ADVOCATES FOR INTERNATIONAL DEVELOPMENT

AT A GLANCE GUIDE TO BILATERAL & REGIONAL TRADE AGREEMENTS

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TABLE OF CONTENTS 1. INTRODUCTION

What are bilateral and regional trade agreements? How do bilateral and regional trade agreements work within global international trade?

2. MAIN FEATURES
The concept of international free trade The history of the WTO and the multilateral trading system Most favoured nation status The development of bilateral and regional trade agreements The impact of bilateral and regional trade agreements on global trade

3. RELEVANT LEGISLATION
Article 13, UN Charter Article 24 GATT

4. CASE STUDY The North American Free Trade Agreement

What is NAFTA? NAFTA highlights NAFTA and world trade

5. CONCLUSION

For further information, please contact: Liz Brownsell, Associate: Liz.Brownsell@allenovery.com DD: 020 3088 1842 Matthew Gearing, Partner: Matthew.Gearing@allenovery.com DD: +852 2974 7177 Allen & Overy LLP One Bishops Square London E1 6AD

INTRODUCTION What are bilateral and regional trade agreements? A bilateral or regional trade agreement is an agreement entered into between two or more countries under which the participants agree to reduce tariffs, quotas and other restrictions on trade between them. Bilateral trade agreements are, as the name suggests, bilateral in character; whereas regional trade agreements are generally entered into between a number of countries in a particular region. The agreements cover both trade in goods and trade in services and also deal with issues such as the protection of intellectual property. They also frequently contain provisions or whole chapters dealing with protection for foreign investments. Bilateral and regional trade agreements are sometimes referred to as preferential trade agreements because they are only beneficial to the particular states or countries to which they relate. They can also be divided into two categories: "customs unions" where two or more countries enter into an agreement to remove tariffs and other restrictions on trade among themselves, but apply a common external tariff to trade with any other countries (for example, the Southern African Customs Union1); and "free trade areas" where two or more countries enter into an agreement to remove tariffs and other restrictions on trade among themselves, but each continues to determine the tariffs that apply to trade with any other countries (for example, the North American Free Trade Agreement2).

How do bilateral and regional trade agreements work within global international trade? Bilateral and regional trade agreements are a feature of a global trading system alongside multilateral trade agreements, the first of which was the General Agreement on Trade and Tariffs (known as GATT). The GATT created a multilateral trading system, which is now promoted by the World Trade Organisation (the WTO), and which has resulted in the removal of trade barriers around the world and the creation of a global marketplace.
Figure 1 - RTAs 2010

Bilateral and regional trade agreements have become an increasingly prominent feature of international trade over the last two decades. Statistics available on the WTO website show that 205 bilateral and regional trade agreements were in force in July 2007 and by 2010 it is estimated that this number will increase to approximately 4003 (see Figure 1 for proportions).

10%

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F ree Trad e Areas

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The proliferation of bilateral and regional trade agreements in recent years has resulted in significant debate as to the effect that "regionalism" will have on the multilateral trading system. There are valid arguments on both sides of the debate but there is also a school of thought that we should not be debating whether or not regionalism is a good or bad thing but instead should be looking at the way that bilateral and regional trade agreements operate and the new economic opportunities arising as a result4. MAIN FEATURES The concept of international free trade In 1776 Adam Smith published The Wealth of Nations, in which he included the proposition that free trade among nations improves overall economic welfare5. The concept of "free trade" has since become a generally accepted principle and is the concept that underlies the multilateral trading system. Free trade involves the removal of tariffs, quotas or other

