Olivier Cadot
email: olivier.cadot@unil.ch

Céline Carrère
email: c.carrere@u-clermont1.fr

Jaime De Melo
email: demelo@ecopo.unige.ch

Bolormaa Tumurchudur
email: bolormaa.tumurchudurklok@unil.ch

Paul Brenton

Antoni Estevadeordal

Alberto Portugal

Kati Suominen

Product Specific Rules of Origin in EU and US Preferential Trading Arrangements: An Assessment*

Keywords: JEL classification: F13, F15 Rules of Origin, costs, NAFTA, PANEURO

Building on earlier work by Estevadeordal, we construct a synthetic index (R-index) intending to capture the restrictiveness on market access due to product specific rules of origin (PSRO) that apply at the tariff-line level. The R-index is constructed for rules of origins under NAFTA and under the single list applying to PANEURO, the new regime applying to all EU preferential trade agreements. The R-index highlights how identical PSRO have different impacts across countries, and how the complexity of PSRO varies across sectors. Having controlled for the extent of tariff preference at the tariff-line level, the R-index contributes to account for differences in utilization rates at the tariff line level. The index is then used to assess composition effects across countries subjected to some set of PSRO and to compute estimates of the compliance costs associated with rules of origin under both regimes.

Introduction

Notifications of preferential trading arrangements (PTAs) to the WTO secretariat indicate that all but twelve countries (small islands and municipalities except for Mongolia) belong to at least one PTA. According to a recent tally (World Bank 2005, table 2.1), the average number of PTAs per country is 6, with 45 developing countries having signed bilateral trading arrangements with a Northern partner, and of the 109 North-South (N-S) PTAs, 90 having been created since 1990. A huband-spoke trading system is developing in which the partners with the largest markets (the EU and the US) sign individual (or group) Free Trade Agreements (FTAs) with a range of peripheral countries. Current examples include the ongoing negotiations for the Economic Partnership Agreements (EPAs) and those to be scheduled for a Free Trade Area of the Americas (FTAA). At issue is how much market access Southern partners will get to the Northern partner. Next to these, Northern countries also have in place the Generalized System of Preferences (GSP) and more recently the Everything But Arms (EBA) and Africa Growth Opportunity Act (AGOA) initiatives of the EU and US respectively. Reciprocity (as in the FTAs) or not (as in the GSP and other initiatives), these PTAs being less than a Customs Union, establishing origin is key to the implementation of the agreement, since it is how imports are prevented from entering the preferential area through the low-tariff partner, a situation that might be highly liberalizing in the absence of Rules of Origin (RoO) if partners were to compete for tariff revenue (see [START_REF] Richardson | Tariff Revenue Competition in a Free Trade Area[END_REF]. Neglected until recently, RoO are attracting increasing attention, both theoretically and empirically. 1 The theoretical literature is slowly leading to a consensus on the effects of RoO, several of these going beyond the avowed intent of conferring origin. 2 The empirical literature is more scattered, partly because the necessary data on utilization rates of origin are only starting to become available, and are also difficult to interpret (see below). Because of the complexity of the RoO (both regime-wide and product-specific RoO (PSRO) but mostly because of the latter), after controlling for the extent of preferential access, patterns of utilization rates show a great disparity across activities, partners, and PTAs. This complexity in the patterns of uptake of preferences makes it extremely difficult to assess how much market access Southern partners are getting from these PTAs. At the same time, knowing more about the extent of effective market access is of significance for the evolving multilateral trade negotiations, since one of the objectives of the Doha Round is to provide increased market access for developing countries, and LDCs in particular. 3 This paper describes and evaluates the PSRO governing the PTAs entered by the two leading Northern partners, the EU and the US. It draws on utilization rate data on Mexican exports to the US in 2001 and similar data for ACP exports to the EU in 1 Early theoretical contributions include [START_REF] Krueger | Free Trade Agreements Versus Customs Unions[END_REF], [START_REF] Krishna | Implementing Free Trade Areas: Rules of Origin and Hidden Protection[END_REF], and previous efforts at quantification include Herin (1986) and [START_REF] Koskinen | Excess Documentation Costs as a Nontariff Measure: an Empirical Analysis of the Import Effects of Documentation Costs[END_REF] for EFTA, Estevadeordal (2000), Carrère and de Melo (forthcoming), and Anson et al (forthcoming) for NAFTA. Brenton and Imawaga (2004) survey the debate and policy implications of RoO, and Cadot et al. eds. (forthcoming) assembles recent contributions. 2 The main effects are: (i) raising the costs of production; (ii) redirecting investment towards the partners to satisfy RoO; (iii) trade suppression (i.e. changing trade patterns within the zone to satisfy RoO) 3 In view of these objectives, it is worth recalling that it is at the insistence of industrialized countries that harmonization of RoO was not put on the agenda of the current round of multilateral trade negotiations. For further discussion, see Brenton and Imagawa (2004).

2002. 4 More specifically, the paper makes two contributions.

First, we construct an R-index of restrictiveness of PSRO along the lines first proposed by Estevadeordal (2000) in the case of NAFTA, modifying it and extending it for the EU single-list (SL) set in place under PANEURO. This synthetic Rindex is then used to compare PSRO under NAFTA and PANEURO.

To anticipate our main conclusions, first, we show in the case of the PANEURO that the R-index is useful to summarize how countries are differently affected by the same set of RoO because of their different export baskets to the EU. Second, we show that the R-index is a relatively reliable statistic in the sense that, subject to caveats, after controlling for the extent of tariff preference at the tariff-line level, it accounts for differences in utilization rates at the tariff line level. Finally, together with utilization rates, the index can be used to estimate total compliance costs of PSRO.

The remainder of the paper is organized as follows. Section 2 contrasts PSRO under PANEURO and NAFTA and discusses the construction of a restrictiveness index (R-index) at the tariff line level. Section 3 then applies this index to describe and compare the two regimes for broad product categories. Having checked that the R-index is indeed correlated with utilization rates after having controlled for preference rates, Section 4 uses the distribution of R-index values to non-parametric estimates of upper and lower bounds 4 The implicit assumption here is that the PANEURO and NAFTA regimes will survive pretty much unaltered in the negotiations underway for an FTAA and for the EPAs. Estevadeordal and Suominen (forthcoming) describe in great detail the complexities of RoO across PTAs. [START_REF] Cadot | The Rules of Origin facing ESA Trade: Analysis and Proposals for EPA Negotiation[END_REF] use the approach in this paper to compare AGOA and EBA ROO for those ESA countries. Compared with EBA, AGOA has less product coverage, but simpler ROO, since a single criterion of 35% regional value content is used to confer origin outside of textiles, while for textiles and apparel (T&A) a yarn forward rule which would be the strictest criterion under the observation rule adopted in this paper. They conclude that EBA and AGOA give similar treatment, except for T&A for non-LDCs where AGOA PSRO are stricter.

of total compliance costs associated with rules of origin. Section 5 concludes. An appendix describes in detail the observation rule used to construct the R-index.

The NAFTA and PANEURO regimes

Virtually all PTAs have regime-wide Roo and PSRO. We describe briefly those rules in the case of NAFTA and PANEURO, starting with regime-wide rules.

Regime-wide rules. These usually include: (i) a de minimis (or tolerance) criterion which stipulates a maximum percentage of non-originating materials that can be used without affecting the origin of the final product; (ii) cumulation 5 ; (iii) rollup 6 ; (iv) duty-drawback 7 ;(v) certification method. How these 5 Cumulation allows PTA producers to import non-originating materials from other PTA member countries without affecting the final product's originating status. Three types of cumulation rules are distinguished: bilateral, diagonal and full cumulation. Bilateral cumulation is most common and applies to trade between two partners in a PTA. It stipulates that producers in country A can use inputs from country B without affecting the final good's originating status provided that the inputs are themselves originating (i.e. provided that they themselves satisfy the area's ROOs). Under diagonal cumulation (the basic principle of the EU's PANEURO system), countries tied by the same PTA can use materials that originate in any member country as if the materials were originating in the country where the processing is undertaken. Finally, under full cumulation, all stages of processing or transformation of a product within the PTA can be counted as qualifying content regardless of whether the processing is sufficient to confer originating status to the materials themselves. It is easy to show that full cumulation allows for greater fragmentation of the production process than the more commonly used bilateral and diagonal cumulation, and hence is less restrictive. 6 The absorption or roll-up principle allows non-originating materials which have acquired origin by meeting specific processing requirements to maintain this origin when used as input in a subsequent transformation. In other words, the non-originating materials are no longer taken into account in calculating value added. The roll-up or absorption principle is used in most PTAs (in particular the EU's GSP and Cotonou), although a few have exceptions for the automotive sector.

7 Duty drawbacks are refunds to exporters of tariffs paid on imported intermediate inputs. Many PTAs, especially in the Americas, mandate the elimination of duty-drawback schemes for exports to partner countries, on the ground that a duty drawback claimed by a producer in A to export to B would put that producer at a competitive advantage compared to domestic producers in B given that the A-producer already benefits from the elimination of intra-bloc tariffs. The elimination of duty drawbacks as regime-wide rules differ between NAFTA and PANEURO is described in table 1. 1 shows that even for regime-wide rules, there is an impression of 'made-to-measure', an expression first used by [START_REF] Johnson | The Theory of Tariff Structure with Special Reference to World Trade and Development[END_REF] in describing the complexity of the tariff structures in developing countries. The table also shows that regime-wide rules differ across PTAs for the same Northern partner, confirming the hub-and-spoke characteristic of N-S PTAs. Also note the difference in certification methods between the EU and US PTAs: in the US PTAs, certification is easier to carry out, at least in principle, compared with the EU PTAs.

