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Regionalism versus Multilateralism: the case of the European Union

Trade Policy∗∗∗∗

Antimiani, A.♣, Salvatici, L.♠

Abstract

In 2006 the European Union (EU) decided to abandon its moratorium on negotiating new free trade

agreements. Since then, numerous negotiations have been started. In particular, the EU joined in the

scramble for preferential market access starting bilateral negotiations both with individual countries

and with regional sub-groupings. The discriminatory character of these agreements is controversial in

economics, not simply because of the classic ‘Vinerian’ view that they can divert rather than create

trade, but also because of the unresolved disagreements over when a regional trade agreement is likely

to precede, rather than preclude, more global agreements. In this paper, we use a computable general

equilibrium (CGE) model to assess the effects of the possible agreements between the EU and different

partners, namely India, Mercado Común del Sur (MERCOSUR), and United States of America (USA).

We evaluate the impact of the free trade agreements by themselves, assess their mutual compatibility

and compare them with a scenario including all bilateral agreements as well as a benchmark global free

trade scenario.

Keywords: CGE Model, Trade policy, WTO, EU

J.E.L. Codes: F13, F15

∗This work was supported by the “Exploring the Future of Global Food and Nutrition Security (FOODSECURE)” (Grant Agreement no. 290693) research project funded by the European Commission. The views expressed in this paper are the sole responsibility of the authors and do not necessarily reflect those of the European Commission.

♣ Istituto Nazionale Economia Agraria (INEA), Italy ♠ Department of Economics – Roma Tre University, Italy

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1. Introduction

The proliferation of bilateral agreements has helped to fill a gap in a multilateral process that is

impeded by the impasse of negotiations in the World Trade Organization (WTO). At the same time, the

development of bilateral trade agreements arguably has discouraged some States from engaging in

multilateral negotiations (Trakman, 2008). By January 2014, a total of 583 regional trade agreements

had been notified to the WTO and its predecessor, the General Agreement on Tariffs and Trade

(GATT). Of these, 377 are in force and, among these, by 255 are free trade agreement (FTAs).

What can explain the recent growth in regionalism, and why do governments choose to pursue their

policy objectives through FTAs?

The main explanations provided in the literature (WTO, 2011) are:

1) that regionalism has been spreading because multilateral talks tend to progress too slowly

(Bhagwati, 1992, 1997);

2) on the contrary, decades of multilateral liberalisation could actually have helped the recent

spread of bilateral initiatives since lower tariffs reduce the costs from trade diversion: Freund

(2000), for instance, finds that deeper multilateralism provides greater incentives to form FTAs

since lower multilateral tariffs improve the sustainability of preferential liberalisation;

3) the so-called “bandwagon” or “emulation arguments” that posit a link between FTAs signed by

the ‘trade giants’ (US, EU and Japan) and the attitudes of other nations (Solis, Stallings and

Katada 2009): more generally, the “domino theory” of regionalism formalised in Baldwin

(1993) argues that the signing or deepening of one FTA can induce excluded nations to sign

new FTAs previously shunned;

4) the political-economy explanations pointing out coordination failures of adversely affected

interest groups or profit gains for exporters in excess of the losses that would be suffered by

import-competing industries (Grossman and Helpman, 1995).

Be that as it may, FTAs have become a major and strategic part of commercial policy for many

countries, including the European Union (EU). The EU already signed a motley assortment of both

unilateral and reciprocal preferential agreements. More recently, the EU joined in the scramble for

preferential market access starting bilateral negotiations both with individual countries, for example,

India and Canada, and with regional sub-groupings, such as the Association of Southeast Asian Nations

(ASEAN) and the Mercado Común del Sur (MERCOSUR).

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The proliferation of FTAs over the past two decades has kept the debate alive between those who view

FTAs as discriminatory instruments hostage to protectionist interests and those who see them as

conducive to multilateral trade opening (Bhagwati, 1996; Freund and Ornelas, 2010): 'building' or

'stumbling blocs' using the famous words introduced by Bhagwati (1992). The literature suggests

several possible linkages between preferential and multilateral tariff cutting. The main goal of this

paper is to provide a quantitative assessment for some of these linkages. In other terms, we are not

going to add new arguments to the theoretical debate, but rather to provide evidence supporting the

empirical relevance of some of those that have been already suggested.

We focus on the EU trade policy and compare the effects of some FTAs presently negotiated by the

EU. As it is customary in the literature providing ex ante evaluation of policy changes, we use a

computable general equilibrium (CGE) model of global world trade. Our assessment is rather standard

with respect to those already existing, and we certainly do not pretend to provide a more

comprehensive, detailed or sophisticated results with respect to those already existing in the literature.

The main goal is to use a consistent theoretical framework in order to compare different arguments put

forward in the building/stumbling bloc debate. To this end, several counterfactual scenarios are

simulated, including a multilateral free-trade scenario that provides a benchmark for the assessment of

“second-best effects”.1 This provides useful insights for assessing the potential effects of different trade

liberalization strategies in the attempt to connect high theory with empirically grounded research that

has more policy relevance.

