Assessment and Measurement of Regional Integration

Assessment and Measurement of Regional Integration

How fast and how deep are current processes of regional integration? What is their impact for different countries and how can it be measured? How are they related to globalisation and the quest for global free trade? How important is the macroregional level of governance? Using an interdisciplinary approach, this book explores how regional integration can be quantified, evaluated and monitored. It investigates the methodological problems involved in designing monitoring tools for regional integration, and makes suggestions for designing and organising systems of indicators of regional integration. The volume is organised into three sections: • • •

Part I discusses general theoretical and methodological aspects of building indicator systems. Part II focuses on the measurement of regional economic integration and interdependence. Part III explores the possibilities for monitoring political integration, regional governance and conflict.

This book will be of interest to students and researchers of international relations and economics as well as policy makers and professionals within international and regional organisations. Philippe De Lombaerde is an economist and a Research Fellow at the United Nations University – Comparative Regional Integration Studies (UNU-CRIS) in Bruges, Belgium.

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Assessment and Measurement of Regional Integration Edited by Philippe De Lombaerde

First published 2006 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2006 Philippe De Lombaerde for selection and editorial matter; individual contributors, their contributions

This edition published in the Taylor & Francis e-Library, 2006. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Assessment and measurement of regional integration / edited by Philippe De Lombaerde. p. cm. – (Routledge/Warwick studies in globalisation ; 13) Includes bibliographical references and index. 1. Regional economics. 2. Regionalism. 3. International economic integration–Evaluation. 4. Regionalism (International organization)– Evaluation. I. Lombaerde, Philippe de. II. Series. HT388.A77 2006 337.1′072–dc22 2005022668 ISBN10: 0–415–36635–6 (hbk) ISBN10: 0–203–08789–5 (ebk) ISBN13: 978–0–415–36635–9 (hbk) ISBN13: 978–0–203–08789–3 (ebk)

To Liliana, Griet and María Paz P.D.L.

Contents

List of figures List of tables List of contributors Acknowledgements Introduction and summary

xi xiii xv xvii 1

PHILIPPE DE LOMBAERDE

PART I

General theoretical and methodological aspects

7

1 Indicators of regional integration: conceptual and methodological aspects

9

PHILIPPE DE LOMBAERDE AND LUK VAN LANGENHOVE

2 Towards a qualitative monitoring of regional integration

42

LUK VAN LANGENHOVE

3 Communicative indicators for the study of regional integration: a critical theory perspective

52

ANN-CHRISTIN RASCHDORF

PART II

Assessment of economic integration 4 Regional integration agreements and the geography of world trade: statistical indicators and empirical evidence LELIO IAPADRE

63

65

x Contents 5 Explaining regionalisation via relative trade intensities

86

GUILLAUME GAULIER, SÉBASTIEN JEAN AND DENIZ ÜNAL-KESENCI

6 Assessing the impact of regional trade agreements: an analytical framework for rulemaking in trade and investment

107

STEPHEN WOOLCOCK

7 Comparative fiscal integration indicators

130

PHILIPPE DE LOMBAERDE AND ANA-CRISTINA COSTEA

8 Indicators of real economic convergence

146

JOSÉ VILLAVERDE CASTRO

9 Measuring and explaining levels of regional economic integration

162

JENNIFER PÉDUSSEL WU

PART III

Assessing political integration, regional governance and peace

181

10 Regional integration and (good) regional governance: are common standards and indicators possible?

183

EDWARD BEST

11 Assessing accountability of global and regional organisations

215

MONICA BLAGESCU AND ROBERT LLOYD

12 Measuring the impact of regional organisations on peace building

232

RODRIGO TAVARES AND MICHAEL SCHULZ

Index

252

Figures

1.1 1.2 1.3 1.4

Dobson’s ‘Policy Conflict–Independence–Integration’ spectrum The independence–interaction spectrum Preconditions in phased integration processes Regional integration as a process: proposal for a conceptual framework 3.1 Parsons’ pattern variables revisited 4.1 Intra-regional trade shares 4.2 Intra-regional trade intensity (traditional Balassa indicator) 4.3 Intra-regional trade intensity (homogeneous indicator) 4.4 Intra-regional trade intensity (symmetric indicator) 4.5 Intra- and extra-regional trade intensity (EU-15) 4.6 Trade introversion 4.7 Relative trade openness 4.8 Relative intra-regional trade propensity 5.1 The polarisation of foreign trade with regard to the Triad, by country, 2001 5.2 Breakdown of Regional Trade Agreements by geographical area 8.1 Lorenz curve 8.2 Per capita income distribution – polarisation versus inequality 8.3 Convergence clubs 8.4 Stochastic kernel 9.1 Evolution of regional trade agreements in the world 1948–2002 9.2 Types of regional integration arrangements 9.3 Regional integration in 150 countries 1965–1995 12.1 Violence and peace are part of the dyadic relationship of a continuum

14 14 23 25 56 76 76 77 78 78 79 79 80 88 95 149 150 153 156 162 164 166 245

Tables

1.1 1.2

Anderson’s criteria for choosing ‘good’ economic indicators Overlapping memberships of integration arrangements for African countries 1.3 Proposal for classifying variables in a SIRI 1.4 Bensidoun and Chevallier’s indicators of regionalisation 5.1 Top relative trade intensities in America 5.2 Top relative trade intensities in Eurafrica 5.3 Top relative trade intensities in Asia-Oceania 5.4 Estimating a gravity model for RTIs, 1967–2001 6.1 Proposal for an analytical framework for rulemaking in trade and investment 7.1 The World Bank’s list of fiscal decentralisation indicators 9.1 Ordered probit regression 1960–98 9.2 Ordered probit regression 1987–98 9.3 Bivariate probit regression 1960–98 9.4 Bivariate probit regression 1987–98 12.1 Regional integration dimensions 12.2 Various forms of regional interventions

12 19 26 30 90 91 93 100 112 136 172 174 175 176 242 247

Contributors

Edward Best, Head of Unit, European Institute of Public Administration (EIPA), Maastricht . Monica Blagescu, Accountability Programme Manager, One World Trust, London , and PhD candidate at the University of Bath. Jose Villaverde Castro, Professor, Department of Economics, Universidad de Cantabria, Santander . Ana-Cristina Costea, Assistant to the Director, United Nations University – Comparative Regional Integration Studies (UNU-CRIS), Bruges . Philippe De Lombaerde, Research Fellow, United Nations University – Comparative Regional Integration Studies (UNU-CRIS), Bruges . Guillaume Gaulier, Economist, Centre d’Études Prospectives et d’Informations Internationales (CEPII), Paris . Lelio Iapadre, Associate Professor of International Economics and Economics of European Integration, University of L’Aquila, and Associate member of the Inter-department Centre of International Economics of the University of Rome ‘La Sapienza’. Robert Lloyd, Accountability Project Officer, One World Trust, London . Rodrigo Tavares, PhD candidate, Department of Peace and Development Research (PADRIGU), Göteborg University . Ann-Christin Raschdorf, Political Affairs Officer, Office of the Special Representative for Sierra Leone, UNAMSIL. Michael Schulz, Senior Lecturer, Department of Peace and Development Research, and Director, Centre for Middle Eastern Studies, Göteborg University .

xvi Contributors Sébastien Jean, Senior Economist, OECD Economics Department ; External Fellow, Leverhulme Centre for Research on Globalisation and Economic Policy, University of Nottingham; and Managing Editor of Economie Internationale. Deniz Ünal-Kesenci, Economist, Centre d’Études Prospectives et d’Informations Internationales (CEPII), Paris and associated with the network of the Forum of Euro-Mediterranean Economic Institutes (FEMISE) and with the Groningen Growth and Development Centre (GGDC). Luk Van Langenhove, Director of the Comparative Regional Integration Studies Programme of the United Nations University (UNU-CRIS), Bruges and Professor at the Vrije Universiteit Brussel (VUB) . Stephen Woolcock, Associate Research Fellow, UNU-CRIS , and Lecturer in International Relations and Coordinator of the Trade Policy Unit, London School of Economics (LSE), London . Jennifer Pédussel Wu, Senior Fellow, Zentrum für Europeische Integrationsforschung – Center for European Integration Studies (ZEIb), Bonn .

Acknowledgements

This book arose from papers presented in the context of a Virtual Workshop on Indicators of Regional Integration that took place in 2003–2004 and was convened by UNU-CRIS, and in which academics and practitioners from all over the world participated. Monitoring and assessing regional integration processes is one of the research priorities of UNU-CRIS (see www.cris.unu.edu). We wish to thank all those that participated in the workshop, many of them being co-authors of this book, and those that joined the book project later. We are grateful to Luk Van Langenhove, Director of UNU-CRIS for his support, and to Kim Reynvoet and Eveline Snauwaert for their outstanding job in formatting the manuscript. We are also indebted to Heidi Bagtazo, Grace McInnes, Harriet Brinton and staff of Routledge, Kelly Hallett, Andrea Platts, Emma Wood, Jackie Mills and last, but not least, series editor Professor Richard Higgott from Warwick University. Philippe De Lombaerde Bruges

Introduction and summary Philippe De Lombaerde

Without any doubt, regional integration will continue to be one of the driving forces that will shape the world polity and economy in the years to come. Regional integration is thereby understood as covering a variety of forms and modalities. From a governance point of view, scholars are now focusing on the present and future role that the (macro-)regional level might play in a complex multilevel governance context. Both theoretical approaches and real world cases show that the regional level is likely to maintain and probably increase its importance in the global governance architecture. There is not necessarily a consensus, however, about certain causalities or tendencies. It is not clear, for example, whether regional economic integration contributes or not to multilateral economic governance, whether the regional level is an optimal level for the provision of certain public goods, whether regionalism contributes or not to regional and global political stability, whether it contributes to the alleviation of underdevelopment and poverty, whether it contributes to ‘good’ and democratic governance, whether interregionalism will become more and more important in international relations, etc. In order to find answers to these types of questions, scholars need to have good data at their disposal and a good understanding of the dynamics and mechanics of regional integration processes. All too often facts and trends are taken for granted and not scientifically verified. New theories or theoretical ideas do not always have a solid empirical basis. On the other hand, policy-makers, regional leadership and civil society do not always have the necessary monitoring tools at their disposal to follow up these processes, define their political positions and propose and design policies and measures. This book aims to contribute to the advancement of assessment and measurement tools for monitoring regional integration processes in the world. The starting points (working hypotheses) of this joint effort include the following: • •

regional integration processes are complex and multidimensional phenomena and therefore require a multidisciplinary approach, regional integration processes are heterogeneous and cannot be modelled in a unique way,

2 Philippe De Lombaerde • •

monitoring of regional integration requires a combination of quantitative indicators and qualitative assessments, monitoring can increase democratic participation and therefore improve the quality of policy-making in the context of the regional integration processes.

The book explores the methodological problems involved in designing monitoring tools for regional integration in a systematic way and makes a number of concrete suggestions for designing and organising systems of indicators of regional integration. It also offers a critical overview of available indicators and tools and presents some new monitoring instruments. The book is organised in three parts. In the first part, general theoretical and methodological aspects of building indicator systems are discussed. The second part focuses on the measurement of regional economic integration and interdependence. And, finally, the third part explores the possibilities for monitoring political integration, regional governance and peace.

PART I Chapter 1 explores the panorama of conceptual, methodological and organisational issues that arise in the process of constructing a multidimensional system of indicators for regional integration processes. De Lombaerde and Van Langenhove also present a proposal for the classification of regional integration variables and indicators for reference, comparison and design purposes. The authors end with a check-list of issues that should be addressed when building indicator systems. Van Langenhove, in Chapter 2, argues that next to quantitative data, studying regional integration also needs empirically based qualitative data and advocates that a qualitative monitoring and impact assessment method can be constructed upon the so-called ‘fourth generation evaluation’ model and that such an approach allows to develop a participatory monitoring and assessment scheme able to demonstrate the ‘added value’ of regional integration. The argument in favour of qualitative assessments is taken further by Ann-Christin Raschdorf in Chapter 3, stressing that communicative indicators should be included and operationalised. Special attention is given to procedural indicators for communicative participation and empowerment.

PART II Iapadre, in Chapter 4, presents a critical survey of the available statistical indicators for the measurement of intra-regional trade intensity, as well as some proposals in order to overcome their limitations (such as the symmetrical trade-introversion index). He further discusses some indicators that can be obtained by combining trade and GDP data, aimed at measuring the trade-creating effects of regional

Introduction and summary 3 integration. The indicators that are presented are then applied to the analysis of intra-regional trade within four regional integration agreements (ASEAN, EU, Mercosur and NAFTA). From this application, it becomes clear that the empirical assessment of intra-regional trade is strongly influenced by the choice of the statistical instrument used to measure its importance. When assessing and interpreting the dynamics of trade integration, this should be borne in mind. In order to evaluate whether trade within a given region is more intense than elsewhere, Gaulier, Jean and Ünal-Kesenci (Chapter 5) first look at the ‘normal’ level of trade between partners (and, in particular, neighbours), and its ‘normal’ evolution across time. The authors argue in favour of controlling for country-pair fixed effects in the estimations when assessing the impact of regional trade arrangements (RTAs) on trade flows. They first consider different indexes to assess the regionalisation of international trade and then go on to study these observed patterns using a gravity model based on a global data set. They find that the distorting impact of RTAs on the geographical polarisation of member countries’ foreign trade appears to be far more limited than the one based on OLS estimations. The impact of regional agreements is clear as far as Western Europe or Mercosur are concerned. In many cases, however, causality is not straightforward. The aim of Woolcock’s chapter (Chapter 6) is to present an analytical framework for making qualitative assessments of the impact of RTAs. It argues that the current wave of preferential agreements necessitates augmenting the existing theoretical and analytical frameworks. The rulemaking (or deeper integration) that is involved in the new wave of preferential agreements necessitates the study of the detailed content of the agreements, which has been eschewed by many of the more model-based approaches to assessing RTAs. Furthermore, as rulemaking invariably touches on ‘governance’ issues in that trade or investment rules limit domestic regulatory autonomy, there is a need to be able to more easily identify how regional or free trade agreements impinge upon domestic regulatory policy autonomy. The chapter provides a taxonomy of the key elements of trade and investment agreements that is applicable to most issues covered by RTAs and all aspects of rulemaking, in order to facilitate more effective comparisons of RTAs, both across regions and with the multilateral level. De Lombaerde and Costea (Chapter 7), present an overview of the conceptual framework offered by fiscal federalism theory and the technical tools which have been designed to analyse (fiscal) decentralisation processes. They then go on to explore how these tools could be adapted in order to be used for the monitoring and comparative analysis of regional integration processes and, more specifically, how fiscal integration indicators could be designed. The authors present a preliminary discussion of the specific methodological and practical issues and problems that can be envisaged in doing so. Villaverde, in Chapter 8, deals with the measurement of economic convergence or divergence, a much and growingly debated issue at the regional level in Europe and elsewhere. The focus of the chapter is with real convergence; that is, with the long-term process of reducing inequalities across economies. The chapter not only explores the σ-convergence and β-convergence approaches, but also examines

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4 Philippe De Lombaerde other less standard concepts like convergence as reduction of inequality, stochastic (or time-series) convergence, dynamics distribution convergence and spatial analysis convergence, and how to measure these. Wu’s chapter (Chapter 9), provides a more complete empirical test to identify factors contributing to different levels of participation in regional integration agreements (RIAs). Using the level of regional integration as the dependent variable, a probit model is developed and tested. The author argues that data on regional integration have not been previously gathered in a systematic manner. Therefore, a database of regional integration is developed which ranks the levels of integration across countries. The main conclusions of the chapter are, first, that high-income, democratic countries with high populations who are landlocked and are not islands are more likely to belong to deeper levels of regional integration; and, second, that only trade uncertainty, and not other forms of economic and/or political uncertainty, appears to be of any significance to explain the chosen level of regional integration.

PART III The aim of Best’s chapter (Chapter 10) is to explore whether regional systems can be assessed according to common ‘indicators’ of (good) regional governance. It is argued that regional systems do need to be evaluated in terms of their democratic (i.e. ‘good-governance’) quality and that such an exercise is plausible. The question which is addressed is whether one can evaluate the quality of regional institutional arrangements, in those cases where an integration process produces a regional system of significant multilevel governance. It is argued that – beyond the basic operating standards, and assuming that the regional organisation does not constitute a negative impact on good governance within countries – the quality of a particular set of regional arrangements can be evaluated in terms of stability and legitimacy. A set of basic principles is suggested by which regional bodies and systems can be assessed: openness, accountability, participation, effectiveness and appropriateness. In the next chapter (Chapter 11), Blagescu and Lloyd further develop the concept of accountability within a multilevel governance setting. They challenge the traditional approaches to accountability and note that, in thinking about regional accountability, the focus should not lie with inter-state institutions alone; non-state actors such as transnational corporations (TNCs) and international non-governmental organisations (NGOs) have considerable impact on regional and global organisations as well. In this regard, it is argued that the lack of accountability among regional institutions cannot be amended solely through state-based accountability systems but that new approaches to accountability need to be developed. Any indicators will need to try to capture the multifaceted and multilevel understanding of accountability. In the final chapter (Chapter 12), Tavares and Schulz concentrate on the phenomenon of regionalism and its contribution to intra- and extra-regional peace

Introduction and summary 5 building by suggesting some (quantitative and qualitative) measures of regional integration, regional peace and regional intervention. After a conceptual discussion on regionalism and regionalisation and on their linkages with peace and conflict, they offer some considerations about what to measure and how to operationalise the impacts of regional organisations on the variable peace. They propose indicators that can cover how regions cope with open conflicts; these relate to regional integration, regional peace, as well as to interventions. Tavares and Schulz argue that the regional peace dividend cannot merely be quantitatively measured but must also include some qualitative evaluations concerning the way regional interventions are related to time, scope and goal.

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Part I

General theoretical and methodological aspects

1

Indicators of regional integration: conceptual and methodological aspects Philippe De Lombaerde and Luk Van Langenhove1

INTRODUCTION Regional integration (RI) refers to processes of complex social transformations characterised by the intensification of relations between independent sovereign states. It creates new forms of organisation, co-existing with traditional forms of state-led governance at the national level. The processes of regional integration that emerged after the Second World War, were originally mostly about trade and economics, but it has become clear that, especially since the 1980s, with the so-called ‘new regionalism’ wave, regional integration can be seen as a multidimensional process that implies, next to economic cooperation, also dimensions of politics, diplomacy, security, culture, etc.2 Trade and economic integration remain a central aspect of ongoing integration schemes. And in today’s globalising world, there seems to be a growing tension between the quest for global free trade (as managed through the WTO) and the fact that trade liberalisation is more often regionally than multilaterally organised. Indeed, the number of regional integration initiatives is steadily increasing. About 250 RTAs are currently in force (Gavin and Van Langenhove, 2003). This trend raises the question of what the impact of regional integration is, both for the countries involved and for those excluded from a given regional integration scheme. Also, given the fact that the ‘new regionalism’ is said to have at least the potential to protect countries from possible negative aspects of globalisation (Van Langenhove, 2003), one can wonder how such claims can be assessed. However, these issues are linked to broader questions about the future of the international institutional and governance architecture, and whether tendencies may be expected in the direction of multilateralism, (multi-)regionalism or a (new) combination of both (Fratianni and Pattison, 2001; Hettne, 2005). Looking for answers to these questions implies that one needs to have tools to monitor regional integration and assess its impacts. This could be realised through a system of indicators of regional integration (SIRI). There is evidence of a growing interest of policy-makers for such a system. The explicit objective to monitor RI processes in ACP countries in the framework of the Cotonou Agreement (European Commission 2002a, 2002b) and the proposal by the

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10 Philippe De Lombaerde and Luk Van Langenhove European Central Bank (ECB) to measure institutional and economic integration (Dorrucci et al., 2002), illustrate this point. The Inter-American Development Bank is also considering as one of its priority actions within its Strategy on Regional Integration, ‘gathering, evaluation and dissemination of compatible data to measure progress in the regional integration effort’ (IADB, 2002), whereas ALADI planned the preparation of yearly reports on the evolution of integration in Latin America. Proposals for worldwide systems of indicators on other specific aspects of governance, like the database under construction for the Fiscal Decentralisation Indicators of the World Bank, also suggest the feasibility of such a system.3 And finally, the African economic integration indicators project at UNECA needs to be mentioned.4 Notwithstanding the above-mentioned interesting efforts, a SIRI able to monitor RI worldwide and based upon sound methodological premises does not exist yet. Hence, this chapter explores organisational, conceptual and methodological issues that arise in the process of constructing a SIRI. Also, a proposal regarding the dimensions and variables to be included in a SIRI will be advanced.

USERS AND PRODUCERS OF A SIRI A first issue to tackle is ‘who’ should and could be involved in constructing and operating a SIRI as well as ‘for whom’ a SIRI has to be developed. Ideally, the construction of a SIRI should not be seen exclusively as an academic project, but also as an exercise in building up a relevant policy instrument. The recent announcement by the European Commission (EC) of its intention to monitor the progress of regional integration schemes which involve ACP countries and to condition future resource allocation in terms of demonstrated progress in these processes, is a clear illustration of the scope and importance of such a system and the possibilities of combining an academic interest with political relevance. The announcement of the EC is a logical consequence of the inclusion of regional integration as a goal and means of development and development cooperation in the framework of the Cotonou Agreement.5 So, regional organisations are likely candidates for being involved in the construction of a SIRI. Not only because, as in the case of the EC, they want to monitor RI elsewhere but also because regional organisations want to engage in monitoring their own policies. One can also imagine that individual countries could be interested in a SIRI as a tool to monitor the impact of their involvement in regional trade agreements or other regional cooperation schemes on their domestic performances. There are also academic interests in developing a SIRI. For instance, to address the question to what extent regional integration initiatives can help in reducing the possible negative consequences of globalisation. Or: to what extent have regional integration initiatives positive effects on raising the quality of life in a developing region? The above implies that many different actors can, for different reasons, be interested in a SIRI.

Indicators of regional integration 11 For cost-efficiency reasons, but also for political reasons, it would be useful to pool resources for the construction of a SIRI. Three types of institutions would be natural candidates for participating in such a project: multilateral institutions (UN, WB, WTO), regional institutions and the academic sector. In addition, certain interest groups that are operating internationally (NGOs, foundations) could also be interested in participating. Designing and implementing a SIRI will only be successful if conceived as a joint product between ‘users’ and ‘producers’, taking into account input from all relevant stakeholders.

GENERAL CRITERIA FOR THE IMPLEMENTATION OF A SIRI Independently from the choice of overall objectives, dimensions and contents of the system, a whole range of problems are likely to occur at the moment of implementation. These problems range from the difficulty of measuring a specific variable and the quality of a particular data source to the problems related to managing and funding the system. Other problems relate to the availability, generation and frequency of the data needed to feed the system, and the management of a workable and sustainable system of indicators. Sustainability is likely to involve some degree of co-responsibility from the side of the data-generating institutions. The quality of the data is needed to guarantee comparability. A crucial issue will obviously be the translation of the chosen variables into indicators. Although each variable brings with it its specificities, some general criteria should be identified for selecting appropriate indicators. Especially when systems are multidimensional (multidisciplinary) it is useful to have some generally applicable criteria. Anderson (1991) has offered an example of an attempt to identify such criteria (see Table 1.1), but it should be noted that, although thought-provoking, these criteria were developed in the context of the national economy. If a SIRI is used for comparative research, as would be in the case of an indicator system for monitoring different regional integration processes in the world, a choice is possible between traditional (‘comparative’) indicators (permitting a direct comparison between regions on their score on a particular variable) and ‘relative’ (‘reflexive’) indicators (comparing first the performance of each region with its own objectives). The World Bank (2002), for example, favours relative comparisons. A concrete example of a case where both types of indicators are combined is the system of Indices of Economic Integration Effort in Africa (UNECA, 2001: 2). In that system two yardsticks are used: 1 2

the self-defined pre-determined targets for target-driven indicators (if they exist for particular integration groupings), or an average of the n best performers.

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12 Philippe De Lombaerde and Luk Van Langenhove Table 1.1 Anderson’s criteria for choosing ‘good’ economic indicators Criteria that SHOULD NOT be used

Criteria that SHOULD be used

1 An indicator should have to carry with it an automatic evaluation.

1 An indicator, or the information it is calculated from, should be already available, or else able to be made available easily and cheaply. 2 An indicator should be relatively easy to understand.

2 An indicator should have a policy instrument which corresponds to it. 3 An indicator has to be new. 4 Proposals for sets of indicators should be based on particular theories of economic, social and human development.

3 An indicator, to work at all, must be about something measurable. 4 An indicator should measure something believed to be important or significant in its own right, or should reflect or represent something important beyond what the indicator is itself a measurement of (for example, life expectancy figures might be used to indicate the general state of health of the population). This is really what makes something an indicator, rather than just a statistic. 5 There should preferably only be a short time-lag between the state of affairs referred to and the indicator becoming available. 6 An indicator should be based on information which can be used to compare different geographical areas, social groups, etc., so that a picture of distribution – and not just totals and averages – can be built up. 7 International comparability is desirable.

Source: Anderson (1991: 48–51).

Furthermore, designing an indicator system can be either conceived as an ordered presentation of the values of the selected relevant variables, permitting – for each variable – cross-country or cross-region comparisons and time series analysis, but without establishing explicit weights for the variables and their categories. Or, one can design the system so that it is based on the calculation of aggregate indicators per country, per region and/or per sector. This is when one is confronted with the so-called ‘index problem’. The weighting and aggregation procedures that are designed ‘pre-process’ the data so that the reading by the users is simplified, not necessarily its interpretation. The weighting procedure can be based on statistical criteria (based on the statistical contribution of the variables in the explanation of a goal variable), expert opinion or practical considerations (data availability, lack of knowledge or valid criteria, etc.). In any case, weighting procedures will always

Indicators of regional integration 13 be arbitrary to some extent. The World Bank (2002), for example, pointed to the problem of combining indicators applying to different topics or different regional arrangements, and suggests accompanying the quantitative data with qualitative assessments. Although it is attractive to combine both types of indicators, it would be helpful to have more clarity on the specific potential contribution of both and on the borderline between quantitative measurements and qualitative assessments. It should also be borne in mind that qualitative assessments are more difficult to implement (although not necessarily to interpret) in international and intercultural contexts than quantitative ones.6 Another choice that has to be made is whether the system should confine itself to descriptive measurements of observable variables or whether a combination is needed of such measurements with analytical information and estimations. The second option makes a SIRI richer for analysis but one is then confronted with the problems of non-standardised methods of analysis, difficulties with the data collection and the complexity involved in the interpretation of the information contained in the system.

