; 11 - 25506 ' - - February 2003 Public Disclosure Authorized ., [ R'EGIONAL INTEGRATION- AND DEVELOPMENT Public Disclosure Authorized lku &ADDVEOMN , ,..,U- .. .i.. SCHIFFLMAURICE and L. ALAN WVINTERS .. Public Disclosure Authorized Public Disclosure Authorized Regional Integration and Development Maurice Schiff and L. Alan Winters © 2003 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: [email protected] All rights reserved. 1 2 3 4 05 04 03 A co-publication of the World Bank and Oxford University Press. The findings, interpretations, and conclusions expressed here are those of the author(s) and do not necessarily reflect the views of the Board of Executive Directors of the World Bank or the governments they represent. The World Bank cannot guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mall [email protected]. Library of Congress Cataloguing-in-Publication Data Schiff, Maurice W. Regional integration and development / Maurice Schiff and L. Alan Winters. p. cm. Includes bibliographical references and index. ISBN 0-8213-5078-1 1. Trade blocs. 2. Regionalism. 3. Commercial policy. 4. Free trade. 5. International economic relations. I. Winters, L. Alan. ll. Title. F1418.7 .S35 2002 337.1-dc2l 2002074094 Contents Preface xi Abbreviations and Acronyms xv Chapter 1. Regional Integration Agreements: An Overview 1 RIAs in History 4 Why Regionalism? o Why Another Book on Regionalism? 10 Summary 13 Regionalism as Trade Policy Making the Most of Regionalism Regionalism and Investment Growth and Location Integration of Domestic Policies Regionalism as Politics Regionalism and the Rest of the World Rules of Thumb for Regionalism Appendix. Selected Regional Integration Agreements with Developing Country Members 26 Notes 29 Chapter 2. How Trade Blocs Increase Trade and Competition 31 Increased Trade between Members of Trade Blocs 32 Is More Trade Good, or Bad? Trade Creation and Trade Diversion 33 Growth of Trade over Time 36 Not All Changes Come from Regionalism 40 A Change of Perspective: Imperfectly Competitive Markets 46 iii iv REGIONAL INTEGRATION AND DEVELOPMENT Larger Markets, More Competition 50 Appendix. The Simple Analytics of Trade Creation and Trade Diversion 54 Notes 59 Chapter 3. Making the Most of Regional Integration 63 Free Trade with Whom? 64 Why Not with Everyone? Choosing Partners:The "Natural Trading Partners" Fallacy Choosing Partners:Comparative Advantage Neighborhood RIAs North-South or South-South RIAs How Many RIAs? 75 Free Trade Areas and Customs Unions 78 Trade Deflection and Rules of Origin: More Protection Indirect Trade Deflection: Exporting Protection Customs Unions Offer Lower Trading Costs and Greater Integration External Trade Policy 82 Setting External Tariffs in an FTA: A Race to the Bottom? Trade Policy Institutions in Customs Unions Can Increase Protection Lobbies Bias RIAs toward Trade Diversion RIAs Open a New Environment for Lobbying RIAs and Protection: Summing Up Integration and Taxes 94 Fiscal Compensation Tax Competition Notes 100 Chapter 4. Stimulating Investment 101 Investment Policies 103 Investment Planning:A Dead End Bilateral Investment Treaties Treatment of Investment in Current Regional Arrangements MultilateralInvestment Agreements Integration as an Aid to Credibility-Not an Automatic Effect 107 RIAs Allow Bad Policy to Be Punished RIAs Can Affect the Incentives for Good Policies RIAs Can Signal Government's Reform Intentions- If Genuine Regional versus Multilateral Routes to Credibility RIAs as Investment Stimuli 113 Integration Affects Incentives to Invest Investment Does Not Necessarily Mean Growth in RIAs CONTENTS V Regional Integration and Foreign Direct Investment 117 Motives for FDI Evidence of the Positive Effects of Integration Notes 121 Chapter 5. Growth and Location 123 South-South and North-South Regionalism as Stimulants to Growth 124 Knowledge and Institutions as Keys Trade, Convergence, and Spillovers Choosing the Wrong Partners Can Harm Growth FDI and Knowledge Spillovers Cross-Country Evidence on Openness and Growth Agglomeration and Inclustrialization 137 The Balance between Centripetaland Centrifugal Forces Trade Liberalization Can Aid