The rest of the paper is organised as follows. After reviewing the most recent developments of the EU

trade policy (Section 2), the third section follows Baldwin’s critical review (2009) of the building bloc

- stumbling bloc debate literature in order to describe various economic mechanisms that determine

whether preferential trade arrangements help or hinder multilateral trade liberalisation. The Global

Trade Analysis Project (GTAP)2 CGE model is used to evaluate the impact of the free trade agreements

by themselves and their mutual compatibility as well as their relations with the larger agenda of global

free trade (Section 4). In Section 5, we discuss the results of simulations; while Section 6 presents some

concluding remarks.

1 In the words of Winters: "If one could determine the perfectly multilateral volume and pattern of trade, one could then easily define the index of actual multilateralism by any of several distance measures between actual and "perfect" trade" (1999, p.9). 2 https://www.gtap.agecon.purdue.edu/

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2. The EU (bilateral) trade policy

We think that the EU provides a good case study since it has long been involved in regional trade and

integration initiatives, beginning with the formation of the European Community itself in 1958, and

through the negotiation of a large number of FTAs. Presently, there are 29 trade agreements already in

place: with members of the Andean region, Colombia and Peru; with Central America countries –

Honduras, Nicaragua and Panama; as well as with South Korea, Mexico, South Africa, and Chile. On

top of these "classic" free trade deals, FTAs are a core component of many Association Agreements in

force with a number of countries and territories in Europe (Faroe Islands, Norway, Iceland,

Switzerland, Macedonia, Albania, Montenegro, Bosnia and Herzegovina, Serbia), in the Southern

Mediterranean region (Algeria, Egypt, Israel, Jordan, Lebanon, Morocco, Palestinian Authority, Syria,

Tunisia) as well as with several African, Caribbean and Pacific countries. Finally, the EU is also part of

custom unions with countries such as Andorra, San Marino, and, more importantly, Turkey.

The growing number of these agreements has been the subject of discussion in Brussels since the mid

1990s. In the 2006 European Commission's Communication on the common trade policy, significant

shifts are discernible in the Commission's Position (European Commission, 2006), especially since they

relate to the prominence given to bilateral and regional trade agreements and the shift away from an

almost exclusive focus on multilateral rule-making which used to be the norm (Evenett, 2007). In

recent years, eleven trade agreements have been finalized though they have yet to enter into force: the

EU has recently concluded negotiations with Canada and Singapore; a deep and comprehensive Free

Trade Area with Moldova, Armenia, Georgia, and Ukraine; Association Agreements were signed with

several members of the Central American region (Costa Rica, El Salvador, Guatemala, Honduras,

Nicaragua and Panama); finally, there have also been five Economic Partnership Agreements with

African, Caribbean and Pacific States that have been negotiated (Cote d'Ivoire, Cameroon, the Southern

African Development Community, Ghana and the Eastern African Community).

The EU is actually pursuing a new generation of carefully selected and prioritised FTAs as one of the

main goals of its trade policy. The targets of the EU's new external trade policy are the large as well as

the emerging markets, as it is confirmed by the on-going negotiations with United States of America

(USA), Japan, Association of Southeast Asian Nations (ASEAN), Morocco, India, Mercado Común del

Sur (MERCOSUR). In addition to these trade negotiations under way, there are several trade and

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development negotiations ongoing to establish Economic Partnership Agreements (EPAs) with

African, Caribbean and Pacific countries (ACP).

In our simulations, we will focus on three cases corresponding to different typologies as well as

geographical locations: a large developed country (USA), a large developing country (India), a trade

integration area (MERCOSUR). More specifically:

� The EU is India’s largest trading partner, accounting for around one-fifth of India’s total trade

(14.4 per cent in 2011), whereas India contributes around 2.2 per cent of total EU trade and is

its tenth-ranking partner. Since 2001, bilateral trade has increased annually by over 11 per cent

(Khorana, Garcia, 2013). Even if India remains a rather small trade partner for the EU, the

combination of rapid economic growth and relatively high market protection makes India an

interesting partner for one of the new generation of EU FTAs. The EU Council adopted a

negotiating Directive for a Free Trade Agreement (FTA) with India on 23 April 2007 and

negotiations were launched on 28/29 June 2007. The FTA will cover trade in goods and

services but will also pay attention to other issues: investment, public procurement, technical

regulations (co-operation on technical barriers to trade and sanitary and phyto-sanitary

measures), intellectual property rights, competition policy, and dispute settlement provision.