CONCEPTS OF INTEGRATION A core issue in the development of a SIRI is the underlying definition of (regional) integration that will be used and how it will be operationalised into dimensions and variables. The concept of integration refers to a process in which units move from a condition of total or partial isolation towards a complete or partial unification. Applied to the interaction between independent sovereign states, integration refers to a process of large-scale territorial differentiation characterised by the progressive lowering of internal boundaries and the possible rising of new external boundaries. Such complex social transformation may or may not imply some kind of permanent institutional structure. Although integration at the level of states can refer to many different aspects of cooperation, it is mostly used in a context of economics and international trade. Integration then becomes economic integration and can be defined as ‘the voluntary linking in the economic domain of two or more formerly independent states to the extent that authority over key areas of domestic regulation and policy is shifted to the supranational level’ (Mattli, 1999: 41). The assessment of ‘levels of integration’ has led to the use of typologies, like in the case of Balassa’s stages approach. Although these typologies are attractive and allow the classification of countries and regions, it should be clear that in empirical research the first problem is to position the countries or regions in a continuous multidimensional ‘space’ which can then (ex post) be ‘compartmentalised’, more or less successfully. Obviously, no unique definition of integration is available in the literature, so that here too important choices need to be made. The designers of a SIRI (from the academic world or from policy institutions), will have to make these choices as a necessary precondition for the construction of the system. The definition of

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14 Philippe De Lombaerde and Luk Van Langenhove integration will almost necessarily imply that other related concepts will have to be defined also. These include, for example, cooperation and coordination.7 It should be stressed that the delimitation of the concept of integration and the scope of the information system is not an exclusively academic exercise. Ultimately, the builders and users of the system will have to make the key decisions on the basis also of political and practical considerations. Therefore the discussion below is limited only to giving some orientations for the definition of the concept and will not present a particular and exclusive definition yet. Often, regional integration is presented as a location in a spectrum of forms of interaction between states. In Dobson’s spectrum, for example (Figure 1.1), integration is presented as the most intense form of inter-state interaction, involving common policies among states (Dobson, 1991). This way of presenting the phenomenon of integration has the advantage of showing how it is positioned visà-vis other forms of interaction, but does not necessarily clarify when cooperation becomes integration.8 In this framework, integration is opposed to conflict, and independence occupies a central place. However, one might argue that both conflict and integration imply interaction, so that interaction (voluntary or non-voluntary merger, in its extreme appearance) should rather be opposed to independence; conflict and integration being (negative and positive) expressions of interaction (Figure 1.2).9 For Greif (1997), integration has to be seen as the opposite of segregation. COOPERATION

CONFLICT

INDEPENDENCE

COORDINATION

INTEGRATION

Figure 1.1 Dobson’s ‘Policy Conflict–Independence–Integration’ spectrum Source: Dobson (1991: 3).

INTERACTION

INDEPENDENCE

POS.

NEG.

Figure 1.2 The independence–interaction spectrum

MERGER

Indicators of regional integration 15 The problem of delimiting the phenomenon exactly also has to do with the fact that integration itself is usually presented as a process with changing characteristics. It has long been established that integration can refer to both ‘states’ and ‘processes’ (Balassa, 1961: 1), but all the implications of this for the construction of a SIRI should be analysed. Because of the nature of the phenomenon, a SIRI should be able to monitor the process. It should not be forgotten, however, that within the integration processes there are significant qualitative steps, breakpoints, accelerations or crises that deserve to be addressed. Around these crucial ‘moments’ within the process, evaluations of the type ‘before/after’, as suggested by the static view of integration, are possible and useful. A SIRI should also be sufficiently flexible to consider processes that are characterised by a tendency towards integration, but allowing for phases of stagnation or even temporary disintegration. Another issue consists of the duality between ‘formal’ and ‘informal’, or ‘real’, integration. In Ondarts’ typology (Ondarts, 1992: 6), ‘real’ is opposed to ‘formal’ or ‘institutionalised’, meaning ‘based on formal agreements and discourses’; it is not opposed to ‘monetary’ or ‘financial’ like in international economics.10 Formal and real integration can be thought of as two parallel processes which are relatively autonomous, the first does not necessarily imply the second, nor vice versa. Formal integration will be usually state-led, while the so-called real integration can be occurring without much interference from states. We are not inclined to use the term ‘real integration’. In a way, it suggests that formal, institutionalised integration is necessarily an ‘empty box’, which in reality is not or only partly the case. There is at least an effect on the political debate, vocabulary and leadership, and on the collective consciousness and imagination; but usually it goes much further than that. The concept of interdependence is related to what is meant by ‘real’ integration. According to Cooper (1985), interdependence should be understood as a special case of ‘openness’. Openness becomes interdependence when the entity (country) under consideration suffers the feedback effects of the consequences of its own policies for the rest of the world or region. It is more than ‘mutual’ dependence, a situation whereby two entities (countries) have two-way economic relations and whereby an economic cost would occur if these relations should cease to exist. Whereas mutual dependence depends normally on the transaction volumes, interdependence would rather refer to marginal dependence from (two-way) economic relations (Cooper, 1985: 1198).11 Interdependence is likely to become a more relevant concept for small countries in a regional rather than in a global context. One should be aware, however, that formal/institutionalised integration can also have a direct impact on interdependence, through the creation of supranational policy institutions. In the research programme on the so-called ‘new regionalism’ (Hettne, 1999) and the literature on growth circles (Thant et al., 1994), real integration is also emphasised. It reminds us also that integration should not necessarily be seen as a form of inter-state interaction, but that the geo-political actors involved might well

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16 Philippe De Lombaerde and Luk Van Langenhove be sub-national (regional) actors.12 A SIRI that is able to monitor such different modalities of integration would be superior to one that is not. However, in order to avoid a SIRI becoming too abstract and irrelevant, the system will have to be restricted to regions that have been institutionalised, albeit in a minimal way, or at least explicitly recognised as such by relevant actors (public authorities, political movements, business communities, international community, etc.). In this regard, one can refer to the different levels of ‘regionness’ as identified by Hettne and Söderbaum (2000) and determine a minimum level of regionness necessary to qualify for the application of a SIRI, provided that this concept can be satisfactorily operationalised. A mechanical identification of ‘real regions’, based on indicators of interdependence and homogeneity, is probably not a sound basis for the selection of the regions in the system, as the system would be less policy-relevant and some of these regions might lack sense, politically speaking. However, one should be aware of the possibility that in top-down approaches to micro-regions used by certain international organisations, institutional recognition might follow a more or less mechanical identification of the region. For example, in the case of growth triangles, we have the impression that this is not uncommon. In these cases, an ex post justification in terms of historical relations (and what does history not prove?), cultural proximity, etc. is usually not too difficult either.13 Indicators in a SIRI should also (be restricted to) reflect the specific characteristics of the integration process. Variables that describe characteristics of the countries involved should not necessarily be included although they could be part of a background information section in the same system. There is, however, a large grey zone consisting of variables that are, as such, purely national indicators but that can easily be transformed into indicators of convergence/divergence.14 Another group of variables that are in a grey zone, are those belonging to political economy approaches to integration, such as underlying motivations of integration processes,15 role of interest groups, permeability and degree of corruption of regional institutions, etc. Without understanding the underlying motivations of a regional integration effort, it is difficult to evaluate. For example, it would obviously be incorrect to judge the success or failure of pre-AFTA ASEAN on the basis of purely economic criteria. Finally, a SIRI should be capable of reflecting expressions of both ‘positive’ and ‘negative’ integration (Tinbergen, 1954). ‘Negative’ integration refers to the elimination of barriers; ‘positive’ integration refers to the formulation of common policies. It is possible to frame this distinction in a time dimension. Low levels of integrative ambition (Best, 1997) usually imply negative integration, whereas high levels of integrative ambition usually imply positive integration. Best (1997: 56) rightly points out, however, that it is difficult to conceive negative integration without a minimum amount of positive measures. Integration should be seen as a varying mixture of both types of measures.

Indicators of regional integration 17 THE ROLE OF THEORY AND THE NORMATIVE AND EURO-CENTRED TRADITION IN INTEGRATION STUDIES Accepting a workable definition of regional integration allows the scope of a SIRI to be delineated but it needs to be complemented by choices regarding the theoretical framework used. Decisions on whether or not to include specific variables into a SIRI will also be dependent on the theoretical affinities of the SIRI producers. Although it would be tempting to regard the availability of data as the first criteria, this should be avoided and theory should obviously be the major guiding principle for including variables. A theoretical framework is also needed to decide on how to structure the variables and analyse them. An example of the link between theory and the selection of indicators of regional integration is the ECB proposal to measure economic integration (Dorrucci et al., 2002). In this case, the authors base the choice of indicators of economic integration, and not only monetary integration, on optimum currency area theory (see p. 22). Integration is a multidimensional social phenomenon and its study has generally been undertaken along disciplinary lines. That partly explains why various (sometimes complementary, sometimes competing) theories exist. Our recommendation to give the SIRI a theoretical basis, does not mean that the system should be limited to the variables that constitute a particular theoretical model of integration but rather that the incorporation of each of the variables should be based on a structured and scientific argument. The existence of a variety of theories should not be an obstacle for the construction of a SIRI; eclecticism is inherent to scientific activity. In addition, we agree with Anderson that it might be a sufficient condition for selecting an indicator to be perceived as important by the community of users of the system, without necessarily having a particular theory that corroborates this. In this context it should also be noted that theories about regional integration are not developed in abstracto but are linked to what is happening in the world. As the research on the Single Market, transition issues, the EMU and EU enlargement very well illustrate, the development of integration studies has gone hand in hand with political developments, especially in post-Second World War Europe, and is very much a response to the signals emitted by the political centres and actors. That explains the normative tradition in integration studies (Bekemans et al., 2000: 55–7). The problem with normative theory is that the evaluation of the facts (actions, decisions, effects) is reduced to a mechanical application of the model labelling them as positive or negative, progress or decline, functional or dysfunctional, etc. The stages approach to economic integration, attributed to Balassa (1961), for example, has been extremely influential in academia and lends itself very well to a measurement of ‘progress’ of a particular integration scheme. Those who are familiar with regional integration issues know, however, that one has to be very prudent in applying this kind of theoretical scheme mechanically; all too often they are confused with general laws governing integration processes. In the real world, simultaneity, inversion and endogeneity is not uncommon. The ECB (Dorrucci et al., 2002) has shown, however, that Balassa’s scheme is perhaps flexible enough

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18 Philippe De Lombaerde and Luk Van Langenhove to be used in the presence of these phenomena. In other words, using an open and flexible theoretical framework is one of the preconditions of a SIRI with wide applicability. It should be further stressed that qualifying variables as theoretically relevant does not imply that the direction of any causal linkages with other variables can be easily established. In many cases there will be uncertainty about the causality and its direction, in some cases there might be a ‘double’ causality and/or feedback effects. The variables under consideration are part of a complex social system (with simultaneities and chaotic processes) in which causality often becomes difficult to trace or even irrelevant as it will be the social meaning that will be essential. Best (1997) has rightly pointed to some of these problematic relationships between certain variables in terms of the causal links between them and their direction. For example, although Olson’s Logic of Collective Action would suggest a positive relation between the number of countries involved and the difficulties encountered in the decision-making process (Olson, 1965), the real effects of the number of countries also depends on the characteristics of the individual countries and the design of the decision-making process. Majority voting might well have the opposite effect. Best also mentions some other theoretically problematic relationships, including the following: the relation between the scope of coverage of an integration agreement and its stability, the relation between the time perspective of an arrangement and its stability, and the relation between the degree of real interdependence and the degree of formal integration. Another (theoretically) problematic relationship is the one between, on the one hand, the degree of structural asymmetries between the members of an integration arrangement, and the stability and impact on economic development of the agreement, on the other.16 Again, using Olson’s logic, integration processes built on asymmetric groups where a leading (hegemonic) country perceives enough benefits to justify the provision of the collective good (the integration agreement) would be expected to be the more dynamic and effective ones. 17 This idea can be seen as a regional application and implication of hegemonic stability theory (Keohane, 1980; Kindleberger, 1981; Gilpin, 1987). In a context of developing countries, the World Bank also defends asymmetric integration agreements (Collier et al., 2000). However, Stakhovitch (1991), for example, questioned this thesis on empirical grounds.

METHODOLOGICAL AND ORGANISATIONAL OPTIONS RELATED TO THE CONSTRUCTION OF A SIRI Next to preciseness in the concepts used and explicitness in the underlying theoretical adherences, one needs to make a number of methodological and organisational decisions in order to further design a SIRI. This will include choosing between specific or general SIRIs and between the use of area versus country indicators.

Indicators of regional integration 19 Systems can be more or less specific, meaning that they can cover one, a few or many aspects of integration, or that they intend to monitor specific sectors (transport, commerce, agriculture, etc.). Proposals have been made, for example, to design indicator systems for the evaluation of the public-management capacities for regional integration among groups of countries (Best, 1997), or for the measurement of the economic integration effort in Africa (UNECA 2001, 2002). On the infra-national level, the World Bank designed a system of fiscal decentralisation indicators (World Bank, sd). The builders of a SIRI will also have to decide upon the relevant level(s) of analysis. A system can be built to monitor the dynamics of a group of (integrating) countries or regions, or it can be built to monitor the participation of individual countries/regions in the integration schemes (individualised effects, policy implementation, etc.). An interesting attempt to build a multilevel SIRI is the indicator project of UNECA (2001) where indices are being estimated on four levels: 1 2 3 4

the country level, the regional level, the sectoral level, and the continental level.

A particular and related problem is that many countries, all over the world, are simultaneously a member of more than one integration arrangement. The African case illustrates this very well (Table 1.2). Currently 45 countries out of 53 are simultaneously members of (at least) three regional integration arrangements. One country (DR Congo) is even a member of four arrangements but, paradoxically, it is not known as a particularly active actor in African regional integration. In these cases of overlapping memberships, it might be difficult to separate the effects of different integration agreements. In addition, it is often the case that the different agreements have similar orientations and that RIAs that involve WTO members, are generally WTO compatible. Table 1.2 Overlapping memberships of integration arrangements for African countries Category

Number of memberships of integration arrangements per country

Number of countries per category

1 2 3 4 5 Total

0 1 2 3 4

0 7 27 18 1a 53

Source: UNECA (2002). Notes a DR Congo.

20 Philippe De Lombaerde and Luk Van Langenhove Considering indicators at the country or the group level has political implications. As observed by the World Bank (2002), the evaluation of a regional arrangement, especially when it involves ‘rewards’ or ‘sanctions’ from the international community (as in the case of the Regional Cooperation Review Process (RCRP)), should be able to handle asymmetries within the groupings, such as passive or obstructive behaviour by one or a minority of members. This, in turn, can be caused by different factors, such as the occurrence of a conflict in one or more member countries or diverging policy preferences between the coalitions in power in different member countries. In the case of the Cotonou Agreement and the RCRP, the identification of the region as a relevant policy level is imposed from outside and is embodied in the regional strategy papers. Finally it should be noted that the evaluation of integration policies and their implementation is an essential part of any SIRI. This requires the incorporation of indicators of policy implementation and effects of regional integration. Again, this brings with it several problems. •

•

•

The useful distinction between positive and negative integration has been mentioned before, but one should be aware that positive integration might suggest more ‘policy effort’ and be captured as such by many indicators, although nothing assures ex ante that these measures have more important effects than negative integration. It is a well-known characteristic of empirical research that the observers tend to show a higher sensitivity for observations that tend to confirm the hypothesis or the existence of what is sought. As far as indicators of integration policies are concerned, the registration of policies and measures might offer a biased view in the sense that simultaneous policies (possibly in other policy areas) in the other direction (revealing disintegration, protectionism, nationalism, etc.) might or might not yield a net progress. This is even more so because integration policies tend to be common policies, whereas disintegration policies (protectionist reactions) tend to be national. Theoretically, ideal indicators would be net indicators, showing whether a given set of policies and measures taken during a period of time do or do not contribute to integration. However, these kinds of indicators are difficult to construct. In its discussion of the UNECA methodology, the COMESA Secretariat expressed strong reservations over the methodology used, precisely for the reason that the UNECA indicators do not necessarily reflect the effects of programmes being undertaken by regional organisations (COMESA, 2002: 6). As an example, COMESA criticised the ranking of SADC and ECOWAS as the most successful regional organisations. According to COMESA, these rankings simply reflect the presence of a member with a large economy in each case (South Africa and Nigeria, respectively). One should therefore carefully distinguish between structural characteristics of countries and regional groupings, on the one hand, and integration policies, on the other hand.

Indicators of regional integration 21 DIMENSIONS AND CATEGORIES OF VARIABLES Once the coverage and limits of a SIRI are established, its variables should be organised systematically. As the multidimensional character of the phenomenon is obvious, the variables could be organised according to disciplinary fields (political, social, cultural, economic, etc.), and/or policy areas (trade, investment, migration, competition, agriculture, industry, infrastructure, legal cooperation, etc.). The latter could be called the traditional sectoral approach to integration. A third way of classifying the variables consists of a classification on a functional basis, as in the input–output approach. Integration is then implicitly seen as a process where some variables act as inputs, some as outputs, while others characterise the process. The advantage of this approach is the emphasis on the output (effects) of integration; from a welfare and development point of view, that is what it is all about. The assessment of the developmental impact of regional integration processes and policies could be carried out by incorporating regional development and (social) spending indicators in the SIRI.18 However, one should be cautious in classifying variables along these lines. Double causalities and systemic relationships are more often the rule than the exception. Whereas, the World Bank (2002) stresses the importance of incorporating in a SIRI indicators that assess the long-term economic impact of regional integration or cooperation, such as indicators about cross-border movements of people, capital, information and goods and services, the European Commission (2002b) favours indicators of inputs and efforts. This brings us to the fact that there exist a number of proposals on how to classify the variables. These include the proposals respectively made by DG Development of the European Commission, UNECA and ECB. DG Development proposed the classification of the indicators of the foreseen indicator system for monitoring economic integration in the ACP countries in the following broad categories: • • • •

regional economic cooperation, functional regional cooperation, governance, financial issues and functioning of institutions, implementation of EDF projects and programmes.

A more detailed description of this proposal is shown in Appendix 1.1. UNECA (2001, 2002) considers eight ‘clusters of activity’ to classify the variables and indicators. These are: 1 2 3 4 5 6

trade and market integration, monetary, fiscal and financial integration, transport, communications, industry, energy,

22 Philippe De Lombaerde and Luk Van Langenhove 7 8

food and agriculture, and human development and labour markets.

ECB distinguishes between institutional and economic integration (Dorrucci et al., 2002). The former is evaluated on the basis of the implementation of decisions in four dimensions, based on Balassa’s stages approach to integration: 1 2 3 4

free trade area/customs union, common market, economic union, total economic integration.19 Within the latter category, seven subcategories (and 11 variables) are considered:

i ii iii iv v vi vii

synchronisation of the business cycle, convergence of inflation rates, exchange rate variability, trade openness and integration, financial market integration, convergence of interest rates, income convergence.

As a response to DG Development’s proposal, the COMESA Secretariat launched a proposal for a system of indicators with an alternative design (Appendix 1.2). The philosophy of that proposal is different in the sense that inter-regional comparisons are not the main focus, but rather the monitoring of their own integration process. COMESA considers 12 categories of variables: 1 2 3 4 5 6 7 8 9 10 11 12

trade liberalisation, trade facilitation, trade in services, transit facilitation, monetary convergence, domestic payments and settlement systems, fiscal environment, government intervention in the economy, capital flows and foreign investment, governance issues, regulatory environment, licensing requirements.

Related to the question on how to organise the variables in a SIRI, is the question on whether and how to integrate the preconditions for regional integration, or ‘forward-looking’ variables, in the system. In the literature, several attempts can be found to measure the potentiality (feasibility and effects) of future integration

Indicators of regional integration 23 agreements. In the economists’ jargon they are referred to as ex ante studies. Of special interest for us are those attempts that permit comparison and those that are also relevant for monitoring purposes. The conception of integration as a phased process, as suggested above, allows of course to consider many ‘befores and afters’ within the same process, so that ex ante studies and methods are not necessarily without relevance for our purpose (Figure 1.3). The ex ante/ex post approach can be linked easily to the input–output typology of variables, mentioned above. The following can be considered as ‘inputs’: structural characteristics of the integrating area (number of countries, shared borders, etc.), asymmetries, capacities to integrate, commitments, governance structure, overlapping memberships, etc. The following could be considered as ‘outputs’: policy implementation, effects on flows, effects on growth, etc. A special category of inputs could be called preconditions for integration. Although originally intended to assess (ex ante) the possibilities and potential of (future) integration agreements, the variables involved can also be used in a dynamic manner to evaluate the compatibility of the formal integration process with the preconditions. In addition, these preconditions are not static, they are often endogenous because of feedback effects of the integration process. Well known are the ex ante trade analyses that estimate the foreseeable effect of new regional trade agreements on trade flows and welfare. These include the estimates of trade creation and trade diversion, 20 the identification of ‘natural markets’ (Krugman, 1991; Kreinin and Plummer, 1994), the tests of regionalisation of international trade and the capacity to trade of individual countries (Freudenberg et al., 1998a, 1998b), among others. However, ex ante studies have not been limited to trade issues. Best (1997), for example, analysed the public-management capacities for regional integration. Best’s starting-point is the difficulty (for his purpose) that integration is not a homogeneous phenomenon, that its contents and orientations change over time, and that its (theoretical) finality is not pre-established since it is impossible to identify the ‘optimal’ policy levels. In order to be practical, Best considers ‘levels of integrative ambition’; he implicitly refers hereby to formally expressed models of integration that are aimed at by a group of countries (Best, 1997: 54–5). He proposes to use Pelkmans’ detailed taxonomy to classify the levels of integrative ambition (Pelkmans, 1993), although he is aware that actual integration processes M1

M2

M3

PRECONDITIONS

TIME PRECONDITIONS PRECONDITIONS

Mi: critical moments in integration process

Figure 1.3 Preconditions in phased integration processes

24 Philippe De Lombaerde and Luk Van Langenhove are not always exact copies of the (text book) models and that the suggested sequence of these models is not always respected. In Pelkmans’ taxonomy, we find the traditional Balassa-type (text book) stages of economic integration, but each level is broken down in more specific arrangements. Preferentialism is differentiated into partial sectorial preferentialism, sectorial integration, non-reciprocal preferential systems, and reciprocal partial preferentialism; free trade areas are differentiated according to whether they cover all industry or all sectors; customs unions are broken down into various stages of product market integration; and common markets and economic and monetary unions are also broken down in stages. Best stresses that a combination is needed of the identification of governing needs, on the one hand, and the identification of governing capacities, on the other (Best, 1997: 56–9). He proposes as a first step ‘to evaluate the degree of difficulty posed for a particular group of countries, and for each participating administration, to deal effectively with a particular set of integration objectives at a given time’ (Best, 1997: 60). The author identified nine key variables that shape the complexity of the implementation of the integration objectives (Appendix 1.3).21 The variables are: 1 2 3 4 5 6 7 8 9

number of member states, relative sizes of the participating countries, different levels of development, scope of coverage, type of impact, time perspectives, degree of real interdependence, political framework, perceptions, values and norms.

Best does not present, however, a method or a scheme that links the complexity variables to a specific institutional arrangement or specific institutional changes. Rather, he considers the variables as input in a complex negotiation process. The outcome of this process is institutional readjustment. He stresses that almost every integration agreement has implications for public management, but that there is no linear relationship between integration and the centralisation of public administration. The discussion on the subsidiarity principle illustrates this. Horizontal cooperation and partnerships are often important components of the integration architecture.

DIMENSIONS AND CATEGORIES OF VARIABLES: A PROPOSAL Taking stock of the many issues and problems presented in the previous sections, a proposal for a conceptual framework that could serve as a basis for the

Indicators of regional integration 25 construction of a SIRI will now be presented. Or at least, it can be thought of as a check-list for selecting the variables that should be incorporated in the system. The framework explicitly recognises the multidimensional and dynamic character of regional integration and distinguishes between six categories of variables, which can easily be converted into six modules of a SIRI. The logical relationships between the categories of variables are shown in Figure 1.4 and explained briefly below. We consider the distinction between real and formal integration as not really appropriate; we prefer to consider parallel (but interconnected) processes of regional integration: institutional (more or less capturing what is usually called ‘formal’), political, economic, cultural, etc. The effects of integration policies and the evolution of regional interdependence will obviously have feedback effects for the institutionalisation process, thus conceptually restoring its endogenous character. We think that this is a workable way to classify the relevant variables into broad categories. Particular SIRIs will have to opt for some combination of variables of these categories. In Table 1.3, a proposition is made regarding which variables and/or sub-categories correspond to the different categories.

CAT. III: INSTITUTIONALISATION

CAT. I: ACTORS

CAT. II: STRUCTURAL FACTORS

CAT. IV: IMPLEMENTATION

FEEDBACK

CAT. V: EFFECTS

CAT. VI: INTERDEPENDENCE

ECONOMIC

POLITICAL

SECURITY

CULTURAL ETC.

TIME

Figure 1.4 Regional integration as a process: proposal for a conceptual framework

26 Philippe De Lombaerde and Luk Van Langenhove Table 1.3 Proposal for classifying variables in a SIRI Category

Sub-categories

I

Actors

Number of integration units involved (countries, regions, organisations, etc.) Number and quality of actors in the decision-making process Level of activity of the actors Actors’ opinions and perceptions (survey results) Overlapping memberships

II

Structural factors

Proximity of the actors (geographical, cultural, etc.) Structural complementarities Structural asymmetries Historical patterns of cooperation, integration and conflict

III Institutionalisation

Number of treaties and agreements Contents of treaties and agreements Time frames of treaties and agreements Institution building Arrangements on common policies and policy coordination Gradualism, exemptions and differential treatments

IV Implementation

Status of implementation of general treaties Status of implementation of specific agreements Degree of accomplishment of convergence criteria

V

Human development Economic growth Trade Migration Capital flows

Effects

VI Interdependence

Mobility of persons Political interdependence (existence of common policy variables, de facto coordination of policies, occurrence of conflicts, tensions, etc.) Economic interdependence (trade, capital flows, correlation of activity levels, symmetry of shocks, etc.) Information and knowledge flows

Actors and structural factors The categories of ‘Actors’ (cat. I) and their structural characteristics (‘Structural factors’) (cat. II), contain information about the basic building blocks of the integration effort. The category of ‘Actors’ refers to the number and type of actors involved and their behaviour.22 The number of countries or regions involved has a direct influence on the dynamics of the decision-making process, although that relationship is not straightforward and should be seen in combination with the issue of asymmetries (see above). From an administrative and political point of view, the number and character of the policy-making and implementing levels is also important.