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The Southern African Customs Union was originally established in 1910 between the then Union of South Africa and the High Commission Territories of Bechuanaland, Basutoland and Swaziland. In December 1969, after these nations became independent, it was replaced by an agreement entered into between the Republic of South Africa, Botswana, Lesotho and Swaziland. In 1990 Namibia joined the agreement as a fifth member (following its independence from South Africa). The North American Free Trade Agreement was entered into between Canada, Mexico, and the United States of America and came into effect on 1 January 1994. http://www.wto.org/english/tratop_e/region_e/region_e.htm. Director-General Pascal Lamy speaking at the Conference on Multilateralising Regionalism on 10 September 2007 in Geneva information sourced from the WTO website (http://www.wto.org/english/news_e/sppl_e/sppl67_e.htm). A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776).

restrictions on international trade, enabling global production of goods and services in the most effective and efficient way possible. Whilst it is generally accepted that free trade does provide overall benefits in the "big picture", the benefits are not necessarily seen at a more local level. If imported products and services can be produced and sold more cheaply than local produce, then local producers may lose out. In such a situation, if those local producers hold enough political power, the result is the implementation of trade restrictions to protect local producers from foreign competition. Clearly the quickest method of introducing a system of free trade would be for all countries to unilaterally decide to remove all tariffs, quotas and other restrictions on international trade. There are various studies that illustrate the economic benefits of making independent tariff reductions without requiring any reciprocal action from other countries6. However, for the reasons given above, many countries find it difficult to make such a complete transition on their own. This is a key reason for the establishment of the WTO and a multilateral trading system, under which all major trading countries negotiate agreements for the removal of barriers to international trade. The history of the WTO and the multilateral trading system The origins of the multilateral trading system and the WTO can be traced back to the Bretton Woods Agreement in 19447 and the subsequent creation of the United Nations (UN)8. Article 13 of the UN Charter9 states that the UN General Assembly shall: "initiate studies and make recommendations for the purpose of promoting international co-operation in the political field and encouraging the progressive development of international law and its codification" Within months of the UN Charter coming into force, negotiations began between UN member states to enter into an international trade agreement for the reciprocal reduction of tariffs on trade in goods. Negotiations continued for 2 years and agreement was finally reached on 30 October 1947 when the GATT10 was concluded and signed in Geneva by 23 of the original 50 UN member states11. At the time that the GATT was signed, the intention was that it would be a provisional arrangement until the establishment of an International Trade Organisation12 as a specialised agency of the United Nations. The ITO Charter was agreed in Havana in March 1948, but was never fully ratified and so the International Trade Organisation never became operational. GATT was therefore the only existing multilateral trade agreement to govern international trade between 1948 and 1995 (when the WTO was established). From 1948 onwards, under the auspices of GATT, the UN continued in its efforts to reduce tariffs through a series of multilateral negotiations (known as "trade rounds") and it is a widely held view that these trade rounds have been a significant cause of progress in international trade liberalisation. For the first few years of GATT, the focus of each trade round was on reducing tariffs. Then between 1964-67 (in the "Kennedy" round) a broader and more liberal approach was taken and this approach was further progressed in the "Tokyo" round between 1973-79. The most recent round (the "Uruguay" round between 1986-94) was the most progressive round and resulted in the creation of the WTO and several new multilateral trade agreements.

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See for example: Julio Nogues, The Choice Between Unilateral and Multilateral Trade Liberalization Strategies (1989). The Bretton Woods Agreement was signed in July 1944 by delegates from 44 nations. The delegates met for a conference in Bretton Woods, New Hampshire to discuss how to rebuild world economy following World War II. The result was the creation of the Bretton Woods system to govern monetary relations between nations. Two institutions were also established: the International Monetary Fund (the IMF) and the International Bank for Reconstruction and Development (the World Bank). Although it was not within the remit of negotiations at Bretton Woods, the delegates identified the need for an institution to facilitate free trade among nations, which would complement the IMF and the World Bank. The United Nations was established in the wake of World War II with the aim of facilitating co-operation between nations in the hope of saving "succeeding generations from the scourge of war". Today there are 192 member states. The UN Charter established the United Nations and was signed on 26 June 1945 in San Francisco at the conclusion of the United Nations Conference on International Organisation. It came into force on 24 October 1945. The General Agreement on Tariffs and Trade became effective on 1 January 1948. The Commonwealth of Australia, the Kingdom of Belgium, the United States of Brazil, Burma, Canada, Ceylon, the Republic of Chile, the Republic of China, the Republic of Cuba, the Czechoslovakia Republic, the French Republic, India, Lebanon, the Grand-Duchy of Luxemburg, the Kingdom of the Netherlands, New Zealand, the Kingdom of Norway, Pakistan, Southern Rhodesia, Syria, the Union of South Africa, the United Kingdom of Great Britain and Northern Ireland and the United States of America. The International Trade Organisation was intended to be an institution to complement the existing Bretton Woods institutions (the World Bank and the IMF)(see footnote 7 above), which would deal with trade aspects of international economic co-operation.

