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The Best of Both Worlds: Open Trading Clubs

Traditional trade theory teaches us that country A and country B both will benefit if trade barriers between A and B are removed. Modern trade theory teaches us that such an outcome is possible, but not inevitable. Both traditional and modern trade theorists agree, however, that in real life a move towards free trade is most likely to generate welfare gains for all participating countries.

If trade liberalization encompasses all countries of the world (let us call them A, B and C), they all can expect to enjoy welfare gains. If trade liberalization is restricted to countries A and B only, these countries will most probably win, but third country C may lose – due to trade diversion. If the US and the EU will agree on TTIP, for instance, Spanish or Slovakian component suppliers to the motor car industry may get better access to the US market (trade creation), whereas Mexican component suppliers may lose their competitive edge resulting from their NAFTA membership (trade diversion).

For these reasons, economists strongly prefer multilateral over bilateral trade negotiations. In fact, the tremendous success in trade liberalization since the end of WW2 was predominantly achieved within the multilateral framework of the GATT/WTO. In recent years, however, multilateralism has constantly been replaced by bilateralism. On the one hand, this development may be criticized because of associated trade diversion effects. On the other hand, rising bilateralism at least keeps the idea of further trade liberalization alive. Presumably, the true alternative is not bilateral vs. multilateral liberalization, but bilateral vs. no liberalization. It seems extremely unlikely that the WTO Doha Round, which started 2001, will ever be finished or will be followed by another WTO liberalization round in the near future.

By contrast to the WTO calamity, many new bilateral trade rounds are underway: CETA (Canada – EU), TTIP (USA – EU), TTP (Asia – USA), to name just a few. It can be expected, therefore, that the world economy will see a lot of trade creation in the future, but also a lot of trade diversion – especially at the expense of emerging markets.

In order to strengthen the former and dampen the latter, trade diplomats should consider regarding bilateral trade agreements as open clubs. When concluding any new bilateral agreement, they should allow and even encourage third countries to join. Provided third countries are ready to comply with the rules and principles of the respective agreement, they should be able to become members with bureaucratic obstacles as low as possible. Such an approach would be suitable for combining the best of both worlds – trade creation for the members of regional agreements and the option to join for countries which might otherwise suffer from trade diversion.

Henning Klodt

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