Indicators of regional integration 27 The new forms of integration, sometimes called ‘new regionalism’, 23 have stressed the importance of considering the participation of different types of actors involved in the (real) integration processes. When the non-governmental actors are formally organised and linked to the formal integration process, then it is rather easy to identify and evaluate their participation, and incorporate this information in an indicators system. If it is not the case, then it will be more difficult to do so. Examples of formalised participation of non-governmental actors range from the Economic and Social Committee in the EU to the Private Sector Forum in the ZMM-GT (Slocum et al., 2003). It might be relevant to distinguish between primary (active?) and secondary (passive?) actors. The primary actors being persons, groups of persons and organisations that have an influence on the dynamics of the integration process; the secondary actors being all those that are affected by the process. Such secondary actors do not necessarily belong to the integrating region. The supranational actors might be seen as a third category, although they can be both a primary stakeholder or a secondary actor. In addition to their numbers, within each category of actors a list of attributes could be established to reflect their character and importance. The intensity of their involvement and their importance in the decision-making process could be evaluated through quantitative methods (number of meetings attended, financial contribution, etc.) or qualitative assessments (expert opinion). The category of ‘Structural factors’ (cat. II), includes all those variables that refer to structural characteristics of the integration grouping and of its members. They should logically be restricted to variables that are directly or indirectly related to the integration process. These variables might relate to the scale of the arrangement, the structure of the grouping and of each component, the nature of the components, etc. Proximity of the actors is obviously a relevant variable to evaluate the potential and sustainability of an integration grouping. Gravity type models of economic interaction have shown significant (negative) relationships between the intensity of economic relations between countries and their distance. 24 It has also been shown that proximity/distance is a typical multidimensional variable; physical, economic, political, cultural, linguistic and historical proximity are all relevant variables. As we mentioned before, structural asymmetries play an important role in integration processes although the direction of causalities is not clear. Its measurement can be based on variables of population, the economy, external relations, and so on.

Indicators of institutionalisation and policy implementation The actors involved in integration processes take steps (measures) that are supposed to contribute towards regional integration and the ‘Institutionalisation’ of the region and its integration effort (cat. III). These political decisions are implemented to some extent (‘Implementation’, cat. IV) and either do or do not

28 Philippe De Lombaerde and Luk Van Langenhove have certain impacts (‘Effects’, cat. V) in different areas (social, economic, cultural, etc.). Also relevant is the institutional basis on which the whole integration process rests (for example, constitution-based versus treaty-based integration processes); institutionalisation should thus be analysed on different levels. Obviously, institutional activity has quantitative (for example, number of treaties or ministerial meetings) and qualitative aspects (content of the treaties or decisions). Productivity measures might be applied to the institutional activity, thus linking policy outputs to their resource cost. The World Bank (2002) pointed to the problem that there might be discrepancies between (formal) objectives and the institutional set-up to achieve them. As a consequence, indicators that reflect institution building do not necessarily show progress towards reaching the integration goals. Although relevant, inconsistencies between expressions of formal integration might be difficult to assess. In our opinion, it is further useful to distinguish between policy implementation (at the regional or national level) and the assessment of the impact of implemented policies.

Effects Seen from the perspective of citizens and policy-makers, this should be the most important category of variables. But from the point of view of a designer of a SIRI, it is also the most problematic category to include in the system. This is related to the fact that it is difficult to isolate effects of integration from those of other phenomena. Integration is a complex and dynamic process not necessarily adequate for causal explanation. On top of that, for many aspects of integration, there are no comparable data sets or standardised research methodologies available.25 This is certainly true for the analysis of static effects of integration (directly linked to the reallocation of resources among sectors and countries), but even more so for the analysis of the dynamic effects of integration. Although researchers often concentrate on the short-term (static) effects of integration measures rather than on the dynamic ones, it should be stressed that the sign (direction) of the effects does not necessarily coincide, so that the former cannot necessarily be used as a proxy for the latter. In practice, it is often explicitly understood and accepted that short-term costs (transition costs) are the price to pay for reaping long-term benefits. Other aspects of monitoring the impact of regional integration policies are outlined below: First, as Devlin and Ffrench-Davis (1998) pointed out, the methodological problems related to counterfactual analysis are particularly important: • • • •

the more complex the studied process is, the longer the time period considered, the bigger the changes involved, and the more the analysis turns on exact magnitudes. Most of these items apply in the case of integration studies.

Indicators of regional integration 29 Second, the right balance has to be struck between quantitative indicators and qualitative assessments.26 Third, a distinction should be made between the strength and the type of impacts (Best 1997). Fourth, the existence of overlapping integration agreements (see above), often with convergent objectives, makes the identification of effects even more difficult. Devlin and Ffrench-Davis (1998) add that this phenomenon might also have a cost of its own in terms of reduced transparency and higher transaction costs. Fifth, the comparison of effects between countries does not allow for analysing the distribution of effects within member countries. Integration might well favour the agglomeration of activities within the countries, might preferentially favour border areas, might have an impact on the income distribution, etc. Finally, in developing countries, integration policies are often an integral part of more general structural adjustment and liberalisation policies, so that their specific effects cannot easily be established.

Indicators of interdependence ‘Effects’ of integration, together with structural conditions and exogenous influences, can explain the degree and evolution of ‘Interdependence’ between the regional actors (cat. VI). Effects are thus attributable to specific integration policies, whereas the degree of interdependence is autonomously measured and reflects the evolution of interdependence on different dimensions. Interdependence is used here as a substitute for what is often called ‘real’ or ‘de facto’ integration. Interdependence tries to capture the degree of ‘regionness’ of the region, or at least some aspects of it. Regionness is also a central concept in the new regionalism approach (Hettne, 1999; Hettne and Söderbaum, 2000). Interdependence can be assessed on different dimensions, such as economical, political, cultural, security and infrastructural. These dimensions coincide broadly with those considered in the proposal for a system of indicators of interconnectedness, made by Held and others in the framework of the Global Transformations project (Held et al. 1999).27 The following dimensions are being considered in that project: • • • • • • •

political-legal indicators, military indicators, economic indicators, migration indicators, culture indicators, environment indicators, global stratification.

Many of the indicators proposed could be transformed into indicators of regional interconnectedness.

30 Philippe De Lombaerde and Luk Van Langenhove The measurement of the degree of interdependence can be approximated via the measurement of the flows (of people, goods, capital, information, etc.) that are interconnecting the actors or via direct measurements of correlations of variables (for example, symmetries in business cycles, interest rate spreads, etc.). For the forms of interdependence that are more difficult to measure, like political interdependence, indirect measurements should be considered. The patterns of voting behaviour in multilateral organisations might, for example, be a possible indicator of regional policy convergence/divergence. Interdependence through trade flows is probably the most studied kind of interdependence. Its study is usually based on simple indicators such as the relative importance of intra-regional trade and its growth, which can easily be calculated. More sophisticated indicators are available, which correct the former for size effects in order to allow for methodologically sound inter-regional comparisons (Iapadre, 2000, 2001). The indicators of the degree of integration can be complemented with indicators of the direction and nature of commercial integration. This is particularly relevant from an analytical point of view. The composition of the flows induced by the integration process are good indicators of the underlying socio-economic changes that take place in the member countries. In the case of trade flows, for example, indicators of intra-industry trade and of the technological content of intra-regional trade28 can easily be calculated. A proposal for a combined set of indicators on (trade) regionalisation has been made by Bensidoun and Chevallier (1998) (Table 1.4). The fact that studies on regional trade flows are relatively abundant can be explained by trade data being relatively readily available, and of sufficient detail and good quality. This is much less frequently the case for data on capital flows, migration and flows of information. In the case of intra-regional migratory flows and stocks of immigrants, for example, although it is essential information, in many countries the quality of the data is insufficient or the data are lacking.29 The ex post analysis of the flows of (public) funds between national governments and the supranational institutions within a group of countries (a region) also permits an evaluation of the degree of their integration, provided that these flows reflect the actual level of organised solidarity, the importance of the supranational institutions, etc. The category of variables related to the budget in DG Development’s framework, for example, could easily be broadened to include indicators on the Table 1.4 Bensidoun and Chevallier’s indicators of regionalisation Indicators 1 2 3 4 5

Relative trade intensity index North’s share in South trade (or South’s share in North trade) Degree of currency anchor (relative volatility of the exchange rate) Intra-industry index (Aquino coefficient) Similarity of South–North trade with South–Rest of the World trade

Source: Bensidoun and Chevallier (1998).

Indicators of regional integration 31 composition of revenues and expenditures and on vertical (im)balances between the national and supra-national levels.30 The conceptual framework and indicator systems developed to monitor decentralisation processes from a fiscal perspective might be very helpful to structure a fiscal module of a SIRI. Appendix 1.4 shows the list of indicators incorporated in the system of fiscal decentralisation indicators of the World Bank (sd). Three categories are considered: 1 2 3

main indicators, composition of sub-national revenues and grants, composition of sub-national expenditures. Vertical imbalances could also be calculated on a sectoral basis.

CONCLUSIONS Adequate monitoring tools for regional integration processes would allow better (regional) policy design and implementation, better scrutiny and participation by all stakeholders and affected groups and individuals, as well as more in-depth academic analysis of these complex social transformation processes. The aim of this chapter was to explore the conceptual and methodological aspects related to building a system of indicators of regional integration (SIRI). We have tried to demonstrate that there are multiple and interconnected issues to be considered, and that choices need to be made, related to: • • • • • •

the kind of users and producers involved in its design, the underlying concepts and theories, the scope of the system and level(s) of analysis, the adequate selection and organisation of the variables, the balance between quantitative indicators and qualitative assessments, the ‘correct’ observation and construction of indicators.

Future attempts to implement monitoring tools for regional integration processes, launched at the regional, inter-regional or supranational levels, will require due consideration of these issues raised and answers to the questions posed. The attempts will only have a chance to succeed if conceptual, technical, political, institutional and organisational aspects are simultaneously addressed.

32 Philippe De Lombaerde and Luk Van Langenhove APPENDIX 1.1 DG Development’s proposal for a system of indicators to measure regional integration and cooperation performance Categories

Subcategories

Variables

Economic integration

Trade liberalisation policy

WTO compatibility of rules of customs valuation Quality of classification of goods Application of rules of origin Exemptions Phasing out of temporary measures Liberalisation of trade in services Importance of intra-regional trade

Other integration policies

Facilitation of investment Movement of persons Right of establishment Competition policy Creation and implementation of cohesion policy Improvement of comparable statistics Macroeconomic surveillance Trade facilitation measures

Transport

Progress towards a common transport policy Expenditure for maintenance of regional network Application of harmonised transit regulations

Maritime resources

Human and physical input for a common surveillance Human and physical input for a common evaluation of natural resources Enforcing of common quality and sanitary standards

Functional regional cooperation

... Governance, financial issues and functioning of institutions

Institutions

Number of meetings Qualitative assessment of meetings Performance of specific institutions

Budgets

Fulfilment of requirements of budgetary contributions Transparency of procedures Implementation of budgets

Indicators of regional integration 33 HR Implementation of EDF projects and programmes

Progress on appraisal Decisions Disbursements

Recruitment policy Staff training

Contracts concluded Contracts implemented

Source: European Commission (2002a).

APPENDIX 1.2 COMESA’s proposal for the development of a set of regional integration indicators Categories

Variables

Trade liberalisation

Number of non-zero tariffs Highest MFN tariff Highest regional tariff Weighted average MFN tariff

Trade facilitation

Level of conformity to the WTO TBT Agreement Capacity of member states to implement mutually recognised certification marking schemes Notification of National Enquiry Points Ability to regulate and monitor sanitary and phytosanitary standards Use of ASYCUDA (or similar) Use of GATT valuation system Use of COMESA customs document Use of HS1996 (or later) customs classification system

Trade in services

Establishment and publication of Contact and Enquiry Point Performance with regard to commitments Reductions in exemptions over time

Transit facilitation

Implementation of COMESA harmonised road transit charges Use of the COMESA carriers license Use of the COMESA customs bond guarantee Implementation of harmonised axle load and vehicle dimensions regulations Implementation of the COMESA third party vehicle licensing system

Monetary convergence

Inflation Size of the budget deficit Size of the external debt Exchange rate movements continued . . .

34 Philippe De Lombaerde and Luk Van Langenhove Categories

Variables

Domestic payments and settlement systems, banking and exchange rates

Restrictions on the current account Restrictions on the capital account Level of government ownership of banks Restrictions on foreign banks to open branches and subsidiaries Government influence over the allocation of credit Restrictions on private sector companies to offer all types of financial services, securities and insurance policies Use of domestic electronic clearing systems Restrictions on foreign financial institutions

Fiscal environment

Weighted average income tax rate Income tax as percentage of GDP Weighted average of direct taxes on business Direct business taxes as percentage of GDP VAT rate VAT as percentage of GDP Government expenditure as percentage of GDP

Government intervention in the economy

Government consumption as percentage of the economy Government ownership of businesses and industries Share of government revenues from state-owned enterprises and from government-owned property Economic output produced by government

Capital flows and foreign investment

Existence of foreign investment code providing national treatment Degree to which there are any restrictions on foreign ownership of businesses Level of restrictions on foreign ownership of land Level of restrictions on repatriation of earnings

Governance issues

Freedom of the judicial system from government influence Level to which contracts are respected and whether there is an independent arbitration of contract disputes Level of transparency and accountability of the judiciary Legally granted and protected private property rights

Regulatory environment Existence of an independent competition authority tasked with implementing a set of legally recognised rules and regulations on competition Existence of an independent telecommunications authority tasked with implementing a set of legally recognised rules and regulations on telecommunications Existence of an independent standards authority tasked with implementing a set of legally recognised rules and regulations on standards Existence of defined regulations dealing with public procurement in member states Licensing requirements

Source: COMESA (2002).

Level of licensing requirements to operate a business Time taken to obtain appropriate licenses to start business operations Transparency of the licensing system

Indicators of regional integration 35 APPENDIX 1.3 Best’s key variables of complexity in regional integration arrangements Key variables

Possible breakdown

Number of member states Relative sizes of the participating countries Different levels of development Scope of coverage

Type of impact

Time perspectives Degree of real interdependence

Number of sectors covered Number of sensitive sectors excluded Length of exclusion lists Strength of impact: impact on macro-economic variables, impact on flows, population affected, etc. Type of impact: distribution of costs and benefits, degree of uncertainty of impact, time-lags, etc. Degree of complementarity Intra-group trade Degree of transnational interaction Degree of transgovernmental interaction Importance of political ties Importance of military alliances

Political framework

Existence of common threat Awareness of individual international impotence Existence of historical perceptions of the relationships between the participating countries

Perceptions, values and norms

(Dis)similarity of perceptions of the nature, objectives and importance of the integration process Differences in constitutional systems Differences in political systems Attitude towards institutionalisation Perception of a common (regional) identity (Dis)similarities in national value systems (Dis)similarities in social structures

Source: Best (1997: 60–66).

36 Philippe De Lombaerde and Luk Van Langenhove APPENDIX 1.4 The World Bank’s list of fiscal decentralisation indicators Categories

Indicators

Main indicators

Sub-national expenditures (% of total expenditures) Sub-national revenues (% of total revenues) Vertical imbalance (%) Sub-national expenditures (% of GDP) Sub-national revenues (% of GDP)

Composition of sub-national revenues and grants

Tax revenue (% of total sub-national revenues and grants) Transfers from other levels of government (% of total sub-national revenues and grants)

Composition of sub-national expenditures

General public services (% of total sub-national expenditures) Defence (% of total sub-national expenditures) Public order and safety (% of total sub-national expenditures) Education (% of total sub-national expenditures) Health (% of total sub-national expenditures) Social security and welfare (% of total sub-national expenditures) Housing and community amenities (% of total sub-national expenditures) Recreational, cultural and religious affairs and services (% of total sub-national expenditures) Fuel and energy (% of total sub-national expenditures) Agriculture, forestry, fishing and hunting (% of total sub-national expenditures) Mining and mineral resources, manufacturing and construction (% of total sub-national expenditures) Transportation and communication (% of total sub-national expenditures) Other economic affairs and services (% of total sub-national expenditures) Other expenditures (% of total sub-national expenditures)

Source: World Bank (sd).

Indicators of regional integration 37 NOTES 1 The authors wish to thank Brigid Gavin and Dirk Hansohm for comments on a previous version of the text. Only the authors are responsible for its contents. 2 See for example Hettne (1999). 3 See http: //www1.worldbank.org/publicsector/decentralization/webfiscal.pdf 4 Based upon a specific methodological framework (UNECA, 2001), data have been gathered back to 1994, the year the Abuja Treaty came into force. First results have been published in UNECA (2002). 5 This is the case for articles 28–30 of Section 3 on Regional Cooperation and Integration, as well as for article 22 on Macroeconomic and Structural Reforms and Policies; it is also in accordance with Article 11 of Annex IV of the same Agreement. 6 Although aspects of interculturality also appear at the stage of choosing and weighting the variables in the system, reflecting cross-cultural differences in preferences. 7 Recently, for example, the problem of conceptualisation has been illustrated very well in the context of the discussions about the RCRP proposal of the European Commission. The World Bank (2002), proposed to distinguish between ‘integration’ and ‘cooperation’ on the basis of the degree of sovereignty that countries agree to transfer to supranational institutions, but recognised that the borderline is not clear-cut. The Commission itself proposed a category of inter-state interaction called ‘functional regional cooperation’. 8 The most intense form of cooperation, namely policy coordination, refers to the coordination of common objectives, of the choice, amplitude and moment of the policy measures, or the exchange of policy information, expectations and economic structures (Van Velden, 1988: 1). 9 ‘Positive’ and ‘negative’ is used here in its usual sense, not in the sense suggested by Tinbergen. 10 Ondarts (1992) disaggregates the category of formal integration further into integration ‘by treaty’ and formal integration in sensu stricto. The latter category implies the creation of supranational entities that start to coordinate the integration process with certain autonomy. 11 The author makes a further distinction between four forms of interdependence: (1) structural interdependence, (2) interdependence between (economic) policy objectives, (3) interdependence between exogenous variables, and (4) political interdependence (Cooper, 1985: 1199–1200). As far as the measurement of the degree of interdependence is concerned, he adopts the distinction between vulnerability and sensitivity from Keohane and Nye (1977). 12 See, for example, Hettne (1999). 13 The ZMM-GT might be an example of this (Slocum et al., 2003). 14 As in the case of the COMESA proposal (Table 1.4; COMESA, 2002), this can simply be only a matter of presentation (i.e. not involving calculations of convergence indicators). 15 See, for example, Page (1998) for an exploration of the ‘real’ motivations behind 14 country groupings. 16 Structural asymmetries can be distinguished from: (1) asymmetries arising from differences in commitments by the member countries, (2) asymmetries in the decisionmaking process and in the organisational design, (3) asymmetric effects of integration, and (4) asymmetries embedded in common policies (De Lombaerde, 2002). 17 For a more recent presentation of club theory and its application to international organisations, see Fratianni and Pattison (2001). 18 See, for example, The World Bank (2001), Silva Lopes (2003). 19 It is correct to consider the four categories as dimensions rather than as stages within a single process, because the regional integration agreements are evaluated by the ECB

38 Philippe De Lombaerde and Luk Van Langenhove

20 21 22 23 24

25

26

27 28 29

30

independently in terms of their progress in each category, thus taking into account that integration in the real world does not always respect Balassa’s model and that parallel processes and inverted sequences are not exceptional. For a good overview of methods and results since Verdoorn’s pioneering studies (Verdoorn and Meyer zu Schlochtern, 1964), see El-Agraa (1999). Several of these ‘key variables’ are in reality a set of variables themselves. For an overview of actors involved in integration projects in the real world, see, for example, the mapping exercises of the WTO (2000) and UNU/CRIS (www.cris.unu. edu). See Hettne (1999). The classical references on gravity models for trade analysis are Tinbergen (1962), Pöyhönen (1963) and Linnemann (1966). For an overview of the theoretical discussion on the validity of the gravity equation (and an application to trade flows in the Baltic Sea area) see Paas (2002). Paas identifies three classes of theoretical foundations in the literature: (1) regional science and new economic geography, (2) microeconomic foundations, (3) trade theories. Hinojosa et al. (1996), for example, provide an overview of the debate on the (national and regional) labour market impacts of NAFTA for the United States and show the sensitivity of the results towards the type and quality of the data, and the methodology used. For illustrative purposes, we might mention some examples of combined indicator systems that have been presented as monitoring tools for integration processes. The Transport and Environment Reporting Mechanism (TERM) model of the European Environment Agency, for example, is a relevant and interesting model for monitoring a specific policy area on a regional level. The TERM is a flexible instrument containing quantitative as well as qualitative data on progress made in these policy fields. The indicators-based model shows the quality of policies, the degree of their implementation and the need for more policy coordination in specific areas (EEA, 2001). Another recent example is Sustainable Calgary’s system of indicators of sustainability and the quality of life (Keough, 2002). Although conceived as a tool for the local community, it is thought to be a system that can be transformed to monitor the effects of international trade agreements. See http: //www.polity.co.uk/global/ See, for example, Devlin and Ffrench-Davis (1998). In addition, from a social policy perspective, it is necessary to distinguish between the magnitude of the flows of migration and the degree to which the immigrants are actually ‘integrated’ in the host societies. Figures on temporary migration and return migration could give some indication about the structural character of migration but the ‘integration’ issue of immigrants is much more complex and its monitoring would require specific indicators. According to the typology proposed by Werth et al. (1997), three different types of indicators could be considered: (1) indicators of accessibility, dealing with the legal framework in which migrants live, (2) indicators of the living situation of migrants, referring to employment, education, welfare, housing, etc., and (3) indicators on attitudes, expectations and political participation of migrant and host population, using opinion surveys. The typology is based on the work presented in the framework of the project ‘The Integration of Immigrants: Towards Equal Opportunities’ of the European Committee on Migration (CDMG) of the Council of Europe. The complete series of papers, showing the different national perspectives, has been published as Council of Europe (1997). ‘Vertical imbalances’ refer to the degree to which national governments rely on revenues from supranational institutions to support their expenditures.

Indicators of regional integration 39 REFERENCES Anderson, V. (1991) Alternative Economic Indicators, London: Routledge. Balassa, B. (1961) The Theory of Economic Integration, Homewood, Ill: Richard Irwin. Bekemans, L., Fiorentino, R. and Van Langenhove, L. (2000) ‘Reshaping Integration Studies in Social Sciences: Challenges and Perspectives for Research’, Collegium, 20: 43–72. Bensidoun, I. and Chevallier, A. (1998) ‘Indicators of Regionalisation in North America, Asia, Central and Eastern Europe and the Mediterranean Basin’, in OECD, Globalisation, Migration and Development, 15–33, Paris: OECD. Best, E. (1997) ‘Capacities for Regional Integration: Conceptual Framework for Comparative Analysis’, in M.O. Hosli and A. Saether (eds) Free Trade Agreements and Customs Unions: Experiences, Challenges and Constraints, 51–75, Maastricht: TACIS/European Commission – EIPA. Collier, P., Schiff, M., Venables, A. and Winters, L.A. (2000) Trade Blocs, The World Bank, Washington–New York: Oxford University Press. COMESA (2002) Discussion Paper on Surveillance as a Means to Measure the Degree to Which Integration is Taking Place in the COMESA Region, COMESA Secretariat. Cooper, R. (1985) ‘Economic Interdependence and Coordination of Economic Policies’, in R.W. Jones and P.B. Kenen (eds) Handbook of International Economics, 2: 1195–1234, North-Holland, Amsterdam. Council of Europe (1997) Measurement and Indicators of Integration, Strasbourg: Council of Europe. De Lombaerde, P. (2002) ‘Integración asimétrica’, in P. De Lombaerde (ed.) Integración asimétrica y convergencia económica en las Américas, 15–32, Bogotá: Universidad Nacional-Antropos. Devlin, R. and Ffrench-Davis, R. (1998) ‘Towards an Evaluation of Regional Integration in Latin America in the 1990s’, Working Paper, INTAL, 2. Dobson, W. (1991) ‘Economic Policy Coordination: Requiem or Prologue?’, Policy Analyses in International Economics, 30. Dorrucci, E., Firpo, S., Fratzscher, M. and Mongelli, F.P. (2002) ‘European Integration: What Lessons for Other Regions? The Case of Latin America’, European Central Bank Working Paper Series, 185. EEA (2001) ‘Term 2001. Indicators Tracking Transport and Environment Integration in the European Union’, Environmental Issues Series, European Environment Agency, 23. El-Agraa, Ali M. (1999) Regional Integration. Experience, Theory and Measurement, Basingstoke and London: Macmillan Press. European Commission (2002a) ‘Regional Cooperation Review Process’, Discussion Paper, Brussels: DG Development, European Commission, (DEV/B/1/WKD(2002)). European Commission (2002b) ‘Informal Workshop to Discuss the Regional Cooperation Review Process’, Meeting Report, Brussels: DG Development, European Commission (DEV/B/1/WK D(2002)). Fratianni, M. and Pattison, J. (2001) ‘International Organisations in a World of Regional Trade Agreements: Lessons from Club Theory’, The World Economy, 24(3): 333–58. Freudenberg, M., Gaulier, G. and Ünal-Kesenci, D. (1998a) ‘La régionalisation du commerce international: Une evaluation par les intensités relatives bilatérales’, Document de Travail, Paris: CEPII (1998–05). Freudenberg, M., Gaulier, G. and Ünal-Kesenci, D. (1998b) ‘La régionalisation du commerce international’, Économie Internationale, 74: 15–41. Gavin, B. and Van Langenhove, L. (2003) ‘Trade in a World of Regions’, in G. Sampson

40 Philippe De Lombaerde and Luk Van Langenhove and S. Woolcock (eds), Regionalism, Multilateralism and Regional Integration, Tokyo: UNU Press, 277–313. Gilpin, R. (1987) The Political Economy of International Relations, New Jersey: Princeton. Greif, A. (1997) ‘Cultural Beliefs as a Common Resource in an Integrating World’, in P. Dasgupta, K.G. Malter and A. Vercelli (eds) The Economics of Transnational Commons, 238–96, Oxford: Clarendon Press. Held, D., McGrew, A., Goldblatt, D. and Perraton, J. (1999) Global Transformations: Politics, Economics and Culture, Cambridge: Polity. Hettne, B. (1999) ‘Globalisation and the New Regionalism: The Second Great Transformation’, in B. Hettne, A. Inotai and O. Sunkel (eds) Globalism and the New Regionalism, 1–24, Macmillan Press. Hettne, B. (2005) ‘Regionalism and World Order’, in M. Farrell, B. Hettne and L. Van Langenhove (eds) Global Politics of Regionalism, London: Pluto Books. Hettne, B. and Söderbaum, F. (2000) ‘Theorising the Rise of Regionness’, New Political Economy, 5(3): 457–73. Hinojosa Ojeda, R., Dowds, C., McCleery, R., Robinson, S., Runsten, D., Wolff, C. and Wolff, G. (1996) North American Integration Three Years After NAFTA. A Framework for Tracking, Modeling and Internet Accessing the National and Regional Labor Market Impacts, Los Angeles: North American Integration and Developing Center, UCLA. IADB (2002) Draft Profile Strategy. Regional Integration, Washington: IADB. Online. Available HTTP: . Iapadre, L. (2000) ‘Accordi di integrazione regionale e geografia del commercio mondiale: problemi di misurazione ed evidenza empirica’, Quaderni di ricerca, Istituto nazionale per il Commercio Estero, 13. Iapadre, L. (2001) Intra-Regional Trade Intensity: A Survey of the Indicators, Powerpoint presentation Aquila: University of l’Aquila – ICE. Keohane, R. (1980) ‘The Theory of Hegemonic Stability and Changes in International Economic regimes, 1967–77’, in O.R. Holsti et al., Change in the International System, Boulder, CO.: Westview Press, Chapter 6. Keohane, R.O. and Nye, J.S. (1977) Power and Interdependence: World Politics in Transition, Boston: Little Brown. Keough, N. (2002) ‘Using Indicators to Engage the Community in Sustainability Debates’, in J.J. Kirton and V.W. MacLaren (eds) Linking Trade, Environment, and Social Cohesion. NAFTA Experiences, Global Challenges, 277–95, Aldershot: Ashgate. Kindleberger, C.P. (1981) ‘Dominance and Leadership in the International Economy: Exploitation, Public Goods, and Free Rides’, International Studies Quarterly, 25: 242–54. Kreinin, M.E. and Plummer, M.G. (1994) ‘“Natural” Economic Blocks: An Alternative Formulation’, The International Trade Journal, 8(2): 193–205. Krugman, P. (1991) ‘Is Bilateralism Bad?’, in E. Helpman and A. Razim (eds) International Trade and Policy, Cambridge: MIT Press. Linnemann, H. (1966) An Econometric Study of International Trade Flows, Amsterdam: North-Holland. Mattli, W. (1999) The Logic of Regional Integration. Europe and Beyond, Cambridge: Cambridge University Press. Olson, M. (1965) The Logic of Collective Action, Cambridge, Mass.: Harvard University Press. Ondarts, G. (1992) ‘La nueva integración’, Integración Latinoamericana, 92: 3–12.

