Why multilateralism must die

The World Bank’s latest Global Economic Prospects, out last week, has a series of simulations that give teeth to what economists have been saying for a long time, namely that regional trade agreements (of the type India seems to be rushing to sign nowadays) don’t really help to boost trade to the extent that multilateral agreements like those at the WTO do.

The Bank’s macro-modelling projects that world income levels will go up by $263 billion in real terms by 2015 in case there is completely free trade between countries and domestic distortions in the US/EU agriculture sector, for instance, are removed and all textile trade curbs are eliminated.

If, however, multilateral trade remains as stuck as it is today and gets replaced by a host of bilateral RTAs/FTAs between developing countries and members of the extended Quad group of countries (the US, the EU, Japan, Canada plus Australia and New Zealand) this growth will come down dramatically.

In such a situation, the model suggests, world income will grow by only $112 billion in real terms, or around 40 per cent of what is projected under the unfettered free trade model.

And in case big developing countries like Brazil, China, and India are not able to get into such bilateral deals with the extended Quad, as looks likely, the increased world income would be a mere $40 billion, or around a seventh that of a full-blown multilateral trading system.

While this loss in potential income would hit all countries, the Bank’s simulations show, again something intuitively quite obvious, that it is the developing countries that will get hit the most if the WTO process doesn’t get moving.

While income growth for high-income countries will reduce from $154 billion in a full-blown trade situation to $134 billion in a purely bilaterals-with-the-extended-Quad case, those for low-income countries will actually move into the negative if bilateral deals become the preferred trading route.

While income levels for low-income countries are projected to rise by $17 billion in the full-trade case as these countries’ exports are allowed unfettered access to developed markets, their incomes could actually fall by $19 billion if Quad+ countries sign bilaterals with countries like China and Brazil, which will then capture the bulk of the increased trade—what makes things worse is that since the Quad+ will dictate terms in any bilateral deal, this automatically restricts the growth in world trade and income.

If the US or the EU has bilateral deals with the US or China, for instance, it is likely they will be able to keep their agriculture markets a lot more closed than they would in a pure multilateral trading system.

While much of this is obvious even without the complex modelling, the Bank’s study makes a couple of very interesting points, one of which pretty much underlines why multilateralism is in the comatose shape it is in today, or why the US or the EU isn’t going to go out of its way to ensure the WTO process moves rapidly.

To quote from the report, “Both the United States and the EU (the most aggressive advocates of bilateral deals) would appear to benefit more from pursuing bilateral arrangements with all developing countries than from global reform. The United States would gain an additional $7 billion (0.1 per cent of GDP) while the EU would gain $27 billion (0.4 per cent) of GDP.”

That is, the US and the EU can still retain their distorted markets while driving deals with individual countries and still benefit more as compared to a situation in which they reduce their gargantuan farm subsidies and allow free trade.

But if multilateralism is under serious threat, what’s the solution? Isn’t going in for more bilateral RTAs/FTAs a good idea, like India is doing? Certainly there is little other option, but the Bank’s study provides some useful tips.

While RTAs/FTAs have increased six-fold over the past decade and a half, and today cover around a third of world trade, the Bank points out that it is north-north pacts that work the best.

Indeed, while south-south pacts account for around 80 per cent of all such trading arrangements, it is the north-north pacts that account for 80 per cent of all trade within these bilateral/regional agreements.

That is, bilateral trade pacts of the developed world do well, while those of the developing world don’t. Indeed, when you look at the trade expansion as a result of bilateral RTAs/FTAs, it is the north-north ones that result in increased trade while the south-south ones result in trade contractions. Why?

One reason is that since the developed world has very low tariffs anyway, their trade pacts don’t restrict trade from other parts of the world. On the other hand, trade pacts of the south still maintain very high tariffs for the rest of the world.

While NAFTA has tariff levels of around 3 per cent for non-NAFTA countries, SAPTA countries have a 22 per cent import tariff for non-members.

This higher tariff then restricts trade with the rest of the world, and so also keeps the efficiency gains of trade limited because these countries cannot access low-cost goods from the rest of the world. Indeed, countries that have high trade levels with the rest of the world are those that have high intra-region trade as well!

The moral of the story is quite evident: as India goes and signs up bilaterals with the rest of the world, it just has to unilaterally lower its tariffs and open up markets to imports.

Protecting inefficient local producers through bilateral deals that maintain high tariff walls vis-à-vis low-cost producers in the rest of the world will only make the economy more inefficient.