WCO Research Paper No. 28

Effects of Preferential Trade Agreements on Globalization and Development

(December 2012)

Varduhi Tovmasyan

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Abstract

Proliferation of Preferential Trade Agreements (PTA) during the last two decades requires thorough

attention and evaluation of the effects they have on international trade. The PTAs are expected to

support trade liberalization and facilitate the international exchange of goods, fostering the process of

economic globalization and thus, also promoting development. However, theoretical policy analysis

suggests that the PTAs may have perverse effects due to Rules of Origin provisions, and they are a likely

impediment to the promotion of international trade and development. This paper will take an empirical

approach and compare the increasing number of PTAs to trade statistics, revealing a positive correlation

between the two. It will show that increasingly, developing countries engage in preferential trade

relations and at the same time increase their significance in world trade.

Key words

Preferential Trade Agreements (PTA), Rules of Origin (RoO), globalization, development

Acknowledgements

This paper was written by Varduhi Tovmasyan of the WCO’s Compliance and Facilitation Directorate.

The author is grateful to Allen Bruford, Mette Azzam, Atsushi Tanaka and Man-Hee Jo for their

suggestions.

Disclaimer

The WCO Research Paper Series disseminates the findings of work in progress to encourage the

exchange of ideas about Customs issues. The views and opinions presented in this paper are those of

the author and do not necessarily reflect the views or policies of the WCO or WCO Members.

Note

All WCO Research Papers are available on the WCO public website: www.wcoomd.org. The author may

be contacted via research@wcoomd.org.

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Copyright © 2012 World Customs Organization. All rights reserved.

Requests and enquiries concerning translation, reproduction and adaptation rights should be addressed to copyright@wcoomd.org.

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Introduction

Global processes shape an essential part of today's social reality, where existing margins

between cultures, national economies and states are being dissolved. Central to this process is

the recent and increasingly rapid progress of economic globalization. A genuinely global

economy is in the process of emerging, whereas the importance of individual national

economies is decreasing. This process will likely continue to reduce the economic inequality

that currently exists between developed and developing countries. For this reason,

international and intergovernmental institutions are actively involved in creating supporting

conditions for the expansion and productive functioning of a thoroughly international economy

by empowering international trade. These efforts respond to developments in the world

economy and adjust the policies governing international trade.

Since the 1990s, the system of international trade has experienced major changes. In the pre-

Uruguay Round atmosphere the attention of the multilateral trading system was centred on

border measures in trade in goods. Structural and economic challenges encountered by the

developing countries were highlighted, and some special and differential treatment was

provided to those countries. This was realized through non-reciprocity in trade relations

(concessions) that include preferential market access.1

The post-Uruguay Round trading milieu is different in several respects. An essential number of

developing and transforming countries have joined the World Trade Organization (WTO),

established in 1995 as a result of the Uruguay Round of multilateral trade negotiations under

the Generalized Agreement on Tariffs and Trade (GATT). The WTO played a profound role in the

transformation of the world’s trading system. In comparison with GATT 1947, the WTO’s

activities extended the scope of the trading systems which now also include services, trade-

related aspects of intellectual property rights and investment. The successful efforts to lower

tariffs and extend trade disciplines to development policies had a profound positive impact on

the inclusion of developing countries in international trade.

1 Among many possibilities, the most important for preferential market access is perhaps the generalized system of

preferences (GSP) which was negotiated under UNCTAD auspices and the Lomé Convention that the European

Union granted to African, Caribbean and Pacific countries. Note that non-tropical agricultural exports were either

excluded from preferential schemes or subjected to quotas. Quotas were also established for textiles and clothing

which was regulated by Multi-Fibre Arrangement (MFA). Market access for manufactured products was subject to

administrative restrictions such as rules of origin.

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The freer trade encouraged by the GATT/WTO system over the last 65 years certainly has

contributed to advancing world trade and global economy, and thus pushed forward trade-

driven globalization. The wide capacity of WTO arrangements has special implications for

developing countries to become more proactive in development strategies. The system of

preferential trade is a technique for establishing economic equilibrium at the development

level among the world's countries.

The Doha Round of multilateral trade negotiations, started in 2001, targets multilateral trading

systems and promotes development through multilateral economic collaboration. The Doha

Round reflects goal 8 of the Millennium Development Goals which is focused on the

establishment of “an open, equitable, rule-based, predictable and non-discriminatory

multilateral trading and financial system”. The importance of international trade in economic

growth and development is also highlighted by the World Customs Organization, particularly in

its document entitled “Customs in the 21st Century.”

There is an important synergy between economic globalization, the enhancement of

international trade opportunities and the economic development of nations. The content of

international trade is largely defined by preferential trade agreements (PTA) that shape the

implications of economic integration on different levels. The PTAs are also important tools used

to stimulate a nation's economic progress. An understanding of the role of preferential trade

agreements is especially important in today's reality, as an essential portion of international

trade takes place within preferential trade areas. There have been attempts to evaluate the

role of preferential trade agreements and to analyse the effects of the Rules of Origin (RoO) –

one of the most important instruments of the PTAs – but those analyses have mainly been

theoretical speculation. This paper endeavours to provide statistical verification for the

arguments derived from theoretical analysis. In the context of globalization, it evaluates the

role played by PTAs in trade-driven development promotion. In other words, the purpose of

this analysis is to understand if the PTAs with origin provisions promote globalization and

contribute to development or on the contrary, provide impediments and obstacles to

international trade and thus also to development.

This paper will first focus on globalization, particularly economic globalization, applying a

historical perspective. Here, different levels of economic integration, as well as the different

effects of economic globalization, are discussed.

