – 1.68

0.549 0.459 – 1.65

0.739 0.686 – 1.26

253

Industrialization, trade policy and poverty reduction

Table 10.4 Results: Southeast Asia – Thailand, Indonesia, Malaysia and the Philippines Change in total poverty

Change in rural poverty

Change in urban poverty

Coeﬃcient t-statistic Coeﬃcient t-statistic Coeﬃcient t-statistic Constant Agriculture growth Industry growth Services growth Population growth

1.589 0.5430

4.226 2.283

0.0578

0.476

1.186

Intercept dummy, Thailand Intercept dummy, Indonesia Intercept dummy, Malaysia R2 Adjusted R2 F-statistic

5.860 3.369

0.150 0.174

0.996 1.826

0.0064

0.057

0.053

1.078

8.621

1.0941

8.376

0.120

2.167

0.071

0.631

0.036

0.353

0.0367

0.815

1.050

3.627

0.885

2.408

0.232

1.997

0.412

1.355

0.666

2.408

0.239

1.968

0.6291

1.956

0.712

2.431

0.3376

2.618

0.672 0.652 34.5

2.006 0.729

0.708 0.691 40.9

0.2554 0.2112 5.8

Taiwan, Southeast Asia and India use the same format, but are conducted independently. For Southeast Asia, the method of pooling requires explanation. Considering the diﬀerences between these countries in the measurement of poverty, the real value of the poverty lines, the position and shape of the cumulative income distribution and the detailed structure of the four economies, it could hardly be expected that the same numerical relationship between poverty incidence and economic growth could obtain in all four. The method used here employs dummy intercept variables to capture these diﬀerences. Dummy variables are used for three of the four countries. Their coeﬃcients amend the intercept coeﬃcients estimated for the fourth country. The results are the same whichever country is selected as the ‘fourth’. It is, of course, being assumed in this pooling process that the slope coeﬃcients are the same for all four Southeast Asian countries, but this

254

Table 10.5

Trade and poverty reduction

Regression results: India I – 1957–92 Change in total poverty

Change in rural poverty

Change in urban poverty

Coeﬃcient t-statistic Coeﬃcient t-statistic Coeﬃcient t-statistic Constant Agriculture growth Industry growth Services growth Population growth

0.309 0.501

0.478 2.507

0.180 0.420

0.296 2.234

0.219 0.096

1.506 2.100

2.114

2.524

1.930

2.430

0.120

0.642

1.299

2.130

1.323

2.321

0.066

0.475

1.061

2.082

0.842

1.790

0.251

2.195

R2 Adjusted R2 F-statistic Durbin– Watson

0.766 0.688 9.83 2.248

Table 10.6

0.717 0.642 9.62 2.141

0.556 0.439 4.75 2.244

Regression results: India II – 1957–97 Change in total poverty

Change in rural poverty

Change in urban poverty

Coeﬃcient t-statistic Coeﬃcient t-statistic Coeﬃcient t-statistic Constant Agriculture growth Industry growth Services growth Population growth

4.56 0.49

0.49 2.2

4.09 0.41

0.75

0.82

1.34

2.21

1.22

2.19

0.49

1.94

R2 Adjusted R2 F-statistic Durbin– Watson

0.59 0.49 6.5 2.21

0.763

0.56 0.46 5.8 2.3

0.49 1.98

0.44 0.085

0.22 1.76

0.92

0.041

0.21

0.12

0.89

0.26

0.27

2.2 0.48

0.38 0.25 2.85 1.9

Industrialization, trade policy and poverty reduction

255

assumption applies only among the four Southeast Asian countries; no such assumption is being made with regard to Taiwan and India. If sectoral economic growth and population growth aﬀected poverty reduction jointly through their eﬀects on per capita sectoral growth, equation (10.16) could be rewritten dPa1b1aHa(yan)b1i Hi(yin)b1s Hs(ysn),

(10.20)

and similarly for equations (10.17) to (10.19). That is, (10.16) to (10.19) would each satisfy the restriction that baj Hab ijHibsjHsc j, j(1, . . . , 4). When this restriction was imposed on the estimates of equations (10.16) to (10.18) it was rejected at the 95 per cent level of significance in the case of Taiwan and India and at the 10 per cent level of significance for Southeast Asia. We shall therefore not impose this assumption. It is convenient to focus the discussion on the equation for aggregate poverty incidence, equation (10.16). For Taiwan (Table 10.3), the estimated coeﬃcients for all three sectors, agriculture, industry and services, were negative (growth of each of these sectors was associated with poverty reduction) but only the coeﬃcient for industry was significantly diﬀerent from zero. The null hypothesis that the coeﬃcients for each sector were the same was rejected by an F-test at the 90 per cent confidence level. For Southeast Asia (Table 10.4), the estimated coeﬃcients for agriculture and services were negative and significantly diﬀerent from zero at the 95 per cent confidence level. Growth of agriculture and services was thus strongly associated with reductions in poverty. The coeﬃcient for industry was positive, but small and not significantly diﬀerent from zero. The null hypothesis that the three coeﬃcients were the same was again rejected by an F-test at the 95 per cent level. For India, the results will first be presented for the years 1957 to 1992, corresponding to the period covered in an important paper by Ravallion and Datt (1996). The null hypothesis that the three coeﬃcients were the same was again rejected by an F-test at the 95 per cent level. The results are similar to those derived earlier for India by Ravallion and Datt, despite diﬀerences in methodology.5 Growth in agriculture and services each produce reductions in poverty and the coeﬃcients are significantly diﬀerent from zero at the 95 per cent confidence level. Growth of industry was associated with increases in poverty and this coeﬃcient was also significantly diﬀerent from zero at the 95 per cent confidence level. Ravallion and Datt also obtained a positive estimate for this coeﬃcient (it was significant at the 90 per cent confidence level), but these authors do not oﬀer an economic explanation for the result.

256

Trade and poverty reduction

According to these results, growth of agriculture and services is consistently associated with poverty reduction. The diﬀerences arise with industrial growth. In Taiwan, growth of industry was strongly associated with poverty reduction. In India (1957 to 1992) it was associated with rising poverty. The results for Southeast Asia are exactly intermediate. Industry growth was neutral with respect to poverty incidence. An obvious explanation is available. The trade policy regimes under which the industrial growth occurred were radically diﬀerent in these three case studies. In Taiwan, growth of industry was not based on import substitution policies. Industry received little protection and agriculture was the more highly protected sector. The result was a pattern of industrialization that was relatively labour-intensive, contained a substantial small enterprise component and was closely linked to rural areas. In India heavy protection of industry led to a capital-intensive, large-scale and urban-based pattern of industrialization. Southeast Asian industrial policies were exactly intermediate between these two extremes. They were not as protectionist as India’s, not as liberal as Taiwan’s. The Stolper–Samuelson theorem (Lloyd, 2000) leads us to expect that a capital-intensive industrial strategy will reduce real wages by reducing the demand for labour and increase the return to capital. It is well understood that a strongly protectionist trade policy will reduce the rate of growth. The above results suggest that, in addition, it will promote a pattern of industrial growth that does not serve the objective of reducing poverty. The Indian experience oﬀers a possible test of this hypothesis. Since 1991 India has embarked on a programme of trade liberalization that has seemingly changed its pattern of industrial growth (Srinivasan, 2000; Jha, 2003). If the trade-policy explanation of the results obtained in Tables 10.3 to 10.5 is correct, India’s industrial growth since 1991 should have been more pro-poor. Table 10.6 shows the results obtained when the Indian data are updated to the latest year currently available, 1997. The estimated coeﬃcients for agriculture and services barely change. But the estimated coeﬃcient for industry declines sharply and while still positive, is no longer statistically diﬀerent from zero. If the coeﬃcient of 2.11 for the full time period (1957 to 1997), based on 29 data points, is a weighted average of the coeﬃcient of 0.75 pre-reform period (1957 to 1991), based on 24 data points, and an unknown coeﬃcient for the post-reform period (1992 to 1997), with fi f ve data points, with the number of data points as weights, then the unknown post-reform coeﬃcient must be negative (growth producing poverty reduction) and large. These results, while hardly conclusive, are strongly suggestive that since its reform India’s pattern of industrial development has become significantly more pro-poor.

