Category Archives: Preferential Trade

A reminder about the definition of trade diversion

It’s likely been more than a decade since a Trade Diversion blog post actually mentioned trade creation and trade diversion. Having missed numerous opportunities in recent years, I won’t pass up commenting on the following paragraph in Noah Smith’s recent post about experts and public policy:

Nor was this the only form of deception that economists employed in defense of free trade. Economists have known for many decades that some countries as a whole can be hurt by free trade. If a multilateral trade agreement — like the WTO, for example — admits new member countries, existing countries who compete directly with the newcomer nations can become poorer. This is called “trade diversion”, and it follows directly from the same simple classical economic theories of comparative advantage that economists typically use to justify free trade.

That paragraph is neither the most important nor most interesting part of his recent post, but it is salient for the owner of the leading trade-diversion-related domain name on the internet. Simon Lester, David DeRemer, and Michael Lane already pointed out on Twitter that Noah’s description of trade diversion has problems. Michael’s thread explained it clearly, but for posterity’s sake, here’s a blog post about the definition of trade diversion.

The concepts of trade creation and trade diversion concern the economic consequences of preferential trade agreements. They were introduced by Jacob Viner in a 1950 book titled The Customs Union Issue (that was, surprisingly, reprinted with a new introduction in 2014). Alan Deardorff’s glossary contains a concise definition of trade diversion: “Trade that occurs between members of a PTA that replaces what would have been imports from a country outside the PTA. Associated with welfare reduction for the importing country since it increases the cost of the imported good.”

Here’s a longer explanation from Richard Lipsey (Economica, 1957):

A is a small country whose inhabitants consume two commodities, wheat and clothing. A specialises in the production of wheat and obtains her clothing by means of international trade. Being small, she cannot influence the price of clothing in terms of wheat. Country C offers clothing at a lower wheat price than does B, so that, in the absence of country-discriminating tariffs, A will trade with C, exporting wheat in return for clothing. It is assumed that A levies a tariff on imports but that the rate is not high enough to protect a domestic clothing industry, so that she purchases her clothing from C. Now let country A form a customs union with country B, as a result of which B replaces C as the supplier of clothing to A. B is a higher cost producer of clothing than is C but her price without the tariff is less than C’s price with the tariff. Hence, the union causes trade diversion, A’s trade being diverted from C to B.

The language of economics was a bit different in 1957, to say the least.

The welfare losses that might result from trade diversion are a consequence of lost government revenue: consumer expenditure switches to the higher-cost supplier because it does not face an import tariff. Viner wrote “This is a shift which the protectionist approves, but it is not one which the free trader who understands the logic of his own doctrine can properly approve.” If one treats consumer surplus and government tariff revenue as equally valuable, trade diversion may cause a net loss. A typical diagram:


Returning to the blog post that sparked this one, Noah’s paragraph is odd for at least two reasons. First, it’s unusual to think of the World Trade Organization as a preferential trade agreement. WTO members are obliged to charge each other most-favored-nation (MFN) duties. For the WTO to be a preferential agreement associated with trade diversion, Noah must have in mind lower-cost non-WTO suppliers. But China wasn’t joining an exclusive club. Back in 2001, Vietnam and Afghanistan were not yet WTO members, but something like 140 nations already were and Vietnam already had MFN access to the US market.

Second, import duties on Chinese goods were not lowered when it became a WTO member. The United States had charged MFN rates on imported Chinese goods since 1980 (these were annually renewed; China’s WTO accession made them permanent). A policy change that does not lower import duties cannot cause trade diversion in classical trade theory. Of course, trade policy uncertainty was reduced, but that story is a bit far from the theory of comparative advantage taught in undergraduate economics classes.

Bottom line: When thinking about whether the United States was hurt by China joining the WTO, you don’t need to contemplate trade diversion.

Is it easier to liberalize agriculture via bilateral or multilateral deals?

Tyler Cowen’s latest Bloomberg column is about bilateral trade deals. He’s more optimistic than most:

The smartest case for trade bilateralism is that trade in many goods is already fairly free, but some egregious examples of tariffs and trade barriers remain. Look at agriculture, European restrictions on beef hormones in beef, and the Chinese unwillingness to allow in foreign companies. Targeted strategic bargaining, backed by concrete threats emanating from a relatively powerful nation — in this case the U.S. — could demand removal of those restrictions. Furthermore, the negotiating process would be more directly transactional and less cartelized and bureaucratic.