Year 1947 1949 1951 1956

Round Geneva Annecy Torquay Geneva

Achieved GATT Tariff reductions Tariff reductions Tariff reductions and policy on developing countries Tariff reductions

1960-62

Dillon

1964-67

Kennedy

Tariff reductions and customs valuation rules

1973-79

Tokyo

Rules on anti-dumping duties, agreement on import licensing and tariff reductions Intellectual property rights and services included, establishment of the WTO

1986-94

Uruguay

Upon its creation the WTO adopted the GATT principles and agreements and has since continued to administer and develop them further. The aim of the WTO is to reduce barriers to international trade through a multilateral trading system. Most favoured nation status If a country has "most favoured nation" (or MFN) status with another country, it means that it has been granted the same trade advantages extended by that country to any other country. One of the key principles of the WTO is that all member countries must extend MFN status to each other. The idea being that this prevents any preferential treatment or discrimination between member countries. Despite incorporating a general principle of MFN between member countries, the WTO does allow certain exceptions. Together with preferential treatment for developing countries, the establishment of bilateral and regional trade agreements is one such exception. As explained in the introduction, bilateral and regional trade agreements are agreements between two or more countries under which the participants agree to reduce tariffs, quotas and other restrictions on trade between them. These agreements are an exception to the general MFN principle within the WTO because they allow member countries to extend preferential treatment to a select number of other member countries. The development of bilateral and regional trade agreements The increase in the number of bilateral and regional trade agreements in recent years has occurred despite the existence of the WTO and the multilateral trading system. One explanation for this is that the WTO has become increasingly slow and comparatively ineffective as a means of establishing a system of free trade between countries. As the trade rounds of the WTO have become more liberal and sought to address wider issues, they have also become more lengthy and difficult to conclude, with the last round (the "Uruguay" round) lasting for 8 years. It is perhaps not surprising that decisions required to be made unanimously on numerous issues relating to trade liberalisation often move slowly. It is also not surprising that the requirement for absolute consensus limits how far any trade reform agreements are able to go. There are also many external factors to consider, such as politics and economic growth, all of which have an impact on negotiations. The current difficulties in bringing the "Doha" round to a conclusion are a good illustration of the slow nature of negotiations under the WTO trade rounds. It is possibly as a result of these limitations on the WTO that bilateral and regional trade agreements have become such a prominent feature in world trade in recent years. The impact of bilateral and regional trade agreements on global trade As bilateral and regional trade agreements have become an increasingly prominent and important trade policy tool there has been a corresponding increase in the amount of literature discussing the impact that these agreements may have on global trade. There has been much discussion about the fact that bilateral and regional trade agreements could have a significantly detrimental impact on the progress of trade liberalisation and that, whilst certain benefits can be seen in the short term, unless care is taken, the long term result could be a complex system of preferential trade moving further away from the concept of multilateralism. Roberto V. Fiorentino, Luis Verdeja and Christelle Toqueboeuf express this view