Product-specific RoO (PSRO). Estevadeordal (2000) proposed a synthetic index based on an observation rule to summarize the restrictiveness of a given PSRO. His ordinal index computed at the tariff line level, ranged from one (least restrictive) to seven (most restrictive), (i.e. 1 7 i R < < ). His observation rule was based on the following two assumptions. The first is that the restrictiveness of a change of Tariff Classification (CTC) can be ranked in terms of its restrictiveness on the basis of the following observation: A change of classification at the chapter level (CC) has to be more difficult to satisfy than a change at the Heading (CH) level; likewise, a change at the heading level has to be stricter than at the subheading (CS) level, and a change at the subheading level more stringent than at the tariff line or item level (CI). This implies that part of a PTA's formation can imply a cut in the profitability of finalgood assembly for export to partner countries in the area, although tariff escalation, when present, already provides some protection for finalassembly operations (as it implies lower tariffs on intermediate goods than on final ones). The resulting ordinal R-index thus assigns a single number estimate to the restrictiveness of PSRO that must be negotiated to obtain origin. In addition to the inevitable arbitrariness involved in setting up the observation rule described in the annex, the R-index has other shortcomings. In particular, it does not control for the degree of preferences and for the characteristics of the different activities:

satisfying a CTC involving a CH for intermediate activities is likely to be easier than if it is to be satisfied for a final good activity.

Before applying the R-index to describe the restrictiveness of PSRO, we describe its characteristics and, since it was constructed independently of tariff preferences, we compare R i values for both NAFTA and PANEURO regimes with the distribution of tariff preferences, where the tariff preferences, τ i , are also defined at the tariff line level as follows: Since tariff preferences are usually known when RoO are negotiated (preferences being equal to the MFN tariff since negotiated N-S PTAs are in effect FTAs except for some agricultural products), it is interesting to see whether values of the R-index are higher for sectors with tariff peaks (and hence lower for sectors with below-average tariffs).

1 pref mfn i i i mfn i t t t τ - = + (0.

Table 3 compares average values of R i and i

τ values, leaving out the middle third of the distribution of i τ from the comparison. 8 8 In these comparisons, and all the following ones, only tariff lines with positive exports are considered and outlier observations have been removed.

In the NAFTA case, 5 observations with (and u

100% i τ > i =100%
) were eliminated (3 belonging to Chapter 24 -Tobacco and 2 to Chapter 12 -Vegetables). In EU case, 88 observations were deleted (accounting for 0.02% of total trade to the EU). These are(preference rates in parenthesis): mushroom (HS 200310 -150%); garlic (HS 070320-100%); sugar (HS 170111-67%, HS170199-70%); tobacco (HS 240310-75%, HS 240399-42%, HS 240220-58%); alcohol (HS 220710-47%).

For both NAFTA and PANEURO, average R-index values are higher for tariff-peak sectors than for low-tariff sectors. That the

R-index values and tariff preference values follow this pattern either confirms that the R-index values corroborate

what is believed to be an accurate description of the restrictiveness of PSRO or, alternatively if one believes that the criteria underlying the observation rule are indeed accurate on average, then indeed PSRO are more restrictive in sectors with high tariff preferences, a result confirmed below with regressions at the tariff line level.

Insert table 3 here: PSRO Restrictiveness Index and Protection

The patterns in table 3 suggest that indeed, the politicaleconomy of RoO-making may well be one in which the negotiation Departures from the 45 0 line are thus entirely due to aggregation effects, i.e. to the fact that not all product categories are exported for each group of countries. Note first that the R-index usually takes on higher values down the sector classification, i.e. for activities with increasing degrees of processing (e.g from live animals (1) to T&A (11).

Since, roughly speaking, increasing numbers in that classification correspond to more round-about techniques of production (lower sectoral value-added ratios), it appears that PSRO rules become generally more restrictive for sectors requiring more processing. In a world of increasing verticalization of trade, and in which tariff escalation implies that protection (and hence tariff preferences) increase with the degree of processing, this pattern suggests that final goods producers in Northern countries lobby successfully to obtain restrictive PSRO for final goods (while at the same time using VC restrictions to prevent Southern producers from purchasing intermediates outside the zone).

Overall, not surprisingly for this large sample of countries, composition effects are small since most observations are close to the 45 0 line (observations below the 45 0 line like sector 2 (vegetables) correspond to non-LDC specialization in activities with the corresponding R i values). Thus, as a group, be explained by slightly different regime-wide rules under both regimes. However it is most likely due to learning effects (recall that utilization data are for 2002, the first year that EBA was in full effect). [START_REF] Cadot | The Rules of Origin facing ESA Trade: Analysis and Proposals for EPA Negotiation[END_REF] discuss reasons in the case of East and Southern Africa countries.

LDC and non-LDC interests appear to be equally affected by PSRO, at least at this level of aggregation.

The picture changes dramatically when one moves from the product composition to differences in the volume of exports within these sector categories. Table 2( The scatter plot shows a positive correlation between preferences and restrictiveness already noted in table 3. This is confirmed by the following regressions using all observations (section dummies not reported and t-statistics in parenthesis) 2 (0.86) (4.14) 0.01 0.005 ;

.31 ; 3555

US US i i R R N τ = + = = 2 (8.26) (8.27)
0.01 0.004 ;

.41, 19720

EU EU j j R R N τ = - + = =
Both set of regressions confirm that the scatter plot pattern at the section level carries on at the tariff-line level. For both EU FTAs and NAFTA, higher preference rates are associated with higher R-index values. 11

Correlates of utilization rates and non-parametric cost of compliance estimates.

As a second application, we use to the distribution of R-index values along with utilization rates to derive upper and lower bounds of compliance costs associated with rules of origin under PANEURO and NAFTA. Before carrying out this exercise, we 11 Regressions use unweighted values. Using trade weights to compute an aggregate rate of protection raises two problems (see e.g. [START_REF] Trefler | International Factor Price Differences: Leontief Was Right![END_REF]. First, since trade flows are endogenous, the resulting endogeneity bias will understate the extent of protection. Second, tariff lines are not equivalent because of domestic product specialization and demand effects. So using export weights introduces a bias, but accounts for the relative importance of products. Correlations using export weights (not reported here), would indicate the relative importance of products.

check first the correlation between variations in utilization rates and R-index values after having controlled for variations in preferences rates and other potential determinants of utilization rates. Indeed, if after controlling for preference margins, one finds the expected negative correlation between utilization rates and R-index values, variations in R-index values can be used as a proxy for the likely costs of PRSO.

Prior to correlating utilization rates with preference margins and R i u i values, note that rates vary greatly across broad categories of products in both NAFTA and ACP regimes.

Since the decision to export is taken at the firm level, if data were collected at the firm level, we would only have utilization rates of zero and one. In fact the utilization rate is observed at the HS-6 product level, so the process of aggregating zero-one firm decisions will produce rates in the zero-one range at the HS-6 level. Finally, as expected, using trade weights (compare cols. 2 and 1 and cols. 5 and 6) lowers the estimated coefficient values.

In view of the above encouraging results, we feel justified to use values of the R-index to carry out a non-parametric 13 An endogeneity problem would also arise if a second equation explaining i R as a function of i τ and another (omitted) variable influenced the endogenous variable, . Unfortunately, we do not have a good instrument at our disposal, and in any case instrumenting would be difficult if it were to take place over the PRSO variables which all take zero-one values except for VC. In reality, PSRO are probably negotiated simultaneously with the speed of phase-in (at least this is the negotiation process described for NAFTA by Estevadeordal (2000), and there is also a more limited phase-in for EBA).

0% 100% i u < < 0% 100% i u < <
. Applying this reasoning, we obtain the estimates in rows 1-3 in table 6 (unweighted estimates in parenthesis).

The R-index can then be used to breakdown the administrative cost component in total compliance costs. Let total compliance costs be given by:

i c i i c i δ σ = + (0.3)
where i δ is the administrative component and i σ is the distortionary component and all variables are expressed as a percentage of unit price. Assume that administrative costs would be negligible for firms on their participation constraint, i.e. for ( 0% 100%

Insert table 6 here: Estimates of Compliance Costs of Rules of Origin

The rather large differences between the PANEURO and NAFTA estimates, especially when using unweighted data, suggest caution in interpreting these estimates since too much weight is probably given to outlier observations with small trade volumes.

Nonetheless, the higher estimates for the EU are coherent with likely higher administrative costs associated with certification. PANEURO relies on a two-step private and public certification method which is stricter that certification under NAFTA where it is single-step private certification that need not be carried out each time (see Estevadeordal and Suominen (forthcoming, tables 5 and 6).

Further caution is also warranted by an examination of the pattern of preferences requested under PANEURO. 15 Indeed, if 15 Based on the same data, Cadot, de Melo and Tumurchudur (2005, table 3.10) estimate that the 4 non-LDCs in the group of 16 ACP countries of East and South Africa lost about 16% of a total value of preferences estimated at €201 million by requesting the less favorable trade regime (usually MFN instead of ACP) but occasionally GSP instead of ACP. The former choice which accounts for the bulk of losses could be attributable to compliance costs, but the latter could reflect also ignorance or recording mistakes. Interestingly, for the 12 LDCs in the group who had an estimated value of there are costs in proving origin, then one should not observe exporters requesting preferences when there are no preferences, yet at the HS-6 digit level there were 4% of the tariff lines with such requests. Neither should one observe requests for preferential status when preferential margins are low, here assumed to be 3% i τ =

. 16 Yet, according to the bottom row of table 6, there were 10% of tariff lines. At best, the data are only broadly consistent with the estimated values reported here.

