Policy
Anchors: Do Free Trade Agreements and WTO Accessions Serve As Vehicles For
Developing-Country Policy Reform?
Michael J. Ferrantino
Michael.Ferrantino@usitc.gov
"Policy Anchors" analyses the relationship between domestic policy
reform and entry into free trade agreements (FTA ) and WTO accessions. The
following is an abridged version of the original paper, which may be downloaded
at: http://hotdocs.usitc.gov/docs/pubs/research_working_papers/EC200604A.pdf
The WTO has received notifications of 167 FTAs which entered into force from
the beginning of 1990 through July 1, 2005, and there may be others. It is
sometimes claimed that FTAs between large countries and smaller developing
countries serve as "policy anchors" by acting as a mechanism for
the smaller developing country to make credible commitments to policy reform
which they might not otherwise make. Is there evidence associating FTAs with
policy reform, over and above preferential tariff reduction? How do they compare
with WTO accessions in this regard?
By virtue of the broad scope of the Uruguay Round's single undertaking, WTO accession agreements contain provisions in a wide variety of areas other than tariff reduction, such as investment policy, services, intellectual property, and so on. The corresponding provisions in FTAs are free to go deeper in these areas and in others, such as regulation (SPS/TBT) and competition policy. As a result, a developing country may use an FTA with a large developed partner as a vehicle for policy reform, and its developed partner may similarly use the FTA as a vehicle for encouraging such reform. The same applies to the relationship between a developing country acceding to the WTO and its working party. These commitments to policy reform might not be as easy to achieve within the domestic political processes of developing countries acting autonomously, but may become feasible as the result of a commitment one or more a large outside partner. Deeper integration with a large developed partner may thus serve as an "anchor" or "lock-in mechanism" for domestic reforms (Bilal (2003), Crawford and Fiorentino (2005)). One incentive for such commitments is the possibility that foreign direct investment (FDI) may be attracted thereby (Schiff and Winters (2003), chapter 4). Often cited examples of developing-country reform linked to negotiations with outside actors are, for the FTA case, Mexico and NAFTA, and for the WTO accession case, China.
Ferrantino hypothesizes that the period during which negotiations take place is a good place to look for policy linkages. This will typically be an extended period of time before the agreement enters into force. Such an approach contrasts with analyses which look for effects of an agreement conditional on the date of entry into force or analyses which exploit the gradual phase-in of tariff commitments to look for trade effects. This hypothesis is examined by constructing data on timelines associated with recent U.S. FTAs and WTO accessions, and by looking at changes in the behavior of governance indicators during the period of negotiation. For this analysis, the various subcomponents of the World Bank's "Governance Matters IV" indicators are used (Kaufmann, Kraay, and Mastruzzi (2005)), as well as the aggregate score and some subcomponents of the Heritage Foundation's Index of EconomicFreedom. (Heritage Foundation (2006)).
The preliminary analysis offered in the paper contains no strong and general conclusions about the tendencies of FTAs to lead to policy reform in developing countries. The results from the "Governance Matters" indicators show relatively little evidence of improved policies associated with the period of engagement, while some of the Heritage Foundation indicators are more likely to show improvement. The relationship between FTA negotiations (or WTO accession) and reform is likely to be very country-specific. Different partner or acceding countries are likely to differ in their ex ante willingness to reform. The nature and extent of commercial interests, both export-promoting and import-competing is likely to vary from case to case, which can potentially affect the value that both parties place on "deeper integration" commitments. Also, it turns out that some of the commitments associated with the negotiation process may not be embodied in the text of an FTA agreement but are in the nature of "side" commitments, which makes the process of generating a history of such commitments fairly challenging. These two problems taken together lead to a significant analytical problem of endogeneity. An ongoing process of engagement between a developing country and an external anchor is likely to be influenced both by domestic drivers for policy change and by the expectations of the anchoring partner, so that identifying whether any given reform is "caused" either by the FTA negotiations or by the domestic reform process is problematic and perhaps not useful.
Some useful stylized facts do emerge from Ferrantino's preliminary analysis. These include the following: (1) U.S. FTAs are generally negotiated much more quickly than WTO accessions, which often take many years to complete. Even if the degree of policy commitment achieved with the two mechanisms were approximately equal, this would suggest that making the commitment through FTAs is more efficient. (2) The length of time it takes to negotiate an FTA or accession WTO accession varies widely. Agreements with larger economies and economies with weaker initial policies appear to take longer. This suggests that both the extent of needed reform and the weight of commercial issues play a role in the length of time. (3) Recent U.S. FTA partners begin negotiations with a stronger policy environment than recent WTO accession candidates, which may be associated with a greater ex ante commitment to reform. This suggests that selection of potential partners may play a role in the extent of the success of any policy commitments achieved during FTA negotiations. WTO accession, by contrast, is in principle open to all comers. (4) While there is anecdotal evidence of countries undertaking reforms as part of an FTA negotiation or accession process, there is no systematic pattern of improved governance associated with the period of negotiation. This is definitely the case for the "Governance Matters" indicators. For the Heritage Foundation indicators, indicators of trade policy improve as well as (for WTO accessions) the aggregate indicator of "economic freedom," but some subindicators (such as FDI, regulation, and property rights) deteriorate more often than they improve. The observed deterioration should not be interpreted to mean that either U.S. FTAs or WTO accessions are bad for reform. Rather, they point up the fact that negotiations often take place in circumstances in which the policy environment in the developing partner or acceder is challenging. This fact should be taken into account in understanding the results of the negotiations in question.
Michael Ferrantino is Lead International Economist at the U.S. International Trade Commission, Office of Economics, Research Division.