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Regionalism versus Multilateralism: the case of the European Union
Trade Policy∗∗∗∗
Antimiani, A.♣, Salvatici, L.♠
Abstract
In 2006 the European Union (EU) decided to abandon its moratorium on negotiating new free trade
agreements. Since then, numerous negotiations have been started. In particular, the EU joined in the
scramble for preferential market access starting bilateral negotiations both with individual countries
and with regional sub-groupings. The discriminatory character of these agreements is controversial in
economics, not simply because of the classic ‘Vinerian’ view that they can divert rather than create
trade, but also because of the unresolved disagreements over when a regional trade agreement is likely
to precede, rather than preclude, more global agreements. In this paper, we use a computable general
equilibrium (CGE) model to assess the effects of the possible agreements between the EU and different
partners, namely India, Mercado Común del Sur (MERCOSUR), and United States of America (USA).
We evaluate the impact of the free trade agreements by themselves, assess their mutual compatibility
and compare them with a scenario including all bilateral agreements as well as a benchmark global free
trade scenario.
Keywords: CGE Model, Trade policy, WTO, EU
J.E.L. Codes: F13, F15
∗This work was supported by the “Exploring the Future of Global Food and Nutrition Security (FOODSECURE)” (Grant Agreement no. 290693) research project funded by the European Commission. The views expressed in this paper are the sole responsibility of the authors and do not necessarily reflect those of the European Commission.
♣ Istituto Nazionale Economia Agraria (INEA), Italy ♠ Department of Economics – Roma Tre University, Italy
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1. Introduction
The proliferation of bilateral agreements has helped to fill a gap in a multilateral process that is
impeded by the impasse of negotiations in the World Trade Organization (WTO). At the same time, the
development of bilateral trade agreements arguably has discouraged some States from engaging in
multilateral negotiations (Trakman, 2008). By January 2014, a total of 583 regional trade agreements
had been notified to the WTO and its predecessor, the General Agreement on Tariffs and Trade
(GATT). Of these, 377 are in force and, among these, by 255 are free trade agreement (FTAs).
What can explain the recent growth in regionalism, and why do governments choose to pursue their
policy objectives through FTAs?
The main explanations provided in the literature (WTO, 2011) are:
1) that regionalism has been spreading because multilateral talks tend to progress too slowly
(Bhagwati, 1992, 1997);
2) on the contrary, decades of multilateral liberalisation could actually have helped the recent
spread of bilateral initiatives since lower tariffs reduce the costs from trade diversion: Freund
(2000), for instance, finds that deeper multilateralism provides greater incentives to form FTAs
since lower multilateral tariffs improve the sustainability of preferential liberalisation;
3) the so-called “bandwagon” or “emulation arguments” that posit a link between FTAs signed by
the ‘trade giants’ (US, EU and Japan) and the attitudes of other nations (Solis, Stallings and
Katada 2009): more generally, the “domino theory” of regionalism formalised in Baldwin
(1993) argues that the signing or deepening of one FTA can induce excluded nations to sign
new FTAs previously shunned;
4) the political-economy explanations pointing out coordination failures of adversely affected
interest groups or profit gains for exporters in excess of the losses that would be suffered by
import-competing industries (Grossman and Helpman, 1995).
Be that as it may, FTAs have become a major and strategic part of commercial policy for many
countries, including the European Union (EU). The EU already signed a motley assortment of both
unilateral and reciprocal preferential agreements. More recently, the EU joined in the scramble for
preferential market access starting bilateral negotiations both with individual countries, for example,
India and Canada, and with regional sub-groupings, such as the Association of Southeast Asian Nations
(ASEAN) and the Mercado Común del Sur (MERCOSUR).
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The proliferation of FTAs over the past two decades has kept the debate alive between those who view
FTAs as discriminatory instruments hostage to protectionist interests and those who see them as
conducive to multilateral trade opening (Bhagwati, 1996; Freund and Ornelas, 2010): 'building' or
'stumbling blocs' using the famous words introduced by Bhagwati (1992). The literature suggests
several possible linkages between preferential and multilateral tariff cutting. The main goal of this
paper is to provide a quantitative assessment for some of these linkages. In other terms, we are not
going to add new arguments to the theoretical debate, but rather to provide evidence supporting the
empirical relevance of some of those that have been already suggested.
We focus on the EU trade policy and compare the effects of some FTAs presently negotiated by the
EU. As it is customary in the literature providing ex ante evaluation of policy changes, we use a
computable general equilibrium (CGE) model of global world trade. Our assessment is rather standard
with respect to those already existing, and we certainly do not pretend to provide a more
comprehensive, detailed or sophisticated results with respect to those already existing in the literature.
The main goal is to use a consistent theoretical framework in order to compare different arguments put
forward in the building/stumbling bloc debate. To this end, several counterfactual scenarios are
simulated, including a multilateral free-trade scenario that provides a benchmark for the assessment of
“second-best effects”.1 This provides useful insights for assessing the potential effects of different trade
liberalization strategies in the attempt to connect high theory with empirically grounded research that
has more policy relevance.