Conclusions

This paper has compared the product-specific rules of origin (PSRO) that are used in the two best-known North-South FTAs:

NAFTA and the PANEURO system single-list used by the EU in all its FTAs. Building on earlier work by Estevadeordal (2000), we use an observation rule to build a restrictiveness index intended to capture the complexity of PSRO across tariff lines. Much like the effective rate of protection is intended as a single measure of the complexity of a tariff regime, the resulting R-index purports to fill the same role in a much more limited way (because of the inherent difficulties in assessing the restrictiveness of varied and complex measures) in the case of PSRO.

Higher values of the constructed synthetic ordinal R-index at the tariff line level correspond to PSRO perceived to be more restrictive. Higher (lower) R-index values are found in sectors with tariff peaks (low tariff sectors) this reflecting widely perceived characteristics of PRSO, namely that they are preferences of €95 million lost less than 0.01% from requesting the less favorable regime. 16 Using threshold estimation techniques, [START_REF] Manchin | Preference Utilisation and Tariff Reduction in EU Imports from ACP Countries[END_REF] estimates for the same data that preferential status is not asked when 3 4% i τ -< tailor-made to fit the protectionist interests of lobby groups in the Northern partner. Regressions of utilization rates of preferences at the product line level for PANEURO an NAFTA also show that, after controlling for the effect of preferential access on utilization rates, sectors with higher R-index values have lower utilization rates.

Two applications follow. First, the index is used to study the pattern of PSRO across activities and countries. A progression of the restrictiveness of PSRO is observed as one moves down the sectoral classification to activities with higher processing (and hence higher tariffs in the countries granting market access via preferences). Non-LDCs and LDCs who will jointly negotiate EPAs with the EU are also shown to be affected differently because of the commodity composition of their exports to the EU, and non-LDCs face the most restrictive PSRO in sectors in which they have a revealed comparative advantage (in the sense of high export volumes).

Second, revealed preference calculations on utilization rates combined with the R-index are used to estimate the overall restrictiveness of the two regimes yielding trade-weighted compliance [administrative] cost estimates of approximately 8.0% [6.8%] for PANEURO and 6.8% [1.9%] for NAFTA. While these estimates should be interpreted with caution for reasons discussed in the text, the higher administrative costs for PANEURO are consistent with the more cumbersome procedures required for certification in the EU-based agreements.

Tables and figures to

Product Specific Rules of Origin in EU and US Preferential Trading Arrangements: An Assessment

0 i u = 1 4.3(4.7) L i c τ = = 0.2(0.3) L i c τ = = 0 i u < <1 2 8.0 (7.2) i c τ = = 6.8 (6.2) i c τ = = 1 i u = 3 10.2 (8.2) U i c τ = = 7.6 (7.1) U i c τ = = Distortionary cost (σ) 2 i R ≤ & 95% i u ≥ 5 0.9 (3.8) U σ τ = = 4.9 (4.4) U σ τ = = 2 i R ≤ & 90% i u ≥ 6 1.2 (3.9) U σ τ = = 4.9 (4.3) U σ τ = =
Administrative cost estimate (δ) 7

8.0 0.9 7.1 (3.4) 8.0 1.2 6.8 (3.3)

U U c c δ σ δ σ = - = - = = - = - =
6.8 4.9 1.9 (1.8) 6.8 4.9 1.9 (1.9) Therefore, as far as the CTC is concerned, we follow the above ES's assumptions in the construction of our observation rule (see details in table A1).

In both EU SL and NAFTA, in most cases, a CTC criteria is always accompanied by one or two (in a few cases even 3) of the other requirements such as Value Content, Technical Requirement, Exception, Wholly obtained, Allowance and NONOR.

According to ES's assumptions a value of 2 is assigned to a Change of Subheading, 4 to a Change of Heading and 6 to a Change of Chapter. Therefore the observation rule assigns higher values to the index resulting from the CTC when these other requirements are added (and assigns a lower value in the case of allowance being followed after the CTC criteria).

For instance, from table A1, a change of Heading -∆CH takes a value of 4, but the value increases to a 5 when ∆CH is accompanied by R1(Wholly obtained criteria) or R2(either one of ∆CS, Technical Requirement and Exception). Conversely, it takes a lower value of 3 when it is accompanied by an Allowance Requirement.

In the case of a Value Content requirement we have taken a different approach from ES since in our case the requirement varies between 50% and 85%. Thus we use a cut-off point of 60% originating, and we assign a value of 4 to a VC strictly smaller than 60% (VC1), and of 5 to a VC higher than or equal to 60% (VC2).

Therefore whenever a VC is combined with other requirements (including a CTC) the assigned value will depend on whether the percentage of VC is higher or lower compared to the cutoff point of 60%. (See details in table A1.)

Allowances are treated as mitigating factors that make the index jump down one level. In several cases, however, allowances are given along with certain restrictions such as adding a Value Content restriction (AllowVC).

Exceptions are treated as aggravating factors making the index jump up one level. Exceptions as a stand alone are assigned a value of 2.

In a few instances (8.8% of tariff lines), EU PSRO allow for a choice between alternative composite rules to determine a product's origin. For each alternative, we computed a value for the R-index and we assigned the lowest index value for that line, since in principle the exporter, not customs, chooses which rule applies. We therefore assign the index value of the least stringent of the two rules.

Another alternative for exporters is between a VC rule and a composite alternative. This option was available for 29.4%

of the tariff lines. Again, we assigned the lowest index value to the corresponding tariff lines.

The largest differences between our index and ES's index come from the different approaches to the "wholly produced" (WH). Index values are different mostly for two reasons.

First, because of the importance of agricultural goods in ESA exports, the overall value for our index is lower than ES's. Second, we have tried to take into account the choices facing exporters, and have consequently assigned the lowest possible value for the index when several options were available.

First, allowances are

  taken into consideration. Second, the "wholly-obtained" criterion which applies mostly to agricultural products (and is not present in NAFTA) should be given a low restrictiveness value since PSRO rarely bind for agricultural products. Third, in view of the large differences in allowances for the extent of non-originating inputs in PANEURO, it is plausible to assign a higher value for VC rules that require high values for intermediates originating regionally. Finally, we also code two other additional requirements under PANEURO and take into account the possibility of choice of PRSO given to exporters under the PANEURO S-L by assigning the lowest R-index value when exporters have a choice among alternative requirements to meet origin. When applicable to NAFTA PSRO, we recomputed the Rindex accordingly. Details on the construction of the R-index (computed for 3555 tariff lines for NAFTA and 5595 tariff lines for PANEURO) are given in the annex.

  Figure 1 describes the resulting distribution of R-index values computed for NAFTA and for PANEURO. The shapes of the two distributions are quite similar with the bulk of values in the 4 and 5 range. The major difference between the two histograms comes from the low index values (R i =1) assigned to "wholly obtained" criterion used for PSRO for agricultural products under PANEURO.

  Figure 2(a) reports simple (i.e. unweighted) figures.

  figure 3 plots the average restrictiveness value for section against the average preference margin.

  and lower bound estimates following inspiration from early work byHerin (1986) for NAFTA. As inAnson et al. (forthcoming) where a similar exercise was carried out for NAFTA using Estevadeordal's (2000) R-index, we carry out non-parametric compliance cost estimates.By revealed preference, for headings with 100% the remaining sectors with , assumptions must be made. One could argue that, heterogeneity of firms notwithstanding, firms would be indifferent to exporting under the preferential regime. Then, an approximation of compliance costs would be given by the average rate of tariff preference computed for the remaining sectors, i.e. on the sample

  that firms would also be confronted with low values of , i.e. values estimates are given in row 7.

  GSP and Cotonou Agreements text; Estevadeordal and Suominen (forthcoming) for NAFTA. Notes: a/ Chapters 50-63 (textiles & apparel) do not benefit from a de minimis provision. T-S (PP) = Two-step private and public;(L S-C) = limited self-certification (S-C)= self-certification.

  Figure 1: Distribution of R-index Figure 1a : NAFTA

  weighted estimates appear first followed by corresponding unweighted averages in parenthesis a Total number of tariff lines (at HS-6 digit): 19720 b Total number of tariff lines (at HS-6 digit): 3555 c Only for PANEURO Annex to Product Specific Rules of Origin in EU and US Preferential Trading Arrangements: An Assessment This annex describes the construction of the restrictiveness index and compares it to an earlier index constructed by Estevadeordal and Suominen (ES) (2003). EU ROO are defined at the HS-4 digit, however the fact that EU ROO were given at the more detailed HS 6 digit level, we have constructed our index at the HS 6 digit level that corresponds to the 5595 tariff lines (see table A1). This also facilitates comparisons with NAFTA's ROOs which are defined at the HS-6 level. Let ∆CC stand for a change of chapter, ∆CH for a change of heading, ∆CS for a change of subheading, and ∆CI for a change of item. Like Estevadeordal's index, our index is based on the following classification convention for Change of Tariff Classification (CTC) criteria: ∆CC > ∆CH > ∆CS > ∆CI.

Table 1

 1

	here: Regime-Wide RoO in NAFTA and EU's GSP and
	Cotonou Agreements
	Table

Table 2

 2

describes the distribution of the main PSRO at the tariff line level for NAFTA and PANEURO. The main difference between the two regimes is apparent from the distribution of single criteria: for PANEURO, 13% of tariff lines only rely on a VC criterion whereas for NAFTA 89% of tariff lines rely on a CTC or a single exception.

