Chapter

VI Regional Trading Arrangements

Author(s):
Peter Uimonen, Arvind Subramanian, Naheed Kirmani, Nur Calika, Michael Leidy, and Richard Harmsen
Published Date:
February 1995
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Author(s)
Richard Harmsen and Michael Leidy1 

Regional trading arrangements2 have become increasingly important in the relations among Fund members. This paper reviews recent developments in regional trading arrangements, factors contributing to their proliferation, and the effects of increased regionalism including its compatibility with multilateral liberalization. This is supported by a comprehensive catalog of existing arrangements (in Appendix I). Two of the most prominent regional initiatives, the European Union (EU)3 and the North American Free Trade Agreement (NAFTA), are reviewed in some detail. Selected agreements are examined briefly in Appendices II-IX (the EU’s trading relations with transition and Mediterranean economies, the Southern Cone Common Market (Mercosur), the Central African Customs and Economic Union (UDEAC), the Cross-Border Initiative (CBI), the ASEAN Free Trade Area (AFTA), the Asia-Pacific Economic Cooperation Forum (APEC), the Gulf Cooperation Council (GCC), and the Economic Cooperation Organization (ECO)). Appendix X provides information in intra- and extra-regional trade flows.

The key conclusions of the paper are as follows:

  • Since the second half of the 1980s, some important new regional trading arrangements emerged, and many others were reactivated, in particular in Europe and the Western Hemisphere. The trend toward increased regional integration was due partly to frustration with slow progress in the Uruguay Round, but factors beyond the Round appear to have played an important role. While the completion of the Round may lessen some of the impetus toward regionalism, indications are that interest will remain strong in the future.

  • As regionalism emerges as an integral part of the trading environment, it should not be allowed to divert attention from the fact that the first-best policy is most-favored-nation (MFN) liberalization, and the ultimate goal is global free trade. Hence, it is important that regional initiatives be implemented in a manner that would harness them securely to the long-run goal of multilateral liberalization and that regional trading arrangements develop as “building blocks” to such liberalization. The Fund’s policy advice should actively support such an objective.

  • Regional trading arrangements are most likely to contribute to global trade liberalization and minimize trade diversion if they satisfy a number of conditions. These include coverage of all sectors (without exception), transparent rules of origin, liberal rules of accession, and strengthened disciplines on the use of anti-dumping action against third parties. Most important, MFN liberalization should precede or accompany new arrangements, especially when protection against non-members is high. Deeper forms of integration (including, e.g., services trade) can enhance potential gains from efficient resource allocation within the regional grouping.

  • Many of the major regional initiatives in the recent past have been associated with outward orientation, as evidenced, for example, by MFN liberalization that preceded or accompanied regional liberalization.

  • Measured by the scope of integration and the number of countries involved, the EU is the most advanced regional trading arrangement; some of the forces behind its integration are unique and not easily replicated. In the manufactured goods sector, there has been substantial net trade creation in the aggregate as a result of European integration. Earlier concerns by trading partners of “Fortress Europe” as a result of the Internal Market Program have not materialized. Nonetheless, pockets of discrimination continue within the manufacturing sector, where trade diversion has affected specific sectors and countries and the level of industrial subsidies is high. In the agricultural sector, trade diversion effects were clearly predominant as a result of the Common Agriculture Policy, with significant negative implications for welfare in the EU and third countries. Given the major impact of the EU on the world economy, and prospects for its further expansion, the Fund needs to continue to press for liberalization in areas still subject to significant protection.

  • NAFTA is unique in that it attempts integration among economies at very different income levels. While the potential for trade diversion in the aggregate as a result of NAFTA appears to be limited, there may be significant effects in selected sectors or individual countries.

Overview of Recent Developments and Issues

Regional trading arrangements come in a variety of packages, with varying degrees of internal liberalization and alternative external commitments (Box 1). This section summarizes the recent interest in pursuing regional trading arrangements, discusses the political and economic factors that motivated these initiatives, reviews the theoretical considerations that help to evaluate their economic effects, and identifies a number of specific guidelines for the formation of economically preferred regional trading arrangements.

Recent Developments in Regional Trading Arrangements

During the first half of the 1990s, some important new regional trading arrangements emerged, and many existing ones were reactivated (Appendix I). In Europe, developments were many and rapid. Progressive implementation of the Internal Market Program aimed to stimulate expansion of trade and growth within Europe. The European Economic Area (EEA) was formed between the EU and Austria, Finland, Iceland, Liechtenstein, Norway, and Sweden.4 Of these, Austria, Finland, Norway, and Sweden completed negotiations for their accession to the EU and are expected to accede in 1995 if their governments pass referendums. The EU entered into association agreements with several Central and East European countries, cooperation and partnership agreements with several countries of the former Soviet Union, free trade agreements with the Baltic countries, and a customs union with Turkey; it is in the process of negotiating agreements with some Mediterranean countries (Appendix II). Central and East European countries are negotiating similar agreements with the European Free Trade Association (EFTA); the Czech and Slovak Republics formed a customs union and concluded a free trade agreement with Hungary and Poland; Hungary and Poland have applied for EU membership. The Baltic countries concluded a free trade agreement among themselves. The Commonwealth of Independent States (CIS) agreed to form an economic union.5

In the Western Hemisphere, too, the trend toward regional trading arrangements accelerated. In addition to NAFTA, a substantial number of new arrangements were formed, most notably Mercosur (Appendix III), and existing regional integration schemes, such as the Andean Pact and the Central American Common Market (CACM), were revived. Many of the new arrangements tended to be bilateral, in most cases taking the form of free trade agreements, and were typically formed by countries already in one or more regional trading arrangement.6 A number of countries (Colombia and Venezuela, for instance) recently formed trade partnerships with several other countries. Additional agreements are under negotiation (e.g., those of the Group of Three—Colombia, Mexico, and Venezuela; the Caribbean Community (Caricom) and Colombia; and the Caricom and Venezuela). A number of countries in Latin America have expressed interest in acceding to the NAFTA. Within the set of existing arrangements recently revitalized, the Andean Pact and the CACM agreed on a common external tariff, and the Caricom became more active.

While there was not much change in the status of the many long-standing regional trading arrangements in Africa, there were some new developments toward greater integration. With the recent devaluation of the CFA franc, the Central African Customs and Economic Union (UDEAC—see Appendix IV) moved forward on a number of fronts, including implementation of a common external tariff, replacement of quantitative restrictions (QRs) with tariffs, and phased elimination of intra-UDEAC duties. In eastern and southern Africa, there is a new Cross-Border Initiative (CBI) (Appendix V), sponsored by the World Bank, the European Commission, the African Development Bank, and the Fund. The CBI is intended as a pragmatic step toward economic integration in the subregion, including cross-border trade, investment, payments and exchange systems, and institutional development.

Economic integration in East Asia principally reflected private market forces; institutional arrangements tended to play more of a supporting than a leading role. Recent developments include the establishment of the ASEAN Free Trade Agreement (AFTA) (Appendix VI), and increased activity within the Asia-Pacific Economic Cooperation (APEC) forum (Appendix VII). Elsewhere in Asia, a decision was reached in 1992 to draft a preferential trading arrangement for the South Asian Association for Regional Cooperation (SAARC) with the recommendation that all formalities for putting this arrangement into operation, including the finalization of schedules of concessions, be completed before 1995.7

Box 1.Types of Regional Trading Arrangements

Free Trade Area

In principle, a free trade area (FTA) entails the full elimination of tariff and nontariff trade barriers between the partner countries, while each partner’s trade barriers with third countries are left intact. Rules of origin establish conditions under which an item qualifies for preferential access within the area. Some FTAs have recently included provisions to liberalize investment rules, services trade, government procurement, and other steps to achieve greater economic integration. Typically, provisions for factor mobility are not included, except perhaps in the context of facilitating services trade. The GATT’s Article XXIV (see Box 3) defines an FTA as an arrangement that eliminates duties and other restrictions on “substantially all the trade” between members. In practice, however, arrangements that are referred to as FTAs typically include a number of sectoral exceptions in which intraregional trade barriers remain in place (e.g., in sensitive sectors such as agriculture and textiles and clothing). Further, FTAs typically include provisions for contingent protection through, for example, one or more safeguards clauses and the maintenance of antidumping provisions.

Customs Union

A customs union is an FTA that also adopts a common external tariff against third countries. GATT’s Article XXIV defines a customs union essentially as a free trade area that applies “substantially the same duties and other regulations of commerce”1 to trade with countries not included in the union. It also requires that duties and other regulations of commerce applicable to nonmembers “shall not on the whole be higher or more restrictive than the general incidence of these prior to the formation of the union.”2

Common Market

A common market is a customs union with provisions to liberalize regional factor movements.

Economic Union

An economic union is a common market with provisions for the harmonization of certain economic policies, particularly macroeconomic and regulatory policies. It is sometimes argued that the practical distinction between a common market and an economic union will disappear over time since factor mobility within a common market will create pressures for a high degree of policy harmonization.3

1See GATT (1986), Article XXIV, Section 8:a.2See GATT (1986), Article XXIV, Section 5:a.3See OECD (1993), p.23.

Interest also increased in regional initiatives in the Middle East. The Gulf Cooperation Council (GCC) liberalized movements of capital and labor, worked toward establishing a common external tariff, and held discussions with the EU concerning the possibility of an economic cooperation agreement (Appendix VIII). Ambitious plans for integration within the Arab Common Market (ACM) and the Arab Maghreb Union (AMU), both established in the 1960s, remained largely unimplemented. The Economic Cooperation Organization (ECO) made efforts to improve cooperation, and recently added as members a number of states of the former Soviet Union (Appendix IX).

The Impetus for Regionalism

Regional trading arrangements are pursued for a variety of reasons that may differ across arrangements and across participating countries within a given arrangement. While it is not always possible to identify a single overriding motivation underlying an arrangement, several factors seem to have played key roles in the regional initiatives of the 1990s. This subsection reviews the principal factors contributing to the increase in arrangements.

The Economie Effects of Regionalism

The prospect of enhanced economic growth (stemming from the opportunity to exploit scale economies, regional specialization and learning-by-doing, as well as attracting investment by expanding the regional market) is a motivation that is present in virtually every regional trading arrangement, between both industrial and developing countries. The realization of scale effects was a major consideration underlying the Internal Market Program in the EU. In Africa, possibly the most important reason for regional integration is the belief that individual economies need to overcome the drawbacks of small size and limited physical and human capital, which constrain economic growth. Foroutan (1992), for example, identifies this consideration as the key factor underlying regional integration in sub-Saharan Africa.8 It is also an explicit goal of AFTA and Mercosur to exploit scale economies, deepen the division of labor across the region, and attract foreign direct investment (FDI) by presenting the region as a stable and prosperous single market.9 The dynamic growth effects expected by Mexico, especially the anticipated surge in FDI, were also a key motivation for Mexican interest in NAFTA.10

Noneconomic Objectives

Regional initiatives may be viewed as a means to promote a broad range of noneconomic objectives, from enhancing regional political cohesion to various foreign policy considerations, such as managing immigration flows and promoting regional security. The formation of the EU had strong political roots, as did the formation of the Association of South East Asian Nations (ASEAN). The desire of a number of EFTA countries to join the EU was also motivated, in part, by non-economic objectives. Mercosur is perceived as a means of fostering cooperation between its member states.11 In Africa and the Middle East, regional trading arrangements have been motivated by similar cooperative impulses.12 The promotion of political and economic stabilization and control of immigration flows were also important elements underlying both NAFTA and the association agreements of the EU with East European countries.13

Reasons Related to Uruguay Round

The Uruguay Round played an important role in fostering interest in regional trading arrangements. Regionalism was sometimes perceived as an alternative to multilateral trade liberalization under the Uruguay Round in view of its slow progress. In other cases, it reflected a desire to strengthen negotiating positions in the Round and in the international trading system as a whole. One or both of these elements were present in the formation of regional arrangements in North America. South East Asia, and most of those in Latin America.14

Regional “Safe Havens”

Regional initiatives at times have been viewed as an instrument to pre-empt future restrictions on market access—access that appeared not to be sufficiently guaranteed by emerging developments in the Round—and to help create a more stable and predictable trading environment. Smaller nations may seek such safe-haven trade arrangements with larger countries when future market access appears uncertain.15 This seems to have been a key element in CUSFTA, NAFTA and Mercosur. It may have also contributed to the interest of some EFTA countries in joining the EEA.16 In North America, Mexico was partially motivated by fear of changes in U.S. trade policy toward a more “managed” or “strategic” trade orientation.17 Canada’s pursuit of the CUSFTA was significantly motivated by a desire to discipline the use of antidumping and countervailing measures in the United States;18 this issue arose again in the context of NAFTA.

Locking in Domestic Policy Reforms

Regional trading arrangements have been perceived as enhancing the prospects for sustaining domestic policy reforms, including unilateral trade liberalization, as well as fostering an environment conducive to the maintenance of macroeconomic stabilization, in particular in developing countries and economies in transition.19 This view suggests that a regional arrangement may complement and solidify domestic policy shifts toward privatization and market-oriented reform.20 East European countries view their association agreements with the EU as very important in enhancing and cementing their economic reforms. “Locking in” domestic reforms was also a motivation of considerable importance in many Latin American initiatives. Mercosur is viewed by Argentina as complementing domestic deregulation, and in Paraguay it has supported market-based policy reform and trade liberalization. Recent efforts to revive the Andean Pact and CACM are seen by member countries as an attempt to capture and lock in the outward orientation of the economic reforms initiated by individual countries during the past decade.21 NAFTA was particularly attractive to the United States as a means of accelerating and encouraging domestic policy reforms in Mexico.

The Domino Effect

As new regional trading arrangements form, or existing ones expand or deepen, the opportunity cost of remaining outside an arrangement rises. Nonmember exporters could experience costly reductions in market shares if trade is diverted to members. This may be sufficient in some nonmember states to tip the political balance in favor of accession, as exporting interests begin to dominate import-competing interests. In turn, as new members join the arrangement, trade diversion from other outsiders may lead to a second round of accessions. The “domino effect,”22 or the anticipation of such, appears to have been prominent, for example, in the initiative of EFTA countries to apply for accession to the EU. East European countries were similarly interested in improving access to West European markets and in not being left out of the emerging Internal Market.

The negotiations between Mexico and the United States to form a free trade area (FTA) may have started a comparable process in the Western Hemisphere. Canada’s interest in NAFTA was strongly influenced by the potential erosion of the benefits expected from the CUSFTA were it not to join the newly emerging NAFTA.23 In a similar vein, the large number of bilateral trade arrangements between Mexico and several Latin American countries is viewed by Mexico’s partners as a first step toward joining NAFTA.24

Access to NAFTA has become an important objective of many Latin American countries as a way to correct the expected trade and investment diversion toward Mexico. Finally, Paraguay and Uruguay’s interest in Mercosur was significantly motivated by their desire to prevent diversion of trade to Argentina and Brazil.25

Infant Industry Regionalism

Sometimes support for regionalism is based on a regional infant industry argument. Regional trading arrangements have often been pursued as a strategy to broaden and deepen domestic regional markets as a precursor to exposing regional industries to the full rigors of extraregional competition. Liberalization at the regional level combined with a protectionist commercial policy toward third countries could, in this view, prepare regional industries eventually to compete beyond the region. This conception was behind most Latin American and sub-Saharan African arrangements during the 1960s and 1970s and was a regional manifestation of import-substitution industrialization strategies pursued at the national level.26 It is noteworthy that those arrangements that in the past were most influenced by this perspective were also the least successful in expanding trade and fostering economic growth.27 That an infant industry rationale might underly the relative failure of such initiatives may reflect the connection between initial objectives and the precise design of an agreement. The hesitancy to embrace competition on a global level implicit in the infant industry rationale appears to have manifested itself in relatively weak commitments to liberalize trade internally. The regionalism of the 1990s is far less influenced by regional infant industry arguments, although remnants of this view remain.

Effects of Increased Regionalism

Unlike the strong case for unilateral and multilateral trade liberalization, economic theory offers neither unqualified support nor unqualified opposition to regional trading arrangements, whether they be free trade areas, customs unions, or deeper forms of economic integration.28 The fact that many of the arrangements identified above fail in significant ways to satisfy textbook definitions of FTAs or customs unions adds to the difficulty in reaching definitive conclusions. Theory does, however, offer several general guidelines for assessing the welfare implications of such arrangements. Their economic effects and their compatibility with the multilateral trading system are examined below.

Static Effects

Jacob Viner’s distinction between trade diversion and trade creation delineated the static trade-offs implied by preferential moves toward free trade.29 The tendency of regional trading arrangements to induce a shift from less efficient to more efficient producers within the region (trade creation), together with opportunities to exploit economies of scale, imply a regional expansion in real national income, other things equal. However, the tendency of regional trading arrangements also to induce some substitution of inefficient regional suppliers for efficient suppliers in nonmember countries (trade diversion) tends to reduce regional national income, other things being equal (Box 2).30 The real income of the regional grouping, therefore, tends to rise when trade creation dominates trade diversion.31

Box 2.Static Trade Diversion and Trade Creation: Simple Numerical Examples

The distinction between trade diversion and trade creation in the formation of a customs union or other preferential trading arrangements can be illustrated with the help of several numerical examples in the Ricardian tradition.1

Opportunity Cost (at existing exchange rates) of a Single Commodity (X) in Three Regions

CountryABWorld
Opportunity cost352620

Case 1 (High MFN Tariffs). Suppose countries A and B both have an MFN tariff of 50 percent. Before the formation of the customs union, country A would be importing from the world market—the least-cost source—while country B would use domestic sources. With the formation of the customs union, country A’s imports of X would be shifted from the world market to producers in country B. Production would expand in B but contract in the rest of the world. Country A had been using the world market sources at an opportunity cost of 20 and following the formation of the union it uses sources from country B at 26 per unit. This is a case of trade diversion and national income is reduced both within the union and in the rest of the world. The problem of trade diversion illustrated here is due to the relatively high MFN tariff.2

Case 2 (Low MFN Tariffs). A sufficiently low MFN tariff would have eliminated this effect. Suppose, for example, the MFN tariff is 10 percent in both countries A and B. Both countries would import commodity X from the world market before and after integration. Thus the MFN tariff in this case would be sufficiently low to avoid the trade diversion of Case 2.

