Efficiency and Limitations of Regional Trade Agreements (Trade Blocs)!
Trade blocs, free trade areas, and bilateral agreements are emerging fare and wide in international trade. In 2001, regional trade agreements (RTAs) accounted for 43 per cent of world trade. The emergence of RTAs has added diversity and complexity thereby creating a web in international trade relation.
Growth in trade is observed as a result of these negotiation but are they really the best method of liberalising trade on a global level? The rapid surfacing of RTAs evokes concerns for the future of free trade, and in general the welfare of the world economy in the long run. There are six dominant concerns involving the efficiency and limitations of RTAs.
Efficiency is great concern surrounding the creation of trade blocs. Trade diversions can be the unfortunate effect of these preferential trade agreements. Trade diversions are created when trade barriers are lowered in a bloc or region, thus making prices on imports from outsiders comparatively higher, even if they are the low-cost supplier. Trade is then diverted away from the low-cost supplier, to the less efficient incumbent. These breaches in efficiency have welfare effects.
“Competitive Regionalism”, Costly Negotiation Process and Overlapping Agreements Establishment of regional trade agreements has gained momentum. Small countries in particular are vulnerable to pressures to join trade blocs in order not to be left out of benefits from increased trade volume. This tendency is referred to as “competitive regionalism”. The pressure to quickly regionalise may also distract efforts from the greater goal of multilateral liberalisation of trade.
Since the pace of multilateral talks is generally slow (the Uruguay Round took seven years) requiring extensive negotiations; countries that would prefer liberalisation of trade on a multilateral level are, in the mean time, scrambling to regionalise.
Furthermore, the negotiation process is costly,” particularly to smaller countries, and given the “cost of non-participation” in RTAs efforts are concentrated on quick regional agreements. Given the pressures to regionalise, and limited negotiation resources, countries may hastily create trade blocs. This “competitive regionalism” can ultimately divert efforts away from greater free trade, and rather create complex barriers among blocs.
The rapid creation of regional agreements may also hinder the greater goal of free trade by creating a complex web of agreements, thus posing a challenge to and complicating multilateral solutions through the WTO. Agreements with too much red tape can initially look attractive, but if not in harmony with greater global negotiations; the participants can find themselves at a disadvantage in the future.
In this light, it is warned that the benefits given by the preferential treatment through regionalisation, may be short lived, and unable to exceed the costs of continuous administration of the bloc.
Preferential Liberalisation Can Potentially Increase Vulnerability Entering into a trade bloc makes all parties vulnerable to the decisions and practices of all countries involved. For political or other reasons an incumbent of the region may revoke or modify the preferential treatment granted by the agreement.
This situation is particularly dangerous when there is a dominant trade partner in the bloc that may shift its weight around for political gains. Furthermore, the preferential agreement may shelter industries and hamper inefficiencies within the bloc.
In the case that the bloc should expand, or the terms of the agreement change, the margins of preference are eroded, and the countries are worse off. A more stable system would be multilateral reduction of barriers within a common set of rules.
Inclusion of Additional Elements in RTAs:
It is common for RTAs to include elements unrelated to trade, that may in fact serve to restrict trade rather than promote trade in the long run. RTAs, especially many involving the US, oftentimes contain parameters on labour standards, environmental issues; intellectual property rights, and capital movements.
In some cases non-compliance with the agreed parameters results in trade sanction or other forms of punishment. These types of standards could be detrimental to trade growth especially for countries in which institutions are weak.
Free Trade Agreement Pros and Cons
Six Advantages and Seven Disadvantages and Their Possible Solutions
Free trade agreements regulate tariffs, taxes and duties that countries impose on their imports and exports. The most well-known U.S. regional trade agreement is NAFTA.
Advantages of Free Trade Agreements
Free trade agreements are designed to increase trade between two countries. Increased trade has six main advantages:
1. Increased economic growth. The U.S. Trade Representative Office estimates that NAFTA increased U.S. economic growth by 0.5 percent a year.
2. More dynamic business climate. Often, businesses were protected before the agreement. These local industries risked becoming stagnant and non-competitive on the global market. With the protection removed, they have the motivation to become true global competitors.
3. Lower government spending. Many governments subsidize local industry segments. After the trade agreement removes subsidies, those funds can be put to better use.
4. Foreign direct investment.Investors will flock to the country. This adds capital to expand local industries and boost domestic businesses. It also brings in U.S. dollars to many formerly isolated countries.
5. Expertise. Global companies have more expertise than domestic companies to develop local resources. That's especially true in mining, oil drilling and manufacturing. Free trade agreements allow the global firms access to these business opportunities. When the multi-nationals partner with local firms to develop the resources, they train them on the best practices.
That gives local firms access to these new methods.
6. Technology transfer. Local companies also receive access to the latest technologies from their multinational partners. As local economies grow, so do job opportunities. Multi-national companies provide job training to local employees.
Disadvantages of Free Trade Agreements
The biggest criticism of free trade agreements is that they are responsible for job outsourcing.
There are seven total disadvantages:
1. Increased job outsourcing. Why does that happen? Reducing tariffs on imports allows companies to expand to other countries. Without tariffs, imports from countries with a low cost of living cost less. It makes it difficult for U.S. companies in those same industries to compete, so they may reduce their workforce. Many U.S. manufacturing industries did, in fact, lay off workers as a result of NAFTA. One of the biggest criticisms of NAFTA is that it sent jobs to Mexico.
2. Theft of intellectual property. Many developing countries don't have laws to protect patents, inventions and new processes. The laws they do have aren't always strictly enforced. As a result, corporations often have their ideas stolen. They must then compete with lower-priced domestic knock-offs.
3. Crowd out domestic industries. Many emerging markets are traditional economies that rely on farming for most employment. These small family farms can't compete with subsidized agri-businesses in the developed countries. As a result, they lose their farms and must look for work in the cities. This aggravates unemployment, crime and poverty.
4. Poor working conditions. Multi-national companies may outsource jobs to emerging market countries without adequate labor protections.
As a result, women and children are often subjected to grueling factory jobs in sub-standard conditions.
5. Degradation of natural resources. Emerging market countries often don’t have many environmental protections. Free trade leads to depletion of timber, minerals and other natural resources. Deforestation and strip-mining reduce their jungles and fields to wastelands.
6. Destruction of native cultures. As development moves into isolated areas, indigenous cultures can be destroyed. Local peoples are uprooted. Many suffer disease and death when their resources are polluted.
7. Reduced tax revenue. Many smaller countries struggle to replace revenue lost from import tariffs and fees.
Solutions to the Problems
Trade protectionism is rarely the answer. High tariffs only protect domestic industries in the short term.
But, in the long term, global corporations will hire the cheapest workers wherever they are in the world to make higher profits.
The best solutions are regulations within the agreements that protect against the disadvantages. Environmental safeguards can prevent destruction natural resources and cultures. Labor laws prevent poor working conditions. The World Trade Organization enforces free trade agreement regulations.
Developed economies can reduce their agribusiness subsidies, keeping emerging market farmers in business. They can help local farmers develop sustainable practices, and then market them as such to consumers who value that.
Countries can insist that foreign companies build local factories as part of the agreement. They can require these companies to share technology and train local workers.