How do preferential trade agreements impact multilateral trade?

1 Trade creation

Trade creation occurs when a PTA lowers the cost of trade between its members and induces them to increase their trade flows. Trade creation can benefit both the PTA members and the rest of the world, as it enhances efficiency, productivity, and welfare. Trade creation can also support multilateral trade by expanding the size of the global market and generating positive spillovers for non-members. For example, a PTA between two large economies, such as the European Union and the United States, could create significant trade opportunities for third countries that supply intermediate goods or services to the PTA members.

2 Trade diversion

Trade diversion occurs when a PTA shifts trade from more efficient non-members to less efficient members, because of the preferential treatment. Trade diversion can harm both the PTA members and the rest of the world, as it reduces efficiency, productivity, and welfare. Trade diversion can also undermine multilateral trade by creating distortions, inequalities, and conflicts in the global trading system. For example, a PTA between two small economies, such as New Zealand and Singapore, could divert trade from more competitive non-members, such as China or India, and erode their market access and bargaining power.

3 Trade liberalization

Trade liberalization refers to the reduction or elimination of trade barriers across countries, either through unilateral, bilateral, or multilateral measures. Trade liberalization can enhance both the PTA members and the rest of the world, as it fosters competition, innovation, and growth. Trade liberalization can also complement multilateral trade by creating a more open and fair trading environment and by promoting convergence and harmonization of trade rules and standards. For example, a PTA that adopts high-quality and comprehensive provisions on issues such as intellectual property rights, environmental protection, or labor rights, could set a positive example and a benchmark for multilateral trade negotiations.