International Trade
Regional Integration

Interest in regional integration has recently revived in both developed and developing countries. The US has responded to the lack of progress in the Uruguay Round of the GATT by pursuing bilateral trade negotiations with Canada and Mexico, while the developing countries' trade liberalizations of the 1980s have prompted them to re-evaluate the potential benefits of regional integration. The tendency for the world trading system to divide into three blocs the European Community, the Americas and East Asia is bringing the benefits of guaranteed access to large markets to their members. Many poor non-member countries will suffer from the loss of access to industrial country markets, however, and the risk that trade wars will impede the realization of global benefits from multilateral trade is increasing. The renewed attractiveness of regional integration to individual countries, the types of integration that are suitable to various circumstances, the conditions necessary to their success, and the relationship of regionalism with multilateral free trade were discussed in papers presented at a conference on `New Dimensions in Regional Integration', jointly organized by CEPR and the World Bank in Washington DC on 2/3 April. The programme was organized by Jaime de Melo of the World Bank, a Research Fellow in CEPR's International Trade programme, and Arvind Panagariya, of the World Bank and the University of Maryland.
In his opening remarks, Lawrence Summers (World Bank and Harvard University) suggested that interest in regional integration schemes has increased because such agreements now include both developed and developing countries, as in the negotiations over the North American Free Trade Agreement (NAFTA). The benefits of trade liberalization whether achieved on a multilateral, regional or bilateral basis swamp other stakes in these agreements. Trade creation dwarfs trade diversion, and regional trade agreements spur rather than retard movement towards trade liberalization. Although regional agreements may sometimes be ineffective, they will not inflict harm on the world economy, so there is a strong case for supporting regional efforts towards integration.

Systemic Implications of Regional Integration

In the first conference paper, `Regionalism and Multilateralism: An Overview', Jagdish Bhagwati (Columbia University) noted that despite Keynes's opposition to regionalism in trade policy at the end of World War II, the GATT had included Article XXIV to accommodate regional trade pacts. Early efforts at regionalism in the 1960s failed because they lacked support from the US, which then strongly favoured multilateralism. US policy has since changed, and it now favours regional agreements in a policy environment with an anti-multilateral, anti-GATT ethos. Since regionalism is here to stay, Bhagwati suggested creating safeguards and disciplines in the GATT to ensure that regional agreements do not damage the multilateral world trading system. Bhagwati concluded by proposing a strategy for regional integration which could lead to eventual free trade in the world.

Robert Baldwin (University of Wisconsin) suggested that US support for free world trade after World War II had been motivated by foreign policy concerns and has eroded as those concerns have changed and as foreign competition has increased. The GATT's rule-writing on issues such as non-tariff barriers has been less successful than its negotiations to reduce tariffs. Richard Blackhurst (GATT) suggested that the US was still working hard for the success of the Uruguay Round despite its pursuit of new regional agreements. Also, some existing regional agreements may not be working, and further work is needed to ensure their compliance with GATT rules and limit their scope for trade diversion.

In `Regionalism vs. Multilateralism: Analytical Notes', Paul Krugman (MIT and CEPR) expressed cautious sympathy towards regional trade arrangements, for which the economic case is favourable and the political economy case strongly favourable. For a model of three trading blocs with internal free trade, which set tariffs non-cooperatively to maximize their own welfare, he found that world welfare may be reduced, although this result softens if the blocs' members are `natural' partners. Assuming realistically that governments do not maximize national welfare, but rather give extra weight to the preferences of producers, trade negotiations balance the interests of exporters and import-competing producers and therefore promote free trade. Krugman concluded by favouring regionalism on grounds of political economy, since such an approach can help to harness bad motives to a good cause: trade liberalization and the credibility of policy reform.

T N Srinivasan (Yale University) said that Krugman's trade models come close to `theory without relevance', since they cannot fully address the complementarities and contradictions of regional and multilateral trade policies, while bilateral or regional policies tend to use threats and political muscle to generate undesirable outcomes. A political economy model in which governments attach greater weight to producer interests may overlook the rent- seeking activities of producers trying to increase their weight in that function, while symmetric models take no account of the heterogeneity and asymmetric nature of countries and trade policies. Ronald Jones (Rochester University) maintained that economists can favour multilateral over regional liberalization, but they cannot favour regional liberalization alone. Small developing countries should not focus on regional integration at expense of the world market; complementarities in production may lead to tariffs that worsen their terms of trade in some cases.

