Economics of European integration Lecture 5: EU trade policy Thomas Blondiau (Center for Economic Studies, KU Leuven) Louvain Institute for Ireland in Europe, January 2012

EU Trade Policy: outline International framework Benefits of free trade EU as a trading partner EU external trade policy Preferential trade liberalization (revisited)

EU Trade Policy Common Commercial Policy - Article 113 of the Treaty of Rome: Community tariff regime Common trade agreement with third countries (trade in goods, service and intellectual property)

International framework GATT (1948) WTO (1995) functions: Regulations for conduct of international trade Settlements of disputes Negotiations to liberalize world trade Latest negotiations rounds: 1986-94: Uruguay round 2001-?: Doha round

International framework: WTO principles Non-discrimination Reciprocity Binding and enforceable commitments Transparency Safety valves (for specific circumstances)

WTO organizational structure Council for trade in goods (GATT) Council for trade related aspects of intellectual property rights (TRIPS) Council for trade in services (GATS) Trade negotiations committee (TNC): Uruguay round, Doha round, etc. Decision-making: practice of consensus Dispute settlement body Including Appellate Body, arbitrators, etc.

International framework: Road to WTO Progress in international trade talks was made during a successive set of ‘trade rounds’ Initially, trade rounds were aimed at reducing trade barriers through lower tariffs Uruguay round (1986-1994) was more ambitious: Significantly reduce agricultural subsidies (led by ‘Cairns group’: Australia, Brazil, Canada, Indonesia, New-Zealand) Liberalize framework for foreign investment (TRIM) Liberalize trade in services (GATS) Obtain wider protection and recognition of patents/copyrights (TRIPS) Obtain further reduction in tariffs (GATT)

International framework: Road to WTO Doha round (2001 - …): Goal is to improve market access Talks have stalled since 2008 Issues: Continued protectionism and export subsidies for agriculture in developed world (US, EU, Japan) Singapore issues difficult to digest (US, G20 developing countries) Trade facilitation (more efficiency in customs clearing) Public procurement (current GPA scheme is voluntary under WTO) Trade & investment Trade & competition (more uniformity in ‘market rules’) Additional issues: Related to TRIPS and access to patented medicines in developing countries (innovation incentives vs. public health) Special and differential treatment Implementation issues (related to Singapore issues)

International framework: Doha Round Copenhagen consensus evaluated the Doha round as the second best investment for global welfare, after provision of vitamin supplements to malnourished children Evaluation based on economic cost-benefit analysis

Benefits of free trade: theory Technological differences; comparative advantage (Ricardo) Difference in endowments (Heckscher-Ohlin) Economies of scale Economies of scale and product varieties (Krugman, New Trade Theory; intra-industry trade)

Comparative advantage: example In two hours, France could produce 6 kg of bread and 4 liters of wine Assume trade becomes possible at 6 kg of bread for 6 liters of wine France produces 12 kg of bread, and trades 6 kg of bread for 6 liters of wine. They end up with 6 kg of bread and 6 liters of wine Similar reasoning for Italy; both countries better off with trade Lower wages in Italy Relative world price is between relative autarky prices Technology France Italy Bread (kg produced in a man-hour) 6 1 Wine (liters produced in a man-hour) 4 2

Heckscher-Ohlin A country will export the commodity whose production is intensive of the factor in which the country is relatively abundant Assume same technology in both countries

Heckscher-Ohlin Assume the production of bread is capital intensive and the production of wine is labor intensive Assume France has a relative abundance of capital and Italy has a relative abundance of labor This shows up in the production possibility frontiers

Heckscher-Ohlin graphically

Heckscher-Ohlin graphically Indifference curves shows combinations of wine and bread consumption that give the same level of satisfaction Assume same preferences in both countries (so same indifference curves) Higher indifference curve means higher level of satisfaction (higher utility level)

Heckscher-Ohlin graphically

Heckscher-Ohlin graphically Relative price is the price of wine / the price of bread Slope of the blue lines in the next figure