The rest of the paper is organised as follows. After reviewing the most recent developments of the EU
trade policy (Section 2), the third section follows Baldwin’s critical review (2009) of the building bloc
- stumbling bloc debate literature in order to describe various economic mechanisms that determine
whether preferential trade arrangements help or hinder multilateral trade liberalisation. The Global
Trade Analysis Project (GTAP)2 CGE model is used to evaluate the impact of the free trade agreements
by themselves and their mutual compatibility as well as their relations with the larger agenda of global
free trade (Section 4). In Section 5, we discuss the results of simulations; while Section 6 presents some
concluding remarks.
1 In the words of Winters: "If one could determine the perfectly multilateral volume and pattern of trade, one could then easily define the index of actual multilateralism by any of several distance measures between actual and "perfect" trade" (1999, p.9). 2 https://www.gtap.agecon.purdue.edu/
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2. The EU (bilateral) trade policy
We think that the EU provides a good case study since it has long been involved in regional trade and
integration initiatives, beginning with the formation of the European Community itself in 1958, and
through the negotiation of a large number of FTAs. Presently, there are 29 trade agreements already in
place: with members of the Andean region, Colombia and Peru; with Central America countries –
Honduras, Nicaragua and Panama; as well as with South Korea, Mexico, South Africa, and Chile. On
top of these "classic" free trade deals, FTAs are a core component of many Association Agreements in
force with a number of countries and territories in Europe (Faroe Islands, Norway, Iceland,
Switzerland, Macedonia, Albania, Montenegro, Bosnia and Herzegovina, Serbia), in the Southern
Mediterranean region (Algeria, Egypt, Israel, Jordan, Lebanon, Morocco, Palestinian Authority, Syria,
Tunisia) as well as with several African, Caribbean and Pacific countries. Finally, the EU is also part of
custom unions with countries such as Andorra, San Marino, and, more importantly, Turkey.
The growing number of these agreements has been the subject of discussion in Brussels since the mid
1990s. In the 2006 European Commission's Communication on the common trade policy, significant
shifts are discernible in the Commission's Position (European Commission, 2006), especially since they
relate to the prominence given to bilateral and regional trade agreements and the shift away from an
almost exclusive focus on multilateral rule-making which used to be the norm (Evenett, 2007). In
recent years, eleven trade agreements have been finalized though they have yet to enter into force: the
EU has recently concluded negotiations with Canada and Singapore; a deep and comprehensive Free
Trade Area with Moldova, Armenia, Georgia, and Ukraine; Association Agreements were signed with
several members of the Central American region (Costa Rica, El Salvador, Guatemala, Honduras,
Nicaragua and Panama); finally, there have also been five Economic Partnership Agreements with
African, Caribbean and Pacific States that have been negotiated (Cote d'Ivoire, Cameroon, the Southern
African Development Community, Ghana and the Eastern African Community).
The EU is actually pursuing a new generation of carefully selected and prioritised FTAs as one of the
main goals of its trade policy. The targets of the EU's new external trade policy are the large as well as
the emerging markets, as it is confirmed by the on-going negotiations with United States of America
(USA), Japan, Association of Southeast Asian Nations (ASEAN), Morocco, India, Mercado Común del
Sur (MERCOSUR). In addition to these trade negotiations under way, there are several trade and
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development negotiations ongoing to establish Economic Partnership Agreements (EPAs) with
African, Caribbean and Pacific countries (ACP).
In our simulations, we will focus on three cases corresponding to different typologies as well as
geographical locations: a large developed country (USA), a large developing country (India), a trade
integration area (MERCOSUR). More specifically:
� The EU is India’s largest trading partner, accounting for around one-fifth of India’s total trade
(14.4 per cent in 2011), whereas India contributes around 2.2 per cent of total EU trade and is
its tenth-ranking partner. Since 2001, bilateral trade has increased annually by over 11 per cent
(Khorana, Garcia, 2013). Even if India remains a rather small trade partner for the EU, the
combination of rapid economic growth and relatively high market protection makes India an
interesting partner for one of the new generation of EU FTAs. The EU Council adopted a
negotiating Directive for a Free Trade Agreement (FTA) with India on 23 April 2007 and
negotiations were launched on 28/29 June 2007. The FTA will cover trade in goods and
services but will also pay attention to other issues: investment, public procurement, technical
regulations (co-operation on technical barriers to trade and sanitary and phyto-sanitary
measures), intellectual property rights, competition policy, and dispute settlement provision.