Industrialization, trade policy and poverty reduction

5.

257

CONCLUSIONS

The three Asian case studies presented in this chapter suggest the following provisional conclusions. Output growth in the agriculture and services sectors consistently reduces poverty. But the contribution of industrial growth depends on the trade policy environment in which the growth occurs. Taiwan’s outward-oriented trade policy apparently induced a pattern of industrialization that was conducive to a massive reduction of poverty incidence, occurring in both rural and urban areas. In Southeast Asia, moderately protectionist industrial policies produced a pattern of industrial growth that made little contribution to poverty reduction. In India’s prereform period, high protection of industry produced a pattern of industrial growth that actually increased poverty. This eﬀect was reversed in the more liberal post-reform period. The eﬀect that industrial growth has on poverty reduction depends on the trade regime because in a poor country protection of capital-intensive industries can not only reduce the rate of growth, but by reducing the demand for unskilled labour it can greatly diminish the poverty-reducing capacity of that growth.

NOTES * 1. 2. 3. 4. 5.

Excellent research assistance from Chen Yuyu and helpful discussions with Premachandra Athukorala and Raghabendra Jha are gratefully acknowledged. The author is responsible for all defects. Among non-economists, there is much less agreement on this. In the author’s view, the lack of consensus usually derives from a failure to distinguish between the concepts of absolute poverty and relative inequality. Some countries base poverty incidence estimates on household incomes (including Taiwan, Thailand, Malaysia and the Philippines), while others use household expenditures for this purpose (including India and Indonesia). The word ‘economies’ is used rather than ‘countries’ to avoid dispute over whether Taiwan is a ‘country’. The results presented here draw in part on work contained in Warr and Wang (1999), Warr (2002, 2003). In the Ravallion and Datt methodology the dependent variable is the proportional change in poverty incidence, rather than the absolute change, as in the present study. When poverty incidence is low, small absolute changes in poverty incidence produce large proportional changes, distorting the results. In addition, Ravallion and Datt seemingly suppress the intercept term in their regression, forcing the regression to pass through the origin. This imposes the unwarranted assumption that zero growth implies zero change in poverty.

REFERENCES Anand, Sudhir and S.M.R. Kanbur (1985), ‘Poverty under the Kuznets process’, Economic Journal, 95 (March), 42–50.

258

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Chenery, Hollis B. and Moshe Syrquin (1975), Patterns of Development, 1950–1970, Oxford: Oxford University Press. Fields, Gary S. (1980), Poverty, Inequality and Development, Cambridge: Cambridge University Press. Jha, Raghabendra (ed.) (2004), Indian Economic Reforms, Basingstoke: Palgrave Macmillan. Lloyd, Peter (2000), ‘Generalizing the Stolper–Samuelson theorem: A tale of two matrices’, Review of International Economics, 8, 597–613. Ravallion, Martin and Gaurav Datt (1996), ‘How important to India’s poor is the sectoral composition of economic growth?’, World Bank Economic Review, 10, 1–25. Srinivasan, T.N. (2000), Eight Lectures on India’s Economic Reforms, New Delhi: Oxford University Press. Warr, Peter G. (2002), ‘Poverty reduction and sectoral growth: Evidence from Southeast Asia’, WIDER Discussion Paper DP2002/20, available at: http://www. wider.unu.edu/publications/publications.htm Warr, Peter G. (2003), ‘Poverty and economic growth in India’, in K.P. Kalirajan and U. Sankar (eds), Economic Reform and the Liberalisation of the Indian Economy, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 185–209. Warr, Peter G. and Wang Wen-thuen (1999), ‘Poverty, inequality and economic growth in Taiwan’, in Gustav Ranis and Hu Sheng-cheng (eds), The Political Economy of Development in Taiwan: Essays in Memory of John C.H. Fei, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 133–65.

PART FIVE

Empirical Investigations in Trade

11.

The surge in US imports, 1995–2001 Mordechai E. Kreinin

1.

INTRODUCTION

In 1987, after six straight years of large current account deficits, the USA became a net debtor country. In year 2001, the trade deficit was $426 billion and the current account deficit reached $417 billion (over 4 per cent of GDP). It was financed by a capital account surplus of over $400 billion and a small rise in foreign oﬃcial reserves.1 (Imports declined somewhat from 2000 to 2001, reflecting the slowdown in the economy.) By year 2000 the US net foreign debt position reached $1.8 trillion – about 18 per cent of GDP. The sustainability of these large current account deficits and their potential consequences have been a matter of discussion in the literature. But their root cause has been attributed to the large trade deficits propelled by diﬀerential growth rates in the USA and abroad.2 In particular the massive growth in US imports, to $1223 billion in 2000, is said to be the result of an income eﬀect; to wit, the rapid growth of the economy between 1995 and 2000, with real GDP rising at over 4 per cent per year. By comparison, US exports were hampered by stagnation and crisis elsewhere in the late 1990s. In short, the surge in US imports is explained by the usual independent variables in the importdemand function. Indeed, all the evidence points to the growth eﬀect on US consumers and producers sucking in an ever-increasing quantity of imports. Yet a nagging question remains: do the traditional income and relative price variables explain the entire surge in US imports volume in 1995–2000; or did other factors help uplift imports above the trend established in earlier years? If there was a break from the traditional relationship, by how much did it uplift imports? In other words, what would imports have amounted to if the price and income eﬀects had retained their historical explanatory power? And finally, did a similar break occur in other industrial countries?

261

262

2.

Empirical investigations in trade

THE US EXPERIENCE

To address the above question, I estimated the usual import-demand function using quarterly data dating from 1983.1 to 2001.3 but added a binary variable: 1 for the 1995.1–2001.3 quarters and zero otherwise. In other words, the volume index of imports is made a function of: real GDP, import prices, domestic wholesale prices and the binary variable. The estimating equation is of the form: Qm 0 1GDPreal 2PM3WPI4BVu The same regression, but without the binary variable, was estimated separately for two sub-periods: 1983.1–1994.4 and 1995.1–2001.3. Table 11.1 presents the results of the three regressions, in both index number form (left-hand side) and double log form (right-hand side). In the latter case the estimated coeﬃcients can be interpreted as elasticities. Separate regressions for manufactured imports yielded similar results. It is seen that the income elasticity of import demand is nearly 2.5, while the price elasticity with respect to import prices is just under 1. The domestic wholesale price variable is not significant, but domestic prices did not vary much over the period. Reformulation of the estimating equations in terms of a price ratio variable (import prices/domestic wholesale prices) yields similar results. While the table shows a strong income eﬀect on US imports, it does not address the question of whether the current account drives the capital account or vice versa. Figure 11.1 shows actual US imports, and US imports estimated by the equation in the last column of Table 11.1. One main interest is the behaviour of the binary variable that would indicate a possible break from the historical relationship. It is seen in Table 11.1 that the binary variable is significant at the 1 per cent level; the income elasticity of import demand exhibits a quantum jump from 2.3 in the first period to 3.4 in the second period. There has been a break from the traditional relationship in the second half of the 1990s. To assess the degree to which imports surged we applied the first-period coeﬃcients to the GDP and prices data in 1995.1–2000.4, thereby obtaining an estimate of what imports would have been had the early relationships been maintained. Figure 11.2 shows that in 1996 the two series began to diverge, with the excess of actual over estimated imports growing rapidly over time. By year 2000 this excess was between $250 and $300 billion. This means that if the historical relationships had held, 2000 merchandise imports would have been well under $1 trillion instead of $1.22 trillion, and the trade deficit would have been under $200 billion instead of $450 billion.