Insert table 2 here: Distribution of PSRO under NAFTA and PANEURO

A synthetic index, like the R-index developed by Estevadeordal and subsequently modified by Estevadeordal and Suominen (forthcoming) based on the principles described above, is arguably a useful way to summarize the complexities of PSRO evident from the entries in table 2. In the following, we modify the R-index by taking into account the following considerations that apply mostly to the S-L under PANEURO.

Table 1

 1 Regime-Wide RoO in NAFTA and EU's GSP and Cotonou Agreements

	PTA	De minimis or	Absorption	Cumulation	Drawback	Certification
		tolerance	(roll up)		allowed	method
		rule
	NAFTA	7(except agr.	Yes	Bilateral No after 7	(S-C)
		& ind. prod;	(except		yrs
		7% of weight	autos)
		in chs 50-63)
	US-Chile	10(except in	Yes	Bilateral	Not	(S-C)
		agr. &			mentioned
		processed
		agr. prod)
	US-GSP	10 (10% of	Not	Bilateral,	Not	(S-C)
		weight in chs	mentioned	limited	mentioned
		50-63)		diagonal
	Cotonou	15%	Yes	Full	Not	T-S (PP);
	Agreement				mentioned	(L S-C)
	EU GSP	10%
		(excepted
		chps 50-63) a

Table 2

 2 Distribution of PSRO under NAFTA and PANEURO Each cell is the percentage of tariff lines that have the ROO in the corresponding row and in the corresponding column.

	% of tariff lines	"No other requirement" or "EXC"	"TECH" or "TECH+EXC"	"VC" or "VC+EXC"	"TECH+VC" or "TECH+VC+EX C"	"Wholly obt'd"	Other Requir. addit.	SUBTOTAL
		NAFTA	PAN NAFTA PAN	NAFTA	PAN	NAFTA	PAN	NAFT A	PAN	NAFT A	PAN	NAFTA	PAN
	No CTC 0.54 0.59 0.0 2.59 0.0 12.98 0.0	0.20 0.0 8.10 0.0 7.02 0.54 31.47
	CI	0.02	0.0 0.0 0.0 0.02	0.0	0.0	0.0 0.0 0.0 0.0 0.0 0.04 0.0
	CS	3.81 0.11 0.44 0.04 0.1	0.38	0.0	0.0 0.0 0.07 0.0 0.36 4.35 0.95
	CH	36.27 16.50 0.16 7.76 4.12 12.78 0.1	0.07 0.0 0.29 0.0 13.87 40.65 51.26
	CC	48.66 0.0 5.78 7.31 0.0	0.0	0.0	0.14 0.0 0.0 0.0 0.21 54.44 7.67
	Altern.											8.65 0.0 8.65
	Total 89.3 17.19 6.38 17.69 4.24 26.13 0.1	0.41 0.0 8.45 0.0 30.12 100	100
	CTC = change in tariff classification with CC = Change in Chapter / CH =
	Change in Heading / CS = Change in Subheading / CI = Change in Item;
	EXC = Exception to change of tariff classification;
	VC = Regional Value Content;
	TECH = Technical Requirement.
	Note:

  All values are trade weighted averages b Outlier tariff preferences excluded for NAFTA and PANEURO c All tariff lines that exceed 3 times the average tariff level d All tariff lines that are less than one third of the average tariff Source: Authors calculations

		Table 3
	PSRO Restrictiveness Index and Protection
		Index value a,b
		NAFTA	PANEURO
	Tariff peaks c	6.2(257)	4.20(3595)
	Low tariffs d	4.8(1432)	3.41(6092)
	Total number of tariff lines	3555	19720
	Notes:
	Number of tariff lines in parenthesis. Only tariff lines with positive
	exports (after excluding the outliers)are considered.

a

Table 5 :

 5 Correlates of Utilization rates( )

		18.00%
	ACP Tariff preference	16.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00%	1. Live animals 12. Footwear 6. Chem. 9. Wood 8	2. Veg 3 10	4. Food.Bev & T obacco elect.eq. 11. T extile & apparel 15. Metals 16. Mach &
		-	1	2	3	4	5		6	7
					ROO index
			Figure 3a : NAFTA
			ROO index & tariff Preference (weighted)
		18,00%
									11. Textile
		16,00%
		14,00%
	Tariff preference	6,00% 8,00% 10,00% 12,00%			17. Transport equip.	12. Foot wear 8. Leat her goods 2. Vegetable products
		4,00%					13. St one & glass 7. Plast ics 3. Fat s and Oils
		2,00%	16. M achinery & elect .eq. 9. Wood products	15. Base metals 14. Jewelry 4. Tobacco	6. Chemicals
		0,00%	20. M isc.	18 . Opt ics		10. Pulp & paper 19. Arms 5. M ineral 1. Live animals
		3	4		5			6	7
					ROO index

Table 6

 6

		:
		Compliance Cost Estimates
		(percentages)
	Row	PANEURO Average i τ	NAFTA Average i τ
		Total Compliance Costs (c)

Table A1 The

 A1 Observation Rule to construct the R index

	r=1 (R1) if
	y*=NC
	y*=WH
	y*=R2+allow (*)
	r=2 (R2) if
	y*=∆CS
	y*=TECH
	y*=EXC
	y*=R1+R2
	r=3 if
	y*=R2+R2
	y*=∆CH +allow (*)
	r=4 if
	y*=∆CH
	y*=VC1
	y*=VC1+Oth.Req
	y*=∆CH+R2+allow (*)
	r=5 if
	y*=VC2
	y*=VC2+Oth.Req
	y*=VC1+R1 (orR2)
	y*=∆CH +R1 (or R2)
	y*=∆CH +R1 (or R2)+R1 (or R2)
	y*=∆CH +VC1
	y*=∆CH +VC1+R1 (or R2) +allow (*)
	r=6 if
	y*=∆CC or
	y*=VC2+R1 (or R2)
	y*=∆CH +VC2
	y*=∆CH +VC2+R1 +allow (*)
	y*=∆CH +VC1+R1 (or R2)
	y*=∆CH +VC1+ R1 (or R2) +R1(or R2)
	y*=VC1+R1 (or R2) +R1 (or R2)
	r=7 if
	y*=VC2+ R1 (or R2) +R1 (or R2)
	y*=∆CH +VC2+R1 (or R2)
	y*=∆CH +VC2+ R1 (or R2) +R1 (or R2)
	y*=∆CC +R1 (or R2)
	y*=∆CC +VC
	y*=∆CC +R1 (or R2)+ R1(or R2)
	y*=∆CC +VC+R1 (or R2)+ R1(or R2)

Note: y* is the latent variable approximated by the observation rule and assignment to the corresponding R value on the left-hand side column; (*) only applies for EU ROO; VC1 if VC>40, VC2 if VC <=40; Oth.Requirement are NONOR, VC-R;

See Cadot et al. (forthcoming) for evidence in the case of NAFTA.

In all the computations that follow we restrict our analysis to request for ACP treatment from ACP countries. We do this simply because this is the tariff regime requested in the majority number of cases, even though tariff-free under GSP (EBA) preferences would have given equal or greater market access. This request for sometimes less favorable preferences could

Simple [trade-weighted] average MFN tariffs for LDCs are 4.2% [5.0%] and for non-LDCs

15.5%, [5.4%] while GSP (EBA) tariffs are 0% for LDCs while for non-LDCs ACP tariffs are 0% [0.2%] and GSP tariffs are 6.9% [2.7%].


Jaime Melo

Olivier Cadot

Antoni Estevadeordal

Céline Carrère

Riccardo Faini

Mark Melatos

Marcelo Olarreaga

Alberto Portugal-Perez

Maurice Schiff

Nicolas Schmitt

Alan Winters

Regionalism and Developing Countries: A Primer

Keywords: F11, F15, regional integration, trade creation, trade diversion, political economy

The paper discusses regionalism from the standpoint of developing countries surveying the more significant recent contributions surrounding the contentious debate about identifying resulting benefits for Southern partners in the recent wave of North-South Preferential Trading Agreements (PTAs). The primer starts with an assessment of efficiency effects of PTAs with a focus on the consequences of partner choice, then moves on to non-traditional aspects of regionalism. Implementation issues deal with the extent of integration and the implications of rules of origin for the extent of market access. Finally, the political economy of trade policy decisions in a regional environment, and the politics of regional agreements.

Regional Trading Arrangements (RTAs henceforth synonymous with preferential i.e. discriminatory arrangements) are rising and, for many observers, have become the most promising route to market integration, in particular for developing economies which are the focus of this paper (see figure 1). According to a recent tally [World Bank (2005), table 2.1], the average number of RTAs per country is 6, with 45 developing countries having signed bilateral trading arrangements with a Northern partner, and of the 109 North-South (N-S) PTAs, 90 having been created since 1990. At issue is whether the Multilateral Trading System (MTS) which replaces gunboat diplomacy by a rules-based system and a dispute-settlement procedure is working well for developing countries. Also at issue is how much market access Southern partners get from the Northern partner. A huge literature on regionalism and development has spawned, and this paper is a selective review (hence 'a primer') of that literature asking what the developing countries can expect to obtain from preferential market access rather than relying on multilateralism.

Figure 1 here: The proliferation of RTAs If the MTS works as it is supposed to, primary beneficiaries are the developing countries, so anything that weakens it should be considered very carefully from their perspective.