� The FTA between EU and the United States (US) would be the world’s largest since the two

economies represent about half of the world’s Gross Domestic Product (GDP) and contribute to

almost a third of the global trade flows. The negotiating, for a Transatlantic Trade and

Investment Partnership (TTIP), started officially during the first round which took place in

Washington D.C. in July 2013. At this stage, it aims at removing trade barriers in a wide range

of economic sectors to make it easier to buy and sell goods and services between the EU and the

US, as path towards a full free-trade agreement. The third round of talks of negotiations has

been held from 16-20 December 2013 in Washington D.C.

� The EU is MERCOSUR's3 first largest trading partner, representing 18.8% of total

MERCOSUR trade in 2012 and MERCOSUR ranks 8th among EU trading partners, accounting

for 3.2% of total EU trade in 2012. Negotiations for an inter-regional Association Agreement

between the EU and the MERCOSUR were launched in 1999 at the Rio de Janeiro Summit but

were, however, suspended in October 2004: the Commission decided in May 2010 that

3 Mercosur was established in 1991 and encompasses Argentina, Brazil, Paraguay, Uruguay and Venezuela.

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negotiations could continue. The major deadlocks seem to be on agricultural goods, primarily

over EU farm subsidies and the lack of European market access for less-expensive

MERCOSUR products.

Since countries may have much to gain by forming a union with a major trade partner that is subject to

low natural trade costs, where trade creation is likely to dominate, FTAs featuring a large share of

intrabloc trade are traditionally dubbed as "natural" (Wonnacott and Lutz, 1989). Even if there is no

theoretical guidance to determine how large is "large" (Kreinin and Plummer, 1994), Table 1 shows

that the share of bilateral trade on total trade flows is much lower for the EU than for the FTAs’

partners. Indeed, in the EU, the shares of intrabloc trade never exceed 5%, with the exception of USA

(14,5%), although it is worth noting that there can be large differences across sectors. On the other

hand, the EU is a much more important trade partner for the other countries since the intrabloc trade

shares range between 13% (India) and 23% (MERCOSUR).

With regard to the literature that attempted to evaluate the impact of these trade agreements using CGE

models, as far as the MERCOSUR agreement is concerned it is worth mentioning the work by Boyer

and Schuschny (2010) that simulates an FTA between EU and MERCOSUR (with and without the

exclusion of sensitive products) using the GTAP model. Their results appear to be broadly consistent

with ours, taking into account differences in the experiments and in the baseline definition. Similarly,

in the work of Bouet et al. (2011), even if results are computed with a different model (MIRAGE), they

show the same sign for the impact on terms of trade we found for FTAs between EU and MERCOSUR:

positive for the latter and negative for EU. However, it should be noted that, if sensitive product

exceptions are “included” in the scenario of bilateral agreement (instead of full free trade), the sign and

intensity of welfare gains could be substantially different, as shown by Laborde and Ramos (2006).

INDIA MERCOSUR USA

EU partner 13.2 23.3 16.3

EU 2.2 3.2 14.5

Source: COMTRADE

*For Mercosur and EU, intratrade is excluded; for India data refer to 2011.

TABLE 1 - Intrablocs trade share (%, 2012)*

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In the case of India, a work by Achterbosch, Kuiper and Roza (2008) also using the GTAP model

confirms our results, in that the EU economy is only slightly affected whereas India would have more

to lose than to gain from the FTA. In the same vein, simulations by Polaski et al. (2008) suggest a small

welfare loss for India (250 $ million) and larger gains for EU (2.2 $ billion). On the other hand, results

by Decreaux and Mitaritonna (2007), Khorana and Garcia (2013) and the European Commission

(2009) show an overall positive result for India although this is mostly due to the inclusion of

liberalisation in services (not included in our simulations).

Several studies about the negotiations for the TTIP have been issued, even if this negotiate has been

launched so recently. Focusing on the studies which are comparable to ours from a methodological

point of view (i.e., CGE analysis), one of the most comprehensive is carried out by the CEPR (2013),

on behalf of the EU Commission. It uses the same model adopted in this paper, namely the GTAP

model, though allowing for imperfect competitions in some sectors. The results indicate positive and

significant gains for both the EU and the US. GDP is expected to increase by 119 billion € for EU and

95 billion Euros for the US. However, an FTA limited to tariff liberalisation would lead to 24 billion

Euros increase in GDP for the EU and 9 billion Euros increase for the US. Overall, total exports would

increase 6% in the EU and 8% in the US. Petersen (2013), using a CGE model allowing for frictional

unemployment, finds that a deep liberalization of trade between the two regions would increase the real

per capita gross domestic product while simultaneously boosting employment. In the same vein, a

study commissioned by the Dutch Ministry of Economic Affairs, Agriculture and Innovation (Ecorys,

2012), highlights that a potential EU-US FTA would yield positive results in terms of GDP growth

both for the USA (+1.6%) and the EU (+2.4%) and the same is true for the study carried out by

Fontagné, Gourdon and Jean (2013) using the MIRAGE model to evaluate what the economic

consequences of an agreement taking into account the obstacles to trade in services and non-tariff

measures. By and large, then, there seems to a quite a large consensus about the fact that significant

economic gains could be achieved from the TTIP.