� The FTA between EU and the United States (US) would be the world’s largest since the two
economies represent about half of the world’s Gross Domestic Product (GDP) and contribute to
almost a third of the global trade flows. The negotiating, for a Transatlantic Trade and
Investment Partnership (TTIP), started officially during the first round which took place in
Washington D.C. in July 2013. At this stage, it aims at removing trade barriers in a wide range
of economic sectors to make it easier to buy and sell goods and services between the EU and the
US, as path towards a full free-trade agreement. The third round of talks of negotiations has
been held from 16-20 December 2013 in Washington D.C.
� The EU is MERCOSUR's3 first largest trading partner, representing 18.8% of total
MERCOSUR trade in 2012 and MERCOSUR ranks 8th among EU trading partners, accounting
for 3.2% of total EU trade in 2012. Negotiations for an inter-regional Association Agreement
between the EU and the MERCOSUR were launched in 1999 at the Rio de Janeiro Summit but
were, however, suspended in October 2004: the Commission decided in May 2010 that
3 Mercosur was established in 1991 and encompasses Argentina, Brazil, Paraguay, Uruguay and Venezuela.
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negotiations could continue. The major deadlocks seem to be on agricultural goods, primarily
over EU farm subsidies and the lack of European market access for less-expensive
MERCOSUR products.
Since countries may have much to gain by forming a union with a major trade partner that is subject to
low natural trade costs, where trade creation is likely to dominate, FTAs featuring a large share of
intrabloc trade are traditionally dubbed as "natural" (Wonnacott and Lutz, 1989). Even if there is no
theoretical guidance to determine how large is "large" (Kreinin and Plummer, 1994), Table 1 shows
that the share of bilateral trade on total trade flows is much lower for the EU than for the FTAs’
partners. Indeed, in the EU, the shares of intrabloc trade never exceed 5%, with the exception of USA
(14,5%), although it is worth noting that there can be large differences across sectors. On the other
hand, the EU is a much more important trade partner for the other countries since the intrabloc trade
shares range between 13% (India) and 23% (MERCOSUR).
With regard to the literature that attempted to evaluate the impact of these trade agreements using CGE
models, as far as the MERCOSUR agreement is concerned it is worth mentioning the work by Boyer
and Schuschny (2010) that simulates an FTA between EU and MERCOSUR (with and without the
exclusion of sensitive products) using the GTAP model. Their results appear to be broadly consistent
with ours, taking into account differences in the experiments and in the baseline definition. Similarly,
in the work of Bouet et al. (2011), even if results are computed with a different model (MIRAGE), they
show the same sign for the impact on terms of trade we found for FTAs between EU and MERCOSUR:
positive for the latter and negative for EU. However, it should be noted that, if sensitive product
exceptions are “included” in the scenario of bilateral agreement (instead of full free trade), the sign and
intensity of welfare gains could be substantially different, as shown by Laborde and Ramos (2006).
INDIA MERCOSUR USA
EU partner 13.2 23.3 16.3
EU 2.2 3.2 14.5
Source: COMTRADE
*For Mercosur and EU, intratrade is excluded; for India data refer to 2011.
TABLE 1 - Intrablocs trade share (%, 2012)*
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In the case of India, a work by Achterbosch, Kuiper and Roza (2008) also using the GTAP model
confirms our results, in that the EU economy is only slightly affected whereas India would have more
to lose than to gain from the FTA. In the same vein, simulations by Polaski et al. (2008) suggest a small
welfare loss for India (250 $ million) and larger gains for EU (2.2 $ billion). On the other hand, results
by Decreaux and Mitaritonna (2007), Khorana and Garcia (2013) and the European Commission
(2009) show an overall positive result for India although this is mostly due to the inclusion of
liberalisation in services (not included in our simulations).
Several studies about the negotiations for the TTIP have been issued, even if this negotiate has been
launched so recently. Focusing on the studies which are comparable to ours from a methodological
point of view (i.e., CGE analysis), one of the most comprehensive is carried out by the CEPR (2013),
on behalf of the EU Commission. It uses the same model adopted in this paper, namely the GTAP
model, though allowing for imperfect competitions in some sectors. The results indicate positive and
significant gains for both the EU and the US. GDP is expected to increase by 119 billion € for EU and
95 billion Euros for the US. However, an FTA limited to tariff liberalisation would lead to 24 billion
Euros increase in GDP for the EU and 9 billion Euros increase for the US. Overall, total exports would
increase 6% in the EU and 8% in the US. Petersen (2013), using a CGE model allowing for frictional
unemployment, finds that a deep liberalization of trade between the two regions would increase the real
per capita gross domestic product while simultaneously boosting employment. In the same vein, a
study commissioned by the Dutch Ministry of Economic Affairs, Agriculture and Innovation (Ecorys,
2012), highlights that a potential EU-US FTA would yield positive results in terms of GDP growth
both for the USA (+1.6%) and the EU (+2.4%) and the same is true for the study carried out by
Fontagné, Gourdon and Jean (2013) using the MIRAGE model to evaluate what the economic
consequences of an agreement taking into account the obstacles to trade in services and non-tariff
measures. By and large, then, there seems to a quite a large consensus about the fact that significant
economic gains could be achieved from the TTIP.
