The path to global free trade Spaghetti bowls

The path to global free trade: Spaghetti bowls as building blocs Richard E. Baldwin Professor of International Economics Graduate Institute of International Studies, Geneva World Economy Annual Lecture Nottingham 22 June 2006 1

Introduction & Plan • Topic: Final steps to global free trade. – Bhagwati’s paths. – Define: global free trade. – Bold prediction & caveats. • Outline 1. 2. 3. 4. 5. Political economy of liberalisation. Structured historical narrative. Staging post 2010. The final 2 steps. WTO’s job. 2

6 stylised facts 1. The GATT process started when tariffs were very high worldwide; 2. Rich nations liberalised much more than poor nations, in both the GATT process (i. e. bound rates) and RTAs; 3. The liberalisation focused on industrial goods in which two-way trade in similar goods is prevalent; 4. The process took 40 years; 5. Some sectors were excluded entirely and others experienced much less tariff cutting; 6. Regional tariff cutting went hand-in-hand with multilateral liberalisation. 3

Political Economy • Status quo tariff. • Tariff balances supply & demand for protection. • Supply = marginal cost curve (marginal welfare damage). • Demand = marginal utility curve (marginal benefit to special interests). 4

Protection demand S euros a P’ P Protection demand P T T’ Pw D quantity T T’ T 5

Protection supply S euros b d P’ c a P T’ e Naïve opt’l tariff Protection Supply f g Pw Pw’ D quantity T’ T 6

Juggernaut: demi-cycle 1 • Political equilibrium tariff balances S & D for protection. • Reciprocal trade talks re-align political economy forces inside each participating nation. • Protection supply shifts up. – Exporters become anti-protectionists. euros Protection Supply (recip. ) Protection Supply (unil. ) Protection demand T’ T T 7

Juggernaut: demi-cycle 2 • Politically optimal Tariff, T tariff depends of size of import competing To sector. FE – Walrasian entry, n. • Number of import competing firms rise with tariff. • FE curve. • Same for export sector, but can’t plot. n no 8

Juggernaut effect • Fold supply & demand into GFOC. – Solution to govt first order condition. Tariff, T To FE Eo GFOC (unil) • GFOC rises with n since politically optimal T rises with n. – More to protect on margin. n no 9

Juggernaut effect • Start: unilaterally politically optimal tariff, To. • Reciprocal trade talks shift GFOC down. – Lower opt’l T for any given n (exporters are now in the game). Tariff, T FE To A T 1 T’ GFOC (unil) Eo E’ B GFOC (recip) • Juggernaut rolls forward to E’ n 10

Juggernaut effect • If all exports covered by the reciprocity, politically optimal tariff is zero. • Could take decades crush the anti-trade forces (import competing firms) & build pro-trade forces (export firms). Tariff, T GFOC (unil) To FE Eo GFOC (MTN) Efinal n 11

Domino effect • Demi-cycle I: Idiosyncratic formation or deepening of a trade bloc re-aligns the political economy forces inside non-member nations. • Pro-membership political economy forces: – Non-member exporters: Trade diversion (fresh loses) & Trade Creation (lost opportunity). • Anti-membership political economy forces: – If deeper, may resist more. • If export sectors are politically larger than import competing sectors. • Demi-cycle II: if a new member joins, “forces for inclusion” get stronger in non-member nations. 12

RTB unilateralism • Competition for out-sourcing jobs and investment drive nations to unilaterally cut tariffs. • Re-aligns political economy forces in DCs. • Unbundling of manufacturing process (i. e. fragmentation, vertical differentiation, slicing up value added chain) is key. – Destroys import substitution (scale, competition) – Makes export-led industrialisation more successful (foreign technology from MNC/buyers, ready market). • Finer division of labour may mean no import competing industry. • MNC role may imply imports mostly re-exported. – Importers are also exporters => no political economy conflict. 13

Ancillary effects • Intra-sectoral special interest politics. – Melitz model & reciprocal liberalisation: big firms win, small firms lose. – Add Mancur Olsen’s Asymmetry on political organisation & juggernaut effect works well on intra-industry trade. • Losers lobby harder. • Home market magnification effect. – Industry becomes more footloose, not less, as trade barriers fall. – Competition for industry becomes more fierce as tariffs fall globally. (Small preference margins can matter a lot). 14

Historical Narrative • • 3 key effects: Jugger (MTNs), Domino (RTAs), RTB (unilateralism). “Empirical evidence” intended to “demonstrate” usefulness of the 3 key effects. Line sketch. Can’t pretend to explain everything. 15

Historical Narrative • 1947 -1958. – GATT starts. – Juggernaut works but stops in 1950 s. 16