Heckscher-Ohlin graphically

Heckscher-Ohlin graphically For trade to occur, relative world price must be between relative autarky prices: Rel. p(France) > Rel. world price > Rel. p(Italy) World price is slope of green line in next figure

Heckscher-Ohlin graphically

Heckscher-Ohlin graphically Because of trade, both countries end up on a higher indifference curve and are therefore better off Both countries specialize Points outside of production possibility frontier become possible

Benefits of protection Protect specific groups in society Diversify production (uncertainty) Strategic independence (e.g. food, energy) Protect employment Protect infant industry Strategic argument (terms-of-trade) Avoid (social) dumping

EXPORTS IMPORTS

Pattern of Trade EU25 (2003) EXPORTS IMPORTS

Differences among Member States, imports 2003

Composition exports and imports

What with whom?

Institutions Trade policy is an exclusive competency of EU. Customs Union requires COORDINATION. Trade in goods: Commission has responsibility for negotiating, Council of Ministers sets “Directives for Negotiation.” Karel De Gucht (Trade Commissioner). Council accepts/rejects final deal by Qualified Majority Vote. Commission in charge of surveillance and enforcement of 3rd nation commitments to EU. Trade disputes with US, China, etc. European Parliament has no explicit powers. It’s only informed.

QUALIFIED MAJORITY VOTE Each member state has a fixed number of votes roughly determined by its population, but progressively weighted in favour of smaller countries. To pass a vote by QMV, all three of the following conditions must apply: the proposal must be supported by 255 votes from a total of 345 - about 74% of the votes; the proposal must be backed by a majority of member states; the countries supporting the proposal must represent at least 62% of the total EU population.

Treaty of Rome only gave Commission power over trade in goods. Treaty of Nice (& Amsterdam) extended Commission’s authority to some aspects of services trade and intellectual property rights. It made QMV the rule in Council on such matters.

Contingent Protection (anti-dumping&anti-subsidy) WTO allows members to raise tariffs to (does not violate WTO): 1. Counter ‘unfair’ trade practices, e.g. Antidumping (often) Anti-subsidy 2. Provide temporary protection “safeguards.” (Iron, steel, consumer electronics, chemicals) The various WTO articles on these require a procedure; in EU the Commission is in charge of these procedures, but the final decision is subject to QMV approval of the Council. Tariffs and preferably price undertaking (avoid complaints on EU’s protection). Trade-off between consumer welfare and producer welfare.

Distributional consequences: Home

EU External Trade Policy Complex Has preferential trade agreements with all but nine of the WTO’s 148 members. Each free trade agreement can contain hundreds of pages of exceptions and technical rules. Has general agreement on trade, but also has separate sectoral agreement See http://ec.europa.eu/trade for updating details.

EU External Trade Policy EU has special deals with 139 nations; often more than one per partner.

EU External Trade Policy European-Mediterranean area: 1. West, Central and Eastern Europe = Single market in industrial goods; EU + EFTA (but not agricultural food) 2. Euro-Med10 Association Agreements: Morocco, Algeria, Tunisia, Egypt, Israel, the Palestinian Authority, Lebanon, Jordon, Syria and Turkey. Bilateral duty-free trade in industrial goods Asymmetric: Asymmetric dependence (e.g. 70% of Morocco’s exports to EU, but <1% of EU to Morocco) EU cuts its tariffs faster, Med 10 promise to eliminate their tariffs on EU industrial goods by 2010

EU External Trade Policy European-Mediterranean area: Turkey uses EU’s common external tariff for industrial imports EFTA nations sign similar agreements with Med-10

EU External Trade Policy Former Soviet republics & Western Balkans 1. Partnership and Cooperation Agreements (PCAs). Generalised System of Preference - GSP plus. Russia, Ukraine, Georgia, Belarus, Armenia, Azerbaijan, Kazakhstan, Kyrgyzstan, Moldova and Uzbekistan. 2. Stabilisation and Association Agreements (SAAs). Former Yugoslavian states. Croatia has started membership; others likely to follow. These are all GSP (Generalized System of Preference), a WTO rule allows rich nations to charge lower tariffs on imports from poor nations. (Asymmetric)