Douglas Irwin (University of Chicago) noted the historical roots of the preference for multilateral versus bilateral trade liberalization in his paper, `Multilateral and Bilateral Trade Policies in the World Trading System: An Historical Perspective'. The late nineteenth century achieved multilateral free trade, but the inter-war period saw an outbreak of protectionist bilateral trading blocs and preferential arrangements. Multilateral free trade was accomplished in the nineteenth century entirely through bilateral treaties, and a progressive, trade-liberalizing bilateralism during the depression was suppressed in an unrealistic effort to reintroduce non-discrimination in international trade. Furthermore, several attempts to contain protection in the 1920s and 1930s through multilateral means were unsuccessful. Irwin concluded that the historical case for preferring multilateral over bilateral means of trade liberalization was weak.

Barry Eichengreen (University of California at Berkeley and CEPR) questioned why unconditional most-favoured-nation treatment had been so effective in the nineteenth century, when it may have encouraged free riders. He also suggested placing greater stress on the internal political economy of trade policy in various countries and on the role of country size in promoting or retarding trade agreements. Mancur Olson (University of Maryland) suggested that the theory of collective action could account for Irwin's findings: the benefits of multilateral agreements are spread widely, while the costs of obtaining them are greater than for bilateral or regional accords; the benefits of limited agreements are more apparent to particular interest groups, which then lobby for liberalization.

In his paper, `GATT's Influence on Regional Arrangements', J Michael Finger (World Bank) described the treatment of preferential arrangements under Article XXIV of the GATT and its effectiveness. Finger stated that good rules on regional agreements should include provisions that they be open to entry, have liberal rules of origin, limit trade remedies and have few exceptions. Article XXIV included many of these rules, including the requirement that such agreements eliminate all restrictions on substantially all trade. Finger found, however, from the GATT's review of the European Community in the 1950s, that these rules were never enforced and never seriously considered: indeed they contained a `free lunch', since they suggested that regional arrangements would not adversely affect other countries.

Jean Baneth (World Bank) argued that the plethora of regional arrangements since the EC should not have been stopped because they were all substantially trade creating: the European Community was an impulse to trade liberalization that had allowed political will to overcome pressure groups. Robert Hudec (University of Minnesota) agreed that the GATT had failed adequately to enforce and regulate such regional agreements and that Article XXIV had been trumped by other GATT policies, such as special and differential treatment and the enabling clause that allowed developing countries to discriminate in favour of one another. Hudec suggested that the GATT participate in negotiations over regional agreements: once member countries have finalized such agreements, it cannot stop the political momentum towards their implementation.

Jaime de Melo and Arvind Panagariya presented their overview paper, `Regional Integration: An Analytical and Empirical Overview', written jointly with Dani Rodrik. Panagariya noted that the orthodox theory of customs unions tends to produce ambiguous results, while the traditional dichotomy between `trade creation' and `trade diversion' is not helpful for policy. Complementarity in imports among partners, higher initial tariffs and lower final tariffs can all help to ensure that free trade agreements improve welfare; but these are also the circumstances that make unilateral trade liberalization even more desirable.

Turning to institutional aspects of regional agreements, de Melo stressed that integration enforces arbitrage in institutions, as well as in markets for goods and factors, which may improve economic performance if decision-making becomes less sensitive to factional interests. By enabling governments to delegate authority to appropriately designed regional institutions, such an agreement may act as a commitment mechanism to more liberal trade policies, reduce protectionist lobbying by factional interests and hence improve economic performance. De Melo also described their empirical work, which suggested that few existing regional integration agreements had increased both openness and intraregional trade. Nor was there any evidence that joining a regional agreement increased economic growth or convergence, although recent attempts at integration differ significantly in their starting-points and objectives from past effort, which therefore provide a poor guide to regionalism's future prospects.

Costas Michalopoulos (World Bank) argued that the theory of preferential trade agreements must be confronted with reality, since current moves towards regional agreements were motivated more by the needs to secure market access and reduce non-tariff barriers than by concern over tariff preferences. Further, the authors' empirical model could not capture the complexities of growth in the European Community. Ronald Findlay (Columbia University) suggested that their conclusions were too optimistic about the benevolence of regional agreements. He cited Madison's thesis that increasing the size of the nation should diminish factions, but he argued that it may lead instead to more powerful factions as the opportunities for insidious alliances increase.

Country Perspectives

In his paper, `The European Community: A Case of Successful Integration?', L Alan Winters (University of Birmingham and CEPR) noted the Community's role in inspiring many regional arrangements to press to the limits of harmonization and cooperation, but he maintained that the success of its economic performance is much less clear. The deep integration of the founding members led to a convergence of income levels across Europe, and the enlargements of the early 1970s (Denmark, Ireland and the UK) and the late 1980s (Spain, Greece and Portugal) also count among the Community's achievements. Winters noted lingering concerns, however, that the Community is falling behind Asia in technology, while subsidies and sectoral policies may undermine its future competitiveness. Further centrally directed policies are needed to safeguard the non-discrimination and low tariffs achieved by the customs union from member governments' interventions. Winters concluded that other regional associations wishing to take account of Europe's experience should note the need for deep political commitment, the dangers of becoming inward-looking, the need for additional policies of integration to maintain the initial agreement, and the value of pragmatism and consensus.