In other words, whether or not RTAs represent building blocs is a more important issue for countries with little bargaining power than for the US or the EU. With some South-South (S-S) exceptions, the majority of RTAs are of the N-S variety. Yet, with lopsided bargaining power, there is concern that developing countries are not gaining much market access. Given the risks of an unraveling of the MTS, it is necessary to examine carefully the benefits conferred to developing countries by the current wave of RTAs.

In addition, to the three basic principles of the MTS enshrined in the WTO, 1 the dispute settlement understanding supposedly establishes a credible mechanism to resolve disputes. Nonetheless, evidence is accumulating that the dispute settlement process under the WTO is not redressing the pattern of GATT-inconsistent activity that took place under the GATT, activity that was largely targeted against bilaterally powerless countries [START_REF] Brenton | Trade Disputes and the Implementation of Protection under the GATT: An Empirical Assessment[END_REF]). 2 An RTA, which is almost always built around discriminatory preferential trade policy, is in direct contradiction with the spirit of Article I. Article XXIV, however, opens the door for exceptions, provided that substantially all trade barriers are removed, and that the partners do not raise their protection towards non-members. Furthermore, the MTS is supposed to be 'favorable' to the developing countries by 1 The three basic principles of the MTS enshrined in the WTO are: nondiscrimination, known as the most-favored-nation or MFN clause (in article I)); national treatment (article III); transparent and foreseeable bound tariffs as the only instruments of protection (article XI), and; participation of all members by reciprocity to avoid the freeriding inherent in the MFN clause (article XXVIII). Reciprocity also limits terms-of-trade motivations since reduced protection at home and abroad leave terms-of-trade roughly unchanged and it also helps overcome internal political pressures since losses in import-competing sectors are offset by gains in exporting sectors. 2 After controlling for market access interests, [START_REF] Bown | Participation in WTO Dispute Settlement: Complainants, Interested Parties and Free Riders[END_REF] shows that the determinants of participation in the WTO Dispute Settlement between 1995 and 2000 continues to display an "institutional bias": under current rules developing countries with little power of retaliation or capacity to absorb substantial legal costs do not participate in the litigation. Neither do countries participate if they are particularly reliant on bilateral assistance from the respondent or are engaged in a PTA with the respondent.

granting them special and differential treatment, which in the case of RTAs means that South-South RTAs can be carried out under the so-called enabling clause which gives full leeway in the extent of reduction in trade barriers. 3 This primer examines the implications of regionalism from the perspective of developing countries. Section 1 provides some background that sets up the issues. Section 2 turns to what we have learnt about the efficiency effects of RTAs.

Section 3 turns to implementation (depth of integration and rules of origin). Section 4 deals with politics and political economy. Section 5 concludes with recommendations that would make regionalism more supportive of multilateralism.

Background, controversies and historical perspective

During the sixties, RTAs were either of the S-S type (with an objective of industrialization by import substitution) or of the N-N type (EFTA and the European Common market) involving deeper integration, because it was essentially a political endeavor. The second wave starting in the early nineties involved primarily N-S RTAs like the several enlargements of the EU and the EU relations with developing countries (the EU has some form of PTA with all but 10 of 3 Sometimes, a distinction is made between non-discriminatory arrangements (policy cooperation at the regional level) and discriminatory (or preferential trading arrangements-PTAs). Regional cooperation agreements often serve to coordinate policies (e.g. sharing power networks, building basic infrastructure). They are non controversial since, in principle, they provide some benefits to all participants without harming non-participants (internalization of externalities and no negative spillovers). Since almost all regional integration arrangements (RIAs) are discriminatory, we do not consider this non-controversial type of arrangement further. its trading partners [START_REF] Sapir | The Political Economy of EC Regionalism[END_REF])), or in the case of the US, NAFTA the several bilateral FTAs (with Chile, Jordan, Poland, etc…). The most notable exception was MERCOSUR, representing a case of substantial integrations---a customs Union (CU) among developing countries.

Why then is regionalism so contentious? First, in spite of the fact that reducing trade barriers is a move in the direction of reducing barriers to trade and hence distortions in the allocation of resources across countries, the basic economics of discriminatory reduction in trade barriers is ambiguous for participating members. Second, it is difficult to ascertain what trade policy the member countries would have followed if they had not chosen a preferential approach to trade policy (e.g. what agricultural policy would have emerged in Europe in the absence of RTAs). Third, today RTAs are widespread (usually FTAs) and the negotiating agenda goes beyond commercial preferences (i.e. involves some form of 'deep integration' which is hard to quantify). 4 Fourth, with the spread of RTAs (see figure 1), regionalism may diminish the incentives to participate in future multilateral trade negotiations as countries perceive they have sufficient market access, and do not want to expose themselves to increased competitive pressures from non-members. Fifth, concern has been expressed that if the world gets divided in a few large trading blocs, the probability of trade conflicts would increase as each country exploits its market power [START_REF] Krugman | Is Bilateralism bad?[END_REF]). Developing countries, with little negotiating power would then be the main losers of the consequences of widespread regionalism.

The relation between regionalism and multilateralism will not be pursued further here, 5 beyond noting that the tendency for countries to seek privileged trade partnerships with (usually neighboring) countries has been widespread throughout history. A prominent example is the near freetrade status enjoyed by the world trading system in the latter part of the 19th Century which was the result of a 'domino' effect following the Anglo-French establishment of a FTA (the Cobden-Chevalier treaty of 1863) which set into motion a series of bilateral treaties between France and its major trading partners who did not want to be left out in the cold following the market access gained by the British. 6 So 19th Century regionalism was the mechanism by which goods markets were integrated around the world suggesting that PTAs could be a stepping stone towards a world-wide move to free trade. In the 19th Century, the widespread application of the unconditional MFN clause (much like in the presentday MTS under the aegis of the WTO), was through the application of bilateral treaties. At the same time, while the WTS enjoyed quasi free-trade status, unlike today's system then, as noted by [START_REF] Irwin | Multilateral and Bilateral Trade Policies in the World Trading System: A Historical Perspective[END_REF], there were no limits equivalent to today's tariff bindings for WTO members, which 5 For early views, see the contributions in de Melo and Panagariya eds. (1993). For later comprehensive reviews see World Bank (2000, chp. 7) Schiff and Winters (2003, chp. 8) and World Bank (2005, chp. 6). 6 This domino view of regionalism has been put forth recently in evaluating the expansion in membership in the EU [START_REF] Baldwin | The Causes of Regionalism[END_REF]. Basically, as the EU enlarged, non-participating firms saw their demand shrink, leading them to lower their price-cost margins, lowering profits and from there to lobbying efforts at membership participation.

could have prevented the surge of protectionism that occurred in the early part of the 20th Century.

Since it is a safe bet to assume that regionalism is here to stay, in my focus on developing countries' interests, I pay particular attention to the choice of partner, i.e. are North-South RTAs (the majority among recent agreements) preferable to S-S from the perspective of what do RTAs bring to developing countries that they cannot obtain from the WTO, and is this costly?

Efficiency Effects of PTAs

Trade creation and trade diversion 7

Since tariffs are still non-negligible for developing countries, it is sensible to start with the efficiency or welfare effects of PTAs. Efficiency effects are analyzed using the notions of 'trade creation' and 'trade diversion' (see the annex for a definition and a numerical example illustrating the welfare for country A of engaging in an FTA with country B).

Applying these concepts to RTAs involving developing countries suggests four comments. First, in the case of trade diversion (here DVDs in table A1), note that if the difference in unit costs between B and C exceeded the tariff imposed by A on DVDs (here 20%), nothing would happen since C would continue to the low-cost supplier in A. This 7 The seminal contributions are collected in the readings edited Bhagwati et al. (1999), and exhaustively surveyed in [START_REF] Panagariya | Preferential Trade Liberalization: The Traditional Theory and New Developments[END_REF]. Being a primer rather than a survey, the paper keeps citations to a minimum and generally to the more recent contributions. [START_REF] Schiff | Regional Integration and Development[END_REF] and World Bank (2005) have extensive bibliographies. situation, coupled with the small reduction in tariffs prevalent in many S-S RTAs of the first generation, explains why trade among partners often did not increase significantly following the implementation of the PTA.

Second, if the partner B cannot flood A's market (i.e. if it supplies DVDs at increasing marginal costs)--again a case prevalent for many S-S PTAs, especially among small countries--then the price of DVDs will not fall in A since it will continue importing from C. In this case, A's welfare will unambiguously fall because it is losing tariff revenue to B (in effect it is subsidizing inefficient partner producers), while B's gain will be less than A's loss. As a result, overall welfare (here the combined effects on A's and B's welfare since the welfare of C is unaffected) will fall. Third, note that in the case of a N-S FTA (typical of second wave RTAs), A's partner will typically be the EU or the US. Then, when there is trade diversion, the welfare-reducing effect coming from subsidizing the higher-cost partner B is likely to be small since the partner will often be close to the low-cost supplier on a world-wide basis.

Quantifying costs and benefits

The evaluation of the welfare effects of FTAs and CUs are either carried out ex-ante on the basis of simulation methods or ex-post on the basis of an analysis of the evolution of intra-bloc and extra-bloc trade shares. 8 8 Ex-ante simulation methods give orders of magnitude of the welfare effects under alternative assumptions about market structure and elasticities. Unfortunately, the elastiticies needed for the evaluation are rarely estimated and the behavioral assumptions in the models are not confronted with the data. Ex-post methods rely on a detailed analysis of observed trade flows, and usually do not infer welfare effects. This latter approach is confronted with two problems: (a)

Ex-ante estimates. In addition to capturing the efficiency effects operating under the perfect competition case discussed above (and illustrated in the annex), simulation models also include the following effects of trade policy changes for industries operating under imperfect competition: (i) pro-competitive effects coming from a reduction in protection which forces firms to lower their mark-up over costs as they face a more elastic demand for their products; (ii) scale efficiency effects whereby firms operating at less than minimum efficient scale may move up or down their average cost curve leading to scale efficiency effects; (iii) entry/exit effects; (iv) variety-related welfare effects (trade liberalization increases varieties offered to consumers and varieties of intermediate inputs for producers).