Preferential arrangements with former colonies Colonial preferences conflicted with Common External Tariff. EU made exception for these nations to avoid imposing new tariffs; signed “unilateral PTAs” Yaoundé Convention and Arusha Agreement When UK joined 1974 extended to many Commonwealth nations. “ACP nations” (Africa, Caribbean & Pacific); the new agreement = Lomé Convention. Duty-free but subject to quota for sensitive items (sugar, banana, etc.). These didn’t help the ACP nations to industrialize. When Lomé Convention renewed in 2000, the EU and the ACP nations agreed to modernise the deal. Cotonou Agreement; eventually reciprocal free trade.

Regional groups, ACP nations West Africa Central Africa East South Africa Southern Africa Caribbean Pacific Benin Burkina Faso Caper Verde Cote d’Ivoire Gambia Ghana Guinea Guinea Biss. Liberia Mali Mauritania Niger Nigeria Senegal Sierra Leona Togo Cameroon Chad Congo Equat. Guinea Gabon Sao Tome e Principe Burundi Comoros Congo (Rep Dem) Djibouti Eritrea Ethiopia Kenya Malawi Mauritius Madagascar Rwanda Seychelles Sudan Uganda Zambia Zimbabwe Angola Botswana Lesotho Mozambique Namibia Swaziland Tanzania Antigua Bahamas Barbados Belize Dominica Domin Rep Grenada Guyana Haiti Jamaica Sta Lucia St Vincent St Ch and Nevis Surinam Trinidad and Tobago Cook Is Fed Micron Fiji Kiribati Marshall Isl Nauru Niue Palau Papua NG Samoa Solomon Is Tonga Tuvalu Vanuatu

Preferences for poor nations: GSP 1971 GATT provision. EU grants GSP-generalised system of tariff preferences- to almost all poor nations. 1. General GSP (to all developing countries). 2. “Super-GSP” more generous on market access :‘Everything but Arms’ for least developed nations. On paper, EBA grants zero-tariff access to all goods, except arms and munitions. Goods in which these nations are most competitive are in fact excluded from the deal. Tariffs on bananas, rice and sugar – products where these poor nations could easily expand their EU sales – are to come down only in the future. Moreover, even though all tariffs on these items should be gone by 2009, the exports quantities are limited by bilateral quotas.

Non-regional free trade agreements Mexico, Chile, and South Africa. Mercosur (Argentina, Brazil, Paraguay & Uruguay) Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates) India and ASEAN (Indonesia, Malaysia, Philippines, Thailand, Singapore, Vietnam, Cambodia, Burma & Laos).

Non-preferential trade Only affects 9 nations But represents 1/3 of EU imports (US, Japan, etc.) Thus CET still matters Also important to evaluate how much of an edge a country obtains by awarding duty-free GSP or FTA treatment Average Common Ext. Tariff 6.5% Average industrial goods 4.1% Average on agricultural imports 16.5% with huge variation

EU Common external tariff Agricultural products have much higher tariff than others!

EU common external tariff May explain why EU is ready to provide duty-free treatment for many industrial goods to certain countries Very little impact on EU market In areas where zero tariffs may matter, EU is much more reluctant for signing FTA Industrial goods coming from USA, Japan Agricultural goods

Current facts… “Traditionally, there has been a divide between northern liberal countries, such as Britain and Sweden, and protectionist founder members, such as France and Italy”. The Economist Dec 2006 USA and EU blaming each other for failure in trade negotiations. “What they're saying is that for every dollar that they strip out of their trade-distorting farm subsidies they want to be given a dollar's worth of market access in developing country markets," Commissioner Mandelson said. "That is not acceptable to developing countries and it's a principle that I on Europe's behalf certainly couldn't sign up to either." US trade representative Susan Schwab insisted the US remained "fully committed to multilateral trading system”.

Some remarks on poverty World Trade policies are fundamental to diminish poverty and inequality. Poverty is the main cause of violence Disparities in trade policies increase the gap among countries. Globalization and technology progress make more difficult the migration control. Restrictive policies are not the solution… eliminating miserable conditions from certain areas in the world is. But how to really help poor countries to develop?

