Sunday, December 11, 2005

On bilateral or regional free trade areas

Dean Jorge Bocobo has a couple of posts lamenting the USA's reluctance to pursue a free trade area with the Philippines. Now unless you are a rabid protectionist, there seems to be little that is objectionable about bilateral or regional free trade. After all reduces import costs by dropping barriers; moreover export access is widened.

Economists are less than enthusiastic. Reason? The arguments against "customs unions" made by Jacob Viner and others. By selectively dropping import barriers, a county may end up diverting imports to relatively high cost countries that happen to participate in the free trade area. As usual the Concise Encyclopaedia of Economics has a brief and informative treatment of the subject. The example given there is as follows:
Suppose, for example, that Japan sells bicycles for $50, Mexico sells them for $60, and both face a $20 U.S. tariff. If tariffs are eliminated on Mexican goods, U.S. consumers will shift their purchases from Japanese to Mexican bicycles. The result is that Americans will purchase from a higher-cost source, and the U.S. government receives no tariff revenue. Consumers save $10 per bicycle, but the government loses $20. If a country enters such a "trade-diverting" customs union, economists have shown that the cost of this trade diversion may exceed the benefits of increased trade with the other members of the customs union. The net result is that the customs union could make the country worse off.

Whether a bilateral or regional free trade area would end up improving a country's welfare is an empirical issue. I would endorse such agreements, but only as launching pad for multilateral approaches. Domestic political opposition may after all be softened by initial exposure to limited amounts of free trade. However it can go either way - as the example of the EU shows, resistance to dropping barriers outside the customs union may stiffen as a result of regionalized free trade. In the case of the Philippines though, I sense the ASEAN is functioning more as a stepping stone than a stumbling block. Agree or disagree? Discuss.


cvj said...

I first read of the scenario of a world where regional trading blocks with internal free trade zones and trade barriers to the outside a decade back in one of Peter Drucker's books.

Ideally, we would like to be in a world where the ideals of the WTO are realized but failing this, it may be better to join one of the trading clubs than to be totally left out. ASEAN seems a logical first choice. The South Asian nations such as India sound promising as well.

Econblogger said...


I take it then you agree with me that ASEAN is a stepping stone. Certainly regionalism prior to global free trade is one possible path; my fear is that the world will be stuck with regionalism.

cvj said...

That's a legitimate fear.

Amadeo said...

Right, why can't the country be actively involved in both regional and international groups?

Isn't the EU one big example of such?

Econblogger said...

Right amadeo. The EU as a whole is engaging with the WTO. In doing so it is driving a very hard bargain in favor of the status quo, particularly on farm subsidies and agricultural tariffs. The opposition by virtually one country (France, on subsidies) can hold an entire customs union hostage, it seems. Go figure.