263

0.44 (19.24)** 8.77 (5.24)** 13.48 (4.18)** 10.47 (18.15)** 48 0.98

2.31 (21.25)** 0.93 (6.23)** 0.13 (0.78)

1983.1– 1994.4

20.83 (17.65)** 27 0.99

3.42 (17.80)** 0.47 (2.89)** 1.14 (3.51)**

11.87 (17.99)** 75 0.99

2.34 (23.62)** 0.73 (7.08)** 0.03 (0.2) 0.08 (5.91)** 11.10 (19.87)** 75 0.99

1983.1–2001.3

2.46 (20.96)** 0.94 (7.89)** 0.17 (0.87)

Log form

1995.1– 2001.3

Sources: Indexes of import volume (1996 100), real GDP (1996 100) import prices (1996 100) and domestic wholesale prices all from the Bureau of Economic Analysis website.

154.99 (1.5) 75 0.98

0.24 (12.11)** 8.70 (5.63)** 1.25 (0.49) 54.08 (2.72)** 115.03 (1.15) 75 0.98

1983.1–2001.3

0.25 (12.65)** 9.71 (6.20)** 0.06 (0.23)

Index form

1995.1– 2001.3

2151.15 (14.41)** 27 0.99

Notes: Absolute value of t-statistics in parentheses. ** Significant at 1% level.

No. of observations Adjusted R2

Constant

Dummy (1995 1)

Wholesale prices

237.82 (4.08)** 48 0.96

0.16 (13.59)** 4.99 (56.00)** 1.98 (1.54)

Real GDP (1996 $)

Import prices

1983.1– 1994.4

Independent variable

Table 11.1 US import-demand functions, 1983–2001 (dependent variable is import at 1996 prices)

264

Empirical investigations in trade 180 Actual 160 140

Import quantity

120 100

Estimated

80 60 40 20

19

9 19 5 9 19 5 9 19 6 9 19 7 9 19 8 9 19 8 9 20 9 0 20 0 0 19 1 8 19 9 9 19 0 9 19 1 9 19 2 9 19 2 9 19 3 9 19 4 9 19 5 9 19 5 9 19 6 9 19 7 9 19 8 9 19 8 9 20 9 0 20 0 01

0

Year and quarter

Figure 11.1

Estimated and actual US imports

180 160

Actual import

Import quantity

140 120 100

Estimated import

80 60 40 20

8 19 3 8 19 4 8 19 5 8 19 6 8 19 6 8 19 7 8 19 8 8 19 9 8 19 9 9 19 0 9 19 1 9 19 2 9 19 2 9 19 3 9 19 4 9 19 5 9 19 5 9 19 6 9 19 7 9 19 8 9 19 8 9 20 9 00

19

19

83

0

Year and quarter

Figure 11.2 Actual and estimated imports in the USA, with estimates based on 1983–94 coeﬃcient

The surge in US imports, 1995–2001

3.

265

POSSIBLE EXPLANATIONS

What might be the reason for this upward departure from earlier trends? One possible reason is the overvalued dollar, especially relative to the yen and the euro. But the overvaluation did not increase towards the end of the decade, so as to explain the widening gap between actual and estimated imports in Figure 11.2. More important, exchange rate changes are mostly reflected in import prices, which are significant at the 1 per cent level. The rise in imports under study is what occurred over and above that induced by income and relative price changes. Further explanations are necessarily speculative in nature. One is the strained productive capacity in various sectors of the US economy, with the excess demand over supply being filled by imports. This possible explanation has more general implications. The alleged trade-oﬀ between inflation and unemployment, that was absent in the second half of the 1990s, should perhaps be reinterpreted as a relation between domestic inflation and global unemployment, rather than domestic unemployment. Now that the US economy is reasonably open to foreign imports, the domestic negative trade-oﬀ is between unemployment and imports. In other words, it is not only productivity growth but also import growth that held down inflation in the USA. This hypothesis would become testable once unemployment in Europe, Asia and Latin America receded considerably, limiting their capacity to export to the USA. Another possible explanation is a wealth eﬀect. To test that proposition, household assets and debts variables were added to the equations. Only the debt variable is significant, with the ‘correct’ sign (Table 11.2). Surprisingly, there appears to be no positive wealth eﬀect on US imports. It was not possible to test for such an eﬀect for other countries because they do not provide quarterly asset and debt data. (Annual data on assets for Australia for 1981–2001 showed no asset eﬀect.)

4.

EXPERIENCE OF OTHER COUNTRIES

I conducted a similar analysis, using the same estimating equation, for a number of other OECD countries for which data are available. In the case of Germany, unification of East and West limited the series to years 1990–2001. Several other countries did not report quarterly statistics. Of the large industrial countries, the equation was estimated for the UK, Japan, France, Germany (truncated), Italy, Canada and Australia using the IMF International Financial Statistics for import volume and price data; and the OECD Quarterly National Account Statistics for real GDP.

266

Empirical investigations in trade

Table 11.2 US import-demand function, 1983–2001, with assets added (log form) Independent variable Log of GDP Log of import prices Log of wholesale prices

(1)

(2) (assets added)

2.46 (20.96)** 0.94 (7.89)** 0.17 (0.87)

3.65 (13.39)** 0.68 (5.88)** 0.06 (0.33) 0.17 (0.56) 1.12 (4.35)** 17.66 (14.50)** 75 0.99

Log of household assets Log of household debts Constant No. of observations Adj. R2

11.87 (17.99)** 75 0.99

Notes: Absolute value of t-statistics in parentheses. ** Significant at 1% level.

Only in the cases of Japan and France was the binary variable significant. Therefore Table 11.3 shows the regression results for the entire period for four countries, for separate periods for Japan and France, and for a truncated period for Germany. Estimates were also made for a couple of small countries: for Denmark the binary variable was significant, but for New Zealand it was not. Comparison of Tables 11.1 and 11.3 shows that the income elasticity of import demand is higher in the USA than in its trading partners, especially Canada and Japan. This is particularly true in the last half of the previous decade, when the US elasticity is nearly double that of Canada, triple that of Japan (where the elasticity actually declined), and higher than its European trading partners’. The insight of the 1970s, that if all countries enjoyed the same growth rate, the USA would develop a deficit and other countries a surplus, still holds in the 1990s and beyond. The US trade deficit is due not only to a higher growth rate, but also to a higher propensity to import! Much has been written about sustainability of the trade and current account deficits at such high levels. Will the massive inflows of funds into the USA continue, especially after the euro becomes an established currency, after the European capital markets are integrated (now still fragmented),

267

Canada

Italy

Notes: Absolute value of t-statistics in parentheses. ** Significant at 1% level.