Dominos trigger juggernauts • 1958 -1972. – EEC formation: • Europe domino effect phase I. • Kennedy Round. • RTAs: US Auto Pact & EEC, EFTA. • MTNs, RTAs & unilateralism proceed in tandem. • Liberalisation begets liberalisation. 17

1973 -1985 • EEC first enlargement and EEC-EFTA FTAs, create another incentive for an MTN (Tokyo Round, 73 -79). • Stagflation postpones all forms of trade liberalisation. Tokyo 18

1986 -1990 • Juggernaut & domino reengage. • Single European Act, 1986. • US-Canada FTA talks start, 1986. • Uruguay Round starts, 1986. 19

1990 -1994 • European spaghetti bowl forms. – USSR collapse. • North American spaghetti bowls forms. – US-Mexico FTA triggers massive domino effect. – NAFTA, Mercosur, dozens of spoke-spoke FTAs, long queue for US bilaterals. 20

1994 -2000 • European spaghetti bowl advances. – Euro-Meds, etc. • North American spaghetti bowls advances. – NAFTA crushes Mexican anti-trade forces. – Mexico ‘sells’ its politically optimal tariff cuts in over 40 bilaterals. • Japan, EU & US. 21

1986 -2000 • RTB unilateralism in East Asia (circa 1985). Reductions in applied MFN tariffs on Asian crisis 22

MTNs, RTAs & unilateralism • In 1990 s, as in the 1960 s & 1980 s, all the ‘isms’ progress hand-in-hand. • No evidence that ‘isms’ are substitutes. 23

2000 -2006 • East Asian noodle bowl starts. • China’s approach to ASEAN for FTA triggers domino effect in East Asia. – ACFTA, AKFTA, AJFTA, many bilaterals. – No significant regionalism to date, but lots promised. • Western Hemisphere spaghetti bowl advances. – US opposition to FTAs crushed by NAFTA; US follows promiscuous FTA strategy. • European FTAs multiply, spokes start to proliferate FTAs. 24

Staging Post 2010 • Europe, North America and East Asia: ‘fuzzy’, ‘leaky’ trade blocs. – North America & Europe done deals; between & within near-duty-free status (major flows). • Many East Asian FTAs may have problems (typically south-south), but Japan-Malaysia, & 4 other big ASEANs very likely to be implemented. – Rest due to domino and RTB unilateralism. • Prediction: Applied tariffs will be near zero for world’s major trade flows around 2010. 25

Fractals • Definition: “A rough or fragmented geometric shape that can be subdivided in parts, each of which is (at least approximately) a reduced/size copy of the whole. ” • World trade system made of 3 fuzzy, leaky trade blocs each of which is made up of fuzzy leaky sub-blocs. • The point: • Solution to one is the solution to all (roughly). 26

PECS • How PECS fixed the European spaghetti bowl and why. • Spaghetti bowl problems: – Multi ROOs (hard to do biz in spokes) – Bilateral cumulation (hinders efficient sourcing in spokes) • 1997, EU set up PECS: – imposed common set of ROOs on EU, EFTA & CEECs. – Imposed diagonal cumulation. 27

PECS • Spaghetti bowl is not by accident. – Pair-specific political economy forces => pair-specific policy; especially hub & spoke. • Unbundling & off-shoring – Former beneficiaries of complexity downsized and off-shored from EU. – Some EU firms set up in spokes and are now harmed by the complexity (“us” becomes “them”). – EU firms push EU to tame the tangle of FTAs. • “Spaghetti bowl as building blocs” • Complexity & unbundling create new politically economy force – Push system the short distance from near-free trade with matrix of bilaterals to free trade ‘lake. ’ – Multilateralise the FTAs. • Domino effect in ROOs/Cumulation. 28

2 final steps • Penultimate: • Multilateralise the spaghetti bowl FTAs in North America (when US firms become victims of the complexity). – NAFTA ROOs already popular. – Diagonal cumulation is next. • East Asia, much more difficult. – Might be RTB unilateralism makes ROOs/Cumulation irrelevant. – ASEAN ROOs already popular. 29

2 final steps • Ultimate • As global unbundling continues, SBBB pressures will mount. • Impractical to do a PECS given PECS, NAFTA & ASEAN ROOs. • Alternative is ITA-like agreement with coverage of most industrial goods. – Zero-for-zero. 30

WTO’s role • Penultimate: not much, should study impact of PECS on non-members more closely. • The final step could be in WTO, but not like DDA. • ITA was much more like old-fashioned GATT Rounds. – Much less emphasis on S&D. – Principle supplier ideas. – RTB unilateral to bring newly industrialising nations along. 31

END Thanks for listening: www. hei. unige. ch/baldwin/ 32