These simulation exercises highlight the relative importance of the following effects. First, if the elimination of protection favors, on average, industries with increasing returns to scale, all else equal, an FTA is likely to be welfare-enhancing. Second, for small developing economies engaged in a S-S FTA, the gains from market access to the protected partner's market is not likely to compensate for the trade diversion effects of switching to the less efficient partner. Third, unilateral trade liberalization is always superior to an equivalent trade liberalization on a discriminatory basis. As a corollary, additive regionalism considering what trade policies countries would have followed in the absence of the FTA (typically the assumption is one of no change in trade policy); (b) do the observed changes in trade flows attributed to an FTA in fact represent the effect of some omitted variables was correlated with a variable included in the model. is always preferable to single-partner regionalism for the country that engages in it. 9

Ex-post estimates. Trade intensity and import propensity calculations for the major recent FTAs reveal the mixed patterns (under the counterfactual assumption that in the absence of the FTA, trade would have increased pari passu across partners). In some cases (e.g. MERCOSUR, UDEAC, GCC) increases in openness were reflected in rising import shares in GDP and trade intensity for partners and non-partners alike; in others (e.g. CACM II, CARICOM, AFTA), intra-bloc import propensities declined. As a result, the recent experience reveals no general patterns.

A preferred approach to building the counterfactual is to estimate an econometric model predicting the intensity of trade in terms of country size, transport costs between partners, and other variables (common border, common language, landlockedness), and then augment this model by dummy variables to capture the effects of RTAs. Known as the gravity model, this approach is currently the preferred one to estimate the sought-after Trade Creation and Trade Diversion effects.

For many well-established RTAs like the EU, MERCOSUR and NAFTA (but also for some S-S RTAs), recent gravity-based 9 For example, Chile is engaged in 12 trade agreements. Simulations (see Schiff and Winters 2003, figure 3.2) show that Chile gains successively more as it enters NAFTA, NAFTA + MERCOSUR, and then NAFTA+ MERCOSUR+ an FTA with the EU. Of course, for partners that engaged in an FTA with Chile to get a preferential market access of 11 percent (Chile's uniform tariff) saw this additive regionalism with a different eye, as their preferential access was being eroded. Implementation issues will be considered later. [START_REF] Harrison | Rules of Thumb for Evaluating Preferential Trading Arrangements: Evidence from Computable General Equilibrium Models[END_REF] review the lessons from these simulation models.

estimates show that the RTAs usually resulted in intraregional trade flows beyond those predicted by the gravity model (i.e those that would have prevailed in the absence of the RTA), often coupled with a reduction in imports from the rest-of-the-world, and at times coupled with a reduction in exports to the rest-of-the-world. Overall, this suggests evidence of trade diversion. As an example of a recent study, consider the evolution of the estimated trend in the dummy variables for intra-regional trade, exports and imports to and from the rest-of-the-world in figure 2 below.

For both MERCOSUR and NAFTA, one notices a rather significant increase in intra-regional trade accompanied by a decline in trade with the rest-of-the-world around the time of the implementation of the RTA. 10 Figure 2 here: Gravity panel estimates In the efficiency effects identified so far, there is nothing that suggests the superiority of a preferential approach to trade policy over a non-discriminatory one, and one could conclude that there is not much, if any, overall sense of trade creation, even if it appears that the N-S RTAs of the second wave are preferable to the earlier S-S RTAs. Are there other efficiency effects that could overturn these conclusions? Some claim that because typically RTAs are formed between neighboring countries (sometimes described as 'natural 10 Trade diversion can also occur under non-discriminatory reduction in protection if tariff reduction increases the effective rate of protection. Among other recent studies of the efficiency effects of RTAs, [START_REF] Krishna | Are Regional Trading Partners 'Natural'?[END_REF] finds that trade creation dominates trade diversion in 80% of the cases, while Yeats (1998) finds evidence of trade diversion for MERCOSUR.

trading partners' to reflect large trade flows), this justifies their existence. A large trade flow, however, does not mean that it should be stimulated, indeed if might be large in the first place because of a distortion. Others have argued that preferences should be extended to neighbors because it would economize on transport costs. While this may be defended, especially if there are important economies of scale in transport involving irreversible investments11 , there is no evidence so far of any correlation between geographic proximity or the volume of trade and the welfare effects of reductions in preferential tariffs [START_REF] Krishna | Are Regional Trading Partners 'Natural'?[END_REF]). partner is engaging in a less efficient trade pattern as a result of preferences to his partner. For partnerships between very rich and very poor countries, it is likely that the Southern partner will gain, though this is unlikely for partners close to the world average [START_REF] Venables | Regional Integration Agreements: Forces of Convergence or Divergence?[END_REF].

Implementation

Implementing an RTA always involves some form of policy coordination. This coordination may take place over socalled 'behind-the-border' measures that are an obstacle to trade. 12 Then regionalism allows countries to go into deeper red tape costs) give rise to large efficiency gains (rectangles that represent rents in welfare calculations now also reflect efficiency gains that are added to the efficiency triangles associated with tariffs reductions).

Because cooperation on policy requires trust that takes long time to build (to delegate authority in decision-making), no RTA has made much progress on cooperation for standards beyond WTO rules.

Significant gains along the same lines would also apply from preferential liberalization in services and public procurement. For services, the scope for efficiency gains via increased competition could be very large. 13 Yet, even though a services component is often included in RTAs, with the exception of NAFTA, little progress has been made.

Likewise, RTAs have made little progress on public procurement policies (the EU and NAFTA provide for the application of the national treatment rule). 14 Apart from the EU, NAFTA is the only instance of 'deep' integration beyond what might be achieved multilaterally since it includes for national treatment in establishment, MFN treatment in establishment and operation, a ban on performance requirements and a phase out on old ones, as 13 Much like the enabling cause allows S-S RTAs to be exempt from the economically sound constraints of article XXIV (not all trade must be covered, NTBs can be used, and tariff reductions can be reduced as wished) GATTS article V (which is closely modeled on Article XXIV) also gives greater flexibility for S-S agreements. [START_REF] Fink | Does Membership in a Regional Preferential Arrangement Make a Country More or Less Protectionist?[END_REF] discuss the distinctions (mostly relating to market structure) that must be taken into account when discussing the effects of RTAs in services. 14 However, this might be expected as governments may buy products locally either because they are non-tradable or because of asymmetric information that would require monitoring of suppliers calling for geographic proximity.

well as extensive dispute settlement provisions that allow private action against governments. 15 The NAFTA example brings about the potential policy credibility enhancing effects in N-S RTAs for Southern partners. 16 Even though RTA treaties do not include macroeconomic and general domestic constraints, it is generally agreed that in the case of NAFTA, Mexican negotiators were far more interested in using NAFTA to lockin ongoing domestic policy reforms than in exchanging concessions.

Are credibility benefits likely to be widespread in other N-S RTAs? This is particularly important for African countries (and former European colonies-known as the ACP (for African, Caribbean and Pacific), now engaged in negotiations for Economic Partnerships Agreements (EPAs) with the EU on a fully reciprocal basis (the former Lomé conventions now WTOinconsistent amounted to non-reciprocal preferences). In the case of the EPAs, since tariffs are below bound levels at the WTO, one must ask whether the EU will want to play the role of agency of external restraint and prevent former colonies to raise temporarily tariffs for, say balance of payments purposes, following a crisis. Neither can one expect the EPAs to signal that ACPs will reduce their 15 In N-S FTAs, the Northern partner typically sets the agenda. US FTAs typically involve the most explicit negotiations for market access in services and US-style rules for investment and intellectual property, not to mention a level of labor protection resulting in labor laws that are more stringent than those that the Southern partner would adopt. Market access agreements for EU FTAs contain provision for Services, but tend to reinforce international rules for intellectual property. For details, see World Bank (2005, table 5.1). 16 [START_REF] Fernandez | Returns to Regionalism: An Analysis of Non Traditional Gains from Regional Trade Agreements[END_REF] were the first to discuss these so-called non-traditional aspects of RTAs. Also see [START_REF] Schiff | Regional Integration and Development[END_REF]Winters (2003 chps. 4 and6) andWorld Bank (2005, chps. 4 and5) protection against third countries, since during the negotiations, ACPs have insisted on long adjustment periods and sought to obtain a waiver for Lomé arrangements (a waiver was obtained until 2008).

Finally, the use of contingent protection such as antidumping and countervailing duties could be banned in RTAs.

Yet, the anti-dumping specter hangs over virtually all N-S RTAs (NAFTA, APEC, the EU-Turkey CU, and all other FTAs the EU is engaged in) not to mention S-S RTAs like MERCOSUR. So N-S RTAs have not given much reason for comfort for Southern countries in access to their partners' markets. Prospects also look dim for the ongoing Free Trade of the Americas (FTAA) negotiations.

A natural question that arises is whether deep regional integration can arise without an RTA (i.e. a purely cooperative agreement). Monetary unions, for example, have at times occurred in isolation as in the case of Panama, Ecuador and El Salvador who have adopted the dollar. But monetary unions have as an objective to enforce monetary stability rather than to facilitate trade (though this may be a positive side-effect), and does not involve concessions from all countries as in the case of agreements to facilitate trade. In agreements necessitating concessions from all countries, deeper integration has typically been achieved through trade agreements.

