NORTH-SOUTH. Bernard Hoekman

Transcription

1 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page 95 4 NORTH-SOUTH Preferential Trade Agreements Bernard Hoekman This chapter argues that if preferential trade agreements (PTAs) are to be development-friendly, they must focus on complementing liberalization in trade goods with behindthe-border regulatory reforms that are supported through development assistance instruments and that engage the private sector. Such an extension of the PTA agenda to regulatory issues can be beneficial to developing countries. Yet deep and comprehensive PTAs between developed and developing countries bring new risks. The proposed norms may limit policy freedom in inappropriate ways or may result in the allocation of resources to areas that offer few immediate benefits or that are complex and costly to implement. A redesign of the approach to PTAs to liberalize and expand market access, to build in policy flexibility and accountability, and to broaden technical assistance is needed. A basic premise is that a shift in objective from market access or market integration to development means that the modus operandi of negotiating and implementing trade agreements will have to change. One reason is that many of the poorest countries may not benefit much from a traditional trade agreement; they already have good access to major markets through nonreciprocal preference schemes, and they confront potential welfare losses if they pursue preferential liberalization in favor of PTA partners only. Another reason is that the priority needs in many poor developing countries are not related to trade policy but revolve around bolstering trade capacity, improving the investment climate, and maintaining a competitive real exchange rate. PTAs can help address some of these priorities, but only if they are appropriately designed and effectively implemented. The next section provides a brief context for the traderelated reform agenda that confronts developing countries. Some rationales for and challenges facing North-South PTAs are then discussed from a development perspective, and the evolving status quo is described. Suggestions for further steps are presented, proceeding from the assumption that the focus of North-South trade agreements is to promote development. Given that preferential market access liberalization is a second-best exercise from a global welfare perspective, proposals are developed to encourage the pursuit of nondiscriminatory liberalization and a much more targeted focus on the key constraints that prevent developing countries from benefiting more from trade opportunities. Current approaches toward PTAs with developing countries that are being pursued by the European Union (EU) are assessed in light of these proposals. The intention is not to be comprehensive or to single out the EU; a similar analysis could be applied to recent U.S. PTAs. It is, however, true that the EU has been at the forefront in seeking to use PTAs as instruments for promoting development. Finally, the conclusions from the discussion are summarized. Stylized Facts and Key Policy Challenges Until the global economic crisis struck in 2008, the world had witnessed a rapid expansion in developing-country trade. The share of the developing economies in world trade increased from 20 percent in 2000 to 30 percent in 2008 (World Bank 2010b), and all regions experienced greater integration with the rest of the world. There are, however, important differences among developing countries 95

2 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page Bernard Hoekman with respect to both the growth in trade and its pattern and structure. The poorest countries generally did less well than middle-income economies in the 1990s, partly because of the dependence of their foreign exchange earnings on agricultural commodities. This helps explain why Sub-Saharan Africa s share of nonoil world trade remains far below the level that prevailed in the 1970s, despite relatively good growth and trade performance during most of the first decade of the twenty-first century. Research suggests that a lack of diversification is associated with lower growth and greater output volatility. Africa is the least diversified region in the world today. Agricultural trade remains highly important for Sub-Saharan African countries, accounting for 25 percent or more of total exports. One consequence is that countries are subject to greater commodity price (terms-of-trade) volatility than are more diversified economies, and the effect of this volatility is more persistent (World Bank 2010a). Imbs and Wacziarg (2003) note that countries at early stages of development experience a positive relationship between export (output) diversification and growth, suggesting that from a development perspective, the policy focus should be on support for greater diversification (Newfarmer, Shaw, and Walkenhorst 2009; Haddad, Lim, and Saborowski 2010). Existing programs that center on promoting trade of developing countries especially nonreciprocal preferential access to Organisation for Economic Co-operation and Development (OECD) markets have not been very effective. 1 Major reasons for this inefficiency include supplyside weaknesses, civil conflicts, macroeconomic policies that resulted in overvalued currencies, governance problems, corruption, and institutional weaknesses that inhibit local entrepreneurs from taking advantage of market opportunities. The question, then, is to identify what PTAs could do to help achieve progress on such issues. Reform Priorities Because average tariff barriers in developing countries remain higher than in industrial ones, much of the potential welfare gain from trade reforms will arise from their own liberalization. The reasons for imposing trade barriers vary; they include infant-industry protection (importsubstitution industrialization), balance of payments considerations (concerns that liberalization will increase imports more than exports), and fiscal revenue objectives. (Tariffs are easy to collect and can be a significant source of government income.) All these reasons are second-best in most circumstances, in that a lower-cost domestic policy instrument can, in principle, be identified to satisfy the objective at lower social cost, or complementary policies can be identified to address the by-product costs of openness. The persistence of trade policies can be explained by political-economy reasons. Even though the aggregate income and wealth of a nation may be expected to grow when trade distortions are reduced, not everyone will gain. Owners of previously protected inefficient firms will lose, as may their workers, especially if there are doubts regarding the creation of new employment opportunities. Social insurance and adjustment assistance mechanisms may not exist or may be weak. These realities underline the importance of complementary reforms to increase the likelihood of realizing the benefits from trade reforms. The list of beneficial concomitant reforms can be long and rather formidable. This, however, does not necessarily imply that there are difficult trade-offs to be made; most of the policies are essentially additive to trade liberalization in the sense that they do not give rise to trade-offs (Winters 2004). 