3. Bilateralism vs. multilateralism: trick or treat?
The literature that is relevant to this paper is too vast to review in detail. One of the most contentious
aspects of the debate on preferential trade agreements concerns the relationship between regionalism
and multilateralism. Hence, in this section, we refer to some selected contributions specifically related
to how preferential trade agreements may act as building blocs or stumbling blocs on the path to global
free trade. Our review is shaped according to the stocktaking essay by Baldwin (2009) entitled “Big-
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think regionalism: a critical survey”. In this paper, studies are divided according to two typologies:
Small-Think Regionalism and Big-Think Regionalism.
In the 1950s, the debate about regionalism straightened out the economics and established the
intellectual paradigm around Viner’s (1950) key finding: discriminatory tariff liberalisation has
ambiguous welfare effects since preferential liberalisation induces new distortions while removing
others. This literature – what could be called Small-Think Regionalism – focused on the concepts of
trade creation, trade diversion and terms-of-trade effects and ignore systemic implications. In the
1990s, Bhagwati (1992) and Krugman (1991) among other scholars, laid out lines of analysis of what
might be called Big-Think Regionalism. While Small-Think Regionalism focused on the FTA-related
changes in trade flows, prices, production structures, sectoral allocation of factors of production and
welfare of the individual nation, Big-Think Regionalism focuses on the systemic implications such as
the impact on the world welfare or consequences for the multilateral system. Many trade policy
scholars, such as Krugman and Bhagwati, mentioned previously, worried that regionalism was a
stumbling bloc to global free trade, others, such as Bergsten (1996), viewed regionalism as a largely
benign or even as a constructive force in the world trade system. Here we briefly discuss some
conjectures offered in the literature. The main arguments in the debate on regionalism vs.
multilateralism are pointed out below.
#1: Bag of goodies
FTA exporters gain from improved market access in two respects: cheaper exports facilitated by the
agreement replace the importing country domestic production (trade creation) or crowd out exports
from the rest of the world (trade diversion). The latter generate rents that can be thought of as a
stumbling bloc that has been labelled by Baldwin (2009) as the ‘goodies bag’. Since the richness of the
‘goodies bag’ is linked to the preference margins, FTA members have an extra incentive to maintain
high margins by avoiding multilateral liberalisation.4 According to Grossman and Helpman (1995), for
instance, governments that are very susceptible to special interest groups will seek the most trade-
diverting agreements.5
#2: Cherry picking argument
4 Since unilateral preference rents are also affected by an agreement to reduce tariffs on a multilateral basis, the ‘bag of goodies’ stumbling bloc logic plays a leading role in the developing countries’ concern about preference erosion. 5 Krishna (1998) provides the same answer in a different framework, with oligopolistic firms.
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Even if there may be additional benefits in terms of political payoffs, the most obvious economic
reason to undertake a FTA is represented by the expected welfare gains. This is not necessarily bad
news for the multilateral agenda since trade liberalisation is a positive-sum game and free-trade may
guarantee even better performance to the FTA participants. However, if benefits do not monotonically
increase with the number of countries involved in the trade agreement, governments may decide to opt
for partial liberalisation agreements that provide better results.
According to Baldwin (2009), starting from a world where all nations use non-discriminatory tariffs,
the question is: can some group of nations raise their collective welfare above the free trade level by
forming a trade bloc and thus exploiting other nations? If the answer is yes, then that bloc is a
stumbling bloc on the road to multilateral free trade because the bloc members will not have an
incentive to pursue global free trade.
Such a cherry picking behaviour raises the issue of their structural compatibility with the larger agenda
of global trade liberalisation. When a government goes for low-hanging fruits through a FTA and
moves the economy away from its 'true' comparative advantage, this will raise the cost of achieving
global free trade.
Again, starting from a world in which all nations use non-discriminatory tariffs, the question is: does
the adjustment cost to be incurred to achieve global free trade get larger after the implementation of the
FTA? If the answer is yes, then that bloc is a stumbling bloc on the road to multilateral free trade.
To shed some light on this issue, in the following we compare the different liberalisation scenarios
using a “structural change index”, based on the output change; and a “labour displacement index”,
based on the labour movement across sectors. In all cases, we will assess the similarity of the
allocations resulting from different FTAs with the one corresponding global free trade.
#3: Juggernaut argument
The assertion that FTAs could foster multilateral liberalisation, acting as building blocs on the road to
global duty-free trade, is first based on the notion that preferential liberalisation creates a political-
economy momentum making multilateral liberalisation easier: this is the ‘juggernaut’ building bloc
logic (Baldwin, 2009). Thus, a country that enters into a FTA will expand the political and economic
strength of its pro-liberalisation constituency (juggernaut effect), making it possible for its government
to cut a multilateral deal (Baldwin, 2009).