Indicators of regional integration 41 Paas, T. (2002) ‘Gravity Approach for Exploring Baltic Sea Regional Integration in the Field of International Trade’, HWWA Discussion Paper, 180. Page, S. (1998) ‘Survey of regions’, Politeia, 17(3): 22–43. ‘Partnership Agreement Between the Members of the African, Caribbean and Pacific Group of States of the One Part, and the European Community and Its Member States, of the Other Part. Signed in Cotonou on 23 June 2000’, Special Issue Cotonou Agreement, Brussels: DG Development, European Commission (September). Pelkmans, J. (1993) ‘Comparando las integraciones económicas: prerrequisitos, opciones e implementaciones’, Integración Latinoamericana, 191: 3–17. Pöyhönen, P. (1963) ‘A Tentative Model for Volume in Trade Between Countries’, Weltwirtschaftliches Archiv, 90: 91–113. Silva Lopes, P. (2003) ‘The Relative Usefulness of Social Spending Indicators in Determining Social Outcomes in Sub-Saharan Africa’, paper presented at the IIAS Conference on Shared Governance: Combating Poverty and Exclusion, Yaoundé, July. Slocum, N., Mordonu, A. and De Lombaerde, P. (2003) ‘The Zambia-Malawi-Mozambique Growth Triangle: A Case Study in New Regionalism’, in H. van Ginkel, J. Court and L. Van Langenhove (eds) Integrating Africa: Perspectives on Regional Integration and Development, 89–121, Tokyo: UNU Press. Stakhovitch, A. (1991) ‘Unas y otras integraciones’, in V.L. Urquidi and G. Vega Canovas (eds) Unas y otras integraciones. Seminario sobre integraciones regionales y subregionales, 69–90, México: El Colegio de México, Fondo de Cultura Económica. Thant, M., Tang, M. and Kakazu, H. (eds) (1994) Growth Triangles in Asia. A New Approach to Regional Economic Co-operation, Hong Kong: Oxford University Press. Tinbergen, J. (1954) International Economic Integration, Amsterdam: Elsevier. Tinbergen, J. (1962) Shaping the World Economy, New York: Twentieth Century Fund. UNECA (2001) Annual Report on Integration in Africa. Methodology for Calculating Indices of Economic Integration Effort in Africa, Addis Ababa: UN Economic Commission for Africa. UNECA (2002) Annual Report on Integration in Africa 2002, Addis Ababa: UN Economic Commission for Africa. Van Langenhove, L. (2003) ‘Regional integration and global governance’, UNU Nexions, 1–5. Van Velden, L. (1988) ‘A Survey into the Literature on Game Theory and Policy Coordination in International Economics’, Research Memorandum, University of Amsterdam. Verdoorn, P.J. and Meyer zu Schlochtern, F.J.M. (1964) ‘Trade Creation and Trade Diversion in the Common Market’, in H. Brugmans (ed.), Intégration Européenne et réalité économique, Bruges: de Tempel. Werth, M., Delfs, S. and Stevens, W. (1997) ‘Using Indicators of Integration for the Implementation of Integration Policies’, in Council of Europe, Measurement and Indicators of Integration, 187–93, Strasbourg: Council of Europe. World Bank (sd) Fiscal Decentralisation Indicators, Washington: The World Bank. World Bank (2001) World Development Indicators, Washington: The World Bank. World Bank (2002) WB Comments to the EC Draft Discussion Paper on a Regional Cooperation Review Process, Washington: The World Bank. WTO (2000) ‘Mapping of Regional Trade Agreements’, Note by the Secretariat, Committee on Regional Trade Agreements, Geneva: World Trade Organisation (WT/REG/W/41).

2

Towards a qualitative monitoring of regional integration Luk Van Langenhove

INTRODUCTION From a social scientist’s point of view, processes of regional integration can be studied in a variety of ways. In addition to theoretical approaches that try to understand the nature of regionalisation/regionalism, an empirical approach is also possible. In the latter case, one can focus on monitoring interactions and on assessing the impact of regional integration on both those included and those excluded from a given integration scheme. Both the monitoring and impact assessment processes need indicators. In line with mainstream economic thinking such indicators are usually thought of as quantitative data. In this chapter it will be argued that in addition to quantitative data, the study of regional integration also needs empirically based qualitative data. Also, it will be advocated that a qualitative monitoring and impact assessment method can be constructed upon the so-called ‘fourth generation evaluation’ model (Guba and Lincoln, 1989) and that such an approach allows a participatory monitoring and assessment scheme to develop that can demonstrate the ‘added value’ of regional integration.

THE QUALITATIVE–QUANTITATIVE DICHOTOMY IN THE SOCIAL SCIENCES Two major methodological paradigms occur within social science: there are the ‘general’ and ‘particular’ methodologies, also known as the nomothetic and idiographic approaches. The word ‘nomothetic’ is taken to characterise the search for general laws (applicable in all circumstances at any time). The word ‘idiography’ indicates a concern for what is particular to the individual case. The nomothetic approach is in line with the positivist paradigm: the seeking of general laws by employing only those procedures admitted by the natural sciences. The ‘behaviour’ of a single apple falling down from a tree, for example, can be easily explained by applying the general law of gravitation. So, explaining why apples fall with a certain speed and acceleration to the earth can be discovered by observations and

Qualitative monitoring 43 measurements, the result being a theory that applies to all apples (and for that matter to all other objects). The natural sciences do not seek to explain why one particular apple falls down from a tree at that particular time . . . Applied to the social sciences, this implies that researchers should study aggregates of events in order to detect regularities across individual particulars. The nomothetic approach has thus pushed the social sciences in a ‘positivist’ quest for reliable and replicable data (Van Langenhove, 1996). The difference between quantitative and qualitative methodologies runs, to a great extent, parallel with the above distinction. Quantitative research is based on statistical inference and, to a lesser extent, on mathematical models. For the quantitative researcher, only figures make up valuable ‘data’. Anything that cannot be expressed in figures cannot be analysed scientifically. This view is challenged by the advocates of qualitative methodologies who argue that one should first describe in detail the phenomena one studies before trying to impose quantitative measurements. Some qualitative researchers will even argue that quantifications are always ‘bad’ science. The qualitative approach that opposes the mainstream quantitative approach is not monolithic but consists of different ‘schools’ and has different names such as ethnomethodology, naturalistic inquiry, etc. A central element, however, is the focus on case studies and on descriptive assessments. Today most scholars will state that both methods have their value and that a qualitative approach does not exclude using quantitative data.

THE QUALITATIVE SIDE OF STUDYING REGIONAL INTEGRATION Regional integration is a complex process that needs to be studied from a wide range of perspectives. Obviously, economical and political-legal quantitative indicators will play an important role in such studies (see other chapters in this volume). But there is, in my view, also a need to develop a qualitative approach to the study of regional integration (Levy, 2002). Such a qualitative approach is related to three aspects of the research process: • • •

the data-gathering perspective, the units of analysis, the purpose of the analysis.

Data gathering Qualitative data are words rather than numbers. Those words can come from different sources such as interviews or content-analysis of documents. Applied to regional integration, this implies that sources of data can include treaties, official documents, non-papers, press articles, interviews with stakeholders, etc. If, for instance, one is interested in analysing how regional responses to risk are organised, data could include documents referring to the development of regional early

44 Luk Van Langenhove warning systems to reduce impacts of natural disasters, as well as assessments by participants of the practical functioning of such systems. The main problem with using such data is to make sure that the data-analysis is done in a sound, reliable way. One of the most advanced methodologies for handling qualitative data has been developed by Miles and Huberman (1994). More recently, this methodology has been coupled to software that can assist the researcher in organising the data as well as in producing conclusions. There is no reason to say that qualitative research is less ‘scientific’ than quantitative research, but it requires more thought and takes more time than most off-the-shelf quantitative analysis. Some authors will argue that, all in all, qualitative research is more likely to lead to useful and defensible findings.

Units of analysis Qualitative research works first and foremost with single cases. Quite often studying one single case is the objective of a project. But single cases can also be elements of a comparative analysis and there exist multiple schemes of conducting cross-case analyses. In studying regional integration, this implies that attention can be directed to single integration processes (e.g. the European integration), to single integration organisations (e.g. Mercosur) or to single aspects of a regional integration scheme such as trade or environment. Also, such cases can be used in a broader comparative project.

Purpose Perhaps the important aspect of the qualitative approach is that both its way of data gathering and its focus on single cases are related to the specific purpose of gathering intelligence about one individual process or product. As such, qualitative research has become the prime method in evaluation research where the purpose is to assess single events. In the next paragraph, we will explore in some detail how evaluation processes have evolved towards embracing qualitative research methodology.

FOUR GENERATIONS OF EVALUATION Guba and Lincoln (1989) have presented a four-stage history of evaluation practices that nicely shows how the paradigm moved from a positivist and purely quantitative approach to a qualitative approach. In a first generation, evaluation was focused on measurement of facts. Applied to schools, this resulted in individual students being the object of evaluation. For these studies tools such as psychometric tests were available and the role of the evaluator was purely technical. The second generation shifted attention to descriptions of strengths and weaknesses of school curricula based upon measurements of the extent that curricula

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Qualitative monitoring 45 reached their stated objectives. The focus was no longer on what an individual student had learnt but on what the school had intended them to learn. In a third generation, the main focus was not the achievement of the objectives but the question whether the objectives were worthwhile. The evaluator now became a judge. These three types of evaluation occur in many different contexts and one can easily see their applicability to regional integration. In the ‘measurement’ approach, the focus is on gathering data such as foreign direct investment (FDI) or trade and these data are analysed as such. In the second approach these data are compared with stated regional integration objectives (benchmarks). In the third approach, the objectives themselves are scrutinised, often on the basis of quantitative data. Guba and Lincoln consider the three generations of evaluation they identified to be flawed to the extent of having to be replaced. Three major categories of flaw (cf. Guba and Lincoln, 1989) were described as detailed below.

A tendency towards managerialism The manager who hires the evaluator tends to stand outside the evaluation – his or her managerial qualities are not called into question. The manager/evaluator relationship is disempowering for those being evaluated as they decide which questions should be asked, how answers will be collected and interpreted and who will see the results. Other stakeholders are not represented and may be disenfranchised.

A failure to accommodate value pluralism When evaluation is seen to be about valuing there is the question of whose values. The claim of value-freedom within the scientific mode of inquiry is not tenable and, that being the case, the value-pluralism within societies and between cultures is a crucial matter to be attended to in an evaluation. None of the evaluation approaches of the first three generations accommodates value differences in the slightest.

An overcommitment to the positivist paradigm of inquiry Virtually all of the first three evaluation models use the positivist paradigm to guide their methodological work. But this extreme dependence on the methods of natural sciences has had unfortunate results: • • •

context stripping – leading to generalisation in questions and results and fatally reducing the contextual relevance and usability of the findings, overdependence on quantitative measurement – leading to the modus operandi that what cannot be measured cannot be real, the ‘coerciveness of truth’ – science claims to tell us about ‘the way things really are’ and, given managerialism and commitment to the scientific

46 Luk Van Langenhove

• •

paradigm, this locks thinking into the positivist mode and lends illegitimate support to the status quo, scientific truth is non-negotiable – if science discloses the truth about things then any other alternative explanations must be in error, the evaluator bears no moral responsibility for his or her conclusions if they are ‘scientific truth’.

Although the evaluation practices referred to by Guba and Lincoln are quite distinct from what concerns us, their critiques apply to a large extent to how regional integration is monitored. If one looks at the completed studies available, one can easily detect flaws similar to those of the three generations of evaluation: • • •

a focus on quantitative measurement, a researcher perspective that does not include stakeholders’ perspectives, a ‘value-free’ approach that does not include appraisals of regional integration.

For Guba and Lincoln (1989), the answer to the shortcomings of the first three generations of evaluation practices is the adoption of a social constructionist approach to evaluation which they termed ‘fourth generation evaluation’. In my view this approach can be valuable to organise monitoring of regional integration as well. Fourth generation evaluation is organised by the claims, concerns and issues of stakeholding audiences, and it utilises the methodology of the constructionist paradigm. It includes the following processes but not necessarily in the order indicated: • •

•

Identify the full array of stakeholders who are at risk in the projected evaluation. Elicit from each stakeholder group their constructions about the issues at hand and the range of claims, concerns and issues they wish to raise in relation to it. Provide a context and a methodology through which different constructions, and different claims, concerns and issues, can be understood, critiqued and taken into account: •

•

Carry out this methodology within each stakeholder group, so that the group construction (or several, if there are intra-group conflicts) can emerge and decisions can be reached about which claims, concerns and issues should be pursued. Cross-fertilise each group with the constructions, claims, concerns and issues arising from other groups so that those items must be confronted and dealt with. This cross-fertilisation may also include constructions drawn from the literature, from other sites or from the experience of the evaluator. Any construction, claim, concern or issue may properly be introduced so long as it is open to critique and criticism.

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Qualitative monitoring 47 • • • • •

•

Generate consensus with respect to as many constructions, and their related claims, concerns and issues as possible. Prepare an agenda for negotiation on items about which there is no, or incomplete, consensus. Collect and provide the information called for in the agenda for negotiation. Establish and mediate a forum of stakeholder representatives in which negotiation can take place. Develop a report, probably several reports, that communicate to each stakeholder group any consensus on constructions and any resolutions regarding the claims, concerns and issues that they have raised (as well as regarding those raised by other groups that appear relevant to that group). Recycle the evaluation once again to take up still unresolved constructions and their attendant claims, concerns and issues.

Guba and Lincoln (1989) give five reasons for insisting upon the use of stakeholder claims, concerns and issues as the basis for deciding what information is needed in an evaluation. These are as follows: • •

• • •

Stakeholders are placed at risk by an evaluation; thus, in the interests of fairness, they deserve to have input into the process. Evaluation exposes stakeholders to exploitation, disempowerment and disenfranchisement; thus, in the interests of self-defence, they are entitled to some control over the process. Stakeholders represent a virtually untapped market for the use of evaluation findings that are responsive to self-defined needs and interests. The inclusion of stakeholder inputs greatly broadens the scope and meaningfulness of an inquiry. All parties can be mutually educated to more informed and sophisticated personal constructions as well as an enhanced appreciation of the constructions of others.

QUALITATIVE MONITORING OF REGIONAL INTEGRATION There is a case to be made for developing a qualitative strategy to monitoring regional integration along the lines of the constructionist approach discussed above. Such an approach would allow the inclusion of more than just economic parameters and focus upon the interconnectedness of states in regions. This would be in line with the so-called new regionalism approach. Also, such an approach would allow the monitoring exercises to be performed with the full cooperation of the different stakeholders involved. As a first step in developing such an approach, the following three issues can be put forward.

48 Luk Van Langenhove

Identification of a broad set of dimensions to assess the extent and depth of interconnectedness. Inspired by Held et al. (1999), one should consider including the following dimensions in any regional integration monitoring or assessment exercise: 1

Political-legal dimension: • • • • •

2

Economic dimension: • •

3

regional identity regional civil society.

Security dimension: • •

6

transport migration refugees.

Cultural dimension: • •

5

international trade foreign direct investment.

Mobility dimension: • • •

4

diplomatic connectedness of states growth of Foreign Ministries (and/or ministries following up regional integration) development of customary international law recognised by states membership of formal international treaties international transactions of domestic political agencies.

peace natural disaster.

Cooperation dimension: • •

environment criminality.

The above list is far from exhaustive and needs to be completed. In line with what was discussed before, it should also be noted that the dimensions include much more than quantitative indicators. As such, this list complements the proposal for classifying variables in a SIRI as presented in Chapter 1: the dimensions to be considered can involve different variables of both quantitative and qualitative indicators.

Identification of consequences of integration processes Interconnectedness is not only something that can be described, it also needs to be assessed along a number of dimensions. In my view, what one needs to do is gather

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Qualitative monitoring 49 intelligence regarding the extent to which a certain regional integration initiative has an ‘added value’. As a starting point, one can look to the following possible consequences in such an assessment. 1 2 3 4 5 6 7 8

Contribution to the creation of an appropriate enabling environment for private sector development. Contribution to the strengthening of trade integration in the region. Contribution to developing strong public sector institutions and good governance. Contribution to reducing social exclusion and fostering of an inclusive civil society. Contribution to the development of infrastructure programmes in support of economic growth and regional integration. Contribution to building environmental programmes at the regional level. Contribution to peace and security in the region. Contribution to strengthening the region’s interaction with other regions in the world.

Identification of stakeholders involved in the regional integration process The third step in developing a qualitative approach to the monitoring of regional integration is the identification of different stakeholders involved in the regional integration process. Regional integration stands in a double relation to people: on the one hand, people can gain or lose by regional integration (or they can remain unaffected), and on the other hand some people can have a discretionary power to make decisions about regional integration. From a formal point of view, the following types of stakeholders can be distinguished: • • •

agents beneficiaries victims.

‘Agents’ are those people involved in designing, promoting and implementing regional integration. People who somehow profit from the development or implementation of a regional integration scheme can be called ‘beneficiaries’. Such benefits can be direct or indirect (e.g. more export possibilities for one’s firm versus a better economic climate that contributes to creating someone’s job). Some benefits can be directly related to the regionalisation process itself (e.g. career prospects for international civil servants). Those people who are negatively affected by the regional integration quality as ‘victims’. This can include people who suffer opportunity costs or negative side effects. A distinction should also be made between actual and potential beneficiaries and victims. And one also has to take into account that the same person can be agent and beneficiary or victim at the same time.

50 Luk Van Langenhove Stakeholders can be identified as groups that hold their own claims, concerns and issues regarding regionalisation. A ‘claim’ is any assertion that a stakeholder may introduce that is favourable for regional integration. A ‘concern’ is any assertion that is unfavourable and an ‘issue’ is any state of affairs about which reasonable persons may disagree. Applying this to regional integration means that one has to identify different groups in society that are somehow affected by the success or failure of a regionalisation process. This might prove to be a very difficult exercise as not all stakeholders are fully aware of their role. As a starting point, one could focus upon: • • • • • •

governmental officials (both those involved in external affairs and those involved in internal affairs) officials of regional integration institutions political parties industrialists (regional) non-governmental organisations global organisations.

Together, these three preparatory steps should enable a monitoring exercise to be conducted that follows the constructionist and participative approach as advocated by Guba and Lincoln (1989). The next step would then be to draw up a ‘contract’ between the parties involved in the monitoring process. Such a contract should determine the ambition, scope and limitations of the exercise. It will be essential that the setting up of such a contract is in itself a dialogical process related to the overall question of ‘what do we want to achieve by this exercise?’. Finally, one can then start the process of drawing up lists of claims, concerns and issues.

CONCLUSIONS Regional integration can be studied as a process or as a state of the art. The latter focuses on describing what is actually going on (including the consequences of regional integration). The former deals with how a certain state of regional integration is being achieved. The qualitative and constructionist approach to monitoring regional integration advocated in this chapter puts the focus on the understanding of how and why the processes take place, as well as on studying the broad consequences of those processes. As such it opens avenues for monitoring the progress that countries make in regional integration. Rather than being satisfied with a description of the level of integration, such an approach allows us to study how and at what pace and costs countries achieve a progressive elimination of the imperfections of their regional integration.

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Qualitative monitoring 51 REFERENCES Guba, E.G. and Lincoln, Y. (1989) Fourth Generation Evaluation, London: Sage. Held, D., McGrew, A., Goldblatt, D. and Perraton, J. (1999) Global Transformations: Politics, Economics and Culture, Cambridge: Polity Press. Levy, J.S. (2002) ‘Qualitative Methods in International Studies’, in F.P. Harvey and M. Brecher (eds) Evaluating Methodology in International Studies, Ann Arbor: University of Michigan Press. Miles, M.B. and Huberman, M. (1994) Qualitative Data Analysis: an Updated Sourcebook, London: Sage. Van Langenhove, L. (1996) ‘The Theoretical Foundations of Experimental Psychology’, in J. Smith, R. Harré and L. Van Langenhove (eds) Rethinking Psychology, London: Sage.

3

Communicative indicators for the study of regional integration A critical theory perspective Ann-Christin Raschdorf

This chapter seeks to contribute to an ongoing discussion on what sort of qualitative indicators are required to understand and measure changing degrees of social and cultural integration in non-Western contexts. Following Jürgen Habermas’ discourse theory, it develops a set of procedural indicators for communicative participation and empowerment in regional integration processes. It argues for an application of a formal dialogical matrix that allows for a definition of varying degrees of local ownership through a measurement of processes of discursive inclusion and exclusion (Habermas, 1976a). The intent is to show how critical theory can contribute to an alternative, not state-centric understanding of regional integration from the ground up. This chapter shares many of the methodological concerns that were first voiced by a so-called ‘fourth generation evaluation model’ that aimed ‘to organise evaluation by the claims, concerns, and issues of stakeholding audiences’ (Guba and Lincoln, 1989). However, a communicative approach differs in many ways from a constructionist approach to the monitoring of regional integration. Following Habermas’ critique of Schütz (Schütz and Luckmann, 1979), it argues that it is not sufficient to ensure and monitor formal participation as such. It points at the necessity of scrutinising the contextual basis of the interaction of the involved stakeholders. A prerequisite for such a contextual understanding is a reflexive discursive analysis of both expert and local discourses. In other words, while a constructionist approach signifies an important first step towards a communicative turn in regional studies, this chapter argues that a wider reaching discursive approach is needed to understand all possible sources for misunderstandings and competing interpretation. The intent of this chapter is to demarcate these conceptual spaces that favour or hinder higher levels of communicative cooperation on local, national and international levels. In this context, it aims to include alternative local discourses on regional integration and their validity claims. It will further point at present conceptual shortcomings within the regional integration discourse. In this context, it will be argued that most current approaches fail to explain the full scope of regional integration insofar as they focus either on the issue of systemic complexity or on strategic cooperation and neglect the perceptual dimension of regional integration. This bias leads to a systemic exclusion of issues that are associated with concerns at lower levels (such as human security or local

Communicative indicators 53 ownership of the process). This chapter will argue for a parallel analysis of (nonstrategic/communicative) transformation processes at international, national and, most importantly, at local community level. In recent times, identity-based models have sought to remedy past theoretical shortcomings by adding a perceptual dimension to the field and studying newly emerging identification structures at international, regional and national level. However, their shortcoming lies in the fact that they do not (at least not explicitly) discuss the extent to which alternative local identities are represented, included or excluded. These questions of inclusion and exclusion can only be answered if one chooses to scrutinise further the enabling conditions of identity structures in terms of communication structures and processes. A definition of integration as a structure/outcome and process necessarily implies that we have to ask not only which common dynamics are currently used to reproduce or modify the status quo within given parameters but also which other factors rightly challenge the latter and lie beyond present conceptual categories. In this context, it is important to ensure that the term integration reflects also a critical potential. Following Habermas and Linklater (Linklater, 1998), this chapter suggests an inclusion/exclusion perspective to integration that conceptualises integration as an affirming life-worldly inclusion process and as a negating systemic exclusion process at the same time. It argues that current integration processes reinforce frictions on lower levels that have to be made explicit and have to be addressed by communicative means. As a consequence, this chapter makes a case for a conscious transition of the normative and interactive barriers that characterise the local community, national and international/regional divide. It stresses the importance of participation and conceptual complementarity and coherence on all levels of cooperation. While it is beyond the scope of this chapter to develop this argument fully in a comparative regional context, it will scrutinise current indicators for integration in the United Nations framework. It will question standard institutional definitions and provide conceptual alternatives. This chapter follows a methodology that was first outlined by Jürgen Habermas in his classic Reconstruction of Historical Materialism (Habermas, 1976b). This suggests the necessity of a de- and reconstruction of theoretical and perceptual discourses (e.g. on regional integration) and their normative foundations. It stresses that any analysis should begin with an epistemological critique of the dominant discourse of a discipline. As will be shown, structural-functional and neo-liberal assumptions influence the way we think and talk about regional integration and arguably also influence the ways in which we seek to compare it. The method of conceptual de- and reconstruction is quite straightforward and can be applied to any field of human knowledge. It is comprised of two steps as follows: 1

The first step lies in a de-construction of conceptual/textual certainty through an inclusion of competing normative agendas and a consequent identification of weaknesses within the functional/neo-liberal paradigm. This textual strategy will inform the first part of this chapter.