With regard to liberalizing agriculture, I think the conventional wisdom is that multilateral negotiations are superior. Here’s Jagdish Bhagwati talking to the NY Times back in 2004:

The only way concessions can be made on agricultural subsidies is if you go multilateral. Think of production subsidies, which the United States has: they can’t be cut for just one trading partner. When it comes to export subsidies–which are the big issue for the Europeans and a little bit for us too–we will cut export subsidies say, for Brazil, in a bilateral negotiation, but the Europeans won’t. Then the Europeans will have an advantage. My point is that if subsidies are the name of the game in agriculture, if the foreign countries that export want to remove subsidies, they have to go multilateral.


Mead and Drezner on EU-US trade prospects

Alan Beattie and Joshua Chaffin in the FT:

This month, a working group led by EU trade commissioner Karel De Gucht and US trade representative Ron Kirk is likely to suggest starting formal negotiations…

“The stars are almost aligned,” says Greg Slater, director of global trade policy at Intel, the chipmaker. The US and EU “have the opportunity to try to set the gold standard” in areas such as intellectual property protection, he says, which emerging markets like China and India would then have to respect.

Yet the deal faces complex challenges. Trade policy has moved from focusing on simple import tariffs on goods – already low for most transatlantic commerce – to often complicated “behind-the-border” domestic regulation. Technical standards, not tariffs, are the biggest barriers to integrating fast-growing US and European markets such as pharmaceuticals, medical services and advanced electronics…

“The aim in many instances is not to drive immediately for full regulatory convergence but to try to make sure that regulators on both sides of the Atlantic are making decisions with their eyes wide open,” says Sean Heather, vice-president of the [US Chamber of Commerce] chamber’s centre for global regulation. “The idea that negotiators are going to sit down with a big list and say: ‘We’ll give you that if you give us this,’ is probably not going to work for most regulations.”

Yet even agreeing an approach on convergence confronts bureaucratic and philosophical barriers. Regulation in both economies is frequently divided among different agencies, some jealous of their independence and unused to considering international implications.

Walter Russell Mead:

A U.S.-EU trade deal is essentially a way to ignore countries like Brazil and India while crafting rules that will govern some of the high-tech industries and information-based services that play a growing role in US-EU trade. Once those rules are set, the BRICs will be hard pressed to avoid signing onto them later on down the road.

Dan Drezner:

Two things have changed.  First, the traditional method of multilateral trade liberalization has died.  Second, while both the US and EU are major trading states, they’re not quite as pivotal as they used to be.  Ironically, it’s their declining (though still appreciable) importance in global trade that makes a US-EU agreement feasible now.  The BRIC economies are now sufficiently large that a transatlantic trade deal doesn’t seem like an existential threat.

And here’s Richard Baldwin, “Regulatory Protectionism, Developing Nations, and a Two-Tier World Trade System ,” Brookings Trade Forum: 2000.

Trade at VoxEU

Some recent VoxEU columns:

  • In Belgian firm-level data, a smaller percentage of services-producing firms export than goods-producing firms. Exporting entry and exit rates are higher in services than goods.
  • Richard Baldwin says that vertical specialization requires global trade governance sufficiently distinct from existing WTO practices that it requires a new organization.
  • An optimistic take on the Trans-Pacific Partnership and proposed EU-US trade deal.


This blog has a long history of covering preferential trade, as the title suggests. But I don’t follow proposed trade deals very much these days, largely because serious trade proposals haven’t been forthcoming in recent years.

If I had been paying attention, I would have noticed “a slow and steady effort to generate support for a U.S.-EU free trade agreement” “over the past year or so”, as noted by Simon Lester. At the WaPo, David Ignatius reports/opines:

But a big idea is taking shape that could revitalize the U.S.-European partnership for the 21st century. It was the talk of Berlin and Hamburg when I was there a week ago, and there’s a similar buzz in Washington. The idea is free trade — specifically, a trans-Atlantic free-trade agreement — which I’ll optimistically call “TAFTA.”
Secretary of State Hillary Clinton tipped the U.S. hand on Nov. 29 when she said at the Brookings Institution, “We are discussing possible negotiations with the European Union for a comprehensive agreement that would increase trade and spur growth on both sides of the Atlantic.”…
Curious as to whether Clinton’s speech was just window dressing from a departing secretary, I asked the White House this week whether the TAFTA talk is real. The answer was yes: Obama is considering making a trans-Atlantic trade initiative an important part of his second-term agenda. Combined with the North American Free Trade Agreement in Latin America and the ­Trans-Pacific Partnership in Asia, this could create a global trading system that might be an enduring part of Obama’s legacy.

See Simon Lester for one set of reasons to be skeptical.

Given (my uninformed impression of) current trade politics in the US, I see little reason to take TAFTA seriously at this stage. The Trans-Pacific Partnership negotiations have been going for about five years (with 15 rounds of formal negotiations over the last three years), so I’d be shocked if there were any accelerated action on the TAFTA front.

Did AGOA just divert Chinese exports through Africa?

