Mega-regionals and the mega-mess: A way out

Jayant Menon

With the rise of mega-regional trade agreements, the world trade system resembles a jigsaw puzzle. This column discusses the difficulties involved in consolidating free trade agreements at the regional level, and argues that piecing together the blocs around the world will be even more challenging. A potential way forward is to return to the most widely used modality of trade liberalisation – unilateral actions – but this time involving the multilateralisation of preferences rather than unreciprocated reductions in tariff rates.

Jagdish Bhagwati (1991) famously described the maze of overlapping free trade agreements (FTAs) as akin to a ‘spaghetti bowl’. Several decades later, with the rise of mega-regionals like the Regional Comprehensive Economic Partnership and the Trans-Pacific Partnership (TPP), the fragmentation of the world trade system more closely resembles a jigsaw puzzle. How do we solve this mess? One approach being pursued is to consolidate bilateral FTAs into regional blocs, and then to try and link the blocs up globally – or at least hope that they will eventually. Consolidation at the regional level is akin to solving a regional jigsaw puzzle, while getting to global multilateral trade can be seen as solving a global jigsaw puzzle by linking up the pieces that result from solving the regional puzzles. That is, both regional and global jigsaw puzzles will need to be solved, and in that order, if this route is to eventually lead to global free trade. What is the likelihood that such an approach could work?

The regional jigsaw puzzle

The Regional Comprehensive Economic Partnership is a useful example to consider in terms of solving the regional puzzle. Like any jigsaw puzzle, we begin with disarray. But the puzzle is more than just messy – there is no solution because the pieces do not fit. The pieces – the ASEAN+1 and bilateral FTAs – come in different shapes and sizes. Indeed, they can vary depending on the number of items that are up for negotiated liberalisation, and usually just about everything is, including rules of origin. There are at least 22 different types of rules of origin that operate amongst the ASEAN+1 FTAs (Medalla 2011). The sheer number of rules of origin raises obvious difficulties in harmonising and consolidating them.

But consolidate them they must, if the Regional Comprehensive Economic Partnership is to eventuate. The questions are: How, and in what form? The Regional Comprehensive Economic Partnership aims for harmonisation, yet seeks to retain flexibility – a combination likely to produce one of two outcomes: Because harmonisation implies consensus, it could result in a ‘race to the bottom’, in which the lowest common denominator rules. Alternatively, countries taking advantage of flexibility could result in a conservative approach that preserves the current ‘noodle bowl’. These outcomes are more likely than the hoped-for ‘race to the top’ scenario, unless incentives are provided to overcome pressure from the vested interests that lobbied for different rules of origin to begin with. The very existence of so many rules of origin and exemptions confirms the power of such lobbies. The problem is that some countries may not see any carrot — and there is no stick. Unless there is enough political will to close potential loopholes disguised as ‘flexibility’ and pursue reforms deeper than those ever before attempted, the Regional Comprehensive Economic Partnership’s future as a consolidated bloc remains uncertain.

The global jigsaw puzzle

Despite the difficulties, let us assume that the Regional Comprehensive Economic Partnership succeeds in coming up with a consolidated agreement that supersedes its constituent components – that the regional jigsaw puzzled is solved! Let us also assume that the TPP is concluded as intended, along with all the other mega-blocs around the world. If this is the best-case scenario, what does success look like? Not good, unfortunately – it has merely replaced the mess at the regional level with one at the global level.

To resolve this mess, how should the process of global consolidation of the regional blocs occur? Should it proceed sequentially, or should there be a single undertaking where the different blocs come together to negotiate a comprehensive deal? A sequential bloc-by-bloc or bottom-up approach, building on open-accession clauses of existing agreements, faces the same difficulties as solving the regional puzzles, but amplified by greater diversity. Presumably there would have to be a dominant bloc that sets the standard towards which other blocs would have to converge. If not, it will only reduce the number of fragments, or pieces in the global jigsaw puzzle, without providing a solution. Not only are there likely to be several blocs that aspire to dominate the rule-setting game, but it is also unclear whether the other blocs will be willing to accept a process driven by conformance rather than consensus or negotiated compromise. Furthermore, if the route taken towards liberalising services is through mutual recognition arrangements – as in ASEAN – rather than harmonisation through convergence towards a regional standard, then the merging of different blocs is made even more difficult.

Doha has demonstrated that the single undertaking approach is probably impractical when the agenda is a serious and wide-ranging one, and substituting groupings of countries for individual ones is unlikely to make a significant difference. Although the Regional Comprehensive Economic Partnership highlighted the diversity that can exist between FTAs within a regional bloc, the diversity between regional blocs is likely to be higher still. Moreover, somebody would need to coordinate the process, and it is unlikely that the WTO would want to go down this route again. For these reasons, cross-regional link-ups of mega-blocs have no precedent. Needless to say, multiple tie-ups of the mega-blocs, approximating global multilateral free trade, has never been attempted.