2.43 (18.82)** 0.34 (3.32)** 0.04 (0.31)

UK

1983.1–2001.3 Australia

1983.1– 1994.4 Japan

1995.1– 2001.2

1983.1– 2001.2

Import-demand functions for seven countries (double log form) 1983.1– 1994.4

1.83 3.25 2.34 1.51 1.04 1.48 2.43 (9.55)** (6.90)** (26.32)** (16.29)** 1.61 (17.32)** (7.95)** Import 0.04 0.08 0.56 0.33 0.52 0.33 0.12 prices (0.25) (0.67) (4.69)** (2.58)* (3.53)** (3.44)** (0.79) Wholesale 1.17 0.34 0.25 1.43 4.08 1.69 0.37 prices (5.12)** (1.44) (2.29)* (4.41)** (4.01)** (5.47)** (1.58) Dummy 0.06 (1995 1) (6.97)** Constant 2.25 4.06 3.65 2.06 1.12 7.05 1.72 1.92 (13.96)** (19.35)** (9.44)** (24.43)** (1.67) (2.36)* (2.58)* (5.76)** No. of 75 75 73 74 48 26 74 48 observations Adjusted R2 0.99 0.99 0.94 0.98 0.97 0.72 0.98 0.89

GDP

Independent variable

Table 11.3 1983.1– 2001.1

Germany

1990– 2001

0.89

0.96

0.74

2.72 2.55 2.88 (13.20)** (14.79)** (6.86)** 0.25 0.20 0.07 (2.11)* (2.24)* (0.49) 0.52 0.31 3.79 (1.15) (1.67) (2.62)* 0.03 (2.77)** 3.98 2.12 8.51 (3.86)** (7.43)** (1.64) 25 73 41

France

1995.1– 2001.1

268

Empirical investigations in trade

after it adjusts to the ‘one-size-fits-all’ monetary policy, and when it oﬀers a full substitute to the dollar as an investment outlet? Indeed, the existence of the euro as an investment outlet makes it more likely than in earlier years that exchange rate adjustment will occur, so as to lower the deficit to a more manageable level. No one oﬀers a credible time frame for the duration of large capital inflows. But once the inflows subside, or when central bankers and portfolio managers diversify partly from dollars to euros, an adjustment will take place through the exchange rate and interest rates in the USA and abroad. In large measure, the price eﬀect will have to oﬀset the income eﬀect.3 A reasonable question might be: what would be required to reduce US import by 20 per cent, or about $250 billion in terms of year 2000, so that the trade deficit is cut by half ? With US import-demand elasticity of about 1, and a pass-through of 2/3, the dollar would have to depreciate by about 25 to 30 per cent. These estimates were made when the euro was about $0.84. Since then it has moved well above parity with the dollar so that relative to the euro the dollar depreciated by about 30 per cent. But it still needs to depreciate against other currencies as well. Such depreciation would also stimulate US exports, further reducing the deficit. But the price elasticities of import demand in Canada, Japan, the UK, Italy and France are small and the pass-through eﬀect is also known to be small. So US exports may rise by only about 10 per cent, or well under $100 billion. Also, given a long period of dollar overvaluation, hysteresis may have set in, contributing to a time lag in the adjustment process. But everything considered, it is not unreasonable to expect a real, trade-weighted, depreciation of the dollar of this order of magnitude over the next decade. Such dollar depreciation may create global imbalances inasmuch as Europe and the Far East fail to stimulate domestic demand and continue to depend on exports to the USA as their main engine of growth. Finally, the overvalued dollar is one cause of the ‘disconnect’ between GDP growth and corporate profit in the 2001–02 recovery of the US economy.

5.

GDP GROWTH AND CORPORATE PROFIT: A DISCONNECT

Although the 2001 US recession was both mild and short-lived, it was the harshest in memory when measured in terms of profit level. After-tax corporate profits declined by 15.9 per cent in 2001; and the companies included in the Standard & Poor’s 500 stock index reported a 50 per cent drop in pre-tax income. This brutal profit environment, plus the decline in confidence in corporate governance following the revelations of faulty

The surge in US imports, 1995–2001

269

accounting practices, goes a long way toward explaining the decline in the stock market in 2001–02. Note, however, that our concern is with corporate profitability and not with the stock market behaviour. What is unique about the 2001–02 recovery in the USA was not its slow nature – the post-1991 recovery was equally slow until 1995. Nor is the fact that the decline in unemployment lagged behind GDP unique – employment is always a lagging indicator. Rather it is the fact that corporate profits failed to recover from the recession. This is reflected in the behaviour of the S&P 500 stock index. In the 13 recoveries since 1933 this index rose an average of 20 per cent in the 23 weeks after the recession trough. Even in the post-1991 recession it rose, albeit by only 5 per cent, over 23 weeks. By sharp contrast, in the 2001–02 recovery that index declined by 10 per cent relative to the trough in mid-2001. What are the factors responsible for the disconnect between GDP growth and corporate profits? It is important to explore the answer to this question, if for no other reason than to assess how long this phenomenon is likely to last. The answers are necessarily hypothetical. But three possible factors suggest themselves. First, the large discounts oﬀered by the auto and other industries in 2001 promoted sales but undercut corporate profits. These have largely been phased out. Second, the overvalued dollar on the foreign currency markets meant that profits realized overseas were translated into fewer dollars when repatriated to the USA. This eﬀect will cease once the dollar depreciates by a significant amount, as suggested in the previous section of the chapter – a depreciation that has already begun, especially relative to the euro. Depreciations should also improve profitability by making US companies more competitive at home and abroad. But a smooth global adjustment would require Europe, Japan, and other Far Eastern countries to promote recovery via the expansion of domestic demand rather than reliance on export to the USA. Third is post-9/11 adjustments to security concerns in the transportation and other industries. Consider the following examples: 1. 2. 3.

4.

If and when corporations replace the glass windows of their boardrooms with bullet-proof glass, GDP rises but corporate profits decline. The same applies to the hiring of security personnel and the installation of security apparatus. Enhanced eﬃciencies in the supply chain, such as the deployment of just-in-time inventories, must be partly rescinded because of possible disruptions or delays in the arrival of parts and materials. This may be due to adjustments in the transportation system. Delays of shipments in the Canadian and Mexican borders, as well as in all ports and airports, due to security checks.

270

Empirical investigations in trade

These security-related costs may add up to over 1 per cent of GDP (I have seen estimates of between $100 and $125 billion). So if GDP grew by 1 per cent, corporate profits could be at a standstill. But they are ‘one-oﬀ’ expenses, in that once spent they would not need to be magnified further. Assuming there are no other massive terrorist attacks, these expenses would stabilize within one to one and a half years, and beyond that point would have no further eﬀect of disconnecting GDP from corporate profit. This section is necessarily speculative in nature, but it contains some measurable hypotheses. If the above factors are indeed those responsible for the ‘disconnect’, it is likely to disappear in the not-too-distant future, because the three factors themselves are temporary in nature.

NOTES 1. See Mann (2001), p. 97. 2. See, for example, Humpage (1998, 2000). 3. See Mann (2002).

REFERENCES Humpage, O.F. (1998), ‘Is the current-account deficit sustainable?’, Federal Reserve Bank of Cleveland, Economic Commentary, 15 October. Humpage, O.F. (2000), ‘Foreign economic growth and the dollar’, Federal Reserve Bank of Cleveland, Economic Commentary, 1 September. Mann, Catherine (2001), ‘Is the U.S. current account deficit sustainable?’, Finance & Development, IMF, Washington, DC, March, 42–5. Mann, Catherine L. (2002), ‘Perspectives on the US current account deficit and sustainability’, Journal of Economic Perspectives, Summer, 131–52.