The second section is a theoretical analysis of the role of PTAs in international trade. The role of

PTAs is discussed, with a focus on the rules of origin provisions, highlighting the possible

positive and negative effects that they may have on trade internalization.

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The final section analyses trade statistics, proposing empirical evidence for the existing positive

correlation between the number of PTAs and the trade volume during the last two decades. In

particular, it focuses on the trade of developing countries and shows that the proliferation of

PTAs in the developing world has been accompanied by an expansion of trade in those

countries.

A limitation of the analysis, however, is that though it shows the correspondence between the

number of PTAs and trade volume, it lacks specific statistical evidence that shows definitively

how the adoption of a PTA alters the trade within the preferential trade area and what specific

factors impact intra- and interregional trade. Further studies are required to reveal the specific

reasons of this dynamism.

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1. Globalization and international trade

Globalization is an important feature of modern society. It is one of the most powerful forces

that determine the further development of the world. The term globalization highlights the

variation in societies and in the economy that are the consequence of significantly increased

cultural exchange, cross-border trade and international investment. Globalization is about

intensifying processes of international exchange and collaboration in an open, integrated

environment as well as about the unprecedented increase in world trade. It is a truly complex

process and affects all aspects of society.

Main features of Globalization

Very often, three phenomena are mentioned as being the main features of globalization:

technological progress, liberalization of trade, and expansion of organizations' activities.

Technological progress led to a drastic reduction of transport and communication costs,

essentially a decrease in the costs of processing, storage, access and use of information. With

the creation of e-mail and the World Wide Web, these tools became central to establishing a

low-cost, high-quality, uninterrupted exchange of information.

Liberalization of trade and, in general, economic liberalization brought the politics of

protectionism to a minimum and thus made global trade substantial. This process was

accompanied by lower barriers to trade, particularly by the reduction of tariffs. The

liberalization measures led to an increased movement of capital and other production factors.

The other feature of globalization, the significant expansion of organizations' activities,

became possible due to technological progress and enhanced managing possibilities via new

means of communication. Thanks to this, companies that earlier were focussed only on local

markets have expanded their production and marketing opportunities, reaching a multinational

and even global level.

There is an interesting synergy between globalization and economic activities, particularly

trade: liberalized trade is an essential source for globalization and, at the same time,

liberalization of trade is possible thanks to the changes brought by the process of globalization

(advanced technologies, particularly communication and production technologies, enhanced

logistics, etc.). Economists and specialists in the field of political economy portray globalization

as a process of increasing exchange of goods among nations based on stable institutions that

allow individuals and companies located in different countries to trade with minimal friction.

The process of goods exchange has an interesting evolution and is worth a brief discussion from

a historical perspective.

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Historical perspective on globalization and trade

Highlighting the fact that the increasing exchange of goods is an attribute of globalization, it has

been recognized that globalization is not a recent phenomenon; rather, it has been an ongoing

process since the pre-modern era. In fact, rudimentary elements of what is now called

globalization have been identified even in the ancient era, dating back to the Roman Empire in

Europe and the Han Dynasty in China. From approximately 200 B.C. until 400 C.E., the ancient

Silk Road was operational. The Silk Road was made possible by the existence of the first trading

networks, and at the same time itself made possible other trading networks. While the Silk

Road was operating, merchants facilitated the exchange of goods as well as, most importantly,

the contact of cultures throughout almost all of Eurasia. The collapse of the Roman Empire and

the Han Dynasty brought an end to the first appearance of inter-regional trade and exchange of

ideas.

Long-distance trade began to re-emerge around the 6th century C.E. At this stage, trade paths

reached even further destinations and became even busier thanks to more frequent use of the

sea-routes across the Indian Ocean. Traders again connected Europe and Asia, and with them

missionaries and explorers started to travel, facilitating cultural exchange.

In the 13th century the conquest by the Mongols of a great part of Eurasia created the most

culturally and technologically advanced country to date. Roads built throughout the territories

conquered by the Mongols connected China, the Near East and Europe, and made possible

traders’ movement across a huge area. Along with goods, merchants transferred also ideas,

practices and technologies between the Asian and European continents. This era can be justly

considered as the first era of globalization, though only on the Eurasian level. This period

became less and less active by the 14th century with the spread of disease and outbreaks of

plague, also spread by overland travel. Long-distance trade did not vanish altogether, but its

volume largely decreased.2

The acceleration of trade between continents and nations only restarted in the 19th century and

was based on the Pax Britannica, under which the British Empire controlled most of the

important naval trade routes. This stage was accompanied by industrialization and was marked

2 More on this: Bentley, J., 1993. Old World Encounters: Cross-Cultural Contacts and Exchanges in Pre-Modern

Times. Oxford University Press.

Findlay, R., 2002. Globalization and the European Economy: Medieval Origins to the Industrial Revolution. In Henry Kierzkowski (ed.), “Europe and Globalization”. Palgrave Macmillan.

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by widespread use of currencies. The gold standard, established in more influential

industrialized states around 1850-1880, facilitated an effective exchange of goods between

nations. This era of progressive development in production and trade was disrupted by World

War I and later with the crisis of the gold standard at the end of the 1920s and at the beginning

of the 1930s.

