In order to understand better how bilateral and multilateral international trade agreement lead to an economic integration, we have to look on its fundamental of actors’ preference at the micro level. What are their strategy and tool to accomplish their goal? In my paper, I will consider the preferential trading agreements (PTAs), which most economists use this basic economic model from international trade to comprehend the pros and cons of this issue. In my analysis, I will build my argument, which is creating bilateral trade agreement will depress the cooperation between nations to accomplish multilateral trade agreement, by employing international trade model. Furthermore, I will support and approach to my argument, based on the public choice view.
As a pervasive use of international trade analysis, I will assume that there are only three countries; A, B, and C. Country A is a small importing country which means it can trade with country A and B, large countries, as much as it wants with the prevalent free trade price. I will let the price in country A>B>C, so that the price in country C is the lowest among three countries which is equal to the world free trade price. Originally, suppose that country A imposes a unit tariff of import products from both country B and Country C at the same rate “t”. This same unit tariff rate will pull up the import price per unit from country B and C up to “t”. In the post tariff trade, it is a rational decision for country A to import all products from country C where products price is still lower than country A and B. In this case, consumers in country A will gain more benefits from cheaper price, whereas the producers in country A will lose their competition from the lower import price e.g. consumers in the US are delightful for cheap labor-intensive products from China, on the other hand, domestic-similar industry might shut down its business. However the welfare of country A might be large or small, it is depended on the term of trade between A and C. But as a result, a reduce magnitude of free trade direction has led GATT, as its successor WTO, to eliminate tariff rate between the country members in order to improve the world welfare. If the outcome of free trade can increase the world welfare by more cooperation of most country members, but why we cannot see the bilateral trade lead to multilateral trade agreements?
The missing factor that public choice scholars would take it into consideration is the movement of political interest groups. Olsen has found out that the cost of collective action has positive relationship with the numbers of actors in the economy. From this perspective, it is difficult to get a unanimous concensus on a single policy, in this case the tariff rate. In addition, it is not a party that has the majority of people involved (size) will win, but economists defend further that the most influential well-established interest group (may be small like the US automobile industry, sugarcane growers, fishermen in the south, and etc.) will have more impact on the specific public policy. From above analysis, I can classify both interest groups into two major groups. Firstly, consumers, who will maximize their welfare by forcing government to open country to free trade, will enjoy the benefit from lower product price. They will prefer a lower tariff rate. Secondly, producers, whose products are competed by the low cost of production in the abroad, prefer higher tariff rate in order to protect their profits. Each party will form their interest group seeking the way to change the tariff rate toward one’s preference. From the median voter theorem, it is not common to see neither no tariff nor the maximum tariff rate, but the theorem suggests that the tariff rate will fall somewhere between these two extreme ends. Where the tariff rate should be defined is counted on how strong each party can express and pressure on the government officials. Upon this claim, it is a just ratification in my model that country A might end up trading with the third country, B, whose product price falls between prices in country A and C (Krishna, 1998). After the PTA, country A eliminates all tariff on products from country B but it still remains trade protection policy from country C. The size of benefits is designated by the term of trade between the two countries’ negotiation. Forming a PTA sometimes is not a bad practice under existing tariff imposition. Even though such a bilateral trade agreement between country A and B causes a trade diversion; trading away from the lower cost product from non-PTA member, country A might gain or lose from PTA depending on how much price different between PTA price and the free world trade prices.
My framework gives an impressive ground of building the argument on that bi-lateral trade agreement will undermine the cooperation of multi-nations regional trading agreement. Again it is a sound reasoning for domestic producers to object the trade agreement that will sign on the low price country and vice versa in the case of consumers. Pravin Krishna using a new political economy approach has found that trade policy is determined by lobbying concentrated interest groups who will politically support the diverting preferential trade agreement. Furthermore, he concludes that the diverting trade will change domestic preference away from multi-lateral trade agreement that once seems feasible under free trade. My further discussion here is that if trade policy is determined by the interest group at the micro level and if country decides to join the membership of WTO at the macro level, does conflict of interests exist under the two-levels game framework? Since under the membership of WTO, member countries will be reduced tariff rate by WTO agreement, which individual nation will lose its own policy integrity. This is an infeasible outcome because the WTO does not have the enforcing power (Maggi, 1999). It acts like an intermediate institution to accommodate and reconcile the trade conflicts by using its persuasive power and verifying the violations of agreement (Maggi, 1999). So the decision to reduce tariff falls on each nation’s shoulder not the WTO officials. To receive a unanimous vote from every nation, it takes time for negotiation. For example, the failure of the DOHA round in Qatar is the best support to my argument. Developing countries denied to accept the proposition from the US and EU to remove tariff on agricultural products which is the high political major concern in the LDCs. Phillip Levy also gives the supportive claim by theoretical research that “…in some cases bilateral free-trade agreements can undermine political support for further multilateral trade liberalization. If a bilateral trade agreement offers disproportionately large gains to key agents in a country.” In his view, multilateral trade will reduce the benefits that they are enjoying under bilateral free-trade agreement and transfer to other parties. The most extreme idea from Levy posits that bilateral free-trade agreements can never increase political support for multilateral free trade. Bhagwati and Panagariya point out that the effect of gain and loss can be perceived by looking at tariff-income distribution, which is corresponding to my argument.
In conclusion, I posit an argument that bilateral free-trade area once it is established, it is unlikely to lead to the next step of free trade ideology of multilateral trade agreement. Taking interest group into the analysis of PTA will yield us solid ground knowledge that individual will only try to maximize one’s own utility. The public choice theory, median voter theorem, depict the reasonable proposition that it is unlikely to have zero tariff nor 100 percent tariff rate, but it will be defined somewhere between these two ends depending on how much influence of each player in the game.
