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MEB 2009 – 7  International Conference on Management, Enterprise and Benchmarking 
June 5‐6, 2009   Œ   Budapest, Hungary 

Regional Trade Agreements and the WTO

Ildikó Virág-Neumann
Ph.D student, university lecturer
Department of Applied Economics, University of Pannonia,
Egyetem u. 10, H-8200 Veszprém, Hungary, [email protected]

Abstract: While trade is growing fast, the multilateral trading system faces a number of
internal difficulties linked to the size of its membership and the diversity of economic
situations, trade interests, and previous commitments. But the multilateral trading system is
also challenged by the outside rapid development of regional and bilateral free trade
agreements. This raises serious challenges for the multilateral trading system. There has
been a rapid growth in the number of regional trade agreements (RTAs) in recent years. It
has raised the question as to whether RTAs pose a threat to the multilateral trading system.
The trend in the growth of RTAs should express strong concerns about the negative effects
of growing regionalism. We should tend to regard regionalism much more as a complement
to multilateralism.

Keywords:regionalism, multilateralism , RTAs, multilateral trade negotiations, WTO

1 Introduction
International economic order is rapidly changing. Until the early 1990s,
multilateralism was dominant and regional remained marginal. Today, however,
regionalism is well acknowledged as one of the two pillars of international
economic order, together with multilateralism. It will be thus important to explore
the harmony between regionalism and multilateralism .The question is whether
regionalism may be a faster way to reach multilateralism or, rather, hurt
multilateral liberalization. Are regional integration arrangements “building blocks,
or stumbling blocks,” in Jagdish Bhagwati’s phrase [17], or stepping stones
toward multilateralism? Since the end of the Uruguay Round, the world trading
system has experienced the emergence of a large group of regional blocs. Ranging
from the NAFTA and the Mercosur to the APEC and the enlargements of the EU,
regional blocs seem to become factors that have to be taken seriously in the future
trading system.

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2 Regional Trade Agreements in the World

One of the most striking development in the world trading system since the mid
1990s is a surge in Regional Trade Agreements (RTAs). “Regional Trade
Agreements (RTAs) are a major and perhaps irreversible feature of the
multilateral trading system” is the opening sentence of a Working Paper of
Crawford and Fiorentino (2006) [11]. Initially WTO encouraged the growth of
RTAs because it believed that regional integration initiatives can complement the
multilateral trade regime. However, the high proliferation of RTAs in global trade
and increased diversion of trade through this route is increasingly becoming a
cause for concern for the multilateral trading system under WTO.

Source: Crawford, J-A.-Fiorentino, R. V. [11]

Figure 1
RTAs notified to the GATT/WTO (1948-2006), currently in force, by year of entry into force

2.1 The Nature of RTAs

Many countries which traditionally relied on the multilateral trade regime are
increasingly joining regional agreements to promote trade.
Regional Trade Agreements (RTAs) are defined as groupings of countries which
are formed with the objective of reducing barriers to trade between member
countries. Contrary to what the name suggests, these groupings or unions may be
concluded between countries not necessarily belonging to the same geographical
region. Depending upon their level of integration, RTAs can be broadly divided

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into five categories: Preferential Trade Agreements (PTAs), Free Trade

Agreements (FTAs), Customs Unions (CUs), Common Markets and Economic
Unions.

Source: Crawford, J-A.–Fiorentino , R. V. [11]

Figure 2
Notified RTAs in force, as of December 2006, by type of agreement

Figure 3
RTAs' configuration, as of December 2006 Source [11]

The main reason for WTO member’s preference of bilateral FTAs1 before
multilateral FTAs or CUs is probably the mere fact that bilateral FTAs are easier
to conclude than multilateral FTAs and certainly a lot easier than a CU. Apart

1
A PTA is a union in which member countries impose lower trade barriers on goods
produced within the union, with some flexibility for each member country on the
extent of the reduction. A Free Trade Area (FTA) is a special case of PTA where
member countries completely abolish trade barriers (both tariff barriers and non-tariff
barriers) for goods within the member countries. It should be clarified here that in
most cases, countries do not abolish trade barriers completely even within Free Trade
Areas. Most agreements tend to exclude sensitive sectors. A Customs Union (CU)
provides deeper integration that an FTA because, unlike FTAs where member
countries are free to maintain their individual level of tariff barriers for goods
imported from non-member countries, in a CU, member countries also apply a
common external tariff on a good imported from outside countries.