Case 3 (Low and High MFN Tariffs). Consider the case in which MFN tariffs are quite different between the parties to a preferential trading agreement. Suppose that the pre-integration MFN tariffs are 10 percent and 40 percent in A and B, respectively. In this case, before integration, country A imports commodity X from the world market, but country B sources commodity X domestically. If a customs union is formed, and the lower tariff is adopted by the union, trade is created between country B and the rest of the world. In this case, of course, it is the MFN liberalization in country B that produces the positive outcome. This example points to the simple observation that customs unions that adopt the tariff structure of the most liberal member create additional pressures for trade creation, other things equal, due to the implied MFN liberalization.

This one-commodity, constant-cost example yields certain elementary propositions about the trade-diversionary effects of customs unions that apply more generally. First, countries with high trade barriers that are nevertheless integrated into the world economy (Case 1) stand to divert more trade than otherwise due to the extreme nature of the post-union preferences. Second, (Case 2) countries with low MFN tariffs stand to divert less trade than otherwise due to the relatively minor nature of post-union preferences. To the extent that these countries are also natural trading partners and were thus trading substantially with each other before the union, the preferential trading arrangement would also create more trade than otherwise. Third, a customs union that adopts the least restrictive tariff structure of the member countries (Case 3) is likely to create trade with the rest of the world because of the associated MFN trade liberalization.

1This discussion draws on Lipsey (1960).2If a country’s MFN tariff structure is prohibitively high, so that the country is in virtual autarky, preferential liberalization would, of course, improve resource allocation without diverting any trade, simply because there is no trade to divert. But this extreme case is of no practical interest since it is difficult to identify any single country, let alone several, that are sufficiently close to autarky to make this theoretical possibility relevant.

The incentives for trade diversion are minimized when a regional trading arrangement’s external barriers are low. Alternatively, high MFN tariffs generally set up greater pressure for trade diversion. Regional groupings between countries that are already major trading partners (and have relatively open trade regimes) suggest less pressure for trade diversion, and a greater opportunity for trade creation. This is because, before regional preferences are introduced, trade flows are generally consistent with least-cost sourcing. If prospective union partners are trading heavily with each other, it is because each offers the other the least-cost source for a large set of goods. Thus the likelihood is reduced that a large number of items will be diverted from least-cost suppliers outside the union to higher-cost suppliers within the union. In the case of the Canada–U.S. Free Trade Agreement, for example, MFN tariffs were already quite low in both countries, suggesting that pressure for trade diversion was minimal. Further, each had long-established close trading ties and were natural trading partners, also indicating less pressure for trade diversion, while opportunities for trade creation—although limited by the already low tariffs—were also greater than otherwise.

As a regional grouping moves from minimal trade preferences toward regional free trade, there is a tendency for the incremental regional gains from trade creation to decline while the likelihood of trade diversion increases.32 This appears to call into question the economic rationale for GATT Article XXIV, which requires regional trading arrangements to liberalize “substantially all” trade (Box 3); however, the GATT requirement is compatible with the long-term goal of full multilateral liberalization and helps to preclude the kinds of partial preferential trading schemes that prevailed throughout the 1930s.

An important proposition helped to clarify the potential welfare effects of customs unions. Kemp and Wan (1976) showed that it is always possible to select a common external tariff so that the formation of a customs union will have no adverse effect on nonmembers while improving the welfare of members. While Kemp and Wan supplied the theoretical proof that these Pareto superior33 customs unions could be devised, there is no reason to believe that actual customs unions are devised so as to satisfy the Kemp-Wan criteria. Nevertheless, the insight of Kemp and Wan might be used to assess welfare effects of actual regional trading arrangements by looking at indicators of the volume of extraregional trade.34 In a static sense, if the volume of imports into a region is at least as great as the volume imported prior to the regional grouping, it would suggest that the Kemp-Wan criteria have been met and that the grouping is welfare improving.35

Other Effects

Trade liberalization may also give rise to effects that produce a sustained increase in economic growth through information transfers, increased competition, accelerated technological change, and the perception of improved investment opportunities.36 These spillover effects are occasionally cited among the reasons for pursuing regional trading arrangements. To the extent that an arrangement stimulates regional growth, it may offset static trade diversion effects and produce an expansion of trade both inside and outside the arrangement. There is, however, the additional risk for outsiders that improved investment opportunities, combined with restrictive or nontransparent rules of origin, or both, may divert direct investment flows from non-members.37 This effect is likely to be less significant from a worldwide perspective when a regional grouping maintains relatively low MFN tariffs or the grouping is economically small. Further, the stronger the conviction that multilateral trade liberalization will proceed apace, the less the incentive to alter longer-term investment plans in response to current regional trading arrangements.

Regional Arrangements and the Multilateral Trading System

Apart from the above conceptual issues, an assessment of the welfare effects of regional arrangements must also consider possible policy linkages to the process of multilateral trade liberalization. Are regional trading arrangements likely to be “building blocks” or “stumbling blocks” to the multilateral trading system?38 During the protracted Uruguay Round negotiations, there was concern in some official and academic circles that preoccupation with regional initiatives might divert attention from the multilateral trade negotiations. There was also concern that if the Uruguay Round discussions did not succeed, regionalism might prove to be inward looking and thus antithetical to the multilateral trading system.

If properly conceived and implemented, regional trading arrangements can be supportive of the goal of multilateral liberalization. Blackhurst and Henderson (1993) argue that regional arrangements are neither inherently inimical, nor inherently favorable, to such a goal. They point out that regional arrangements involve a liberalizing process, and unless they are combined with protectionist elements or clearly disregard multilateral rules set out under GATT Article XXIV, they contribute to the long-run goal of global free trade.

Box 3.Regional Arrangements Under the GATT and the WTO

Article I (General Most-Favored-Nation Treatment) of the General Agreement on Tariffs and Trade (GATT) requires Contracting Parties not to treat the trade of any country more favorably than that of any other Contracting Party. In other words, improved conditions of market access granted to one must also be made available unconditionally to all. A principal exception to nondiscrimination is embodied in GATT Article XXIV (Customs Unions and Free Trade Areas), which explicitly sanctions the formation of FTAs and customs unions. Preferences in the context of customs unions or FTAs, or “interim arrangements” leading to these, may be granted as long as barriers are eliminated on “substantially all” trade in goods between members, and provided extraregional trade barriers are not raised.

In practice, the disciplines intended to limit regional trading arrangements to bona fide FTAs and customs unions have not materialized.1 At times, this has been due to the granting of waivers,2 but more often it has occurred because regional arrangements are notified to the GATT as interim agreements with a significant transition period before the formation of a free trade area or customs union. GATT Article XXIV was imprecise in the language governing interim agreements, saying only that they must lead to the formation of an FTA or customs union “within a reasonable length of time.”

The Uruguay Round Understanding on the Interpretation of Article XXIV (GATT (1994)) provides for clarification. First, the “reasonable length of time” for the completion of transitional arrangements is not to exceed ten years, except under exceptional circumstances. Second, any notification of a new or enlarged regional arrangement shall be examined by a working party, and the working party will submit a report to the Council for Trade in Goods, which will make subsequent recommendations to the World Trade Organization (WTO). In the case of interim arrangements, the working party may make recommendations concerning the time frame and measures required to complete the transition to a customs union or a free trade area. This reaffirms, and appears to strengthen, the previous notification and review commitments under GATT. Third, the Understanding includes explicit reference to the applicability of the WTO dispute-settlement procedures to any matters arising from the application of Article XXIV. Finally, the Understanding also clarifies the technical procedures appropriate to an assessment of the stance of a customs union’s external trade barriers.

The Uruguay Round Understanding on Article XXIV does not significantly alter the multilateral rules governing the formation of regional trading arrangements. Nevertheless, it may lead to greater attention to the intent of Article XXIV—which is to limit regional trading arrangements to bona fide FTAs and customs unions—through enhanced oversight and tighter enforcement.

1See, for example, the discussion in Jackson (1969, Ch. 24), and Bhagwati (1991, pp. 66-69).2See Jackson (1969).

Blackhurst and Henderson recall that concerns over the rise of regionalism are not new and figured prominently also in several earlier rounds of multilateral trade negotiations.39

Bhagwati (1992) and (1993) generally agrees but warns that certain measures are needed in order to secure a complementary relationship between regional initiatives and the multilateral trading system. Bhagwati expresses concern that countries may attempt to present regionalism as an alternative to multilateralism in order to attempt to strengthen future negotiating positions. Also, the current rise of regionalism may gain further strength because the United States, previously a strong countervailing voice against regionalism, is now a major advocate. Together, these factors risk reinforcing the mistaken belief that multilateralism and regionalism are always antithetical, even those regional trade arrangements sanctioned under Article XXIV, which could lead to inward-looking policies. In this view, “confidence-building” measures are called for—for example, pronouncements by the major players and institutions that regionalism and GATT/WTO can be fully compatible—and institutional reforms are desirable to firmly harness new regional initiatives to the goals of multilateralism.40

Another concern that has been raised is that enhanced competition within regional trading arrangements may induce increased resort to antidumping actions toward firms outside the arrangement.41 This endogenous use of antidumping actions might lead to considerably more trade diversion than otherwise. Hindley and Messerlin (1993), using the example of the EU, offer casual empirical support for this proposition and call for a strengthening of multilateral rules in this area.

Krugman (1993) has pointed out that as a trading bloc increases in economic size, there may be an incentive to increase external tariffs in order to exploit expanding market power, thereby improving its terms of trade. If this were so, the formation of regional trading blocs would appear to threaten the goals of multilateralism.42 But this observation may not reflect how trade policies are actually formed—as Krugman acknowledges. It ignores the existence of multilateral rules—including GATT tariff bindings and GATT Article XXIV requirements—that constrain such choices. Moreover, successful efforts toward multilateral cooperation have repeatedly taken place over past decades, and governments rarely act according to unidimensional motives (such as achieving optimal tariffs). Krugman’s observation does, however, reinforce the significance of strict adherence to the multilateral rules governing the formation of regional trading arrangements if they are to complement multilateralism.

Principles for Assessing Regional Trading Arrangements

Two fundamental points are suggested by the above discussion. First, the best regional arrangements are those that divert the least trade and create the most. Minimizing trade diversion is beneficial for both members and nonmembers. It also avoids introducing friction into the multilateral trading system. This suggests that, particularly in those cases where the problem of trade diversion would be more pronounced (e.g., among countries with relatively high MFN tariffs), MFN tariffs should be reduced as preferential tariffs proceed toward zero.43 Second, adhering to a strict interpretation of GATT Article XXIV should be regarded as essential if regional arrangements are to be complementary to the multilateral trading system. Indeed, surpassing the conditions of GATT Article XXIV would more securely harness the impetus toward regionalism to the goal of multilateral trade liberalization.

These principles suggest the following normative guidelines for preferred arrangements;44 these go beyond the obligations set out in GATT Article XXIV:45

  • Regional trading arrangements should cover all sectors without exception.46

  • The transitional phase should not be overly long (preferably less than the maximum period of ten years set out in the Uruguay Round agreement) and should include well-defined liberalization schedules at the sectoral level.

  • MFN liberalization should precede or accompany every new free trade agreement. This is particularly important when MFN tariffs are initially high.

  • Customs unions, in setting their common external tariff, should strive to adopt either the tariff code of the least restrictive member in its entirety (as is contemplated, for example, in the Cross-Border Initiative among several African countries), or—a more demanding standard—the lowest prevailing MFN tariff among members for each product.47

  • Regional trading arrangements should include liberal rules of accession so that regional liberalization can spread to new members.48

  • Rules of origin should have a high degree of transparency and minimal scope for influence by protectionist interests within the union.49

  • Deeper forms of integration,50 other things equal, are preferred since the potential gains from efficient resource allocation within the bloc are maximized; deeper forms of integration would include liberalization also of services trade, investment, some regulatory coordination and harmonization (without rejecting the legitimacy of regional diversity in, for example, areas such as labor standards, environmental protection, and tax policy), and liberalization of factor flows including labor.51

  • The use of antidumping laws should no longer apply among members of regional trading arrangements (as occurred, for example, in the Australia-New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) and the EU, and has been sought by Canada in the Canada-U.S. Free Trade Area and NAFTA), and disciplines should be strengthened on use of antidumping against countries outside the arrangement.52

Intra- and Extraregional Trade Flows

Whether or not a given regional arrangement leaves participants better off while leaving others no worse off is essentially an empirical matter that could be investigated on a case-by-case basis. Although there are many empirical studies of the costs and benefits of various regional arrangements for members, few attempt the more difficult task of assessing the effects on countries excluded from the arrangement or on the world trading system as a whole. An indication of the overall economic effects of the trend toward regional arrangements can be drawn from developments in intra- and extraregional trade shares. Such indices are an imperfect measure of the effects of regional arrangements, because intra- and extraregional trade flows evolve also in response to other factors, such as changes in comparative advantage, technology, multilateral liberalization, relative prices, regional economic size and diversity, and various noneconomic events unrelated to regional trading arrangements. Nevertheless, these descriptive statistics offer a broad indication of whether the arrangements are associated with greater regional concentration in trade flows. Extraregional trade as a share of GDP for selected regional arrangements and trends in intraregional and extraregional trade-to-GDP ratios for geographic regions are given in Appendix X. Box 4 discusses these regional trade developments. The general conclusion is that the increased emphasis on regional trading arrangements has not apparently occurred at the expense of ongoing integration between regions. This implies that thus far the trend toward regionalism appears to have been broadly compatible with the goal of deeper global economic integration.

European Union

With the adoption of the Treaty of Rome in 1957 the six original member states of the EU laid the basis of a process of continuous political and economic integration in Western Europe that has resulted in one of the largest internal markets in goods and services in the world economy.53 Three different stages of integration can be distinguished. The first, transitional period (from 1958 to 1969) was marked by the phased elimination of internal tariffs, the dismantling of quantitative restrictions on imports from other member states, and the introduction of a common external tariff. The transition period also saw the establishment of the Common Agricultural Policy (CAP) aimed at the introduction of free trade in agricultural goods within the Community. The second period of integration, covering the 1970s and the years up to the mid-1980s was marked by the introduction of a number of important institutional changes (such as an enhanced political role for the European Council) and by two enlargements of the Community, first with the accession of Denmark, Ireland, and the United Kingdom in 1973, followed by Greece, Portugal, and Spain in the 1980s. The third period (from 1986 onwards) was dominated by the adoption and subsequent implementation of the Internal Market Program and the Treaty on the European Union, which brought further important institutional changes and a road map for the establishment of an Economic and Monetary Union. This period was also marked by closer cooperation with surrounding countries (notably the member states of EFTA and countries in Eastern Europe and those of the former Soviet Union) and accession talks with Austria. Finland, Norway, and Sweden.54

This section reviews the present status of EU integration with respect to trade and trade-related issues. A description of the Internal Market Program and its status of implementation is followed by a review of empirical work on the trade and aggregate real income effects of European integration since the establishment of the Community. Conclusions about the implications of European integration from the point of view of multilateral trade liberalization are also presented.

Completion of the Internal Market Program

The progressive implementation of the Internal Market Program can be seen as the most important European initiative directed toward stimulation of trade and growth since the establishment of the Community. The formal deadline of the program was December 31, 1992. Although the imposition of a deadline was of great significance for the negotiation process within the EU, the implementation of the Internal Market Program is in effect a continuous process that started soon after the adoption of the While Paper on the program in 1985 and is not yet fully completed. The creation of the Internal Market brought, inter alia, the following changes in the area of trade in goods and services:

  • Removal of physical controls on cross-border shipments of goods. This required a change in the administration of indirect taxes, which was strongly dependent on customs declarations. This change and the removal of controls became effective on January 1, 1993. Also, differences between levels of indirect taxation within the EU were reduced since the start of the program.

  • Elimination of remaining national restrictions on imports of industrial products from third countries, and their replacement in some cases with EU-wide restrictions. Member states still maintained a large number of QRs and voluntary export restraints (VERs) on cars from third countries with implications for intra-Community trade. In some cases, national restrictions were replaced by Community-wide restrictions, notably the VER on Japanese cars, the tariff quotas on bananas, and QRs on imports of toys, ceramics, and foot-wear from China.

  • The definition of essential minimum requirements with respect to technical regulations on product standards (mainly in the interests of health, safety, and the environment), the promotion of harmonized industry standards and the mutual recognition of testing and certification.

  • Elimination of barriers to cross-border services, notably transportation and financial services. The Internal Market Program provided for minimum harmonization of prudential supervision and technical rules, where appropriate, and the elimination of discriminatory restrictions on trade in services between member states.

  • Introduction of the principle of home country control related to prudential supervision in the financial sector and mutual recognition of licenses.

  • The opening of public procurement markets. Public procurement of goods and services has been made subject to rules providing for transparency and free market access.

  • The approximation of rules in the area of intellectual and industrial property rights.

  • The full liberalization of capital movements. All restrictions on capital movements between member states are eliminated.