2 Social costs may be lower if adjustment can be spread over a period of time, as long there is confidence that reform will actually occur. Without credible commitment to a clearly defined and commonly known final goal, investments and adjustments may look undesirable, and efforts may be diverted to lobbying. Trade agreements can play an important role in this connection by laying out a timetable for gradual liberalization that is credible because it is enforceable by trading partners. Failure to maintain a realistic real exchange rate has been one of the main causes of unsuccessful trade liberalizations in developing countries (World Bank 2001). Another cause is failure to address the fiscal consequences of tariff revenue losses. These losses are far from inevitable, especially if nontariff barriers are converted into tariffs, exemptions are reduced, and tariff collections are improved. But they can pose a problem for poorer countries in which trade taxes account for large proportions of total revenue. Developing alternative sources of revenue may take time. Experience suggests, however, that moving toward a more uniform tariff structure and a concomitant elimination of exemptions may increase revenue collection, providing the space to develop alternative tax bases before undertaking more far-reaching liberalization. A major area in which administrative constraints bind is institutional reforms. Given the importance of building up the legitimacy and ownership of these reforms among the population, not only significant technical setup time but also a good deal of political time is required. Getting institutions right the first time is very difficult, if not impossible, and continuing monitoring and adjustment

3 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page 97 North-South Preferential Trade Agreements 97 are needed. There are often advantages to proceeding on a broad front in order to maintain some semblance of fairness, and extensive institutional reforms are likely to require time and considerable administrative skill to carry out. These observations apply, in particular, to regulatory policies and the agencies responsible for implementing them, because regulation can give rise to significant operating costs and entry barriers for firms in a given market once tariffs have been lowered. Tariff reforms can be executed at the stroke of a pen; regulatory reforms are much more complex. Designing Successful Reforms Governments have to build up support for their policies. Powerful interests will need to be assuaged unless reforms are implemented in the context of major economic crises. Compensating these interests through the careful design of complementary policies is not just a matter of sordid logrolling. 3 Although any single efficiencyenhancing reform will hurt someone, if enough of them are packaged together, negative effects will be netted out, and many more people and interests will gain, on balance. This is one of the main reasons for proceeding on a broad front. It is of great importance to ensure that potential beneficiaries from trade-related reforms have the capacity to actually exploit new trade opportunities. This requires attention to the business environment and transaction costs, measures to enhance the productivity of firms and farms, improvement of connectivity to markets, steps to ensure access to finance, and the like. Specific areas for attention may include the following: Infrastructure support. Farmers need to be able to reach major market centers at reasonable cost, firms need access to a reliable and efficient power supply, and so on. In poor countries, transport (logistics) and transaction costs are often a multiple of any tariffs exporters confront. This is one explanation for the more limited participation of poor countries in the process of international specialization that was noted previously. Credit markets. Access to finance is a critical input, both for new start-ups and for the expansion of existing plants. For example, achieving minimum consignment size might entail hiring draft power or seasonal labor, but this is not possible without credit. Credit constraints are a major reason for limited adjustment to trade reforms. Labor markets and mobility. The primary vehicle for spreading widely the benefits of increased labor demand is labor mobility. If labor markets are segmented or distorted, benefits will be reduced. Establishment of new businesses. Cumbersome regulations for establishing new firms, constraints on access inputs (such as utilities), and restrictions on physical expansion or labor recruitment and separation can curtail the willingness of entrepreneurs to start or expand operations. All these themes are highlighted in the research that focuses on the magnitude and determinants of adjustment costs and the factors that affect the size and distribution of the gains from trade reforms (Porto and Hoekman 2010). Thus, the benefits of trade liberalization depend, in part, on support from other policies and institutions. Openness can help induce improvements in these dimensions by making them more visible and by creating incentives to fix the problems, but additional investments and reforms will be required to address many of the constraints. For landlocked countries and poor, remote economies, reducing trade costs is often of critical importance. As discussed below, development assistance and mechanisms for monitoring impacts can help ensure that reforms are effective and can anchor expectations (i.e., increase credibility). Trade agreements can provide focal points, but only if they address national priorities and are seen to do so and are implemented. Trade Liberalization Strategies: What Role Is for Preferential Agreements? For