Regional trade agreements can either promote broader trade liberalization ("building blocks") or discourage it ("stumbling blocks"), depending on how member countries treat non-members. This study examines the effects of regionalism on Latin American countries' external tariffs towards non-members from 1990-2001. The results show that tariff reductions within free trade areas significantly lowered members' external tariffs, but tariff reductions within customs unions did not, suggesting regionalism functioned as a "building block" within FTAs but not CUs. Instrumental variable regressions that control for endogeneity support these findings.

1. Jaeyoun Roh
Does Regionalism Affect
Trade Liberalization
Towards Non-Members?
Estevadeordal, Freund and Ornelas (2008)

2. Introduction

3. “Building blocs” vs. “Stumbling blocs”
• The main question is whether the member countries
lower tariffs on non-member countries or not.
• If the preference induces a faster decline in external
tariffs in Free Trade Area, the regionalism is a “building
block” to free trade and if not, the regionalism is a
“stumbling block”.
 The result is that regionalism is a building bloc to free
trade in Latin America.
 The result is both statistically and economically
significant.

4. “Free Trade Area” vs. “Custom Unions”
• CU members have the common external tariff.
• The common external tariff allows CU members to pursue of
their joint market power in world markets, which lead to
higher external tariffs.
• Therefore, the incentive to reduce external tariffs to
moderate trade diversion may be weaker in CUs.
 Based on this idea, extending preferences in customs
unions does not seem to lead any significant change in
multilateral tariffs.
At best, it could induce a reduction in the MFN tariff that
is considerably smaller than that in an FTA.

5. Regionalism in Developing countries
• There are several reasons why regionalism may be
correlated with external trade liberalization in developing
countries.
First, since the multilateral system has had only a limited
impact on tariff reduction in developing countries,
regional agreements may serve as an enforcement
mechanism for a broader reform package.
Second, with high external tariffs, the possibility of
costly trade diversion resulting from RTA could provide
governments with an incentive to liberalize.
• Because of these reasons, Free Trade agreement issue
is especially important in developing countries.

6. Latin America
• Why Latin America can be an excellent area for this
study Among the developing countries?
First, 88% of trade in Latin America is potentially eligible
for preferential treatment.
Second, while applied tariffs in Latin America are
normally high relative to those in advanced countries.
 This implies that those countries have ample room to
either raise or lower their applied tariffs subsequent to
the formation of a regional agreement.
It makes it easier to identify the influence of RTAs.

7. Three distinct strategies
• Three distinct strategies to determine whether
regionalism and multilateralism are correlated each
other.
First, our results depend critically on the type of agreement,
whether FTAs or CUs.
Second, the effect of a trading bloc on external tariffs
depends not only on the preferential rates, but also on the
relative importance of preferential imports.
Lastly, this paper uses an instrumental variable approach.

8. Related literature
• A lager literature has addressed the related questions of
(1) Whether allowing countries to form RTAs help or
hinder the viability of a multilateral free trade agreement
(Levy 1997, Krishna 1998, Antras and Helpman 2007)
(
(2) How RTAs affect the efficiency properties of the
multilateral trading system. (Bagwell and Staiger 1996 b)
(3) How the efficiency properties of free trade differ when
it is preceded by RTAs. (Freund 2000 b)
(4) How political economy motivations alter the
willingness of governments to engage in RTAS
(Grossman and Helpman 1995, Ornelas 2005 b)

9. The problem of Theoretical analyses
• Existing theoretical analyses often also disregard two
central features of actual RTAs.
First, preferential tariffs are frequently not reduced to zero.
- The conventional theoretical approach is to assume that countries
within an RTA fully eliminate trade barriers among themselves.
- This is consistent with Article 24 of the GATT but, in reality the
complete elimination of internal tariffs is the exception.
Second, countries engage simultaneously in multiple RTAs.
- Increasingly, tariff preferences are granted to multiple countries, with
the margin of preferences varying across recipients and across time.
- This implies that we need to define a measure of preferential
liberalization to use.