Box 4.Intra- and Extraregional Trade Developments

In western Europe intraregional trade as a percentage of GDP has grown steadily, increasing from 14.8 percent in 1948 to 33.0 percent in 1990 (Appendix X, Table 7). Extraregional trade as a percentage of GDP fell between 1948 and 1963 but has been roughly constant since then at about 13 percent. In the EU in particular, extraregional imports as a share of GDP have stayed at around 9 percent since 1970 (Appendix X, Table 6). Thus, notwithstanding increasing integration. EU imports from third countries have generally kept pace with the growth in GDP. Eastern Europe and the former Soviet Union’s intraregional trade as a share of GDP expanded quickly between 1948 and 1968 (owing partly to the creation of the former Council for Mutual Economic Assistance (CMEA)), but it has been falling since then. Extraregional trade as a share of GDP had fallen to 9.7 percent by 1958 (Appendix X, Table 8), but has been on an upward trend since then.

In the NAFTA region, intra- and extraregional trade have increased. Extraregional imports as a share of the region’s GDP have grown from 2.9 percent in 1970 to 7 percent in 1992 (Appendix X, Table 6). Both North American intra- and extraregional trade as a share of GDP were considerably greater in 1990 than they had been in 1948 (Appendix X, Tables 7 and 8). In contrast, Latin American regional trade shares fluctuated, but there was a trend toward decline in intraregional trade shares, while extra-regional trade shares were roughly constant.

In the ASEAN countries, extraregional imports as a share of GDP have been growing rapidly (in 1990 they reached 26.9 percent, compared with only 9 percent in 1970) (Appendix X, Table 6). Much of Asia experienced rapidly expanding intra- and extraregional trade (as a share of GDP) due to the region’s dynamism and growing openness. Japan’s intraregional and especially extraregional trade as a share of GDP increased between 1948 and 1958 reflecting the country’s export-led growth. Both shares remained roughly constant since the 1960s. In ANCZERTA a mild increase in extraregional imports as a share of GDP can be traced between 1970 and 1992.

Africa’s intraregional trade as a share of GDP followed a downward trend from 1948 through 1979, and it increased slightly during the 1980s, while extraregional trade as a share of GDP fell from 1948 until 1968, and has been on a mildly upward trend since then. In the Middle East, intraregional trade decreased sharply between 1948 and 1968 and roughly stabilized thereafter. Extraregional trade varied widely from 1948 through 1979, then stabilized at about 50 percent of GDP.

Trade-weighted averages for the world show that intraregional trade as a share of GDP has more than doubled since 1948 (it grew from 7.3 percent in 1948 to 17.4 percent in 1990). While the path of extraregional trade as a share of world GDP has been less clear, it moved to its highest post-world war levels in the last decade. Thus, intraregional integration has been important throughout the postwar era, but it does not appear to have precluded interregional trade expansion.

As noted above, the implementation of the Internal Market Program is still going on. There were some delays in the legislative work at the Community level and in the implementation of EU legislation by member states. For example, legislation liberalizing road haulage was adopted only after the formal deadline of the program. Also, some liberalization measures provide for relatively long implementation periods, such as in the case of road and air transportation. Some areas were not covered by the program, notably leasing services, services which are subject to private regulation (legal services, accountancy), energy, and some areas of telecommunications and postal services. Most of these sectors are currently subject to a more active application of the principles of competition policies, including new legislative initiatives.

Also, private enterprises continue to face trade barriers from time to time related to the practical implementation of the rules. This seems to be particularly relevant in cases where the introduction of EU legislation on a national level has been combined with specific national regulations, notably in the area of technical product standards. The effectiveness of the enforcement of Internal Market rules is also receiving increased attention. For instance, in the field of public procurement there are problems with the monitoring of the vast range of public contracts. The European Commission has drawn up a “strategic program” of priorities that aims to improve the functioning of the Internal Market, providing, inter alia, for better enforcement of rules and calling for faster transposition of EU rules into national legislation.

Trade and Real Income Effects of European Integration

This subsection gives a brief overview of empirical work on the trade diversion and trade creation effects of European integration and the third country effects of the Internal Market. The conclusion can be drawn that in the manufactured goods sector, trade creation exceeded trade diversion by a wide margin, and that the Internal Market Program likely has net positive effects on third countries. A clear exception is the agricultural sector, where trade diversion dominated as a result of the CAP.

Trade Creation and Trade Diversion

The trade creation and diversion effects of European integration have been subject to a large number of studies, covering different periods between the establishment of the Community and the beginning of the 1990s. Mayes (1978) reviews estimates from studies of the trade effects of integration during the 1960s and the 1970s. The various estimates in the survey are not strictly comparable due to differences in coverage and methodology, and in any case quantitative estimates in this area have a number of drawbacks.55 Nevertheless, the broad conclusion can be drawn that trade creation in the manufactured goods sector in this period was significant (10 percent to 30 percent of total EU imports of manufactured goods), and that it exceeded trade diversion by a wide margin (estimated at 2 percent to 15 percent). This development likely can be explained by at least two factors, namely, the process of multilateral trade liberalization during the same period, and the different structure of intra- and extra-Community trade in manufactured products. The impact of the elimination of internal tariffs on the size of the resulting trade diversion was mitigated by the more or less simultaneous reduction of external tariffs in the context of various GATT rounds. Average external tariff rates declined from 13 percent in 1958 to 6.6 percent after the implementation of the Kennedy Round agreement. As concerns the structure of intra-EU trade, computations of Balassa (1975) and Buigues, Ilzkovitz, and Lebrun (1990) show that the share of intraindustry trade in total EU trade steadily increased since the establishment of the Community, reflecting continued product differentiation and scale effects.56 Trade with third countries, however, is more based on interindustry specialization related to different factor endowments.

The above-mentioned studies on trade creation and diversion, in general, did not cover trade in services and agricultural products. Balassa (1975) made a first attempt to measure trade creation and diversion including trade in agricultural products. He came to the conclusion that the Common Agricultural Policy had resulted in significant trade diversion, although the overall effect—combining manufactured and agricultural products—remained positive. A computation by Jacquemin and Sapir (1988) for the period 1975-82 also showed that total trade creation effects outweighed trade diversion effects in the four largest member states of the Community. A study by Sapir (1992) covering nine member states confirms this picture for the period 1980-91 (Table 1). The calculations are based on a decomposition of expenditure into three shares: domestic production, intra-EU imports, and extra-EU imports. Table 1 shows that the share of domestic supplies of all processed goods (including processed agricultural products) steadily decreased since 1980, whereas the shares of intra- and extra-EU imports increased. This points to trade creation both within the EU and in relation to third countries. However, the trade figures on food, drink, and tobacco indicate that in the agricultural sector trade diversion effects occurred since 1985.

Table 1.Sources of Apparent Consumption: EU-91(In percent)
All Processed ProductsFood, Drink, and Tobacco
YearDomestic productionIntra-EU importsExtra-EU importsTotaldomestic productionIntra-EU importsExtra-EU importsTotal
198066.719.114.2100.082.111.16.7100.0
198165.319.615.1100.081.411.67.0100.0
198264.320.515.2100.081.112.06.9100.0
198363.820.715.5100.081.411.76.9100.0
198461.621.516.9100.080.612.17.3100.0
198560.622.616.9100.079.913.17.0100.0
198661.222.616.2100.081.112.96.1100.0
198760.523.216.4100.081.013.15.9100.0
198858.823.517.7100.080.013.86.2100.0
198957.124.618.3100.079.914.06.1100.0
199057.424.518.1100.080.513.75.8100.0
199156.125.018.9100.080.114.25.7100.0
Sources: Sapir (1992).

Implications of the Internal Market Program for the Multilateral Trading Environment

The Internal Market Program was primarily directed toward the creation of the conditions for free trade in goods and services within the European Union. However, the Internal Market also had implications for third parties. In this connection, two observations should be made.

First, the positive demand effects of the Internal Market Program are a likely contributor to the growth of world trade in goods and services. The European Commission is still working on an evaluation of the economic effects of the program. The Commission initially estimated the eventual permanent effect of the program on the level of real income at 4.25 percent to 6.5 percent of GDP for the Community as a whole.57 The trade diversion effects at the expense of foreign suppliers were estimated at 2.5 percent of imports. Assuming an average income easticity of EU demand for imports from the rest of the world of 2, and a GDP growth rate of 5 percent, the net positive impact of the program on extra-EU imports would reach 7.5 percent. The Commission also estimated that this increase would be compensated by lower extra-EU imports owing to improved competitiveness of European industries as a result of the program. In a separate study, Haaland and Norman (1992) also came to the conclusion that the third country effects of the program would be small. More updated information on trade and income provide only partial support to their conclusions. Preliminary estimates suggest that the permanent real effect of the program was 2.4 percent to 3.4 percent of GDP, somewhat less than initially expected, although still considerable.58 At the same time, the progressive implementation of the program was associated with a strong increase in both intra- and extra-EU imports (Table 1).

Second, the elimination of remaining national quantitative restrictions and technical barriers to trade and liberalization in the financial sector (services and capital movements) have implications for suppliers outside the EU. The elimination of trade barriers resulting from the harmonization of technical product standards does not only promote trade between member states, but also with third countries. The same holds, mutatis mutandis, for liberalization of financial services and capital movements. The Second Banking Directive grants to foreign bank subsidiaries established in a member state the same benefits as EU banks. New foreign establishments are subject to the principle of reciprocity in national treatment. As U.S. legislation is considered by the EU to satisfy this principle, the implementation of the Second Banking Directive has in practice created full market access for U.S. subsidiaries. Further, the elimination of restrictions on capital movements also covers capital transactions between the EU and third countries. All restrictions are prohibited, with the exception of any restrictions on direct investment, the right of establishment, the provision of financial services or the admission of securities that existed on December 31, 1993. In this area, new measures that constitute a step back as regards the liberalization of capital movements to or from third countries require a unanimous Council decision. Thus the new regime on capital movements implies a standstill on restrictions on direct investment and the right of establishment from third countries.

At the same time, the elimination of national quantitative trade restrictions under the Internal Market was in some cases replaced by EU-wide restrictions. In one well-documented case—the replacement of national quotas on imports of bananas (mainly affecting Latin American countries) with a EU-wide tariff quota—there is a risk that efficient producers may lose market share in the EU, especially in previously unrestricted markets. Another example is the replacement of national quotas and VERs on Japanese cars with a EU-wide VER. Also, provisions in public procurement directives leave the possibility for national authorities to maintain a 50 percent EU content requirement and a 3 percent price preference for EU suppliers. This could potentially reduce market access for third countries, although the liberalization of public procurement markets in the EU may still have a net positive impact on foreign suppliers.

European Union: A Model for Integration?

A question often raised is whether the EU provides a model for integration that other countries could emulate. Some of the forces behind European integration are unique and not easily replicated in other regions.

First, and most important, European integration, although predominantly economic in nature, should also be seen in the light of the geopolitical considerations of its founding fathers. The European Economic Community and its sister organization, the European Coal and Steel Community, were established to create a multilateral framework for cooperation between industrial countries that were previously engaged in two world wars, and faced with the pressures of the east-west conflict after the war. The establishment of the European Communities was a unique attempt to create an area of political stability in Europe, and this objective has not lost its value since then. The closer cooperation with countries of Eastern Europe and of the former Soviet Union and recent applications for EU membership by Hungary and Poland should also be seen in this light.

A second relatively important distinction is the structure of trade in manufactured goods. As noted earlier, a large and growing share of trade within the EU consists of intra-industry trade, reflecting increasing product differentiation and narrowing differences in the economic development of EU member states. Product specialization within a certain industry typically requires less structural change than interindustry specialization that may be associated with the closure of whole enterprises and substantial new investments. As a result of the specific circumstances in Europe, the overall adjustment costs of economic integration have remained relatively small.

Third, European integration goes beyond the creation of an internal market in goods and services. EU member states have agreed to establish an economic and monetary union including a single currency, in accordance with the provisions of the Maastricht Treaty. The EU also aims at the enhancement of economic cohesion, requiring substantial financial transfers by the wealthier member states to the economically weaker regions in the EU—total resources committed for the period 1995-99 are set at Ecu 176 billion.

Fourth, the process of integration and liberalization took place over a prolonged period, which unnecessarily delayed its net benefits. The transition period (1958-69) was unduly long, and before 1985 progress in the field of trade in services, liberalization of capital flows, and the enforcement of competition policies (including those directed toward the reduction of distortive state aids) was limited, due to wide differences of policies and practices between member states. The Internal Market Program gave an important impetus to further liberalization, but even today, after the nearly full implementation of the program, some important areas of economic activity (such as the production and distribution of energy) are not yet completely liberalized.

Notwithstanding these qualifications, most computations of the trade creation and diversion effects of European integration indicate that the aggregate real income effects have clearly been positive, notably in the manufactured goods sector. Given the limited gross trade diversion effects measured in this sector, and the positive impact of higher income in the EU on imports, industrial producers in third countries are in general likely to have benefited from European integration, especially because internal integration was associated with external liberalization in the context of the GATT. The harmonization and liberalization under the Internal Market Program probably have added to these positive effects. Also, European competition policies may have contributed to some reduction in state aids during the 1980s, and possibly have prevented harmful subsidy wars between European countries. However, the present level of subsidization is still very high, and reaching agreement on faster reforms has proved difficult.

A clear exception to the positive real income effects is the CAP, which has effectively closed EU markets for temperate zone products and seriously distorted world markets in agricultural commodities. The costs for consumers within the EU and for more efficient foreign producers (including many developing countries) are high, and the introduction of necessary reforms has proved difficult. Although computations of trade diversion and creation indicate that the negative trade effects in the agricultural sector were smaller than the positive effects in the manufactured goods sector, the interests of those countries that are heavily dependent on exports of temperate zone products are seriously damaged by these policies.

North American Free Trade Agreement

The North American Free Trade Agreement liberalizes barriers to trade and investment between Canada, Mexico, and the United States, while leaving barriers to countries outside the NAFTA unchanged. Its provisions include improved market access as well as changes in trade rules and new issues; these are briefly summarized below. Subsequent to the signing of the NAFTA, two supplementary agreements were negotiated in the areas of environmental and labor standards.

The NAFTA is expected to stimulate trade and raise living standards within North America. Existing studies indicate that the NAFTA will not have substantial adverse effects on nonmembers in the aggregate—trade diversion is estimated in most studies at less than 1 percent of non-NAFTA partner country exports to North America. It is important to note, however, that these studies provide, at best, rough orders of magnitude of the full economic effects and they typically do not capture the distribution of adverse effects at the level of individual nonmember countries.

Main Provisions

The NAFTA was signed by the Governments of Canada, Mexico, and the United States on December 17, 1992, and entered into force on January 1, 1994.59 The agreement provides for improved market access in many sectors, including agriculture, the automotive sector, energy, financial services, telecommunications, textiles and apparel, and transportation. Additionally, there are provisions governing the rules for international trade within North America, including dispute settlement, government procurement, intellectual property, and investment.

Improvements in market access are provided in the form of phased tariff reductions, liberalization of nontariff barriers (NTBs), relaxed investment restrictions, and harmonization of standards. The principal provisions in the NAFTA on market access and trade rules are briefly summarized below for a selection of key sectors.

The NAFTA has separate bilateral agreements concerning agricultural products for U.S.-Mexico trade and Canada-Mexico trade. The Canada-U.S. Free Trade Agreement still covers U.S.-Canada trade. On U.S.-Mexico trade, tariffs will be reduced over a 15-year period (over half of bilateral trade became duty free as of January 1, 1994), and both countries eliminated all NTBs by converting them into tariffs or tariff-rate quotas, to be phased out over 10 to 15 years. Canada and Mexico eliminated all tariff and nontariff barriers on their agricultural trade, with the exception of those in the dairy, poultry, egg, and sugar sectors.

Mexico will phase out all tariffs and most NTBs on cars over five to ten years. Car imports into the United States from Mexico became duty free upon implementation of the NAFTA; the light truck tariff fell from 25 percent to 10 percent, to be phased out over five years. Mexican domestic content and trade balancing provisions will be phased out over ten years. The rule of origin specifies that finished automobiles must contain at least 62.5 percent North American content, as compared with 50 percent in the CUSFTA.

In the energy sector, the NAFTA contains provisions in the areas of investment, tariffs and NTBs, and procurement. Mexico will open most petrochemical and electric generation sectors to U.S. investment; however, restrictions will remain on foreign investment in the basic energy sector, including investment in oil and gas exploration, production, and refining, where Pemex (the Mexican state-owned oil company) will continue to hold a monopoly. Pemex and CFE (the State Electricity Commission) contracts will be opened up to foreign competition.

Mexico agreed to eliminate its restrictions on foreign investment in the banking, insurance, and brokerage industries but with long phaseout periods. There are limits on the market shares of foreign firms in the transition period. The NAFTA partners are only required to allow subsidiaries of North American firms in their countries rather than branches. Each subsidiary is subject to the minimum capital and reserve requirements of the host country.

The NAFTA provides for rapid progress for North American firms in gaining access to Mexico’s telecommunications market. Mexico eliminated the majority of tariffs and NTBs to its telecommunications equipment market upon implementation of the NAFTA and will accelerate cross-border investment in telecommunications goods and enhanced services.

U.S. import quotas were eliminated upon implementation of the NAFTA on Mexican textiles and apparel trade, provided the strict rules of origin requirements are met. For Mexican goods that do not meet these rules, quotas will be eliminated over ten years.60 All tariffs will be eliminated within ten years; tariffs covering the majority of U.S.-Mexico textile trade will be eliminated within six years.

Under the NAFTA, trucking companies may carry cargo across the border, and foreign investment in bus and trucking services is permitted. Prior to the NAFTA, U.S. truckers were prevented from carrying cargo across the border, and Mexican truckers were allowed limited access to the United States.