governments that have decided to pursue opening of the economy, a practical question is how to do so. Starting in the 1960s, a number of economies were highly successful in increasing incomes and reducing poverty. Notable examples include Chile; Hong Kong SAR, China; the Republic of Korea; Singapore; and Taiwan, China. More recently, China, Malaysia, Mauritius, and Turkey, among others, have joined the list. All of them dramatically increased their ratio of trade to gross domestic product (GDP), but they pursued considerably different models of trade policy reform and economic integration. The success stories may be grouped into four broad categories: Economywide trade liberalization. Some economies have pursued very liberal, most favored nation (MFN) trade regimes, avoiding nontariff barriers and adopting either free trade (as did Singapore and Hong Kong SAR, China) or low, nonnegotiable, uniform tariffs (e.g., Chile and Estonia, before the latter s accession to the EU). Since the creation of the World Trade Organization (WTO) in

4 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page Bernard Hoekman 1995, a number of countries have pursued MFN liberalization in the context of accession to that body, using the WTO to anchor and precommit to reform; this was the case for China and Vietnam. Protection with offsetting policies for exporters. Other economies reduced the incentives created by protection to produce for the domestic market, employing elaborate systems that offset the bias against exports, including complex duty-drawback systems. Japan (in the early stages); Korea; and Taiwan, China, are examples. Protection with export-processing zones. Along with protection, exporters located in specific zones are offered tariff-free access to intermediate inputs, with better infrastructure and fewer regulatory requirements. The limited geographic scope of the zones makes them easier to manage, for countries with weak governance, than the Asian economywide model. Few countries have succeeded in stimulating exports substantially through this model. An exception is Mauritius, where the zones generated about two-thirds of gross exports and employed one-sixth of the workforce. Zones have also played a significant role in China. PTAs. An increasing number of countries are joining PTAs to provide a focal point or blueprint for reforms, a mechanism for increasing market size and enhancing the contestability of markets, and a means of overcoming political-economy resistance to reforms. Examples are accession to the EU by many Central and Eastern European countries, Turkey s entrance into a customs union with the EU, and Mexico s membership in the North American Free Trade Association (NAFTA). In all these instances, PTA membership complemented WTO accession or membership. The first three approaches are unilateral. Trade liberalization by other countries is clearly desirable, however; trade negotiations are the time-honored mechanism for seeking such liberalization. In South-South agreements, the focus is increasingly on expanding the size of the market by not only abolishing trade barriers but also easing internal constraints on intraregional trade and investment through improvement of infrastructure trade facilitation and transit and corridor management. Given the large asymmetries in economic power (as indicated by market size), the challenge for small and poor countries in North- South agreements is to ensure that any negotiated outcome is in their interest. Such countries have very little scope to use their trade policies as an instrument for inducing other countries to open up their markets. There are two implications. First, unilateral reforms cost developing countries little in mercantilist terms large (potential) PTA partner countries simply will not be that interested because the developing countries markets are too small. Second, and a related factor in PTA negotiations, quid pro quo payments are likely to be requested in nontrade areas such as regulatory regimes, investment policy, and so on (Schiff and Winters 2003; Limão 2007). That raises the issue of whether, in the negotiating process, governments lose access to potentially useful instruments for promoting development. (See, for example, Fink, ch. 18 in this volume.) The Primacy of National Circumstances and Priorities A challenge for developing-country governments is not only to generate better access to partner markets but also to use the PTA as a vehicle for promoting competition, reducing policy uncertainty, and improving the investment climate and business environment. Ensuring that deep integration will benefit developing-country PTA members requires that the specifics of regulation and cooperation reflect national circumstances. Regulatory standards and institutions need to be tailored to national circumstances to be effective and attain the desired objective. An increasing body of evidence has shown that a one-size-fits-all approach including international best-practice norms may not be appropriate. For example, Barth, Caprio, and Levine (2006), in a comprehensive cross-country assessment of the impact of the Basel Committee s standards for bank regulation, find no evidence that any single set of best practices will necessarily promote well-functioning banks. They argue that a high degree of country specificity may be needed, rather than mere adoption of international norms off the shelf. What may be most appropriate from an economic welfare (development) perspective is to create a framework for assisting governments in identifying good policies, rather than a system that is premised on negotiated harmonization or convergence. Instead of being (too) prescriptive ex ante, there is a case for maintaining flexibility conditional on ex post monitoring of outcomes. An important corollary of such an approach must be restraint on the part of large industrial partner countries in PTAs and accountability for performance and outcomes. Creating a focal point for constructive, as opposed to adversarial, interactions between governments on the competitive, marketsegmenting effects of regulation or lack of regulation and on the costs and benefits of specific reforms could do much to mobilize the needed support by constituencies in developing-country PTA members. This is especially so if the high costs of adjustment and of subsequent compliance by developing-country members are recognized through increased technical assistance and investment to upgrade facilities (Hoekman and Winters 2009).