3. Bilateralism vs. multilateralism: trick or treat?

The literature that is relevant to this paper is too vast to review in detail. One of the most contentious

aspects of the debate on preferential trade agreements concerns the relationship between regionalism

and multilateralism. Hence, in this section, we refer to some selected contributions specifically related

to how preferential trade agreements may act as building blocs or stumbling blocs on the path to global

free trade. Our review is shaped according to the stocktaking essay by Baldwin (2009) entitled “Big-

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think regionalism: a critical survey”. In this paper, studies are divided according to two typologies:

Small-Think Regionalism and Big-Think Regionalism.

In the 1950s, the debate about regionalism straightened out the economics and established the

intellectual paradigm around Viner’s (1950) key finding: discriminatory tariff liberalisation has

ambiguous welfare effects since preferential liberalisation induces new distortions while removing

others. This literature – what could be called Small-Think Regionalism – focused on the concepts of

trade creation, trade diversion and terms-of-trade effects and ignore systemic implications. In the

1990s, Bhagwati (1992) and Krugman (1991) among other scholars, laid out lines of analysis of what

might be called Big-Think Regionalism. While Small-Think Regionalism focused on the FTA-related

changes in trade flows, prices, production structures, sectoral allocation of factors of production and

welfare of the individual nation, Big-Think Regionalism focuses on the systemic implications such as

the impact on the world welfare or consequences for the multilateral system. Many trade policy

scholars, such as Krugman and Bhagwati, mentioned previously, worried that regionalism was a

stumbling bloc to global free trade, others, such as Bergsten (1996), viewed regionalism as a largely

benign or even as a constructive force in the world trade system. Here we briefly discuss some

conjectures offered in the literature. The main arguments in the debate on regionalism vs.

multilateralism are pointed out below.

#1: Bag of goodies

FTA exporters gain from improved market access in two respects: cheaper exports facilitated by the

agreement replace the importing country domestic production (trade creation) or crowd out exports

from the rest of the world (trade diversion). The latter generate rents that can be thought of as a

stumbling bloc that has been labelled by Baldwin (2009) as the ‘goodies bag’. Since the richness of the

‘goodies bag’ is linked to the preference margins, FTA members have an extra incentive to maintain

high margins by avoiding multilateral liberalisation.4 According to Grossman and Helpman (1995), for

instance, governments that are very susceptible to special interest groups will seek the most trade-

diverting agreements.5

#2: Cherry picking argument

4 Since unilateral preference rents are also affected by an agreement to reduce tariffs on a multilateral basis, the ‘bag of goodies’ stumbling bloc logic plays a leading role in the developing countries’ concern about preference erosion. 5 Krishna (1998) provides the same answer in a different framework, with oligopolistic firms.

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Even if there may be additional benefits in terms of political payoffs, the most obvious economic

reason to undertake a FTA is represented by the expected welfare gains. This is not necessarily bad

news for the multilateral agenda since trade liberalisation is a positive-sum game and free-trade may

guarantee even better performance to the FTA participants. However, if benefits do not monotonically

increase with the number of countries involved in the trade agreement, governments may decide to opt

for partial liberalisation agreements that provide better results.

According to Baldwin (2009), starting from a world where all nations use non-discriminatory tariffs,

the question is: can some group of nations raise their collective welfare above the free trade level by

forming a trade bloc and thus exploiting other nations? If the answer is yes, then that bloc is a

stumbling bloc on the road to multilateral free trade because the bloc members will not have an

incentive to pursue global free trade.

Such a cherry picking behaviour raises the issue of their structural compatibility with the larger agenda

of global trade liberalisation. When a government goes for low-hanging fruits through a FTA and

moves the economy away from its 'true' comparative advantage, this will raise the cost of achieving

global free trade.

Again, starting from a world in which all nations use non-discriminatory tariffs, the question is: does

the adjustment cost to be incurred to achieve global free trade get larger after the implementation of the

FTA? If the answer is yes, then that bloc is a stumbling bloc on the road to multilateral free trade.

To shed some light on this issue, in the following we compare the different liberalisation scenarios

using a “structural change index”, based on the output change; and a “labour displacement index”,

based on the labour movement across sectors. In all cases, we will assess the similarity of the

allocations resulting from different FTAs with the one corresponding global free trade.

#3: Juggernaut argument

The assertion that FTAs could foster multilateral liberalisation, acting as building blocs on the road to

global duty-free trade, is first based on the notion that preferential liberalisation creates a political-

economy momentum making multilateral liberalisation easier: this is the ‘juggernaut’ building bloc

logic (Baldwin, 2009). Thus, a country that enters into a FTA will expand the political and economic

strength of its pro-liberalisation constituency (juggernaut effect), making it possible for its government

to cut a multilateral deal (Baldwin, 2009).