In the area of dispute settlement, the NAFTA parallels and augments the dispute settlement provisions in Chapters 18 and 19 of the CUSFTA. The NAFTA establishes the Free Trade Commission, comprising cabinet-level representatives of the three member countries, to supervise implementation of the agreement and resolve disputes. The NAFTA also extends the CUSFTA dispute resolution procedures regarding antidumping and countervailing duty actions to Mexico. NAFTA members agree to replace judicial review of final antidumping and countervailing duty determinations with binational panel review; such binational panel decisions are binding. In addition, the NAFTA includes new provisions to ensure that a country complies with panel procedures and rulings, and strengthens existing extraordinary challenge procedures of the CUSFTA.61

In the area of government procurement, Mexico will open up competition to all North American companies over a 10-year period. For Pemex, CFE, and construction contracts, procurement will be opened to Canadian and U.S. bidders progressively over ten years. Liberalization in Pharmaceuticals will proceed more rapidly, with patented drugs opened immediately and nonpatented drugs opened within eight years. Subnational governments are encouraged but not required to enter into the obligations of the NAFTA.

In the intellectual property area, the NAFTA commits Canada to eliminate its compulsory pharmaceutical licensing requirements and Mexico to follow the GATT intellectual property agreement. The NAFTA also enhances Mexican protection of patents, copyrights, trademarks, and trade secrets, largely along the lines set out in the Uruguay Round Agreement. Canada will maintain its cultural exemption, and biotechnology inventions are excluded from patentability.

Under the NAFTA, member countries agree to provide national treatment to investors of another NAFTA member; the agreement also accords most-favorednation treatment to investors of NAFTA members. Mexico agreed to phase out its export performance, local content, and foreign exchange balancing requirements. In addition, investors of NAFTA members may seek binding investor-state arbitration before an impartial tribunal. In anticipation of the NAFTA, the United States and Mexico concluded a bilateral tax treaty in September 1992 that reduced the high statutory tax rates on interest, dividends, and royalties flowing in both directions. There are some significant sectors exempted from these provisions, including Canada’s cultural industry, Mexico’s energy and railroad industries, and U.S. airline and radio communication industries.

Supplementary Agreements

Subsequent to negotiation and signature of the NAFTA, the three countries embarked upon a series of parallel negotiations, culminating in supplementary agreements on labor, the environment, and import surges. These supplementary agreements were implemented along with the main NAFTA with effect from January 1, 1994. The agreement on import surges reaf-firms the right to emergency protection provided in the safeguards clause (Chapter 8) of the NAFTA and includes provisions to facilitate its effective use. It establishes both an “early warning system” for responding to import surges, and a Working Group on Emergency Action. The Working Group will assess the performance of NAFTA’s safeguards provisions and make recommendations for revisions, as appropriate.

The North American Agreement on Environmental Cooperation creates a new Commission for Environmental Cooperation, commits the NAFTA partners to work toward improving their environmental protection laws and to enforce existing laws, and establishes a dispute-settlement procedure to address complaints of a persistent failure to enforce domestic laws (monetary fines as high as $20 million may be assessed).

The North American Agreement on Labor Cooperation sets forth shared objectives and obligations in the area of labor standards and sets up a dispute resolution mechanism similar to that established in the environmental side agreement, including establishment of a trinational Commission for Labor Cooperation. The Commission provides a forum for consultations and, in addition, has the authority to form dispute resolution panels. If a country shows a persistent pattern of failure to comply with enforcement of mutually recognized, trade-related labor law, the panel may assess monetary fines (up to $20 million). If the fines are not paid within an established time frame, NAFTA benefits may be removed temporarily in the case of the United States and Mexico; in the case of Canada, enforcement shall be handled by Canadian courts.

Effects on Member Countries

Implementation of the NAFTA is expected to result in a broad-based expansion of trade within North America, especially between Mexico and the United States, and in increased real incomes in all three member countries. Substantial rationalization and gains from trade are expected in the areas of agriculture, automobiles and auto parts, machinery, chemicals, textiles and apparel, and services (banking and insurance, Pharmaceuticals, and telecommunications). There has been considerable debate concerning the effects of NAFTA on aggregate employment and real wages for low-skilled workers in Canada and the United States. Available evidence is mixed—some studies show increases and others decreases—but in most cases the effects are small (real wages change by less than 2 percent). Effects of the NAFTA on member countries have been extensively analyzed in the literature, using a variety of modeling methods.62 It is important to note, however, that these studies were conducted without full information as to the exact nature of the agreement, and therefore may be subject to a larger margin of error than otherwise.

Aggregate Effects for Member Countries

The distribution of the aggregate gains from trade liberalization under NAFTA depend on the relative magnitudes of trade between the partner countries, as well as the relative sizes of the economies. The Canadian economy is about one tenth the size of the U.S. economy, whereas the Mexican economy is less than half the size of the Canadian one (measured in terms of GDP). The CUSFTA has already liberalized trade between the two partners, hence the NAFTA is unlikely to have important effects on U.S.-Canada bilateral trade (or investment) flows. Canada-Mexico bilateral trade flows are currently very small. It is unlikely that the NAFTA would lead to a substantial increase in trade between them. Mexico is a significant trading partner for the United States, but because the U.S. economy is large, Mexico only accounts for about 7 percent of U.S. exports and 7 percent of U.S. imports. In contrast, trade with the United States is very important for Mexico; around 70 percent of its trade occurs with its northern neighbor. It is therefore to be expected that Mexico will reap most of the gains, and bear much of the adjustment burden, from the NAFTA.

This is confirmed by existing studies. Although the studies indicate that the NAFTA is likely to lead to an increase in aggregate real income for all partner countries, estimated increases in aggregate real income for Canada range from 0.03 percent to 0.07 percent and, for the United States, they range from 0.07 percent to 0.3 percent.63 Real income gains for Mexico are more substantial; they range from 0.1 percent to 5.0 percent, with the range depending upon whether the studies incorporate gains due to rationalization of production in the presence of scale economies, and whether the NAFTA induces substantial capital flows into Mexico.64

Notwithstanding the insignificant nature of estimated aggregate effects for the United States, there has been considerable attention given to the possibility that low-skilled U.S. workers may suffer reduced earnings or lose their jobs as a result of the NAFTA. While some studies do distinguish low-skilled workers from other workers, their findings are inconclusive; regardless of the direction of the estimated change in earnings, however, “the preponderance of evidence indicates an almost indiscernible effect on U.S. wage rates for both low-skilled and high-skilled groups.”65

Effects on Selected Sectors

The NAFTA liberalizes imports of fresh fruits and vegetables into the United States and imports of grains (principally corn) into Mexico. This is expected to reduce U.S. production especially in certain horticultural products, such as asparagus, avocados, fresh and canned tomatoes, oranges and orange juice, and sugar.66 Liberalization of corn trade is expected to lead to substantial displacement of Mexican production and, in turn, to migration of displaced farmers into urban areas.67

The effects of liberalization of North American trade in cars will depend crucially on decisions by the large multinational producers. Currently, five auto producers operate in the Mexican market, all of which are wholly foreign owned: Chrysler, Ford, General Motors, Nissan, and Volkswagen. On the demand side, the income elasticity for autos is very high in Mexico, hence strong economic growth there (due to the NAFTA) would lead to a substantial increase in car sales.68 On the supply side, existing domestic content and trade balancing provisions under the Auto Decrees have led to uneconomical investment in parts production, and to production at too small a scale for efficient operation. The NAFTA would be expected to lead to substantial rationalization in the Mexican auto industry, but to only slight production and employment changes in Canada and the United States.69

The NAFTA liberalizes tariffs and quotas on North American trade in textiles and apparel. Safadi and Yeats (1993) show that Mexico has consistently underutilized its Multifiber Arrangement quotas with the United States over the 1980s, Mexico’s market share in the United States is low, and that the NAFTA incorporates a strict rule of origin based on “triple transformation.” This makes it unlikely that Mexico would experience a major expansion in its textiles and apparel industry as a result of the NAFTA, especially as quotas under the MFA are phased out as a result of the Uruguay Round.70

Effects on Nonmembers

Given the preferential trade liberalization, there is the potential for trade diversion, as NAFTA member countries shift their purchases to other countries within North America and away from countries excluded from the NAFTA. Additionally, there is potential for investment diversion; firms may relocate operations to North America to serve the integrated North American market. Rules of origin in the NAFTA are particularly strict in the auto, computer, and textiles and apparel sectors, and this may exacerbate the exclusionary tendencies of the agreement. Available studies, however, though tentative, suggest that the adverse economic effects of the NAFTA on excluded countries in aggregate are likely to be quite small. Caution is warranted, however, in interpreting such results, as disruption at the level of individual countries, or specific sectors within countries, may be significant. Because such studies typically model the rest of the world as a single entity, significant effects for individual nonmember trading partners are not captured. Potentially significant trade diversion may take place within a limited range of items—for example, in certain agricultural sectors and labor-intensive manufactures such as textiles and apparel where MFN protection is high—for selected countries whose trade is concentrated in these items. The conclusion to draw from these studies is that trade diversion due to NAFTA is not likely to appreciably disrupt the pattern of aggregate world trade, but that individual trading partners might still experience an adverse trade shock.

Aggregate Effects

Using partial equilibrium methods, Laird (1990) finds that removing tariffs completely within North America would reduce exports of other countries in the Western Hemisphere to the United States by less than 0.8 percent; for all industrial countries, the NAFTA would reduce their exports to the United States by 0.5 percent. Erzan and Yeats (1992) also use partial equilibrium methods to show that trade diversion from preferential tariff elimination within North America would be limited, 94 percent of total trade diversion would affect countries outside the Western Hemisphere, and total trade diversion would amount to about 0.5 percent of U.S. imports from nonmembers.

While a large number of computable general equilibrium (CGE) models constructed to analyze the economic effects of the NAFTA concentrate mainly on the NAFTA members themselves, a few do provide some results for the rest of the world. These indicate generally that nonmembers suffer losses in trade shares and in welfare as a result of the NAFTA, albeit their magnitude is very small.71 Estimated trade diversion effects of the NAFTA based on these CGE models depend importantly on the manner in which foreign investment flows are incorporated, if at all, and on the way in which the model’s structure influences terms of trade changes in response to preferential trade liberalization within North America.72

Effects on Selected Regions

East Asian countries generally face the highest tariffs and hard-core NTBs on exports to the United States (their largest North American market) in labor-intensive manufactures, such as textiles and apparel and footwear; China, Korea, Malaysia, and Singapore also face significant trade barriers on exports of iron and steel as well as electronic equipment.73 Diversion of East Asian exports induced by the NAFTA is estimated to range between $380 million and $700 million based on partial equilibrium and gravity equation methods as employed by Braga and others (1992); this amounts to less than 1 percent of East Asian exports to the United States in 1989. Partial equilibrium estimates constructed by Kreinin and Plummer (1992). however, suggest somewhat greater trade diversion. For ASEAN, this is estimated at $434 million, or 4 percent of exports to North America; this amounts to less than 1 percent of ASEAN global exports in l988. For Korea, trade diversion is estimated at $1,015 million, or 5 percent of Korean exports to North America (or just over 2 percent of Korea’s global exports in 1987).74Noland (1994) obtains estimates of trade diversion for Korea ranging from 1 percent to 3 percent of Korea’s global exports in 1991, using a variety of partial equilibrium models. There is only anecdotal evidence on the likelihood of investment diversion from East Asia to Mexico as a result of the NAFTA, in particular regarding the rules of origin; this remains an open and potentially important question. Countries in East Asia are also concerned about the potential trade-diverting effects of possible future accessions by Latin American countries to NAFTA.

Countries in South Asia mainly compete with Mexico for sales of textiles and clothing in the U.S. market and are subject to tariffs in the range of 15 percent to 30 percent and to bilateral quotas under the Multifiber Arrangement (MFA); India has by far the largest share of South Asian exports to the United States. While Mexico’s access to the U.S. market for textiles and apparel will increase under the NAFTA, Mexico currently underfills its existing quotas by about 25 percent and many of the items Mexico exports to the United States do not overlap with exports from other countries.75 In view of this, trade diversion due to the NAFTA in textiles and apparel is unlikely to be significant. Diversion of exports from South Asian countries due to the NAFTA is expected to be minor (about 1 percent of South Asian exports to the United States) based on partial equilibrium simulations of preferential removal of tariffs and NTBs on textiles and apparel within North America.76 It is noteworthy that diversion of South Asian exports due to the NAFTA is estimated at about 1 percent of the expected gains from the Uruguay Round.

Latin American and Caribbean countries compete with Mexico in certain agricultural products (frozen orange juice concentrate from Brazil and sugar from Caribbean Basin countries, for instance) and in labor-intensive manufactures, such as textiles and apparel and footwear.77 Regarding orange juice, there is potential for trade diversion from Brazil (on the order of 5 percent of Brazilian citrus production) if the NAFTA stimulates significant new investments in Mexican citrus.78 Clearly, the Caribbean is also vulnerable to changes in U.S. sugar quotas. Trade diversion is likely to be minor (1 percent) for Latin America and the Caribbean as a whole, although some exceptions may occur in certain product groups vis-à-vis particular countries.79

Estimates of trade diversion for each region may overstate the actual trade diversion in view of the aforementioned capacity constraints in the Mexican economy (as evidenced by the small Mexican share of the U.S. market), substantial underfilling of MFA quotas, and tight rules of origin that may reduce the value of preferential liberalization in the NAFTA. Phaseout of the MFA (and other improvements in market access) contained in the Uruguay Round agreement will erode the margin of preference in textiles and clothing, thereby lessening trade diversion in this area. Nevertheless, it will be important to monitor implications for individual countries as NAFTA implementation proceeds.

Appendix I: Regional Trading Arrangements

This appendix presents the membership, objectives, and recent progress toward integration of regional trading arrangements. It includes only regional trading arrangements of a reciprocal nature. Unilateral preferential agreements, for example, arrangements under the Generalized System of Preferences, are not included.