5 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page 99 North-South Preferential Trade Agreements 99 The Continuing Evolution of PTAs The growth of PTAs has been significant. Recent PTAs tend to be more open than earlier vintages, many of which were designed to implement import-substitution strategies at the regional level. They also increasingly involve North-South cooperation and extend to behind-the-border regulatory policies relating to investment, labor, environment, and competition. Examples involving the United States include bilateral agreements with Australia, Chile, Central America, Jordan, and Morocco. Investment and competition policies are being discussed as part of the economic partnership agreement negotiations between the EU and the African, Caribbean, and Pacific (ACP) countries and are on the agenda of the EU s association agreements with non-acp countries. 4 Often, the implementation of such policies may entail pecuniary spillovers to other countries, providing a rationale for cooperation on, for example, tax or other incentive programs to attract foreign direct investment. In many cases, however, the purported rationale is that the disciplines themselves will promote development. From a development perspective, the extension of PTAs to regulatory issues can be beneficial if it improves policy credibility, thereby reducing risk premiums and helping attract investment. There is a prima facie case that regional cooperation on regulatory issues may be advantageous. Partners, to begin with, may be rather similar and may have common legal or administrative systems. North-South PTAs also tend to be associated with transfers of finance and knowledge (technical assistance), potentially helping reduce implementation and adjustment costs. In addition, high-income partners may provide offers of assistance in the form of implicit insurance, as in the case of U.S. financial intervention to assist Mexico during the tequila crisis. In part, the expansion of the negotiating agenda is driven by a need to mobilize additional political support for abolishing the remaining trade-distorting policies in areas such as agriculture. The Uruguay Round was premised on such a grand bargain, with developing countries accepting new disciplines in a variety of areas, including intellectual property rights (IPRs) and services, in return for the elimination of the Multifibre Arrangement, the outlawing of voluntary export restraints, and inclusion of agriculture in the WTO. 5 A similar dynamic is driving PTAs today. The regulatory standards that are written into trade agreements generally start from the status quo prevailing in OECD countries, so that the lion s share of associated implementation costs but presumably also of the benefits lies with developing-country signatories. From a development perspective, the acid test is whether the proposed or negotiated rules in regulatory areas will improve the business environment and address supply-side priorities. Proponents of deep integration in North-South agreements argue that binding disciplines in areas such as competition and investment policy are critical for integrating markets. This point is discussed further below. All this information may help explain why recent PTAs involving countries that object to the inclusion of issues such as investment and competition in the WTO not to speak of more controversial subjects such as labor and environmental standards may include disciplines in these areas at the regional level. Presumably the net balance is positive, in part, because the smaller number of negotiating parties makes it easier to exclude issues that are sensitive and to identify quid pro quo deals. But deeper integration may not be beneficial to all signatories. From a development perspective, the issue is not whether there are net benefits but how to maximize the potential payoffs. There may be cause for concern, in particular, about PTAs that offer partial access to large markets for goods in exchange for acceptance of regulatory norms that may do little, if anything, to increase the flow of investment to developingcountry partners. The use, however, of PTAs as a framework to reduce the frictional costs of trade by harmonizing regulations and standards, increasing the credibility of reform initiatives, or acting as vehicles for governments to test the waters of freer trade may be very beneficial, even if they are difficult and complex to realize. Summing up, there is a clear trend for PTAs to go beyond trade in manufactures. Recent U.S. PTAs include agriculture, and movement on this front is discernable in the EU; the Euro-Mediterranean negotiations include a proposal to pursue reciprocal liberalization of trade in agricultural products. Services, investment, and regulatory regimes are areas where, it can be argued, there is much to be gained by developing countries from policy reforms and liberalization. There are potential concerns about these areas insofar as developing countries perceive proposed or actual disciplines not to be in their interests but still necessary if these countries are to (continue to) gain preferential access to northern markets. Clearly, much depends on the coverage of the agreements and, in particular, on whether the regulatory disciplines for behind-the-border policies are appropriate in the sense that the benefits outweigh the costs of implementation. Much also depends on the extent to which merchandise trade is liberalized, through, for example, access to agricultural markets and removal of the threat of contingent protection, and whether services liberalization is covered, through all modes of supply, including mode 4 (temporary movement of service providers).

