The New Wave of Regionalism

The propensity of countries to enter PTAs, the pace of regionalism, and its welfare implications depend on political conditions.

The preferences of government officials and the nature of domestic institutions influence the establishment and economic effects of PTAs.
Both the formation of regional trade agreements and their consequences hinge on international political conditions.
Whether states choose to enter regional trade arrangements and the economic effects of these arrangements depend on the preferences of national policymakers and interest groups, as well as the nature and strength of domestic institutions.
Two waves of regionalism:
First wave took place from the late 1950s through the 1970s, was marked by the establishment of EEC, EFTA and CMEA. They were initiated against the backdrop of the Cold War, the sudden increase of decolonization following WWII, and a multilateral commercial framework, all of which colored their economic and political effects.

Second wave emerged in the wake of the Cold War’s conclusion and the attendant changes in interstate power and security relations.
Societal Factors
As neofunctional studies indicate, the preferences and political influence of domestic groups can affect why regional strategies are selected and their likely economic consequences.
The domestic political viability of a prospective PTA, the extent to which it will create or divert trade, and the range of products it will cover hinge partly on the preferences of and the influence exercised by key sectors in each country as well as the particular set of countries that can be assembled to participate in it.
The political viability of a PTA often depends on the amount of discrimination it yields. Agreements that divert trade will benefit certain interest groups while creating costs borne by the populace at large.
Trade-diverting PTAs will face fewer political obstacles than trade-creating ones. If so, using preferential arrangements as building blocks to support multilateral liberalization will require surmounting substantial domestic impediments.
What is unclear is that why exporters would prefer to liberalize trade on a regional rather than a multilateral basis in the first place. One possibility is that exporters will be more likely to support regional strategies if they operate in industries characterized by economies of scale, since, by protecting these sectors from foreign competition and broadening their market access, the formation of PTA can bolster their competitiveness.
Research focusing on societal factors on regionalism has two drawbacks:
There is a lack of empirical evidence indicating which domestic groups support regional trade agreements, whose interests these agreements serve, and why particular groups prefer regional to multilateral liberalization.
We know very little about whether, once in place, regional arrangements foster domestic support for broader, multilateral trade liberalization or whether they undermine such support.
Domestic Institutions
Many regional trade arrangements that LDCs established during the 1960s and 1970s, for instance, grew out of import-substitution policies that were actively promoted by policymakers and strongly supported by various segments of society. However, PTAs also have been created by policymakers who preferred to liberalize trade but faced domestic obstacles to doing so unilaterally.
For a state that is interested in making liberal economic reforms, the attractiveness of locking them in through an external mechanism, such as joining a PTA, is likely to grow if influential segments of society oppose reforms and if domestic institutions render policymakers especially susceptible to societal pressures. Under these conditions, governments must have the institutional means to circumvent domestic opposition in order to enter such agreements, and the costs of violating a PTA must be high enough to ensure that reforms will not be abrogated.
Governments may choose to join regional arrangements if they resist reforms but are anxious to reap the benefits stemming from preferential access to other members’ markets. Existing members of a preferential grouping may be able to influence the domestic economic policies and the political institutions of prospective members by demanding that they institute domestic reforms prior to accession.
Using PTA membership to stimulate liberal economic and political reforms is a distinctive feature of the latest wave of regionalism. The latest wave has been marked by cases where accession to a PTA was used to facilitate liberal economic and political reforms and to dilute the political efficacy of societal groups that opposed such changes.
Underlying demands for democratic reform are fears that admitting nondemocratic countries might undermine existing PTAs composed of democracies and the belief that regions composed of stable democracies are unlikely to experience hostilities. Then, the contemporary rise of regionalism may contribute to both commercial openness and political cooperation.
Political viability of such PTAs, the credibility of the institutional changes they prompt, and the effect of these arrangements on international openness and cooperation depend heavily on the preferences of powerful domestic groups.
Why state leaders have displayed a particular preference for entering regional trade arrangements? One possibility is that they do so to liberalize trade when faced with domestic obstacles to reducing trade barriers on a unilateral or multilateral basis.
The feasibility of creating a regional agreement depends on prospective members having relatively similar economic or political institutions.
Others point out that countries in close geographic proximity have much less impetus to establish regional arrangements if their political institutions differ significantly. In Asia, for example, the scarcity of regional agreements is partly attributable to the wide variation in the constituent states’ political regimes.
Political Power, conflict and Regionalism
Gilpin argues that as a hegemon’s power recedes, it has reason to behave in an increasingly predatory manner. To buffer the effects of such behavior, other sates might form a series of preferential trading blocks, thereby setting off a wave of regionalism. He suggests that this sort of process began to unfold during the 1980s, giving rise to a system of loose regional economic blocs that is coalescing around Western Europe, the U.S and Japan. Because of problems of pluralist leadership, these developments threaten the unity of the global trading order, a prospect that recalls Krugman’s claims about the adverse effects on global welfare stemming from systems composed of three trade blocs.