54 Ann-Christin Raschdorf 2

The second step is a reconstruction of the normative foundation of analysis and a development of a new set of (communicative) indicators (e.g. for regional integration).

According to Talcott Parsons (Parsons, 1949), the founding father of structural functionalism, integration specifies one of the key functions that every social system (this includes any kind of organisation, groups of individuals, communities or states and hence also regions) has to fulfil to ensure its survival. According to his AGIL scheme, social systems reproduce themselves through the fulfilment of four core tasks: •

• •

•

Adaptation: this task is derived from the necessity of a system to acquire/ reproduce adequate material resources. This function is fulfilled by the economic subsystem of a social system. Goal attainment: this task corresponds to the necessity of goal setting and implementation. This function is fulfilled by the political subsystem. Integration: this task highlights the necessity to maintain solidarity and coordination among the subunits of the system. This function is fulfilled in all (economic, political, cultural) subsystems and (cultural, personal, behavioural) action systems by the social and legal system. In other words, integration is necessarily a normative function that is safeguarded by normative agents. Latency: this task stresses the necessity to create, uphold and transmit the system’s particular cultural norms and values. This educative function is fulfilled by the cultural subsystem.

The above-mentioned functions are accomplished by different subsystemic actors: • • • •

in the economic domain, systemic needs for adaptation are met by fiscal bodies/large cooperations, in the political domain, governments fulfil goal-attainment functions, in the social domain, courts/unions/political parties ensure the systemic survival through the meeting of integration tasks, in the cultural domain the same needs are met by schools and churches.

Each subsystem operates either in terms of directive or communicative media that are: 1 2 3 4

money in the economic domain, votes in the political domain, normative influence/legitimacy in the social domain, value commitment in the cultural domain.

The latter are natural indicators for the success and stability of a system and its constitutive (economic, political, social and cultural) components. These indicators have been explored by regime theorists like Haas (Haas, 1958) and system theorists

Communicative indicators 55 like Luhmann (Luhmann, 1975). Clearly, structural-functionalism has undergone many modifications since Parsons’ days. However, one generic problem of his theory has remained for his predecessors and has been a subject of criticism ever since. While his model is one of the most adequate approaches to explain the functioning of a systemic status quo (e.g. in organisational studies), it cannot explain normative change insofar as it is lacking a critical perceptual dimension. It is this very aspect that is often forgotten in the study of international regimes and processes of regional integration. However, most interestingly, this theoretical shortcoming also has practical ramifications, insofar as Parsons’ structuralfunctional core assumptions are not only reflected in expert discourses but also in current peace-building practices. As will be shown below, most, if not all, UN programmes for action (seeking to rebuild failed, rough or post-conflict states, ensuring their integration in the world community) can be explained through Parsons’ blue-print. As a consequence, they also share the perceptual shortcomings associated with his static model. This is a real issue of concern insofar as peacebuilding processes are commonly understood as transformation processes seeking to promote normative change within a society/region and are aiming to rebuild social cohesion. However, it is difficult to envisage how this could be done without any in-built perceptual dimensions at regional as well as at national and local level. Any critical review of the past requires an ideology-critical (life-world) perspective, which the present integration and peace-building discourse is lacking. The next section will show how a critical based approach could contribute to a better understanding of additional challenges for peace-building and regional integration. Figure 3.1 shows how the four main areas of the current UN sustainable peacebuilding strategy – sustainable development, good governance, rule of law and education – reiterate Parsons’ catalogue of functional necessities of an integrated system. The optimum systemic condition is in this instance a peaceful international order that reproduces itself through free markets and economic globalisation, democracy, universal norms like the adherence to human rights and access to Western education. These ideals have corresponding indicators. Poverty is quantified as an income under one dollar a day, economic success is measured by a state’s share in the world market, good governance means that leadership is also being made quantifiable – through elections/the number of votes. Even social and cultural progress is operationalised in numeric terms like number of people with internet access/literacy rates. Obviously, these indicators are focused on quantifiable outcomes that can legitimise ‘result-orientated’ processes. They are modelled in analogy to quantifiable media of the economic and political domain (money and votes) since variables like normative influence/legitimacy and value commitment are difficult to operationalise, quantify and measure in a cross-cultural context. This equation is clearly problematic and has sparked many methodological debates. It has also exemplified the urgent need for alternative indicators. But this is just one side of the story. While it is difficult to explain a normative phenomenon (like integration) solely in quantitative terms, there is an even more worrying aspect that has remained largely unnoticed. The structural-functional parallels

56 Ann-Christin Raschdorf DEVELOPMENT

RULE OF LAW GOOD GOVERNANCE EDUCATION/ CULTURAL IDENTITY

Economic dimension Social dimension Political dimension Cultural dimension

SYSTEMIC DIMENSION INT. COMMUNITY/REGIONS/STATES

Figure 3.1 Parsons’ pattern variables revisited

between UN programmes for action and Parsons’ model show that in most current practices peace-building is equated with finding ways to guarantee the functioning of a system and not with a normative recovery of a society. In other words, current peace-building processes neglect core perceptual transformation processes in the field of social and cultural integration. They seek to establish a status quo, a particular predetermined functional outcome. They do not allow the simultaneous conceptualisation of integration as a process and outcome. Why is that? The dilemma described above echoes a theoretical debate on legitimatisation that took place in sociology roughly 20 years ago. It was sparked by some observations made by Jürgen Habermas that have remained largely unnoticed in other disciplines but that have nevertheless not lost their validity. These thoughts provide an interesting new angle on how to define or redefine processes of integration. Habermas argues that while Parsons’ model can explain the importance of integration for the order and maintenance of a society, it does not account for the fact that present communicative integration processes are disrupted and changed by systemic forces. He speaks in this context of a ‘legitimisation crisis’ that characterises all modern societies. According to Habermas, integration

Communicative indicators 57 processes are the product of cultural life-worlds (Parsons’ social/cultural domain). Habermas argues that these processes are disrupted by the system (Parsons’ economic and political domain) (Habermas, 1981). He argues that integration processes are impoverished through the systemic interference of quantifiable media (money/votes) which replace communicative media that are based on a shared normative understanding. In other words, the life-world is organised according to quantifiable systemic priorities (money/power). Habermas refers to this process as ‘colonialisation of the life-world’. Systemic priorities (money/power) alienate actors from their cultural and normative values and turn them into agents of the system. Actors become either clients of the welfare state, and global consumers with misconceived needs, or disillusioned anarchists who might turn against the system but without any normative reference point (think of anarchic opposition or violent protests at World Summits or Attac). In the long run, the growing normative anomy also threatens the survival of the system insofar as the latter loses its normative foundations and hence its integrative powers. The system has to compensate for this through an increased systemic and administrative effort in which it tries to appease its citizens through further concessions of a welfare state. This requires a renewed intervention into the life-world (and on the periphery if one thinks for example of the ongoing changes in immigration and asylum policies). As a result the public sphere – that is for Habermas the mechanism through which agents of the life-world can engage in discursive will formation, that is to say can give expression to their real needs and influence policies – is again reduced and fragmented. In this way, faith in the normative foundations of the system and hence its legitimacy is eroded. Culturally shared feelings of a common purpose and shared visions that have safeguarded processes of social and cultural integration are lost. This process results ultimately either in moral anomy and blind consumerism or extreme traditionalism and violence. Current phenomena like terrorism and weak states can be (among other things) explained through an inadequate integration of (local/national) social systems in the current world order. It can be argued that these counter-movements that challenge the merits of globalisation seek to assert and open lost public spheres that could legitimate and control the process. Habermas’ argument suggests that a stable international/ regional order (based on successful integration processes) requires participation processes in all dimensions of the public sphere, that is to say on local, national and international level. Hence, any international, regional, national or local system that is not based on complementary normative understandings ultimately undermines itself and becomes a subject of disintegration. On the indicator front this means that key areas for research have to be those communicative media that are operative in the life-world and that reflect and reproduce shared understandings. But how can these variables be operationalised if they cannot be quantified? The key to a definition of qualitative indicators for (regional) integration is, of course, communication. To establish which kind of communicative indicators can be used, we have to look at the prerequisites of discourse. Obvious choices are, for example, the degree of participation in a society, an intact public sphere and a reflexive state of cultural/collective (self)knowledge

58 Ann-Christin Raschdorf (e.g. willingness to redefine a group identity in the light of contesting values). The latter point is particularly important for a successful development of truly inclusive identity formations. To achieve and develop fully reflexive and inclusive ways of thinking within a (regional/national/local) community, it would be necessary to undertake a critical but also affirmative re-reading and recovery of traditional forms of identification and cultural knowledge. The above-mentioned aspects could be positively influenced through grass-root consultations and empowerment of the poor and women through participatory education. Of course, much of what has been said so far is not essentially new. There is a growing number of practitioners who acknowledge that every institutional and interactive practice promoting integration exists through and is limited by its terminology. This insight finds its expression, for example, in a recent trend for cultural-political correctness in the language of the United Nations. For example, the term ‘local ownership’, which was first introduced by the United Nations Development Programme (UNDP) and then later reluctantly adopted by other international actors like the World Bank (WB), is one prominent example for a new awareness and acceptance of the cultural Other, the concession of limited modern wisdom and contextual constraints. This term stresses the importance of alternative normative agendas and the necessity of local participation and empowerment. The growing acceptance of sustainable peace as a necessary precondition for sustainable development (best expressed in the Brahmini Report, the latest UNDP strategy papers and the Special Reports of the Secretary General on Conflict Prevention and Conflict Resolution in Africa) further demonstrates an increasing understanding of procedural interdependence and a change in settings of objectives. Besides standard reforms of the security sector, demilitarisation and supervision of ceasefires (through classic peace-keeping operations) and macro-economic initiatives (WB/UNDP), other social components like the promotion of the rule of law, electoral assistance, re-education and resettlement of former combatants and the support of national reconciliation commissions have been added to the catalogue of activities. The latter are coordinated through the UNDP resident representative system, which also includes the UNDAF framework, that explicitly seeks to foster and facilitate communication processes between UN agencies in the field, local NGOs, INGOs and governments. Through the procedural inclusion of actors at all levels, processes of political participation and civil society building have been strengthened. However, despite all of these efforts, it cannot be denied that this kind of sustainable peace-building still follows the unreflected principles of a dominant political Western discourse and consequently has not much in common with a culturally sensitive approach that fosters international, regional or national integration from the ground up. Current buzz words in the UN discourse like ‘good’ governance still suggest that the ultimate task of any integrating practice lies in the facilitation of a structural assimilation of periphery states to Western democracies.

Communicative indicators 59 In this comparative context, any alternative set of beliefs (reflecting different life-worldly/cultural knowledge) must appear suspect and/or inferior. True is what is dictated by science and economic interest. Just is what is to be considered as Western law. To give a simple example: not many practitioners would equate the application of the Sharia with rule of law. This is surprising insofar as the Sharia has been part of the constitution of secular democratic countries like India for the past 50 years. Although there are some penal provisions that give clear cause for concern, much of Islamic family law is a consistent alternative legal universe that has made provisions for divorced women long before females even had property rights or could get a divorce. On the whole, there is an ongoing trend to mistrust cultural/life-worldly solutions that are pivotal for integration. Adherence to traditional values is internationally misunderstood as an indicator for less developed, in structural terms, weaker states. And nearly every form of ideology is perceived as a potential terrorist threat. This is clearly as much a result of a realist discourse (‘norms are contra-productive to order’) as it is a product of neo-liberal thinking (‘democracy equals free trade and profit’) and a cultural bias (‘Western democratic states are structurally better developed (and more peaceful) than nonWestern states’). These narratives are structural equivalents to Parsons’ economic and political domains and Habermas’ notion of the system. They are major agents of colonialisation. They hide some of the most predominant causes for disintegration on the periphery. They conceal, for example, the fact that conflicts do not necessarily result from the intra-systemic inability to cope with internal problems through the application of traditional, normative solutions (e.g. weak states) but from systematic misuse or a lost/limited understanding of the latter, or external pressures of a neo-liberal world order and its (national/local) agents. There are many ways in which cultural/ life-worldly knowledge can be distorted and people can be prevented from being themselves or are hindered from engaging in reinterpretation. Put differently, although normative systemic agents like UNDP acknowledge the importance of local ownership they do not give sufficient attention to the structural function that this notion has for integration processes like peace-building and sustainable development. As a result, UN agents perceive local ownership as an additional goal and not as an enabling condition. As a consequence, the current terminology still lays more stress on the necessity for a cultural transformation of the non-Western rather than the need for local reinterpretation and cultural adaptation of functional transformation processes. This conceptual shortcoming is a consequence of a missing awareness and research into the normative/life-worldly components of integration processes. This weakness is best expressed in terms of another systemic UN buzz word ‘resultorientated process’. The latter clearly specifies a functional/systemic outcome (in Habermas’ terminology ‘strategic action’). It does not describe a consensual/ communicative based process. The current peace-building and development discourse simply ignores the fact that there is not only a necessity for a – economic, political and legal – sustainable order but also for a social and cultural sustainable peace. The present regional integration discourse commits the very same error

60 Ann-Christin Raschdorf through a conceptual negligence of communicative indicators for (socially and culturally sustainable) integration. Current functionalist assumptions stress the ideal of systemic stability at the cost of cultural diversity. Neo-liberal values of globalisation and economic expansion subjugate communicative and moral needs further under strategic prerogatives of systemic survival and reinforce the wellknown pathologies of modernity/colonialisation of the life-world that affect all societies but in particular the weaker states on the periphery. Despite all lip-service, most peace-building, development and integration efforts are still part of these narratives. This chapter has tried to show that an analysis of integration must lie beyond standard answers. It can not solely equal the meeting of functional needs. A successful integration process starts with a joint communicative/critical assessment of functional and normative needs (of all parties involved) and ends with a concrete assessment of the process within the framework of a society’s own categories and values. Given the normative nature of the process, the success of integration processes could be measured by the degree of dialogue between concerned actors on the ground and those actors and agencies in power (this applies on a national, regional and international plane). Integration starts from the ground up. It is this form of participation that should ultimately serve as a cross-cultural indicator for good indigenous governance (and not, for example, the frequency of elections) and a functioning civil/international society. So far, peace-building, development and other integration strategies have not been based on a critical and creative application of cultural knowledge which has always led – in one way or the other – to a duplication of existing (Western) knowledge. This explains why practitioners have found it extremely difficult to include ideals of local ownership and community empowerment in their peace-building and development agendas. Ultimately, practitioners are faced with an unsolvable dilemma. On the one hand, their functional framework for action provides clear guidelines that encourage a replication of Western political and economic structures. Their action is focused on systemic adaptation and functional/neo-liberal goal attainment. On the other hand, they are confronted by competing normative directives seeking to promote integration and latent pattern maintenance. These objectives have, strictly speaking, no reference point in their framework for action. In this context, a critical theory based approach to regional integration can provide a unique normative/life-worldly perspective on interrelated questions of regional peace and development (compare Chapter 10). Its explanatory value results from its conceptual ability to bridge the gap between the domestic and the regional/international and its capacity to overcome the system/life-world divide. Integration, empowerment, local ownership and participatory practice are all communicative terms that depend on the application of communicative reason. Following Habermas, a critical approach suggests the introduction of a life-worldly perspective to integration that respects cultural knowledge and diversity. It argues for structural reform through communicative and moral learning instead of simple adaptation. It attempts to highlight those unjust and unequal power structures that the term ‘globalisation’ seeks to conceal and offers an ideology critique.

Communicative indicators 61 Current static models of integration leave little or no room for normative adjustments. They can explain neither transformative change nor ideological distortions. Some theorists have suggested remedying this condition by understanding functional outcomes in their procedural context. However, this does not solve the initial problem insofar as systemic processes assign structural functions to different actors that reproduce outcomes. This is why the study of the phenomenon of integration requires a life-worldly perspective. One aspect that will be crucial for the success of regional integration concepts on the periphery is the avoidance of structural-functional analogies that suggest the possibility of copying a European model of integration. The term ‘regional integration’ must not become yet another conceptual addition to a list of strategic do and don’ts for states on the periphery in their quest to survive the rough waters of the international system. It should become an expression of real and legitimate communicative cooperation of states/regions that share a common colonial history or that feel they have other shared local reference points/interests. This chapter has argued for an inclusion of communicative indicators in the monitoring of regional integration processes. It has suggested operationalising, in addition to numeric/systemic indicators of money and power, alternative communicative variables measuring cultural legitimacy and value commitment through an inclusion of a life-worldly perspective to integration. In this context, special attention was given to procedural indicators for communicative participation and empowerment. These two variables specify cornerstones of a formal dialogical matrix that seeks to put different normative assumptions on different levels under a constant review. The latter would allow for a definition of varying degrees of local ownership through a measurement of processes of discursive inclusion and exclusion. Positive communicative indicators for local ownership would include a promotion of local discursive participation through grass-root consultations, communicative gender/minority mainstreaming, communicative empowerment of the poor and minorities, a fostering of openness and diversity of public spheres through the application of participatory methodologies and an adoption of a reflexive learning position of peace-building and development practitioners. Of course, this list is not comprehensive but it indicates how a communicative approach can help local actors by opening spaces for authentic participation and through reviewing the assumptions that are held by expert practitioners in the field.

REFERENCES Guba, E.G. and Lincoln, Y. (1989) Fourth Generation Evaluation, London: Sage. Haas, E. (1958) The Uniting Europe: Political, Social and Economic Forces, 1950–1957, Stanford: Standford University Press. Habermas, J. (1976a) Vorstudien zur Theorie des kommunikativen Handelns, Frankfurt: Suhrkamp Verlag. Habermas, J. (1976b) Zur Rekonstruktion des Historischen Materialismus, Frankfurt: Suhrkamp Verlag.

62 Ann-Christin Raschdorf Habermas, J. (1981) Theorie des kommunikativen Handelns, Frankfurt: Suhrkamp Verlag. Linklater, A. (1998) The Transformation of the Political Community, Cambridge: Polity Press. Luhmann, N. (1975) Soziologische Aufklärung Bd 2, Opladen: Westdeutscher Verlag. Parsons, T. (1949) The Structure of Social Action, New York: Free Press. Schütz, A. and Luckmann, T. (1979) Strukturen der Lebenswelt, Frankfurt: Free Press.

Part II

Assessment of economic integration

4

Regional integration agreements and the geography of world trade Statistical indicators and empirical evidence Lelio Iapadre1

INTRODUCTION A process of international economic integration, propelled by strong technological and economic forces, as well as by trade liberalisation policies, characterised the second half of the twentieth century, and translated into a growth of world trade much more rapid than that of production. This phenomenon has been gradually assuming a global scope, but manifested itself with particular intensity within groups of countries tied by geographic proximity, or by historical and political factors, such as the conclusion of preferential trade agreements. Regionalism is at the centre of a growing body of theoretical and empirical research, and its implications for the multilateral trading system are still a source of controversy. At the same time, policy circles tend to adopt a pragmatic approach to the issue, aimed at recognising the strong political and institutional motivations for regional integration policies, as well as at reducing their possible economic costs (World Bank, 2000). One of the first steps to be taken in order to assess the trade effects of regional integration agreements is to measure the actual intensity of trade among their member countries. The problem is less trivial than it could appear at first sight, and this chapter aims to offer a contribution to its solution, by proposing and experimenting with new measurement methods. The following section contains a critical survey of the available statistical indicators for the measurement of intra-regional trade intensity, as well as some proposals which aim to overcome their limitations. There follows a discussion of some indicators that can be obtained by combining trade and GDP data, aimed at measuring the trade-creating effects of regional integration. Next, all the indicators are applied to the analysis of intra-regional trade within the four main regional integration agreements (ASEAN, European Union, Mercosur and NAFTA) in the 1990–2003 period. Some brief remarks conclude the chapter.

66 Lelio Iapadre MEASURING THE INTENSITY OF INTRA-REGIONAL TRADE In the literature on international trade, countries are often grouped in areas – or regions – that are defined according to different physical, political or economic geography criteria, among which the membership of preferential trade agreements is particularly important. Trade flows are defined as intra-regional if both partners belong to the same region, and extra-regional if they belong to different regions. The importance of intra-regional trade (exports plus imports) is often measured by the intra-regional trade share (Si):

Si = tii /ti .

(4.1)

where: tii = region i’s intra-regional trade, ti. = region i’s total trade. At first sight this indicator seems the most obvious choice to detect the trade effects of regional integration and is indeed widely used in empirical studies.2 However, its usefulness for both cross-region and time-series analysis is limited by some problems, which have been outlined by Anderson and Norheim (1993: 80–1), as well as by Frankel (1997: 21–5). When comparing different regions, for example, the intra-regional trade share may give misleading information, because its value is biased by the number of countries in each region and by their dimensions. Given the size of a region, as measured by its total trade, the higher the number of countries in that region, the larger its intra-regional trade share will be. In other words, splitting a region into an increasing number of countries (as happened in Central and Eastern Europe in the 1990s) raises its intra-regional trade share by transforming domestic exchange into international (intra-regional) trade. Moreover, other things being equal, a region with a high number of member countries would show a larger intra-regional trade share than a region of the same total trade size, but with a smaller number of members. The second problem is more important and subtle. In order to understand it, the concept of geographic neutrality of trade flows must be introduced, defined as the absence of preferential directions: the geographic distribution of a region’s trade is said to be neutral if the weight of every partner in the region’s trade is equal to its weight in world trade. If a partner is more important than what would be implied by the neutrality criterion, this reveals the presence of factors, such as common borders or regional integration agreements, that generate a preferential orientation in trade flows. Using the neutrality criterion, it is easy to verify that, other things being equal, and in particular for any given number of member countries, the intraregional trade share is positively influenced by the size of the region, as measured by its total trade. In other words, even assuming that every member country’s trade is geographically neutral, larger regions would show a higher intra-regional trade share only because of their greater size, that is independently of the actual intensity of intra-regional trade.

Indicators of intra-regional trade 67 Similar arguments may be used in the case of a single region to explain why an increase in its intra-regional trade share does not necessarily imply a higher inward orientation of trade flows, but may simply reflect a growth in the region’s relative size in world trade. Stated differently, other things being equal, the intra-regional trade share is biased by a pro-cyclical distortion. In order to eradicate these problems, one may use the trade intensity index, proposed by Brown (1949) and elaborated by Kojima (1964). In its simplest form, the intra-regional trade intensity index of the region i (Ii) is equal to the ratio between the intra-regional trade share (Si) and the region’s share in world trade (Wi):3

I i = Si /Wi = (tii / ti . )/(ti . /T )

(4.2)

where: T = world trade. This index is equal to one if the region’s weight in its own trade is equal to its weight in world trade (geographic neutrality). On the contrary, if intra-regional trade is relatively more important than trade flows with the rest of the world, as is usually the case, the intra-regional trade intensity index is higher than one. It can be considered as a variant of the well-known index of revealed comparative advantages, which was proposed by Balassa (1965) in order to study trade specialisation patterns. If a region’s intra-regional trade intensity is higher than one, it can be said that the region’s trade is ‘specialised’, i.e. relatively more oriented, towards its member countries rather than towards the rest of the world. An increase of the index, revealing that the region’s importance for its own trade rises more (or falls less) than its weight in world trade, can be considered as an ex post indication of an increase in trade integration, that is a reduction of trade resistances among the region’s countries (Drysdale and Garnaut, 1982). The meaning of the intra-regional trade intensity index can be further clarified using the interpretation proposed by Kunimoto (1977) for a wide class of similar indicators.4 The intra-regional trade intensity index can be seen as the ratio of the actual value of intra-regional trade flows to their expected value, E(tii), under the assumption of neutrality in the regional direction of trade:

I i = tii / E(tii )

(4.3)

where: E(tii) = ti.2/T In other words, assuming that the matrix representing the geographic distribution of world trade flows shows no statistical connexion between their regions of origin and destination, this would reveal the absence of preferential directions (neutrality) and would translate into values of intra- and extra-regional trade flows that would be proportional to the importance of each region in world trade. These hypothetical values represent the benchmark against which the intensity of actual trade flows can be evaluated. In a region, if factors of any kind foster trade relations among

68 Lelio Iapadre member countries, the value of intra-regional trade will be higher than its expected value under the neutrality assumption, which translates into an intra-regional trade intensity index higher than one. Although immune to the specific problems afflicting intra-regional trade shares, due to their sensitivity to the number and size of member countries, the traditional Balassa intensity index is also characterised by at least three uncomfortable features, which limit its interpretability and usefulness: • • •

range variability: the maximum value of the index is inversely related to the region’s total trade size; range asymmetry with respect to the threshold value of one; dynamic ambiguity: possible sign concordance between the changes of complementary indicators.

The following subsections will be devoted to the analysis of these problems, and point to a possible solution for each of them.

Range variability Looking at equation (4.2), it is easy to see that the actual range of values assumed by the intra-regional trade intensity index is influenced by the region’s size. In fact, whilst in the extreme case of no intra-regional flows the intensity index is equal to zero for any region, its maximum value, which is reached in the opposite case when all trade is intra-regional, is inversely proportional to the region’s relative size in terms of total trade:

Max ( I i ) = T /ti .

(4.4)

In other words, the intra-regional trade intensity index ranges from zero (no intraregional trade) to a maximum value (no extra-regional trade), which is the higher, the smaller the region’s total trade. This range variability problem implies that indices computed for different regions and/or periods are not perfectly comparable among each other. At first sight, the solution for this problem could appear to divide the intraregional trade intensity index by its maximum value. However, the result of this normalisation would simply be equal to the intra-regional trade share, arousing again the problems mentioned before. An alternative solution consists in changing the denominator of the intra-regional trade intensity index, by substituting the region’s weight in the trade of the rest of the world (Vi), which is equal to zero in the limiting case of no extra-regional trade, for the region’s weight in world trade. The result could be called homogeneous index of intra-regional trade intensity (HIi):

HI i = Si /Vi = (tii /ti . )/(t ri /t r .) where: tri = region’s i extra-regional trade, tr. = total trade of the rest of the world.

(4.5)

Indicators of intra-regional trade 69 The threshold value of this index, in the case of geographic neutrality, is equal to one, no different from its traditional Balassa formulation, but its range goes now from zero (no intra-regional trade) to infinity (no extra-regional trade), independently of the region’s trade size.