6 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page Bernard Hoekman The tariff equivalents of the trade-restricting effects of domestic policies are a large multiple of the prevailing border tariffs today. Further services liberalization would have much greater positive effects on national welfare than would the removal of trade barriers see, for example, Konan and Maskus (2006) on Tunisia, and Jensen, Rutherford, and Tarr (2007) on the Russian Federation. The standard increase in welfare from goods liberalization is 1 percent, but introduction of greater competition on services markets raises the gains to the 5 10 percent range or more. These large effects of services liberalization for which there is increasing econometric evidence (Francois and Hoekman 2009) reflect both the importance of services in the economy and the extent to which many sectors continue to be protected. There are, indeed, potentially large gains from reducing the prevalence and costs of differences in regulation, as well as the incidence of policies that simply prevent access to specific markets. A key question, however, is whether progress on liberalization can be, and is being, facilitated through PTAs, specifically. A recent assessment by Roy, Marchetti, and Lim (2006) concludes that many of the trade agreements reported to the WTO since 2000 show a sectoral coverage that greatly exceeds the commitments the countries involved made in the General Agreement on Trade in Services (GATS). In areas where there are no WTO disciplines (e.g., on safeguards, subsidies, and procurement), there tend not to be PTA rules either. The same is true for domestic regulation; only one PTA (the Trans-Pacific Economic Partnership Agreement, between Brunei Darussalam, Chile, New Zealand, and Singapore) has established an acrossthe-board necessity test that is, an assessment of whether the trade-restricting effects of a policy are necessary to achieve the underlying regulatory objective (Fink and Molinuevo 2007). Harnessing Regional Integration for Development It can be argued that, to be most beneficial to developingcountry signatories, PTAs should Remove foreign barriers to trade in products in which developing countries have a comparative advantage. Lower domestic barriers that raise the prices of goods and services that firms and households consume. Promote more general MFN-based liberalization, which best serves global development prospects. Support the adoption of complementary measures, reforms, and investments that allow the potential benefits of trade opportunities to be realized. The first two objectives are the bread and butter of PTAs. Their realization is constrained by political-economy forces. Small, poor countries have little to offer, in mercantilist terms, to induce large countries to remove policies that harm them. Such market access, however, is important for mobilizing political support for domestic reforms in the developing-country partner. A problem is that nonreciprocal preference programs may imply that exporters already have free access to the high-income market or markets. The third objective, MFN-based liberalization, does not, of course, drive PTAs, which revolve around discriminatory access. 6 Realization of the fourth objective, adoption of complementary measures, is the key challenge, if North-South PTAs are to be most relevant from a development perspective. It may be impeded by the fact that the rules embedded (or proposed) in North-South PTAs tend to reflect the status quo in the high-income countries. From a development perspective, the extension of PTAs to regulatory issues can be beneficial if it improves policy quality or credibility, thereby reducing risk premiums and helping to attract investment. Regional cooperation may be more effective in this regard than multilateral cooperation because the partners may be more similar; for example, they may have common legal or administrative systems. As discussed below, North-South PTAs also tend to be associated with more extensive transfers of finance and knowledge (technical assistance), potentially helping to reduce implementation and adjustment costs. Proponents of deep integration in North-South agreements often argue that binding commitments in areas such as competition law and regulation are critical for integrating markets and that it is easier to envisage enforcement among the small number of partner countries. Although this can certainly be the case, the specific disciplines that are embedded in a PTA may not be a priority for development, implying that even if financial and technical assistance is made available, it could constitute diversion because the resources would have had a higher return elsewhere. None of the four objectives is straightforward to achieve, explaining why many PTAs have partial coverage in market access terms and include rules that may not be first-best for developing-country members. If PTAs are to do more to satisfy the four criteria suggested, the modus operandi of designing and implementing them should give more weight to development considerations (economic efficiency and equity). Concretely, four changes could make North-South PTAs more development-friendly: Unconditional acceptance by all parties to a PTA of MFN liberalization of trade in goods and services by

7 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page 101 North-South Preferential Trade Agreements 101 developing-country signatories, and preferential removal of all barriers by OECD partner countries bound, in both cases, by an enforceable treaty instrument Construction of mechanisms to pursue priority national regulatory policy objectives in developingcountry partners, as opposed to harmonization with the standards of OECD countries, while maintaining the role of PTAs as a commitment device Strengthened, grant-based financing mechanisms (aid for trade) to improve trade supply capacity and increase the benefits of trade reforms for poor households, using a local analysis of needs, with allocations determined by the country s overall development strategy Active engagement by and with the private sector in the surveillance and enforcement of the implementation of the various dimensions of the PTA, including the provision of financial and technical assistance. Adjusting the Rules to Promote Market Access PTAs are a steadily increasing source of discrimination in trade today. Lowering the external levels of PTA protection to reduce the extent of discrimination against nonmembers which will often be developing countries would promote the global public good. A solution offered by realists has been to point to MFN liberalization through WTO negotiating rounds, according to the fact that efforts to regulate PTAs through the WTO rule-making and enforcement process have been totally ineffective (Mavroidis 2005). In principle, however, if development were to be taken more seriously as a goal, changing the WTO rules on regionalism could help make the PTA process more developmentfriendly. Concretely, high-income countries would be required to liberalize in all sectors (not just substantially all ) on a preferential basis, with liberal and simple rules of origin. 