REGIONALISM VERSUS MULTILATERALISM: WILL PREFERENTIAL AGREEMENTS UNDERMINE THE GLOBAL TRADING SYSTEM

Will the spread of regionalism - groupings like the EU, NAFTA, ASEAN and Mercosur - undermine the progress of multilateralism in establishing a global system of free trade? Or does recent success with multilateralism, the Uruguay Round and the new World Trade Organisation (WTO) actually encourage the spread of regionalism? These are the key issues tackled in the Controversy section of the latest Economic Journal, edited by Professor Sajal Lahiri and featuring contributions from several distinguished economists, including Professor Jagdish Bhagwati, former Chief Economist at GATT.

Regionalism can broadly be defined as a tendency towards some form of preferential trading arrangements between a number of countries usually belonging to a particular region. The word ‘preferential’ is the key word, implying that countries not belonging to a particular regional arrangement are discriminated against.

The controversy over the desirability of regionalism is not a new one. The discriminatory aspect of regional agreements led Jacob Viner to question, in his famous 1950 book The Customs Union Issue, the then conventional wisdom that such agreements are necessarily welfare-improving by drawing attention to the possibility of significant ‘trade diversion’. Subsequent formation of Europe’s Common Market gave fresh impetus to the controversy in the 1950s and 1960s when many attempts were made at different parts of the world to form regional trading blocs. Most of these agreements, with the notable exception of the Common Market, did not really get off the ground - they are sometimes called the ‘old’ or ‘first’ regionalism.

The controversy remained latent for nearly two decades and came back with a vengeance in recent years with the advent of ‘new’ or ‘second’ regionalism. In this second phase of regionalism, preferential trading agreements are being formed at unprecedented speed with the explicit blessings of influential political forces, such as the US administration. Some estimates suggest that currently there are nearly one hundred regional arrangements.

The old issues such as trade diversion have not been forgotten in the debate on new regionalism, although influential economists such as US Deputy Treasury Secretary Professor Larry Summers have tried to ‘laugh off’ those issues. For example, recent research by economists at the World Bank has found evidence of significant trade diversion in the case of the Mercosur in Latin America. And Professors Bhagwati, David Greenaway and Arvind Panagariya in their contribution to the Controversy make a powerful case that trade diversion should be taken very seriously in assessing the welfare effects of preferential trading agreements.

Nevertheless, the old and new regionalisms have many important differences and these differences may explain why new regionalism could prove to be more successful than the old one. In his contribution to the Controversy, Professor Wilfred Ethier points to many of the fundamental differences. For example, at the time of the old regionalism, the multilateral trading system was at its infancy. In contrast, today the WTO has wide-ranging powers with an explicit goal of multilateral free trade not only in commodities but also in services and capital.

While it is true that the current decade has seen a proliferation of regional agreements, in some sense the reverse has happened in some regions. For example, the demise of the Soviet Union also saw the end of the East European economic bloc - Comecon. Casual empiricism suggests that trade between many of the former members of Comecon has more or less collapsed. Presumably, they were trading ‘too much’ (compared to the ‘ideal’ situation) between themselves before the break up, and now it seems that they are trading ‘too little’. Is this significant diversion of trade in favour of the EU a strategic move on the part of the East and Central European countries to influence future EU decisions on new membership?

Another example is South Asia. In spite of the formation of the South Asian Association for Regional Cooperation in the mid-1980s, intra-regional trade between the member countries remains negligible even in absolute terms. Trade between India and Pakistan is restricted by numerous quantitative and administrative measures - what might be called inverse regionalism. The political processes in the two countries have a lot do with this inverse regionalism. Clearly such restrictions to trade can be reduced by regional agreements without necessarily imposing trade restrictions against countries outside South Asia. Such reversals of inverse regionalism could only reinforce the multilateral trading system.

Note: ‘Regionalism versus Multilateralism’, a Controversy edited by Sajal Lahiri is published in the July 1998 issue of the Economic Journal. Lahiri is Professor of Economics, University of Essex, Colchester CO4 3SQ.

For Further information: contact RES Media Consultant Romesh Vaitilingam on 0117-983-9770 or mobile 0468-661095 (email: romesh@compuserve.com ); or Sajal Lahiri on 01206-872733 (fax: 01206-872724; email: lahiri@essex.ac.uk ).