André Sapir (Commission of the European Communities, Université Libre de Bruxelles and CEPR) argued that Winters's results provided no substantiation of his claim that the Community was lacking in economic success. There had been a major convergence of the core European economies (France, Germany and Italy), while the fraction of imports in GDP, when measured at purchasing power parity, had increased substantially for the Community as a whole. Ravi Kanbur (World Bank and CEPR) argued that promoting integration required additional supranational interventionist policies to prevent wasteful competition over tax and other policies that would undermine the agreement, although it is far from clear that harmonization is desirable for all member countries.

In `Regional Integration in Eastern Europe: Prospects for Integration within the Region and with the European Community', Josef Brada (Arizona State University) discussed the collapse of the Council for Mutual Economic Assistance (CMEA), which regulated trade within Eastern Europe during the communist period. The CMEA reduced the transactions costs of trading within Eastern Europe, but its operations also reduced the region's trade with the rest of the world and led to flawed industrialization and misdirected capital accumulation. Following the CMEA's collapse and the concomitant decline in the region's intra-trade, Brada argued that there should be no effort institutional or otherwise to promote intraregional trade, which had been uneconomic from the outset. Countries in this region should concentrate instead on moving to trade based on world prices in the world market. Sectoral issues, such as agriculture, textiles, and steel, pose a barrier to the rapid integration of East European trade with the European Community.

Gábor Obláth (Kopint Datorg Institute for Economic and Market Research and Informatics, Budapest) agreed that Eastern Europe should take steps to integrate with the world economy and not try to continue the overtrading that previously took place in the region; regional efforts such as clearing arrangements would be unnecessary, undesirable and infeasible. Alan Gelb (World Bank) argued, however, that new and better institutions to regulate Eastern Europe's trade need not perpetuate bad trade patterns; and such cooperation might ease the short-run, transition costs of moving towards a market economy.

Faezeh Foroutan (World Bank) presented a paper entitled `Regional Integration in Sub-Saharan Africa: Past Experience and Future Prospects', which argued that African countries had not fulfilled the conditions for economic integration to be effective or desirable. Countries tended not to trade with one another relative to the rest of the world; also the gains from any regional integration arrangement would be unevenly distributed and hence difficult to bring to fruition in an equitable, workable, non-distortionary way. Europe was an important market for many African countries, to which many already had free access through the Lomé Convention. Despite past failures, harmonization of government policies and regulations nevertheless held some promise for the future.

Christopher Bliss (Nuffield College, Oxford, and CEPR) agreed that African integration was hampered by administrative difficulties such as the distribution of tariff revenue. Industrial activities should be concentrated by location, but a regional agreement might require them to be fragmented for political reasons. Bliss expressed concern that an African integration programme might perpetuate regional marginality and unimportance unless it focused on and cooperated with the rest of the world. Ishrat Husain (World Bank) argued that illegal trade flows in the forms of smuggling, under-invoicing and capital flight indicate untapped potential for regional integration: Africa should aim to recapture its share in world markets, however, and not focus on regional integration.

Julio Nogués and Rosalinda Quintanilla (World Bank) then presented their paper, `Latin America's Integration and the Multilateral Trading System', in which they noted that the region's past policies based on import substitution had failed, in contrast to the more liberal, outward-oriented policies pursued elsewhere. The greatest gains from trade reform had been achieved by unilateral trade reforms (as in Chile, Argentina and recently Brazil), which vastly exceeded the gains from any possible regional arrangement. Nogués and Quintanilla concluded that a move towards a common market with a low external tariff might be useful, but this must be set in a multilateral context.

Jésus Seade (Mexican Ambassador to the GATT) suggested that the authors focus on positive rather than prescriptive aspects of Latin American integration; several delicate balances must be addressed to meet their recommendations of open entry, liberal rules of origin and limited sectoral exceptions as features of any regional agreement. Christopher Clague (University of Maryland) attributed Latin America's poor growth performance to the lack of an institutional basis for secure property rights and contracts. Countries with the right institutional framework in place can sometimes pursue bad policies and still have good outcomes; trade policy can then play a role in promoting growth by liberalizing to the world market and enhance the credibility of good institutions by committing to reforms and maintaining the expectation of open markets.