Index 11 September 2001 137 absolute poverty 239, 240 ad-valorem tariﬀs 107, 110, 157–8 adjustment costs, customs unions 186 adjustments loans 13 Africa gains from trade reform 212–14 preferential market access 217–21 see also West Africa Africa Growth and Opportunity Act, US 221 aggregate growth and poverty 249–50 Agreement on Agriculture, WTO 231 Agreement on Technical Barriers to Trade (TBT Agreement) 57–8 agricultural biotechnologies 230 growth and poverty incidence 255–7 policies 225 protection 222–3, 229–30 tariﬀs 98, 103, 107–8 trade liberalization 100 agricultural trade reform, WTO 205–7 eﬀect on food security 231–2 impact on developing countries 216–29 maximization of benefits 230–31 risks of re-instrumentation of protection 229–30 welfare gains 207–16 agriculture multifunctionality of 229–30 special treatment of 163–5 analytical framework, poverty incidence study 248–52 anti-competitive practices 70, 73, 74, 79 anti-dumping 69, 80, 85 anti-trust 74–5, 85 ANZUS free trade agreements 153–4, 166–8

alternative trade liberalization shocks 161–6 model structure and data source 154–8 sensitivity analysis 160–61 simulations 158–60 APEC Competition Principles 78 meetings 137 New Zealand Summit (1999) 140–41 trade and investment liberalization 143 Appellate Body, WTO 45, 51, 52–3, 55–7 applied tariﬀs 103–8 arbitrage, goods markets 194–5 Argentina 34, 37, 196 Armington elasticity function 109, 155, 161 asbestos products 52, 55 ASEAN challenges for 121–2, 144–50 economic integration in 122–9 as a hub 146–7 Ministerial Meetings 139 RTAs 134–8 Secretariat 149–50 Summits 138, 149 trade 124–7 trade and investment liberalization 143 ASEAN Economic Community (AEC) 129, 148 ASEAN Expert Group 135 ASEAN Framework Agreement on Services (1995) 127, 143 ASEAN Free Trade Area (AFTA) 124, 129 Common Eﬀective Protective Tariﬀs (CEPT) 127 ASEAN Free Trade Area–CER Closer Economic Partnership (2002) 134 271

272

Index

ASEAN Free Trade Area-plus approach, ASEAN integration 147–8 ASEAN Regional Forum 124 ASEAN Surveillance Process (1998) 128, 139 ASEAN Swap Arrangement (1977) 128, 139 ASEAN Vision 2020 128–9 ASEAN–CER Closer Economic Partnership 134 ASEAN–China Comprehensive Economic Cooperation 134–6, 147 ASEAN–China Expert Group 134 ASEAN–India Framework Agreement on Economic Cooperation 138 ASEAN–Japan Framework Agreement 137 ASEAN–US Business Council 137 ASEAN–US Partnership 137–8 ASEAN+1 144 ASEAN+3 130, 138–9, 140, 150 ASEAN-5 121 ASEAN-6 124, 128, 135, 138 ASEAN-10 121, 128, 138–9, 140 Asia currency upheavals 180 industrialization 223 poverty and economic growth 239–56 relationship with US 165–6 unemployment 265 see also East Asia; Northeast Asia; South Asia, Southeast Asia Asia Pacific G-Cubed model 166–7 Asia-Pacific Economic Cooperation see APEC Asian Development Bank 128 Asian financial crisis (1997–98) 32, 34, 121, 128, 130, 138, 150, 248 Asian Monetary Fund, proposal for 139 asset markets, development of 9 assistance programmes 83 Association of Southeast Asian Nations see ASEAN Australia and competition policy 78 economic performance 181 FTAs 140 imports 265

as an optimal currency area 185–6, 198 productivity 194 RTAs 47, 134, 143 see also ANZUS free trade agreements Australia–New Zealand Closer Economic Relations (CER) 134 automobile industry 195 Badawi, Datuk Seri Abdullah Ahmad 144 banana import regime, European Union 220 Bangkok Declaration (1967) 121 Bank of Canada 190, 193, 194 base rates, tariﬀs 102 Bhagwati, Jagdish 42 bilateral free trade agreements ASEAN 129–40 MFN exemptions 81, 84 as protection against cartels 75 bilateral trade, level of 196 bilateralism 140–44 issues and implications 144–50 ‘binding overhang’, tariﬀs 93–5, 103, 107–8 border taxes 49–50 bound tariﬀs 92–3, 97, 102, 103–7 Brazil 34, 93, 103, 107–8, 114 British Columbia 188–9 British Commonwealth 196, 222 Brunei 121, 127, 144 Bush, President George W. 137, 153, 167 Cairns Group 90, 96, 231 California 188–9 Cambodia 121, 124, 127, 130 Canada and competition policy 77 economic performance 180–81 exchange rates 190–91 exports 190 FTAs 140, 146 imports 265, 266, 268 market separation 195 as an optimal currency area 182–3, 188–9, 197, 198 productivity 191–2, 194

Index Cancun Ministerial Conference (2003) 90, 103 capacity building 71, 72–3, 75, 82, 83, 149, 213 capital markets development of 9 eﬀects of customs unions 182–5, 266–8 capital-intensive industrial strategies 256 Caribbean 38, 217–21 cartels 69, 70, 80, 83–4, 85 clarification of provisions on 75–7 ‘ceiling bindings’, tariﬀs 95, 97, 98, 99, 100 Central American Integration System 153 Central Bank of the Netherlands 184 central banks 128, 180, 184, 185–6, 188, 189 characteristics, endogeneity of 187–9 Chiang Mai Initiative 139 child labour 14, 15–16 Chile 34 China cooperation with ASEAN 129, 130 economic development 127, 130–31, 137 economy 121 eﬀects of accession to WTO 207, 227–9 as a hub 147 labour standards 27–9, 31, 34 labour-intensive exports 32 RTAs 134–6, 143 tariﬀs 97 CLMV countries 121–2, 124, 128, 134–6, 138 Closer Economic Relations (CER) Agreement 47, 134, 154 clothing industry 208, 223, 227, 230–31 Cobb–Douglas aggregation 155 Codex 58 Colombia 34, 37 Committee on Trade and Environment (CTE) 60 commodity prices as determinants of exchange rates 190–92 and poverty 247

273

Common Eﬀective Protective Tariﬀs (CEPT), AFTA 127 common market-minus approach, ASEAN integration 147–8 comparative advantage, developing countries 223 competition law, core principles of 84 policies 70–71, 80–81 promotion of 68–70 and WTO Working Group Agenda (2002) 72–3 Competition Commission, EC 76 Competition Policy Committee, WTO 74 ‘competitive liberalization’ model 145 competitiveness, eﬀects of labour standards 26–7 computable general equilibrium (CGE) modelling 109, 167 consumer subsidies 232 Corden, Max 5, 7, 194 core principles, competition law 77–80, 81, 84 corporate profit 268–70 Cotonou Agreement 217 Courchene, Tom 192 Croatia 143 Crosby, Mark 194 cross-border competition conflicts 82 cultural relativism 15–16 currency depreciation 192, 194–5, 268, 269 overvaluation 265 currency boards 196, 197 current account deficits, sustainability of 266–8 Czech Republic 143 Daly, Don 194 data pooling, poverty incidence study 241 data source, ANZUS free trade agreements 154–8 Denmark 184, 266 developed countries assistance to farmers 229–30 gains from trade reform 210–12 tariﬀs 112–13

274

Index

developing countries capacity building/technical assistance 72–3 and competition policies 71, 79–81, 83 economic development 11–12 importance of WTO 45–6 market access 111–13 political elites 14–15 poverty incidence surveys 241 requirement to meet standards 60 tariﬀs 93, 96, 98 welfare gains from trade reform 208–12 developing countries, poverty reduction 205–7 future prospects 230–32 gains from WTO trade reform 207–16 impacts of further trade reform 216–29 risks of re-instrumentation of agricultural protection 229–30 development policies 80–81 programmes 13, 83 direct taxes 49–50 ‘dirty tarrification’ 95 discretionary approaches monetary policy 188 tariﬀ cuts 100–102 discrimination 26, 48–60 dispute settlement process ASEAN 147, 148 WTO 44–5, 46, 51, 220 Dispute Settlement Understanding, WTO 45 distorted agricultural policies 225 prices 48, 225–6 trade 109–10, 208, 210, 214–15, 222, 223 world food markets 206 Doha Ministerial Conference (2001) Agenda 13, 80, 90, 206–7 Declaration 70–71, 72, 77–8, 85 endorsement of LDC preferences 221 gains from 232 Harbinson proposal 231

launching of 41, 62–3, 130 likely outcomes 144–5, 232 Market Access Committee 97, 77–8, 85 resources 146 tariﬀs 95, 96, 97, 98 domestic cartels 75 food prices 205–6, 227–9 production capability 231–2 taxes 49–50 domestic policies harmonization of 62–3 linkages to WTO rules 41–2 dumping see anti-dumping duty-free access, developing countries 217, 221, 222 dynamic economic model 215–16 ‘early-harvest’ packages 134, 135, 138, 149 East Asia economic integration 130, 138–40 labour standards 27–31, 35–6, 37–8 labour-intensive manufactured exports 31–3 new bilateralism 140–50 regionalism 129–34, 145 tariﬀs 98 East Asia Economic Caucus, failure of 131 East Asia Free Trade Area, proposals for 139–40 East Asia Vision Group (EAVG) 139 Easterly, William 13 Eastern Europe, economic development 127 econometric analysis, labour standards and labour-intensive exports 34–8 economic assistance, East Asia 130 adjustment, avoidance/delay in 191–2 characteristics, endogeneity of 188–9, 198 development, developing countries 11–12 performance, database of 195–6 economic growth Africa 213–14

