Preferential Trade Agreements and Trade Liberalization Efforts in the OIC Member States

With Special Emphasis on the TPS-OIC

With a customs union, each of the participating countries agrees on a common external tariff,

and hence the problem of trade deflection goes away. With a customs union there typically also

needs to be some form of revenue sharing arrangement. This is because with a common

external tariff, and with no tariffs within the union, trade flows are likely to go via the country

which provides the lowest shipping costs. Hence goods may enter the union from third

countries via one of the customs union countries, even if they are ultimately destined for

another country in the union. Tariff revenue then needs to be redistributed to the country of

destination.

There is a large amount of theory and empirical evidence which suggests that trade

liberalisation, for example via lower tariffs leads to welfare gains (ie higher GDP) for the

liberalising countries. There are various channels which could drive this result:

Specialisation according to comparative advantage: Where one country can produce a

good relatively more cheaply than another country then there are likely to be gains from

specialisation. Those differences in relative prices (costs) across countries can either arise

because of differences in technology between countries, or differences in relative factor

endowments. For example, Bangladesh has a comparative advantage in textile products

(because it has a high proportion of unskilled labour).

ii)

Where markets are imperfectly competitive there may be further welfare gains. In the

first instance these can arise because of the increased competition that trade provides and

forces domestic firms to compete with lower prices. The reduction in prices is a welfare gain

for consumers in the economy. Secondly, one of the reasons for markets being imperfectly

competitive is the presence of economies of scale in production. As trade is liberalised, and

markets become more accessible, firms expand production and take advantage of economies of

scale. This is an efficiency gain for the economy, which is once again translated into lower

prices. Finally, consumers and producers may gain from having a greater variety of products

available.

iii)

There may also be within-industry reallocation effects. Firms within even narrowly

defined industries typically vary considerably in terms of size, productivity, and export

orientation. The impact of more competition (as in (ii) above) is likely to lead to less efficient

firms either reducing production or exiting the industry, and more efficient firms either

expanding or entering the industry. Each of these leads to increased aggregate productivity as

the share of the more efficient rises.

iv)

Finally, there may be a positive effect on the economy if the process of trade

liberalisation leads to higher rates of economic growth. Economic growth typically arises

either as an economy becomes more efficient, and/or if levels of investment rise and thus

increase the productive capacity of the economy. Opening up to international trade may

encourage firms to invest either because the market has become more accessible, or in order