Political and economic turmoil in the early 1900s considerably decreased the volume and value

of international trade. The globalization process, shaken by the start of the World War I, kept

disintegrating until the end of World War II, the aftermath of which was marked by destroyed

economies and shuttered trade relations. Toward the end of World War II, with the creation of

the Bretton Woods institutions (the International Monetary Fund and the World Bank in 1944)

and the establishment of the General Agreement on Tariffs and Trade in 1946, the situation

started to change. Economic platforms initiated by these institutions to eliminate the effects of

the war created a positive atmosphere for investments, for expanding economic collaboration

between states and for international trade. It took about two decades to achieve perceptible

results in terms of trade flows and investments. Already by the late 1960s a number of

countries began to experience a period of uninterrupted economic expansion.

Trade negotiation rounds, under the patronage of the General Agreement on Tariffs and Trade,

established a number of arrangements to remove restrictions on trade and to promote free

trade. The Uruguay Round established a treaty that founded the World Trade Organization to

arbitrate trade disputes. Some later agreements, such as the Maastricht Treaty and the North

American Free Trade Agreement, were initiated to further reduce tariffs and other barriers to

trade.

Types of economic integration

The reduction of tariffs and the elimination of trade barriers created an atmosphere of

cooperation between nations, thus promoting economic integration. The latter is central for

the current understanding of globalization as it refers to the increasing economic inter-reliance

of countries through the increasing size and range of international exchange of products,

services and capital. Several forms of economic integration can be identified today. Perhaps the

most widely spread form of economic integration is the Free Trade Area, where all involved

countries eliminate all trade barriers between each other but are responsible for defining their

policies and relations with non-member countries3. Customs Unions are another form of

3 Examples of free trade areas are the North American Free Trade Agreement (NAFTA) and the ASEAN Free Trade

Area (AFTA).

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economic integration, very much similar to a free trade area. The main difference is that

members involved in customs unions need to establish similar external economic relations with

non-member countries4. The Common Market is a customs union where, in addition to the free

trade of goods and services, the free movement of capital, workforce and technology is also

possible5. Those common markets where monetary and fiscal policies are also correlated form

Economic Unions where participating nations develop a central body to coordinate economic

and trade policies. In other words, economic unions can be described as a ‘single country’ but

only from an economic perspective6. A step further from economic unions is the Political

Union, where participating nations give up an essential part of their economic and political

sovereignty and together form a new political and economic unit7.

It is easy to notice that moving from a free trade area to a customs union, to a common market,

to an economic union and finally to a political union, the level of economic integration is

enhanced and these forms reflect the degree of economic integration within a region8. The

agreements establishing free trade areas (FTA) form the bases for the economic integration at

any degree. Thus, in the context of globalization, free trade agreements have a significant

importance.

Effects of economic globalization

From an economic perspective, the concept of globalization is applied to distinguish the

developments in the fields of production, financial markets and financial investment. More

specifically, this notion denotes the upshots of trade, especially the free trade or trade

liberalization. In general use the concept of liberalization signifies the amalgamation of so-

4 The Andean Community (CAN) is a customs union.

5 The Southern Common Market (MERCOSUR) is an example of common market.

6 The Caribbean Community and Common Market (CARICOM) is an example of an economic union.

7 Political unions can be of various types; federal states are only one example of political unions.

8 Economic integration is also possible by multilateral cooperation, which promotes economic collaboration on a

global level, yet the above mentioned forms of integration focus mainly on regional integration. Multilateral cooperation agreements are drafted to administer general trade both in products and services (WTO is one of the organizations responsible for these matters) and to coordinate investments or to secure fiscal stability (the WB or IMF are examples of responsible institutions). Thus, currently international economic integration takes place on two levels – global (facilitated by international/intergovernmental organizations) and regional (mainly though economic collaboration agreements). The most recent period of globalization led by nation states, national economies, and national identities is being replaced with the processes promoted and facilitated by liable intuitions on regional and global levels.

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called laissez-faire economic doctrine and the removal of barriers for the movement of

products. As a result of this process, a growing number of nations have started to specialize in

exports, and barriers to the free trade, such as protective tariffs, were forced to end9.

Moreover, it also became possible to set up production with branches in different countries. So,

economic globalization, which improves relations and expands free trade between numerous

parties of an industry in different nations, diminishes the domination of any one nation in the

economic realm.

Market-oriented globalization specialists point out that free trade makes possible the cost-

effective distribution of resources and creates an environment where all involved countries can

benefit (see for example Levitt (1983); Gill (1995). This kind of economic relationship generates

more employment, increase productivity, decreases prices and provides better consumption

opportunities.

Supporters of laissez-faire economic relationships suggest that greater political and economic

freedoms extend the market economy and generate a better democratic reality, making it

possible to increase material wealth. From this perspective, globalization supports

development through the diffusion of democracy and market economy.

The current process of globalization has had a number of positive effects with regards to

communications, the delegation of centralized power, and economic efficiency. Some contend,

however, that of this process can also work against the public interest. Fair trade supporters

argue that free trade provides beneficial opportunities inequitably to those that have more

financial power10.

Wide-reaching statistics provide evidence of globalization's positive effects. They show that

with the acceleration of globalization, the percentage of the population living under the poverty

line is decreasing (by 50% over the last two decades); life expectancy is being enhanced; infant

mortality is reducing; and the disproportion of earnings on a global level has decreased11.

While the Great Recession has slowed the benefits of globalization, the positive trends will

likely resume when the global economy recovers.

9 This process is still ongoing.

10 Critics of globalization target different aspects of the process, such as the so-called ‘imperialistic’ nature of the

globalization, imposed credit-based economics, and a corporate agenda, but in the framework of this paper the effects of globalization on trade realized within the margins of free trade agreements will mainly be analyzed.