In sum, lack of policy integration should not be a surprise since most RTAs have after all, a commercial objective rather than an economic union like the EU which has taken the step to create the necessary supranational institutions with mandates to make policies in specific areas.

Rules of Origin (RoO)

Most RTAs are FTAs so that establishing origin is necessary to prevent trade deflection (imports entering into the area via the partner with the low tariff). At the same time, even with RoO, nothing prevents the low tariff partner from satisfying domestic consumption by imports and exporting all its production to the high tariff partner (called indirect trade deflection). RoO occupy 80 pages in the FTA agreement between the EU and Poland and no less than 200 for NAFTA.

With countries simultaneously engaged in several (sometimes overlapping) RTAs, administering RoO adopted to identify origin (change of tariff classification, technical requirements and exceptions, various forms of regional content requirements) becomes complex and burdensome. While RoO are necessary, it is increasingly recognized that their complex design impose both economic costs beyond those needed to meet reasonable definitions of origin, and additional administrative costs associated with their complexity.17

Because the rules for establishing origin are so complex, a recent (and growing) literature has sought to devise summary indices indicating the restrictiveness of the set of RoO and applied these indices at the tariff-line level. Table 1 summarizes the restrictiveness of the product specfic rules of origin (PSRO) for the two main Northern countries instigators or FTAS with Southern partners: the EU and the US. Note that the PSRO are more restrictive for the highly protected sectors suggesting that market access for the Southern partner is, indeed, limited.

Table 1 here: Product Specific Rules of Origin

Restrictiveness Index and Protection

As a result of these costs, it has been observed that in N-S preferential market access schemes such as the Generalized System of Preferences (GSP), utilization rates are often quite low, even in sectors where preferential access in the Northern partner is substantial (i.e. over 10% in textiles & clothing). Utilization rates under NAFTA status for Mexican exporters in 2001 (when they faced zero duties in US markets) was not particularly high (.e.g. 79% in textiles and clothing where the preferential access margin was 12%).

Taking Mexican exporters under NAFTA as an example, it would appear that RoO in N-S FTAs are designed to give market access to inefficient US textile producers (intermediates goods) in Mexico thereby raising the costs of Mexican producers of clothing [START_REF] Anson | Rules of Origin in North-South Preferential Trading Arrangments with an Application to NAFTA[END_REF].

Under those circumstances, one is tempted to conclude that RoO in N-S FTAs almost end up yielding no market access for the Southern partner, resulting in the Southern partner being just about left on its 'participation constraint'. In sum, since RoO are not necessary under a full CU (that is a CU with both a CET and coordination on other trade policies), deeper commercial integration should be preferable to shallow integration.

Political Economy

There is more to RTAs than elimination of trade barriers since the process of integration is likely to affect trade policy stance towards non-members, especially for developing countries which have tariff bindings at the WTO well above actual levels. For example, in the case of the MERCOSUR, a CET had to be negotiated. Usually, in such negotiations the bigger partner takes the lead with the result that the CET is closer to its prevailing tariff which is also usually higher because large countries often have higher protection.

Politics also pay an important role in RTAs. We review both below.

Lobbying Activities

Whether integration brings a reduction in lobbying activity (a dilution effect if lobbies diminish their activities because of higher costs since they have to be active over a larger jurisdiction) or not will depend largely on the extent to which lobbies coordinate activities across countries. For example, in a S-S RTA among middle income countries, an initial lobbying game where agriculture and manufacturing lobbies cancel each other, could be transformed into a situation of cooperation among agricultural lobbies while manufacturing lobbies compete (as they produce the same things) so that a CU could lead to agricultural protection. 18 18 Arrangements for supranational institutions under deep integration raises further the possibility of a bias towards a protectionist outcome. Two simple models of institutional failures show how this might occur. In the first, suppose that a country's benefit from a policy is proportional to its share in production (e.g. via a production subsidy)

It is difficult to assess the importance of the dilution effect in an RTA. But examples of the results of lobbying activities in N-S and S-S RTAs show that the highly protected sectors usually obtain concessions resulting in trade diversion. This is not surprising since trade creation is a mixed blessing for a negotiating government because it generates surpluses for its consumers and for exporters in partner countries at the expense of profits in importcompeting industries where lobbies are the strongest (protection being a public good, free-riding will be less among producers than among consumers and least among producers in concentrated activities). Trade diversion, by contrast, avoids the reduction in profits, and may be preferable for governments if producer's interests weigh more heavily in their objectives than consumer's interests (whose gains will be less under trade diversion).

Pushed to the extreme, suppose that negotiators care only about producers' profits when they negotiate an RTA. Take again a three-country framework where producers are profitmaking oligopolists. Starting from a non-discriminatory trade policy, let A and B contemplate an FTA. Will governments get the necessary support? Quite likely they while its costs are proportional to its share in consumption GDP. In a CU where consensus is prized, countries deciding on a package of price increasing measures will end up adopting an all-encompassing package even, if, overall each country would preferred a no-subsidy policy outcome. (This is known as the 'restaurant bill' problem in reference to behavior in restaurants when the bill is split equal among hosts.) The second, known as universalism, is the situation where the share of the spoils are concentrated while the costs (which exceed the benefits because of the inefficiency of protection) are split evenly. Then, each government's negotiation position is best summarized in the statement: " we are opposed in principle to this measure, but if it passes, we want a share of the spoils". See Schiff and Winters (2003, box 3.2).

will because while producers might lose market share (and hence profits) to each other, they may well gain more market share and profits at the expense of C so that they will support an FTA because their profits would go up. By the same reasoning, producers would be less likely to support participation in subsequent multilateral negotiations because this would essentially involve giving up market share and profits to C (Krishna (1998)). 19 4.2 The Politics of RIAs.

For policy-makers, and certainly for politicians, there is more to regional integration than economics. Reflecting on the relative role of economics and politics, Walter Hallstein, president of the European Commission said: "We're not in business at all; we're in politics". Political scientists have concluded that the use of trade diplomacy in a regional context, and especially deeper integration like the EU, might assist political relations leading to lesser conflict. Preferential trading relations among neighboring countries (those that are most likely to enter into armed conflict) requiring more contacts would then diffuse tensions. Obvious in the case of tensions between France and Germany in the EU, tension diffusion between Argentina and Brazil under military rivalry was also an important objective for MERCOSUR.

But trade integration can also increase tensions, especially when it involves large transfers between unequal partners, 19 Using data for 50 coutries, Foroutan (1998) both integrating and nonintegrating countries have reduced their trade barriers so that regionalism would, so far at least, be benign. Estevadeordal and Robertson (2004) also find that MFN tariffs and preferential tariffs have been falling in tandem in Latin America over the period 1985-97.

as for example in the case of the East African Community (EAC), where the dominating country Kenya, was benefiting both from agglomeration effects in industry and from large income transfers from lost tariff revenue by Tanzania and Uganda. The EAC was closed in 1978, and the resulting atmosphere of hostility contributed to conflict between Tanzania and Uganda in 1979.

The EAC example also indicates the importance of lump-sum (i.e. non-distortionary transfers) from the rich to the poor partners when per capita and economic differences between partners are large (a commonplace among many S-S RIAs in Africa). Unfortunately, unlike the second enlargement of the EU where such transfers were available for the new entrants, for low-income countries, such resources are not available even among the richer members. This aspect too, points to the superiority of N-S RIAs for even if transfers are nonexistent, at least they avoid the path taken by many firstwave S-S RTAs where partial compensation was accomplished by distortionary policies which exacerbated the already strong trade diverting effects of the RIA.

From a long list of political motives for regionalism, three deserve mention. The MERCOSUR protocol made democracy a precondition for membership with consultation procedures in the case of violations. Helping restore or strengthen democratic rule was also implicit on the EU's Southern and Eastern enlargements. Respect of democracy and human rights also figure in the current regional EPAs negotiated with ACP countries, though in this case, the credibility of enforcement mechanisms may be doubted because of lack of proximity and former colonial ties. Second for small countries engaged in an RTA that delegate authority at the regional level, such as the CARICOM members, there are cost savings from the pooling of resources, and the negotiation position with the outside world are is strengthened. Third, some RTAs are also formed to deal with outside threats and regional hegemons (the GCC was partly formed in response to threats from Iran and Iraq, ASEAN in response to perceived threats from communism and the SADDC was formed in 1980 to provide a united front against apartheid South Africa).

Political motives are also present for rich countries engaged in N-S RTAs. For rich country members in N-S RTAs, these are viewed as a means to stem the increasing migratory pressures, often perceived as threatening social stability. This was quite evident in the NAFTA negotiations when President Salinas said that NAFTA would help Mexico export more goods and fewer people. Similar concerns were expressed in the EU's FTA negotiations with East European countries.

Recent research and observations, however, casts doubt on this view that trade integration and immigration are substitutes, suggesting instead that they may be complements so that an RTA could increase migratory pressures. First, by raising incomes of the poorest families who are the most promote to emigrate, trade liberalization may increase migratory pressures. Second, more information about the destination country for migrants reduces migration costs.

Third, a N-S RIA may not benefit unskilled workers, as for instance in the case of NAFTA, where unskilled workers saw a decline in their real incomes of 10 to 15 percent between the mid-eighties and the mid-nineties.