succinctly in the abstract to their paper The Changing Landscape of Regional Trade Agreements: 2006 Update where they state that: "the promotion of free trade through preferential agreements can foster trade liberalisation and benefit the economic development by integrating developing countries into the world economy; yet the development of complex networks of non-MFN trade relations will increase discrimination and may well undermine transparency and predictability in international trade relations."13 Of particular concern is the complex nature of interlacing bilateral and regional trade agreements and the impact that this structure may have on the developing world. In recent years, bilateral and regional trade agreements have become increasingly sophisticated and they now cover a far wider remit than the multilateral trading system: for example, most bilateral and regional trade agreements address issues relating to competition and intellectual property, which are contentious issues within multilateral trade negotiations. In addition, they are becoming geographically more far reaching; many regional trade agreements are now entered into between several countries from different regions with consistent trade policy aspirations. This suggests that regional trade agreements are increasingly being used to strengthen political and economic partnerships rather than to simply enhance regional integration.

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The Changing Landscape of Regional Trade Agreements: 2006, by Roberto V. Fiorentino, Luis Verdeja and Christelle Toqueboeuf, respectively Economic Affairs Officer, Junior Economic Affairs Officer and Administrative Assistant with the Regional Trade Agreements Section of the Trade Policies Review Division of the WTO Secretariat.

RELEVANT LEGISLATION Article 13, UN Charter The United Nations was established in the wake of World War II with the aim of facilitating co-operation between nations in the hope of saving "succeeding generations from the scourge of war"14. The UN Charter established the United Nations and Article 13(a) relates to the liberalisation of world trade. It states that: "The General Assembly shall initiate studies and make recommendations for the purpose of: a. promoting international co-operation in the political field and encouraging the progressive development of international law and its codification".15

Article 24 GATT Article 24 of GATT recognises "the desirability of increasing freedom of trade by the development, through voluntary agreements, of closer integration between the economies of the countries parties to such agreements". It therefore expressly permits the formation of customs unions and free trade areas between member states despite the fact that this is contrary to the general principle of MFN status. Article 24 states that: "the provisions of this Agreement shall not prevent, as between the territories of contracting parties, the formation of a customs union or of a free-trade area or the adoption of an interim agreement necessary for the formation of a customs union or of a free-trade area; Provided that: (a) with respect to a customs union, or an interim agreement leading to a formation of a customs union, the duties and other regulations of commerce imposed at the institution of any such union or interim agreement in respect of trade with contracting parties not parties to such union or agreement shall not on the whole be higher or more restrictive than the general incidence of the duties and regulations of commerce applicable in the constituent territories prior to the formation of such union or the adoption of such interim agreement, as the case may be; (b) with respect to a free-trade area, or an interim agreement leading to the formation of a free-trade area, the duties and other regulations of commerce maintained in each of the constituent territories and applicable at the formation of such freetrade area or the adoption of such interim agreement to the trade of contracting parties not included in such area or not parties to such agreement shall not be higher or more restrictive than the corresponding duties and other regulations of commerce existing in the same constituent territories prior to the formation of the free-trade area, or interim agreement as the case may be; and (c) any interim agreement referred to in subparagraphs (a) and (b) shall include a plan and schedule for the formation of such a customs union or of such a free-trade area within a reasonable length of time."16

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Preamble to the Charter of the United Nations 1945. Article 13 Charter of the United Nations 1945. The full text of the UN Charter can be found at http://www.un.org/aboutun/charter/. Article XXIV(5) General Agreement on Tariffs and Trade 1947. The full text of the GATT http://www.wto.org/english/docs_e/legal_e/gatt47_e.pdf.