11 International Monetary Fund. Globalization: A Brief Overview, issue 02/08, May 2008

10

A correlation between economic globalization, the promotion of global trade and economic

development is evident. The role of PTAs in defining the conditions of global trade is central, as

they outline the framework of international trade. A theoretical analysis of the role of PTAs and

the impact they have on international trade is presented in the next section.

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2. PTAs and international trade

Preferential trade arrangements are important instruments of international trade, and they are

gaining more and more attention due to their increasing number over the last two decades. In

the early 1990s, only about 50 Preferential Trade Agreements (PTA) were counted. As of April

2012, the number of Regional Trade Agreements (RTA)12 for goods and services recorded by the

GATT/WTO had reached 511. Of these, 319 agreements are already in force. The number of

trade agreements being ratified is steadily increasing. This trend is likely to be strengthened

due to a large number of trade agreements that are currently under negotiation. Free trade

agreements and partial scope agreements account for 90% of all PTAs, the remaining 10% being

customs unions13.

Preferential trade agreements are ever more consequential to the world economy and to the

process of economic globalization. They may alter the international economic environment to

an essential extent. Nowadays, approximately 30%14 of global trade takes place on a

preferential basis15.

Even more, every country in the world, with a few exceptions, has at least one preferential

trade agreement. The great majority of these countries are signatories to multiple PTAs at the

same time; some, like Mexico, Japan, and the United States, belong to more than a dozen

preferential trade agreements at once. PTAs have enabled the parties of the agreement to

benefit from a crucial preferential edge in overseas markets. At the same time, they provide

opportunities for economies to advance by creating an attractive environment for foreign direct

investment, accelerating development and progress and facilitating cross-border collaboration

between countries.

12 Though the World Trade Organization uses the term Regional Trade Agreement, in the frames of this paper's

analysis preference is given to the term Preferential Trade Agreement as many of them extend further than the regional level and establish preferential trade relations between countries belonging to different regions.

13 These WTO figures correspond to 390 physical RTAs (counting goods and services together), 211 of which are

currently in force. More details are available at: http://www.wto.org/english/tratop_e/region_e/region_e.htm . This site was last retrieved 25 November, 2012.

14 This figure also includes intra-EU trade, without which around 16% of world trade is regulated by preferential

trade agreements.

15 In the case of the Americas, Preferential Trade Agreements are regulating trade nearly in its entirety. For

instance, countries like the United States of America, Mexico and Chile have established trade agreements with all of their main trading partners.

12

Such swift and systematic proliferation of PTAs has attracted the attention of trade and

economic analysts and has generated a controversial policy debate about the impact of those

agreements. Some analysts argue that PTAs facilitate trade creation, and others claim that PTAs

impede or, in the best case, divert the trade. In this context it is essential to clarify if PTAs cause

a deviation from global trade or, on the contrary, if they function as a facilitator for a global

exchange of goods and thus also promote economic development. In other words, what is the

input of PTAs in the process of economic globalization and what role do they play in the

promotion of development?

Contentious views about the effects of PTAs are not unanticipated, as even from the very first

glance at preferential trade agreements it becomes obvious that countries engaged in such

agreements gain preferential treatment in accessing and operating in the markets covered by

that agreement. This means that PTAs provide a market access advantage for insiders and

isolate the rest of the world. In this context, PTAs very often may be considered to have the

opposite effect of the most-favoured nation principle (MFN) 16, which has been the essence of

the post-war multilateral trading system.17

Indeed, PTAs are very complex and some component disciplines of those agreements may not

necessarily promote trade liberalization. The provision of the rules of origin (RoO) very often is

viewed as such. The RoOs are considered as a protectionist, vague and unclear trade policy

instrument that nullifies the benefits of tariff liberalization enabled by the PTAs.

16 The most-favored-nation principle is applicable to all WTO signatory countries and signifies that member

countries cannot normally discriminate between their trading partners or grant any of the countries a special condition (for instance, a lower customs duty rate for any of their products). Otherwise, they must do the same for all other WTO members. This principle is laid down in the first article of the General Agreement of Tariff and Trade (GATT) for trade in goods, in the second article of the Agreement on Trade in Services (GATS) and as the fourth article of the Agreement of Trade-Related Aspects of Intellectual Property Tights (TRIPS).

17 These concerns didn’t pass unnoticed by the Doha Trade Round negotiations at the WTO where RTAs are

regarded as a priority in the multilateral talks. The 29th

paragraph of Doha Declaration states: “We also agree to negotiations aimed at clarifying and improving disciplines and procedures under the existing WTO provisions applying to regional trade agreements. The negotiations shall take into account the developmental aspects of regional trade agreements”. DOHA WTO Ministerial 2001: Ministerial Declaration, 20 November 2001.

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The role of RoO in trade internationalization

During the last two decades, not only has the number of PTAs multiplied but also the content of

those PTAs has remarkably expanded. Currently, they cover trade disciplines like conditions for

market access for goods and also for services, instruments, standards, government

procurement, labour regulations, etc. The result of this complication is a broadened interest by

political entities to participate in shaping and negotiating PTAs, expanding policy debates on

preferential trade among political actors and also in academic circles. The most analyzed, and at

the same time the least understood discipline in a PTA, is the provision of the rules of origin

because they are, in fact, the most important instrument of discrimination set in the agreement

itself. In general terms, the RoOs define the processes to be carried out and/or the elements to

be incorporated in a final good within a specific preferential trade area in order for the final

good to gain originating status in that preferential trade zone and thus to be qualified for

preferential treatment.