Index Asia 242–8 customs unions 184–5 US 261 economic growth and poverty reduction 239–48, 257 analytical framework 248–52 results of study 252–6 economic integration 129–38 ASEAN countries 121–2, 122–9 beyond ASEAN 129–38 East Asia 138–40 economies of scale 214–15 Ecuador 189 education 14, 15–16 Egypt 34, 37 Eichengreen, Barry 186 embargos 55 Enterprise for ASEAN Initiative (EAI) 137–8 environmental policy-making 60–62 protection 55–6 standards 11, 12, 13, 14, 15, 230 taxes 49–50 ethical considerations 53 euro 266–8, 269 Europe domestic demand 268, 269 eﬀects of EMU 183–5 FTAs 140 integration of capital markets 266–8 investment 130 labour markets 10, 186 regionalism 131, 145 tariﬀs 90, 114 unemployment 265 European Central Bank 188 European Community (EC) and competition policy 73, 77, 78, 81, 85 securities 184 European Economy: One Market, One Money (1992) 182 European Free Trade Area (EFTA) 140 European Monetary Union (EMU) 150, 180, 182, 183–4 European Union agriculture subsidies 229–30 banana import regime 220

275

economic assistance 130 preferential market access schemes 217–22 protectionism 221 tariﬀs 93, 103, 107, 110–11, 112, 115 see also Single European Market exchange rate risk 183 exchange rates and labour market flexibility 188–9 US 265 see also flexible exchange rates excluded countries, eﬀects on 144–5 exogenous shocks 186–7, 188–9, 193 export cartels 76, 77, 85 sector, labour standards 27 exports Canada 190 East Asia 31–3 Far East, domestic demand 268, 269 Farm Bill, US 153 farm labourers, developing countries 224–6 farm lobby, US 154 Final Report of the East Asia Study Group (2002) 139 financial cooperation, ASEAN 128–9, 138–9 firm, theory of the 193–4 ‘first movers’ 145, 146 flexible exchange rates, cost of 190–95, 198 food aid 232 import bills, eﬀect on NFIDCs 223–4 insecurity 224–6, 231–2 prices 210, 224–6, 227–9 safety 58, 230 self-suﬃciency 222–3, 225 stocks, holding of 231 Food and Agriculture Organization (FAO), UN 216 foreign direct investment (FDI) 136 Forging Closer ASEAN–China Economic Relations in the Twenty-First Century 134

276

Index

formula approach to tariﬀ reduction 90–91, 95–7, 113–15 examples 103–8 line-by-line cuts 97–100 practical issues 100–103 Framework Agreement on ASEAN–China Comprehensive Economic Cooperation (2002) 135 Framework Agreement on the ASEAN Investment Area 127 France 196, 265, 266, 268 Frankel, Jeﬀrey 197 free trade opponents of 13 political/social willingness to forgo 7 see also ANZUS free trade agreements Free Trade Area of the Americas (FTAA) 130 free trade areas ASEAN 124–7 bilateral 140–50 East Asia 139–40 establishment of 130 European Union 124, 130 FTAA 130 NAFTA 124, 130 freedom of association see trade union rights Friedman, Milton 187–8 full employment, restoration of 187 GATS 214 GATT 6, 9 Agreements on trade and investment liberalization 143 Articles 50, 54–5, 57–8, 69 dispute settlement panels 51 objectives 43–4, 61 RTAs under 47 reciprocal liberalization rounds 12 role of 41, 62 tariﬀ negotiations 91, 95, 102 treatment of ‘like’ products 51–2 GEMPAK 166–7 General Agreement on Tariﬀs and Trade see GATT General Agreement on Trade in Services see GATS

Generalized System of Preferences (GSP) 11–12, 217, 222 genetically modified organisms (GMOs) 45, 60, 230 Germany 183–4, 265, 266 Glick, Reuven 196–7 global governance, role of WTO 42–3 markets, promoting competition in 68–70 modelling, trade reform 214–16 terrorism, security concerns from 269–70 trade reform and erosion of tariﬀ preferences 217–22 welfare gains, WTO trade reform 207–8 Global Trade Analysis Project GTAP 154–5, 157–8, 166–8, 207, 210, 214–16, 227 globalization 3–4 and national standards 11–15, 16 and trade liberalization 8–9 Goh Chok Tong 129 government autonomy 42–3 normative views of 3–4, 7 as a social good 6–7, 15 Greece 184 gross domestic profit (GDP) growth in 268–70 and poverty incidence 249 Grubel, Herbert 6 Harbinson, Stuart 90 hardcore cartels 75–7, 79, 83–4 Harris, Richard K. 192, 194 health risks from products 52–4, 57–8 Hecksher–Ohlin model 9, 10, 15, 182 Hong Kong and competition policy 81 currency boards 196 labour standards 27–9 labour-intensive exports 32 hormones, meat products 58 ‘hub-and-spoke’ eﬀects 129, 146–7, 148 Hudec, Robert 42 hukou system, China 227–8

Index ILO and Korea 30 ratification of conventions 27–9, 31, 34, 35, 37–8 IMF dissatisfaction with 130 International Financial Statistics 265 undermining of 139 import cartels 76, 77, 85 substitution strategies, ASEAN countries 122, 134 import-demand function 262, 266–8 importers, eﬃciency eﬀects 108–11 imports 261 GDP growth and corporate profit disconnect 268–70 national treatment 50–57 US 262–5 income eﬀects on imports 261–5 eﬀects of trade levels 197 inequality 227–8 international equalization of 10–11 stability 193 income distribution eﬀects of trade liberalization 224 objectives 5–7 post-globalization 9–11, 16 income elasticity of import demand 262, 266 India cooperation with ASEAN 129 economic development 127 FTAs 140, 143 labour standards 34 poverty and growth 240–42, 242–8, 252–6 tariﬀs 93, 103, 107, 114 indirect taxes 49–50 Indonesia FTAs 144 labour standards 29, 34 labour-intensive exports 32 membership of ASEAN–5 121 political changes 128 poverty and growth 240–42 industrial countries, tariﬀs 107 growth and poverty incidence 255–7

277

policies 80–81 tariﬀs 91–5, 107–8 inflation, nature and measurement of 194–5 inflationary policies 187 information revolution 10, 46 Initiative for ASEAN Integration (2000) 128 institutionalization, ASEAN 149–50 intellectual property rights 41, 44 interest rate, customs unions 182–3, 184–5 international agencies 4 arbitrage, goods markets 194–5 cartels 77 food prices 210, 224–6 International Labour Organization see ILO International Monetary Fund see IMF investment behaviour, impact of trade reform 215 Italy 183–4, 265, 268 Japan and competition policy 78, 81 cooperation with ASEAN 129 domestic demand 269 economic assistance 130 economic partnerships 131 economic stagnation 136 FTAs 136–7, 140, 141–2, 143, 148 imports 265, 266, 268 influence of 135 preferential market access schemes 221 tariﬀs 90, 103, 114 Japan–Singapore Economic Partnership Agreement (2002) 136, 141–2 Joint Declaration on ASEAN and Japan Comprehensive Economic Partnership (2002) 136–7 Kennedy Ministerial Conference (1963–67) 95, 96, 103, 114 Keynesianism 186, 187, 188, 189, 193, 198 Koizumi 136