Regional Trading Arrangements
NameMembershipObjectivesProgress to Date
Africa
AEC (African Economic Community) (1991)Fifty-one African member states.Economic Union. Six stages progressing through a strengthening of existing regional arrangements, the formation of a pan-African FTA, customs union, and eventually a common market and monetary union. The community is to be established over a transitional period not to exceed 34 years.Ratification and entry into force on May 12, 1994.
CBI (Cross-Border Initiative) (1993)Burundi, Comoros, Kenya, Madagascar, Malawi, Mauritius, Namibia, Rwanda, Seychelles, Swaziland, Tanzania, Uganda, Zambia, Zimbabwe. Members of Comesa, SADC or IOC can participate.Economic union. Supporting integration objectives of Comesa, SADC, and IOC. Promoting cross-border trade, investment and payments. Facilitating factor mobility. Removing intraregional trade barriers, as well as lowering external tariffs. Liberalizing administration and other controls relating to investment.A framework on core policies was agreed upon. It calls for immediate abolition of NTBs and removal of tariffs on trade in goods and services among reciprocating countries by the end of 1996 and for moving toward a common external tariff by lowering external tariffs at least to the level of the member with the lowest tariffs.
CEAO (Communauté Economique de I’Afrique de I’Ouest)(1974) Abolished in 1994Benin, Burkina Faso, Côte d’Ivoire, Mali, Mauritania, Niger, Senegal.Customs Union. Ultimate objective is to establish an economic union (now within the framework of WAEMU; see below).Only 428 products receive regional preferences. Some success in achieving labor mobility and regional cooperation.
CEPGL (Communauté Economique des Pays des Grands Lacs) (1976)Burundi, Rwanda, Zaïre.Free trade area, Free factor mobility and sectoral regional cooperation.Application of preferential tariffs has not been fully implemented.
Comesa (Common Market for Eastern and Southern Africa) (1993), formerly PTA (Preferential Trade Area for Eastern and Southern African States) (1982)Angola, Burundi, Comoros, Djibouti, Ethiopia, Kenya, Lesotho, Madagascar, Malawi, Mauritius, Mozambique, Namibia, Rwanda, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zambia, Zimbabwe.Common market. A common market is to be established by 2000. Ultimately, an economic union. Sectoral cooperation in industrial, agricultural, and interstate transport and communications development, environment, natural resources, energy and the development of economically depressed areas. Cooperation in monetary and financial matters.PTA tariff reform calls for an initial set of tariff cuts ranging from 10 percent to 70 percent, followed by a 10 percent tariff reduction every two years between 1988 and 1996. The remaining 50 percent would be eliminated in two steps: 20 percent in 1998 and 30 percent in 2000. NTBs are to be eliminated during that period as well. This schedule is being implemented by most PTA members. To facilitate intraregional transactions, checks denominated in UAPTA (PTA Units of Account) were introduced in 1988. To ease intercountry flow of merchandise trade, the Road Customs Transit Declaration (RCTD) was introduced; it has replaced diverse documents previously required by member states. In 1987, the PTA Motor Vehicle Insurance scheme was introduced to obviate the need to take out separate insurance in every country.
ECCAS (Economic Community of Central African States) (1992)Burundi, Cameroon, Central African Republic, Chad, Congo, Equatorial Guinea, Gabon, Rwanda, Sao Tome and Principe, Zaïre.Common market. Coordinating and expanding efforts at regional cooperation in Central Africa.A framework agreement is being discussed.
ECOWAS (Economic Community of West African States) (1975)Benin, Burkina Faso, Cape Verde, Côte d’Ivoire, Gambia, Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Mauritania, Niger, Nigeria, Senegal, Sierra Leone, Togo.Common market. Fiscal and monetary harmonization. Joint development projects. New target to eliminate NTBs by 1995.Limited trade liberalization; common external tariff remains to be designed; the Fund for Compensation and Development is not yet functional. A protocol on labor mobility was signed in 1979, but it has not been implemented.
IOC (Indian Ocean Commission)(1984)Comoros, Madagascar, Mauritius, Seychelles.Economic cooperation. Promote cooperation in economic, commercial, and industrial development.Some success in sectoral cooperation in fishing, transport, communication, and information.
Lagos Plan of Action (1980)All countries in sub-Saharan Africa.Economic union. Providing a unifying framework for existing arrangements.The ECCAS was created under the auspices of the Lagos Plan of Action in order to coordinate economic integration in Central Africa.
MRU (Manu River Union) (1973)Guinea, Liberia, Sierra Leone.Economic union.Intra-MRU trade is tariff free and a common external tariff is in place. However, progress toward integration and intraregional trade has been slowed by pervasive NTBs.
SACU (Southern African Customs Union) (1910)Botswana, Lesotho, Namibia, South Africa, Swaziland.Common market. Free movement of goods and right of transit among members.Goods and labor markets are relatively well integrated. A common external tariff is in effect, With the exception of Botswana, all SACU countries are also members of the Common Monetary Area or Rand Monetary Area.
SADC (Southern African Developtment Community) (1992), former SADCC Southern African Development Coordination Conference) (1980)Angola, Botswana, Lesotho, Malawi, Mozambique, Namibia, South Africa, Swaziland, Tanzania, Zambia, Zimbabwe.Economic cooperation. Foster economic cooperation among members, initially with a view to reducing economic dependence on South Africa; promote balanced regional development; and secure and coordinate support from foreign donors, SADC members have now expressed their willingness to welcome South Africa into the organization, Since 1988, the SADCC included trade as an additional area for cooperation.Some success in undertaking joint development projects in transport and communication, food and agriculture, and industrial rehabilitation.
UDEAC (Union Douanière des Etats del’Afrique Centrale) (1966)Cameroon, Central African Republic, Chad, the Congo, Equatorial Guinea, Gabon.Common market; policy harmonization. Members of the UDEAC are also members of the Franc Zone, with a common central bank, BEAC.QRs among member countries are being eliminated. A common external tariff with four rates (5 percent, 10 percent, 20 percent, and 30 percent) is being implemented. A preferential tariff equal to 20 percent of the common external tariff is to be applied to member states. UDEAC countries signed a treaty establishing the Economic and Monetary Community of Central Africa (CEMAC) (1994).
WAEMU (West African Economic and Monetary Union) (1994)Benin, Burkina Faso, Côte d’Ivoire, Mali, Niger, Senegal, Togo.Economic union. Adding a common market to the existing monetary union through the BCEAO. Harmonizing tax systems and coordinating sectoral policies.Agreement signed in January 1994. Main goals in the agreement: coordination of macroeconomic policy, fiscal convergence, harmonization of budget procedures, public finance statistics, indirect taxation, and business law.
Asia
AFTA (ASEAN Free Trade Arrangement) (1992)Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore, Thailand.Free trade area. Regional industrial cooperation. The FTA is to be achieved in 2008, 15 years after the start of the phasing down of tariffs in 1994. The goal is to reach a zero to 5 percent preferential tariff on manufactured goods by 2008. QRs are to be eliminated upon enjoyment of initial concessions, and other NTBs are to be phased out over five years from the date of initial concessions on an item. Raw agricultural products and services are not included.1The starting date for implementation was moved forward from January 1993 to January 1994. An average of 25 percent of member country tariff lines are covered in the program of tariff reduction with effect from 1994. According to the present schedule, roughly 88 percent of these tariff lines will reach the target level of zero to 5 percent tariff by 2003.
ANZCERTA (Australia–New Zealand Closer Economic Relations Trade Agreement) (1983)Australia, New Zealand.Free trade area. Harmonization of business law and cooperation in the area of standards and customs procedures. Elimination of antidumping within the FTA.Since 1990, all intra-area trade in goods and services is free of tariffs, QRs, antidumping measures, and production subsidies.
APEC (Forum for Asia-Pacific Economic Cooperation) (1989)Australia, Brunei Darussalam, Canada, China, Hong Kong, Indonesia, Japan, Malaysia, Mexico, New Zealand, Papua New Guinea, Philippines, Republic of Korea, Singapore, Taiwan Province of China, Thailand, United States.Economic cooperation, Promoting the multilateral trading system and intensifying regional consultation and cooperation. Representing member countries’ views in multilateral negotiating forums.Exploratory work is under way on reviewing member countries’ customs procedures and investment regimes and prospects for mutual recognition of standards. A draft free trade agreement for the Asia-Pacific region is to be discussed at the APEC summit on November 15, 1994.
ASEAN (Asia-Pacific Economic Cooperation Forum) (1967)Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore, Thailand.Economic cooperation, Initially concerned with regional peace and security issues. Since 1977, when the ASEAN Preferential Trading Arrangement was signed, the goals became more economic in nature. Mainly enhancing regional trade, maintaining the area’s competitive position, and exploiting economies of scale.Under the auspices of ASEAN’s PTA, preferences for a limited range of products were implemented; no agreement on reducing NTBs; liberalization process hindered by strict rules of origin; some joint ventures. Regional trade liberalization plan now formally codified in AFTA (1992).
Bangkok AgreementBangladesh, India, Republic of Korea, Lao People’s Democratic Republic, Papua New Guinea, Sri Lanka.2Intended to promote regional economic development through trade expansion.Tariff preferences established for about 300 products.
EAEC (East Asian Economic Caucus) (1990)Brunei, China, Hong Kong, Indonesia, Japan, Republic of Korea, Malaysia, Philippines, Singapore, Taiwan Province of China, Thailand.Economie cooperation. Regional grouping to represent members’ views in multilateral negotiating forums and to expand regional cooperation.The EAEC proposal was put on the agenda for the ASEAN summit meeting in January 1992. ASEAN leaders agreed to suspend it and launched the AFTA proposal instead.
SAARC (South Asian Association for Regional Cooperation)Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka.SAARC countries are committed to step-by-step liberalization of trade in such a manner that all countries in the region share the benefits of trade expansion equitably.In July 1992, a decision was reached to draft an agreement for a SAARC Preferential Trading Arrangement (SAPTA). The draft agreement was submitted to the SAARC Standing Committee in December 1992 and signed April 11, 1993. As of January 1994, negotiations were continuing to finalize schedules of concessions.
Europe
Baltic FTA (1993)Estonia, Latvia, Lithuania.Free trade area. The agreement does not apply to agricultural goods, for which a special protocol will be signed at a later date. Customs duties and QRs abolished upon entry into force of the agreement. No new tariffs or NTBs are to be introduced among the three countries in future. During a transitional period export restrictions on some specific goods will be maintained by each republic.The agreement went into effect on April 1, 1994.
Belarus-Russia Economic Union (1994)Belarus, Russia.Economic union. A full economic union is to be achieved in stages between the two countries. The first stage involves a customs union. The final stage features the complete elimination of barriers to trade between Belarus and Russia.The first stage of the economic union is being implemented.
BENELUX (1948) (Belgium-Netherlands-Luxembourg Economic Union)Belgium, Netherlands, Luxembourg.Economic union.Closely integrated common market. Tax policy coordination.
Bilateral free trade agreements between individual Baltic countries and Finland, Norway, Sweden, and Switzerland (1992) (1993)Estonia, Finland, Latvia, Lithuania, Norway, Sweden, Switzerland.Free trade area. Agriculture is not included and restrictions apply to textiles. A separate agreement between Sweden and Latvia grants Latvia lower import duties on agricultural exports to Sweden.Most agreements have come into force throughout 1992 and 1993.
CEFTA (Central European Free Trade Agreement), or Visegrad Agreement (1992)Czech Republic, Hungary, Poland, Slovak Republic.Free trade area. Liberalization of trade in “normal” goods over a period of three to four years and in “sensitive” products (textiles, steel, agriculture) over eight years. Exceptions remain, for example, QRs in agriculture will remain indefinitely.Implemented as of March 1993.
CIS (Commonwealth of Independent States) Economic Union (1993)Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, the Kyrgyz Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, Uzbekistan.Economic union. Gradual deepening of integration through the establishment of a free trade zone, a customs union, a common market, and monetary coordination. Customs procedure to be harmonized and legal provisions and policies for interstate contracts, investment, and joint ventures to be coordinated. The treaty envisages the coexistence of countries belonging to a renewed ruble area with countries with national currencies. Regarding national currencies, the treaty calls for limiting exchange rate fluctuations between currencies. The treaty also provides for the harmonization of national fiscal policies, to be specified in a future agreement.No deadlines have been specified regarding implementation. Several supplementary agreements are being negotiated. As of May 1994, all CIS republics except Tajikistan had introduced interim or permanent national currencies to be used alongside rubles.
Customs Union between Czech and Slovak RepublicsCzech Republic and Slovak Republic.Customs union, Part of an effort to preserve previous commercial relationships between themselves and with third parties.Entered into force January 1993. No transition period since no tariff or nontariff barriers previously existed between the members.
Customs Union between Kazakhstan, the Kyrgyz Republic, and Uzbekistan.Kazakhstan, the Kyrgyz Republic, and Uzbekistan.Customs union, Establish a common market by the year 2000.Kazakhstan and Uzbekistan agreed in January 1994 to allow free movement of goods and factors of production with the goal of establishing a common market by the year 2000. The Kyrgyz Republic acceded to the plan in February 1994.
EEA (European Economic Area) (1994)European Union, Austria, Finland, Iceland, Liechtenstein, Norway, Sweden.3Free trade area plus factor mobility. It excludes agricultural products.Entered into force in 1994.
EFTA (European Free Trade Association) (1960)Austria, Finland, Iceland, Liechtenstein, Norway, Sweden, Switzerland.Free trade area. Agricultural products are excluded.All tariffs on manufactures eliminated by 1967. QRs eliminated by the late 1970s.
EFTA-Turkey FTA (1991)EFTA, Turkey.Free trade area. Most agricultural products are excluded.By 1994, EFTA countries had abolished all customs duties on most imports from Turkey, For textiles and apparel they will be completely phased out by end of 1995. Turkey had by 1993 reduced the tariff rate on EFTA imports by 70-80 percent.
EU (European Union) (1993) EC(1957)Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, United Kingdom.4Economic union. Economic and Monetary Union to be achieved by 1997 or 1999 at the latest. Coordination of fiscal and socioeconomic policies.By the end of 1993, the Internal Market Program had almost been completed. Some barriers remain in areas such as energy, telecommunications, and transportation. Free capital mobility has been achieved. Labor movement is almost completely liberalized. Exchange rate coordination through the European Exchange Rate Mechanism.5
Europe Agreements: EU Association Agreements (bilateral) with:Bulgaria (Interim Agreement 1993); Czech Republic (Interim Agreement 1992); Hungary (Interim Agreement 1992); Poland (Interim Agreement 1991); Romania (Interim Agreement 1993); Slovak Republic (Interim Agreement 1992).Free trade area. Liberalization of trade in manufactured goods. Ultimately, the goal is accession to the European Union. The agreements include provisions on political dialogue and traderelated issues, such as competition law. Commitment to negotiate the liberalization of trade in services. Approximation of legislation of East European countries to European Union law.Most tariffs and QRs on industrial goods were eliminated after the coming into effect of the agreements. Substantive restrictions remain in steel, textiles and clothing, and coal, but are due to be phased out over a four-to five-year period after the entry into force of the agreements. Concessions were made by East European countries, although more limited, with longer phase-in periods for implementation (with a maximum of ten years).
EU-Baltic countries FTA (1994)(bilateral)EU, Estonia, Latvia, Lithuania.Free trade area.Negotiations have been concluded. Under these agreements, the EU will liberalize imports of industrial goods and services from the Baltic countries. The same sensitive areas which receive special treatment in the Europe Agreements will be protected in the EU agreements with the Baltic countries. Estonia will eliminate all QRs upon entry into force of the treaty. Latvia and Lithuania will be granted a five-to-six year period to do so.
EU-FSU Cooperation and Partnership Agreements (1994) (bilateral)EU, former Soviet Union (Belarus, Kazakhstan, the Kyrgyz Republic, Moldova, Russia, Ukraine).Free trade area. In the medium run, the “cooperation and partnership agreements” of the EU with the countries of the former Soviet Union provide for MFN treatment of merchandise trade and certain services. The agreements also schedule a revision in 1998 with the possibility of creating a free trade area.Negotiations with Russia, the Kyrgyz Republic, Moldova, Kazakhstan, and the Ukraine were concluded in 1994, and they are still in process with Belarus. The EU had already signed a treaty on commercial and economic cooperation with the U.S.S.R, in 1989. Under the auspices of that treaty, specific EU ORs were removed in 1989 and 1990.
EU-Turkey Association Agreement (1963)EU, Turkey.Customs union. To be achieved by 1995.Industrial products of Turkish origin have been exempt from customs duties and ORs in the EC since 1971. By 1993, Turkey had brought the cumulative rate of tariff reductions on EU imports to 70-80 percent. Very significant tariff reductions are also being implemented in Turkey with regard to non-EU countries in anticipation of the implementation of the common external tariff in 1995.
Intra-CIS Bilateral Trade Arrangements (1992) (1993)CIS member states.Easing supply, payments, and terms of trade problems. The agreements typically included three sections: one on “obligatory trade” in “strategic goods,” such as energy and key inputs for which prices were fixed and governments were obliged to ensure delivery; a second section with “indicative lists” of enterprise-to-enterprise trade in which the government was only obliged to issue the necessary licenses; third, in all other goods, trade was left free to enterprises.The agreements were implemented throughout 1992. They were renegotiated for 1993 and 1994. The new agreements reduce the volume of government-to-government trading to a few “strategic” products, provide for quotas and tariff quotas for enterprise-to-enterprise trade and, in general, give preferential treatment to the signatory countries. Transactions under the agreements have fallen short of the targets.
Middle East
ACM (Arab Common Market) (1964)Egypt, Iraq, Jordan, Libya, Mauritania, Syria, Yemen.Customs union.Tariffs on manufactured goods had, with a few exceptions, been removed by 1992. Considerable QRs remain. No progress on common external tariff.
AMU (Arab Maghreb Union) (1989) (fomer Maghreb Customs Union)Algeria, Libya, Mauritania, Morocco, Tunisia.Economic union. In its 1991 meeting, the AMU agreed to a four-stage economic integration process. The announced deadlines were the end of 1992 for an FTA, the end of 1995 for a customs union and the end of 2000 for a common market. There was no set deadline for the stage of monetary union, which should be established “some time thereafter.”Some multilateral trade liberalization agreements have been signed but remain largely unimplemented. An agreement was signed by the five central banks of the AMU in 1991 to help facilitate interbank payments, and it has been implemented since April 1992. Some joint projects in the energy and industrial sectors have been reached and are being carried out under the aegis of the Union.
BSEC (Black Sea Economic Cooperation Project) (1992)Albania, Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Moldova, Romania, Russian Federation, Turkey, Ukraine.Economic cooperation. Enhanced movement of goods, services, and labor and capital. Regional economic cooperation.Working groups have been established covering areas such as organizational matters, exchange of statistical data and economic information, banking and finance, trade and industrial cooperation, transport and communications, agriculture and agro-industries, and free travel for businessmen of the participating states.
ECO (Economic Cooperation Organization) (1985) (former Regional Cooperation Development)Islamic Republic of Iran, Pakistan, Turkey. Since 1992: Islamic State of Afghanistan, Azerbaijan, Kazakhstan, the Kyrghyz Republic, Tajikistan, Turkmenistan, Uzbekistan.Economic cooperation. Bilateral trade and investment promotion and sectoral economic cooperation.In 1992, a very limited system of tariff preferences among member countries was established granting a 10 percent reduction on specific tariff lines. The agreement was initially for four years, but would be automatically extended for further periods of two years each. Several committees to coordinate sectoral cooperation have been formed. Initiatives under consideration include the establishment of a regional trade and development bank and formation of an ECO shipping company.
GCC (Cooperation Council for the Arab States of the Gulf, or, alternatively, the Gulf Cooperation Council) (1981)Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates.Common market. Achieving “deep integration” among the member countries by establishing free movement of goods, services, and factors of production.Virtual elimination of customs tariffs by 1982 and liberalization of trade in services by 1983. Free movement of factors of production has been achieved.
Western Hemisphere
ANCOM or Andean Pact (Andean Common Market) (1969) Revived 1990Bolivia, Colombia, Ecuador, Peru, Venezuela.Common market. Harmonization of social and economic policies, joint programs.By 1993, tariff barriers between member countries had been eliminated in almost all product categories except capital goods. A four-tier common external tariff—5, 10, 15, and 20 percent—has been agreed upon and should start to be implemented in January 1995, with some exceptions. Strict rules on foreign ownership relaxed significantly in 1987.
Argentina-Brazil (199)Argentina, Brazil.Common market. Establishing a bilateral common market by 1994.Efforts at liberalization are being concentrated in the Mercosur framework.
CACM (Central American Common Market), (1961) Revived 1990Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua.Customs union. Agricultural goods are excluded from trade liberalization; a common price band for some key agricultural products is in place.Many restrictions to intraregional trade were lifted in the 1960s and 1970s. NTBs were reintroduced in the 1980s. Common external tariff between 5 percent and 20 percent by the end of 1992.
Caricom (Caribbean Community) (1973)Antigua and Barbuda, Bahamas, Barbados, Belize, San Cristobal, Dominica, Grenada, Guyana, Jamaica, Montserrat, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Trinidad and Tobago.Common market. Phasing down of the common external tariff to reach a 5 percent to 20 percent range by 1998.Most intraregional trade has been liberalized. The first phase of the common external tariff, which will bring tariff rates down to a range of zero to 35 percent, has been implemented starting in January 1993.
Caricom-Colombia (1991)Caricom member countrics, Colombia.Free trade area. During a transition period, it would work as a system of unilateral preferences for access of Caricom products into Colombia. Eventually, Caricom countries would reciprocate.Negotiations under way.
Caricom-Venezuela (l99l)Caricom member countries, Venezuela.Free trade area. During a period of five years, all duties on Venezuelan imports from Caricom should be phased out. After five years, negotiations should start on how to eliminate trade barriers on Venezuelan imports into Caricom countries.Negotiations under way.
Chile-Colombia FTA (1993)Chile, Colombia.Free trade area.The free trade area is operational as of January 1994.
Chile-Venezuela FTA(1993)Chile, Venezuela.Free trade area. The final deadline for complete trade liberalization between the two countries is 1999. Eventually a customs union.Intraregional tariffs are to reach zero in 1999.
Colombia-Central America FTA (1993)Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Panama, Venezuela.Free trade area. During a transitional period, Colombia is to grant unilateral tariff Cuts to Central American countries. Eventually these cuts should be reciprocated and result in a free trade area.Negotiations under way.
Colombia-Ecuador-Venezuela FTA (1992)Colombia, Ecuador, Venezuela.Customs union. Elimination of tariffs and NTBs to bilateral trade and establishment of a simplified common external tariff.An automobile trade agreement was signed in 1993 and became effective in January 1994; it includes a unified automobile industrial policy through a common external tariff and common rules of origin. Negotiations on the harmonization of agricultural policy to stabilize prices and align them within the customs union are under way.
Colombia-Venezuela (1992)Colombia, Venezuela.Free trade area.Intra-area tariffs were eliminated in 1992 and a common external tariff was agreed.
EAI (Enterprise for the Americas Initiative) (1990)Bolivia, Caricom (the 13 Caribbean members), Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Peru, Southern Cone countries (Argentina, Brazil, Paraguay, and Uruguay), United States, Venezuela.Free trade area. Aims to achieve a free trade zone for the entire Western Hemisphere. Reinforcing market-oriented reforms in Latin America by expanding trade, increasing investment, easing the debt burden, and strengthening environmental policies.The United States has signed framework agreements with 31 countries.6 Framework agreements establish the agenda for bilateral negotiations, as well as institutional mechanisms.
El Salvador-Guatemala FTA (1991)El Salvador, Guatemala.Free trade area.It entered into force in 1991.
GROUP of 3: Colombia-Venezuela-Mexico FTA (1993)Colombia, Mexico, Venezuela.Free trade area. Creating a free trade zone over a ten-year period starting in January 1995. Agricultural goods are excluded. Liberalization of the car sector will be phased in over a 13-year period.Treaty signed in June 1994. Agreement provides for an immediate zero tariff for some items and a ten-year transition for others. Tariff cuts will proceed more quickly for Colombian and Venezuelan exports to Mexico than vice versa. Venezuela has been granted two extra years to dismantle tariffs on textiles.
LAIA (Latin American Integration Association) (1980), formerly LAFTA (Latin American Free Trade Association) (1960)Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru, Uruguay, Venezuela.Common market. Area of economic preferences constituted by regional tariff preferences, “regional scope agreements,” and “partial scope agreements” (among only some of the member states) on sectoral issues of economic cooperation or trade liberalization.Numerous bilateral trade agreements. In 1990, member countries doubled the level of the Regional Tariff Preference to an average of 20 percent. The non-extension of preferences granted by Mexico to Canada and the United States under NAFTA will require an amendment of the treaty.
Mercosur (Southern Cone Common Market)(1991)Argentina, Brazil, Paraguay, Uruguay.Common market. Coordinating fiscal and exchange rate policy. Accelerating economic development.Intraregional trade is being gradually liberalized, with 1995 as the final deadline for the elimination of tariffs as well as NTBs. A common external tariff ranging from zero to 20 percent has been agreed for 85 percent of products. There is no common external tariff on capital goods and high technology products.
Mexico-Chile FTA(1991)Chile, Mexico.Free trade area. Promoting inward investment. Phased elimination of tariffs and NTBs by 1998. Oil products and certain agricultural goods are excluded. Harmonization of taxation and investment rules.Since 1992, NTBs have been eliminated and the maximum mutual tariff is 10 percent. This rate is being cut by 2.5 percent a year until it reaches zero in 1996 for goods in the fast track. For goods in the slow track (key among them oil and textiles) duties on bilateral trade will be reduced over seven years.
Mexico-Costa Rica FTA (1994)Mexico, Costa Rica.Free trade area.An agreement was signed in 1994 and is scheduled to go into effect in January 1995.
Mexico-Costa Rica-El Salvador-Guatemala-Honduras-Nicaragua FTA (1992)Mexico, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua.Free trade area.Deadline for achieving the FTA has been set for 1996. Negotiations are in process.
NAFTA (North American Free Trade Agreement) (1994)Canada, Mexico, United States.Free trade area. Including goods and services, government procurement and intellectual property rights. Canadian agricultural and Mexican petroleum products are partially excluded. Liberalization of investment flows and professional services.Staged elimination of tariffs and NTBs over a maximum of 15 years. Effective January 1, 1994.
Nueva Ocotepeque Agreement (1992)El Salvador, Guatemala, Honduras.Customs union. Forming a free trade area by 1993, and eventually evolving into a customs union.Member countries have signed Economic Complementation agreements. Little progress toward establishing a free trade area.
OECS (Organization of East Caribbean States) (1991)Antigua and Bermuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines.Customs union. Its main goal was to implement Caricom’s common external tariff ahead of schedule.A few countries (e.g., Dominica and St. Vincent and the Grenadines) have implemented the common external tariff.
United States-Canada FTA (1989)Canada, United States.Free trade area. Tariff liberalization for trade in goods in 5—10 years, some harmonization of technical standards, standstills agreed in services and investment, some liberalization of government procurement.Implementation ahead of schedule; three rounds of accelerated tariff cuts completed. Parts of the agreement will be superseded by NAFTA. The Auto Pact remains and membership is frozen.
United States-Israeli FTA (1985)Israel, United States.Free trade area. Eliminating by 1995 tariffs on all products traded between Israel and the United States.Liberalization on schedule.
Venezuela-Central America FTA (1992)Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Panama, Venezuela.Free trade area. During a transitional period, unilateral tariff cuts will be made by Venezuela. Eventually, Central American countries will reciprocate.Negotiations are under way.
Appendix II: The European Union: Trade Relations with Transition and Mediterranean Economies