John Whalley (University of Western Ontario) discussed the CanadaUS Free Trade Agreement and the forthcoming North American Free Trade Agreement in his paper, `Regional Trade Arrangements in North America: CUSTA and NAFTA'. He noted that the widely anticipated large economic benefits had yet to appear in the actual performance of the Canadian economy. The CUSTA had many `empty' chapters, tariffs on bilateral trade were low already, and several of the sectoral parts of the agreement may have simply rearranged protection and even become more exclusionary to third countries through tighter content rules. CUSTA should therefore be called a trade agreement, not a free trade agreement. The impact of NAFTA on Mexico, even before its conclusion, is much greater: it is already reaping large benefits of increased inflows of foreign investment.

Ulrich Lachler (World Bank) commented that the CUSTA had had little impact because the two countries were quite similar, while Mexico's recent success was due more to unilateral reforms than to US concessions. Fernando Clavijo (Economic Adviser to the President of Mexico) also stressed the contrast between the limited effects of the CUSTA and the greater benefits reaped from the NAFTA. T N Srinivasan argued that economic models cannot assess the value of `safeguard agreements', since the counterfactual is never observed.

Stanley Fischer (MIT) spoke about his paper, `Prospects for Integration in the Middle East'. Most countries in this region have traditionally pursued import-substitution policies and traded with the rest of the world rather than each other, although intra-regional flows of labour and hence of migrants' remittances have been large. Sharp political conflicts have blocked major trade reforms, and the prospects for enhanced integration are not good, although cooperation on water policies and other public investments may yield beneficial results. Fischer suggested the formation of a Middle Eastern Bank for Reconstruction and Development, charged with the reconstruction of the region's war-ravaged economies and infrastructural development, to create a framework for regional collaboration.

Enzo Grilli (World Bank) agreed that the tense, fragmented nature of the region limited the prospects for trade integration, which was further complicated by the lack of capital flows in the region owing to lack of security on investments. Richard Baldwin (Institut Universitaire des Hautes Etudes Internationales, Genève, and CEPR) argued that there were no good economic reasons for trade integration in the Middle East, which would distract policy-makers from the right types of reforms, promote trade discrimination, and probably fail.

In his paper, `Trading Blocs, Pacific Trade and the Pricing Strategies of East Asian Firms', Gary Saxonhouse (University of Michigan) developed an econometric model, incorporating elements of the gravity and HeckscherOhlin models, to assess the prospects for East Asian integration. He found that the region's exports were well explained by this factor endowments-based gravity equation and that there was no distortion in favour of intra-regional trade. This finding also held for specific countries, although Japan trades more with the US and less with the European Community than the model predicted. Saxonhouse cautioned that the absence of bias need not indicate an absence of trade barriers.
Vinod Thomas (World Bank) suggested that proposals for regional integration in East Asia were ironic because liberalization there had focused on the world market and had sustained strong growth in past decades. The lack of a trade agreement had not hurt the region in the past, and there was no compelling reason to have one now. Hugh Patrick (Columbia University) noted that Saxonhouse did not address institutions or policies in the region, which may be `underinstitutionalized', having no EC or OECD, although a trade bloc was not needed to conduct trade negotiations. Japan had proposed creating a Pacific Free Trade Area to counter the EC in the 1960s, which the US had opposed: East Asia must now choose whether to join NAFTA or fight it.

Conclusions

The conference concluded with a round table discussion on the policy implications of regional integration. Richard Cooper (Harvard University) suggested that the details and motivation of each individual preferential trade arrangement were all important in determining its effects on the world economy. He expressed extreme scepticism of regional agreements for developing countries, which tend to be motivated by foreign ministries searching for symbols of cooperation. Such agreements may play a useful role in locking in unilateral reforms, however; they need not be `regional' in the geographic sense; and they may also be a means of achieving conditional most-favoured-nation treatment. Cooper noted a tendency to underrate the role of economic ideas in ensuring that protection was no longer respectable and promoting liberalization around the world.

W Max Corden (Johns Hopkins University, Baltimore) emphasized that developing countries even in groups do not have a large market and must therefore orient their trade towards the larger world market. Bilateral free trade agreements certainly improve upon older import-substitution policies, but most such arrangements came far short of achieving free trade. Developing countries above all have a major stake in the multilateral system.

Rudiger Dornbusch (MIT and CEPR) stated that regional integration was needed as an addition to, not a replacement for, multilateralism. The GATT achieved good results in the past and is not dead, but it is resting because the agricultural stumbling-block proved too big in the Uruguay Round. Discriminatory integration can achieve large welfare gains even if it entails small welfare loss triangles; while regional agreements can increase the pace of developing countries' liberalization, weaken anti-trade interests, and induce a dynamic momentum for freer trade. Regionalism may also play a major role in dealing with the new trade issues of the environment and labour standards, which require a degree of specificity that the GATT cannot handle efficiently.


The papers presented at this conference will be published early next year, in a volume to be edited by Jaime de Melo and Arvind Panagariya.