Concluding remarks

reduction of technical barriers to trade avoid the ambiguity of reducing rent-ridden measures such as tariffs. Thus, if an exchange of concession at the regional level can take place to remove 'behind-the-border' measures, the resulting deep integration would enhance trade and welfare without the traditional costs of discriminatory RTAs.

Finally, rules at the WTO could be modified to make regionalism more supportive of multilateralism. First, the leniency of the Enabling Clause which allows FTAs that are not all-inclusive could be tightened. Second, the WTO forum should be used to enforce simple and uniform rules-of-origin across product categories and especially across RTAs. Third, when RTAs are implemented among WTO members, they could be required to eliminate the gap between bound and applied tariff rates, thereby forcing members to commitment to multilateralism and free trade. Fourth, given the limited amount of WTO resources, monitoring RTAs should be avoided and the WTO Committee on Regional Trade Agreements should strive to focus on devising rules that are more likely to be welfare improving. For DVDs, the FTA results in a shift of supply away from the low-cost outside partner. This is called trade diversion.

Trade diversion always results in some welfare loss because of lower tariff revenues for A (a transfer of rents to the no spillovers are assumed to occur. Recent evidence [START_REF] Carrère | Revisiting Regional Trade Agreements with Proper Specification of the Gravity Trade Model. European Economic Review[END_REF], however, suggests that non-partners see their terms-of-trade deteriorate following the formation of an FTA or CU. In this case, the above results would need to be modified, with the possibility of gains from an RTA not available in the case of non-discriminatory trade liberalization. Notes: A higher value of the index means a more restrictive RoO a,b . The index takes a value ranging from 1 (least restrictive) to 7 (most restrictive). c . Tariffs that are three times above the mean.

d . Tariffs that are less than one third of the mean.

Source: Cadot et al. 2005, table 3. 1962 1966 1970 1974 1978 1982 1986 1990 1994

Finally

  , there is concern that trade liberalization which modifies the interactions between the forces of agglomeration (centripetal forces associated with labor pooling, knowledge spillovers and forward/backward linkages) and dispersion (transport costs and other barriers to trade, and congestion effects) might lead to de-industrialization in the South. Does this justify preferential S-S partnerships? So far, as in the case of economies of scale in transport, convincing evidence is still lacking. However, illustrative simulations in a three-country world in which two small Southern countries can reduce protection either multilaterally or bilaterally (either with a large Northern country or with a small Southern neighbor) suggest that a N-S partnership is likely to offer better prospects than a S-S partnership because of better overall net market access.However, for each Southern partner, multilateral liberalization is less desirable because of competition in the Northern country is stiffer when the other Southern country also has market access[START_REF] Puga | Trading Arrangements and Industrial Development[END_REF]).The superiority of N-S agreements on efficiency grounds also holds when one views trade as largely driven by comparative advantage effects where countries exports the services of their abundant factors: (labor for the South and capital for the North). Suppose then that the world consists of countries that either have a capital-labor endowment above the world average (Northern countries) or below average (Southern countries). An FTA between two Northern [e.g. Switzerland and Hungary] (Southern) [e.g. Kenya and Uganda] countries is likely to lead to income convergence (divergence) as the richest [Switzerland] (poorest) [Uganda]

  for Peace, New York World Bank (2000) Trade Blocs, Washington, D.C. World Bank (2005) Global Economic Prospects: Trade, Regionalism and Development, World Bank, Washington, D.C. Wulf, L. de and J. Sokol, eds. (2004). The Customs Modernization Handbook, The World Bank, Washington, D.C. Yeats, A. (1998) Does Mercosur's Trade Performance Raise Concerns about the Effects of Regional Trade Arrangements?.World Bank Economic Review: 12(2) 1-28.Annex: Trade Creation and Trade DiversionThe following example illustrates these two concepts.Countries A and B consider forming an FTA, with the rest-ofthe-world represented by C. The focus is on the welfare effects for A from eliminating its 20% tariff on imports from its partner B. Arrows in table 1 indicate the source of import supply in A under the two trade policies: a nondiscriminatory tariff of 20% and a tariff applied only to imports from C.

Figure

  Figure 1: The Proliferation of RTAs

Table A1 :

 A1 Trade Creation and Trade Diversion

			B	A		C
		c 0	11	13	10
	DVDs	c 0 (1+t 0 )	13.2	13	← 12
		C 0 (1+t 1 )	11 →	13	12	Trade diversion
		C 0	18	15	20	Neither trade
	Textiles	C 0 (1+t 0 )	21.6	15	24	Creation nor
		C 0 (1+t 1 )	18	15	24	trade diversion
		C 0	15	17	16
	Shoes	C 0 (1+t 0 )	18	17	19.2
		C 0 (1+t 1 )	15→	17	19.2	Trade creation
	Notes:
	c 0 = unit cost
	t 0 = A's tariff before the FTA (t 0	C = t 0 B = 20%)
	t 1 = A's tariff after FTA with B (t 0 C = 20%; t 0 B =0%)

Table 1

 1 Product Specific Rules of Origin Restrictiveness Index and

	Protection
		Index value a,b
		NAFTA	PANEURO
	Tariff peaks c	6.2(257)	4.20(3595)
	Low tariffs d	4.8(1432)	3.41(6092)
	Total number of tariff lines	3555	19720

Because of multiple memberships, it is difficult to evaluate implementation costs. Indeed, some countries find themselves simultaneously engaged in a CU partnership (which involves a common trade policy) while at the same time participating in an FTA with another set of partners.

Freund (2000) develops a simple model with economies of scale in transport involving sunk costs. She shows that if non-members reach a lower welfare level, members reach a higher welfare level under regionalism than under multilateralism.Hummels and Skiba (2004) give some evidence of economies of scale for transport in Latin America.

'Behind-the-border' barriers to trade result from segmented labor markets, lack of coordination among regulatory institutions, and lack of

See Brenton and Imagawa (2004) andCadot et al. eds (2005) for a compendium of contributions on various aspects of the costs of RoO.

market integration than under multilateralism. But implementation also involves rules of origin when integration is less than a CU, and bargaining over a common external tariff under a CU.

Integration of domestic policies

Most RTAs have on their agenda some form of policy integration going from the least demanding (coordination on an ad-hoc basis) to harmonization of national standards and regulation (often driven by market size effects) up to recognition of foreign regulatory regimes and assessment procedures by Mutual Recognition Agreements (MRAs). So far, only the EU has used MRAs, and the process has taken 30 years to reach this relatively advanced stage of policy integration and delegation of authority to supranational institutions. Again, much of the benefits from policy integration such as reduction in red tape, harmonization of standards to international norms could be carried out on a non-discriminatory basis.

However, there is a fundamental difference with discriminatory trade liberalization: unlike for tariff preferences that lead to rents, reductions in transactions costs only involve increases in efficiency. As such, they will always lead to an improvement in efficiency, at least in a competitive environment, thereby avoiding the ambiguity associated with preferential reduction in goods which involve rents. Moreover, efficiency gains are likely to be significant, since reductions in trade transaction costs (border formalities, standards certification, frictional or harmonization on standards. See World Bank (2005, chp. 4) for further discussion.

Regional integration in the form of discriminatory trade preferences is controversial justifying the often-heard remark that a well-functioning WTS with low levels of protection relying heavily on non-discrimination and transparency would protect best the interests of developing countries. If the politics and political-economy aspects of RTAs show why they are so popular, efficiency considerations show that the biggest share of the gains from trade liberalization comes from dismantling domestic protection.

Neglecting systemic issues, this means that the ideal trade policy for a developing country would then be unilateralism first, followed by multilateralism in second (when political constraints limit the extent of own liberalization reciprocity is effective in further liberalization), with regionalism in third place. Unfortunately for developing countries, led by the EU and the US, most countries are following exactly the reverse strategy, a trend that is only likely to be reversed if the Doha Round is successful.

This primer also suggests that, with regionalism here to stay, developing countries are likely to be best served by partnerships with Northern countries, even though this means in the end little market access both because of falling protection worldwide and because of stiff RoO and because the industrialized countries will be setting the agenda for 'deep' integration. At the same time, to minimize the losses associated with trade diversion, they should maintain low protection towards non-partners. In general, deep integration agreements which extend beyond reduction in trade barriers to include services and cooperation on 'behind-the-border' measures should be encouraged because inefficient partner B). In the constant cost supply case illustrated here, the price for consumers in A is also lower. This effect is a source of welfare gain for A. In this case, the net welfare effect on A is ambiguous: on the one hand, it goes up because DVDs sell in A at a price closer to their opportunity cost of 10 in C, while on the other hand A loses tariff revenue to DVD producers in B who are in effect subsidized by consumers in A.

For textiles, since A is the low-cost supplier, the FTA has no welfare effect.

For shoes, B is the low-cost supplier. The FTA leads to a welfare gain since supply is always from the low-cost partner (in effect it is as if A had reduced its tariff in a non-discriminatory way). In fact there is both a transfer of government revenue from the government in A to its consumers (of no welfare consequence), and a reduction in price for consumers which is a source of welfare gain. Two caveats. First, in the numerical example in table A1, products are assumed to be homogenous, while in practice products are typically differentiated. Then A will import both from B and C before and after the FTA. 20 Differentiated goods makes gains from an FTA more likely, as the price of the variety supplied by the partner will have to fall, while at the same time, the link between tariff reduction and price reduction (the source of welfare gain) is weakened so the magnitude of the gains and losses are reduced. Second, 20 For example, in the case of NAFTA, in 1991 before NAFTA was a real possibility, 70 percent of Mexico's imports came from the US (614 out of 4854 headings) while in 1996, 78 percent of imports came from the US (296 out of 4854 headings).