The past several years brought important changes to trade arrangements between the European Union and countries in Eastern Europe and the former Soviet Union. In 1989, the EU concluded an agreement on trade, commercial, and economic cooperation with the U.S.S.R., which gave the latter most-favored-nation status and established a timetable for the removal of general quantitative restrictions on exports to the EU. Specific EU quantitative restrictions were removed in 1989 and 1990. Also, in January 1993, the EU gave Russia and other countries of the former Soviet Union access to the Generalized System of Preferences (GSP). In October 1991, the Council gave a mandate to the European Commission to negotiate separate “cooperation and partnership agreements” with Russia and other countries of the former Soviet Union. Negotiations with Russia, Moldova, Kazakhstan, the Kyrgyz Republic, and the Ukraine were concluded in 1994. The agreements provide MFN treatment for merchandise trade and certain cross-border services and contain rules on investment protection and the free transit of goods. They also provide for a review in subsequent years to examine the possibility of the creation of a free trade area. The European Union has a separate agreement with Russia on textiles, steel, and uranium. Trade relations with other countries of the former Soviet Union are still governed by the agreement with the U.S.S.R.

The EU has negotiated free trade agreements with Estonia, Latvia, and Lithuania, which provide preferential treatment on imports from these countries, comparable with the trade sections of the EU’s Association Agreements with East European countries. Under these proposed agreements, Latvia and Lithuania will have a five- to six-year transition period.

The EU concluded Association Agreements (“Europe Agreements”) with Bulgaria, the Czech Republic, Hungary, Poland, Romania, and the Slovak Republic. Trade and some trade-related aspects covered by interim agreements became effective on March 1, 1992 for the Czech and Slovak Federal Republic, Hungary, and Poland, on May 1, 1993 for Romania, and on December 31, 1993 for Bulgaria. The final agreements with Hungary and Poland entered into force on February 1, 1994. The EU also maintains special agreements on trade in wine and meat with most East European countries.

The Association Agreements with Eastern Europe contain provisions on, inter alia, political dialogue, trade in goods and services, and trade-related issues, such as competition law. They provide for immediate or phased elimination of trade restrictions on industrial products. The EU abolished QRs and tariffs on a large number of industrial products upon entry into force of the agreements; remaining tariffs (including tariff quotas and ceilings) will be eliminated after a three-year period.80 However, special, more restrictive arrangements apply to so-called sensitive goods: agricultural products, clothing and textiles, coal, and steel. Market opening in agricultural trade is rather limited. The level of protection in agriculture will remain high after the full implementation of the agreements, and cereals are excluded from liberalization. The provisions on the other sensitive product categories are more favorable: barriers to re-exports of textiles and clothing in connection with processing activities were lifted upon entry into force of the interim agreements, and elimination of remaining duties and QRs will be phased over a five-year period. Quantitative restrictions on steel were eliminated upon entry into force of the interim agreements; and those on coal will be removed a year later (with the exception of coal imports into Germany and Spain). Tariffs on steel will be abolished in three to four years. Comparable liberalization will be undertaken by the associated countries, although in some areas it is more limited, and implementation periods are longer (up to ten years).

Notwithstanding the maintenance of restrictions on sensitive products, the reduction of trade barriers in recent years has facilitated the strong growth of trade in the region. Total trade between the EU and East European countries grew on average by about 21 percent a year between 1989 and 1992. Progress remains limited, however, on the application of other important provisions of the Association Agreements, in particular the approximation of laws by the associated countries to EU law (such as competition law and legislation in the field of technical standards and intellectual property). Progress in this area is essential for further integration and liberalization, for instance, in trade in services. Another point of concern is the latitude provided in the Association Agreements for protective measures, such as safeguards and antidumping actions, and for the reintroduction of trade taxes. For example, on several occasions the EU imposed restrictions on imports of steel from Eastern Europe. Poland also introduced safeguard measures against imports of sugar and some agricultural products from the EU; and both Poland and the Slovak Republic introduced import surcharges.

The EU has had longstanding nonreciprocal preferential trade agreements with Mediterranean countries, such as the Maghreb countries (Morocco, Tunisia, Algeria) and Turkey. Morocco has had a Trade and Cooperation Agreement with the EU since 1976. Morocco’s industrial exports enter the EU duty free and virtually unrestricted, with the exception of a VER on clothing and a QR on petroleum products. Morocco’s agricultural exports face greater restrictions. Some agricultural products are admitted duty free up to a certain quota and are accorded preferential treatment thereafter. The restrictions on fruit and vegetable imports are the most onerous for Morocco. The EU and Morocco are currently negotiating a new partnership agreement that includes new provisions on agricultural exports. Tunisia has a Cooperation Agreement with the EU that provides for duty-free and unrestricted access for industrial products (with the exception of textiles and clothing that are subject to a voluntary export restraint). There is also preferential treatment of some important agricultural products (olive oil, wine, citrus fruits) up to certain limits. Tunisia is also negotiating a new agreement with the EU. Algeria has a Cooperation Agreement with the EU similar to (but more limited in scope than) Morocco’s and Tunisia’s.

Turkey’s Association Agreement with the EU provides, as a general rule, for duty-free and unrestricted access to EU markets for industrial products, with the exception of textiles and clothing (which are subject to a VER) and petroleum products (subject to a tariff quota). Agricultural products are restricted. Turkey has embarked on a trade liberalization program that provides for the elimination of tariffs and other restrictions on imports of industrial products from the EU by the end of 1994. A customs union with the EU is currently planned for January 1, 1995.

Appendix III: Southern Cone Common Market

The Southern Cone Common Market (Mercosur) was founded by the Treaty of Asunción signed by Argentina, Brazil, Paraguay, and Uruguay in 1991. It aims to establish a common market among the member countries by 1995. The instruments set forth by the treaty include the free movement of goods, services, and factors of production through the elimination of tariffs and nontariff barriers, establishment of a common external tariff, coordination of macroeconomic policy, and harmonization of the respective internal legislation as needed.

In contrast to the emphasis on regional import substitution that characterized Latin American integration in earlier decades, regional cooperation in the 1990s was part of a more general strategy to deregulate and liberalize the economy, and to promote multilateral trade liberalization by reducing external trade barriers. Mercosur is a good example of this new trend.

The Treaty of Asunción mandates signatory countries to apply a progressive and automatic schedule of intraregional tariff reduction in eight equal steps beginning in 1991 and to be completed by the end of 1994. Nontariff barriers are to be eliminated by the same date.81 Member countries are to agree on a common external tariff by 1995. Paraguay and Uruguay, as relatively less advanced countries within the area, are given one extra year in the phase-in period for free trade. Factor mobility should be free by 1995.

According to the Asunción Treaty, assembled products must have a minimum of 40 percent of domestic value added in order for them to qualify for regional preferences. Rules of origin will no longer be in force after the implementation of the common external tariff. The treaty provides a few rules concerning the settlement of disputes that may arise among member countries during the transition period. In December 1991, a Protocol was signed that mandated that disputes should be settled through arbitration. Also, until 1995, member countries were allowed to reintroduce tariffs and quotas as a safeguard in case of balance of payments crises or in the case of a threat of injury to domestic industry. The Asunción Treaty allows production-sharing arrangements to be signed within Mercosur.

Implementation has been on schedule. As planned, by the end of 1993, member countries had reduced their intra-area tariffs by 82 percent and the elimination of NTBs was quite advanced. After 1994, export incentives will no longer be possible within Mercosur, and the agreed common legislation on antidumping and countervailing duties will enter into force. Agreement has been reached for a common external tariff for about 85 percent of tariff lines, and will range from zero to 20 percent. But there is no common external tariff for capital and high-technology goods, which Brazil produces. A second key area in which an accord has not yet been reached is the list of products that will definitely be excluded from Mercosur.82 Production-sharing arrangements allocating different stages of the production process among Mercosur firms have been signed in almost all industries. These sectoral arrangements are included under Article 5 of the Treaty of Asunción as one of the key instruments in the constitution of the common market; they are assigned the objective of making the best use of the factors of production in the region and contributing to exploiting efficient economies of scale. However, they risk hampering the potential gains from trade creation, especially in Argentina and Brazil. In April 1992, for instance, a production-sharing arrangement was signed for the steel industry for the period up to the end of 1994.

At the present time, the potential net gains from Mercosur seem large. Trade within the area during 1993 rose by one third to reach $8 billion. Brazil is now Argentina’s largest export market, and Argentina is Brazil’s second biggest market. For Paraguay and Uruguay, the importance of Mercosur is even greater, since the regional market accounts for 40 percent and 35 percent of their exports, respectively. Dynamic gains from trade creation may arise from the new opportunity of member countries’ firms to exploit economies of scale, as well as from the eventual increase in intra-industry trade if macroeconomic stabilization proceeds in the region and economic growth continues. Further gains are already being reaped from foreign investment, as the region is increasingly viewed by investors as a single market. Other less tangible, but nevertheless important, gains will come from enhanced bargaining power of the region as a whole and from strengthening political relations among its members. The single largest benefit probably resides in the role of Mercosur in locking in the unilateral trade liberalization currently being implemented in the region.

There is some potential for trade diversion. Much depends on the level of the common external tariff. The introduction of the common external tariff for most goods, which ranges from zero to 20 percent, will cause trade diversion for some Mercosur countries who have lower tariffs on some lines than those established by the common external tariff (especially Paraguay, whose maximum tariff at present is 16 percent). Brazil will apply a higher tariff on high-technology goods.

Appendix IV: Central African Customs and Economic Union

The Central African Customs and Economic Union (UDEAC) was founded by a treaty signed in Brazzaville in 1964 and became effective at the beginning of 1966. It comprises six Central African countries83 which are also members of the Franc Zone, with a common currency (the CFA Franc) and a common central bank (the Banque Centrale des Etats de l’Afrique Centrale, BEAC). With the ultimate objective of establishing an economic union, the Treaty envisaged the creation of a customs union with a common external tariff, the elimination of all barriers to intra-union trade, and the establishment of a “Taxe Unique” or single-tax system84 to foster the creation of a regionally balanced industrial structure. The Treaty also provides for the establishment of a common customs administration, the creation of a UDEAC investment code, the progressive harmonization of domestic fiscal systems, coordination of transport sector issues, and the free intra-union movement of labor, services, and capital.

The performance of the UDEAC over the last thirty years has been mixed. While it has had some success in areas such as training and research, its goal of an integrated regional market has remained elusive. This relatively poor record can be traced to two major factors.

First, buoyed by the commodity price boom of the 1970s, oil exporting members of the UDEAC (Cameroon, Congo, and Gabon) embarked on an import-substitution strategy, mainly through ambitious programs of public investment and public enterprises. In order to accommodate the objectives of these countries, the UDEAC treaty was revised in 1974, and the scope of free intraregional trade was restricted to raw materials and unprocessed agricultural products; trade in other products originating from the UDEAC was limited unless they had access to the single-tax regime, which became an instrument of restricting preferential treatment on intra-UDEAC trade to only a selected number of products.

Second, the sharp decline in commodity prices and the overvaluation of the CFA franc, combined with inappropriate macroeconomic policies, resulted in a severe economic crisis in all UDEAC countries in the second half of the 1980s. To cope with the difficult economic situation, individual countries introduced several measures to circumvent the provisions of the Treaty and further their own objectives, thereby exacerbating the distorted incentive structure created by the single tax. As a result, tariffs became very high and dispersed across and within countries, and nontariff barriers to intra-union trade, and trade in general, increased.

