# 1 Introduction

Over 130 preferential trade agreements (PTAs) were formed in the last ten years—more than in the previous 50 years combined. Nearly all countries are currently members of at least one PTA and nearly a third of world trade is carried out under such agreements. Although most economists favor multilateral trade liberalization (MTL), there is no such consensus on the desirability of preferential liberalization. The original concern with PTAs was their ambiguous effect on welfare: positive if the preferential partner is more efficient than the rest of the world but negative otherwise (Viner [1950]). During the late 1980s and early 1990s, MTL was stalled while the United States and the European Union pursued PTAs, generating much debate on whether PTAs are a “building block” or a “stumbling block” toward MTL. (Bhagwati [1991]) This issue is also prominent in the current multilateral round with several developing countries fearing that MTL by the countries that provide them with preferential treatment will erode those preferences.<sup>1</sup> An important source of concern with PTAs is that they can hurt non-members. One direct channel by which this occurs is if the PTA members divert their import demand away from the non-members and that effect is large enough to reduce non-members’ export prices. There is evidence of trade diversion and also some direct evidence that PTAs do lower export prices for non-members.<sup>2</sup> This and other costs to the non-members due to discrimination disappear if the preference is fully eroded by MTL. Thus, it is crucial to determine if PTAs hold back MTL and entrench these costs, particularly given that two-thirds of world trade is not covered by any preferences. After much debate there is still no theoretical consensus about, and scant empirical evidence of, a “clash of liberalizations”. We provide evidence of such a clash during the last multilateral trade round by applying product-level protection data to estimate a model of the interaction of preferential and multilateral liberalization.

Most of the early theory analyzing the effect of PTAs on MTL assumed that MTL implied free trade. So the research focused on the effect of PTAs on a binary choice between free trade and no MTL and it effectively asked whether PTAs made a multilateral trade round more or less likely.<sup>3</sup> Assuming that a round leads to free trade and focusing on the probability of a round simpli fi es the

> 1 The latest round was launched in 2001 and, according to a recent article in the leader section of the Economist, a key factor that may lead to its collapse is that “Poor countries with preferential access to rich world markets want to make sure that freer trade will not reduce these preferences”. (“Talking the Talk”, July 17th 2004, p.14.) The possibility that these preferences would reduce MTL is not new: it was a concern raised by opponents of the generalized system of preferences when it was originally proposed (Johnson [1967] p. 166).

> 2 Romalis (2004) provides evidence of trade diversion for the North American Free Trade Area and its predecessor between the US and Canada. Chang and Winters (2002) fi nd that Mercosur caused lower export prices for non-members.

> 3 Krishna (1998) argues that PTAs reduce the likelihood of a multilateral round because the export rents generated by PTAs disappear when countries liberalize multilaterally and so the producers that bene fi t from those rents will oppose MTL. Levy (1997) shows that the median voter may reject multilateral free trade after voting for a PTA even though he would have accepted it if no PTA had been available.

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