The main purpose of the RoO is to avoid trade deflection by preventing the shipment of goods

from a non-PTA area to a higher-tariff PTA member through a low-tariff member. In this way

the RoO prevent non-PTA members from benefiting from the preferential market access that is

granted solely to PTA partners.18 Thus, the RoO can be described as gatekeepers of

international trade: any product exported from a PTA member country to benefit from

preferential treatment in the importing country must meet the conditions established by the

RoO. So, if a failure to meet the RoO disqualifies an exporter from preferential treatment in a

PTA-area, RoO must be regarded as a central instrument for market access. But what makes the

RoO especially important is that almost never are they an impartial instrument. It is predictable

that if the RoO can discourage or even prevent trans-shipment of goods, political economy may

use these rules for purposes other than prevention of trade deflection.

The role of the RoO in the political economy has been analysed from different perspectives.

Often they are regarded as a trade policy instrument that may contribute to or counterbalance

the benefits of tariff liberalization. Most importantly, the RoO can be used to promote

industrial and commercial connections within a preferential trade area and obstruct the

economic relations outside the preferential trade area. The result of such a function is the

18 RoO are innate for those free trade agreements where the member states have different external tariffs or

where member parties prefer to keep their individual tariff policies vis-à-vis the rest of the world. As well, customs unions may have RoO, where they play the role of a transitory tool in the process of establishing a common external tariff (CET), though sometimes RoO are permanent tools in customs unions and they deal with product categories for which it is impossible to establish a CET (for example, for sensitive products or for product tariff differentials that have essential differences between member countries).

14

indirect protection of intra-PTA input production and intra-PTA industry linkages against those

linkages that are between a PTA and the rest of the world. As such, the RoO indirectly protect

PTA-based input producers vis-à-vis their competitors outside the PTA area19. In such scenarios,

RoO have a similar function with the duty imposed by an importer country on a middle

product20. Hence, it is possible that a PTA member can use the RoO to secure the market for its

intermediary goods in the partner economies21. Even more, governments can use the RoO to

attract investments especially in those segments of the economy that provide more jobs and

offer higher added value22. More importantly, as the RoO define the products’ access to the

global market, the role they play on firms’ decisions on investments, outsourcing and exports is

significant. The real effect of RoO as gatekeepers of trade becomes more vivid when the

preferential tariff liberalization is essential and when the gap between multilateral and

preferential tariffs is so big that exporters prefer preferential trade arrangements and the

compliance with the RoO over the conditions proposed by the MFN.

The analyses show that restrictive and selective RoO can have negative effects on trade flows.

Estevadeordal and Suominen mention that at the sectoral level both restrictive RoO and

19 Krishna, K. and Anne O. K., 1995. “Implementing Free Trade Areas: Rules of Origin and Hidden Protection.” In

Alan Deardorff, James Levinsohn, and Robert Stern (eds.), New Directions in Trade Theory. Ann Arbor: University of Michigan Press.

Krueger, A. O., 1993., “Free Trade Agreements as Protectionist Devices: Rules of Origin.” NBER Working Paper No. 4352. Cambridge, MA: National Bureau of Economic Research.

Cadot O. and de Melo, J., 2007. "Why OECD Countries Should Reform Rules of Origin," World Bank Research Observer, Oxford University Press, vol. 23(1), pages 77-105, October.

20 Falvey, R., and Reed, G., 2000. “Rules of Origin as Commercial Policy Instruments.” Research Paper No. 2000/18.

Nottingham, U.K.: Centre for Research on Globalization and Labor Markets, University of Nottingham.

Lloyd, P. J. 2001. “Rules of Origin and Fragmentation of Trade.” In Leonard K. Cheng and Henryk Kierzkowski (eds.), Global Production and Trade in East Asia. Boston: Kluwer Academic.

21 Krueger, A.O., 1993; Krishna and Krueger, 1995;

Chase K. A., 2008. “Protecting Free Trade: The Political Economy of Rules of Origin,” International Organization.

22 Jensen-Moran, J., 1996. “Trade Battles as Investment Wars: The Coming Rules of Origin Debate.” Washington

Quarterly 19(1):239–53.

Hirsch, M., 2002. “International Trade Law, Political Economy and Rules of Origin: A Plea for a Reform of the WTO Regime on Rules of Origin.” Journal of World Trade 36(2):171–89.

15

selectivity in RoO for final goods encourage trade in intermediate goods.23 In other words,

restrictive RoO generate diversion of trade in intermediate goods. Nevertheless, those regime-

wide RoO that operate in the same way in all sectors of a particular preferential trade

agreement (though they can alter from PTA to PTA) like cumulation and de minimis, make the

application of product-specific rules more flexible and thus encourage trade. In this way,

regime-wide RoO can counterbalance the negative effects of restrictive product-specific RoO on

trade.

Without a doubt, the introduction of the RoO in preferential trade agreements may affect trade

flows. PTAs without RoO provisions would also have a robust impact on trade patterns as for

obvious reasons the trans-shipment of goods via a PTA partner economy with the lowest

external tariff would rise dramatically. The effect of preferential agreements would be

extremely liberalizing, as the lowest applicable tariff would be applied to every import.

However, the application of the RoO may possibly reduce the imports of inputs to the

preferential trade area from the rest of the world, as the producers would prefer to source

intermediate goods within the PTA area and get a preferential treatment for the final products.

Accordingly, it is predictable that the trade within the PTA area would increase. Nevertheless, it

is also possible that the same rules of origin in the long run can moderate this boost in trade of

intermediate goods in the PTA area: it is a well-known fact that increased demand for goods

raises their price; hence the increased prices on inputs will increase the production costs for the

producers acting within the PTA. This, in turn, may reduce the level of production of the final

goods in the PTA area and thus also reduce the demand for inputs within the PTA24.