7 Conversely, developing-country signatories would reduce their tariffs and apply negotiated trade policy commitments on an MFN basis. This MFN liberalization would not imply a requirement to move to zero tariffs across the board; instead, the goal would be a significant reduction in applied MFN tariffs by developing-country partners, bound by the WTO. This method would prevent trade diversion; reduce the administrative burden on customs authorities (as there would be no need to enforce rules of origin on imports); help ensure that the PTA benefits all trading partners, not just members; and allow governments more time to put in place alternative sources of fiscal revenue. Large northern partners will not offer complete dutyfree and quota-free access to large developing countries without a quid pro quo. In principle, such a quid pro quo should be MFN reform as well there is no reason to differentiate between developing countries. In effect, the MFN proposal implies emulation of the type of asymmetric liberalization that has been the norm in the General Agreement on Tariffs and Trade (GATT) and WTO, with the difference being that in the North-South PTA context, the northern countries go all the way commit to free trade. Insofar as the North is not willing to do this for large developing countries, the WTO can and should be used as an instrument for reciprocal liberalization; the fact that the full preference rule might prevent PTAs from forming is, of course, not a problem from a global welfare perspective. The full Monty rule for the North is consistent with the thrust of current WTO rules for regional agreements, except that it would go beyond the substantially all trade requirement to cover all trade. Although a formal rule change to this effect would be desirable, as noted by many see, for example, Mavroidis (2005) GATT Article XXIV (allowing an exception to the MFN rule to permit PTAs) and the Committee on Regional Trade Agreements are basically defunct. Absent effective enforcement of the rules, seeking to change them is a largely irrelevant exercise. Thus, in practice, full liberalization is an action that needs to be taken unilaterally by northern countries. There is no need to change Article XXIV to permit the implementation of this aspect of the proposal; what is needed is a meaningful commitment to take development seriously. 8 That cannot be said for the suggestion that developing country partners commit to MFN liberalization. Both Article XXIV and the Enabling Clause which allows developing countries to liberalize less, especially where South-South agreements are concerned would be implicated by an MFN rule. In terms of Article XXIV requirements, it may be easier to pursue a waiver for specific PTAs, as MFN-based reform implies that all WTO members stand to gain from the PTA. This solution leaves the inconsistency with the Enabling Clause to be resolved. Arguably, the economics here are clear: pursuing a MFN strategy has much less potential for welfare loss and can enhance benefits. 9 The argument in favor of a MFN approach by developingcountry PTA members extends to services. Although actual additional liberalization in the services area has not been great with the exception of the EU, most PTAs have not gone much beyond the GATS services and investment policies are very much on the PTA agenda. Multilateral liberalization opens the market to the largest number of competitors and gives consumers maximum choice. It also leads to a less complex policy regime than a preferential arrangement, implying lower administrative costs for the

8 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page Bernard Hoekman government and lower transaction costs for the private sector. If the market access rule proposals outlined for PTAs are formalized in the WTO, then the next question is what to do about existing PTAs. In practice, the revealed preference of members of these PTAs is clear: full liberalization is often not the objective, and MFN is certainly not the goal. Seeking to change this status quo is unlikely to be fruitful. Existing PTAs will therefore need to be grandfathered, in the unlikely event that it proves possible to change the WTO rules. That said, there is no reason existing agreements could not be reopened by a developing-country government, assuming that development is indeed a major objective of the northern partner. Policy Flexibility and Better Economic Governance We next turn to the second element of a strategy for increasing the development-friendliness of North-South PTAs. The market access dimension of PTAs arguably should involve hard law binding and enforceable commitments. As mentioned previously, a major element of the status quo is an increasing focus on harmonization and hard law for behind-the-border policies concerning services, investment, and regulation. This may well be beneficial to signatories, but much depends on country circumstances. What are the preconditions for such commitments to be beneficial? Have they been satisfied? Do the commitments remove access to policy instruments that are desirable or are the only ones a government can feasibly employ to address a market failure? Given that there is likely to be uncertainty with respect to these issues and, often, differences in views between governments an approach that allows for greater policy flexibility could do much to enhance the perceived benefits of engaging in PTA-based commitments. A precondition for ownership of international agreements is that governments and stakeholders perceive the rules as benefiting the economy overall. A more economically based mode of cooperation as opposed to a focus on harmonization-cum-approximation of laws could help enhance such ownership. From an economic development perspective, a mechanism for identifying good practices makes sense, as these will often differ across countries. The focus would be on the provision of information and learning through regular interactions of relevant policy makers and constituents (stakeholders), peer review, and multilateral monitoring of the impacts of policies and their effectiveness in attaining stated objectives (see Chayes and Chayes 1995; Abbott and Snidal 2000; Helleiner 2000; Sabel and Reddy 2007). Rather than seek to impose existing norms in OECD countries as examples of best practice, cooperation would be geared toward assisting countries in attaining their objectives efficiently. The specific content