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Such an outcome can be explained by two lines of reasoning. First, FTAs re-landscape members’
economies making export sectors larger and import-competing sectors smaller. Of course, in the sectors
where the FTA results in lower exports, the agreement can start the juggernaut rolling backwards.
Second, if the changes in the production structure are consistent with those that would take place under
global liberalisation, the FTA helps to reveal the nation’s true comparative advantage and workers are
in a better position to assess whether they will win or lose from free trade. Even if the building bloc
argument has a clear political-economy flavour, it has some overlapping with the structural congruence
issue, and it is also quite consistent with the more traditional argument based on the ‘trade creation’
effect of FTAs.
4. Model, database and scenarios
As a consequence of the ambiguity concerning the impact of FTAs, economic theory provides very few
clear-cut conclusions as to whether regionalism reinforces or hinders the move toward global free
trade. The bottom line is that theory cannot provide us with undisputed guidance and therefore it is
ultimately an empirical issue to determine the impact of a given FTA. In this respect, there is a decisive
role for quantitative models to assess the impact of FTAs and shed some light on this complex issue.
Since we are interested in “what if” questions, i.e. if the EU were to sign new FTAs, what would be the
consequences for trade, production, employment, income, etc.? Then, we are going to use a global
CGE model that allows us to test some of the arguments presented above. Most ex ante studies of
regional trade agreements use this type of model (see Section 2). The CGE framework builds on
general equilibrium theory and rests on consistent microeconomic foundation in which intersectoral
linkages, resource constraints and policy distortions are the main focus.
The main advantages of the CGE approach are the solid micro-theoretical underpinning and the
economy-wide scope, as well as the complete and consistent coverage of all bilateral trade flows.
Furthermore, changes in welfare can be traced back to the different sectors by performing a welfare
decomposition exercise to identify what is generating the gains and losses. A CGE model, then, is an
appropriate tool when the policy changes being analysed simultaneously affect many countries and
many sectors and have effects on terms-of-trade, factor prices and income.
Our simulations have been carried out using the GTAP model and its database providing a baseline
year of 2007. In our version, the database is aggregated to include 25 regions/countries and 33 sectors
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(Table 2). The product aggregation aims to provide the maximum detail allowed by the database
(version 8.1: Narayanan et al, 2012).
Several changes have been introduced in order to update the 2007 baseline to 2012 using World Bank
data for population, labour force and GDP, and including all the policies already agreed upon even if
yet to be implemented. Accordingly, as far as the Common Agricultural Policy is concerned, direct
payments are modelled as ad valorem subsidies to land. With regard to the trade policies, we introduce
in the baseline the full implementation of the Everything But Arms Regulation (EBA) and the
Commodities and
Activities
Paddy rice Land
Rice Skilled
Wheat Unskilled
Other cereals Capital
Cereal seeds Natural Resources
Vegetables & Fruit
Dairy products
Fishing China
Fibers India
Forestry Korea
Live animals Japan
Meat Eu27
Leather products Euromed
Other crops
Oil fats No WTO countries
Beverage & tobacco Canada
Sugar USA
Other food Mexico
Chemical products Australia and New Zelaand
Machinery Rest of asian countries
Eletronic equipment EFTA
Ferrous products Rest of american countries
Metal products Rest of the World
Minerals EBA countries
Motorvehicle EPA countries
Papers products South Africa
Other manufacture Ukraina
Petrol Colombia and Perù
Textile Chile
Wearing Russian Federation
Wood products Central America
Electricity
Services
Table 2 - GTAP database aggregation
Factors
Labour
Regions*
Asean (Indonesia, Malaysia, Philippines, Singapore, Thailand, Vietnam, Brunei and Myamar)
Mercosur (Argentina, Bolivia, Brazil, Paraguay, Uruguay and Venezuela )
*In bold countries/regions included in the scenarios
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Economic Partnership Agreements (EPA) into the baseline as well as the FTAs with EUROMED,
Korea, Chile, Central America, Colombia e Peru, Mexico and South Africa.
We are going to compare different paths to free trade: on the one hand, the paths starting from different
possible bilateral liberalization scenarios; on the other hand, the ‘direct’ path starting from the baseline.
To this end we define five simulation scenarios:
1. Global free-trade;
2. Joint implementation of FTAs with INDIA, MERCOSUR and USA;
3. FTA EU-INDIA;
4. FTA EU-MERCOSUR;
5. FTA EU-USA.
Finally, it is worth recalling that we use a rather ‘standard’ (i.e., static and perfect competition) model.
Such a model is by construction unable to take into account several FTAs’ effects (possibly even larger
than the ones considered here) such as economies of scale; “learning by doing” from expanded trade;
information, technology and knowledge transfers that increase productivity; increased investment
opportunities in a larger and perhaps more stable trading environment that carries with it advanced
technologies and increased productivity. Central to these issues is the removal of a host of non-tariff
obstacles, found both at the border and in domestic regulations, through the adoption by governments
of more convergent regulatory practices. Indeed, in a world of deepening economic integration, the
regulatory aspects of trade agreements have rapidly been assuming increasing importance (Brown and
Stern, 2011). However, our focus is on tariff regimes and in this respect, the chosen model provides a
consistent framework for the assessment of the different arguments put forward in the
building/stumbling bloc debate.