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Such an outcome can be explained by two lines of reasoning. First, FTAs re-landscape members’

economies making export sectors larger and import-competing sectors smaller. Of course, in the sectors

where the FTA results in lower exports, the agreement can start the juggernaut rolling backwards.

Second, if the changes in the production structure are consistent with those that would take place under

global liberalisation, the FTA helps to reveal the nation’s true comparative advantage and workers are

in a better position to assess whether they will win or lose from free trade. Even if the building bloc

argument has a clear political-economy flavour, it has some overlapping with the structural congruence

issue, and it is also quite consistent with the more traditional argument based on the ‘trade creation’

effect of FTAs.

4. Model, database and scenarios

As a consequence of the ambiguity concerning the impact of FTAs, economic theory provides very few

clear-cut conclusions as to whether regionalism reinforces or hinders the move toward global free

trade. The bottom line is that theory cannot provide us with undisputed guidance and therefore it is

ultimately an empirical issue to determine the impact of a given FTA. In this respect, there is a decisive

role for quantitative models to assess the impact of FTAs and shed some light on this complex issue.

Since we are interested in “what if” questions, i.e. if the EU were to sign new FTAs, what would be the

consequences for trade, production, employment, income, etc.? Then, we are going to use a global

CGE model that allows us to test some of the arguments presented above. Most ex ante studies of

regional trade agreements use this type of model (see Section 2). The CGE framework builds on

general equilibrium theory and rests on consistent microeconomic foundation in which intersectoral

linkages, resource constraints and policy distortions are the main focus.

The main advantages of the CGE approach are the solid micro-theoretical underpinning and the

economy-wide scope, as well as the complete and consistent coverage of all bilateral trade flows.

Furthermore, changes in welfare can be traced back to the different sectors by performing a welfare

decomposition exercise to identify what is generating the gains and losses. A CGE model, then, is an

appropriate tool when the policy changes being analysed simultaneously affect many countries and

many sectors and have effects on terms-of-trade, factor prices and income.

Our simulations have been carried out using the GTAP model and its database providing a baseline

year of 2007. In our version, the database is aggregated to include 25 regions/countries and 33 sectors

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(Table 2). The product aggregation aims to provide the maximum detail allowed by the database

(version 8.1: Narayanan et al, 2012).

Several changes have been introduced in order to update the 2007 baseline to 2012 using World Bank

data for population, labour force and GDP, and including all the policies already agreed upon even if

yet to be implemented. Accordingly, as far as the Common Agricultural Policy is concerned, direct

payments are modelled as ad valorem subsidies to land. With regard to the trade policies, we introduce

in the baseline the full implementation of the Everything But Arms Regulation (EBA) and the

Commodities and

Activities

Paddy rice Land

Rice Skilled

Wheat Unskilled

Other cereals Capital

Cereal seeds Natural Resources

Vegetables & Fruit

Dairy products

Fishing China

Fibers India

Forestry Korea

Live animals Japan

Meat Eu27

Leather products Euromed

Other crops

Oil fats No WTO countries

Beverage & tobacco Canada

Sugar USA

Other food Mexico

Chemical products Australia and New Zelaand

Machinery Rest of asian countries

Eletronic equipment EFTA

Ferrous products Rest of american countries

Metal products Rest of the World

Minerals EBA countries

Motorvehicle EPA countries

Papers products South Africa

Other manufacture Ukraina

Petrol Colombia and Perù

Textile Chile

Wearing Russian Federation

Wood products Central America

Electricity

Services

Table 2 - GTAP database aggregation

Factors

Labour

Regions*

Asean (Indonesia, Malaysia, Philippines, Singapore, Thailand, Vietnam, Brunei and Myamar)

Mercosur (Argentina, Bolivia, Brazil, Paraguay, Uruguay and Venezuela )

*In bold countries/regions included in the scenarios

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Economic Partnership Agreements (EPA) into the baseline as well as the FTAs with EUROMED,

Korea, Chile, Central America, Colombia e Peru, Mexico and South Africa.

We are going to compare different paths to free trade: on the one hand, the paths starting from different

possible bilateral liberalization scenarios; on the other hand, the ‘direct’ path starting from the baseline.

To this end we define five simulation scenarios:

1. Global free-trade;

2. Joint implementation of FTAs with INDIA, MERCOSUR and USA;

3. FTA EU-INDIA;

4. FTA EU-MERCOSUR;

5. FTA EU-USA.

Finally, it is worth recalling that we use a rather ‘standard’ (i.e., static and perfect competition) model.

Such a model is by construction unable to take into account several FTAs’ effects (possibly even larger

than the ones considered here) such as economies of scale; “learning by doing” from expanded trade;

information, technology and knowledge transfers that increase productivity; increased investment

opportunities in a larger and perhaps more stable trading environment that carries with it advanced

technologies and increased productivity. Central to these issues is the removal of a host of non-tariff

obstacles, found both at the border and in domestic regulations, through the adoption by governments

of more convergent regulatory practices. Indeed, in a world of deepening economic integration, the

regulatory aspects of trade agreements have rapidly been assuming increasing importance (Brown and

Stern, 2011). However, our focus is on tariff regimes and in this respect, the chosen model provides a

consistent framework for the assessment of the different arguments put forward in the

building/stumbling bloc debate.