of regulation should reflect national (or local) circumstances. Thus, what may be most appropriate from an economic welfare (development) perspective is to create a framework for helping governments identify good policies, not a system that aims at harmonization. An important corollary of such an approach must be accountability for performance and outcomes, generating information (based on analysis) on whether the policies employed are effective, what their costs and benefits are, and so on. The fact that trade agreements are binding contracts that commitments are enforceable gives them their value: traders have greater certainty regarding policy, and governments know what they are buying when they make commitments. Any approach toward recognizing differential capacities and identifying regulatory options and priorities should minimize uncertainty for traders and investors. Binding, enforceable disciplines on the use of trade policy are likely to be beneficial for development. The case for trade policies designed to deal with specific government and market failures that may prevent a supply response to reforms from emerging is very weak (Pack and Saggi 2006). It may not be obvious, however, what types of domestic policies might be most appropriate and effective, which suggests that experimentation and learning should be encouraged (see, for example, Rodríguez-Clare 2004; Rodrik 2004). The prevalence of complicated trade policies in many countries is often driven by industrial policy objectives, which have a long history. They span not only trade protection but also subsidies and direct government involvement in industry. Although opinions differ, the weight of the evidence suggests that such policies are generally very costly, often prolong the adjustment period, and distort competition. That said, subsidies can facilitate learning, technology acquisition, and dynamic comparative advantage in situations where returns to such activities cannot be appropriated by private agents. Many commentators have argued that policy interventions, including implicit or explicit subsidies, lay behind the economic miracles in East Asia and were a major factor in the economic development of European states, the United States, and Japan in the 19th and 20th centuries. Their case is that import protection and carefully targeted subsidies allowed governments to stimulate key sectors that became efficient in their own right and provided positive spillovers for the economy as a whole. In considering this infant-industry argument for government support, it is important to differentiate between

9 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page 103 North-South Preferential Trade Agreements 103 sector-specific subsidies and policies aimed at facilitating learning and the development of private enterprise. The case for general policy support for certain types of activity, including innovation, education, transport infrastructure, and similar public goods, is uncontroversial. The same is true for policies aimed at promoting socially beneficial activities. Markets can and do fail. There may be good rationales for governments to provide incentives for firms and agents to undertake activities that would otherwise be undersupplied (Rodrik 2004). Specific interventions, however, will often get it wrong, in part as a result of rent seeking and in part because of general equilibrium effects (a subsidy for one activity implies a tax on all others). 10 Monitoring and analysis of impacts and of the performance of supported sectors and activities are therefore important, as is the establishment of credible exit mechanisms; governments need to be able to withdraw support for experiments that fail. Trade agreements offer a potential vehicle for supporting such mechanisms. PTAs can help by creating institutional mechanisms that can assist in identifying policies that would be effective and efficient in attaining specific goals set by governments and by increasing the transparency of policies and their outcomes through joint monitoring and analysis. A first step is to identify the relevant policies via the equivalent of what is done at the WTO through the Trade Policy Review Mechanism and then to carry out an economic assessment of the rationale for and effectiveness of the relevant policies. An example of an institution that does the latter is the Productivity Commission in Australia. Assessment of whether instruments are achieving development objectives and whether less trade-distorting ones can be identified requires judgments regarding appropriate sequencing and the need for complementary reforms and investment. These judgments must be made by the government concerned but would benefit from inputs from other PTA members. 11 Even if one is not convinced by the upside of pursuing greater flexibility on regulatory disciplines in PTAs, the downside risk is arguably limited. At worst, the cost is that PTA members conclude after a number of years that the approach is not beneficial. Such an attitude may, however, be too complacent. A case can certainly be made that if the raison d être of a trade agreement is the negotiation of binding commitments, policy dialogue discussions may do more harm than good by increasing uncertainty; duplicating the efforts of the World Bank, the International Monetary Fund, and others; and incurring transaction costs. An alternative is to leave economic policy dialogue to international development and financial institutions. There is much to be said for this counterargument, but it ignores the reality that PTAs are extending deeper behind the border. Moreover, with the exception of the WTO, trade policy is not a consistent focus of the activities of international organizations. A major advantage of a PTA is that the focus is on trade and trade-related policies. Creation of a focal point for a constructive, as opposed to adversarial, interaction between governments could do much to heighten the domestic profile of the trade agenda for developingcountry PTA signatories. It would also increase information on the effects of existing policy instruments a necessary condition for adopting better policies and ensure that trade-related policy actions and investments are taken into consideration when decision makers allocate resources to public expenditures. All these measures can be characterized as an effort to improve economic governance in partner countries and, in the process, enhance the ownership of PTAs. Clearly, the effectiveness of the implementation of the interactive mechanisms will be critical for their credibility. In the end, when governments (the partners jointly) deem that a binding commitment in an area makes sense, entering into such a commitment will increase the probability of enforcement. Insofar as cooperation in specific areas