The same is true of telecommunications and postal services. However, this argument is not a carte blanche to invest in regional infrastructure to ease trade between partners. Such funds have an opportunity cost, and the returns from integrating with the rest of the world may well be higher. The trade creation gains identified in the previous section arise even under perfect competition because resources are re-allocated within the home country in line with its comparative advantage.
In more recent analysis of welfare effects, the perfect competition assumption has been relaxed in models that allow for imperfect competition, economies of scale and product differentiation. These new analytical perspectives on market integration emphasize the pro-competitive effects of larger markets rather than comparative advantage. The additional sources of welfare gain under imperfect competition include:. In many small countries the domestic market may not support a large number of firms and thus there is a tendency for firms to collude and raise prices at the expense of consumers.
Larger markets as a result of regional integration may allow firms to exploit economies of scale, thus driving down costs and prices to local consumers. Larger markets may increase the range and variety of products which are available to consumers. In well-integrated customs unions such as the EU, much of the increase in intra-regional trade takes the form of intra-industry trade the exchange of similar products such as Renault cars for Mercedes cars between France and Germany rather than the classical inter-industry trade such as the exchange of cars for wine between Germany and Portugal which would be predicted on the basis of comparative advantage.
Modern theory also highlights a number of other consequences of regional trade arrangements: . Accumulation or growth effects. If closer integration improves the efficiency with which factors are combined it is also likely to induce greater investment. While this additional investment is taking place, countries may experience a medium-term growth effect. If such investment is associated with faster technical progress or accumulation of human capital as identified in the new endogenous growth models, long-run growth rates may also be improved.
Investment effects. More emphasis is now given to the impact of regional integration on production via the effect on foreign direct investment and investment creation and diversion. Transactions costs and regulatory barriers. The traditional theory of customs unions was developed in the context of tariff reductions but, as noticed above, the welfare effects of integration can be quite different if the barriers removed are cost-increasing barriers.
Importance of credibility. Many of the effects identified in the modern theory, especially those related to or requiring investment, assume that the integration effort is credible and will not be reversed. If credibility is lacking, and there is uncertainty among investors, their behavior is unlikely to be influenced. The emphasis on credibility assumes the existence of enforcement mechanisms which will ensure the implementation of commitments entered into when a country joins a regional integration scheme.
The way in which access to a Northern country market might be used to enforce policy commitments has led to a new literature outlining the advantages of North-South rather than South-South integration arrangements on grounds quite different to the traditional allocation or accumulation effects. The traditional efficiency advantages of removing barriers to economic activities are likely to appeal to industrialized countries with large, diversified industrial structures where significant scope to re-allocate resources among alternative activities exist.
Page points out that this source of gain is unlikely to be so important in developing country integration, and it has not normally been the objective of developing country groups. For developing countries, the rationale for economic integration has often been structural in nature. They have been concerned with the development of new industries through cross-border coordination to exploit the advantages of economies of scale which a larger home market permits.
Thus, much thinking in developing countries on the advantages of regional integration sees it as a development tool and specifically as a tool of industrial policy Asante, The advocates of import-substitution industrialization strategies could see the problems of pursuing these strategies in the context of small home markets, and saw regional integration as the way to establish these industries on a more competitive footing.
The implicit assumption was that the choices made within the regional context would be efficient, and that member countries would accept the resulting pattern of industrial specialization Page, To avoid uneven levels of industrialization between the member countries, regional integration schemes were often accompanied by an explicit framework of measures designed to ensure an equitable allocation of new complementary investment.
Positive discrimination in favor of the less advantaged countries was implemented through complementarity agreements.
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The experiences of developing countries with regional integration schemes designed on this basis were disappointing. An OECD study examined the performance of 12 regional trading arrangements among developing countries which had been in existence for some time York, This failure was due both to political and economic reasons.
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For many countries - including some that were at the time recently independent nations - surrendering of some sovereignty for economic development was a sacrifice they were not prepared to make. When liberalization programs were put into place, many governments resorted to using unilateral and restrictive trade measures when import surges created pressures for domestic adjustment.
Adjustment problems also led to conflicts between partners over the distribution of the costs and benefits to regional integration. In this framework, the larger the share of third country imports in total imports, the bigger the tariff revenue loss when a region is formed. Similarly, trade partners with initially higher tariffs lose more when a region is formed because more tariff revenue is redistributed away from them. Since developing countries often have high extra-regional trade dependencies and initially high tariffs, they will tend to lose from forming regions.
The costs in terms of trade diversion will be high with a high probability that not only individual partners but also the RTA as a whole will lose overall. From this perspective, the failure of so many developing country regional groupings is not surprising. Poorer or less industrialized members found themselves in the position of subsidizing the inefficient industry of their neighbors and doing so without adequate compensation since the relative wealth of their partners did not permit extensive income transfers.
The new regionalism is occurring in a very different policy context. It typically involves countries that have already committed themselves to lower tariff barriers and are pursuing outward-looking strategies.
These policies reduce the scope for trade diversion costs. Moreover, static trade creation benefits are no longer the primary motivation. The new economics of regionalism stresses the potential gains from reduced administrative and transaction costs and other barriers to trade. These show up for an economy in increased inter-firm competition and a reduction of production costs and monopoly rents. To achieve these gains, however, much more than a simple free trade arrangement is called for if transactions and administrative costs are to be significantly reduced and market segmentation is to be overcome.