5. Results

In this section we analyse the outcome of the simulations in order to check if and to what extent the

theoretical arguments laid down in Section 3 are actually confirmed.

#1 Bag od goodies

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In order to verify the bag of goodies hypothesis, we proxy the preference rents with the ‘preferential

market shares’ computed as the difference between the values of bilateral export flows (at world prices)

in each FTA scenario and under free trade (table 3). Since results are influenced by differences in

sector sizes, in order to compare FTAs, we divide the differences by the corresponding baseline export

values.

The USA agreement generates ‘negative’ results, and this implies that the value of EU exports would

be lower than under global free-trade though the difference is negligible with respect to the export

flows. In all other cases, differences are significant both in absolute and relative terms and their amount

tend to increase with the number of agreements. The India and MERCOSUR agreements, then, would

generate export markets shares that are not likely to be maintained in a multilateral liberalization

scenario. Accordingly, these are going to be possible stumbling blocs on the way to global free trade.

#2 Cherry picking

Welfare gains or losses are crucial when a trade policy agreement is evaluated from an economic point

of view. In Table 4, the first column present the welfare impact of each bilateral agreement. Since it

would not make sense to compare these figures with the overall results of more encompassing

liberalization scenarios, the other columns report the contribution of the removal of bilateral trade

barriers with the same partner within larger liberalisation scenarios, i.e. joint implementation of all

FTAs and global free trade.

TOTAL 2.594.583 (86) 17.033 (47) 36.005 (72) -5.588 (-2)

Source: elaboration on GTAP simulations

*In brackets results normalized by baseline export flows

TABLE 3 - EU Preferentia market shares (USD million)*

ProductsBilateral agreements

Joint FTAs India Mercosur USA

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EU would benefit in all cases, although the order of magnitudes is quite different. The most beneficial

bilateral agreement is by far the one with MERCOSUR. Obviously, the ranking across agreements

results from the interaction between the relevance of bilateral trade flows and the height of bilateral

tariffs. Bilateral tariffs between EU and US, as a matter of fact, are generally lower than in the case of

India or MERCOSUR; on the other hand, bilateral trade flows between EU and MERCOSUR are larger

than in the case of India.

Benefits from bilateral agreements are by and large additive, since they hardly change when all

bilateral agreements are implemented together. Apparently, the whole set of bilateral agreements is

more rewarding than the multilateral one. In the latter case, as a matter of fact, not only the overall

impact of the regions not included in the bilateral agreements is negative, but the positive contributions

of the regions included are lower. Such a decrease is mostly due to the lowering of the terms of trade

gains, but there is a decrease in the allocative efficiency gains as well in the case of FTAs with USA

and MERCOSUR.

Welfare gains are conditional on the adjustments induced by trade liberalisation in each scenario, and

we may well expect them to entail shocks of very different sizes. Adjustment costs are those incurred to

transfer production factors across sectors. These costs, even if difficult to assess, can be quite

significant and governments are mindful about them.

In order to shed some light on the adjustment costs we compute the percentage of factors of production

that needs to be reallocated within the economy as a consequence of the trade policy changes

(Structural change index – SCI). The SCI values are computed as (Roland-Holst and van der

Mensbrugghe,2002; Productivity Commission, 1998):

BILATERAL Joint FTAs FREE TRADE

India** 1,764 1,746 1,657

Mercosur** 5,792 5,746 4,727

USA** 1,431 1,406 1,283

Total 8899* 6,954*

Source: elaboration on GTAP simulations

*It includes the contribution of all the regions in the model.

AgreementsScenarios

**For Joint FTAs and Free trade scenarios, figures refer to the contribution to the EU total welfare

Table 4 – EU welfare impact (million USD)

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1 ≥ ��� = ∑ ∑ �� − � �� ≥ 0� [1]

where � and � � represent each industry’s i share of factor j after and before the trade shock under

consideration (respectively, t and t-1).

Starting from the baseline (t-1), the global free trade scenario requires the largest adjustment (Table 5).

Even if such a result is hardly surprising, it is worth noting that the bilateral agreement with

MERCOSUR leads to a much larger adjustment in the EU economy than it would be the case under the

Joint FTAs scenario.

It is also interesting to verify what are the costs implied by the free trade scenario starting from the

structure of the economy resulting from the partial liberalization scenarios. Accordingly, in Table 6 the

(t-1) shares are the outcomes of the simulations regarding the 3 bilateral scenarios as well as the Joint

FTAs one.