5. Results
In this section we analyse the outcome of the simulations in order to check if and to what extent the
theoretical arguments laid down in Section 3 are actually confirmed.
#1 Bag od goodies
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In order to verify the bag of goodies hypothesis, we proxy the preference rents with the ‘preferential
market shares’ computed as the difference between the values of bilateral export flows (at world prices)
in each FTA scenario and under free trade (table 3). Since results are influenced by differences in
sector sizes, in order to compare FTAs, we divide the differences by the corresponding baseline export
values.
The USA agreement generates ‘negative’ results, and this implies that the value of EU exports would
be lower than under global free-trade though the difference is negligible with respect to the export
flows. In all other cases, differences are significant both in absolute and relative terms and their amount
tend to increase with the number of agreements. The India and MERCOSUR agreements, then, would
generate export markets shares that are not likely to be maintained in a multilateral liberalization
scenario. Accordingly, these are going to be possible stumbling blocs on the way to global free trade.
#2 Cherry picking
Welfare gains or losses are crucial when a trade policy agreement is evaluated from an economic point
of view. In Table 4, the first column present the welfare impact of each bilateral agreement. Since it
would not make sense to compare these figures with the overall results of more encompassing
liberalization scenarios, the other columns report the contribution of the removal of bilateral trade
barriers with the same partner within larger liberalisation scenarios, i.e. joint implementation of all
FTAs and global free trade.
TOTAL 2.594.583 (86) 17.033 (47) 36.005 (72) -5.588 (-2)
Source: elaboration on GTAP simulations
*In brackets results normalized by baseline export flows
TABLE 3 - EU Preferentia market shares (USD million)*
ProductsBilateral agreements
Joint FTAs India Mercosur USA
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EU would benefit in all cases, although the order of magnitudes is quite different. The most beneficial
bilateral agreement is by far the one with MERCOSUR. Obviously, the ranking across agreements
results from the interaction between the relevance of bilateral trade flows and the height of bilateral
tariffs. Bilateral tariffs between EU and US, as a matter of fact, are generally lower than in the case of
India or MERCOSUR; on the other hand, bilateral trade flows between EU and MERCOSUR are larger
than in the case of India.
Benefits from bilateral agreements are by and large additive, since they hardly change when all
bilateral agreements are implemented together. Apparently, the whole set of bilateral agreements is
more rewarding than the multilateral one. In the latter case, as a matter of fact, not only the overall
impact of the regions not included in the bilateral agreements is negative, but the positive contributions
of the regions included are lower. Such a decrease is mostly due to the lowering of the terms of trade
gains, but there is a decrease in the allocative efficiency gains as well in the case of FTAs with USA
and MERCOSUR.
Welfare gains are conditional on the adjustments induced by trade liberalisation in each scenario, and
we may well expect them to entail shocks of very different sizes. Adjustment costs are those incurred to
transfer production factors across sectors. These costs, even if difficult to assess, can be quite
significant and governments are mindful about them.
In order to shed some light on the adjustment costs we compute the percentage of factors of production
that needs to be reallocated within the economy as a consequence of the trade policy changes
(Structural change index – SCI). The SCI values are computed as (Roland-Holst and van der
Mensbrugghe,2002; Productivity Commission, 1998):
BILATERAL Joint FTAs FREE TRADE
India** 1,764 1,746 1,657
Mercosur** 5,792 5,746 4,727
USA** 1,431 1,406 1,283
Total 8899* 6,954*
Source: elaboration on GTAP simulations
*It includes the contribution of all the regions in the model.
AgreementsScenarios
**For Joint FTAs and Free trade scenarios, figures refer to the contribution to the EU total welfare
Table 4 – EU welfare impact (million USD)
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1 ≥ ��� = ∑ ∑ �� − � �� ≥ 0� [1]
where � and � � represent each industry’s i share of factor j after and before the trade shock under
consideration (respectively, t and t-1).
Starting from the baseline (t-1), the global free trade scenario requires the largest adjustment (Table 5).
Even if such a result is hardly surprising, it is worth noting that the bilateral agreement with
MERCOSUR leads to a much larger adjustment in the EU economy than it would be the case under the
Joint FTAs scenario.
It is also interesting to verify what are the costs implied by the free trade scenario starting from the
structure of the economy resulting from the partial liberalization scenarios. Accordingly, in Table 6 the
(t-1) shares are the outcomes of the simulations regarding the 3 bilateral scenarios as well as the Joint
FTAs one.