278

Index

Korea 29, 30, 31, 32, 34 Kuznets eﬀect 246 labelling of products 53–4, 60, 195 labour costs 26–7 market characteristics 186, 188–9 mobility 240, 246, 247 labour standards 11–13, 14–15 East Asia 27–31 eﬀects of 26–7 and labour intensive exports 34–8 labour-intensive products developing countries 208, 210, 233 exports 31–3 and labour standards 34–8 prices 227 land rights 232 land-intensive products, prices of 227 Laos 121, 124, 125, 130 Latin America economic development 127 FTAs 140, 143 labour standards 35–7, 38 tariﬀs 93, 98 unemployment 265 least-developed countries 71, 206, 216, 217, 221, 222 legitimacy of standards 59–60 Leontief nest 155 Liechtenstein 196 ‘like’ products 50–53, 54, 58, 59–60 line-by-line formula cuts, tariﬀs 97–113 Lithuania 196 litigation, policy formation through 45 living standards 13 Lloyd, Peter 3, 4, 6–7, 25, 47, 68, 71, 84, 85, 109, 180 lobbying 231 Lomé Convention 217–21 low-income countries see developing countries low-skilled workers, developing countries 224–6 Lucas, Robert 187 macroeconomic costs of customs unions 187, 195 Mahathir, Mohamad 131

Malaysia labour standards 29, 30, 34 labour-intensive exports 32 membership of ASEAN–5 121 poverty and growth 240–42 RTAs 137, 143–4 trade 127 manufacturing sector 208, 223 market prices 48 separation 195 market access 113–15 developing countries 111–13 exchange of 9 landscape of 91–5 negotiation formulas 90–91 preferential treatment 217–22 McKinnon, Ronald 187, 192–3 Mekong Basin development, China 135 Mexico dispute with US 55 FTAs 140 labour standards 34 membership of NAFTA 35, 130, 146, 180, 182 microeconomic benefits of customs unions 186, 195 Microsoft Excel 99 Middle East 98 migration 228, 229, 241, 246, 247 model structure, ANZUS free trade agreements 154–8 Monaco 196 monetarism 187–9 monetary cooperation, ASEAN+3 138–9 integration, sequencing of 150 policy, approaches to 187–9, 268 monetary union see currency unions; European Monetary Union; optimum currency areas monopolistic competition 214–15 most-favoured-nation (MFN) clauses 9, 50 exceptions 79, 81, 84 preferential market access 217, 220 status 144 tariﬀs 95, 102, 103, 111, 124, 222 violations 54

Index multilateral frameworks, competition law 74–85 trade reforms 62–3, 108–9 Multilateral Environmental Agreements (MEAs) 43, 54, 60–62 multilateral trade negotiations (MTNs), WTO 206–7 multilateralism liberalization under 144–6 US 153 Mundell, Robert 181, 186, 192–3, 197–8 Musgrave, Richard 5, 6, 7, 8, 16 Myanmar 121, 124, 125, 130 national institutions, threat of globalization 4 monetary sovereignty 185, 186, 188 policy objectives, use of subsidies/taxes 48–50 standards 11–15, 16, 60–62 technical regulations 59 treatment 50–57, 58 ‘National money as a barrier to international trade: the real case for currency union’ 196 net food-importing developing countries (NFIDCs) 206, 207, 210, 216–17, 222–3, 227–9 net sellers of food, developing countries 224–6 Netherlands 184 new bilateralism 140–44 issues and implications 144–50 New Zealand and competition policy 78 economic performance 181 FTAs 140–41, 143 imports 266 as an optimal currency area 185–6, 198 RTAs 47, 134 see also ANZUS free trade agreements non ad-valorem tariﬀs 103 non-agricultural tariﬀs 91–5, 98, 103 non-discrimination, competition law 69, 79, 84

279

non-government development agencies 231 non-governmental organizations (NGOs) 46, 80 non-product-related production process (NPPM) 53–4, 56, 60 non-tariﬀ barriers, ASEAN 127 North Africa 98 North America FTAs 130, 140 regionalism 131, 145 North American Free Trade Agreement (NAFTA) 35, 124, 146, 180 North American Monetary Union, creation of 180–81 Northeast Asia 130, 139 Norway 184 ‘not in my backyard’ (NIMBY) 12 OECD agricultural policies 210, 231 and competition policy 74, 77, 83 importers 34 markets 206, 223, 229 policy reform 207–8 practices 30 Quarterly National Account Statistics 265 SPS measures 230 tariﬀs 47, 93, 220 trade union right measure 38 ‘one-size-fits-all’ monetary policy 268 open-door policy, China 130–31 opportunism 9 optimal currency areas 180–81, 197–8 cost of flexible exchange rates 190–95 empirical evidence 195–7 fundamental new modifications 187–9 traditional benefits 182–5 traditional costs 185–6 traditional modifications 186–7 Organisation for Economic Cooperation and Development see OECD output, eﬀects on poverty incidence 248 Oxford Dictionary 51

280

Index

Pacific 217–21 Pacific Economic Cooperation Council (PECC) 144 Pakistan 34 Panama 196 parallel importing 85 Pareto-eﬃciency 5 Permanent Normal Trade Relations (PNTR), United States–Vietnam 137 Peru 34, 37 pharmaceuticals industry 195 Philippines labour standards 29, 30–31, 34 membership of ASEAN–5 121 poverty and growth 240–42 RTAs 137, 144 policy-making autonomy of governments 42–3 through litigation 45 political elites 13, 14–15 force for agricultural reforms 230–31 poor households, food insecurity/poverty 224–6 ‘positive unilateralism’ 69 post-globalization income distribution 9–11, 16 poverty 205–7, 224–6 poverty reduction and economic growth 239–48, 257 analytical framework 248–52 results of study 252–6 pragmatic monetary policy 187–8 pre-globalization views of free trade 5–8, 16 preferential trading agreements 144–5, 217–22 Preferential Trading Arrangement (1977), ASEAN 122 preferred standards, enforcement of 54–5 price changes, eﬀects of 205–6 stability 192–3 variables, eﬀect on imports 261–5 procedural fairness 79 processed products 223 processes, taxes on 48–60

producer price of food 224–5 product diﬀerentiation 230 product-related production process (PPM) 53–4 productive capacity, US 265 productivity, eﬀects of flexible exchange rates 193–4 products, taxes on 48–60 protectionism 6, 7, 8, 9, 46, 220–21, 227–9, 256 public interest groups 62 Quad countries 222 quota-free access, developing countries 217, 221, 222 rational expectations models 187 real factor returns, FTAs 159–60 incomes 239 recession, US 268 reciprocity, market access 220 regional conflicts/tensions 146, 147 regional trade agreements (RTAs) benefits of 130 features of 131–4 implications 146–7 issues and risks 144–6 proliferation of 46–8, 129, 137 rules for 149 regionalism 129–34, 145 Republic of Korea see Korea repurchase agreements 139 resources, negotiation of RTAs 146 results, poverty incidence study 252–6 returns to investment 193–4 Ricardo, David 5 risk assessments 58 Rose, Andrew 195–7 rule-of-reason/case-by-case analysis 76–7 rules of origin (ROOs) 124, 135, 141, 145–6, 149 rural households, developing countries 224–6, 227–9 rural poverty 246 Sala-i-Martin, X. 205 sanctions, imposition of 54, 55–6