Adding up the adjustment costs from Table 5 and 6, it is apparent that a piecemeal liberalization

strategy would always imply larger changes in the EU economy. This would be especially true in the

case of the USA agreement since the SCI required by a further move to global free trade scenario

(0.52) would be even higher than the one computed starting from the baseline (0.48). On the other

hand, it may be argued that the agreement with India and, even more, the Joint FTAs scenario would

decrease the adjustment cost of global free trade.

BILATERAL Joint FTAs FREE TRADE

India 0.011

Mercosur 0.039

USA 0.013

Source: elaboration on GTAP simulations

Table 5 - EU structural change index: different scenarios with respect to baseline

0.028 0.048

BILATERAL Joint FTAs

India 0.042

Mercosur 0.048

USA 0.052

Source: elaboration on GTAP simulations

Table 6 - EU structural change index: free-trade with respect to different reference scenarios

0.030

16

Within the adjustments costs, those regarding labour are particularly relevant from the political point of

view. Then, in addition to the Structural Change Index, we also compute a “Labour Displacement

Index” (LDI) summarizing the effect on the movement of the labour force between sectors (CEPR,

2013). In formal terms, the index is defined as,

100 ≥ ��� = �∑ ��(���)� ∗ 100���� ≥ 0 [2], where, γl is the sector j share of total employment and ��� is the per cent change in sector j employment

after the scenario simulation. Table 7 provides an assessment of the number of skilled and unskilled

workers that have to move across sectors in the global free trade scenario starting from the outcome

resulting from the partial liberalization scenarios: the only exception is the Free trade scenario itself

that can only be computed with respect to the baseline.

Overall, the labour displacement from trade liberalization seems to be easily absorbed through normal

entry and attrition rates since in most cases no more than 2 workers out of 100 would have to move

across sectors. It is worth recalling, though, that the index is a lower bound on labour displacement, as

it is likely to underestimate the actual amount of job churning that occurs: as a matter of fact, workers

who change jobs but do not change sectors are not captured by the above measure6.

The adjustment is larger for less skilled workers than for more skilled ones. In terms of “building” or

“stumbling” block, the LDI suggest that the global free trade would be easier to achieve after a partial

liberalization reform, with the only exception of a bilateral agreement with the US. In the case of US

6 Furthermore, it must be taken into account that GTAP sectors are quite “large”

Less skilled More skilled

India 1.9 1.5

Mercosur 1.9 1.5

USA 2.1 1.7

Joint FTAs 1.8 1.4

Free-trade (from baseline) 2.1 1.7

Source: elaboration on GTAP simulations

Table 7 - EU Labour Displacement Index: free-trade with respect to different reference scenarios

17

the value of LDI are equal to the ones given in the free-trade case: 2.1 for less skilled works and 1.7 for

the skilled ones.

#3 Juggernaut

In order to assess the political congruence between FTAs and free trade (juggernaut) we consider

changes of the export shares in total production (Table 8) as well as export and output changes (Table 9

and 10) under different bilateral scenarios.

If we compare the export shares in total output before and after the bilateral agreements, only the EU-

USA FTA can be considered a building block (Table 8). In this case, as well as in the Joint FTAs

scenario, export orientation (signalled by an increase of the export share in total output) would increase

for the majority of the EU economy.

EU FTAs export share > Baseline export share

Joint FTAs 56.3

India 50.0

Mercosur 43.8

Usa 53.1

Source: our elaboration on GTAP simulations

TABLE 8 - Comparison of export shares in total output under different scenarios (share of

total output in the baseline)

India Mercosur Usa

Correlation 0.76 0.76 0.62 0.14

Opposite sign sectors*

Numbers of sectors 10 9 14 17

Output share (%) 12.3 15.9 18.7 25.0

Overshooting sectors*

Numbers of sectors 8 4 7 4

Output share (%) 12.8 12.3 17.0 7.5

Source: elaboration on GTAP simulations

*Shares in the baseline

TABLE 9 - EU output changes: comparison between free-trade and FTAs

Joint FTAsBilateral agreements

18

In Table 9 and 11, we first compute an aggregate index, namely the correlation between sectoral

changes under each partial liberalisation agreement and global free trade. Then, we compare the sign of

the changes in order to check how many sectors move in opposite directions. Finally, even when signs

are consistent, FTAs may still induce larger adjustments than required by full liberalisation. We check

the sectors characterised by ‘overshooting’ since on the one hand, a larger output or export reduction

than required by free trade could make them wary of any further liberalisation efforts; on the other

hand, sectors experiencing a larger output or export increase than sustainable under free trade could

later on resist any policy reforms forcing them to shrink.

The Joint FTAs scenario would make the structure of the EU output (export) more consistent with the

one implied by global free trade. This means that adding up bilateral agreements makes the EU output

(export) structure more consistent with full trade liberalisation. However, even in this scenario, ten

(nine from the export side) sectors move in the opposite direction from what would happen under free

trade and eight (six) sectors are characterised by ‘overadjustments’. The lowest correlation, for both

output and export, is registered by the agreement with the USA while the best fit with global free-trade

is provided by the India FTA in the case of output changes and MERCOSUR FTA in the case of export

changes.

