Preferential Trade Agreements Can in Theory Reduce International Trade

Preferential trade agreements, also known as PTAs, are agreements between two or more countries that give preferential treatment to certain goods or services. PTAs are designed to promote trade and economic growth among member countries by reducing trade barriers and increasing investment flows. However, despite these goals, PTAs can actually lead to a reduction in international trade.

One of the main reasons why PTAs can reduce international trade is the creation of trade diversion. This occurs when a PTA member country shifts its imports from a more efficient non-member country to a less efficient member country, solely because of the preferential treatment given to the latter. In other words, PTAs can distort the market by encouraging trade with less efficient countries rather than those with the lowest costs and greater economies of scale.

Some critics argue that such trade diversion is not always bad. They point out that PTAs can also lead to the creation of regional supply chains, which can improve the efficiency of production and reduce transaction costs. However, the benefits of regional supply chains must be weighed against the costs of reduced access to the most efficient producers and suppliers outside of a PTA.

Another way that PTAs can reduce international trade is by complicating the rules of origin for goods. In order to receive preferential treatment, goods must satisfy certain rules of origin, which define the country of origin for a given product. These rules can be highly complex and bureaucratic, making it difficult and expensive for businesses to comply. This can reduce the attractiveness of PTAs for businesses, which may choose to avoid using them altogether.

Furthermore, PTAs can lead to increased protectionism as well. PTAs often include provisions that protect domestic producers from foreign competition, such as quotas and tariffs. These provisions can make it more difficult and expensive for non-member countries to trade with PTA members, which can lead to retaliation against those members and a reduction in overall trade.

In conclusion, while PTAs can be useful tools for promoting trade and economic growth, they can also reduce international trade in theory. The creation of trade diversion, complex rules of origin, and increased protectionism can all contribute to the reduction of international trade. It is important for policymakers to carefully consider these potential consequences when negotiating and implementing PTAs.