Index Sanitary and Phytosanitary Agreement (1995), WTO 58, 59, 61, 230 Schweinberger, A. 109 scientific validation of standards 58–9 Seattle Ministerial Conference (1999) 46, 130 sectoral coverage, WTO Agreement 44 growth and poverty 239–40, 247, 250–52 security concerns, global terrorism 269–70 sensitive issues 146 markets 221 products 142 sectors 137, 148 sensitivity analysis, ANZUS free trade agreements 160–61 services growth and poverty incidence 255–7 industries 41, 127, 214–15, 217 trade in 41, 142–3, 214–15, 221 Shrimp–Turtle case 44, 55–6 simulations, ANZUS free trade agreements 158–60 Singapore competition policy 71 FTAs 136, 140–42, 148 labour standards 29 membership of ASEAN–5 121 national markets 122 outward processing rule 149 trade 127 Singapore Ministerial Conference (1996) 70, 85 Singapore–Australia Free Trade Area 134 Singapore–New Zealand Close Economic Partnership 140–41 Singapore–New Zealand Free Trade Area 134 Single European Market 124 skill premium 10 Smith, Adam 5 South Africa 34 South African Customs Union 153, 212

281

South America currency upheavals 180 FTAs 130 regionalism 145 South Asia eﬀects of agricultural trade reforms 210 labour standards 37, 38 tariﬀs 98 South Korea economic partnerships 131 FTAs 140 labour standards 34 South-South trade, expansion of 208, 210 Southeast Asia, poverty and growth 240–42, 242–8, 252–6 ‘spaghetti-bowl’ eﬀects 129, 145–6, 147 Spain 183–4 ‘special and diﬀerential treatment’ 78, 84, 134, 231 special treatment, agriculture 163–5 Standard & Poor 500 stock index 268–9 standards 60–62 agreements on 57–60 appropriateness of 44–5 enforcement of 54–5 harmonization of 42 and WTO/MEAs 60–62 steel tariﬀs, US 153 Stolper–Samuelson theorem 256 strategic trade policy 6–8 sub-Saharan Africa 98, 210–13, 221–2 subsidies 48–50, 85 Suharto, Mohamed 29 supply chain, disruptions in 269 swap arrangements, ASEAN 139 Swiss formula 90, 91, 96–100, 102, 103, 108–9, 110–15 Switzerland 90, 184, 196 Taiwan labour-intensive exports 32 poverty and growth 240–42, 242–8, 252–6 tariﬀ preferences, eﬀect of global trade reform 217–22 tariﬀ rate quotas, imposition of 229

282

Index

tariﬀs 90–91, 113–15 ASEAN 127 bindings 91–5 line-by-line formula cuts 97–113 reduction formulas 95–7 welfare implications 108–13 tax application of 48–50 policies 247 technical assistance 71, 72–3, 213 technical barriers to trade 230 Technical Barriers to Trade Agreement (TBT), WTO 45, 59, 60, 61 terms of trade 9 textile industry 208, 223, 227, 230–31 Thailand labour standards 31, 34 labour-intensive exports 32 membership of ASEAN–5 121 poverty and growth 240–42 RTAs 135, 137, 143 tariﬀs 93, 103, 108, 114 Thaksin, Shinawatra 143 The endogeneity of the optimum currency area criteria (1997) 188 theory of the second-best 6 three-way FTAs 158–60, 161, 162 time series approach, poverty incidence study 241, 242–8 Tokyo Development Round Codes 44 outcomes of 57 tariﬀs 95, 96, 97–8, 100, 103, 114 top-down formula, tariﬀ reduction 90–91, 98, 103, 108–9, 111, 112–13 see also Swiss formula Towards an East Asian Community (2001) 139 trade ASEAN countries 124–7 barriers to 61 cartels 77 deficits, US 261, 266–8 diversion 145, 222 eﬀects of exiting monetary unions 196–7 integration, sequencing of 150 liberalization 8–9, 16, 100–102, 161–6 rules, nature of 44

technical barriers to 230 theory 194 see also agricultural trade Trade Act, US 154 Trade and Investment Facilitation Agreement (TIFA), ASEAN–US 137–8, 144 trade promotion authority (TPA) 153 trade union rights, East Asia 29–31, 34, 35, 38 Trade-related Aspects of Intellectual Property Rights Agreement see TRIPS transaction costs, currency unions 182 transparency, competition law 79, 80, 81, 84 transport costs 163 TRIPS 44, 45, 63 tuna products 44, 55, 56 two-country FTAs 158–60 UK capital markets 184 imports 265, 268 unbound tariﬀs 92–3, 103 ‘Uncommon Arguments for common currencies’ 193 UNCTAD 74–5, 222 TRAINS database 110 unemployment, trade-oﬀ with imports 265 unilateral trade liberalization 102 reforms 108 United Nations (UN) Food and Agriculture Organization (FAO) 216 Millennium Development Goals 205 United Nations Conference on Trade and Development see UNCTAD unskilled workers China 228–9 plight of 10–12 urban households, developing countries 224–6, 227–9 urban poverty 246 Uruguay Development Round 46, 57 Agreement on Agriculture 229 commitments 207–8, 210

Index impact of 216–17 tariﬀs 90, 93, 100, 101, 111 US bilateral trade relationships 153–4, 196 commitment to multilateralism 153 and competition policy 73, 77, 79 ‘competitive liberalization’ model 145 cooperation with ASEAN 129, 137–8 corporate profit 268–70 dollar 265, 268, 269 economic assistance 130 exchange rates 190–91 FTAs 140–44, 146, 180 GDP growth 268–70 imports 261–5 influence of 135 labour mobility 186 market separation 195 as an optimal currency area 182, 188–9, 197 preferential market access schemes 221 productivity 191–2 recession 268–9 skill premium 10 tariﬀs 90, 93, 96, 103–4, 107, 110–15, 153 trade disputes 55 see also ANZUS free trade agreements US Africa Growth and Opportunity Act 221 US Farm Bill 153 US Trade Act 154 US Trade Representation (USTR) 153, 167 US–Singapore FTA 138, 146 Venezuela 34, 37 Vietnam 121, 124, 125, 130, 137, 144 voluntary cooperation, modalities for 73–5 standards 59 wage setting 191–2, 194 wealth eﬀect, imports 265 welfare gains, WTO trade reform 207–16

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welfare implications ANZUS FTA 158, 161–6 customs unions 185 flexible formula tariﬀs 108–13 income stability 193 West Africa 196 World Bank recipients of assistance 13 studies 205, 215–16, 221, 222, 227 tariﬀs 101 World Development Indicators 110 World Trade Organization (WTO) 9, 41–3 accession of China 207, 227–9 addressing competition issues 68–70 Agreement on Agriculture 231 agriculture subsidies 229–30 Appellate Body 45, 51, 52–3, 55–7 binding of reforms 215 changing role of 41–3, 43–8 Competition Policy Committee 74 consistency principles 150 and developing countries 45–6 dispute settlement 44–5, 46–51, 220 liberalization 143, 145, 146 list of RTA 144 membership 130–31 multilateral trade negotiations (MTNs) 43, 54, 60–62 policy implications 62–3 rules of 48–60, 137 Secretariat 74, 75–7 tariﬀs 96, 97–8, 102, 110, 113 trade reform 207–16 use of trade measures 60–62 Working Group (2002–3) 69–71, 72–80, 81, 84–5 see also agricultural trade reform; Cancun Ministerial Conference; Doha Ministerial Conference; GATS; GATT; Kennedy Ministerial Conference; Seattle Ministerial Conference; Singapore Ministerial Conference; Tokyo Ministerial Conference; TRIPS; Uruguay Ministerial Conference world trade, growth of 44 ‘zero-for-zero’ tariﬀ agreements 93 Zoellick, Robert 154