Alberto Osnago, Nadia Rocha and Michele Ruta: Easing the Global Flow of Trade

This article appeared on OMFIF Bulletin (November 2016). The Official Monetary and Financial Institutions Forum (OMFIF) is a global financial think-tank, headquartered in London. Alberto Osnago is a Consultant and Nadia Rocha is a Senior Economist at the World Bank. Michele Ruta is a Lead Economist at the World Bank Group.  Two economic developments have brought the relationship between preferential trade agreements and global value chains to the forefront of research and debate on trade policy. First, technological innovation in communication and transportation has enabled the unbundling of stages of production processes across time and space, resulting in an increase in offshoring. Second, since the end of the 1990s, an increasing number of countries have signed bilateral and regional PTAs. Offshoring can be carried out either within or outside a particular company’s operations. When firms outsource the production of some stages outside their boundaries – when they engage in foreign outsourcing – they generate ‘arm’s length trade’. When they offshore within their boundaries through (vertical) foreign direct investment, they generate ‘within-firms trade’. Traditional and modern PTAs Traditional PTAs mostly consist of reciprocal market access exchanges involving tariff cuts and the reduction of other border measures. Modern-day PTAs frequently contain provisions covering a wide array of non-tariff measures, both at and behind the border. These new trade agreements are referred to as ‘deep’ to distinguish them from traditional PTAs focused solely on market access commitments – sometimes referred to as ‘shallow’ agreements. With preferential tariffs approaching the zero lower bound, the coverage of PTAs in terms of policy areas has widened over time. The WTO documented this development in its 2011 report, ‘The WTO and preferential trade agreements: from co-existence to coherence’. Modern PTAs increasingly contain provisions covering a wide array of non-tariff measures, both at and behind the border. For example, several PTAs include provisions covering technical barriers to trade; sanitary and phytosanitary measures; rules on investment; protection of intellectual property rights; anti-corruption provisions; competition policy; and labour regulations. The WTO mapped a total of 52 disciplines across 100 PTAs signed between 1958 and 2011. Chart 1 shows that PTAs became deeper over time. Agreements signed between 1987 and 1991 included nine provisions on average. Agreements signed between 2007 and 2011 included an average of 15. Chart 2 lists the 20 most common provisions included in the set of agreements mapped by the WTO. As expected, all agreements include reductions in tariffs on manufacturing goods. At the same time, more than 50% of agreements include deeper provisions such as anti-dumping and countervailing measures, rules on competition, movement of capital, and intellectual property rights. Technical barriers to trade, investment disciplines, sanitary and phytosanitary measures are often included. Trends in production networks trade The recent wave of PTAs and the surge in offshoring have raised the question of how trade agreements relate to the international organisation of production. The key insight of the theoretical literature is that the ‘depth’ of trade agreements is associated with the international fragmentation of production. Econometric studies are scarce but suggest a positive relationship between production networks trade and deep integration. According to a 2014 paper, signing deep trade agreements increases trade in parts and components. At the same time, higher levels of trade in production networks increase the likelihood of signing deeper agreements. In terms of the relationship between deep PTAs and offshoring within the boundaries of the firm, the key question is whether the depth of trade agreements between two countries is correlated with more vertical FDI. This relationship can go in both directions. Deep PTAs may stimulate the creation of global value chains by facilitating trade of intermediate goods and FDI flows between potential members of a production network. However, firms involved in intense vertical FDI may lobby for deeper trade agreements to secure and increase the profitability of investments in partner countries. Our research shows that signing deeper agreements can boost existing FDI links and create new ones. Designing better trade agreements A better grasp of the relationship between PTAs and offshoring is important in a world where countries are signing a growing number of trade agreements and firms increasingly seek to engage in international production networks. We have found new evidence to suggest that the content of PTAs is related to the mode of offshoring. In particular, we found evidence that the positive link between the depth of PTAs and vertical FDI is driven by the provisions that improve the contractibility of inputs provided by foreign suppliers, such as regulatory provisions. While more work is needed, this line of research contributes to an understanding of how policy-makers can design trade agreements to support firms’ integration into global value chains.  

DOWNLOAD