The strong effects of regional trade agreements on commerce between members show that economic integration works, writes Per Altenberg. Negotiating RTAs that liberalise trade is an effective strategy for countries that seek economic improvement through trade, he argues.
What are the trade effects of regional trade agreements? As Brexit approaches and both the EU and the US face the ratification of important trade deals, this has become an increasingly important question.
To answer it, Sweden’s National Board of Trade has published a review of the most recent research on the trade effects of RTAs. In our report, the focus is on effects that have already occurred rather than model simulations made before an agreement comes into effect. Interestingly, real-world RTA effects on trade turn out to be stronger than effects predicted by models.
Customs unions produce greater trade effects than FTAs
On average, RTAs double merchandise trade between members after a phase-in period of 10 years. In all surveyed studies, the average trade increase of RTAs after 10 years was in the range of 50% to 170% percent. Eight of 12 surveyed studies reported average trade increases 80% to 125%.
The trade effect of RTAs increases with depth and enforceability. The range of estimated trade effects was 30% to 100% for free trade agreements and 100% to 250% for customs unions and more ambitious forms of economic integration. The trade effects of customs unions, common markets and economic unions are thus at least twice as strong as those of FTAs.
A potential explanation for the strong effect of customs unions compared with FTAs is that trade within a customs union is simpler and requires less red tape. For instance, rules of origin are not required for a customs union.
The results indicate that RTAs that are reciprocal and deep (FTAs or CUs) are considerably more effective in achieving increased trade, than those that are non-reciprocal and limited in depth. They also indicate that a customs union is an attractive option for countries that seek closer economic integration.
While research has advanced in recent years, it is still not possible to determine exactly how much different RTA provisions stimulate trade.
It is clear, however, that tariff elimination only explains part of the effect. Surveyed studies indicate that the elimination of applied tariffs account for 20% to 40% of the total effect on trade in goods. In addition, the reduction of non-tariff barriers as well as trade policy uncertainty caused by tariff bindings stimulate trade. Conversely, increased uncertainty due to the violation of tariff commitments would thus likely hurt trade.
EU has more than doubled goods trade among members
Estimates of trade effects for individual RTAs fluctuate more in terms of economic magnitude and statistical significance than RTA effects measured at the aggregate level or by RTA category.
The estimated trade effect of EU membership is in the range of 100% to 130%, allowing for a phase-in period of 10 years. In other words, the EU has more than doubled trade in goods between members, whether through the original treaty or through different rounds of deepening or enlargement.
The results for the EU are more consistent in terms of statistical significance and economic magnitude than for any other individual accord. For (old) NAFTA, the trade-increasing effect appears to have been strong, at 80% to 90%. Accession to a larger trade bloc moreover boosts trade substantially for the country seeking accession.
Trade creation vs. trade diversion
The discussion of trade creation vs. trade diversion is fundamental to all trade policy considerations related to RTAs. Our survey suggests that the fear that RTAs divert as much trade as they create is unfounded. In several studies that report strong trade-creation effects of RTAs, the trade-diversion effect is statistically and/or economically non-significant.
Deep RTAs generate less trade diversion than shallow pacts, probably because deep integration provisions tend to be less discriminatory. In contrast, the EU is associated with so called open-block effects, probably because many EU reforms benefit both members and non-members.
Services commitments in RTAs ‘cut water’
The estimated impact of RTAs on trade in services is less than half their impact on trade in goods. The reason is probably that commitments for services rarely remove applied barriers to trade in services. Instead, service commitments ‘cut water’, which reduces trade policy uncertainty. Reforms that reduce trade policy uncertainty thus also have a positive impact on trade even if no actual liberalisation takes place.
The results indicate that there is substantial room for improvement in RTA service commitments. Furthermore, if trading partners seek depth in a trade deal, a factor associated with strong effects for trade in goods, ambitious services commitments are important.
Economic disintegration weighs on trade
The trade effect of economic disintegration is the flipside of the effect of economic integration. Reversing deep integration, as in the case of Brexit, means reversing trade agreements that stimulate trade. While counter-factual scenarios are less reliable than empirical estimations, our survey indicates reduced trade as a result of economic disintegration.
In one important aspect, however, economic disintegration is not the flipside of economic integration. While analysis of RTAs typically weighs the gains of additional trade against the costs of structural adjustment, economic disintegration implies both reduced gains from trade and new structural adjustment costs.
The strong overall RTA effects on trade between members indicate that economic integration works. Negotiating RTAs that liberalise trade is an effective strategy for countries that seek economic improvement through trade. Most importantly, it is when countries make commitments – not when they avoid them – that RTAs help them increase trade.
Our most surprising findings were the magnitude of the overall effects compared to model estimations, the absence of substantial trade-diversion effects and a large difference between the effects of customs unions and free trade agreements.
Per Altenberg (@peraltenberg) is a senior adviser at the National Board of Trade in Sweden.
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