10. Data Sources
and Initial Analysis

11. Data Sources
• This paper constructs a comprehensive tariff dataset for
ten Latin American Countries – Argentina, Brazil, Chile,
Colombia, Ecuador, Mexico, Peru Paraguay, Uruguay and
Venezuela - from 1990 to 2001.
• The dataset includes MFN applied tariffs and bilateral
applied preferential tariffs at the ISIC 4-digig level.
(ISIC: International Standard Industrial Classification)

12. Initial analysis
MFN tariffs were just slightly lower.
The average preferential tariff was
much lower under CU

13. Initial analysis
The density for goods with a meaningful margin of preference lies to the left of
that for goods without, which indicates that the former have experienced greater
tariff reduction on average.

14. Initial analysis
The mode for high-share goods is to the left of the mode for the low-share goods.
Higher preferential import shares lead to deeper MFN tariff reduction.

15. Initial analysis
The bulk of points fall in the third quadrant,
indicating the correlation between ΔMFN
and ΔPREF

16. Initial analysis

17. Econometrics Specification
and the results

18. Econometrics specification
The preferential tariff of country j in industry i, year t, as
PREFijt ≡ min { τijtk }
- τijtk represents the preferential tariff set by country j on
sector i imports from RTA partner k in period t.
- A country is defined as “partner ” when it can export sector
i goods to country j under tariffs strictly below country j’s
correspondent MFN rate.

19. Econometrics specification
(1) MFNijt = β1(PREFijt-1) + εijt
Where MFNijt represents the multilateral tariff of country j in industry I,
year t, and PREFijt-1 is the corresponding preferential tariff, but lagged on
period.
- Using lagged preferences to estimate MFN tariffs reflects the idea that
preferences are pre-determined relative to MFN tariffs and MFN tariffs
may react with a lag.
- It also reduces simultaneity bias from an overall reduction in all tariffs in
some industries.
① β1 > 0 – “building blocs” view of preferential
liberalization
② β1 < 0 – “Stumbling blocs” view of preferential
liberalization

20. Econometrics specification
(2) MFNijt = αjt + αij + αijt + β1(PREFijt-1) + νijt
αjt: a country-year fixed effect.  capturing the impact of
broad programs of trade liberalization
αij : a country-industry fixed effect  capturing overall
economic, political and historical factors that influence the
level of protection across industries
αijt : capturing trends in those factors.  It reflects how
distinct countries absorb the impact of sectoral multilateral
agreements and the difficulties in multilateral liberalization
experienced in some industries. (such as agriculture)

21. Econometrics specification
• To eliminate the unobserved heterogeneity αij , we take
first differences in equation (2)
(3) Δ MFNijt = νjt + αij + β1(ΔPREFijt-1) + υijt
where νjt ≡ αij - αj, t-1 and υijt ≡ νijt - νij,t-1
• This paper distinguishes between the hypotheses
(H1) countries lower tariffs on outsiders because they
are offering preferential treatment.
(H2) unobserved sector-specific shocks induce
countries to liberalize or restrict trade generally.
(4) Δ MFNijt = γjt + αij + β1(ΔPREFijt-1)
+ β2(Δ PREFCUijt-1) + υijt

22. The effect of regional agreements on
MFN tariffs in Latin America
• Table 3 is the results from estimating equation (4)
(4) Δ MFNijt = γjt + αij + β1(ΔPREFijt-1)
+ β2(Δ PREFCUijt-1) + υijt
• Dependent variable: percentage point change in the MFN
tariff
• Independent variables of interest: lagged percentage point
changes in the preferential tariff, and with and without
interaction with the customs union dummy.

24. The effect of regional agreements on
MFN tariffs in Latin America
• The first column reports the results from estimating
equation (4) using OLS.
• The positive coefficient on lagged ΔPREF indicates that
MFN tariffs fall in FTA members following a reduction in
preferential tariffs.
• The negative coefficient on ΔPREFCU indicates that this
is not true when the bloc takes the form of a CU.