Against this backdrop, in late 1991, UDEAC members, who had already embarked on structural adjustment programs, started discussions on a Regional Reform Program to reinforce their domestic adjustment efforts. At the core of the program is a simplification of the trade regime, increasing its transparency, and lowering average tariffs and tariff dispersion. The main elements—to be implemented by all UDEAC members between January 1, 1994 and January 1, 1995—are as follows.

On tariff reform, a common external tariff with four rates will replace all previous customs duties and related taxes and levies. The new tariff structure comprises rates of 5 percent for essential products, 15 percent for inputs and capital goods, 35 percent for consumption goods, and a temporary 50 percent for a limited number of products needing special protection. Duties on intra-UDEAC imports are set at 20 percent of the corresponding common external tariffs before being progressively eliminated over the next five years, starting in 1994. The single-tax regime will be abolished, and individual members will regain full control of their jurisdiction on domestic taxation. Quantitative restrictions on imports are to be eliminated over a three-year period and replaced, if necessary, by an import surcharge not greater than 30 percent; this surcharge should be phased out over the following three years.

The new UDEAC trade regime represents a substantial trade liberalization effort, yet still provides significant protection to certain domestic industries. Over the medium term, as the competitiveness of these industries improves (owing to the recent devaluation of the CFA franc), as the domestic tax base is broadened, and as tax administration is strengthened, members would benefit considerably from further tariff reduction. In this regard, the decision of members to accelerate the tariff-reduction process and implement a tariff structure with lower rates (5, 10, 20, and 30 percent) than suggested by the common external tariff, is a notable step in the right direction.

Appendix V: The Cross-Border Initiative

The Cross-Border Initiative (CBI) is a regional integration initiative among 13 Eastern and Southern African countries.85 It is cosponsored by the African Development Bank, the Commission of the European Communities, the World Bank, and the Fund. It has been developed in collaboration with the Common Market for Eastern and Southern Africa (Comseasa), the Southern African Development Community (SADC), and the Indian Ocean Commission (IOC) to provide support for the integration agenda of these arrangements. An agreement on core policy measures to be implemented was reached in August 1993. The broad objective of the CBI is to help reduce impediments to cross-border activity with a view to bolstering economic growth in the region. The CBI is not an “institution” for regional integration, but rather a set of commonly designed and agreed policies to promote trade, investment, payments, and institutional development among participating countries.

Trade Patterns Within the CBI Region

Intra-CBI trade is relatively low and usually involves one or two partners, reflecting the general lack of complementarity among participating countries, but also a poor regional infrastructure. For example, in 1992, the share of individual countries’ exports to the entire CBI region varied from below 3 percent for Malawi, Mauritius, Rwanda, and Uganda to about 9-15 percent for Kenya, Tanzania, and Zimbabwe (Table 2). Kenya and Zimbabwe (which have the most diversified export base among CBI countries), represent the dominant intra-area trading partners and run substantial surpluses with the rest of the region.

Table 2.Trade Between Major Participants in the Cross-Border Initiative, 19921(In percent of each country’s total exports or imports)
BurundiKenyaMadagascarMalawiMauritiusRwandaTanzaniaUgandaZambiaZimbabweTotal
Burundi3.20.53.7
3.30.18.92.90.916.1
Kenya0.50.10.21.21.82.37.80.40.615.0
0.20.10.50.10.30.82.0
Madagascar0.22.20.53.6
1.01.02.0
Malawi0.21.61.02.8
0.20.11.49.210.9
Mauritius0.10.90.62.1
1.40.90.12.4
Rwanda0.20.2
1.39.78.00.219.2
Tanzania4.11.60.14.80.30.611.5
3.00.0.10.53.7
Uganda1.10.40.10.21.8
28.10.229.0
Zambia0.50.70.40.31.23.1
0.57.80.50.35.615.1
Zimbabwe0.11.03.40.10.43.78.9
0.50.20.40.20.72.0
Source: IMF, Direction of Trade Statistics (1993).

Intra-CBI trade is also hampered by the relatively high level of tariffs and nontariff barriers that still prevail in the region despite recent liberalization efforts by some participants. Many countries, including Burundi, Kenya, Mauritius, Tanzania, and Zimbabwe have average tariffs exceeding 30 percent, and in some cases (e.g., Kenya and Mauritius) tariff dispersion is quite wide (Table 3). Quantitative restrictions on imports vary from open general licensing in Burundi and Tanzania, to more or less restrictive licensing in Comoros, and import bans on different items in Madagascar and Mauritius.

Table 3.Trade Regimes of Selected Participants in the Cross-Border Initiative1
TariffsQuantitative Restrictions
BurundiAverage tariff is 40.4 percent.Open general licensing for imports. A few import restrictions for security reasons.
ComorosAverage tariff is 10 percent. Consumption taxes averaging 25 percent applied to imports.Import bans on some goods. Imports outside the Franc zone require licensing. Imports of some clothing and food items are restricted. Government monopoly on rice and petroleum imports.
KenyaAverage tariff rate is 34 percent. Maximum rate of 62 percent is applied on certain goods such as TVs, finished textiles, and some beers.Short negative list for imports for environmental reasons.
MadagascarTariff range is 5–40 percent. Most rates fall into 5–10 percent range. Fiscal duty of 10-50 percent on imports with a surtax of 30 percent on luxury goods.OGL for imports except for import bans of 61 items mainly for health and security reasons
MalawiAverage tariff rate of about 20 percent. Maximum rate is 40 percent.Most imports are under OGL. Specific import licenses are required for certain items in some cases for health and security reasons.
MauritiusAverage tariff is 52 percent. The tariff range is 5-220 percent. Fiscal duty (5-100 percent) and import levy of 17 percent are also applied to imports.Import permits maintained for statistical and tax purposes. Import bans exist for certain items.
TanzaniaAverage tariff is about 30 percent.OGL for imports with a small negative list for health and security reasons, and for eight luxury items.
UgandaTariff rates ranging from zero to 30 percent for most goods. Higher rates of 90-175 percent for some petroleum products.Import bans on beer and soft drinks.
ZambiaTariff rates range from 15 percent to 40 percent for most goods. Luxury goods are at higher rates.Negative list includes those related to security reasons, gold, silver, platinum, alcoholic beverages, tobacco, electronics, and passenger vehicles.
ZimbabweAverage tariff rate is about 20 percent plus a surcharge of 20 percent.Retention of exports earnings up to 60 percent.
Sources: GATT; IMF; and World Bank.

The low level of trade among CBI participants and the differences in the degree of liberalization of their economies make it very important for the initiative to have mechanisms to minimize the risk of trade diversion, and help those countries with the most restrictive trade regime to achieve their liberalization objective.

Main Elements of the CBI

The CBI rests mainly on three pillars: a trade liberalization program, an investment promotion component, and measures to liberalize members’ exchange and payments systems.

The trade liberalization program emphasizes the elimination of tariffs and nontariff barriers among participating countries in the context of an overall trade liberalization effort. Participants in the CBI agreed to eliminate tariffs on intraregional trade by 1996, while at the same time lowering tariffs for third countries to the level of the member with the lowest tariffs. Quantitative restrictions affecting both intraregional trade and trade with non-CBI members are to be removed. The elimination of quantitative restrictions applies also to trade in services. The CBI allows for technical and some financial assistance, as well as some flexibility in the pace of reduction of trade barriers for countries that are likely to be severely affected by the implementation of these measures.

The investment promotion component of the CBI consists of measures aimed at reforming the regulatory environment for investment and progressively harmonizing investment incentives. Participating countries are to take concrete steps to liberalize, streamline, expedite, and publicize procedures for the approval of both domestic and foreign investment. Participants in the CBI should also enhance the incentives for cross-border investment by, inter alia, taking steps to (1) join investment-guaranteeing agencies such as the Multilateral Investment Guarantee Agency; (2) conclude necessary agreements to avoid the double taxation of investment profits; and (3) facilitate labor mobility.

The CBI also seeks to improve significantly the functioning of the intraregional payments system and liberalize members’ exchange systems. In this regard, participants are to take the necessary measures to (1) strengthen the domestic payments and settlements systems; (2) converge to a position that will allow the complete, nondiscriminatory elimination of all restrictions on payments and transfers for current international transactions, and the attainment of current account convertibility; and (3) establish a unified, interbank foreign exchange market by 1996.

As one of the sponsors of the initiative, the Fund has primary responsibility for guiding reforms and providing technical assistance in the area of macroeconomic, monetary and exchange rate policies. Participants are to hold discussions with Fund staff with a view to designing a framework of macroeconomic and structural policies that facilitates the attainment of the objectives of the CBI.

Appendix VI: ASEAN Free Trade Agreement

Beginning in the late 1970s, the Association of Southeast Asian Nations (ASEAN) shifted its attention from a largely political orientation to an economic focus.86 This was viewed as part of an effort to maintain its competitive position in the world economy by increasing opportunities to exploit scale economies and deepen the division of labor across the region. On February 24, 1977, member states signed the ASEAN Preferential Trading Arrangement. This arrangement included provisions relating to long-term quantity contracts, preferential interest rates for purchase finance, preferences in government procurement, selective tariff preferences, and the preferential liberalization of nontariff barriers. The scope of regional liberalization under this arrangement was strictly limited by the request-offer approach to liberalization, extensive exclusions, relatively stringent rules of origin, and the small number of tariff lines covered by intra-ASEAN trade. As a result, the share of intra-ASEAN trade in total ASEAN trade, the direction of intra-ASEAN trade, and the product composition of intra-ASEAN trade have remained virtually unchanged.

The third ASEAN summit held in 1987 essentially paved the way for the ASEAN Free Trade Area (AFTA). Member countries recognized the ineffectiveness of the ASEAN Preferential Trading Arrangement and agreed in 1987 to seek new ways to increase intra-ASEAN trade. On January 28, 1992, ASEAN member countries agreed to implement the Common Effective Preferential Tariff Scheme (CEPT), with the aim of improving the preferential trading area and with a view to moving toward an ASEAN Free Trade Area.

The stated objective of the AFTA was to increase manufacturing competitiveness in ASEAN member countries by attracting greater foreign direct investment and thereby improving the ASEAN production base from which to reach world markets.

A detailed CEPT list was submitted by ASEAN members and announced on October 31, 1993. It includes the products to be liberalized—both fast track and normal track—those excluded from liberalization (both temporary exclusions and general exceptions),87 and a specific timetable of tariff reductions submitted by each ASEAN member to be implemented over a 15-year period from January 1, 1993. The Agreement covers manufactured products and processed agricultural products. Unprocessed agricultural products and services are not covered. The goal is to reach a target preferential tariff on manufactured goods of from zero to 5 percent by January 1, 2008. Nontariff barriers, including quantitative restrictions, on CEPT goods are also to be eliminated; quantitative restrictions are to be eliminated upon enjoyment of initial concessions, and other NTBs are to be phased out over five years from the date of initial concessions on a CEPT product.

Concessions apply only to goods originating in an ASEAN country and the rule of origin is set at 40 percent of local content, either within a single member country or on a cumulative ASEAN basis.

The starting date for the implementation of the AFTA was moved forward by consensus from January 1993 to January 1994. An average of roughly 25 percent of member countries’ tariff lines are to be covered in the program of tariff reductions with effect from 1994. The current schedule indicates that about 88 percent of the tariff lines included in the liberalization schedule will reach the target level of from zero to 5 percent tariff by the year 2003.

The phasing of CEPT tariffs is divided into “fast-track” and “normal-track” timetables. Tariff-reduction timetables are subdivided into those items with tariffs initially above 20 percent and those at or below 20 percent. Fast-track items with tariffs above 20 percent will be reduced to 0-5 percent by January 1, 2003. Those with initial tariffs at or below 20 percent are to be reduced to 0-5 percent by January 1, 2000. Under the normal-track timetable, items with tariffs above 20 percent are to reach a 20 percent tariff not later than January 1, 2001. Subsequently, these items are to reach tariffs of 0-5 percent by January 1, 2008. Normal track items with initial tariffs below 20 percent are to reach the 0-5 percent range by January 1, 2003.

Appendix VII: Asia-Pacific Economic Cooperation Forum

Established in 1989 at a ministerial conference in Canberra—under the initiative of Australian Prime Minister Bob Hawke—the Asia-Pacific Economic Cooperation Forum (APEC) is a vehicle for promoting greater regional economic cooperation. The original membership included the members of ASEAN (Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Brunei), as well as Australia, Canada, Japan, Republic of Korea, New Zealand, and the United States. The group expanded in 1991 when China, Hong Kong, and Taiwan Province of China joined the 12 original members. APEC members together account for 38 percent of world trade (in 1992), and intra-APEC trade represents 60 percent of their total trade. From the outset, the attention of the organization was devoted to trade facilitation and technical cooperation efforts carried out within ten working groups (Telecommunications, Trade Promotion, Human Resources Development, Regional Energy Cooperation, Marine Resource Conservation, Fisheries, Transportation, Trade and Investment Data Review, Investment and Technology Transfer, and Tourism). More recently, exploratory work has been under way in the areas of customs cooperation, reviewing APEC-member investment regimes (with a view to increasing transparency), and exploring the prospects for mutual recognition of standards.

APEC typically has not been viewed as a precursor to an eventual free-trade arrangement. Instead, cooperation efforts and trade facilitation initiatives are pursued under the banner of “open regionalism.” This means that any successful efforts to facilitate trade and investment flows within APEC will be carried out multilaterally, on a most-favored-nation basis. In 1992, a permanent secretariat was established in Singapore to support Asia-Pacific cooperation in trade. Support for the multilateral trading system was reaffirmed with the November 1993 declaration of APEC ministers calling for urgent action to conclude the Uruguay Round successfully.

The November 1993 meeting established a Pacific Business Forum, an APEC Education Program, and an APEC Business Volunteers Program. In addition, several new initiatives were agreed upon including (1) steps to improve the competitiveness of small and medium-sized businesses; (2) an action program to assist in the integration of policies on economic growth, energy security, and environmental protection within APEC; and (3) the development of a set of nonbinding investment principles. With regard to the latter area, APEC countries will undertake a work program to identify barriers to trade and investment flows in the region with a view to pursuing future efforts to eliminate these. Ministers also agreed at the meeting to expand APEC membership to include Mexico and Papua New Guinea.

A vision for the future direction of APEC was recently presented in the Report of the Eminent Persons Group. Ministers endorsed the report’s call for initiatives to achieve freer trade and investment flows in the region, and called for further study in some areas, including the group’s recommendation that APEC pursue an active program of regional trade liberalization consistent with the GATT.

Appendix VIII: Gulf Cooperation Council

The Gulf Cooperation Council (GCC) was established in 1981 by Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates to integrate their economies by establishing free movement of goods, services, and factors of production. Trade in goods between the GCC members is free of tariffs, provided that at least 40 percent of the value added is produced in the GCC region and that at least 51 percent of the capital of the producing firm is owned by citizens of the GCC member countries. Oman, however, was permitted to levy tariffs on some products, reduced to 4 product groups in 1989, originating in the member countries. The GCC countries are to levy a common external tariff ranging between 4 percent and 20 percent. Tariff exemptions are allowed, and the higher range of tariffs is to be levied for protection or other special reasons.

Currently, the trade regimes of the GCC members are practically free of QRs, the tariff structure is relatively uniform, and the average tariff is low. Qatar and the United Arab Emirates levy generally uniform tariffs at 4 percent and 1 percent, respectively. Oman has a basic import duty of 5 percent on non-GCC imports, though on some goods rates of 15 percent to 25 percent are levied. In Saudi Arabia, tariffs on most imports average 12 percent, within an overall tariff structure ranging from zero to 20 percent. Tariffs in Bahrain range from zero to 20 percent with an effective tariff of about 5 percent. In Kuwait, tariffs also range between zero and 20 percent. The recent agreement to apply a common external tariff on commodities on which there is accord should help accelerate the formation of the common market.

Trade among GCC members in 1992 was about 6 percent of their overall trade (about 5 percent for exports and about 7 percent for imports), and imports were significantly lower than exports. While the share of intra-GCC exports in overall trade is small, intra-GCC exports are important in total non-oil exports, varying from about 5 percent to about 30 percent, depending on the country.

Exports are very concentrated, with Saudi Arabia accounting for about 60 percent of intra-GCC exports—a significant portion of which are petroleum exports to Bahrain—while the UAE accounts for another quarter (Table 4). The main importers are Bahrain with about a third of intra-GCC imports, and Oman and the United Arab Emirates with about one fourth each. The main exports from Saudi Arabia are light manufactures, such as garments and paper products, and agricultural goods, such as dairy products. Other important export items include fish from Bahrain and metal products from Bahrain, Qatar, and the United Arab Emirates. For some GCC members, re-exports constitute a significant part of exports.

Table 4.Gulf Cooperation Council: Intra-GCC Export Trade, 1992(In milions of U.S. dollars)
Destination
Total to
OriginBahrainOmanQatarSaudi ArabiaUnited Arab EmiratesGCC1World
Bahrain25.423.2104.243.7196.53,007.6
Oman41.45.226.88.381.77,799.9
Qatar3.78.556.2129.0197.43,488.1
Saudi Arabia1,598.068.083.0909.02,658.051,771.0
United Arab
Emirates32.0957.07.0215.01,241.024,742.0
Total1,675.11,058.9148.4402.21,090.04,374.690,808.6
Source: IMF, Direction of Trade Statistics (1993).

The GCC has been negotiating an economic cooperation agreement with the EU to foster trade between the two regions and for the EU to assist members of the GCC in their economic development. In May 1994, the EU and the GCC agreed to intensify cooperation in a number of areas, such as standards, environment, energy, and industry. The ultimate objective is for an EUGCC free trade agreement. This will be discussed after completion of the common market among GCC members through the establishment of a common external tariff.