I’ve followed the African Growth and Opportunity Act for a long time. This piece of US legislation gave preferential market access to exports from designated African countries, particularly in textiles and apparel. African economies experienced significant export growth in the early 2000s; the question was whether that growth should be attributed to AGOA and the EU’s Everything But Arms initative. The policy debate has been interesting in various ways: AGOA came under fire from both libertarians and Joe Stiglitz while finding favor with those in between.

The most favorable interpretation of the policy was that its temporary advantage would launch manufacturing clusters in Africa. And when researchers found that AGOA had a strong positive impact on African exports, it looked like the policy was spurring industrial growth.

That makes new research (pdf) from friend-of-the-blog Pierre-Louis Vezina (co-authored with Lorenzo Rotunno and Zheng Wang) very intriguing:

During the final years of the Multifiber Agreement the US imposed strict import quotas on Chinese apparel while it gave African apparel duty- and quota-free access. The combination of these policies led to a rapid but ephemeral rise of African exports. In this paper we argue that the African success can be explained by a temporary transhipment of Chinese apparel driven by quota-hopping Chinese assembly firms. We first provide a large body of anecdotal evidence on the Chinese apparel wave in African countries. Second, we show that Chinese apparel exports to African countries predict US imports from the same countries and in the same apparel categories but only where transhipment incentives are present, i.e. for products with binding quotas in the US and for countries with preferential access to the US unconstrained by rules of origin. Using input-output linkages, we then show that African countries imported quasi-finished products with little assembly work left to do, rather than primary textile inputs. We estimate that direct transhipment may account for around half of AGOA countries apparel exports.

The abstract certainly caught my attention; I look forward to reading this paper.

AmPro on the TPP

Kevin Gallagher isn’t very keen on the Trans-Pacific Partnership:

The Trans-Pacific Partnership is best understood as President Barack Obama’s extension of the Bush-era doctrine of “competitive liberalization.”… The Trans-Pacific Partnership (TPP) certainly isn’t about raising standards of living. The most ambitious estimates of the gains from the TPP suggest that participating nations will gain a mere one-tenth of 1 percent of the gross domestic product. Sixty percent of the projected gains go to Vietnam and the United States, and the other 20 percent goes to Malaysia—largely because the U.S. already has trade pacts with the other proposed big players in the TPP.

However, the proposed deal is far from popular in Asia. In exchange for the small portions of trade and growth that will go to some big exporters and foreign investors, each TPP nation will have to give up many of the policies they use to make trade and foreign investment work for employment, growth, and financial stability…

the investment and financial-services provisions in the TPP would restrict the ability of these nations to use joint ventures, local content rules, and regulation of cross-border financial flows to spread benefits, stimulate local manufacturing, promote employment, and provide financial stability.

It may be difficult to grasp that the TPP could harm the broader economic interests of both the U.S. and smaller Asian nations. But if balanced development requires a managed form of capitalism, then a trade deal like the TPP, which strengthens investors and weakens governments, can harm Asians and Americans alike…

I can’t say I share all those concerns, but it’s fair to say that the TPP isn’t a traditional trade deal in the sense of cutting tariffs and quotas. That column comes from a special issue of The American Prospect devoted to critiquing the TPP. For a contrary view, see Fred Bergsten and Jeff Schott, though much of their support for the initiative seems grounded in foreign-policy concerns rather economic benefits.

Is the NAFTA trucking dispute finally over?

A Mexican truck will make a delivery to a Dallas suburb this afternoon, thereby realizing some of the liberalization promised by NAFTA 17 years ago. WaPo:

The first Mexican carrier to deliver goods in the U.S. interior under a long-delayed free-trade provision is scheduled to enter the country at Laredo, Texas, shortly after midday Friday.

The truck owned by Nuevo Leon, Mexico-based Transportes Olympic will make a delivery to the Dallas suburb of Garland. That’s despite continuing opposition from the Teamsters union and some lawmakers who fear the program will make U.S. highways more dangerous and cost American jobs.

The truck will carry a monitoring device. The move complies with a provision of the 1994 North American Free Trade Agreement.

The company was also the first approved under the 2007 pilot program before President Barack Obama’s administration canceled it [in 2009]. Mexico retaliated by placing tariffs on 99 agricultural products worth more than $2 billion annually.

A little over a year ago, I noted that Washington insiders didn’t expect the dispute to be resolved “any time soon”, but in the broader context, 14 months isn’t bad. So what does the program do? It includes a lot of measures to address the safety concerns raised by its opponents:

Supporters say especially strict safeguards have been implemented: Electronic devices will track the routes drivers take, how long they drive and how long they rest. Participating drivers must undergo national security and criminal background checks, and inspectors will administer oral English-proficiency exams.

