Hindering

Trade Diversion
Some economists argued that the benefits of PTA have to depend on the extent of trade
creation in contrast with trade diversion. According to Pugel (2012), trade creation occurs
when lower cost imports from another PTA member replaced higher cost domestic
production and this increases welfare through greater specialization based on comparative
advantage. On the other hand, trade diversion occurs when lower-cost imports from non PTA
members are replaced by higher-cost imports from PTA members due to the preferential
treatment given to member nations and this reduces welfare as it shifts production from
efficient producers to less efficient produces.
PTA may be a great help in lowering tariffs among the trading partners but it reduces the
incentive of the trading partners to liberalize tariffs respectively with the non-member
countries. According to (Wyrzykowska 2008), PTAs can result in trade diversion by diverting
from the third countries that encounter with external tariffs to the benefits of the member
countries of the preferential agreement rather than creating it. It improves the PTAs
members welfare by shifting the costs to non-member countries (Punyakumpol n.d.). This
has actually violates the WTOs rules stated that the average tariff barrier against the third
countries shall not be higher than the member countries of the PTA in the Article XXIV of
GATT agreement (World Trade Organisation 2014).

Terms of Trade
Theory suggested that trade diversion can actually worsen the terms of trade (export prices)
of the excluded countries. The relative price of the rest of the worlds export could be
lowered by the changes of demand from the PTA members. Chang and Winters (2002) did a
research to study the effects of the Southern Common Market agreement (MERCOSUR)
which formed by Argentina, Brazil, Paraguay and Uruguay on the export prices to Brazil.
They found out that Argentinas export prices increased while the non-members of
MERCOSURs export prices has actually declined. The pricing effect has shown that
MERCOSUR while helping its member, Brazil, has actually hurt the non-members of
MERCOSUR.

Discrimination
PTA seems to be beneficial to its members but it actually discriminates and hurt the nonmembers of the PTA. It goes against the principle of non-discrimination stated in the most
favoured nation (MFN) treatment in the first article of the General Agreement on Tariffs and
Trade (GATT). MFN stated that when a country lowers its tariff, same treatment has to be
offered to all its trading partners. If PTA members abolish or adopt rules to strengthen the
discipline on trade remedies actions against the trade of PTA members but not to the trade of
non-members, this will increase the level of discrimination. By offering preferences to
specific countries only, the preferential agreement has definitely violated MFN treatment.
Not only that, PTA especially acts as a discriminatory against the poor and less-developed
countries. Unlike the large countries, low income countries are unable to negotiate forcefully
and have enough resources and infrastructure in order to take advantage of the market
opening (Gerber 2011). Therefore, Bhagwati (1995) stated that it is easy for the large nations
to dominate over the smaller states in the case of PTAs.

Rules of Origin
Rules of origin are extensively used in PTAs to determine the origin of goods and whether
they are qualified for trade preferences offered by the PTA. Furthermore, they ensure that
preferences are only available to the members of the agreement and also that non-members
do not avoid custom duties for their imports by entering through the member with the lowest
tariff (Wyrzykowska 2008, p. 20). However, the increased number of PTAs actually creates
problems for the rules of origin. Some countries misused the rules of origin in attempt of
achieving other objectives. According to Krishna (2012), the reason that the countries
misused the rules of origin is to provide protection to the domestic producers of intermediate
goods against foreign competitors. This may results in a trade diversion from more efficient
producers of intermediates outside and thus hindering the achievement of global free trade.

Other Concerns
One of the motives of entering PTAs is to protect members against each others non-tariff
barriers (NTBs). A country can provide protection to both its domestic producers and the
producers in the PTA partner that export to it by exempting its PTA partners from an NTB
(Limo 2006). However, this further raised the concern for the non-member countries if PTA
members impose higher NTBs such as antidumping measures and other trade remedies
against the non-members. This might even further worsen the discriminatory problem.
Another concern is that the rise of PTAs may create the possibility of an outbreak of trade
restrictions between blocs result in retaliation or trade wars. Nevertheless, the model of trade
wars that came up with the assumption of retaliation is not realistic under the system of
GATT rules ().

(773 words)

List of References

Bhagwati, J 1995, U.S. Trade Policy: the Infatuation with Free Trade Areas. In The
Dangerous Drift to Preferential Trade Agreements, American Enterprise Institute for Public
Policy Research, Washington.
Chang, W & Winters, LA 2002, How Regional Blocs Affect Excluded Countries: The Price
Effects of Mercosur, American Economic Review, vol. 92, no. 4, pp. 889904.
Gerber, J 2011, International Economics, 5th edn, Pearson, Boston, MA.
Krishna, P 2012, Preferential Trade Agreements and the World Trade System: A
Multilateralist View, National Bureau of Economic Research.
Limo, N 2006, Preferential vs. Multilateral Trade Liberalization: Evidence and Open
Questions, World Trade Review, vol. 5, no. 2, pp. 155-176.
Pugel, TA 2012, International Economics, 15th edn, McGraw-Hill, New York.
Punyakumpol, C n.d., The Effect of Preferential Trade Agreement: The Case of Brazil and
the U.S., viewed 8 May 2014,
<http://economics.stanford.edu/files/Punyakumpol_Hthesis2011.pdf>.
World Trade Organisation 2014, Regional Trade Agreements: Rules, World Trade
Organisation, viewed 8 May 2014,
<http://www.wto.org/english/tratop_e/region_e/regrul_e.htm>.
Wyrzykowska, EK 2008, Regional Trade Agreements: a stepping stone or stumbling block
for further multilateral trade opening?, World Economy Research Institute.

(Baldwin & Freund 2011) http://elibrary.worldbank.org/doi/abs/10.1596/9780821386439_CH06