Factors of production move freely within the region, and the capital markets of GCC members are integrated. Citizens of GCC member countries are allowed to move within the area for employment, as well as to purchase and own shares of industrial companies in all GCC member countries. Citizens can also borrow from the specialized financial institutions of any member country providing loans for industrial development on common terms relating to maturity and charges. To open the way for regional enterprises, steps have been taken to harmonize certain prices throughout the region, for example, telephone rates have been unified and there is movement toward unifying water rates and prices of petroleum products. GCC companies are accorded a 10 percent preferential margin in government contracts. The Gulf Investment Corporation aims to set up private joint ventures in the region, and has been operating since 1986.

Appendix IX: Economic Cooperation Organization

The Economic Cooperation Organization (ECO) aims at promoting economic, technical, and cultural cooperation among its member states. Its origins are to be found in its forerunner, the Regional Cooperation for Development (RCD), which was founded in 1964 with identical goals and working procedure as the ECO. The founding members of the RCD were the Islamic Republic of Iran, Pakistan, and Turkey. It became the ECO in 1985. In 1992, ECO found new strength as the newly independent Central Asian countries of Azerbaijan, Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan, as well as The Islamic State of Afghanistan, joined the organization. At the 1993 ECO summit, member states expressed their intention at a future date to take up the Russian Federation’s proposal to become a member.

The activities of ECO are organized through eight working groups or technical committees in the fields of economic and commercial cooperation, transport and communications, agriculture, energy, infrastructure and public works, narcotics, and educational, scientific, and cultural matters.

At the 1992 ECO summit, a very limited system of tariff preferences among member countries was agreed, establishing a 10 percent reduction on specific tariff lines. The agreement was initially for a period of four years, but would be automatically extended for further periods of two years each. The ECO summit of 1993 adopted a decision to establish the ECO Development Bank as well as a joint insurance company for shipping and airlines. Further areas discussed included the setting up of free trade and industrial zones, border trade, joint ventures in the transportation sector, and cooperation in the area of telecommunications, pipelines, and railroads. A proposed project, supported by the World Bank, to build a railway linking Baluchistan and Turkmenistan has not made progress owing to the military conflict in the Islamic State of Afghanistan.

ECO’s progress in achieving regional integration has thus far been limited. The extent of regional trade liberalization is extremely limited, and the projects decided upon at ECO summits are not being implemented. Participation by the Islamic State of Afghanistan is constrained by its internal security situation. The Central Asian countries have only recently joined, and their most pressing needs are internal stabilization and restructuring. They are naturally also desirous of maintaining their economic links to other countries of the former Soviet Union, especially the Russian Federation. Even among the original ECO members, intraregional trade accounts for very small percentages of total trade (Table 5). The trade regimes of ECO member countries vary considerably. Turkey has few QRs and an average tariff of less than 10 percent. The Islamic Republic of Iran retains QRs on some commodities, an average tariff of 30 percent, high import registration fees, and a commercial benefits tax; under its trade liberalization program, the Islamic Republic of Iran intends to cut its tariffs by half by the end of 1994 and incorporate the benefits tax into the tariff structure. Pakistan has the most restrictive trade regime among the three but is currently undertaking significant liberalization.

Table 5.Intra-ECO Trade of Selected Members, 1992(In millions of U.S. dollars)
Islamic State of AfghanistanIslamic Republic of IranPakistanTurkey
CountriesImportsExportsImportsExportsImportsExportsImportsExports
Afghanistan, Islamic State of6.616.00.10.5
Iran, Islamic Republic of184.789.9269.8502.0
Pakistan17.66.099.0168.046.941.7
Turkey0.50.1552.0245.049.83.0
Intra-ECO total18.16.1651.0413.0241.1148.9316.8544.2
Percent of total
Imports and Exports1.10.62.82.62.62.01.33.7
Source: IMF, Direction of Trade Statistics (1993).

In the long run, the region could benefit from increased trade as infrastructure is improved, economic reforms take hold, and military conflicts are resolved.

Appendix X: Intra- and Extraregional Trade Flows

Table 6 presents extraregional trade as a share of GDP for selected regional arrangements, and Tables 7 and 8 provide trends in intraregional and extra-regional trade-to-GDP ratios for geographic regions.

Table 6.Regional Arrangements: Extraregional Imports as a Share of GDP(In percent)
Regional Trading Arrangement (Year founded/entry into force)19701980199019911992
EU-1219.012.59.79.79.1
EFTA (1960)17.222.320.018.819.0
CACM (1958/60)17.223.525.023.0
LAIA (1980; LAFTA, 1960/61)26.810.66.88.0
ANDEAN PACT (1969)11.214.312.614.6
CUFSTA (1988/89)3.07.67.77.47.7
NAFTA (1992/94)2.97.07.06.77.0
Mercosur (1991)5.710.64.04.85.3
ASEAN (1967)9.019.726.9
ANCZCERTA (1983)11.713.013.412.914.3
Source: Braga (1994).
Table 7.Intraregional Trade as a Share of GDP1(In percent)
Region19481958196819791990
Western Europe14.817.721.331.533.0
Eastern Europe and countries of the former Soviet Union11.615.325.421.618.8
Total Europe17.219.124.533.434.3
North America2.92.93.55.86.0
Latin America6.05.04.05.43.8
Total America7.96.65.79.79.2
Japan25.26.75.06.16.2
Australasia236.67.77.714.315.0
Developing countries Asia211.013.311.017.826.2
Total Asia9.610.87.811.214.0
Africa4.23.73.52.73.1
Middle East10.27.03.03.63.3
Total World7.38.810.315.917.4
Table 8.Exrategional Trade as a Share of GDP1(In percent)
Region19481958196819791990
Western Europe20.615.812.516.112.8
Eastern Europe and countries of the former Soviet Union13.49.714.618.422.7
Total Europe16.512.410.212.811.1
North America7.86.36.013.613.2
Latin America24.024.817.421.323.7
Total America6.05.25.211.211.2
Japan2.811.811.513.811.6
Australasia44.729.023.227.228.0
Developing countries Asia15.818.920.428.131.2
Total Asia15.115.513.516.115.2
Africa45.842.234.845.545.6
Middle East40.051.034.252.550.0
Total World14.912.911.618.816.1
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The principal authors of this paper. Clinton Shiells prepared the section on NAFTA; Rosa Alonso i Terme, Ali Ibrahim, and Manmohan Agarwal prepared most of the appendices.

As used in this paper, the term “regional trading arrangements” need not imply geographic proximity of member countries.

The European Union (EU), which came into effect in 1993, is used in this paper to also refer to the European Community.

Parties to the agreement will have virtually complete access to each other’s markets for manufactured goods, services, capital, and labor. Also, non-EU parties accept all the existing EU rules and legislation (except those pertaining to the Common Agricultural Policy and the Common Fisheries Policy) and make certain financial contributions.

Prior to its demise in 1991, trade relations among Central and East European countries and the former Soviet Union were conducted under the auspices of the Council for Mutual Economic Assistance (CMEA); other members of the latter included Cuba, Mongolia, and Viet Nam.

New arrangements include the free trade agreements of Mexico and Chile (1991), Chile and Venezuela (1993), Chile and Colombia (1993), Colombia and Venezuela (1992), El Salvador and Guatemala (1991), MERCOSUR (1991), Mexico and Central America (1992), Nueva Ocotepeque (1992), Mexico and Costa Rica (1994). These are listed in Appendix I.

The contracting states include Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka.

References to sub-Saharan Africa in this paper do not include South Africa.

Cárdenas (1992) views the noneconomic goal of strengthening political relations among the members of MERCOSUR as very important in its motivation.

See, for instance, Foroutan’s description of the importance of cultural ties and institutions dating back to colonial times in influencing the shape of regionalism in sub-Saharan Africa, the political considerations in Nigeria leading to the Economic Community of West African States (ECOWAS), or the noneconomic goal of Southern African Development Coordination Conference (SADCC) members of lessening dependence on South Africa (Foroutan (1992)). Regarding the Middle East, see Fischer (1992).

Hufbauer and Schott (1993) emphasize the U.S. foreign policy dimension of NAFTA, according to which it serves the key U.S. policy objective of enhancing the prosperity and stability of its neighbor to the south.

For the impact of the lack of progress on the Uruguay Round in Latin American regional trading arrangements, see Lustig and Braga (1994); on South East Asia, see de la Torre and Kelly (1992).

Up to the late 1980s, developing countries tended to be less successful in implementing agreed regional trading arrangements compared with industrial countries. For a detailed discussion of the reasons, see de la Torre and Kelly (1992). In brief, de la Torre and Kelly suggest that the poor implementation record of developing countries was a reflection of the fundamental incompatibility between their inward-oriented development policies and the objective of regional integration. One might expect an improvement in the implementation record of regional trading arrangements among developing countries in the 1990s, as many of them have more vigorously pursued market-based reforms and macroeconomic stabilization.

For a detailed analysis of the different national objectives for NAFTA, see Hufbauer and Schott (1992).

For the link between import-substitution development strategies and early Latin American regional trading arrangements, see Cárdenas (1992) and Nogués and Quintanilla (1992).

Notably, the Andean Pact and most regional trading arrangements in sub-Saharan Africa.

For definitions of various types of regional arrangements, see Box 1.

The static and dynamic effects of regional trading arrangements are discussed at greater length in de la Torre and Kelly (1992).

The income-reducing effect of trade diversion need not occur when changes in relative prices and the resulting substitution effects in consumption enter the analysis (Lipsey (1960)). Basically, because the pre-union MFN tariff distorts both production and consumption, by focusing on the production effects alone, Viner neglected the possibility that eliminating the price distortion within the union might improve welfare through adjustments in consumption patterns.

A Pareto superior policy change is one that leaves at least one party better off without making anyone worse off.

This approach was suggested in McMillan (1993). However, it fails to capture what extraregional trade might have been in the absence of regional integration. It must thus be regarded as a rough rule of thumb.

Recently, a number of theorists, for example, Helpman and Krugman (1985), have integrated elements of monopolistic competition under increasing returns into trade theory. In this “new” trade theory the positive effects of trade liberalization are even more pronounced as free trade leads to greater variety of products, increased competition, and lower costs, in addition to the gains from specialization. The welfare implications of imperfect competition and increasing returns for regional arrangements are not clear cut. This remains an area of ongoing research.

Rules of origin establish the conditions under which a product will be eligible for preferential access within a FTA. An item must establish origin within the region in order to qualify for preferential treatment. In the case of an FTA, in which members maintain separate external tariffs and nontariff barriers, rules of origin are used to prevent the deflection of trade through the point of least resistance, that is, the least-protected market. Highly liberal, or unrestrictive, rules of origin tend to transmit some of the benefits of internal liberalization to nonmembers by effectively granting them access to each country in the union under the terms existing in the least protective member country. Strict, or nontransparent, rules of origin may confer protection on some regional producers of intermediates by making it more difficult or costly for processed goods within the union to establish local origin. When rules of origin are applied so as to increase the local demand for some inputs, this may end up taxing certain downstream industries by diverting demand to less efficient regional suppliers.

Bhagwati (1991, p. 77) first suggested this language. See also Lawrence (1991) and Bhagwati (1993) for a detailed discussion of the possible linkages between regionalism and multilateralism.

Also see Preeg (1970).

Bhagwati (1991, pp.77-79) has recommended that Article XXIV of the GATT be modified so that (1) any countries seeking to form an FTA (or join an established one) should be required to simultaneously reduce their MFN tariffs, or, in the case of customs unions, the lowest MFN tariff prevailing among members on each item should be adopted as the common external tariff of the union; and (2) it builds in a commitment that such arrangements be open to the acceptance of new members.

Krugman (1991) and (1993) suggests that the best outcome in terms of world welfare occurs when there are either very few or very many trading blocs. He points out that the intuition is that with very few trading blocs (particularly one) one moves toward free trade; with many such blocs, there is an incentive to set low external tariffs (because each has limited market power).

The fact that trade taxes are currently a prominent source of revenue in many developing countries need not conflict with this prescription. Regional arrangements are typically negotiated over an extended period of time and their implementation typically proceeds over more than five years. This provides an ample window of opportunity during which offsetting nondiscriminatory revenue measures could be developed and implemented—preferably a broad-based value-added tax—thus assuring revenue neutrality. Nonetheless, there is a risk that temporary fiscal problems may induce tariff increases that may fall on nonmembers, given that tariffs on regional partners cannot be increased.

These guidelines do not imply encouragement of discriminatory exchange arrangements that are inconsistent with the Fund’s Articles of Agreement.

If a government can credibly precommit to pursuing a regional trading arrangement without sectoral exceptions, it can avoid both the costs of rent seeking and the patchwork of special exceptions that would otherwise accompany a final agreement.

See Bhagwati (1991). This condition may also help to lessen possible trade friction by giving outsiders, including especially those hurt by trade diversion, the option to accede.

This does not include monetary unions.

It is noteworthy that deeper forms of integration are subject to the same caveats as preferential tariff cuts more generally—that is, deeper integration is both trade creating and trade diverting.

The six original members are Belgium, France, Germany, Italy, Luxembourg, and the Netherlands.

For an overview of the history of European integration and Community institutions, see Swann (1992).

The strongest increase was recorded in Germany, where intraindustry trade in manufactured products grew from 47 percent (1958) to 76 percent (1987) of trade in manufactured products with EU partners.

See Buigues and Sheehy (1993) and Harrison, Rutherford, and Tarr (1994). These estimates do not take into account that the program is not yet fully implemented and that output effects are likely to be realized over a significant period.

Details of the NAFTA’s provisions and an assessment are found in Hufbauer and Schott (1993) and USITC (1993a).

Textiles and apparel must be made from yarn spun in North America or from fabric woven from fibers originating in North America.

Once a panel decision has been made, either country may request a three-person extraordinary challenge committee. If any of the grounds of the extraordinary challenge are met, the panel decision will be overturned and a new panel set up.

See USITC (1993b). The static computable general equilibrium models used to generate these numbers describe the one-time impact on real national income achieved upon full implementation of the agreement. The CGE methodology first solves for the level of national income (and other endogenous variables like prices, employment, and production by sector) under the initial conditions of the trade regime (the status quo including existing tariff levels, quotas and other NTBs). Next, the model is recalculated under the conditions characterizing the postagreement preferential trade regime (e.g., regional tariffs are set at zero). Endogenous variables, such as national income, in the preagreement state are then compared with those under full implementation of the agreement to obtain the kinds of estimates cited above.

See USITC (1993a), pp. 2–7.

See USITC (1993a), pp. 2–3.

The latter two are subject to agreements that effectively limit surges in imports of orange juice and sugar.

See Berry and Lopez-de-Salinas (forthcoming).

See, however, Trela and Whalley (1994), who do find that Mexican exports to the United States will expand significantly, although they assume that quotas on Mexican exports to the United States are binding.

Brown, Deardorff, and Stern (1992), for instance, find that the NAFTA would improve the terms of trade of its members with the rest of the world, thereby leading to trade diversion and a reduction in real income (albeit less than 0.1 percent) for countries outside North America. Cox and Harris (1992) find that U.S. import volumes from countries outside North America decline (but by less than 1 percent), while Canadian imports from outside the NAFTA increase (again by less than 1 percent).

Sobarzo (1992), for example, estimates that changes in Mexico’s trade balance with nonmembers would range from zero to 17.1 percent, depending on the set of assumptions made regarding international capital mobility, exchange rate determination, and factor price flexibility.

Pomfret (1993) argues that the estimates of trade diversion in Kreinin and Plummer (1992) are upper bounds.

Beneficiary countries of the U.S.-Caribbean Basin Initiative expressed concern that their benefits might be eroded by the NAFTA, particularly due to possible investment diversion to Mexico in the area of textiles and apparel. In response, the U.S. administration recently prepared an Interim Trade Program for the Caribbean Basin (ITPCB). The program outlines mutually beneficial measures to allay these concerns. The United States is offering new NAFTA-like preferences in textiles and apparel for beneficiaries of the Caribbean Basin Initiative in return for commitments on trade-related intellectual property rights, trade-related investment measures, environmental protection, labor standards, and adherence to GATT/WTO trade rules. The ITPCB proposal requires Congressional approval before entry into force.

See Braga and others (1994), and USITC (1992).

The European Council of June 1993 decided to reduce this period from the initial five years to three years.

Member states submitted lists of products that were to be exempted from the general tariff-reduction schedule. They included the following number of items: 394 for Argentina, 324 for Brazil, 439 for Uruguay, and 960 for Paraguay. These lists have been progressively reduced and they should reach zero by the end of 1994 for Argentina and Brazil, and by the end of 1995 for Paraguay and Uruguay.

These will likely include some agricultural products, as well as selected sectors of heavy industry.

Cameroon, Central African Republic, Chad, the Congo, and Gabon were original signatories. Chad left the Union in 1968 and rejoined in 1984. Equatorial Guinea gained admission in 1984.

The “Taxe Unique” is a complex incentive regime that favors eligible regional firms in the application of indirect taxes on their imported inputs, and their sales within the Union.

Burundi, Comoros, Kenya, Madagascar, Malawi, Mauritius, Namibia, Rwanda, Seychelles, Tanzania, Uganda, Zambia, and Zimbabwe.

ASEAN was established by Indonesia, Malaysia, the Philippines, Singapore, and Thailand in 1967. Brunei Darussalem joined in 1984.

The general exclusion list includes such products as motor vehicles, mineral fuels, etc. Member states may exclude products from the CEPT scheme for reasons of national security, public morals, protection of human, animal, or plant life and health, and the protection of articles of artistic, historic, or archeological value. Member states may temporarily exclude certain sensitive items from the CEPT scheme and the exclusion list will be reviewed in the eighth year with a view to bringing these items into the scheme and achieving the 0-5 percent tariff within the remaining seven years.

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