Industrialization Intermember Distribution: Divergence Is Likely in South-South RIAS Notes 144 Chapter 6. Integrating Domestic Policies 147 Defining Policy Integration 149 The Baseline: National Treatment Beyond National Treatment: Policy Integration Modes of Policy Integration: Coordination, Harmonization, and Recognition The Economics of Policy Integration 154 Transactions Costs Policy Integration to Increase Competition Spillovers Compensation and Enforcement Local versus Regional versus Global Cooperation Policy Integration to Date: More Promise Than Reality 174 Coverage Depth of Integration:A Function of Political Objective Prospects for Policy Integration in RIAs Conclusion 183 Notes 183 Chapter 7. Regional Integration as Politics 187 Regional Integration as a Means of Reducing Frictions between Antagonistic Neighbors 188 Trade as a Promoter of Peace RIAs as Promoters of Peace RIAs Are Not Always Effective Routes to Peace Vi REGIONAL INTEGRATION AND DEVELOPMENT RIAs and Social and Political Pressures: Potentially Helpful, but Not a Panacea 196 The Role of Regional Integration in Strengthening Democracy and Political Institutions 198 Regionalism and the Nation-State 201 Regional Integration to Deal with Outside Threats and Regional Hegemons Regional Integration and Negotiations with the Outside World Notes 206 Chapter 8. Trade Blocs and the Rest of the World 209 Trade Discrimination: Still Significant 210 Trade Diversion and Excluded Countries 212 Evidence of Trade Diversion Loss of Exports to Trade Diversion The Effect of Large RIAs on Nonmembers' Terms of Trade The Road to Multilateralism: Are RIAs Stepping Stones, or Millstones? 221 Multilateralism as a Process Negotiating Power of RIAs Regionalism and Tariff Levels Has Regionalism Spurred Multilateral Negotiations? Domino Regionalism Regionalism as Insurance RIAs as Negotiating Partners: Do They Promote Free Trade? Do RIAs Make It Easier to Tackle Tough Issues? Open Regionalism: Little More Than a Slogan Regionalism and the WTO 244 GATF, and All That The Rules for RIAs: Useful, but Not Infallible Proposalsfor Improving the Rules on RIAs: "Feasible" and "Desirable" Do Not Overlap Conclusion: Rules Are Not the Answer Notes 256 Chapter 9. Rules of Thumb for Regionalism 261 Annex. Selected WTO Provisions on Regional Integration Arrangements 267 Bibliography 271 Index 299 CONTENTS vii LIST OF BOXES Box 1.1 Defining Terms: What's in a Name? 2 Box 1.2 What the Politicians Say: Hopes and Rationales for RIAs 7 Box 1.3 What the Treaties Say: Aims and Objectives 8 Box 2.1 Computable General Equilibrium (CGE) Modeling: An Explanation and a Health Warning 48 Box 3.1 Rules of Origin Are Protectionist 80 Box 3.2 Restaurant Bills, Universalism, and Protection 87 Box 3.3 Pressure Groups and M/lERCOSUR 91 Box 3.4 Taxes: A Race to the Bottom 99 Box 4.1 NAFTA and the Credibility of Mexico's Policy Reforms 109 Box 4.2 Credibility on Deep Integration: The European Single Market Programme 110 Box 4.3 Will RIAs Enhance Credibility in Africa? 112 Box 5.1 Modeling the Agglomeration Effects of RIAs 139 Box 5.2 The Influence of Regionalism on Within-Country Location: North America 144 Box 6.1 Defining Terms: "Deep" and "Shallow" Integration 151 Box 6.2 Harmonization and Mutual Recognition as Substitutes or Complements: The EU Experience 154 Box 6.3 When Is Nondiscrimination Discriminatory? The Economic Effects of Recycling Requirements 159 Box 6.4 Antitrust Law Competition by U.S. States in the 19th Century 165 Box 6.5 Labor Policies in U.S. States: Spillovers, but No "Race to the Bottom" 166 Box 6.6 Multilateral Policy Integration and the Enforcement Role of RIAs 172 Box 7.1 Trade and Peace: The Political Lineup Follows the Economic Lineup 189 Box 7.2 Modeling Trade and Security Externalities 191 Box 7.3 Democracy in MERCOSUR 199 Box 7.4 Trade Preferences Do Not Inevitably Lead to Political Integration 202 Box 7.5 CARICOM and International Negotiations 205 Box 8.1 Trade Diversion and Investment Switching in Europe 220 Box 8.2 Stepping Stones, or Millstones? A Summary 222 Box 8.3 Regionalism and Protection 227 Box 8.4 Is Open Access the Key to Benign Regionalism? 233 Box 8.5