Range asymmetry The second problem of the intra-regional trade intensity index, in both the formulations discussed so far, is that its range is not symmetric around the neutrality threshold. More precisely, if intra-regional trade is lower than its expected value under the assumption of geographic neutrality, the intensity index ranges only from zero to one, whilst it goes from one to infinity in the homogeneous formulation, and from one to a number which is always much higher than two in the traditional Balassa formulation, if the region’s trade reveals a preferential inward orientation. This problem may give rise to biased assessments of the index changes, depending on whether they occur above or below the neutrality threshold. In addition, it may create problems in econometric estimates involving the index. One possible solution for the asymmetry problem consists in applying to the homogeneous index the transformation proposed by Dalum et al. (1998) for the Balassa revealed comparative advantage index, which yields the following symmetric index of intra-regional trade intensity (SIi):

SI i = ( HI i − 1)/( HI i + 1) = (Si − Vi )/(Si + Vi )

(4.6)

This index ranges from minus one (no intra-regional trade) to one (no extraregional trade), and is equal to zero in the case of neutrality. 5 It is therefore a standardised transformation of the intensity index, which allows proper crossregional comparisons.

Dynamic ambiguity Each of the above-mentioned indicators for intra-regional trade can be compared with a complementary indicator, measuring the intensity of extra-regional trade. In the case of the intra-regional trade share, this complement is given by the share of extra-regional flows in the region’s total trade. It is obvious that an increase in the former implies a decrease in the latter, and vice versa. The complementary indicators of the three intensity indices discussed in the previous subsections are given by the following extra-regional trade intensity indices:

Ei = (1 − Si )/(1 − Wi )

(4.7)

HEi = (1 − Si )/(1 − Vi )

(4.8)

SEi = ( HEi − 1)/( HEi + 1)

(4.9)

70 Lelio Iapadre The value of these indicators will be the higher, the larger is the share of extraregional trade in a region’s trade, relative to the other regions’ weight in world trade, in equation (4.7), or to the intra-regional trade share of the rest of the world, taken as a single region, in equations (4.8) and (4.9). The geographic neutrality threshold is equal to one for the first two indicators, and to zero for the third one. Unfortunately, unlike the intra- and extra-regional trade shares, all the three couples of intensity indices are afflicted by a common problem: the change of the intra-regional index, although having usually opposite sign than that of its complementary extra-regional index, does sometimes take the same sign, which makes it difficult to interpret the dynamics of the indicators. More precisely, it can be shown that, if Ii ⫽ Ei, i.e. if the regional direction of trade is not neutral, and if the ratio between the changes of Si and Wi lies in the interval between Ii and Ei, the two complementary indices change in the same direction (condition of sign concordance). Since almost all regions are intraregionally oriented, Ii is usually higher than Ei. In this case, if:

Ei < ∆Si / ∆Wi < I i

(4.10)

then: ∆Ei ⋅ ∆I i > 0 and, more precisely, if the sign concordance condition holds, and ∆Wi > 0, then ∆Ii < 0 and ∆Ei < 0; on the contrary, if under the same condition, ∆Wi < 0, then ∆Ii > 0 and ∆Ei > 0. In other words, under condition (4.10), if a region’s trade is relatively dynamic, in the sense that its weight in world trade increases, both the intra- and the extraregional trade intensity indices decrease. On the contrary, if the region is relatively slow, the two complementary indices increase. In practice, with reference to the latter case, the increase of the intra-regional trade intensity index is due to the fact that the intra-regional trade share falls at a lower rate than the region’s weight in world trade, whilst the increase of the extra-regional trade intensity index results from a rise of the corresponding trade share which is relatively larger than the increase of the other regions’ weight in world trade. These results are reversed in the few cases where Ii < Ei, and hold also for the homogeneous and symmetric versions of the index. It should be noted that the range of values of ∆Si/∆Wi for which the complementary indices change in the same direction is equal to the difference between their levels, which means that, other things being equal, the probability of obtaining results that are dynamically ambiguous is higher when intra-regional trade intensity is either very high or very low. It is in any case difficult to interpret the data, when the indices show a simultaneous increase (or fall) of both intra- and extra-regional trade intensity. Any reference to the effects of regional integration policies would be problematic, because the first index seems to contradict the second, and vice versa. In order to solve this problem, one could make use of the ratio between the complementary indicators, which shows synthetically if the intensity of

Indicators of intra-regional trade 71 intra-regional trade is growing more or less rapidly than that of extra-regional trade. The resulting indicators of relative intra-regional trade intensity, which could be called trade introversion indices, are the following:

Ji = I i /Ei

(4.11)

HJi = HI i /HEi

(4.12)

SJi = ( HJi − 1)/( HJi + 1)

(4.13)

It is easy to see that, also in this ‘relative’ version, the homogeneous index HJi ranges from zero (no intra-regional trade) to infinity (no extra-regional trade), independently of the size of the region, and is equal to one in the threshold case of geographic neutrality. Correspondingly, its symmetric formulation SJi ranges from minus one to one, passing through the neutrality threshold of zero, and should be preferred to the others for the reasons already explained in the previous subsections.6 Moreover, a symmetric trade extroversion index (SFi) can be defined as:

SFi = ( HEi /HI i − 1)/( HEi /HI i + 1)

(4.14)

and it is clear that SJi = – SFi. The dynamic ambiguity problem is absent in this case, since any change in the trade introversion index necessarily implies an opposite and equal change in the complementary extroversion index. An interesting property of the homogeneous trade introversion index is that it simultaneously measures the intensity of intra-regional trade in the target region i and in the rest of the world, taken as a single ‘complementary region’. Stated differently, if the world is divided into two regions, since, by definition, S2 = (1 – V1); V2 = (1 – S1), and vice versa, it is easy to show that:

HJ2 = [(1 − V1 )/(1 − S1 )] /(V1/S1 ) = HJ1

(4.15)

which obviously implies that SJ2 = SJ1, independently of the regions’ size. Intuitively, it is reasonable that, if the world is divided into only two regions, any level of trade introversion in one of them implies the same result in the other, with the limiting case where both regions are completely isolated from each other. The symmetric trade introversion index can therefore be proposed as the most satisfactory measure of intra-regional trade intensity. It must be stressed, however, that SJi can give only an ex post evaluation of the level of trade integration within the region, which is not enough to draw any conclusion about the strength of the underlying causal links. In other words, trade introversion indices simply measure revealed trade preferences among the region’s members, in analogy to what can be said about the Balassa specialisation index, which measures revealed comparative advantages, without pretending to give any ex ante assessment of their intensity.7

72 Lelio Iapadre THE TRADE-CREATING EFFECTS OF REGIONAL INTEGRATION: INDICATORS OF RELATIVE OPENNESS The indicators discussed in the previous section are all aimed at measuring the relative intensity of intra-regional trade with respect to the region’s trade with the rest of the world. Trade introversion can be the result of a variety of factors, including the trade diversion effects of regional integration agreements. However, an increase in trade introversion indices can also reflect an intra-regional trade creation process, without diverting effects on trade with the rest of the world. Trade introversion simply means that the region’s weight in its own trade is higher than its weight for the rest of the world, or in other words that actual intra-regional trade flows are larger than their expected level under the hypothesis of geographic neutrality. The use of the geographic neutrality criterion requires an exogenously given value of the region’s total trade. However, international integration factors affect not only the intensity of intra-regional flows, as measured by trade introversion indices, but also the total value of the region’s trade. More precisely, a region’s weight in world trade (Wi) is equal to the product between the region’s share of world output (Gi) and its relative degree of openness (Oi) with respect to the world average degree of openness8 (both measured by the trade-to-GDP ratio9):

Wi = Gi ⋅ Oi = yi /Y ⋅ (ti ./yi )/(T /Y )

(4.16)

where: yi = region i’s gross domestic product (GDP), Y = world GDP. The two elements of equation (4.16) are influenced by a complex set of cyclical and structural forces.10 Specifically Gi depends on the various supply and demand factors letting the region’s gross domestic product grow faster or slower than world output. As to the relative degree of openness (Oi), its variations may be seen as reflecting mainly changes in resistance factors which dampen the region’s international trade as a whole (including its intra-regional component), such as those changes induced by the growing integration of national markets and by multilateral trade agreements. In comparing different regions, it should anyway be remembered that the level of trade openness can be the result of many factors, such as country size, economic structure, distance from the main markets and trade policies (in the region and abroad). The speed of integration processes may be different across the regions of the world, resulting in variations in the relative degree of openness of each region. However, changes in Oi may also be influenced by the internal and external trade creation effects of regional integration.11 Some of the problems already described for trade intensity indices also affect the relative openness indicator Oi. In order to solve them, a symmetric indicator of relative openness (SOi ) can be computed:

SOi = {(ti ./yi )/[(T − ti . )/(Y − yi )] − 1}/{(ti ./yi )/[(T − ti . )/(Y − yi )] + 1} (4.17)

Indicators of intra-regional trade 73 SOi is based on the comparison between the region’s trade-to-GDP ratio and that of the rest of the world. This index is higher than zero if the region’s degree of trade openness is higher than the world average, revealing that forces leading to market integration are stronger than in other regions, possibly also as an effect of preferential trade agreements. It can be useful to combine the measurement of intra-regional trade intensity and relative openness, in order to generate a comprehensive measure of the trade effects of regional integration. This can be done through an index of propensity to intra-regional trade (PIi) defined as the intra-regional trade share (Si) divided by the region’s weight in world GDP (Gi):12

PI i = (tii /ti . )/( yi /Y )

(4.18)

It is easy to see that PIi is also equal to the product between the intra-regional trade intensity index (Ii) and the region’s relative degree of openness (Oi):

PI i = I i ⋅ Oi

(4.19)

If PIi is higher than one, the intra-regional trade share is larger than the region’s share of world output, which can be the effect of a high relative degree of openness (global trade creation) and/or of a high intra-regional trade intensity (revealed trade preferences). Adapting to this indicator the approach used by Kunimoto (1977) to interpret trade intensity indices (see equation (4.3)), it can be shown that the propensity to intra-regional trade is equal to the ratio between the actual value of intra-regional trade and its expected value, which is here proportional to the region’s weight in world GDP:

PI i = tii /E′(tii )

(4.20)

where: E′(tii ) = Gi ⋅ ti . = [( yi )2 /Y ] ⋅ (ti . / yi ) There is a clear analogy between the underlying structure of this descriptive indicator and the logic of gravity models of international trade, where the intensity of bilateral flows depends positively on the GDP of partner countries, and negatively on their ‘distance’.13 A PIi higher than one can be interpreted as a sign of a situation where, after controlling for the region’s GDP and its trade-toGDP ratio, intra-regional trade is higher than expected due to the operation of ‘proximity’ factors, such as common borders and preferential trade agreements. The two elements determining the expected value of intra-regional trade capture the effects of the region’s size and of its overall degree of trade openness, which can be related, among other things, to geographic distance and other barriers limiting the region’s international trade. Given such influences, the propensity to intra-regional trade can be directly explained by the linkages among the region’s

74 Lelio Iapadre members, although the relative importance of the various proximity factors can only be estimated with a gravity model.14 The index of intra-regional trade propensity is affected by all the problems already discussed with reference to the traditional specification of the trade intensity index. The maximum value of PIi is inversely related to the size of the region; its range is not symmetric around its neutrality threshold of one; and its changes may have the same sign as those of the complementary indicator of propensity to extra-regional trade (PEi), given by the ratio between the extraregional trade share and the rest of the world’s weight in world GDP:

PEi = (1 − Si )/(1 − Gi )

(4.21)

These problems can be solved in a way similar, but not identical, to that followed for the intra-regional trade intensity index. The difference is due to the denominator of PIi, which cannot be adjusted in the same way as that of Ii, because GDP flows, unlike trade flows, are not associated to a couple of partner regions, but refer only to the region where the product is produced. In order to bypass this hurdle, it is necessary to reverse the sequence followed in the construction of SIi. First, the asymmetry problem can be reduced, although not suppressed, by building a symmetric index of intra-regional trade propensity (SPIi), through a formula similar to equation (4.6):

SPI i = (PI i − 1)/(PI i + 1)

(4.22)

This index is equal to zero under the assumption of neutrality in the regional direction of trade and ranges from minus one (no intra-regional trade) to a maximum value (no extra-regional trade) which is the closer to one, the smaller the region’s weight in world GDP, biasing comparisons among different regions or periods. The second step could be to divide SPIi by its maximum value, getting a normalised index of intra-regional trade propensity (NPIi):

NPI i = SPI i /[(Y /yi − 1)/(Y /yi + 1)]

(4.23)

This index is also equal to zero under the assumption of neutrality, but its maximum value (no extra-regional trade) is equal to one independently of the region’s size. On the other hand, the comparability problem is now shifted to the minimum level of the index (no intra-regional trade), which is a negative number the closer to minus one, the larger the region’s weight in world GDP. In this case the problem is less worrisome, because the intra-regional trade share is almost always higher than the region’s weight in world GDP, so that the section of the NPIi’s range where the comparability problem matters is that of positive numbers. The last remaining problem, that is the possible sign concordance of changes in complementary indicators, has the same features as for the intensity indices. Its solution, although giving rise to a relatively complex indicator, has the advantage

Indicators of intra-regional trade 75 of solving completely the asymmetry and non-homogeneity problems which still affect both SPIi and NPIi. The first step is to compute an index of relative propensity to intra-regional trade (PJi ), given by the ratio between the two complementary indicators of intra- and extra-regional trade propensity:

PJi = PI i /PEi = (Si /Gi )/[(1 − Si )/(1 − Gi )]

(4.24)

Similarly to what is seen for the introversion indices, PJi is less ambiguous than its underlying complementary indicators because, even if their changes happen to have the same sign, it increases if a region’s propensity to intra-regional trade rises more rapidly than that to extra-regional trade, and vice versa. It is easy to see, furthermore, that the range of PJi is homogeneous: independently of the region’s size, it goes from zero (no intra-regional trade) to infinity (no extra-regional trade), crossing at one the neutrality threshold. Finally, a symmetric index of relative intra-regional trade propensity (SPJi) can be obtained in the usual way:

SPJi = (PJi − 1)/(PJi + 1)

(4.25)

SPJi is equal to zero if the regional distribution of trade is neutral and ranges between minus one and one, independently of the region’s size.

RECENT TRENDS IN INTRA-REGIONAL TRADE: A COMPARISON AMONG FOUR PREFERENTIAL INTEGRATION AREAS (ASEAN, EU, MERCOSUR, NAFTA) The indicators discussed in the previous sections will now be applied to the analysis of intra-regional trade intensity in the 1990–2003 period,15 with reference to the four regional integration agreements that have the highest share of world trade: the European Union (EU), the North American Free Trade Agreement (NAFTA), the Association of South East Asia Nations (ASEAN) and the Southern Common Market (Mercosur).16 Time series of trade data have been drawn from the WTO website,17 and are measured in US dollars at current prices. Throughout the 1990–2003 period, the country composition of each region has been kept constant as it was in 2003, independently of the actual accession date of each member, in order to avoid distortions due to changes in the number of member countries.18 Figure 4.1 shows the simple intra-regional trade shares of the four regions, computed according to equation (4.1). In the case of the EU, the trend is slightly decreasing, from around 64 per cent in the early 1990s to less than 62 per cent in the past four years.19 The other three areas show a more or less pronounced upward trend in the 1990s, which in the case of Mercosur was sharply reversed during the financial crises in Brazil and Argentina.

76 Lelio Iapadre 70% 60% 50% 40% 30% 20% 10% 0%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

EU (15)

NAFTA (3)

ASEAN (10)

Mercosur (4)

Figure 4.1 Intra-regional trade shares 16 14 12 10 8 6 4 2 0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

EU (15)

NAFTA (3)

ASEAN (10)

Mercosur (4)

Figure 4.2 Intra-regional trade intensity (traditional Balassa indicator)

The regions’ ranking is clearly influenced by their different trade size, as well as by the number of member countries. A completely different ranking emerges from Figure 4.2, which shows the intraregional trade intensity index, computed according to the traditional formulation of equation (4.2), resembling the Balassa index of revealed comparative advantages. The figure is dominated by Mercosur, whose intra-regional trade share was, on average, 13 times larger than the region’s weight in world trade, with an upward

Indicators of intra-regional trade 77 20

16

12

8

4

0

1990 1991 1992 1993 1994 1995 1996 1997

EU (15)

NAFTA (3)

1998 1999 2000 2001 2002 2003

ASEAN (10)

Mercosur (4)

Figure 4.3 Intra-regional trade intensity (homogeneous indicator)

trend of the intensity index, particularly strong until 1993. The other regions show much lower and more stable intensity indices. A similar picture is shown by Figure 4.3, where the intensity indices have been computed according to the homogeneous formulation of equation (4.5). The level of all the indices is obviously higher than in Figure 4.2, but the relative distances between the regions are lower, because the correction operated by equation (4.5) with respect to equation (4.2) is more pronounced for the larger regions, which lie in the bottom of the figure. Neither of the latter two figures gives a clear view of the time pattern of the indices for the three larger regions, because they are squashed by the high level of the Mercosur index. This problem is solved by the symmetric formulation of the intensity indices of equation (4.6), which has been used in Figure 4.4. Normalising the range of the index, from minus one to one, generates a much more readable figure, where all regions show significant changes across time. As explained above, however, all the intensity indices, whatever their formulation, are exposed to a problem of dynamic ambiguity. Figure 4.5 shows this problem in the case of the European Union. In general, one expects that an increase in intra-regional trade intensity will be associated with a fall in the corresponding index of extra-regional trade, and this is what actually happened in most of the years shown in Figure 4.5. However, there are three exceptions (1993, 1997 and 2000), when both the complementary indices rose, because the condition of sign concordance (equation (4.10)) held, and the EU’s total trade grew at a lower rate than the world average. Figure 4.6 shows the indicator proposed in this chapter in order to solve the above problem, i.e. the trade introversion index, computed in its symmetric specification (equation (4.13)). The regions’ ranking is now partly different from that

78 Lelio Iapadre 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

EU (15)

NAFTA (3)

ASEAN (10)

Mercosur (4)

Figure 4.4 Intra-regional trade intensity (symmetric indicator) –0.33

0.48 0.47 0.46

–0.34 0.45 0.44 –0.35

0.43 0.42 0.41

–0.36 0.40 0.39 0.38

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

INTRA-TRADE (left)

–0.37

EXTRA-TRADE (right)

Figure 4.5 Intra- and extra-regional trade intensity (EU-15) (symmetric indicators)

shown in the previous figures. Mercosur is confirmed as the area with the highest level of intra-regional trade intensity, with an upward trend which was particularly strong in the first three years, but was interrupted by the Argentine crisis. The other regions show similar levels of trade introversion. NAFTA is the area where trade introversion increased more, starting from relatively low levels in 1990. In the ASEAN region a fall of the index until 1995 was followed by an upsurge, particularly in the aftermath of the Asian crisis. Opposite trends appear in the European

Indicators of intra-regional trade 79 1.0

0.9

0.8

0.7

0.6 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

EU (15)

NAFTA (3)

ASEAN (10)

Mercosur (4)

Figure 4.6 Trade introversion (symmetric indicator) 0.6 0.5 0.4 0.3 0.2 0.1 0.0 –0.1 –0.2 –0.3 –0.4 –0.5 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

EU (15)

NAFTA (3)

ASEAN (10)

Mercosur (4)

Figure 4.7 Relative trade openness (symmetric indicator)

Union, where trade introversion has been slowly declining since 1995, after rising markedly in the previous years. As shown in the preceding section, trade introversion indices can be complemented with indicators of relative trade openness, aimed at capturing the total trade-creating effects of regional trade agreements and other integration factors. Figure 4.7 refers to the symmetric indicator of relative openness (equation (4.17)) and shows huge differences among the four areas, with the two American regions much less open than the rest of the world. It is a well-known property

80 Lelio Iapadre of the trade-to-GDP ratio to be inversely related to the size of the country, because the importance of the foreign markets relative to the domestic one decreases with the country’s GDP. Therefore, it is not particularly surprising that the relative trade openness of NAFTA is so low, given the GDP size of the USA. More striking is the position of Mercosur, which is probably due also to the relatively inwardlooking orientation of its member countries’ trade policies, as well as to the market access barriers faced by their exports, particularly in the agricultural sector. It is also interesting to note that no curve in Figure 4.7 shows a clear upward trend in the 1990s, which seems to reveal that the trade-creating effects of regional integration were not particularly strong, or at least not stronger than the other technological and economic factors leading to a global increase of the trade-toGDP ratio. The upsurges of the index for ASEAN in 1998 and for Mercosur in the past five years are due mainly to the sharp depreciations of the local currencies hit by the financial crises, which translated into an increase of trade prices much higher than that of production prices. Combining the indicators of trade openness with the trade introversion indices shown in Figure 4.6, one gets the index of relative intra-regional trade propensity (equation (4.25)), which appears in Figure 4.8. This figure ranks the four regions according to the ratio between their intraregional trade share and their weight in world production. ASEAN and Mercosur show the highest levels of SPJi, but the underlying factors are completely different. In the ASEAN countries the large importance of intra-regional trade is mainly the result of their higher degree of relative openness, as shown in Figure 4.7, whilst in the case of Mercosur it stems from a particularly high level of trade introversion (Figure 4.6). 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

EU (15)

NAFTA (3)

ASEAN (10)

Mercosur (4)

Figure 4.8 Relative intra-regional trade propensity (symmetric indicator)

Indicators of intra-regional trade 81 CONCLUSIONS The figures presented in this chapter show clearly that the empirical assessment of intra-regional trade is strongly influenced by the choice of the statistical instrument used to measure its importance. The simplest indicators, such as the intra-regional trade share and the trade intensity index, suffer from several limitations, impairing their ability to evaluate the dynamics of the process in a single region, as well as to compare different regions. In this chapter, some alternative indicators have been proposed and examined. One of them in particular, the symmetric trade introversion index, seems able to solve the main problems of traditional indicators, and offers a completely different picture of the regional geography of trade patterns. The highest degree of trade introversion is shown by a region, such as Mercosur, whose process of preferential integration began relatively late with respect to other regions, and was not particularly deep. This feature is common to other developing regions, not covered by this chapter, and points to one of the possible interpretations of the index: a high trade introversion could be the outcome of reciprocal protectionism between the region and the rest of the world. It is well-known that trade policies in developing countries are more inward-looking than in developed countries, and that, at the same time, their trade opportunities are severely limited by protectionist policies in the rest of the world. This could help to explain why the trade introversion index of Mercosur appears so high in relation to other regions. However, all the four regions considered in this chapter are characterised by a moderate upward trend in their trade introversion indices, albeit with different timing. In the EU, Mercosur and NAFTA the increase was relatively stronger in the first half of the 1990s. On the contrary, in the ASEAN region the upward trend began in 1996, after a phase of decline in the previous years. It would be difficult to ascribe this common trend to an increase in protectionism, given the prevailing open orientation of trade policies in the 1990s. A possible explanation could be found in the trade effects of the preferences among members of regional integration agreements. A useful complement to the trade introversion index can be found in an indicator of relative trade openness, which is based on the comparison between a region’s trade-to-GDP ratio and the other regions’ average. This index shows if integration forces are stronger at the regional level than on a global scale, and can therefore be interpreted as a measure of revealed internal and external trade creation. ASEAN was shown to be the most open region, while Mercosur and NAFTA were largely below the world average. However, in the 1990s no region exhibited a clear increasing trend in its relative openness, which could indicate that regional tradecreating forces were not stronger than the global drift towards an increase in the trade-to-GDP ratio. The index of intra-regional trade propensity combines the measurement of trade introversion and relative openness. It can be seen as the ratio between the actual and the expected value of intra-regional trade, the latter being based on the size of

82 Lelio Iapadre the region’s GDP and on its trade openness. There is here a clear analogy with the logic of gravity models of international trade. For opposite reasons, ASEAN and Mercosur were the regions with the highest intra-regional trade propensity in the 1990s. However, the simple descriptive indicators proposed in this chapter should be interpreted with caution. For example, an increase in relative trade openness, as measured by equation (4.17), does not necessarily mean that trade policies have become more open in the region than in the rest of the world. It only shows that the trade-to-GDP ratio has grown more rapidly than the world average, which can be the result of many factors other than trade policies, such as changes in economic structure, the international fragmentation of production and the complex linkages between migrations, capital flows and trade. Further research is needed in order to assess the causal relationships underlying the trade effects of regional integration. Moreover, indicators similar to those described in this chapter should be applied to the study of the geographic direction of foreign direct investment, in order to explore its links with trade integration. However, a deeper understanding of the relation between trade and investment in the context of regional integration requires the availability of comparable and detailed data on firms’ international activities, based on a new approach to the production of statistics on globalisation, centred on the enterprises more than on their transactions, which is emerging in several countries. Although these new developments are potentially very interesting, the current state of the available sources is not yet adequate to address the needs.

NOTES 1 The author would like to thank Michel Fouquin and Maurice Kugler for their very useful comments on a previous version of this chapter. The usual disclaimer applies. 2 See, for example, WTO (1995: 38–41). 3 Since no country can trade with itself, the denominator of the index should be corrected by subtracting from the region’s total trade, as well as from world trade, one n-th of the region’s total trade (where n is the number of countries in the region), as shown by Anderson and Norheim (1993: 82, Note 8). This correction ensures that the index is approximately equal to unity, if the geographic orientation of the region’s trade is not inward biased. The more similar are the trade values of member countries, the lower is the approximation error. Frankel (1997: 25–29) calls the non-corrected intensity indices ‘simple concentration ratios’. We will not use the word ‘concentration’ in this context, because it could be confused with its usual definition, which refers to the entire distribution of a region’s trade, rather than to the importance of a single element, such as intra-regional trade. The Anderson and Norheim correction is important for comparing trade intensity levels of different regions, but may be neglected if the interest is focused on the time path of intra-regional trade intensity in a single region. On the other hand, this correction does not solve other problems raised by the fact that no country can trade with itself, which were highlighted by Savage and Deutsch (1960). A more rigorous correction procedure can be found in Freudenberg et al. (1998).