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from this there are two types of regional agreements which provide “deep
integration”. 2 Among the Regional Trade Agreements, a large majority of the
agreements are PTAs or FTAs. In contrast, there are only a handful of Customs
Unions, Common Markets and Economic Unions worldwide. The new generation
of RTAs, especially those comprising developed countries, includes more regional
rules on investment, competition and standards; as well as provisions on
environment and labour. Most of these new agreements also include preferential
regulatory frameworks for mutual services trade.

3 Why are Countries Going for Regional Trade

Agreements?
These explanations can be divided into three broad categories. First is the
traditional explanation of welfare effects through trade liberalization and the
consequent gains from trade at a regional level. Viner, [14] introduced the
concepts of “trade creation’ and “trade diversion” and showed that the net effect
of trade liberalization on a regional basis is not unambiguously positive. He
pointed out that RTAs can lead to trade creation if RTA members switch from
inefficient domestic producers and import more from efficient producers from
other members of the RTA. In this case, efficiency gains arise from both
production efficiency and consumption efficiency. Trade creation and trade
diversion have opposite welfare implications and the net effect will depend upon
which of these two effects dominate. Krugman (1991) [11]is of the opinion that
the beneficial effect of a regional trade agreement will depend on whether there is
enough “inherent regionalism” in the transport costs between the member
countries of the RTA.
According to Bhagwati,[17] trade diversion is more likely to dominate trade
creation in most situations. When trade is multilateral, i.e. when countries import
from and export to union members as well as outside countries, trade diversion is
inevitable.
There is an emerging consensus among economists that frustration with the
multilateral trading system is one of the prime reasons behind the current growth
of regionalism. Krugman suggests that countries find regionalism an easier
alternative because large number of participants in multilateral trade negotiations

2
The first is called Common Markets, where member countries attempt to harmonize
some institutional arrangements and commercial and financial laws and regulations
among themselves. A common market also entails free movements of factors of
production, i.e. removal of controls on free movement of labour and capital. The final
‘deep integration’ level is the ‘Economic Union’ where countries implement common
economic policies and regulations and adopt a single currency.

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reduces the cost of non-cooperation and creates rigidity in the system. Also
according to him, modern trade barriers are much more complicated to negotiate
in a multilateral forum and most countries find it easier to deal with these issues
on bilateral or regional level. Baldwin [14] in his “domino theory of regionalism”
describes similar motivation for joining regional groupings. He believes that
regionalism did not occur because countries have lost faith in GATT or because
USA has adopted regionalism. There is another big debate in the current
international trade literature about whether regionalism can help or hinder the
multilateral trading system. There are opposing views among economists about
the role of regionalism in the current global trade system. Krugman is of the
opinion that regional trade blocs are welfare improving in nature and are unlikely
to have any negative impact on the multilateral trade system. Baldwin [14] does
not see regionalism as a threat to the multilateral trading system. According to
him, because trade is “already quite free in major trading nations, few regional
liberalizations are capable of creating anti-liberalization forces”. Therefore, he
concludes that most regional trade agreements will weaken the opponents of trade
liberalization and hence will promote and foster multilateral trade liberalization.
But the dominant view among mainstream economists suggests that regionalism is
harmful for the multilateral trading system. For example Bhagwati and Krueger
[18] think that preferential trade agreements are essentially discriminatory in
nature and they view the drift towards PTAs as a serious threat to the multilateral
trading system. Increased regionalism is dangerous because it not only leads to
inter block trade wars and domination of small countries by bigger partners in the
regional blocks but also because it reduces the enthusiasm for participation in the
multilateral trade regime. They worry that RTAs divert attention from the
multilateral trading system. They argue that most preferential agreements lead to
trade discrimination and thereby harm the multilateral trading system. Bhagwati
also argues that the growing number of PTAs may lead to a complex system of
regulatory structures. This phenomenon, known also as the “spaghetti-bowl”
problem, may lead to complexity and lack of transparency in the global trading
system.