It does not only matter how much is exported, but also where exports are shipped. Accordingly, we

analyse the “geographical convergence” of trade looking at importers and exporters market shares. The

geographical convergence of trade destinations/sources is assessed for each sector j based on

differences between market shares t in each liberalization scenario, s, and the corresponding shares

under free trade (ft). Hence the analysis uses:

India Mercosur Usa

Correlation 0.87 0.56 0.81 0.47

Opposite sign sectors*

Numbers of sectors 9 13 12 15

Export share (%) 13.4 35.4 18.7 35.8

Overshooting sectors*

Numbers of sectors 6 1 1 3

Export share (%) 5.8 1.3 3.0 4.2

Source: elaboration on GTAP simulations

*Shares in the baseline

Table 10 - EU export changes: comparison between free-trade and FTAs

Joint FTAsBilateral agreements

19

��� = �� � + "�� [3],

where which �� �

is the share of exports of sector j that would be exported to market i in the free trade

scenario. If the trade pattern in each partial liberalization scenarios was the same as under free trade, u

equals zero for every i. The further the trade patterns are apart, the larger the (absolute) differences are.

Therefore, the variance of the vector u can be used as a measure of convergence. In each region and for

each sector, if the variance of the differences in the market shares decreases with respect to the

baseline, the trade pattern converges to the free trade one. An F-test is used to test whether the variance

decreases or increases significantly. Since we never register an increase in geographic divergence,

Table 11 shows the number of sectors with significant convergence based on different significance

levels (1%, 5%, 10%).

Only in the case of the Joint FTAs scenario there is a significant geographical convergence for the large

majority of sectors. As far as the single bilateral agreements are concerned, the largest convergence

(33% export share) is obtained on the case of the USA FTA.

6. Conclusions

In recent years, the proliferation of FTAs has been interpreted as a possible threat to the process of

multilateral trade liberalisation promoted under the GATT/WTO, leading to a large debate centred on

"regionalism toward multilateralism". The relationship between regionalism and multilateralism has

been framed as one where FTAs are either a stumbling bloc or a building bloc to multilateralism.

Winters (1999, p.42), for instance, argues “Trade diversion is good politics even if it is bad economics.

I find quite convincing the view that multilateral liberalism could stall because producers get most of

what they seek from regional arrangements”.

Table 11 - Number of sectors with significant convergence in the EU export (shares of total exports in the baseline)

Joint FTAs India Mercosur Usa

Numbers of sectors*** 16 (85) 2 (0.2) 1 (1) 2 (3)

Numbers of sectors** 4 (7) - 2 (0.3) 4 (29)

Numbers of sectors* 4 (5) - 3 (9) 1 (0.1)

Source: elaboration on GTAP simulations

Note: * = significant at 10%; ** = significant at 5%; *** = significant at 1% (in bracktes share, %, on total export on baseline data)

20

In this paper, we take up Richard Baldwin's recommendation to move the economics' profession

discussion from high theory to one which is more empirically grounded and policy-relevant. We use

the results of the simulations to answer the question of whether it sets up forces that encourage or

discourage evolution toward globally freer trade. It is worth repeating that our scenarios are not meant

to provide realistic forecasts of possible bilateral agreements. As a matter of fact, these agreements are

likely to include several very detailed exceptions, whereas we deliberately compare trade liberalisation

scenarios assuming that they allow the removal of all existing bilateral tariff barriers: in this respect, it

may be argued that our results overestimate the possible impacts.

On the other hand, new preferential agreements are likely to be “deep” ones to the extent that they

include rules on domestic policies while we only deal with border measures. In this respect, we are

likely to underestimate the possible impacts since our simulations only capture the impact of “shallow”

agreements. However, to the extent that the under/overestimation affects all liberalization scenarios in a

similar way, our results still allow meaningful comparisons.

The main conclusions of this paper relate to the building bloc-stumbling bloc debate that identifies

three distinct types of arguments in the literature: preference exploitation, cherry picking, and the

goodies bag. We consistently assess all these possible impacts in several possible EU FTAs. The

resulting picture is far from being black and white: FTAs may deliver important gains for participants,

but often they may also be a source of trade diversion and hamper movements towards greater trade

liberalisation.

The path to regionalism by the EU has been laid out, largely paved with agreements in fact or in

principle and, in many places, is already well-trodden. The apparent desire of the EU to join the

scramble for bilateral market access is probably unstoppable, but it is likely to yield less than some

might think, and it should not be taken for granted that it is likely to facilitate an eventual transition to

more liberal global trade. Empirical simulation models of the kind presented here can support this

evolving regional policies in essential ways, identifying both the opportunities and challenges that lie

ahead for more open multilateralism.

21

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