Consequently, RoO provisions may gradually decrease trade in both intermediary and final

goods within a PTA area.

Thus, the analysis on the theoretical level shows that the rules of origin provisions affect the

intra- and inter-PTA trade either positively or negatively, and as trade plays a central role in the

23 Estevadeordal, A. and Suominen K., 2008. “ What Are the Trade Effects of Rules of Origin?” in Estevadeordal A.

and Suominen K (eds) “Gatekeepers of Global Commerce Rules of Origin and International Economic Integration”. Inter-American Development Bank.

24 The following authors in their analyses show how the rules of origin provisions can alter the commerce in

intermediate goods in the PTA area:

Duttagupta, R. and Panagariya, A., 2001. “The ‘Gains’ from Preferential Trade Liberalization in the CGE Models: Where do they Come From?”. University of Maryland.

Ju, J. and Krishna, K. 1998., “Firm Behavior and Market Access in a Free Trade Area With Rules of Origin”. National Bureau of Economic Research, Working Paper No. 6857. Cambridge.

16

process of globalization and promotion of development, the RoO gain particular importance.

The next section analyses the trade statistics of developing countries. Data of the last two

decades are considered to identify if/how the proliferation of the preferential trade

agreements affected the trade flows.

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3. Analysis of trade statistics

Globalization and the expansion of international trade have not left out developing countries.

Agreements establishing preferential economic and trade relations between developing

counties, as well as between developing and developed countries, have become more frequent

than ever in recent decades. Not only is the number of preferential trade agreements between

developing countries increasing, but also the significance of the share of these countries in

world trade. The growing importance of developing countries in international trade is largely

due to enhanced opportunities for economic relations established by preferential trade

agreements and the environment created by globalization.

In this regard, the trade performance of developing countries is rather informative.

International trade statistics indicate that until the mid 1990s, developing counties played a

marginal role in international trade, and economic cooperation among developing countries

had been a political ambition rather than a reality. However, during the last two decades

developing countries have moved towards the centre of global trade to an essential extent,

achieving a significant role in international economic relations. It has already been mentioned

that trade is an important driver for economic progress in the developing world and global

trade statistics demonstrate that the share of developing countries in international trade has

multiplied since 1990s. Table 1 reveals that the share of developing countries in world trade has

steadily grown since 1990, when it was only 23.3% of the entire world trade. In 2010, it

constituted 40.4% of world trade. During this period, the share of developing countries

increased by more than 7.4 times, while aggregate world trade increased only by about 4.2

times. This speaks to the growing significance of the developing world in the world trade scene

and provides evidence of the existing correlation of the number of preferential trade

agreements and the trade value.

Table 1: Trade Volume of Economies on Different Levels of Development

Region, country or territory

Trade / millions of USD

1990 2000 2005 2008 2009 2010

WORLD 7,081,707 13,107,384 21,296,807 32,550,754 25,009,462 30,527,694

Developing economies 1,652,693 3,972,618 7,223,000 12,039,457 9,531,121 12,340,804

Transition economies 258,654 259,208 634,868 1,350,288 885,243 1,108,417

Developed economies 5,170,358 8,875,557 13,438,940 19,161,009 14,593,098 17,078,473 Developing countries share in world trade (in %)

23.3 30.3 33.9 37 38.1 40.4

Source: Data is compiled based on UNCTAD's Handbook of Statistics, 2011

18

The importance of trade in the creation of favourable conditions for development has been

proven and, moreover, it has been demonstrated that development can be sustainable only in a

fair trade environment. The last two decades, and the forecast for the coming ones, are marked

by the increasing impact of commerce on development and economic progress. The scale and

the value of trade, its expansion and effects on development constitute the key aspects of

globalization.

World exports increased fourfold between 1990 and 2010, and reached 15 trillion USD in 2010.

Since 1990, world trade has been increasing at an average rate of more than 7% annually and

since 2000 it has increased up to 12.5% on average (see Table 2). An important factor for the

expansion of world trade has been the impressive increase by the vibrant developing countries.

The share of the developing economies in exports has constantly increased since 1990, when it

was only 24.3% of the entire world export. The share in worldwide exports of the developing

countries scored 41.8% in 2010. Import-wise, it increased from 22.4% to 39.5% during the same

time period. It is interesting to note that the increase of the developing countries’ share in

world exports and imports has taken place along with the decrease of the share of developed

countries. In 1990, developed economies accounted for 72.3% of world exports; in 2010 it was

only 54.2%. Their share in imports dropped from 73.7% to 58.4%. The trade value of the

economies in transition in the global trade did not change much between 1990 and 2010 -

respectively 3.4% and 4.1% for exports, and 3.9% and 3.2% for imports.