Does this end the dispute? Not necessarily. Look up the Federal Motor Carrier Safety Administration’s announcement in the Federal Register and you’ll discover that this is a three-year pilot program, a fact not made clear by some press coverage. From the Federal Register (pdf):

The Federal Motor Carrier Safety Administration (FMCSA) announces its intent to proceed with the initiation of a United States-Mexico cross-border long-haul trucking pilot program to test and demonstrate the ability of Mexico-domiciled motor carriers to operate safely in the United States beyond the municipalities in the United States on the United States-Mexico international border or the commercial zones of such municipalities (border commercial zones)…

In a pilot program, DOT typically collects specific data for evaluating alternatives to the regulations or innovative approaches to safety while ensuring that the goals of the regulations are satisfied. A pilot program may not last more than 3 years, and the number of participants in a pilot program must be large enough to ensure statistically valid findings.

Will the pilot program have large effects on international trade? Both sides claim big numbers:

Todd Spencer, the executive vice president of the Independent Drivers Association, which represents small independent trucking businesses, said 100,000 trucking jobs will be lost. Proponents say it will spur economic growth as companies save millions by sending the goods door-to-door.

But I doubt we’ll see any such impacts soon. Tire Business reports:

So far two small Mexico-based motor carriers have been certified for the program. They are Transportes Olympic of Monterrey, with two vehicles, and Grupo Behr de Baja California S.A. de C.V. of Tijuana, with five vehicles.

However, the FMCSA is withholding Grupo Behr’s permit while reviewing objections raised by the Teamsters and others regarding Grupo Behr’s safety record. The Teamsters also question Transportes Olympic’s record on safety.

You can track the approvals online at the FMCSA’s website. That site says that Transportes Olympic has registered one vehicle and two drivers. It looks like the dispute will continue in some form, for the time being.

Will the US Congress pass three PTAs this year?

Doug Palmer:

A congressional committee on Wednesday strongly backed deals with South Korea, Colombia and Panama, setting them on course for expected final approval and ending years of trade policy paralysis…

The panel’s chairman, Representative Dave Camp, said approval of the deals could not come at a better time for the struggling U.S. economy…

The three pacts must be approved by the full House and the Senate to become law. The panel backed the pacts on the following bipartisan votes: Colombia, 24-12; Panama, 32-3; and South Korea, 31-5.

Camp said he expected the full House to approve the trade deals next week. The Senate also could move quickly enough for the pacts to be approved in time for South Korean President Lee Myung-Bak’s visit to the White House on Oct 13.

How PTAs may segment regulatory systems

Back in April, I wrote:

One such danger is that FTAs might be a means for the US or EU to try to lock in first-mover advantages in shaping regulatory standards (such as technical barriers to trade). While preferential tariffs can be undone relatively easy by further tariff cuts, plurilateral agreements that promulgate the adoption of a larger economy’s preferred technical standard might serve to determine which standard is later adopted multilaterally. A first mover might gain at the expense of others if its preferred standard is worse for world welfare.

A new WTO report tackles this very issue:

Director-General Pascal Lamy, in launching the World Trade Report 2011 on 20 July 2011, warned that preferential trade agreements (PTAs) “may lock in their members to a particular regulatory regime reducing the potential for trade to prosper with countries outside the arrangement”. “The new challenge posed by deep PTAs to the multilateral trading system is one of market segmentation because regulatory systems, which can become divergent, have now more importance on trade flows than tariffs,” he added…

In fact PTAs of today are less about tariff preferences and more about regulatory measures that were once considered the domain of national rather than international economic policy.  This change is occurring partly because of changes in the way production is being organized internationally with the rise of global production networks.  To prosper, these production networks require an enabling regulatory environment that provides stronger investor protection, better infrastructural services, freedom of movement of corporate personnel, protection to intellectual property rights, and facilitation of trade.   The demand for governance in these policy areas is being met by the supply of deep PTAs…

Another idea would be that we should not ignore the potential difficulties that deep PTAs can give rise to on the regulatory side.  One can observe in the sprawl of agreements what can only be called “families” of PTAs, with each family adopting a particular approach to important policy areas such as technical barriers to trade or competition policy.  The peril here is that PTAs may lock-in their members to a particular regulatory regime reducing the potential for trade to prosper with countries outside the arrangement.

In a nutshell, the new challenge posed by deep PTAs to the multilateral trading system is one of market segmentation because regulatory systems, which can become divergent, have now more importance on trade flows than tariffs. This is not a statement about the legitimacy of these regulatory systems. It is a factual assessment of their impact on economies of scale, which is what the WTO should care about.

The report, titled “The WTO and preferential trade agreements: From co-existence to coherence”, is available online.