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CASE STUDY - The North American Free Trade Agreement

What is NAFTA? In June 1990 President Bush (the then President of the United States) and President Salinas (the then President of Mexico) announced their intention to begin discussions aimed at liberalising trade between the U.S. and Mexico. Shortly afterwards, in August 1990, President Salinas officially proposed to President Bush the negotiation of a free trade agreement. In February 1991 Canada joined the negotiations and the result was the North American Free Trade Agreement (NAFTA), which was signed in December 1992 and came into force in January 1994. NAFTA forms the world's second largest free trade zone after the European Union17. Its aim is to eliminate the majority of tariffs on products traded across its member states. It targets the abolishment of export tariffs in particular industries, with textiles and automobiles a major focus. However NAFTA also created a framework where labour and environmental concerns could be addressed collectively, as well as serve as a platform for dispute resolution and intellectual property protection. In their book NAFTA Revisited: Achievements and Challenges, Hufbauer and Schott explain the key reasons that spurred each of the participating countries to enter into NAFTA. In relation to the US, they state that: "For the United States, NAFTA was an economic opportunity to capitalize on a growing export market to the south and a political opportunity to repair the sometimes troubled relationship with Mexico NAFTA reforms promised to open new doors for US exporters who faced Mexican industrial tariffs five times greater on average than US tariffs to a growing market of almost 100 million people. US officials also recognized that imports from Mexico likely would include higher US content than competing imports from Asia, providing an additional benefit. Increased Mexican sales in the US market would in turn spur increased Mexican purchases from US firms."18 They explain the reasons for Mexico's interest as follows: "For Mexico, NAFTA represented a way to lock in the reforms of the aperture, or "market opening", that President Miguel de la Madrid inaugurated in the mid-1980s to transform Mexico's formerly statist economy in the wake of the devastating debt crisis of the 1980s. Mexico needed more rapid growth to provide new opportunities for its young, expanding population. Given the legacy of the debt crisis of 1982, low domestic savings, and an increasingly overvalued peso, the most practical way to propel growth was to import goods and capital, creating more competition in the Mexican market."19 Finally, in relation to Canada, they explain that: "For Canada, the latecomer to the NAFTA table, the objectives were less ambitious. Initially, Canadian officials suspected that a new agreement with Mexico would erode the hard-fought gains of the CUSFTA, which had come into force only in 1989. Canadian unions felt that Mexico's low wages would undercut Canada's competitive advantage in the US market, possibly diverting US FDI away from Canada Trade between Canada and Mexico was small, the prospective deal seemed unlikely to redress CUSFTA shortcomings on trade remedies, and Canadians were less worried about migration flows than their US counterparts. However, as it became clear in September 1990 that the United States and Mexico were going to move ahead with or without Canada, the Canadian government decided that it had more to gain by joining the negotiations than by staying on the sideline. Involvement allowed the government to minimize the risks to Canada of US-Mexico free trade and offered an opportunity to extract new commercial concessions from the United States."20 NAFTA highlights Article 102 of NAFTA sets out the key objectives of the agreement as follows: "The objectives of this Agreement, as elaborated more specifically through its principles and rules, including national treatment, most-favored-nation treatment and transparency, are to:

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The European Union has more members and a larger population, however, it is a customs union whereas NAFTA is a free trade agreement. G. C. Hufbauer and J. J. Schott, NAFTA Revisited: Achievements and Challenges (2005), p2. Ibid, p3. Ibid, p3.

a) b) c) d) e) f)

eliminate barriers to trade in, and facilitate the cross-border movement of, goods and services between the territories of the Parties; promote conditions of fair competition in the free trade area; increase substantially investment opportunities in the territories of the Parties; provide adequate and effective protection and enforcement of intellectual property rights in each Party's territory; create effective procedures for the implementation and application of this Agreement, for its joint administration and for the resolution of disputes; and establish a framework for further trilateral, regional and multilateral cooperation to expand and enhance the benefits of this Agreement."21