19

Source: Data compiled and calculations made based on UNCTAD's Handbook of Statistics, 2011

Table 2: Export and Import shares in the world trade of different economies

Region, country or

territory

Exports

1990 2000 2005 2008 2009 2010

million USD

share in

world trade in %

million USD

share in

world trade in %

million USD

share in

world trade in %

million USD

share in

world trade in %

million USD

share in

world trade in %

million USD

share in world

trade in %

WORLD 3,485,651 100 6,448,493 100 10,504,579 100 16,099,612 100 12,419,054 100 15,174,439 100

Developing economies 847,708 24.3 2,056,004 31.9 3,806,302 36.2 6,279,876 39.0 4,908,322 39.5 6,339,389 41.8

Transition economies 118,709 3.4 154,514 2.4 363,055 3.5 740,103 4.6 478,651 3.9 617,544 4.1

Developed economies 2,519,233 72.3 4,237,975 65.7 6,335,222 60.3 9,079,633 56.4 7,032,081 56.6 8,217,505 54.2

Region, country or territory

Imports

1990 2000 2005 2008 2009 2010

million USD

share in

world trade in %

million USD

share in

world trade in %

million USD

share in

world trade in %

million USD

share in

world trade in %

million USD

share in

world trade in %

million USD

share in world

trade in %

WORLD 3,596,056 100 6,658,891 100 10,792,228 100 16,451,142 100 12,590,408 100 15,353,255 100

Developing economies 804,985 22.4 1,916,614 28.8 3,416,698 31.7 5,759,581 35.0 4,622,799 36.7 6,001,415 39.5

Transition economies 139,945 3.9 104,694 1.6 271,813 2.5 610,185 3.7 406,592 3.2 490,873 3.2

Developed economies 2,651,125 73.7 4,637,582 69.6 7,103,718 65.8 10,081,376 61.3 7,561,017 60.1 8,860,968 58.4

20

The preferential agreements between developing economies create an effective environment

for those economies to engage in economic relations and to initiate cross-border production

and trade of both intermediate products and final goods. As a result, an increasing number of

developing countries advance economically, speed up their development and diversify the

production, and offer bigger and higher value markets for merchandise from other developing

countries. The growing economic interdependence of developing countries establishes a new

environment for business and commerce. Thus, the trade agreements meant to facilitate the

establishment of a trade relationship in a mutually beneficial way do lead to positive results, a

statement confirmed by data provided by the UNCTAD South-South25 trade information system.

It also indicates that the core of the South-South trade is taking place within the regions

established by economic agreements (chart 1).

Chart 1: Exports of Developing Countries to Developing Countries (2010): Total USD 3,459,941

Source of statistics: UNCTAD South-South Trade Information System

The growth of intraregional commerce may be evidence that regional trade agreements among

developing countries provide a framework for trade liberalization and intraregional trade

25 In the UNCTAD South-South information system the notion South is the generalized name for 139 developing

countries and the notion North is applied to continuum of 57 developed countries and economies in transition. Thus, South-South trade describes the aggregate trade between developing countries.

Asia Intra Asia 2,577,484

Americas Intra Americas

171,392

171 392

Africa Intra Africa

58,795

179,766

15,527

15,940

126,268 166,681

148,094

21

materialization. What is important is that not only is the trade between countries within the

regions multiplying but so is the inter-regional trade of the developing regions (Table 3). More

and more countries from different developing regions are engaging in trade and thus further

intensifying the economic collaboration among developing countries.

Table 3: Exports and Imports of Developing Countries

Developing

economies: Asiamillion USD % million USD % million USD % million USD % million USD % million USD %

World 1 083 576 100 2 895 766 100 4 993 206 100 1 125 010 100 2 608 447 100 4 624 667 100

All Developing

economies505 741 46.7 1 480 431 51.1 2 933 130 58.7 459 233 40.08 1 460 556 56 2 777 505 60.1

Developing

economies: Africa21 349 2 71 202 2.5 166 681 3.3 14 957 1.3 53 488 2.1 145 478 3.1

Developing

economies:

Americas

24 993 2.3 63 291 2.2 179 766 3.6 19 782 1.8 61 164 2.3 168 777 3.6

Developing

economies: Asia458 640 42.3 1 340898 46.3 2 577 484 51.6 423 664 37.7 1 344 188 51.5 2 460 203 53.2

Developing

economies:

Americas

World 230 258 100 575 862 100 868 466 100 243 000 100 516 843 100 865 203 100

All Developing

economies65 119 28.3 165 443 28.7 335 060 38.6 67 270 27.7 202 170 39.1 403 922 46.7

Developing

economies: Africa3 025 1.3 9 517 1.7 15 527 1.8 2 484 1 11 110 2.1 16 513 1.9

Developing

economies:

Americas

6 146 20 105 902 18.4 171 392 19.7 45 492 18.7 108 823 21.1 178 307 20.6

Developing

economies: Asia15 928 6.9 49 990 8.7 148 094 17.1 19 277 7.9 82 206 15.9 209 045 24.2

Developing

economies: Africa

World 113 115 100 318 066 100 492 803 100 124 581 100 261 673 100 491 799 100

All Developing

economies37 874 33.5 95 690 30.1 201 152 40.8 43 507 34.9 110 951 42.4 238 744 48.5

Developing

economies: Africa23 878 21.1 28 842 9.1 58 789 11.9 22 058 17.7 34 531 13.2 61 409 12.5

Developing

economies:

Americas

2 385 2.1 12 322 3.9 15 940 3.2 3 040 2.4 9 842 3.8 21 719 4.4

Developing

economies: Asia11 602 10.3 54 497 17.1 126 268 25.6 18 398 14.8 66 491 25.4 155 311 31.6

Developing

economies in total

World 1 432 450 100 3 796 590 100 6363625 100 1 499 186 100 3396566 100 5995059 100

All Developing

economies609 549 42.6 1 743 758 45.9 3472209 54.6 571 194 38.1 1777519 52.3 3425827 57.1

1995 2005 2010

Exports Imports

1995 2005 2010

Source: Data compiled from UNCTAD Handbook of Statistics, 2011

22

The trade performance between developing countries in recent years is indeed outstanding. It has essentially increased since 1995, rising from 1.2 billion USD to 6.9 billion in 2010, a six-fold increase in 15 years (see Table 3). Consequently the share of developing countries in world exports has also increased, rising from 24.3% in 1990 to 39.5% in 2010 (Table 2).

