The Madrid summit of the European Union (EU) and the United States in 1995 adopted a ‘New Transatlantic Agenda.’ This covers issues ranging from collaboration in Bosnia through environmental protection to cooperation against international terrorism. It also calls for significant steps towards trade liberalization, including bilateral reduction or elimination of tariffs in industrial products, accelerated implementation of Uruguay Round tariff reductions, and negotiated reductions in regulatory and other non-tariff barriers to trade.

In conjunction with the commemoration of the Marshall Plan, which in 1947 helped set the course for US-European relations during the Cold War, a transatlantic trade initiative is now being considered as a way of anchoring relations in the post-Cold War era.

Do the potential benefits justify the two regions pursuing a trade and investment agreement? Equally importantly, would they benefit more from a preferential bilateral initiative or from joint support for multilateral initiatives? These are the issues addressed in a recent CEPR Discussion Paper by Richard Baldwin and Joseph Francois.

Baldwin and Francois provide a quantitative assessment of the implications of preferential trade liberalization by the North Atlantic economies. This includes an examination of the patterns of production, trade and import protection in North America and Western Europe, and the likely trade and income effects of trade liberalization.

Using a general equilibrium model of the world economy, they compare the potential benefits of preferential trade liberalization with the potential benefits of post-Uruguay Round reductions in trade barriers based on the ‘most favoured nation’ principle. Their numerical assessment reveals the impact of these initiatives on both the North Atlantic economies themselves and their important regional trading partners.

Trade between North America and Western Europe consists largely of two-way trade in similar industrial products. In 1994, almost 40% of this trade was in machinery, cars, car parts, and other transport equipment. And out of $276 billion in total transatlantic merchandise trade, very little, in relative terms, was in politically sensitive industries, such as textiles, clothing, steel and agricultural goods, where trade frictions are concentrated.

While the North Atlantic economies account for a large share of world trade, Baldwin and Francois’ analysis suggests that they actually offer relatively limited opportunities for further trade liberalization. Indeed, because of the combination of Uruguay Round commitments to reduce tariffs and the Information Technology Agreement reached at the Singapore Ministerial of the World Trade Organization, most transatlantic trade will face either relatively low tariffs (generally less than 2.5%) or zero tariffs by 2005, even without a preferential trade agreement.

This means that reduction in industrial tariffs alone, without a deeper liberalization initiative, is likely to have little if any impact on trade and incomes. Peaks of protection (tariff equivalents of over 30%) do affect US and EU exports of fishery and mining products, textiles, clothing, fabricated metal products, transport equipment and machinery. But these rates are generally found in Asia, Latin America, and Africa, not Western Europe or North America. (The notable exception is continued EU and US

protection in sensitive agricultural products, textiles and fisheries).

Because remaining protection is relatively low, a narrow preferential agreement, leading only to the elimination of tariffs on industrial goods, is likely to have little, if any, discernible impact. National income in North America will rise very slightly and the effect on EU income will be almost zero.

Baldwin and Francois’ simulations suggest that, in contrast, a deeper agreement, including bilateral elimination of industrial tariffs, agricultural protection and anti-dumping remedies, would generate modest increases in income and wages for the two regions. This would entail a broadening of the coverage of the plurilateral government procurement agreement, and a reduction in trading costs through mutual recognition and harmonization of standards.

The implications of a preferential agreement for third countries vary, depending on the degree of liberalization. One qualitative result which appears across most of the simulations is that a preferential agreement implies welfare losses for North Africa and the Middle East. These are generally of a magnitude that is roughly comparable (as a percentage of GDP) to the gains for the EU. A preferential agreement between the EU and the US erodes these countries’ existing tariff preferences in EU markets.

The results also suggest that any potential economic benefits to Western Europe and North America of preferential liberalization are easily swamped by the potential gains that would arise from comparable multilateral liberalization. For other regions and particularly developing countries, the implications of such multilateral liberalization depend critically on their own participation.

Preferential liberalization among the developed countries, involving either the North Atlantic economies or the entire OECD, can imply adverse effects for various developing country regions (especially in Africa, but also in Latin America). But these adverse effects can be turned into gains through comparable multilateral liberalization in the affected regions.

For example, in the Baldwin and Francois simulations, further trade liberalization involving developing country tariff reductions implies significant gains for developed and developing regions alike. These gains for non-OECD regions largely follow from import liberalization by the developing regions themselves.

In other words, it is not that a liberalization within the OECD ‘fails’ to benefit the other non-OECD economies. Rather, for all regions, the gains that a region enjoys as a result of a liberalization depend on the extent to which the region liberalizes itself.

This article reviews research reported in ‘Preferential Trade Liberalization in the North Atlantic’, CEPR Discussion Paper No. 1611 (March 1997) by Richard Baldwin and Joseph Francois. Baldwin is Professor of International Economics at the Graduate Institute of International Studies in Geneva and Co-Director of CEPR’s International Trade programme; Francois is Professor of Economics at Erasmus University in Rotterdam and a Research Fellow in CEPR’s International Trade programme.

Matthew Canzoneri, Wilfred Ethier and Vittorio Grilli (eds), The New Transatlantic Economy, Cambridge University Press for CEPR (1996)