According to data from the Office of the United States Trade Representative, between 1993 and 2007 "trade among the NAFTA nations more than tripled, from $297 billion to $930 billion"22. This increase in trade may not necessarily be entirely attributable to NAFTA and this is something that is difficult to assess. However the consensus seems to be that NAFTA has played a significant role in this increase in trade23. As with all bilateral and regional trade agreements, agriculture has been a controversial issue for NAFTA. It is an incredibly sensitive issue politically and countries are often reluctant to remove protectionist barriers in relation to farming. The U.S., Canada and Mexico were unable to negotiate the terms on agriculture trilaterally so it is not covered by NAFTA; instead three separate bilateral agreements were signed (i.e. one between the U.S. and Canada, one between the U.S. and Mexico, and one between Canada and Mexico). This, of course, adds a layer of complexity to the arrangements between the three countries. NAFTA and world trade It seems clear that NAFTA has played an important role in increasing trade between its member countries. However, an important question in relation to world trade is whether this increase is a global one or whether the increase actually represents trade diversion (i.e. diversion of trade away from non-member countries, rather than a genuine increase in trade). NAFTA contains restrictive rules of origin24, which are very protectionist in nature and arguably exceed the measures necessary to prevent trade deflection. The rules of origin have arguably resulted in trade diversion for certain industries. Hufbauer and Schott comment that "in a few industries, most notably textiles and apparel where 'yarn forward' rules of origin were imposed specifically to make US textile firms the preferred suppliers for Mexican apparel manufacturers, NAFTA has indeed fostered trade diversion."25 The U.S. hopes to negotiate an regional trade agreement covering all of the Americas, but key countries like Brazil are sceptical of its benefits. Instead certain countries (such as Chile) have preferred to negotiate separate bilateral trade agreements with each of the three current NAFTA members. These agreements all contain different standards of trade liberalisation and are an example of how developing countries, by entering into a variety of bilateral and regional trade agreements, can unwittingly create a complex system of overlapping arrangements that may not be beneficial to them in the long run. CONCLUSION Many developing countries are signing up to bilateral and regional trade agreements because the benefits of the reciprocal arrangements are attractive and offer a much faster solution to trade liberalisation than the "Doha" round is currently able to offer. However, the result of the proliferation of bilateral and regional trade agreements is a complex system of overlapping arrangements, which many people fear will have a negative impact on the developing world because it is not equipped to deal with such a high degree of complexity.

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Article 102, NAFTA (1992). The full text of NAFTA can be found at http://www.sice.oas.org/trade/nafta/naftatce.asp. Office of the United States Trade Representative, NAFTA Facts (March 2008) (available at http://www.ustr.gov/assets/Trade_Agreements/Regional/NAFTA/Fact_Sheets/asset_upload_file202_14592.pdf). 23 See for example G. C. Hufbauer and J. J. Schott, NAFTA Revisited: Achievements and Challenges (2005). 24 "Rules of origin" are important for free trade agreements because, unlike customs unions, under the terms of a free trade agreement each participating country determines its own tariffs to apply to non-member countries. Therefore, those member countries with higher external tariffs need to protect against other member countries with lower external tariffs importing products from non-member countries with the intention of immediately exporting those products to other member countries that have a higher external tariff. This is known as "trade deflection". 25 G. C. Hufbauer and J. J. Schott, NAFTA Revisited: Achievements and Challenges (2005), p23.

The case study on NAFTA is an example of the complexity that can arise even as between the three countries involved. The arrangements between the US, Mexico and Canada are not all encapsulated within NAFTA. There are a number of side agreements in place, setting out different systems in respect of different products depending on the political and economic factors in each case. Bilateral and regional trade agreements are, by their very nature, discriminatory and there is a concern that many developing countries are signing up to arrangements that may erode over time. The worry, therefore, is that developing countries and small corporations, which are unable to handle this chaotic structure, will lose out in the long run. Author: Liz Brownsell Associate at Allen & Overy LLP

Disclaimer Where sources have not been cited the information does not necessarily reflect a non-biased view. This publication provides general information and comments on the subject matter covered and is not comprehensive. It is not intended to provide legal advice.

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