Preferential trade

Marco Fugazza, Alessandro Nicita 15 December 2010

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The multilateral trading system of the GATT and WTO is rapidly being replaced by a system dominated by preferential trade agreements. Since the conclusion of the Uruguay round in 1994, more than 300 new preferential trade agreements have been implemented.

There are two key reasons for the proliferation of preferential trade. The first relates to the sluggish pace of multilateral trade liberalisation after the Uruguay round (Bagwati 2008). The second has to do with the domino effect (Baldwin and Jaimovich 2010). Once a preferential agreement is formed, trade becomes relatively more costly for non-member countries, and this provides incentives for joining an existing agreement or forming a new one. In practice, preferential agreements, by granting lower tariffs to certain countries, give an advantage to some trading partners but have a potentially distorting effect on international trade.

Changes in market access conditions

In a recent study (Fugazza and Nicita 2010), we have investigated how market access conditions have evolved since 2000 and how this evolution has affected international trade.

Our approach consists of capturing changes in market access conditions with two indices calculated at the bilateral level which take into account the complex structure of tariff preferences.

  • The first index captures direct market-access conditions.

This measures the overall tariff restrictiveness faced by exporters; it is related to the work on trade restrictiveness done by Anderson and Neary (2005) and Kee et al. (2008) and (2009).

  • The second index captures relative market-access conditions.

This looks at the overall tariff faced by exporters relative to that faced by competitors. The measure builds on the work on preferential margins (Hoekman and Nicita 2008, Carrère et al. 2008; Low et al. 2009). We label this index the relative preferential margin.

With these two indices we can assess market access conditions separating the direct effect of the applied tariff from that of the relative preferences. This approach also allows capturing the effect of the proliferation of trade agreements on non-members countries.

Our results indicate that direct market access conditions have constantly improved since 2000, while the structure of relative preferences has evolved from a situation where few bilateral trade relationships enjoyed large relative preferential margins, to a situation with a higher number of positive, but smaller, preferential margins. The reduction in most-favoured-nation tariffs and the proliferation of preferential agreements have resulted in a system of preferences which is:

  • Beneficial to a larger number of bilateral trade relationships, and
  • Less discriminatory compared with the situation that prevailed ten years ago.

In numbers, the average tariff across all bilateral trade flows has declined from about 6.9% in 2000 to about 5% in 2007. For world trade as a whole, this has resulted in a reduction of the average level of tariff restrictiveness from about 2.5% to about 2.2%. Relative market access conditions have improved in the majority of cases, implying that a larger number of countries are increasingly negotiating better market access conditions for their products with their major trading partners. At the country level, the average relative preferential margin has increased from -0.2% in 2000 to about 0.7% in 2007.

The key results are:

  • Between 2000 and 2007 direct and relative market-access conditions have improved in about 53.4% of bilateral trade relationships and deteriorated in 13.7% of cases.
  • In 24.5% of cases some of the gains originating an improvement in direct market access conditions (lower tariffs) have been eroded by a decrease in relative market access conditions (even lower tariffs applied to competitors).
  • The opposite (higher tariffs, but a lower increase than that of competitors) happened in about 8.4% of cases (Figure 1).

Countries where relative preferential margins have been eroded are those which were already benefiting from various preferential trade agreements in 2000 (a number of high income countries and countries enjoying free market access such as Mexico and many less developed countries). Countries where relative market access conditions also have deteriorated include those that did not actively engage in forming preferential trade agreements, such as China and India.

Figure 1. Correlation in the changes of absolute market access (TTRI) and relative market access (RPM): 2000 - 2007

Impact on trade

To measure the impact of direct and relative preferences on trade, we use a standard gravity model (Baier and Bergstrand 2007) and add in our two indices. We find that direct market access conditions are the most important for international trade, but we also find that bilateral trade flows are positively correlated with the relative preferential margin.

  • On average, an improvement of one percentage point in direct market-access conditions increases trade by about 0.7%,
  • For every percentage point increase in relative market-access bilateral trade increases by slightly more than 0.3%.

These figures indicate that, for the average country, trade gains from the current system of preferences are estimated to be about 1.6% with respect to market access conditions in 2000, and about 2.3% with respect to a hypothetical scenario based on the prevailing 2007 most-favoured-nation rate.

Conclusion

Our results indicate that although bilateral market-access conditions have constantly improved since 2000, the system of preferences has implications not only for signatory countries but also for third parties. Looking beyond averages, the results show a large variance indicating that for countries still not actively engaging in forming preferential trade agreements the current structure of preferences is detrimental.

The views expressed in this article are those of the authors and do not necessarily represent the views of the United Nations Conference on Trade and Development (UNCTAD) Secretariat or of UNCTAD Members.

References

Anderson, James E and Peter Neary (2005), “Measuring the Restrictiveness of Trade Policy”, MIT Press.

Baldwin, Richard and Dany Jaimovich (2010), “Are Free Trade Agreements Contagious?”, CEPR Discussion Papers 7904.

Baier, Scott L and Jeffrey H Bergstrand (2007), “Do free trade agreements actually increase members' international trade?”, Journal of International Economics, 71(1): 72-95.

Bhagwati, Jagdish (2008), Termites in the Trading System: How Preferential Agreements Undermine Free Trade, Oxford University Press.

Carrère, Céline, Jaime de Melo, and Bolormaa Tumurchudur-Klok (2008), “Disentangling Market Access Effects for ASEAN Members under an ASEAN-EU FTA”, CEPR Discussion Papers 6762.

Fugazza, Marco and Alessandro Nicita (2010), “The Value of Preferential Market Access”, UNCTAD Blue series on Policy Issues in International Trade and Commodities.

Hoekman, Bernard and Alessandro Nicita (2008), “Trade Policy, Trade Costs, and Developing Country Trade”, Policy Research Working Paper Series 4797, The World Bank.

Kee, Hiau Looi, Alessandro Nicita and Marcelo Olarreaga (2009), “Estimating Trade Restrictiveness Indices”, Economic Journal, 119(534):172-199.

Kee, Hiau Looi, Alessandro Nicita and Marcelo Olarreaga (2008), “Import Demand Elasticities and Trade Distortions”, The Review of Economics and Statistics, 90(4): 666-682.

Low Patrick, Roberta Piermartini and Jurgen Richtering (2009), “Multilateral Solutions to the Erosion of Non-Reciprocal Preferences in NAMA”, in Bernard Hoekman, Will Martin, and Carlos Braga (eds.), Trade Preference Erosion Measurement and Policy Response, Palgrave MacMillan.

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Topics:  International trade

Tags:  WTO, preferential trade agreements, GATT

Economist, United Nation Conference for Trade and Development

Economist, UNCTAD

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