Indicators of intra-regional trade 83 4 Bowen (1983) criticised trade intensity indices, arguing that in Kunimoto’s interpretation they imply a hypothetical world where every good is exported and imported by every country, which would be inconsistent with standard trade theories. Bowen’s critique applies particularly to revealed comparative advantage indices, such as that proposed by Balassa (1965), and is questionable for several reasons, including those mentioned by Vollrath (1991). Anyway, it could not be applied to the intra-regional trade intensity index, because this index does not refer to the commodity distribution of trade flows. A world without geographic preferences, in which every country, although not necessarily exporting every good, trades with each partner in proportion to its importance in world trade, appears to be a reasonable yardstick for actual trade flows. 5 Similar properties are shown by the hyperbolic tangent of the natural logarithm of the intensity index, proposed by Jungmittag et al. (1998) as a substitute for the Balassa formulation. 6 It is also easy to verify that Ji happens to be equal to HIi. 7 The problems discussed so far for intra-regional trade intensity indices affect also the measurement of revealed comparative advantages given by the Balassa index. Our trade introversion formula can easily be adapted to this indicator, in order to get a better measure of the intensity of trade specialisation. 8 See Anderson and Norheim (1993: 81), who use the same decomposition in the denominator of the traditional trade intensity index (equation (4.2)). In this case, corrections similar to those described in Note 3 above should be applied to the GDP data to get an unbiased measure of trade intensity. 9 The trade-to-GDP ratio is an imperfect measure of trade openness for a variety of reasons. First of all, it should be borne in mind that trade flows are measured in terms of gross output (including the value of intermediate goods), whilst GDP is expressed in terms of value added. This problem cannot be easily solved because data on the value of gross domestic production is not readily available. Second, since GDP includes the services sector, trade in goods and services should be used in the numerator. However, for the purposes of this chapter, only trade in goods can be taken into account, because data on the geographic distribution of trade in services is difficult to find. Third, independently of these statistical problems, the trade-to-GDP ratio should be used very cautiously in cross-country comparisons, because it is inversely related with country size (see Anderson and Norheim 1993: 80, Note 3). Other things being equal, larger countries tend to show lower trade-to-GDP ratios, only because they face a smaller ratio between foreign and domestic markets. 10 It must be stressed that all the variables are inevitably measured at current prices, given the non-availability of regional trade data at constant prices. As a consequence of this, all the indicators are also affected by inflation differentials and exchange rate fluctuations. The latter tend to influence trade prices more than domestic prices, which can create problems in the interpretation of the indices, particularly after currency crises, as we will see in the section on Recent trends in intra-regional trade, p. 80. 11 It must also be remembered that Gi and Oi are not completely independent of each other. For example, other things being equal, if the region’s GDP is growing faster than world output, capacity constraints could, in principle, have the effect that the pressure of domestic demand in the region makes it easier to purchase goods from external sources, thus raising the region’s relative degree of openness. 12 Similar indicators are discussed by Anderson and Norheim (1993: 84) as well as by Frankel (1997: 27). 13 The relationship between trade intensity indices and gravity models of international trade is analysed in Leamer and Stern (1970), Drysdale and Garnaut (1982) and Frankel (1997). Gaulier (2003) shows how trade intensity indices can be related to the gravity model proposed by Deardorff (1998). 14 A recent survey of the empirical evidence on the trade and investment effects of

84 Lelio Iapadre

15 16 17 18

19

regional integration, based on gravity models, can be found in Adams et al. (2003). Traditional trade intensity indices have been recently used in the context of a gravity model by Gaulier, Jean and Ünal-Kesenci (2004) and by Zhang and van Witteloostuijn (2004). Trade intensity indices for previous periods can be found, for example, in Frankel (1997: 26–29). Many other preferential trade agreements exist, but the sum of their intra-regional trade flows did not exceed 1 per cent of world trade (WTO, 1999: 20). See http: //www.wto.org/english/res_e/statis_e/its2004_e/appendix_e/a03.xls and previous editions. The EU is therefore taken with 15 members (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and the United Kingdom). NAFTA includes Canada, Mexico and the United States. ASEAN includes Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. Members of Mercosur are Argentina, Brazil, Paraguay and Uruguay. The fall in 1993, which seems paradoxical in the completion year of the Single Market programme, is mainly a statistical artefact, due to the introduction of a new collection system for intra-Community trade data (Intrastat), which led to a considerable underevaluation of intra-regional flows (Iapadre, 1996).

REFERENCES Adams, R., Dee, P., Gali, J. and McGuire, G. (2003) ‘The Trade and Investment Effects of Preferential Trading Arrangements – Old and New Evidence’, Productivity Commission Staff Working Papers, Canberra. Anderson, K. and Norheim, H. (1993) ‘From Imperial to Regional Trade Preferences: Its Effect on Europe’s Intra- and Extra-regional Trade’, Weltwirtschaftliches Archiv, 129(1): 78–102. Balassa, B. (1965) ‘Trade Liberalisation and “Revealed” Comparative Advantage’, The Manchester School of Economic and Social Studies, 33(2): 99–123. Bowen, H.P. (1983) ‘On the Theoretical Interpretation of Indices of Trade Intensity and Revealed Comparative Advantage’, Weltwirtschaftliches Archiv, 119(3): 464–72. Brown, A.J. (1949) Applied Economics: Aspects of the World Economy in War and Peace, London: George Allen and Unwin. Dalum, B., Laursen, K. and Villumsen, G. (1998) ‘Structural Change in OECD Export Specialisation Patterns: De-specialisation and “Stickiness”’, International Review of Applied Economics, 12(3): 423–43. Deardorff, A. (1998) ‘Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical World?’, in J. A. Frankel (ed.) The Regionalisation of the World Economy, Chicago: The University of Chicago Press. Drysdale, P.D. and Garnaut, R. (1982) ‘Trade Intensities and the Analysis of Bilateral Trade Flows in a Many-country World: A Survey’, Hitotsubashi Journal of Economics, 22(2): 62–84. Frankel, J.A. (1997) Regional Trading Blocs in the World Economic System, Washington: Institute for International Economics. Freudenberg, M., Gaulier, G. and Ünal-Kesenci, D. (1998) ‘La régionalistion du commerce international: une évaluation par les intensités bilatérales’, CEPII Working Paper, 98–05, Paris: Centre d’Etudes Prospectives et d’Informations Internationales. Online. Available HTTP: .

Indicators of intra-regional trade 85 Gaulier, G. (2003) ‘Trade and Convergence: Revisiting Ben-David’, CEPII Working Paper, 2003–06, Paris: Centre d’Etudes Prospectives et d’Informations Internationales. Online. Available HTTP: . Gaulier, G., Jean, S. and Ünal-Kesenci, D. (2004) ‘Regionalism and the Regionalisation of International Trade’, CEPII Working Paper, 2004–16, Paris: Centre d’Etudes Prospectives et d’Informations Internationales. Online. Available HTTP: . Iapadre, L. (1996) ‘The Intrastat System from a User’s Perspective’, in Eurostat, European Seminar on Intra-Community Trade Statistics, Proceedings of the Intrastat seminar held in Luxembourg on 13 and 14 March 1996, Luxembourg: European Commission, 305–15. Jungmittag, A., Grupp, A. and Hullmann, A. (1998) ‘Changing Patterns of Specialisation in Global High Technology Markets: An Empirical Investigation of Advanced Countries’, Quarterly Journal of Economic Research, 2: 86–98. Kojima, K. (1964) ‘The Pattern of International Trade Among Advanced Countries’, Hitotsubashi Journal of Economics, 5(1): 16–36. Kunimoto, K. (1977) ‘Typology of Trade Intensity Indices’, Hitotsubashi Journal of Economics, 17: 15–32. Leamer, E.E. and Stern, R.M. (1970) Quantitative International Economics, Chicago: Aldine. Savage, I.R. and Deutsch, K.W. (1960) ‘A Statistical Model of the Gross Analysis of Transaction Flows’, Econometrica, 28: 551–72. Vollrath, T.L. (1991) ‘A Theoretical Evaluation of Alternative Trade Intensity Measures of Revealed Comparative Advantage’, Weltwirtschaftliches Archiv, 127: 265–80. World Bank (2000) Trade blocs, A World Bank Policy Research Report, Oxford: Oxford University Press. WTO (1995) Regionalism and the world trading system, Geneva: World Trade Organisation. WTO (1999) Annual Report 1999, Geneva: World Trade Organisation. Zhang, J. and van Witteloostuijn, A. (2004) ‘Economic Openness and Trade Linkages of China: An Empirical Study of the Determinants of Chinese Trade Intensities from 1993 to 1999’, Review of World Economics, 140(2): 254–81.

5

Explaining regionalisation via relative trade intensities Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci1

Trading with a close neighbour is easier than trading with a distant partner, for a wide variety of reasons, ranging from transport costs to information asymmetries. As a consequence, it is no surprise that the bulk of world trade occurs between countries belonging to the same region (whatever the precise meaning given to this notion). Still, the surge in the number of regional trade agreements (208 in force notified to the WTO up to May 2004) has been spectacular during the past 15 years. And the link between this rising regionalism (i.e. institutional agreements across neighbouring countries) and the intensity of regionalisation in international trade (i.e. regional polarisation of trade flows) raises many questions. What is the ‘normal’ level of trade between partners (and in particular neighbours), and what is its ‘normal’ evolution across time? To what extent is trade within a given region more intense than elsewhere? And if it is, does this result from trade agreements or not? Addressing this issue is a complex matter, given the intricacy of foreign trade relationships, and the complexity of their determinants. This chapter primarily updates and extends the work of Freudenberg et al. (1998), based upon the CHELEM-CEPII database, covering international trade worldwide, on a consistent and harmonised basis, for each year from 1967 to 2001. In order to characterise more accurately the extent of regionalisation, this work makes extensive use of an indicator of the geographical orientation of foreign trade, namely the CEPII’s index of bilateral, relative intensity of trade flows. These relative trade intensities (RTIs) are not only used for descriptive purposes, they are also employed for econometric estimates. The most salient particularity of these estimates is to control for country-pair fixed effects when assessing the impact of regional trade arrangements (RTAs) on trade flows. In other words, the estimates only focus on the relative intensity of the trade relationship between any country-pair, compared to its mean level across the period. Working exclusively in comparison to the mean level of trade intensity, for any country-pair, makes it possible to control for any pairwise-specific country links constant across the period considered, such as geographical devices (distance, natural obstacles to transportation, contiguity, etc.), language, former cultural and historical ties (colonial, for example), etc. This is a significant improvement in methodological terms, as recently pointed out by Cheng and Wall (2003), even compared to one-way fixed effects, which control for country-specific variables.

Relative trade intensities 87 However, it has never been carried out before on a worldwide basis for such a long time span, to the best of our knowledge, except by Freudenberg et al. (1998) and Fontagné et al. (1999) and Cheng and Wall (2003), with trade level as explained variable in the latter two cases. Introducing these country-pair fixed effects is crucial when assessing the impact of RTAs, which tend to be signed by countries sharing some kind of proximity link (due to geography, politics or culture). These questions will be tackled in three stages. A first goal is to size up the issues. Different indexes are considered to take an overview of international trade regionalisation. The institutional context is examined, and used to further qualify empirically the regionalisation of international trade. In a second stage, these observed patterns of regionalisation are studied using a gravity model. Trade relative intensities are explained through proximity or gravity factors like physical distance, regional agreements, differences in specialisation and income. The final section concludes.

AN OVERVIEW OF REGIONALISATION OF INTERNATIONAL TRADE The fact that international trade flows are more intense between neighbours naturally leads to a general pattern where a large part of trade flows takes place within geographical regions. In this section, the pattern of regionalisation of international trade flows is first glanced at empirically with regard to the Triad regions, defined here as America, Asia-Oceania and Eurafrica.2 This general pattern is then compared with an overview of the institutional context, namely the rapid development of RTAs during the past decade.

Regionalisation at first glance Since distance is an obstacle to trade, it does not come as a surprise that countries trade more intensively with their neighbours. As a consequence, the regionalisation of foreign trade is a natural pattern, in the sense that countries tend to trade in large part with other countries belonging to the same ‘region’. Of course, there is no straightforward, unique definition of the notion of region. However, following Freudenberg et al. (1998), this regional polarisation of trade is nicely illustrated in a triangle representing the polarisation of each country’s foreign trade across the Triad regions (Figure 5.1). This diagram summarises within a triangle the share of each country’s foreign trade (exports + imports) carried out with a partner belonging to each of the three main geographical regions, namely America, AsiaOceania and Eurafrica. Only 10 out of 80 countries fall within the equilateral inscribed triangle, meaning that 70 out of 80 countries have more than half their foreign trade concentrated within a single Triad region. The 10 remaining countries are mainly large countries, such as the US, Japan, China, India, Brazil and the EU15 (excluding intra-EU trade). It is noteworthy that world trade appears very evenly balanced across the Triad regions when intra-EU trade is not accounted for.

88 Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci Eurafrica

50%

America

World

50%

50%

Asia-Oceania

Figure 5.1 The polarisation of foreign trade with regard to the Triad, by country, 2001 Source: Authors’ calculations, based on CHELEM-CEPII database. Note: Countries are labelled by their ISO code, see Appendix 5.1. In this diagram, for each country, the distance from each of the three triangle summits is inversely proportionate to the share of the corresponding Triad region in the country’s foreign trade (exports + imports). In other words, the point representing a given country is the barycentre of the system formed by the points representing each of three Triad regions, weighted by the share of this region in the country’s foreign trade. ‘W × UE’ refers to world trade, excluding intra-EU trade. ‘EU-15’ refers, to the foreign trade of the EU-15, excluding intra-EU trade.

Regional polarisation is especially strong in Eurafrica. The region accounts for more than 75 per cent of foreign trade in the majority of Western European countries, as well as in CIS countries; in Central and Eastern European countries (CEECs) and Baltic states, trade outside the region generally does not exceed 10 per cent of the total. In comparison, the regional orientation of foreign trade appears rather limited in America. This is notably due to the rather intense trade relationships maintained with European countries (and with Asia as far as Chile and Peru are concerned). Still, except for Brazil, Latin American countries trade in majority within the American region, with a particularly strong polarisation towards the US neighbours, Mexico and Canada. Asia-Oceania appears as the region exhibiting the weakest polarisation. However, except for the three largest economies in the region (Japan, China, South Korea), intra-regional trade accounts for around 55 to 60 per cent of total trade.

Relative trade intensities 89

The CEPII’s index of relative trade intensity Due to widespread differences in size and openness, the extent of trade flows’ regionalisation cannot be established by simply comparing trade shares. Instead, this section makes use of CEPII’s index of bilateral, relative intensity of trade flows. This index is intended to measure ‘trade proximity’ of partner countries, by comparing observed bilateral flows (as a percentage of world trade) with theoretical flows (the product of total relative weights in world trade) that reflect the overall capacity of the partners to trade. The index thus eliminates size effects, in order to reveal what is specifically linked to the bilateral relationship. In practical terms, relative trade intensities (RTI) are the ratios of the observed trade flows to ‘natural’ flows (Deutsch and Savage, 1960; Drysdale and Garnaut, 1982). The latter are determined by the geographical distribution of world trade according to the relative importance of exporters and importers respectively:

Vi , j V ⋅V Vw RTI = = i ,j w Vi ⋅ Vj Vi ⋅ Vj Vw

(5.1)

2

where Vi,j stands for trade between country i and country j, Vi for total trade of country i, Vw for total world trade. Additional corrections are made to this indicator, in order to make sure that it is neutral with respect to the country size (for a detailed description of these changes, see Freudenberg et al. (1998)). RTI has two important properties. First, it is independent from the size and openness of the two partners. Second, it is purely relative, since it focuses on the comparison of trade flows of each country across its different partners, without taking into account the absolute level of flows. For illustrative purposes, the pairwise combinations exhibiting the highest RTI (and at least a value of three) are displayed in Tables 5.1 to 5.3. Table 5.1 confirms that trade regionalisation has reached a fairly high level in Latin America. This is particularly true within the Andean Pact and within the Mercosur. While geographical factors are obviously the main explanation, this might also result from the institutional efforts witnessed during the last two decades (see below). Even though the absolute magnitude of trade is far higher, RTIs are found to be rather limited in North America, slightly below five for the relationships of the USA with its two neighbours. These tables confirm the higher level of regional integration of trade in Europe. The relative intensities are especially high for former communist countries, reflecting both a survival of the former COMECON trade dependencies, and the importance of the EU to them as an export market. This also results from the former integration of these new countries in a national entity (USSR, Yugoslavia) which has split up. This reflects the proximity between small economies, which

Ecuador Peru Venezuela Brazil Chile Peru Peru Ecuador Other America Venezuela Venezuela Peru Kazakstan Chile Colombia Other America

48.3 38.4 29.2 27.5 27.1 22.4 19.9 12.3 11.4 10.8 10.1 8.3 8.0 7.6 7.0 5.8

2001 15.8 28.5 –3.6 2.0 10.6 9.2 –6.3 1.1 2.8 2.4 –3.4 1.6 7.6 –0.5 1.9 1.7

Chg. 95–01

Relative trade intensity

Argentina Brazil Ecuador Argentina Brazil Mexico Brazil Canada Chile Brazil Peru Brazil Brazil Peru Brazil Ecuador

Partners

Other America Nigeria Other America Ecuador Peru USA Venezuela USA Venezuela Other America Other America Algeria Colombia Nigeria Latvia Serbia Monte

5.6 5.4 5.3 5.0 4.8 4.7 4.6 4.4 4.1 4.0 3.8 3.7 3.6 3.2 3.1 3.1

2001 –0.2 2.6 1.4 0.3 –0.8 –0.7 –0.4 –0.5 0.6 –2.5 –0.3 2.0 1.1 3.2 2.7 –3.8

Chg. 95–01

Relative trade intensity

Note: Partner pairs are ranked by decreasing order of relative trade intensity, among pairs including at least one country belonging to America. Column ‘Chg. 95–01’ refers to the absolute change of the RTI between 1995 and 2001 (value in 2001 minus value in 1995).

Source: Authors’ calculations, based on CHELEM-CEPII database.

Colombia Ecuador Colombia Argentina Argentina Chile Colombia Chile Venezuela Ecuador Peru Argentina Other America Brazil Chile Columbia

Partners

Table 5.1 Top relative trade intensities in America

Macedonia Bosnia-Herzego. Bosnia-Herzego. Latvia Kyrgyzstan Albania Belarus Greece Ukraine Bosnia-Herzego. Estonia Croatia Kazakstan Belarus Belarus Caucasus Romania Albania Bulgaria Estonia Estonia Kazakstan Bulgaria Czech Republic Belarus Bulgaria Bosnia-Herzego. Slovenia

Partners

Serbia Mont. Croatia Serbia Mont. Lithuania Other CIS Greece Lithuania Macedonia Other CIS Slovenia Latvia Slovenia Kyrgyzstan Ukraine Latvia Other CIS Brunei Macedonia Macedonia Lithuania Finland Other CIS Greece Slovakia Other CIS Serbia Mont. Macedonia Macedonia

286.5 247.2 151.9 104.5 100.6 99.7 78.6 70.5 68.1 67.0 64.5 61.5 58.0 57.0 56.2 55.9 50.4 44.7 43.3 35.4 35.4 34.5 32.4 31.5 31.0 29.6 29.5 29.3

2001 –134.1 17.1 –1176.1 25.3 –69.8 16.2 16.3 65.2 13.1 17.5 –9.1 –11.0 –117.3 21.0 35.4 19.9 –2.0 –32.1 –41.0 –7.7 –1.7 –20.2 7.2 –40.2 11.6 –54.5 14.7 –8.3

Chg. 95–01

Relative trade intensity

Table 5.2 Top relative trade intensities in Eurafrica

Norway Belarus Portugal Ukraine Romania Estonia Denmark Iceland Gulf Greece Bulgaria Romania Albania Lithuania Albania Ukraine Finland Russian Fed. Nigeria South Africa Gabon Belarus Austria Algeria Estonia Hungary Kazakstan Denmark

Partners

Sweden Kazakstan Spain Caucasus Other CIS Sweden Sweden Norway Pakistan Romania Turkey Serbia Mont. Belarus Ukraine Croatia Macedonia Sweden Caucasus Other Africa Other Africa Other Africa Caucasus Slovenia Turkey Russian Fed. Slovakia Other Europe Norway

11.6 11.4 11.1 11.0 10.5 10.5 10.5 10.0 10.0 10.0 9.9 9.6 9.5 9.4 9.2 9.0 8.9 8.9 8.7 8.6 8.5 8.4 8.4 8.2 8.1 8.0 8.0 7.9

2001

continued . . .

1.7 –4.6 1.8 –8.1 –1.0 1.7 2.2 0.1 2.9 4.0 1.3 –17.3 9.5 –9.2 1.0 2.4 0.5 –1.0 3.7 –1.9 4.3 4.8 1.4 2.0 –2.0 –1.6 7.6 0.3

Chg. 95–01

Relative trade intensity

Serbia Mont. Ukraine Taiwan Russian Fed. Estonia Caucasus Other Europe Kyrgyzstan Iceland Other CIS Macedonia Ukraine Serbia Mont. Caucasus Serbia Mont. Caucasus Ukraine Poland Romania Serbia Mont. Russian Fed. Italy Bulgaria Poland

28.6 28.2 27.9 26.6 21.7 20.8 20.7 20.5 19.3 19.2 19.0 19.0 18.5 16.4 16.4 16.3 15.2 14.4 13.7 13.1 12.6 12.3 12.0 11.7

2001 26.2 –6.2 27.9 –18.7 9.5 7.1 7.4 12.1 1.5 –3.3 –7.3 9.8 15.7 –11.0 6.3 7.5 4.4 6.1 6.2 –21.9 –3.2 2.6 –5.7 3.8

Chg. 95–01

Relative trade intensity

Turkey Kyrgyzstan Hungary Bulgaria Iceland Poland Czech Republic Poland Latvia Nigeria Estonia Albania Austria Turkey Croatia Finland Bosnia-Herzego. Latvia Egypt Ireland Austria Austria Finland Gulf

Partners

Non-OPEC MEast Russian Fed. Romania Russian Fed. Poland Slovakia Poland Ukraine Sweden India Ukraine Turkey Hungary Other CIS Non-OPEC MEast Russian Fed. Belarus Russian Fed. Non-OPEC MEast United Kingdom Croatia Slovakia Latvia Non-OPEC MEast

7.6 7.6 7.5 7.5 7.4 7.3 7.2 7.2 7.0 6.9 6.9 6.6 6.5 6.5 6.5 6.5 6.5 6.4 6.4 6.3 6.2 6.2 6.1 6.1

2001 –0.2 –9.2 –1.1 –3.4 7.0 0.7 –0.3 0.1 –2.0 3.6 –0.5 –1.4 –1.9 –0.2 4.8 2.0 4.5 –6.2 1.0 –0.1 1.5 1.6 –1.3 –1.1

Chg. 95–01

Relative trade intensity

Note: Partner-pairs are ranked by decreasing order of relative trade intensity, among pairs including at least one country belonging to Eurafrica. In order to save space, only the country-pairs exhibiting an RTI above 6 in 2001 are displayed. Column ‘Chg. 95–01’ refers to the absolute change of the RTI between 1995 and 2001 (value in 2001 minus value in 1995).

Source: Authors’ calculations, based on CHELEM-CEPII database.

Croatia Russian Fed. Kyrgyzstan Kazakstan Belarus Turkey Greece Belarus Denmark Russian Fed. Croatia Bulgaria Greece Bulgaria Slovenia Kazakstan Kazakstan Belarus Bulgaria Albania Lithuania Albania Albania Lithuania

Partners

Table 5.2 continued

Romania Kyrgyzstan New Zealand Camb-Lao-Vietn. Singapore Gulf Singapore Thailand Singapore Nigeria Thailand Asia-Oceania nes Malaysia Asia-Oceania nes Hong Kong Camb-Lao-Vietn. Other Gulf Other Asia-Oceania Other Africa Other Asia-Oceania Singapore Taiwan Camb-Lao-Vietn. Japan Other Africa Philippines

50.4 27.9 21.0 16.3 12.3 10.0 7.7 7.4 7.4 6.9 6.7 6.7 6.2 5.9 5.8 5.3 5.3 5.1 5.1 4.8 4.8 4.6 4.4 4.3 4.3 4.2

2001 –2.0 27.9 –0.5 –10.8 1.2 2.9 –1.0 1.6 3.2 3.6 –0.5 0.0 1.9 1.3 –0.5 –0.3 –4.4 0.1 0.6 –0.7 0.7 0.8 1.9 0.6 0.1 1.9

Chg. 95–01

Relative trade intensity

Thailand Malaysia Thailand Singapore Taiwan Australia Australia Korea Indonesia Indonesia Philippines Pakistan India Camb-Lao-Vietn. Japan Philippines China China Malaysia Japan Singapore Brunei Korea India Brunei

Partners

Other Asia-Oceania Thailand Non-OPEC MEast Thailand Camb-Lao-Vietn. Indonesia Brunei Gulf Korea Japan Singapore Non-OPEC MEast Gulf Belarus Philippines Thailand Korea Japan Philippines Thailand Other Europe New Zealand Camb-Lao-Vietn. Other Africa Korea

4.2 4.1 4.1 4.0 4.0 3.9 3.8 3.7 3.7 3.5 3.5 3.3 3.3 3.3 3.2 3.2 3.2 3.1 3.1 3.1 3.1 3.1 3.0 3.0 3.0

2001 1.6 1.1 2.7 –0.3 0.4 0.7 2.7 1.3 0.8 –0.1 1.1 0.2 –1.1 2.7 0.3 1.0 0.3 0.0 1.4 –0.1 1.0 2.3 –0.3 0.0 0.3

Chg. 95–01

Relative trade intensity

Source: Authors’ calculations, based on CHELEM-CEPII database. Note: Partner-pairs are ranked by decreasing order of relative trade intensity, among pairs including at least one country belonging to Asia-Oceania. Column ‘Chg. 95–01’ refers to the absolute change of the RTI between 1995 and 2001 (value in 2001 minus value in 1995).

Brunei Taiwan Australia Brunei Malaysia Pakistan Brunei Brunei Indonesia India Camb-Lao-Vietn. India Brunei Pakistan China Singapore Other Asia-Oceania New Zealand Brunei Australia Hong Kong Hong Kong Australia Brunei Pakistan Taiwan

Partners

Table 5.3 Top relative trade intensities in Asia-Oceania

94 Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci ‘naturally’ leads to high relative intensities of trade. Noteworthily, while steep declines in RTI are experienced for several pairs of partners among former communist countries, many of them experienced an increase between 1995 and 2001. Several neighbourhood relationships are also apparent in these most intense relative trade relationships, in particular between Scandinavian countries, between Spain and Portugal, between UK and Ireland, or between African countries. Although far larger in absolute value, RTI is weaker for relationships like Germany–France (RTI = 1.5 in 2001), Germany–the Netherlands (1.9), France– Spain (3.6) or even Germany–Austria (3.8). In any case, the values obtained for largely open countries, such as European ones, vary across a more limited range than those obtained for less open countries, such as Central Asian ones. In Asia-Oceania, outside some distinctive trade relationships concerning mainly oil trade (in particular those involving Brunei), a few pairs are remarkable for the intensity of their reciprocal trade, in particular Australia–New Zealand, Malaysia–Singapore, Indonesia–Singapore, China–Hong Kong and Hong Kong– Taiwan. Among the main pairs of countries, most exhibit a RTI superior to 3, including those between Japan, China, Korea and Indonesia (with the exception of Japan–Korea, 2.4, and China–Indonesia, 1.4). Although it has been emphasised above that Asian countries make a significant part of their trade (and in particular their exports) outside the region, this illustrates the intensity of their trade links.