Aid policy Instruments: Trade preferences Development aid Humanitarian aid

Aid policy

EU-US trade and investment Disputes over issues as varied as bananas, beef, trade legislation and subsidies to aircrafts. EU and US are the most important world traders. EU share in goods trade is 22.8% and 27.3% in services. US shares are 19.1% and 20.2% respectively. Each other’s largest trading partner: US accounts for 17.7% (24.2%) of EU15 total imports (exports) of goods. While EU accounts for 24.2% of total US trade of goods.

A lot of press attention Trade disputes EU - USA A lot of press attention But most disputes only touched a minimal % of trade Agriculture: USA objected to EU variable levies, domestic support and export subsidies

Preferential trade liberalization Early literature (Viner, 1953) focused on static effects of integration on welfare: Trade creation Trade diversion

Trade creation Benefit of liberalization: domestic production is replaced by cheaper imports from a partner country

Trade diversion Negative effect of preferential liberalization: more expensive imports from a partner country replace low-cost imports from suppliers in third country

Implications for the Global Trading System Questions: Can PTA expansion lead to global free trade? Do PTAs make multilateral liberalization less likely? Do PTAs lead to a rise in trade barriers against non-members? What kind of trade regimes are we likely to have with criss-crossing PTAs (Spaghetti-Bowl Phenomenon)? WTO-illegal policies in PTAs?

Can PTA Expansion Lead to Global Free Trade? Baldwin’s “Domino Theory of Regionalism” Economic incentives for outside countries to seek entry into an existing PTA Unless there are sufficiently strong non-economic factors that counter these incentives, as the PTA expands, eventually all countries want to enter the PTA Limitations of Baldwin’s analysis Trade barriers are seen as transport costs, thus the tariff revenue aspect is not taken into account Assumption that “insiders” have no incentive to block the entry

Do PTAs Make Multilateral Liberalization Less Likely? Building or stumbling blocks? (Bhagwati) Building blocks? Multilateral negotiations will move more rapidly if the number of negotiators is reduced to a handful of blocs However, if blocs take the form of FTAs, there is no effect on the number of participants One voice in EU or too occupied with internal problems? PTAs may serve as a bargaining threat

Do PTAs Make Multilateral Liberalization Less Likely? - ctd. Stumbling blocks? PTAs are mostly between developed and developing countries Such PTAs are associated in public mind (in developed countries) with large inflows of L-intensive goods and reduced wages for the unskilled This can energize and unify protectionist lobbies, generating obstacles against multilateral liberalization Multilateral negotiations, by contrast, involve both developed and developing countries and draw less attention of protectionist lobbies

Do PTAs Lead to a Rise in Trade Barriers against Non-Members? 1. Tariff-revenue objective: If a country is dependent on tariffs for revenue purposes (e.g. Africa), it may be forced to raise the external tariff to maintain the fiscal balance The more the country imports from the FTA partner, the larger the loss of revenue, the greater possibility of an increase in the external tariff and greater the trade diversion

Do PTAs Lead to a Rise in Trade Barriers against Non-Members? - ctd. 2. Political economy: when producers play the central role in determining trade policies, liberalization through FTA is likely to be replaced by increased protection against outside countries Considerable empirical evidence of increases in outside tariffs following the implementation of PTAs

The Spaghetti-Bowl Phenomenon To avoid trade deflection, FTA agreements usually include rules of origin Criss-crossing FTAs leads to a “Spaghetti Bowl” whereby tariffs vary according to origin of the product See Fig. 3: Each FTA has its own rules of origin which vary across products and transition phase For a given product, there are several different tariff rates depending on what origin is assigned to it

Spaghetti Bowl

WTO-illegal policies in PTAs PTAs can undermine the global trading system by introducing arrangements measures which are WTO inconsistent Example: Anti-Dumping provisions in the EU Czech association agreement trade-balancing requirement within Mercosur (an Argentine company operating in Brazil must export as much Brazilian goods to Argentina as it imports) These practices are not widespread