Adding up the adjustment costs from Table 5 and 6, it is apparent that a piecemeal liberalization
strategy would always imply larger changes in the EU economy. This would be especially true in the
case of the USA agreement since the SCI required by a further move to global free trade scenario
(0.52) would be even higher than the one computed starting from the baseline (0.48). On the other
hand, it may be argued that the agreement with India and, even more, the Joint FTAs scenario would
decrease the adjustment cost of global free trade.
BILATERAL Joint FTAs FREE TRADE
India 0.011
Mercosur 0.039
USA 0.013
Source: elaboration on GTAP simulations
Table 5 - EU structural change index: different scenarios with respect to baseline
0.028 0.048
BILATERAL Joint FTAs
India 0.042
Mercosur 0.048
USA 0.052
Source: elaboration on GTAP simulations
Table 6 - EU structural change index: free-trade with respect to different reference scenarios
0.030
16
Within the adjustments costs, those regarding labour are particularly relevant from the political point of
view. Then, in addition to the Structural Change Index, we also compute a “Labour Displacement
Index” (LDI) summarizing the effect on the movement of the labour force between sectors (CEPR,
2013). In formal terms, the index is defined as,
100 ≥ ��� = �∑ ��(���)� ∗ 100���� ≥ 0 [2], where, γl is the sector j share of total employment and ��� is the per cent change in sector j employment
after the scenario simulation. Table 7 provides an assessment of the number of skilled and unskilled
workers that have to move across sectors in the global free trade scenario starting from the outcome
resulting from the partial liberalization scenarios: the only exception is the Free trade scenario itself
that can only be computed with respect to the baseline.
Overall, the labour displacement from trade liberalization seems to be easily absorbed through normal
entry and attrition rates since in most cases no more than 2 workers out of 100 would have to move
across sectors. It is worth recalling, though, that the index is a lower bound on labour displacement, as
it is likely to underestimate the actual amount of job churning that occurs: as a matter of fact, workers
who change jobs but do not change sectors are not captured by the above measure6.
The adjustment is larger for less skilled workers than for more skilled ones. In terms of “building” or
“stumbling” block, the LDI suggest that the global free trade would be easier to achieve after a partial
liberalization reform, with the only exception of a bilateral agreement with the US. In the case of US
6 Furthermore, it must be taken into account that GTAP sectors are quite “large”
Less skilled More skilled
India 1.9 1.5
Mercosur 1.9 1.5
USA 2.1 1.7
Joint FTAs 1.8 1.4
Free-trade (from baseline) 2.1 1.7
Source: elaboration on GTAP simulations
Table 7 - EU Labour Displacement Index: free-trade with respect to different reference scenarios
17
the value of LDI are equal to the ones given in the free-trade case: 2.1 for less skilled works and 1.7 for
the skilled ones.
#3 Juggernaut
In order to assess the political congruence between FTAs and free trade (juggernaut) we consider
changes of the export shares in total production (Table 8) as well as export and output changes (Table 9
and 10) under different bilateral scenarios.
If we compare the export shares in total output before and after the bilateral agreements, only the EU-
USA FTA can be considered a building block (Table 8). In this case, as well as in the Joint FTAs
scenario, export orientation (signalled by an increase of the export share in total output) would increase
for the majority of the EU economy.
EU FTAs export share > Baseline export share
Joint FTAs 56.3
India 50.0
Mercosur 43.8
Usa 53.1
Source: our elaboration on GTAP simulations
TABLE 8 - Comparison of export shares in total output under different scenarios (share of
total output in the baseline)
India Mercosur Usa
Correlation 0.76 0.76 0.62 0.14
Opposite sign sectors*
Numbers of sectors 10 9 14 17
Output share (%) 12.3 15.9 18.7 25.0
Overshooting sectors*
Numbers of sectors 8 4 7 4
Output share (%) 12.8 12.3 17.0 7.5
Source: elaboration on GTAP simulations
*Shares in the baseline
TABLE 9 - EU output changes: comparison between free-trade and FTAs
Joint FTAsBilateral agreements
18
In Table 9 and 11, we first compute an aggregate index, namely the correlation between sectoral
changes under each partial liberalisation agreement and global free trade. Then, we compare the sign of
the changes in order to check how many sectors move in opposite directions. Finally, even when signs
are consistent, FTAs may still induce larger adjustments than required by full liberalisation. We check
the sectors characterised by ‘overshooting’ since on the one hand, a larger output or export reduction
than required by free trade could make them wary of any further liberalisation efforts; on the other
hand, sectors experiencing a larger output or export increase than sustainable under free trade could
later on resist any policy reforms forcing them to shrink.
The Joint FTAs scenario would make the structure of the EU output (export) more consistent with the
one implied by global free trade. This means that adding up bilateral agreements makes the EU output
(export) structure more consistent with full trade liberalisation. However, even in this scenario, ten
(nine from the export side) sectors move in the opposite direction from what would happen under free
trade and eight (six) sectors are characterised by ‘overadjustments’. The lowest correlation, for both
output and export, is registered by the agreement with the USA while the best fit with global free-trade
is provided by the India FTA in the case of output changes and MERCOSUR FTA in the case of export
changes.