Chart 2 presents the most recent data describing the value of exports from developing countries in world trade. In 2010, 41.8% of world export was from developing countries, more than half of which (54.6%) was directed to other developing countries. This is a very significant number, especially if we take into consideration that in 1995 the exports of developing countries to other developing countries was 42.6 % of the world exports (see Table 3). Indeed, developing economies are increasingly engaging in trade relations with each other.26

Chart 2: The value of developing country exports in world trade (2010)

Data presented in the chart is compiled from UNCTAD Handbook of Statistics, 2011

The intensified trade between developing economies has further encouraged regional and

inter-regional economic collaboration, and also economic integration. The emergence of the

vibrant economy in the developing world has emphasized the need for new markets and the

26 An important caveat that should be noted is that some countries have a leading role in the trade of developing

countries. Among more influential exporters in the cohort of developing countries are China, Hong Kong China, the Republic of Korea, Singapore and Saudi Arabia. Many of the developing countries still need to be better integrated and benefit from provided opportunities.

23

consumers’ growing demand for goods with competitive price. An important correlated aspect

is the trade relationship between developing and developed countries, as developed countries

provide the main market for the final products of the developing ones. Consequently, trade

relations established between developing and developed countries are becoming more

dynamic and more central both in terms of quantity and quality.

Leading trading nations and economic groupings increasingly institute trade agreements with

geographically adjacent developing countries, as well as with countries and economic regions

that are distant – for instance EU-MERCOSUR, EU – ASEAN, EFTA – Korea, etc. Furthermore, a

number of countries - including Japan, Republic of Korea, China, India - that in the past tried to

avoid regional trade agreements promoting multilateral trade liberalization have recently

shown an interest in establishing trade agreements with other regional partners, for instance

Japan – ASEAN (2008), China – ASEAN (2005), India – ASEAN (2010), India –MERCOSUR (2009),

Korea – ASEAN (2007) .

For quite a long time, a system of preferences has been granted to developing countries by

advanced economies, which entitles developing countries engaged in the agreement to

unilateral preferences. Lately, a new phenomenon has been observed: unilateral preferences in

agreements are being replaced with mutual concessions between economies at essentially

different stages of development27.

Moreover, the involvement of some developing countries in the worldwide production and

distribution schemes initiated and managed by Western businesses contributes extensively to

trade between developing countries and sketches triangular North-South-South cooperation

that takes place within a firm. The role of multinational industries in changing the economy and

commerce of developing countries is very important, as they tie up the developed and

developing economies in intra- and inter-corporation set-ups. On one hand, they generate

market-driven dynamism in developing economies. On the other hand, they increase the

competitiveness of enterprises in developing countries. This kind of triangular cooperation has

a key importance for the diffusion of development.

Trade is crucial for the economic progress in developing countries and for their firm place in the

regional and global market. Trade statistics indicate that the trade between developing

countries is steadily increasing and is taking place in parallel with the proliferation of

27 This trend needs to be carefully analysed to make certain that this new type of agreement does not have

negative consequences for developing counties’ access to overseas markets, but this is beyond the scope of this analysis.

24

preferential trade agreements as they create a supportive environment for economic

collaboration within those regions. Preferential trade agreements are not isolating economic

regions from each other nor localizing the trade within those regions. Instead, by promoting

economic progress within those regions they make possible global economic collaboration and

international trade between counties and regions that used to have limited cooperation due to

different levels of development.

25

Conclusion This paper has revealed a positive correlation between the number of the Preferential Trade

Agreements and the trade value. The proliferation of trade agreements is accompanied with

the increase of trade in the regions established by the PTAs. The PTAs very often institute

economic relations among countries with compatible levels of economic development. The

Rules of Origin provisions of the PTAs encourage trade within those regions and stimulate the

economic cooperation among those countries. This process has an important outcome: the

PTAs support, if not produce, regionalisation, thus localising economic activities in an area

covered by the agreement. This phenomenon can mistakenly be considered a hindrance to

globalization as it confines the truly free movement of goods and the thorough liberalization of

trade. In fact, this kind of regionalization facilitates integration within a region and in the course

of time makes possible for the integral economies to function as a single geopolitical entity.

PTA-based regionalisation significantly increases productivity and facilitates the fragmentation

of the production process within preferential trade areas. The latter generates a new

international organization of production and allows producers to take advantage by organising

production internationally yet within the area of preferential trade. An outcome of this kind of

production mobility is the harmonization of economic development levels of the countries in

the region.

As the PTAs usually tie together economies on more or less the same level of development -

and very often those are developing economies - the created environment is fair from an

economic collaboration perspective and results in new sources of gain that contribute to the

entire regional economy. The fact that developed economies recently began to increasingly

establish economic relations with developing regions is self-explanatory. The previously

launched Generalized System of Preferences that proposed lower tariffs to developing

countries by the countries with advanced economies is being replaced by trade agreements

between a developed economy and developing region. This takes place partially due to the fact

that, functioning as a region, developing countries not only gain rapid growth, but also acquire

the potency to negotiate with developed countries on the same level.

This gives basis to the claim that by localising trade and economic relations, the PTAs make

possible the economic progress of developing regions. Such regionalization in no way results in

the fragmentation of the world economy. Instead, it ensures the necessary conditions for

thorough economic globalization.

26

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