25. The effect of regional agreements on
MFN tariffs in Latin America
• To control for potential endogeneity, we use the lagged
values of the preferential tariffs of RTA partners as
instrumental variables
• The IV results show strong support for tariff
complementarities in free trade areas in column (2).
• They also show that this effect is absent in customs
unions.
• In this case, we accept the hypothesis that preferential
liberalization has effect on MFN tariffs in CUs.
• In column (3), we use two-and three-times lagged levels
of preferential tariffs to instruments for lagged changes.
Again, we find strong evidence of tariff
complementarities in FTAs but not in CUs.

26. The effect of regional agreements on
MFN tariffs in Latin America
• We estimate equation (4) eliminating the observations
where the preference margin is too small to have a
practical effect, given the costs to comply with ROOs.
• Thus, column (4) reports the results when we consider
only cases which the preference margin is above 2.5
percentage points.
• The results imply that preferential liberalization in FTAs
induces a slightly deeper reduction in MFN tariffs when
ROOs are less likely to bind.
• The effect of preferential liberalization in CUs is
statistically insignificant when ROOs are taken into
account.

27. The effect of regional agreements on
MFN tariffs in Latin America
• In column (5), to control for the alignment of tariffs in the
CUs, we add the following variable.
• Where denotes total imports in year t, industry I, by
members of the CU in which country j participates. This variable is
the weighted-average MFN tariff in the unions.
• A positive coefficient indicates that members of CUs are
moving toward aligning their external tariff overtime.
• The results on tariff complementarities in FTAs and
small tariff subsitutitutablity in CUs are very similar to
those in column (1)

28. The effect of regional agreements on
MFN tariffs in Latin America
• In the column (6), the effects are only present in the
early period, when the bulk of tariff reduction took place.
• In the last column, we split the ΔPREF variable into a
period-one effect(1990-1994) and a period-two
effect(1995-2001).
• The positive effect in FTA is present in both periods,
although it is smaller in period 2.

30. The effect of regional agreements on
MFN tariffs in Latin America
• In table 4, in all specifications, the coefficient on
preferential import shares interacted with MRG (which
means the preference margin is greater than 2.5 percent
point) is negative and statistically significant
• It indicates that higher referential import shares are
associated with reductions of MFN tariffs when meaning
preference margins are present.
• This effect is neutralized in CUs.
• In all cases, the complementarities between tariffs in
FTAs obtained previously remains present, while
changes in preferential tariffs in CUs have no significant
effect on MFN tariffs.

31. Conclusion and Extension

32. Conclusion
• We find that free trade areas are likely to be “building
blocs” to eternal trade liberalization in Latin America.
- So, there is a complementarities effect between
preferential and MFN tariffs.
- Furthermore, external tariffs fall by more in sectors in
which the FTA partners are more important suppliers.
• These findings fit particularly well the theoretical
analysis of Bagwell and Staiger (1999 a).
 In their paper, the formation of an FTA induces a
reduction of applied MFN rates, but the formation of CUs
does not.

33. Conclusion
• Our finding contrast sharply with those of Kimao (2006,
2007) and Karacaovali and Limao (2008), who find that
the U.S. and the E.U. liberalized less during the Uruguay
Round in sectors where preferences were granted.
- This is because the types of countries analyzed are
different.
- Since the multilateral system has not enforced much
tariff reduction on developing countries, tariffs are
relatively high there, creating a large potential for trade
diversion.
- Our suggest that this force is important in explaining
changes in MFN tariffs of Latin America countries
involved in free trade areas.

34. Extension
• Overall, these findings offer an optimistic view of the
ongoing regionalism trend for efficiency of the world
trading system.
• Future work is needed to explore the robustness of
these results to other region, as well as the implications
of the rise of regionalism for liberalization at a
multilateral level.
“ ASEAN Free Trade Area (AFTA) ”
To be continued

35. Q&A
Thank you!