Academic journal article Journal of Business Strategies

The Implications of a South-South Customs Union on Tariffs, Welfare, and the Prospect of Global Free Trade

Academic journal article Journal of Business Strategies

The Implications of a South-South Customs Union on Tariffs, Welfare, and the Prospect of Global Free Trade

Article excerpt

Abstract

Following the failure of multilateral trade negotiations at the Cancun meeting and the Doha Round, developing countries have pursued an alternative in so-called "south-south" trade agreements. Since these agreements lead to trade diversion from efficient north (developed) countries to less efficient south (developing) partners, there have been widespread concerns regarding their welfare implications. Using a three country oligopoly model of trade, we first examine statically the implications of a south-south customs union (CU) on the pattern of tariffs and welfare. We find that south countries always have incentives to form a CU that reduces the welfare of the north country. Moreover, when south firms are sufficiently inefficient relative to north firms, a south-south CU leads to a large trade diversion effect and reduces world welfare. We further show that, in a repeated interaction model, free trade is less likely to be sustainable under the south-south CU relative to no agreement.

Introduction

By permitting a group of member countries of the World Trade Organization (WTO) to form a preferential trade agreement (PTA) wherein these countries extend tariff concessions to each other but not to other WTO member countries, Article XXIV of the General Agreement on Tariffs and Trade (GATT) provides an important exception to the most-favored-nation (MFN) clause (contained in Article I of GATT). (1) Since the notion of non-discrimination as specified by the MFN clause is at the heart of the WTO system, the existence of Article XXIV has not been without controversy. (2) PTAs are so widespread today that MFN treatment appears to be more of an exception rather than a norm and, thus, far from playing a pivotal role in multilateral trade liberalization. According to the WTO (2009), there are over 200 PTAs in force today and almost all major countries participate in one or more PTAs of various types.

Prominent examples of PTAs include the North American Free Trade Agreement (NAFTA), the South American Common Market (MERCOSUR), the Association of South East Asian Nations (ASEAN) Free Trade Area, the Andean Pact, and numerous agreements of the European Union with other countries.

The failure of multilateral trade negotiations at the Cancun meeting and the Doha Round led the developing countries to look for an alternative in so-called "south-south" PTAs. As Stiglitz (2003) argues, even though there is more to gain from North-South trade in theory, just as north-north trade agreements have intensified, there is no question that south-south trade agreements can also flourish. Bhagwati and Panagariya (1996), Ray (1998), and Das and Ghosh (2006) contend that the majority of the PTAs have been formed between similar countries (so-called north-north agreements between developed countries and south-south agreements between developing countries) rather than between developed and developing countries (north-south agreements).

This paper aims at addressing the following questions. What are the implications of a south-south customs union (CU) on the pattern of tariffs and the welfare of the member and non-member countries and the world as a whole? Do these agreements facilitate multilateral trade liberalization process? To address these questions, we develop a three-country oligopoly trade model with one north (developed) and two south (developing) countries. We begin with the premise that the north firms have a superior production technology compared to that of south firms. (3) That the above questions are important is evident from the recent proliferation of PTAs between developing countries. As per WTO, the number of PTAs between developing countries has increased dramatically over the last two decades: 70 new such agreements have been formed between 1990 and 2003 and they account for more than 50 percent of all new trade agreements, including those not notified to the WTO. Important examples include MERCOSUR in South America, South Asia Free Trade Area (SAFTA), the Group of Three, and South Africa Customs Union (SACU). …

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