RESEARCH AND ANALYSIS

The Political Economy of Regional Trade Agreements: General Interests versus Special Interests

Xuepeng Liu, Assistant Professor of Economics
Department of Economics & Finance, Kennesaw State University, USA

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What are the driving forces of regionalism? Besides economic and geographic factors, political economy factors are also important. There are both winners and losers from regional trade agreements (RTAs). RTA decisions will be eventually determined by how the preferences of voters, politicians and interest groups are aggregated in policy making process. Therefore it is important to open the black box of the political economy of RTA formation. Different political economy models, however, can have very different predictions. A majority voting or general interests approach (i.e., median voter model as in Levy, 1997) in a 2-factor Heckscher-Ohlin framework predicts pro-labor trade policy because the median voter is always labor-rich or capital-poor; while a special interests approach (e.g., lobbying model as in Rodrik, 1986) assumes that it is easier for capitalists than workers to overcome the free-rider problem in lobbying and hence predicts pro-capital policy.

In two recent papers (Liu, 2008 & 2010) 1, I find that the prediction of the median voter model is supported by free trade areas and customs unions (FTAs/CUs); while the lobbying model seems to be more relevant in the partial-scope preferential trade agreements (PTAs). This is not surprising given the very different natures of these agreements. The “substantially all the trade” requirement of the GATT Article XXIV for FTAs/CUs can serve to reduce lobbying activities; while the limited sector coverage and many exceptions in PTAs signed usually among developing countries according to the Enabling Clause may encourage lobbying. For this reason, I consider PTAs as partial-scope arrangements and FTAs/CUs as full-fledged agreements. Although most of the FTAs/CUs have long staging periods in internal tariff reduction and some of them may violate the spirit of the Article XXIV, they offer much less scope for exchanging arbitrary preference than PTAs.

The findings in this paper offer some useful policy implications. Although the support for the median voter model by the FTAs/CUs does not necessarily imply good governance, the support for the lobbying model by PTAs does raise some concerns. An RTA heavily influenced by lobbies usually leads to welfare loss due to trade diversion (“static welfare impact”) and prevents the move from regionalism to multilateralism (“dynamic time path”). According to the classic Vinerian approach, an RTA is welfare improving if the trade creation effect dominates the trade diversion effect. Manipulations by special interest groups representing import-competing sectors are often considered a source of trade diversion and “stumbling block” effect. The recent literature of endogenous trade agreement formation (e.g., Maggi and Rodriguez-Clare 1998; Mitra 2002) indicates that trade agreements may serve as a commitment device to tie the hand of a government. Ornelas (2005) shows that FTAs lowering the domestic market shares of import-competing sectors reduce their incentives of lobbying for higher external tariffs (‘‘rent destruction”). The support for the lobbying model suggests that PTAs are less likely to work well as a commitment device, less likely effective in rent-destruction and external tariff reduction, and hence less likely to be stepping stones toward multilateral liberalization, compared to full-fledged RTAs.

Another contribution of my studies is on econometric methodology. Previous researchers usually analyze the determinants of RTAs using the standard binary choice regressions (e.g., probit/logit). The traditional method is inappropriate in panel data analysis because it assumes that the dependent variable (RTA dummy) is conditionally independent over time. For example, Mexico signed NAFTA with the U.S. and Canada in 1994, and NAFTA remains in place for all the following years. Hence the independence assumption is obviously violated. I propose a discrete time duration analysis to correct this problem for the first time in the RTA literature. In duration analysis, we study how long it takes for two countries to sign an agreement by dropping all the repeated positive outcomes (“1”s) for each country pair (e.g., US-Mexico after 1994). No information will be lost because we are not interested in how long RTAs last. Once the repeated “1”s are dropped, the problem of conditional dependence in the standard binary choice analysis disappears.

As a final note, the support for the lobbying model in the case of PTAs does not mean that developing countries should not form PTAs. If an agreement is intended to promote development, cooperation in areas such as regulatory reform and infrastructure provision, or to increase bargaining power in international trade negotiations, then it may be appropriate. In terms of trade promotion, however, we should not expect much gain from PTAs unless the exemptions and sector exclusions are temporary.

Selected References:

Levy, Philip, 1997. A political-economic analysis of free-trade agreements. American Economic Review 87 (4), 506-519.
Liu, Xuepeng. 2008. The political economy of free trade agreements: an empirical investigation. Journal of Economic Integration 23: 237-71.
Liu, Xuepeng, 2010. Testing conflicting political economy theories: full-fledged vs. partial-scope regional. Southern Economic Journal 77(1): 78-103.
Maggi, Giovanni, and Andres Rodriguez-Clare. 1998. The value of trade agreements in the presence of political pressures. Journal of Political Economy 106:574–601.
Mitra, Devashish. 2002. Endogenous political organization and the value of trade agreements. Journal of International Economics 57:473–85.
Ornelas, Emanuel, 2005. Rent destruction and the political viability of free trade agreements. Quarterly Journal of Economics 120(4): 1475-506
Panagariya, Arvind, 1994. East Asian and the new regionalism. World Economy 17 (6), 817-839.
Rodrik, Dani., 1986. Tariffs, subsidies, and welfare with endogenous policy. Journal of International Economics 21 (3/4), 285-299.

Note:
1
. My research benefits from many previous studies, which are cited in my papers. Not all of them are listed in this short article due to the 1000 words space limit. back to text


Dr. Xuepeng Liu obtained his Ph.D. in Economics in 2006 from the Maxwell School at Syracuse University (USA). His research focuses on international trade and economic development. He is currently an assistant professor of economics at Kennesaw State University (USA). For more information, please visit his website.

 

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