It does not only matter how much is exported, but also where exports are shipped. Accordingly, we
analyse the “geographical convergence” of trade looking at importers and exporters market shares. The
geographical convergence of trade destinations/sources is assessed for each sector j based on
differences between market shares t in each liberalization scenario, s, and the corresponding shares
under free trade (ft). Hence the analysis uses:
India Mercosur Usa
Correlation 0.87 0.56 0.81 0.47
Opposite sign sectors*
Numbers of sectors 9 13 12 15
Export share (%) 13.4 35.4 18.7 35.8
Overshooting sectors*
Numbers of sectors 6 1 1 3
Export share (%) 5.8 1.3 3.0 4.2
Source: elaboration on GTAP simulations
*Shares in the baseline
Table 10 - EU export changes: comparison between free-trade and FTAs
Joint FTAsBilateral agreements
19
��� = �� � + "�� [3],
where which �� �
is the share of exports of sector j that would be exported to market i in the free trade
scenario. If the trade pattern in each partial liberalization scenarios was the same as under free trade, u
equals zero for every i. The further the trade patterns are apart, the larger the (absolute) differences are.
Therefore, the variance of the vector u can be used as a measure of convergence. In each region and for
each sector, if the variance of the differences in the market shares decreases with respect to the
baseline, the trade pattern converges to the free trade one. An F-test is used to test whether the variance
decreases or increases significantly. Since we never register an increase in geographic divergence,
Table 11 shows the number of sectors with significant convergence based on different significance
levels (1%, 5%, 10%).
Only in the case of the Joint FTAs scenario there is a significant geographical convergence for the large
majority of sectors. As far as the single bilateral agreements are concerned, the largest convergence
(33% export share) is obtained on the case of the USA FTA.
6. Conclusions
In recent years, the proliferation of FTAs has been interpreted as a possible threat to the process of
multilateral trade liberalisation promoted under the GATT/WTO, leading to a large debate centred on
"regionalism toward multilateralism". The relationship between regionalism and multilateralism has
been framed as one where FTAs are either a stumbling bloc or a building bloc to multilateralism.
Winters (1999, p.42), for instance, argues “Trade diversion is good politics even if it is bad economics.
I find quite convincing the view that multilateral liberalism could stall because producers get most of
what they seek from regional arrangements”.
Table 11 - Number of sectors with significant convergence in the EU export (shares of total exports in the baseline)
Joint FTAs India Mercosur Usa
Numbers of sectors*** 16 (85) 2 (0.2) 1 (1) 2 (3)
Numbers of sectors** 4 (7) - 2 (0.3) 4 (29)
Numbers of sectors* 4 (5) - 3 (9) 1 (0.1)
Source: elaboration on GTAP simulations
Note: * = significant at 10%; ** = significant at 5%; *** = significant at 1% (in bracktes share, %, on total export on baseline data)
20
In this paper, we take up Richard Baldwin's recommendation to move the economics' profession
discussion from high theory to one which is more empirically grounded and policy-relevant. We use
the results of the simulations to answer the question of whether it sets up forces that encourage or
discourage evolution toward globally freer trade. It is worth repeating that our scenarios are not meant
to provide realistic forecasts of possible bilateral agreements. As a matter of fact, these agreements are
likely to include several very detailed exceptions, whereas we deliberately compare trade liberalisation
scenarios assuming that they allow the removal of all existing bilateral tariff barriers: in this respect, it
may be argued that our results overestimate the possible impacts.
On the other hand, new preferential agreements are likely to be “deep” ones to the extent that they
include rules on domestic policies while we only deal with border measures. In this respect, we are
likely to underestimate the possible impacts since our simulations only capture the impact of “shallow”
agreements. However, to the extent that the under/overestimation affects all liberalization scenarios in a
similar way, our results still allow meaningful comparisons.
The main conclusions of this paper relate to the building bloc-stumbling bloc debate that identifies
three distinct types of arguments in the literature: preference exploitation, cherry picking, and the
goodies bag. We consistently assess all these possible impacts in several possible EU FTAs. The
resulting picture is far from being black and white: FTAs may deliver important gains for participants,
but often they may also be a source of trade diversion and hamper movements towards greater trade
liberalisation.
The path to regionalism by the EU has been laid out, largely paved with agreements in fact or in
principle and, in many places, is already well-trodden. The apparent desire of the EU to join the
scramble for bilateral market access is probably unstoppable, but it is likely to yield less than some
might think, and it should not be taken for granted that it is likely to facilitate an eventual transition to
more liberal global trade. Empirical simulation models of the kind presented here can support this
evolving regional policies in essential ways, identifying both the opportunities and challenges that lie
ahead for more open multilateralism.
21
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