4 WTO and RTAs

As well known, the WTO was set up to liberalize international trade on the
principle of non-discrimination and to eliminate trade barriers through multilateral
negotiations. It has contributed to expanding world trade and is expected to do
more if the current DDA multilateral negotiations are completed ever. Some 421
RTAs have been notified to the GATT/WTO up to December 2008. If we take
into account RTAs which are in force but have not been notified, those signed but
not yet in force, those currently being negotiated, and those in the proposal stage,

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we arrive at a figure far more than 400 RTAs. They are scheduled to be
implemented by 2010. Of these RTAs free trade agreements and partial scope
agreements account for over 90% of the turnover while CUs account for less than
10%.
Regional trade agreements represent an important exception to the WTO's
principle of nondiscrimination. According to the WTO rules, countries within a
RTA can trade among themselves using preferential tariffs and easier market
access conditions than what is applicable to other WTO member countries. As a
result, WTO member countries that are not a part of the RTA lose out in these
markets. As increasing amount of global trade is being diverted through this route,
there is a certain amount apprehension about the role of regional trade agreements
in WTO.In general Article I (GATT,1947) forbids any preferential trading
arrangements (the „Most Favoured Nation” principle). An exception to this is that
Regional Trade Agreements are permitted, so long as they take the form of
customs unions or free trade areas satisfying the conditions of Article XXIV,
essentially that „substantially all trade” is fully liberalised, and that there is no
overall increase in external protection.

Source: Crawford, J-A.-Fiorentino, [11]

Figure 4
RTAs notified to the GATT (pre 1995) and WTO (post 1995)

„Article XXIV being an exception to the MFN principle allows discrimination

instead of combating it. The formation of an FTA or CU is regulated under Article
XXIV GATT 1994, which provides for more beneficial treatment between
members to a RTA than that afforded by the schedule of concessions negotiated
under the WTO Article XXIV, consequently, provides for an exception from the
MFN-Principle.” [21] The MFN exception stated in Article XXIV may at first
sight seem illogical, since the only way to be excused from applying non MFN
consistent and discriminatory trade preferences is to completely discriminate,
(MFN denies all discriminatory preferences meanwhile the MFN exception in

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Article XXIV allows discriminatory preferences if they are completely

discriminatory against the non RTA members).Other exception are General
Agreement on Trade in Services (GATS)Article V, The Enabling Clause3 and the
Generalized System of Preferences (GSP).

5 Regionalism or Multilateralism
There is an increased attention being paid to regional arrangements. The threat to
the multilateral trading system does not appear to be as large as is often reported.
The debate about whether RTAs are” building blocks or stumbling blocks” for
global freer trade, which was so virulent in the 1990s, faded because, whatever the
answer to the question, in practice RTAs have made so little difference either way.
The impact on the global trading regime of the hundreds of RTAs notified to the
GATT/WTO as being in contravention of the MFN principle has been trivial
compared to the establishment of multilateral trade law based on the
nondiscrimination principle. The dissemination of regionalism can contract and
distort non-discriminatory multilateralism .Countries are too diverse in their
developments. Negotiations under the framework of WTO take too much time as
well. Regionalism is then an alternative to consider, at least, for countries
geographically close to each other, especially for countries with close economic
exchanges and interests.