But why could countries not seek these lower costs in the world market directly?
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One answer may be the lower transactions costs involved in producing for the regional market compared to the world market. Information on prices and consumer preferences are more readily available, and transport costs are lower. The new regionalism also stresses that schemes of North South integration are likely to be more beneficial to developing countries Venables, The first argument is that because industrialized countries are likely to be among the more efficient global suppliers, the costs of trade diversion switching from cheaper global to more expensive partner imports will be minimized.
Schiff and Winters qualify this conclusion by pointing out that even small cost disadvantages for Northern firms can be costly for Southern partners because of the large amount of trade which will be involved. Also, if the Southern partner continues to import from the rest of the world over significant tariff barriers, prices in its market will not fall to the Northern partner price. Instead, there will be a substantial transfer of rents from Southern consumers to the Northern exporting firms. If developing countries want to establish the credibility of their policy reforms, locking these in through agreements with a Northern partner may be more convincing to investors both domestic and foreign.
The argument assumes that the costs of backsliding in the case of a Northern partner will be greater than for Southern partners. Again, the premises behind this assumption may not stand up to examination. While the Northern partner may have the market power to wield credible sanctions, it may not have the will think of the public relations problems for the EU if it were to withdraw market access from a traditional African supplier because the latter introduced some discriminatory economic policy or the motivation the market of the Southern partner may be so insignificant that the Northern country has no material interest in retaining access to it.
A number of Asian and Latin American countries claim to be pursuing open regionalism. This is defined as regionalism that contains no element of exclusion or discrimination against outsiders. It implies that negotiated tariff reductions between members are agreed on an MFN basis and thus passed on to third party members of the WTO. The regional dimension consists in undertaking these cuts on a jointly agreed phased basis.
In this process, open regionalism is a co-operative arrangement rather than a rules-based community. By definition, it avoids the trade diversion costs which have troubled developing country regional groups in the past.
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The recent experience of APEC, perhaps the best-known agreement of this type, suggests that such informal commitments may be vulnerable to breakdown in the absence of a wider forward momentum of multilateral liberalization. A feature of the new generation of RTAs is that many of them aim to go beyond liberalizing trade in goods and include commitments to liberalize trade in services. The question can be posed whether trade in services has any characteristics which would lead to a modification or change in the conclusions reached about the impact of preferential trade liberalization in the case of goods.
Mattoo and Fink have addressed this question and their conclusions are summarized here. Extending preferences to trade in services extends conventional theory in two ways. First , because trade in services often requires that the producer be close to the consumer, the traditional analysis of cross-border trade needs to be extended to foreign direct investment and foreign individual service providers.
Second , preferential treatment in the provision of services is rarely granted through tariffs, but through the discriminatory application of rules and regulations, or restrictions on the movement of capital or labor. For example, if there are limits on the number of telecommunications firms, banks or professionals that are allowed to operate, partner countries may receive preferred access to licenses or quotas.
Or restrictions on foreign ownership, the number of branches, etc.
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The question is whether the use of instruments of this kind to implement preferential trade agreements, rather than tariffs, raise new issues for the welfare evaluation of RTAs. This is a stronger conclusion than is reached in the analysis of preferential trade in goods. The main reason is that barriers are often prohibitive and not revenue-generating, so there are few costs of trade diversion. In their words,. Because restrictions on services trade in developing countries are much more pervasive than restrictions on trade in goods, the gains from removing these restrictions are likely to be a multiple of those obtainable from further goods trade liberalization.
However, multilateral liberalization under the GATS is likely to be a more efficient way of ensuring these gains than regional integration. The reason again is the danger of trade diversion when liberalization takes place on a regional basis. This danger is particularly great in the case of RTAs between developing countries because the most efficient services suppliers are likely to be ROW firms. Governments introduce regulations to deal with problems arising from market failure, such as asymmetric information, externalities or natural monopoly.
As tariff barriers have fallen, differences in national regulations have appeared as potentially significant barriers to trade. Parallel with the efforts being made in the multilateral trading system to develop international rules to reduce the protectionist impact of regulations, some RTAs now pursue a strategy of regulatory co-ordination to minimize the market-segmenting impacts of differences in national regulations.
The best-known example of this process is the Single Market program pursued by the European Union since In many cases, RTAs are acting as laboratories in which different approaches to regulatory co-ordination are being tried, the lessons from which are feeding back into the multilateral negotiations under WTO auspices. The question of regulatory co-operation is often presented as a choice between harmonization of regulations and standards or mutual recognition of the standards embodied in national rules.
The alternative approach is to encourage mutual recognition of the national standards and conformity testing procedures in place in each member state of an RTA. This may occur if firms within the RTA lobby for less stringent regulation in the face of competition from firms located in more lax regulatory jurisdictions, or threaten to relocate from high- to low-standard countries.
The extent to which competition among rules leads to convergence of standards in practice, or whether national diversities can continue, is an empirical matter on which there is limited evidence to date. In practice, harmonization and mutual recognition may be complementary rather than alternatives. EU experience suggests that mutual recognition will only be accepted as the basis for accommodating different national rules when the difference between national approaches is not too great.
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