The way forward

It is clear that the current trade mess is unlikely to be resolved by trying to tie together the various regional blocs. Indeed, the foundation of this approach – regional consolidation – is itself facing difficulties. Luckily, there is an alternative which is not only easy to implement, but can address the disarray in the world trade system. The solution lies with multilateralising preferences.

Multilateralisation deserves more serious consideration now than ever before because of the proliferation of FTAs that has led to the current state of the world trade system. In Asia, for instance, we find that more than three-quarters of imports of most of the Regional Comprehensive Economic Partnership countries are already covered or about to be covered by an FTA (see Menon 2014a). Therefore, there is little point in holding out to negotiate reciprocity with a small residual set of countries. The benefits of multilateralisation greatly outweigh those of reciprocity when preference utilisation is low, as it is in Asia (Menon 2014b). When so much of a country’s trade is covered by FTAs, preference erosion sets in, reducing the resistance from FTA partners towards multilateralisation of preferences. In other words, the proliferation of FTAs is eroding preferences between FTA partners such that the perceived loss of benefit (to FTA partners) of multilateralising preferences (to non-FTA partners) is diminishing – especially when compared to the rising cost of maintaining multiple FTAs and implementing their rules of origin. Multilateralisation not only removes these costs, but it also removes the potential for trade diversion.

Globally, only 15% of trade flows are conducted under preferential terms (WTO 2011), while the costs of trying to implement largely unused preferential arrangements continue to increase. In this context, the multilateralisation option should no longer be dismissed as ‘pie in the sky’. After all, this kind of unilateral action had accounted for more than two-thirds of all trade liberalisation by developing countries in the two decades leading up to 2003 (World Bank 2005). In this way, the rise in regionalism may eventually be the most compelling factor in contributing to its own demise by revitalising multilateralisation, if not the multilateral system.

While the application of the multilateralisation approach is relatively straightforward when it comes to tariffs, it is also an approach naturally suited to non-tariff barriers and difficult sectors such as services. The removal of many non-tariff barriers has public good characteristics – once the barriers are removed, then it is difficult, if not impossible, to avoid free-riding. In other words, unlike tariffs, it is either costly – often prohibitively so – or impractical to remove non-tariff barriers in an exclusive or preferential manner. Similarly, if services liberalisation is pursued through harmonisation of standards rather than mutual recognition arrangements, non-members can easily accede. In either case, the possibility of multilateralising harmonised rules and regulations or mutually recognised requirements is present, although it is more easily done with the former than with the latter.

Conclusion

The rise of mega-regionals, such as the Regional Comprehensive Economic Partnership, the Trans-Pacific Partnership, and the Transatlantic Trade and Investment Partnership, suggests that the world trade system is becoming more like a jigsaw puzzle than a spaghetti bowl. There are both regional and global jigsaw puzzles to be solved, and in that order, to fix the mega-mess. But both the regional and global puzzles may remain unsolved given the difficulties involved. The problems with FTA consolidation at the regional level have been widely documented, while piecing together the blocs around the world to form a coherent whole is even more challenging, and has never been attempted. In this context, a way forward is to return to the most widely used modality of trade liberalisation – unilateral action – but this time involving the multilateralisation of preferences rather than unreciprocated reductions in tariff rates. Its application to tariffs is straightforward, but it is also naturally suited to non-tariff barriers and difficult sectors such as services. The removal of many non-tariff barriers has public good characteristics that make it either costly or impractical to be discriminatory or exclusive. If harmonisation is achieved through regulatory convergence, for instance, rather than through mutual recognition arrangements, it will facilitate multilateralisation because it will be easier for non-members to accede. Therefore, multilateralisation of preferences – whether tariff or non-tariff – appears to present a practical way forward in addressing the disarray in the world trade system.

References

Baldwin, Richard (2004), “The Spoke Trap: hub and spoke bilateralism in East Asia”, Working Paper 04-02, Korea Institute of Economic Policy, Seoul.

Bhagwati, Jagdish (1991), The World Trading System at Risk, Princeton, NJ: Princeton University Press.

Bhagwati, Jagdish (2008), Termites in the Trading System, New York: Oxford University Press.

Medalla, Erlinda (2011), “Taking Stock of the ROOs in the ASEAN + 1 FTAs: Toward Deepening East Asian Integration”, Discussion Paper Series 2011-36, Philippine Institute for Development Studies, Manila.

Menon, Jayant (2013), “The challenge facing Asia’s Regional Comprehensive Economic Partnership”, East Asia Forum, 23 June.

Menon, Jayant (2014a), “A Way out of Preferential Deals”, Presentation to the OECD Global Forum on Trade 2014, 11–12 February, Paris: OECD.

Menon, Jayant (2014b), “Multilateralization of Preferences versus Reciprocity when FTAs are Underutilized”, The World Economy, forthcoming.

World Bank (2005), Global Economic Prospects 2005: Trade, Regionalism, and Development, Washington, DC: World Bank.

World Trade Organization (WTO) (2011), World Trade Report 2011, Geneva: WTO.