Mansfield and Milner argue that even that is emerging, the situation will not be dire as Gilpin assumes because:
Despite the potential problems of pluralist leadership it is widely argued that global openness can be maintained in the face of declining hegemony if a small group of leading countries collaborates to support the trading system. Drawing smaller states into preferential groupings with a relatively liberal cast toward third parties might reduce the capacity of these states to establish a series of more protectionist blocs and bind them to decisions about the system made by the leading power.
Krugman argues that the dangers posed by a system of three trade blocs are muted if each bloc is composed of countries in close proximity that conduct a high volume of commerce prior to its establishment. Krugman concludes that these ‘natural’ trading blocs reduce the risk of trade diversion and that they make up a large portion of the existing PTAs.
Countries cannot ignore the security externalities stemming from commerce without jeopardizing their political well-being. Gowa argues that countries can attend to these externalities by trading more freely with their political-military allies than with other states. Since PTAs liberalize trade among members, Gowa’s argument suggests that such arrangements are especially likely to form among allies.
Allies may be quite willing to form PTAs that divert trade from adversaries lying outside the arrangement, if they anticipate that doing so will impose greater economic damage on their foes than on themselves. Various preferential agreements in Europe and in countries of Soviet orbit  ended with the collapse of the Warsaw Pact.
Another way that regional arrangements can affect power relations is by influencing the economic dependence of members. If states that derive the greatest economic gains from a PTA are more vulnerable to disruptions of commercial relations within the arrangement than other participants, the political leverage of the latter is likely to grow.
Since WWII, stronger states continued to use PTAs as a means to consolidate their political influence over weaker counterparts. Grieco argues that over the past fifty years, the extent of institutionalization in regional arrangements has been influenced by power relations among members. In areas where the local distribution of capabilities has shifted or states have expected such a shift to occur, weaker states have opposed establishing a formal regional institution, fearing that it would reflect the interests of more powerful members and undermine their security.
Another view is that regional institutions foster stability and constrain the ability of members to exercise power. For example, Germany’s power has enabled it to shape European institutions, but its entanglement within these institutions has taken the hard edge off its interstate bargaining and eroded its hegemony in Europe.
The latest wave of regionalism has been marked by especially few instances of states using PTAs to bolster their political-military capacity. That is probably one reason why regionalism has done less to divert trade over the past fifty years than during the interwar period.
Multilateral Institutions, Strategic Interaction and Regionalism
One of the most distinctive features of the two waves of regionalism occurring since WWII is the multilateral framework in which they arose. Most contemporary PTAs have been established under the auspices of the GATT/WTO, which has attempted to dampen trade diversion by limiting members’ ability to discriminate against third parties.
Throughout the interwar period, PTAs formed in reaction to each other due largely to mercantilist policies and political rivalries among the major powers. For example, EFTA was created in response to EEC.
Contemporary PTAs have formed in reaction to each other for different reasons than before: GATT members have not established them to obtain MFN treatment, and they are not the products of mercantilist policies.
A state entering an existing PTA may provoke concern on the part of its economic rivals that they will be placed at a competitive disadvantage in international markets, unless they respond in kind.
Institutional design of a regional arrangement affects the degree of integration among participants. Deeper integration is more easily attained if states share an interest in economic liberalization; all else equal, the heterogeneity of members’ preferences is likely to increase as the number of members grows. For this reason and because of collective action problems, forming a small PTA is easier than forming a large one, regardless of the level of integration attained eventually.
Customs unions are likely to yield greater protection than FTAs. CUs set a CET, and it may be easier for protectionist groups to ally across states to raise it than to forge an alliance to raise tariffs independently set by each member.
Countries setting trade barriers collectively can dilute the political influence of protectionist interest groups in any given member.
Why certain regions display a high degree of institutionalization but others do not?
More highly institutionalized arrangements arise as functional responses to intensified integration among the constituent states. This is highly criticized.
Kahler argues that the extent of institutionalization depends on the preferences of policy makers and interest groups as well as bargaining among PTA members.

Grieco argues that institutionalization will be forestalled when ‘less powerful countries ina region have experienced or are experiencing a significant deterioration in their relative capabilities’ because of their concerns ‘that the enhancement of regional economic ties brought about by institutionalization will accentuate regional imbalances in capabilities even further in favor of the relatively stronger partners’. In his view, weaker countries of Southeast Asia are likely to oppose the establishment of formal economic institutions, whereas the stronger powers, such as Japan are likely to press for their development.
In contrast to Grieco, Katzenstein points out that today it is China and Japan who oppose rapid moves toward formal institutionalization of regional integration whereas weaker powers like the members of ASEAN seek stronger institutions.
All but a few members of the WTO currently belong to a PTA and it is centrally important to determine why its members often choose to pursue regional trade initiatives rather than relying solely on multilateral initiatives. One possibility is that they view PTAs as a compliment to multilateral liberalization; another is that they view regional and multilateral liberalization as substitutes.