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

With Special Emphasis on the TPS-OIC

TradeReorientation

Note that in the example given above we started from the situation where prior to any

agreement, country B levied the same tariffs on imports from its future partner, A, and also

from the rest of the world, C. Analogously for country A. Consider the situation of trade

diversion which was described earlier. Here, as a result of the agreement between A and B,

there was trade diversion away from C. Starting from this situation, now suppose that country

B also signs a free trade agreement with country C. Prior to the signing of the agreement with

country C, Country A had preferential access to the market of country B. As B signs an

agreement with C, the preferences that Country A had, are now being eroded. If the two

agreements are identical, then country A would no longer have preferential access (relative to

C) to the market of country B. This is preference erosion. Consider what might happen to trade

in product k as a result of this. The original agreement resulted in trade switching away from C

in favour of country A. As preferences are now being matched it is possible that trade will once

again switch this time away from A and back to C as the supplying country. So once again we

have supply switching, which occurs because preferences are being eroded. But in this case we

are switching away from the less efficient country and to the more efficient country. Hence,

here the supply switching tends to increase the real GDP of country C, and is welfare

increasing. This form of supply switching is often referred to as trade reorientation.

It should be clear, but it is worth highlighting, that the extent to which there is trade creation

or trade diversion will depend on the pattern of trade between the participating countries, the

relative competitiveness of the participating countries across products/sector, on the height of

the tariffs prior to the process integration, the height of any external tariff after the process of

integration, and on how comprehensive the agreement is in terms of the number of product

lines being included in the agreement.

Suppose that prior to the agreement:

•

that a given country’s tariff was 5%, then any effects are likely to be much smaller than

if the tariff was 20%.

•

that country A did not import any good from country B, then there can be no trade

creation along the lines of the second channel identified above.

•

that the overall pattern of production in A and B was highly dissimilar; then there is

little scope for trade creation along the lines of the first channel identified above.

•

that the overall pattern of production in A and B was very similar, but that

their competitiveness was very different by product; then trade creation is more likely.

•

that the external tariff that A and B maintain on imports from C is high; then as this

discriminates between third countries, trade diversion is likely to be higher.

The considerations above with regard to trade creation, trade diversion and preference

erosion largely focus on channel (i) identified above. It is also worth noting that a considerable

proportion of the empirical literature evaluating FTAs also tends to focus on this channel.

However, there are the other three channels through which trade and integration might in-