6 Has the WTO Promoted Successful RTAs?

Rose (2004) [4] found that the WTO does not promote trade across a variety of
gravity models. He published a” puzzling result.” After an extensive empirical
search, Rose found no difference in trade patterns between GATT/WTO members
and non-members.
Grant and Parmeter [9] are of the opinion that the WTO has not been as
effective as one might have expected, given the recent proliferation of RTAs in the
last decade. The GATT/WTO has not promoted successful RTAs.
In section one (Generic RTA Effects) they estimated the effects of RTAs.
In section two (GATT/WTO Membership) they tested the effectiveness of the
WTO allowing for separate RTA effects with respect to: both countries are
GATT/WTO members (both-in);

3
Differential and More Favourable Treatment, Reciprocity and Fuller Participation of
Developing Countries

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one trading partner is a GATT/WTO member (one-in); and neither country is a

GATT/WTO member (none-in).
In section three (Notified and Non-Notified RTAs), they allowed for separate
effects of notified and non-notified regional trade agreements, the latter of which
represents RTAs that have never been notified to the WTO and therefore is not
subject to the provisions of Article XXIV.
In the final section (GATT/WTO Membership & RTA Notification Status) they
combined GATT/WTO membership with notified and non-notified RTAs.
RTAs involving country pairs that are not party to the GATT/WTO (none-in) have
been remarkably successful compared to RTAs that include one or both countries
in the GATT/WTO. Two non-GATT/WTO members traded 183 percent more
with each other in an RTA compared to just 86 percent when both RTA members
were party to the GATT/WTO (both-in).
Non-notified RTAs that include at least one GATT/WTO member traded 141
percent more with each other compared to just 80 percent more trade under
notified RTAs that include at least one GATT/WTO member.
Two non-GATT/WTO members of a non-notified RTA traded 216 more with
each other compared to 166 percent between two non-GATT/WTO members in a
notified RTA.
Herz and Wagner [10] found in their analysis a significant positive effect of
WTO membership on bilateral trade: membership in regional trade agreements or
currency unions substantially increase bilateral trade flows as well. By contrast,
they found that the Generalized System of Preferences does not foster trade in
general, rather the opposite. This might be due to the opportunistic behavior of
industrial countries that grant GSP schemes as long as the concerned products are
relatively unimportant, but restrict them as soon as they become relevant.
Recently many studies have used gravity equations4 in order to estimate the effect
of RTAs on trade flows between partners. These studies report very different
estimates, since they differ greatly in data sets, sample sizes, and independent
variables used in the analysis.
Conclusion
The completion of the Uruguay Round of Multilateral Trade Negotiations
coincided with the development of a worldwide trend towards increased
regionalism, as witnessed by the conclusion of NAFTA, the emerging process of
regional integration in Latin America and the launching of APEC. While this new

4
The gravity model is adapted from Newton’s Law of Gravity, and in essence states
that the attraction of goods between countries depends positively on their economic
masses, and negatively on the distance between them.

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trend has caused some observers to evoke the prospect of a world economy
increasingly divided among rival “trade blocs”, recent studies suggest that
regional trade agreements may complement rather than threaten the multilateral
trade system. At a theoretical level, economists are divided over the desirability of
regional trade agreement in a multilateral trade regime. There is still no consensus
about this issue. However, regionalism, with its advantages and drawbacks, is a
reality of the current global trade regime. [12] The wave of regionalism is likely to
intensify in near future. If a very high proportion of global trade gets diverted
through the regional route, WTO is bound to loose some of its relevance in the
global trading system.
However, in the current state of distorted multilateralism, regionalism has turned
out to be one of the more viable alternatives for developing countries to expand
their market access. In this context, South-South RTAs are particularly useful as
they allow developing countries to expand their market. Also, it is always possible
that if the world is divided in a few mega trade blocks, then the weakest countries
will be marginalized.
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