Termites in the trading system -

How preferential agreements

undermine free trade
– JAGDISH BHAGWATI

Rahul Sehgal
Roll No. 38
MIB 1st Sem
 What each Chapter is talking about
• PTA and trade agreements in 20th Century

• GATT article XXIV

• Consequences

• Prospective Solutions
 PTA (Preferential Trade Agreements)
• A Preferential trade area (also Preferential trade agreement, PTA) is a trading
bloc which gives preferential access to certain products from the participating
countries. This is done by reducing tariffs, but not by abolishing them
completely. A PTA can be established through a trade pact. It is the first stage
of economic integration.

• Why it is known as Preferential Trade?

– Discriminate against non participating countries

May not choose lowest cost source

• Trade diversion
–Switch from low cost foreign suppliers to higher cost foreign suppliers in
partner
• Trade creation
–Switch from high cost domestic production to lower cost foreign production
Contd…

• The European Union
• India and Afghanistan
• The Central American Free Trade Agreement (CAFTA)
• The North American Free Trade Agreement (NAFTA)
• The Central European Free Trade Agreement (CEFTA)
• Association of Southeast Asian Nations (ASEAN)

More than 350 PTAs have been reported to WTO and

around 200 are in effect
Contd...

PTAs during the 20th Century

• Not all trade agreements are created equal. More of a
protectionist approach.

• Beggar my Neighbour trade policy - fragmentation

of the global economy into competing trading blocs and
preferential arrangements – JOAN ROBINSON (1937).

• The right way to reduce trade barriers is on a multilateral

basis and in a non discriminatory way (MFN – most
favoured nation).
 GATT Article XXIV
• After World War II, America led the world in creating the General Agreement on
Tariffs and Trade (GATT), which did just that, by encouraging the reduction of
tariffs and liberalization of other import restrictions.

• Article XXIV of the General Agreement on Tariffs and Trade (GATT) provides an
important exception to Article 1 (most favoured nation clause) by permitting
countries to enter into preferential free trade agreements (PTAs). That is, tariff
reductions must be applied in a non discriminatory manner to all signatories to the
agreement.

• Members of FTAs like NAFTA and the custom unions (CU) like the EU should
eliminate trade barriers.

• The GATT was the only multilateral instrument governing international trade from
1948 until the WTO was established in 1995.
Contd…

• Political imperatives that led the United States to abandon its

once-principled stand on non discrimination and admit Article
XXIV's exceptions.
 US – Canada bilateral trade

• In the 1950s, six European countries were allowed to form a

common market under the exception granted by Article XXIV
of the GATT charter.

• In the 1970s, less developed members were allowed to sign

PTAs with each other.
 CONSEQUENCES
• Bad for smaller countries
– US – Columbia FTA

• The Mexico – Soft Drinks Case

– Disadvantage of NAFTA (HFCS Controversy)

• Inclusion of “Trade Unrelated Agendas”

– Labour and environmental standards
– Intellectual property enforcement.
– Social standards be grafted into trade agreements.
Contd…

• The "spaghetti-bowl" phenomenon:

– Discriminatory tariff rates
– Rules of origin
– Content requirements
– Inclusion of nontrade issues in trade agreements

An ever-increasingly complex web of preferential

commitments and rules of origin adds to the
costs of trade and weakens any sense of
responsibility to a single multilateral order.
 What should we do now?
• Things that are not possible:
– Halting the formation of PTAs
• dramatic expansion of global trade
• cross-border investment
• Output

– Consolidating agreements into less discriminatory regional blocs or encouraging PTA

members to lower their external barriers.
– Transparency Mechanism for Regional Trade Mechanisms

Only feasible solution:

Reduce global MFN tariffs to such negligible levels that PTAs no longer matter.

Depends upon future unilateral efforts at trade liberalization and further progress
at the WTO.
THANK YOU!!