continues to be of the soft-law variety, legal enforcement mechanisms are not available. Here, accountability can only come from transparency, engagement, and publicly disseminated analysis of actions and impacts. Oversight by parliaments and analytical assessments by institutions in the North the U.S. Congressional Budget Office and General Accountability Office; similar national institutions in the EU such as the French research institutions Centre d Etudes Prospectives et d Informations Internationales and the Centraal Plan Bureau in the Netherlands; and Australia s Productivity Commission could help inform development assistance programs. But strengthening the capacity to undertake such analysis in developingcountry partners is crucial. Might such monitoring and interaction be better delegated to the WTO? Although non-pta members may have little immediate interest in the policies pursued by a specific developing-country PTA member, the substantive coverage of PTAs will generally overlap to a great extent with the issues that are addressed by WTO agreements or that may be taken up in the future. There is much to be said for considering an expansion of the WTO Trade Policy Review Mechanism to enable it to undertake much more in-depth analyses of the impacts of policies pursued by PTA members and by customs unions (Hoekman 2005). An additional reason for establishing such a mechanism at the WTO is that the consultations and impact assessments associated with any policy flexibility mechanism

10 PTAPD_ qxd:inte_ _ch01 7/5/11 12:18 PM Page Bernard Hoekman will entail resource costs. These may be significant for poor countries with a scarcity of skilled personnel. If the required work is undertaken multilaterally, much of it could be carried out in the context of mechanisms such as the Enhanced Integrated Framework for Trade-Related Technical Assistance, reducing the costs. (See Prowse [2006] for a discussion.) More regular interaction on trade policies would provide a framework for helping governments assess whether instruments are achieving stated objectives. The publication and dissemination in the countries concerned of the results and findings of reports and discussions would also increase the public profile of trade-related policies. More regular cooperative interaction by regulators and trade officials concerning trade policies and constraints on market integration could also improve communications between the development and trade communities, as the analysis and discussions might assist in identifying where development assistance has the greatest potential to help countries benefit more from trade agreements and cooperation. Aid for Trade: Capacity Building for Competitiveness The third plank of a development-focused approach is expanded development assistance to help address supply capacity constraints in poor countries the types of measures briefly discussed in the section on trade liberalization strategies. This effort requires identifying and prioritizing needs and providing funds to address them. Especially in small, low-income countries that already have relatively free access to major markets, using aid to address constraints that reduce their competitiveness can have high payoffs and, indeed, may be the primary source of benefits. A major lesson of experience with projects and programs in the trade area (and in most others) is that country ownership and leadership at the highest levels are critical factors in ensuring concrete and sustained follow-up in removing constraints to trade expansion. The flexibility mechanism proposed above could help mobilize this follow-up by identifying where specific investments are likely to be needed, but it will need to be complemented by a comprehensive diagnostic analysis of factors that constrain supply responses and reduce competitiveness. Such diagnostics should feed into the process through which countries determine public investment allocations and policy reform priorities. In many low-income countries, this process increasingly centers on poverty reduction strategy papers, which form the basis for the provision of donor assistance at the country level. As discussed at greater length by Prowse (2002 and 2006), trade-related funding should be allocated within the context of an overall country development program and an agreed macroeconomic policy framework. As a development tool, stand-alone specific funds and associated mechanisms are less likely to be effective than integration of the prioritization and resource allocation process into national poverty reduction and development strategies. Trade policy often will not be the most important policy area from a growth perspective and it should be borne in mind that many low-income countries have taken actions to move away from nontariff barriers and to reduce dispersion in tariffs. A fortiori, trade policies and institutions that are covered by PTAs may not be among the areas within the trade area where actions and investment are most needed. As stressed previously, the primary determinants of success in harnessing trade openness to deliver growth are concomitant policies and institutions in the developing countries themselves. Supply capacity is a necessary condition for exploiting market access opportunities, which will be determined by the prevailing investment climate and the trade and business environment. Much of the associated policy agenda extends beyond trade policies and cannot be addressed through trade agreements that are narrowly conceived. Measures to facilitate trade to get goods and services in and out of the country for less cost are likely to be particularly important in many of the poorest countries. Given that many of these countries are landlocked, cooperation with neighbors to reduce the costs of transit and transport and of access to ports may well generate a particularly high payoff. In general, measures aimed at improving the investment climate are likely to dominate trade policy, as are macroeconomic policies designed to ensure a realistic exchange rate and actions guaranteeing that markets exist and function. The implication is that financial and technical resources made available by high-income countries to developingcountry PTA partners should be allocated on the basis of national priorities and not tied to the narrow ambit of whatever is embodied in the PTA. As argued in the next section, a corollary of this is that it would be desirable to integrate PTA-based resources into the emerging multilateral mechanisms in order to assist poor countries in bolstering their trade capacity. Private Sector Engagement in Implementation and Enforcement To be credible and meaningful, PTA commitments must be enforceable. Signing a PTA is one thing, but implementing it and enforcing its provisions is quite another. Much of the