Institutional context: regional trade arrangements and their influence on trade flows As mentioned above, regional polarisation is certainly, at least partly, a natural pattern. But it also has a strong institutional background. It has become usual to distinguish three waves of regionalism (see e.g. Adams et al. (2003)). The first wave dates back to the 1950s, when the economic integration of Western Europe began, followed by regional agreements in Africa and in Latin America. The second wave began in the mid-1980s, with the European Single Market (1986), the Canada–US FTA, followed by the NAFTA, and a number of subregional arrangements. The third wave followed the creation of the WTO, and was characterised by the proliferation of FTAs. Figure 5.2 spectacularly illustrates the recent surge in RTAs, in particular since 1991. Up to May 2004, 208 agreements notified to the WTO were in force. This figure also points to the overwhelming importance of the Eurafrica region in this trend. This has in particular been the case since 1991, mainly as a result of the very large number of agreements signed by former communist countries, either CEECs or Former Soviet Union countries, and more recently former Yugoslavia countries. However, it is worth noting that trade agreements signed between members formerly belonging to the same country can hardly be considered as progress toward economic integration, but rather as an accompanying measure to political disintegration. Outside Europe, a number of bilateral agreements have been signed, but they are mainly linked to the intense activity in this domain of a handful of

Relative trade intensities 95 250 World

Number of RTAs

200

Eurafrica 150

100

50

America Asia-Oceania

0 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 Year

Figure 5.2 Breakdown of Regional Trade Agreements by geographical areaa (in force and notified to the GATT/WTOb) Source: WTO, authors’ calculations. Notes a World figures are inferior to the sum of the RTAs by region: when a trade agreement involves two or three regions, the agreement is taken into account in each region. b As of 13 October 2003.

countries, namely Mexico, Canada and Chile in America, Singapore and Australia in Asia-Oceania.

ANALYSING REGIONALISATION BY BILATERAL TRADE INTENSITIES The fact that countries trade more intensively with their neighbours does not come as a surprise, given the well-known negative impact of distance on trade relationships. Nor should the fact that the USA’s neighbours have strong trade links with the USA be counterintuitive, given the relative sizes. Although prima facie evidence is useful to characterise the extent and intensity of trade flows, this means that trade flows are bound to be more intense between neighbours, and within geographical regions. Characterising properly a possible regionalisation phenomenon thus requires going beyond the mere observation of trade intensities. Speaking of regionalisation would only make sense as soon as trade intensities within a region are higher than expected, once ‘natural’ determinants of trade, such as distance, size, cultural and geographical ties, and income per capita have been accounted for. This requires estimating gravity equations. This gravity-based, econometric study of regionalisation is carried out in this section. The analysis focuses on characterising the extent of any regionalisation phenomenon, over and above natural determinants. The general approach follows

96 Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci Freudenberg et al. (1998). As in this chapter, the relative trade intensity is explained by several trade resistance variables. Compared to the 1998 paper, more preferential trade agreements are taken into account.

The gravity model Assuming perfect specialisation,3 strictly positive barriers to trade and CobbDouglas utility, as in Deardorff (1998), the f.o.b. trade flow between country i and j can be written as:

Vi , j =

Yi ⋅ Yj ti , j ⋅ Yw

(5.2)

where Yi is country i GDP, Yw is world GDP and ti,j is a transaction cost factor (one plus transaction cost) of Samuelson’s ‘iceberg’ form. The transaction cost can include different aspects: distance, other transport costs, cultural ties, and market accessibility, both in terms of formal and informal obstacles, of quality of infrastructure cost or of access to information. Naturally, trade agreements ought to be among the determinants of this transaction cost, insofar as reducing it is precisely their purpose. In this rather general framework, taking the logarithm of equation (5.2) provides us with a theoretical grounding of the standard gravity equation:

ln Vi , j = ln Yi + ln Yj − ln ti , j − ln Yw

(5.3)

For the purposes of our study, it is useful to note that a general form can also be derived, as far as the relative trade intensity defined in equation (5.1) is concerned. Indeed, under the set-up used by Deardorff (1998),4 it follows from equation (5.2) that:

ln(RTI i , j ) = − ln(ti , j ) − ln( MPi ) − ln( MPj )

(5.4)

where

MPi = ∑ c

yc tic

denotes the market potential of country i, and index c refers to partners. yc is country c’s share in total world GDP

( yc =

Yc ). ∑ Yn n

Relative trade intensities 97 This variable is already commonly introduced in gravity equations, and belongs to what Anderson and van Wincoop (2003) call ‘multilateral resistance factors’. Gravity equations used to be estimated for trade flows. Equation (5.4) shows that estimating a gravity equation for RTIs also makes sense. As shown by Gaulier (2004), the advantage of this specification is that, except for market potential terms, only purely bilateral transaction costs enter the equation. It is thus likely to allow for a better control of multilateral transaction costs.

RTAs as determinants of trade flows Based on the theoretical foundations laid out above, a gravity model is estimated. The basic model is expressed in logarithms. It has the bilateral trade flow (exports plus imports) between a couple of partners as the dependent variable, and includes the following independent variables: •

relative geographic distance between partners. Based on equations (5.3) and (5.4), it is written as ln(RelativeGeoDist) = ln(di,j) + ln(MPGeoDisti) + ln(MP GeoDistj), where di,j is the geographic distance5 between country i and j and y MPGeoDisti = ∑ c ; c dic

•

dummy variables indicating adjacency, common language, former colonial tie, former common coloniser; GDP of each partner; relative economic distance between partners:

• •

EcoDisti , j =

Max{PCI i , PCI j } Min{PCI i , PCI j }

where PCIi is country i per capita income.

MPEcoDisti = ∑ c

yc EcoDistic

ln(Relative EcoDisti,j) = ln(EcoDisti,j) + ln(MPEcoDisti) + ln(MPEcoDistj); •

•

relative similarity of trade specialisation between partners. As for geographical or economic distance, this term includes the bilateral similarity between partners, but also the multilateral similarity index of each partner (see Appendix 5.2 for the definition of the indicators); dummy variables indicating RTA membership of one partner, as well as joint membership.

This model is rather standard for most variables, already extensively used in the literature. Note, however, that, based on equation (5.4), each partner’s market potential is not considered separately, but incorporated in the measurement of the relative distance. This is more consistent with the model laid out above. It means

98 Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci that market potential can be interpreted as a benchmark, against which absolute distances are compared: relative distance thus refers to distance between two partners, in comparison to (weighted) average distance from each partner to the rest of the world, as measured through market potential. The relative similarity of trade specialisation is the only unusual variable here, although it has already been used in Freudenberg et al. (1998). The bilateral index measures how similar two partners’ sectoral specialisations are, as measured by revealed comparative advantages, through the index of ‘contribution to the trade balance’ (Lafay, 1990). It is arguably difficult to export a given product to a country that has a comparative advantage in this product, since competition from local producers is tough in this case. As a result, a high similarity of trade specialisations implies that strong export sectors from each partner will be faced with tough local competition from the other partner (since this sector will, on average, also correspond to a comparative advantage of the partner). Relative similarity is thus expected to have a negative influence on the magnitude of trade flows. Based on equation (5.4), the model is estimated with bilateral RTI as the independent variable. As already outlined, this specification allows the estimation to focus on purely bilateral resistance factors, thus getting rid of any disturbance linked to other variables. It is also worth emphasising that such estimates have a different meaning from those based on trade flow levels. RTIs exclusively refer to the geographic orientation of foreign trade, and no information can be drawn as to the volume of trade. This implies, in particular, that potential trade diversion effect of a given RTA cannot be studied using RTIs: the results will only refer to the difference between the trade creation effect between members of the RTA, and the trade creation effect with third countries. Based on the CHELEM-CEPII database, the estimates are carried out on an annual basis across the period 1967–2001. The sample covers the whole world, with some countries grouped together, according to the CHELEM-CEPII geographical classification (see Appendix 5.1). As a result, 58 countries are considered. CHELEM-CEPII has the unique device of putting together exhaustive, harmonised and consistent time-series describing worldwide trade over a relatively long period. These devices (and in particular the time-consistency) make it possible to carry out the estimation using two-way fixed effects (actually, the within estimator is reported). In other words, the estimates only focus on the volume of trade between any country-pair, compared to its mean level across the period. The advantage of this approach is that it makes it possible to control for trade determinants specific to any country-pair, which are constant across the time span considered. Although distance, contiguity, common language and colonial ties are taken into account in the model, this is undoubtedly far from being enough to control for the specific ties existing between a pair of countries. As pointed out by Haveman and Hummels (1998), this gives rise to an omitted variable bias. This has already been controlled for by introducing country fixed effects (see e.g. Matyas (1997), or Adams et al. (2003)), and it was found to improve substantially the adequacy of the model. As argued by Cheng and Wall (2003), this is only a special case, where strong restrictions to the nature of heterogeneity of trade flows

Relative trade intensities 99 are imposed. A more general model should be used when estimating gravity equations, allowing for a more general form of heterogeneity. Since specific, bilateral ties cannot be satisfactorily controlled for, they argue that standard methods for estimating gravity models of trade suffer from estimation bias due to omitted or misspecified variables. The problem can be addressed by using the twoway fixed-effects model in which country-pair and period dummies are used to reflect the bilateral relationship between trading partners. Results by Freudenberg et al. (1998) or Cheng and Wall (2003) suggest that standard gravity estimates of the effects of integration can differ a great deal from what is obtained when heterogeneity is not accounted for. Introducing country-pair fixed effects is thus a significant improvement. To the best of our knowledge, except Freudenberg et al. (1998), Fontagné et al. (1999) and Cheng and Wall (2003), there is no example of estimating a fixed-effects gravity model on a worldwide basis for such a long time span.6 Given the exhaustive nature of our country sample, a fixed-effect model is clearly better suited than a random-effect model. With 58 countries considered over 35 years, the theoretical number of observations would be 58 × 57 × 35/2 = 57,855. However, the number of non-zero observations is 55,880. A Heckman two-stage estimation procedure was performed to account for the information provided by these zero flows, but this did not significantly alter the results. An OLS estimate carried out by pooling yearly data and including time dummies gives results in line with the literature (Table 5.4, column a). The fit (Adjusted R2 0.36) is rather low compared to usual estimates. This is due to relative trade intensity replacing trade level as left-hand-side variable: the very good fits obtained in usual gravity estimates come from GDPs and other variables measuring the size of trade partners. The distance coefficient is relatively close to unity, as expected. Common language, common former coloniser, contiguity and, to a lesser extent, former colonial tie have a strong positive impact on trade flows. Economic distance has a very low, yet significant, positive impact. Relative similarity in sectoral trade specialisation has a negative and significant impact on trade flows. This confirms the relevance of taking into account the degree of complementarity between sector specialisations. Countries with similar specialisations seem to be more competitors than customers, one to the other. A very strong preferential impact on trade between members is found for COMECON, Mercosur, the Andean Community, and to a lesser extent CER. Coefficients for Mercosur and CAN are huge: for the latter it would imply a multiplication by 8.7 (exp(2.16)) of trade between Andean Community countries. Such impact is unlikely to stem from the agreement itself, other factors (correlated with the agreement in the cross-section dimension) must play a role. Results for the second specification will confirm this intuition. A more limited impact is found for EU, EFTA, EU-EFTA and Euromed agreements. Except NAFTA, which may be difficult to identify due to lack of points (only three countries), all preferential trade agreements (PTA) have high positive impact on relative trade intensity.

100 Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci Table 5.4 Estimating a gravity model for RTIs, 1967–2001 Dependent variable (ln) Specification Time-independent variables Contiguity Common language Common former coloniser Former colonial tie

RTI OLS (a)

RTI Within (b)

0.63 0.45 0.24 0.83

(0.03) (0.02) (0.04) (0.04)

Time-specific variables other than RTAs ln GDP ln (relative) distance –0.88 ln (relative) similarity –0.92 ln (relative) economic distance 0.05

(0.01) (0.01) (0.01)

0.37 –0.38 –0.28

(0.04) (0.02) (0.01)

Dummy for both partners belonging to the RTA EU-EFTA 0.54 (0.04) Euromed 0.28 (0.04) Israel–US–Canada FTA 0.60 (0.29) NAFTA 0.10 (0.24) EU 0.49 (0.03) EFTA 1.24 (0.05) Comecon 1.64 (0.27) Mercosur 1.93 (0.42) ASEAN 0.63 (0.10) CER 1.67 (0.32) CAN 2.16 (0.18)

0.04 0.29 0.07 0.05 0.21 0.30 0.57 0.98 0.07 0.36 0.96

(0.05) (0.03) (0.23) (0.18) (0.04) (0.07) (0.30) (0.31) (0.07) (0.28) (0.13)

Root MSE N Adj R2 F value

1.33 55 880 0.36 1677

0.83 55 880 0.03 120

Source: Authors’ calculations, based on CHELEM-CEPII database for international trade flows and GDPs. Note: In column (b) (within estimator), the dependent variable is the difference of RTI to the average throughout the period, for the corresponding country-pair. Standard errors are reported in parentheses. All coefficients are statistically significant at the 5 per cent level, except those in italics. Dummy variables denoting RTA’s membership are year-specific, starting from the year of enforcement of the RTA.

Using our preferred specification, the within model (column b), turns out to deliver substantially different results. Variables without time dimension are removed as the country-pair fixed effects capture the cross-section information. Other resistance variables are strongly affected. Relative geographical distance appears with a positive coefficient: it is now a measure of market potential (see formulae above), only affected by change in the ‘centrality’ of countries. If neighbouring countries experience a relative rise in GDP, it has a positive impact on relative trade intensity. The sign for economic distance is reversed to negative. It means that per capita GDP convergence favours bilateral trade. The sign for

Relative trade intensities 101 similarity remains negative. The positive impact of complementarity seems to be robust. With the fixed-effects specification, PTA impacts results are much more heterogeneous: Israel–US–Canada FTA, EU-EFTA, NAFTA and ASEAN have coefficients inferior to 0.1 and non-significant. Other coefficients remain significant but with lower value or turn non-significant with still relatively high point estimates (COMECON, CER). The explanation for such low within estimates may lie in the imperfect fit of the estimates, and in the difficulty of identifying the impact on RTI when a shock concerns a large part of a country’s trade, as is the case for European countries with the EU, and North American countries with the NAFTA. Consider, for instance, Austria entering the EU: this will boost its trade with Italy, but also with all other EU members. As a consequence, the numerator of the RTI will increase, but so too will the denominator. At the end of the day, the change in the index will be moderate, making the impact more difficult to identify. This problem is likely to be blurring the estimation for EU-EFTA and NAFTA, as well as for the EU. The corresponding coefficients should therefore be interpreted carefully. However, generally speaking, fixed effects allow us to eliminate disturbing timeless bilateral ties correlated with PTA. By using only the time dimension, they should provide more reliable estimates of the impact of PTAs. For instance, ASEAN is found to have an insignificant effect on trade between its members. This suggests that ASEAN members did not increase trade with other member countries by more than they did with third countries: ASEAN did not (significantly) increase the polarisation of foreign trade of member countries between each other. Trade in Asia like in other regions is regionalised, but institutionalised preferences do not seem to have significantly distorted the geographical orientation of trade so far. In contrast, agreements concerning European countries had a moderate but significant impact on European flows, and agreements in South America (Mercosur and CAN) had very high impact (a coefficient of 0.98 implies a multiplier of 2.7 for trade). The magnitude of this effect is surprising. However, a free-trade area between countries which are highly protected, as are on average most South-American countries, delivers a high preference margin to each member in the market of each other member. This might explain, at least in part, the strong effect found.

CONCLUSION Regionalisation is an important device of trade across the world, both in terms of trade patterns and in terms of institutions. The link between both aspects is not straightforward to establish, since trade flows are influenced by a bunch of ties between countries, which are not easily controlled for. Beyond the thorough description of the nature and evolution of regionalisation, this chapter proposed an empirical analysis for a large number of countries covering the whole world over the period 1967–2001, based on the CHELEM-CEPII

102 Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci database. This analysis updates and extends the one carried out in Freudenberg et al. (1998). The most salient particularity of our estimations is probably to control for country-pair fixed effects when assessing the impact of RTAs on trade flows. By only using changes across time to identify the impacts, this method makes it possible to control for any country-pair tie constant across the period under study. In so doing, a number of problems potentially blurring the econometric analysis are avoided. The drawback is that identifying the impact of regional agreements is more difficult in some cases, in particular for large agreements, such as the EU and the NAFTA. Using this method has a strong influence on the results. In particular, the distorting impact of RTAs on the geographical polarisation of member countries’ foreign trade appears to be far more limited than is found based on the OLS estimations. The impact of regional agreements is clear as far as Western Europe or Mercosur are concerned. In many cases, however, regionalism might in fact have followed or accompanied regionalisation, rather than caused it.

ALB DZA ARG AUS AUT BLR AAA BIH BRA BRN BGR CAN CHL CHN COL HRV CZE DNK ECU EGY EST FIN AAW AAF

*Albania Algeria Argentina Australia Austria *Belarus Belgium–Luxembourg *Bosnia and Herzegovina Brazil Brunei Darussalam *Bulgaria Canada Chile China Colombia *Croatia *Czech Republic Denmark Ecuador Egypt *Estonia Finland Former USSR Former Yugoslavia

France Gabon Germany Greece Hong Kong * Hungary Iceland India Indonesia Ireland Israel Italy Japan *Kazakhstan *Kyrgyzstan *Latvia *Lithuania *Macedonia Malaysia Mexico Morocco Netherlands New Zealand Nigeria

Country name FRA GAB DEU GRC HKG HUN ISL IND IDN IRL ISR ITA JPN KAZ KGZ LVA LTU MKD MYS MEX MAR NLD NZL NGA

ISO Norway Pakistan Peru Philippines *Poland Portugal *Romania *Russian Federation *Serbia & Montenegro Singapore *Slovakia *Slovenia South Korea South African Union Spain Sweden Switzerland Taiwan Thailand Tunisia Turkey *Ukraine United Kingdom United States of America Venezuela

Country name

NOR PAK PER PHL POL PRT ROM RUS YUG SGP SVK SVN KOR AAI ESP SWE CHE TWN THA TUN TUR UKR GBR USA VEN

ISO

Notes The geographical classification refers to CEPII-CHELEM database. * Countries for which data is available only since 1993. The ‘Eastern European’ countries, former Yugoslavia and former USSR are considered as single zones in the model for the 1967–2001 period.

ISO

Country name

APPENDIX 5.1 Geographical classification

104 Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci APPENDIX 5.2

Similarity of Specialisation Patterns International specialisation of countries is measured by the ‘contribution to the trade balance’ (CTB) indicator (Lafay, 1990). Unlike other indicators of specialisation, the CTB is a symmetrical indicator in the sense that it focuses not only on exports but also on imports. CTB compares observed trade balance for a product to a theoretical trade balance corresponding to an absence of specialisation. The latter is calculated so as to spread the global trade balance on the different products according to their respective weights in the country total trade.

⎡ ⎛ 1000 ⎞ ⎢ k k k k CTB = ⎜ ⎟ ⎢ X i − Mi − ∑ X i − Mi ⎝ GDPi ⎠ ⎢ k ⎣

(

k i

)

(

⎛ k k ⎜ X i + Mi k k ⎜ ⎜ ∑ X i + Mi ⎝ k

) (

)

⎞⎤ ⎟⎥ ⎟⎥ ⎟⎥ ⎠⎦

with i the country, k the product, X are the exports and M the imports. A positive contribution is interpreted as a revealed comparative advantage. By definition, the sum over all products is zero. In CHELEM database we get 72 categories of products. The ‘contribution to the trade balance’ (CTB) indicator is used to evaluate the similarity of specialisation patterns between pairs of countries. Two steps are needed to transform the CTB indicator into a similarity index. We ~ first compute adjusted CTB, (CT B) , in order to eliminate the size effect (degree of specialisation) included in the CTB: CTB are multiplied by a coefficient so that the sum of adjusted values equals 100 for positive contributions and –100 for negative contributions. Then, for each pair of countries, we add up absolute differences of adjusted CTB. The similarity will equal 100, if the two countries have the same specialisation pattern (possibly with different intensities). If each comparative advantage for country i is matched by an equal disadvantage for country j then the similarity will be 0. The similarity of specialisation patterns between country i and j, Simij, is defined as follows:

Simij = 100 −

1 ˜ − CTB ˜ ∑ CTB ik jk 4 k

An index of multilateral dissimilarity is then computed as:

MultiSimi = ∑ j

yj . Simij

Relative trade intensities 105 This index is the equivalent for similarity of what market potential is for distance. It measures how the position of the country in terms of structure of specialisation, compared to all other countries, influences its global propensity to trade.

NOTES 1

2 3

4 5 6

This chapter is based on a study that benefited from financial support from the Directorate General for Trade of the European Commission. We are grateful in particular to Edouard Bourcieu, Andrea Rossi and Vincent Aussilloux for helpful comments and suggestions. The usual disclaimer applies. A large geographical area formed by Europe, the former USSR, Africa and the MiddleEast. Deardorff (1998) refers to the Heckscher-Ohlin Model with impeded trade but he mentions that his results would hold in an H–O model with frictionless trade if factor endowments differ sufficiently to yield perfect specialisation, in a Ricardian model, in an Armington model or in any monopolistic-competition model where differentiation implies specialisation. As in Deardorff, it is assumed that Vw = Yw. As measured based on the methodology proposed by Head and Mayer (2002). Cheng and Wall (2003) estimate an equation with country-pair fixed effects on a data set including upper-middle and high-income countries (following World Bank) covering four years. They end up with 3188 observations.

REFERENCES Adams, R., Dee, P., Gali, J. and McGuire, G. (2003) ‘The Trade and Investment Effects of Preferential Trading Arrangements – Old and New Evidence’, Staff Commission Paper, Australia: Productivity Commission. Anderson, J.E. and van Wincoop, E. (2003) ‘Gravity with Gravitas: A Solution to the Border Puzzle’, American Economic Review, 93(1): 170–92. Cheng, I.-H. and Wall, H.J. (2003) ‘Controlling for Heterogeneity in Gravity Models of Trade and Integration’, Federal Reserve Bank of St. Louis Working Paper Series, 99–010D, revised May 2003. Deardorff, A.V. (1998) ‘Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical World?’, in J.A. Frankel (ed.), The Regionalization of the World Economy, Chicago: The University of Chicago Press. Deutsch, K.W. and Savage, I.R. (1960) ‘A Statistical Model of the Gross Analysis of Transaction Flows’, Econometrica, 28(3). Drysdale, P. and Garnaut, R. (1982) ‘Trade Intensities and the Analysis of Bilateral Trade Flows in a Many-Country World: a Survey’, Hitotsubashi Journal of Economics, 22(2). Fontagné, L., Freudenberg, M. and Pajot, M. (1999) ‘Le potentiel d’échanges entre l’Union européenne et les PECO: un réexamen’, Revue Economique, 50(6): 1139–68. Freudenberg, M., Gaulier, G. and Ünal-Kesenci, D. (1998) ‘La régionalistion du commerce international: une évaluation par les intensités bilatérales’, CEPII Working Paper, 98–05, Paris, Centre d’Etudes Prospectives et d’Informations Internationales. Online. Available HTTP: .

106 Guillaume Gaulier, Sébastien Jean and Deniz Ünal-Kesenci Gaulier, G. (2004) ‘Trade and Convergence: Revisiting Ben-David’, mimeo. Haveman, J. and Hummels, D. (1998) ‘Trade creation and trade diversion: new empirical results’, Journal of Transnational Management Development, 3(2): 47–72. Head, K. and Mayer, T. (2002) ‘Illusory Border Effects: Distance Mismeasurement Inflates Estimates of Home Bias in Trade’, CEPII Working Paper, 2002–01, Paris, Centre d’Etudes Prospectives et d’Informations Internationales. Online. Available HTTP: . Lafay, G. (1990) ‘La mesure des avantages comparatifs révélés’, Economie prospective internationale, 41; reprinted as ‘The Measurement of Revealed Comparative Advantages’, in M.G. Dagenais and P.-A. Muet (1994) International Trade Modelling, London: Chapman & Hall. Matyas, L. (1997) ‘Proper econometric specification of the gravity model’, The World Economy, 21(3): 363–68.

6

Assessing the impact of regional trade agreements An analytical framework for rulemaking in trade and investment Stephen Woolcock

INTRODUCTION The aim of this chapter is to present an analytical framework for making qualitative assessments of the impact of regional or free trade agreements. It argues that the current wave of preferential agreements necessitates augmenting the existing theoretical and analytical frameworks based on customs union theory, optimal tariff theory or rational choice type of political economy approaches. The rulemaking (or deeper integration) that is involved in the new wave of preferential agreements necessitates study of the detailed content of agreements, which has been eschewed by many of the more model-based approaches to assessing regional trade agreements (RTAs). Furthermore, as rulemaking invariably touches on ‘governance’ issues, in that trade or investment rules limit domestic regulatory autonomy, there is a need to be able to more easily identify how regional or free trade agreements impinge upon domestic regulatory policy autonomy. This chapter provides a taxonomy of the key elements of trade and investment agreements that is applicable to most issues covered by RTAs and all aspects of rulemaking. Breaking down the provisions in any agreement facilitates a more effective comparison of RTAs both with one another and with the established multilateral rules. In this instance the multilateral rules used as reference are those of the World Trade Organisation, but the analytical framework could be equally applied to other international rules. The framework also enables a more systemic assessment of whether and how preferential agreements go beyond the WTO provisions. It therefore helps to assess whether and in which areas preferential agreements are simply implementing agreed multilateral principles and where they constitute a threat to existing rules or could pose difficulties for future multilateral rulemaking. It shows that some aspects of rulemaking are likely to embody stronger (regional) preferences than others. For example, most rules on transparency generally result in little or no preference because the information is readily available to parties in third countries. On the other hand, specific regulatory norms are more likely to constitute a preference. In this way the framework can help in assessing the trade and investment effects of deeper integration.

108 Stephen Woolcock THE NATURE OF THE ‘NEW WAVE’ OF REGIONAL AGREEMENTS1 The current wave of regional agreements or ‘new regionalism’ is characterised by a number of features (Hettne, 1996). First, there has been a significant increase in the number of agreements either concluded or in the process of being negotiated. The World Trade Organisation (WTO) estimates that the number of RTAs in force grew from 50 in 1990 to over 300 in 2005, with a further 60 under negotiation (World Bank, 2005). Second, participation in RTAs has now become more or less universal. Up to the mid-1990s most RTAs were limited to Europe and a few involving the United States, but by 2004 almost all countries had become involved in RTAs including countries like China, Japan and India. Whereas most Asian countries eschewed RTAs until the late 1990s, by 2004 the region was one of the most active in terms of RTA negotiations. Third, RTAs now include a growing volume of rulemaking that touches on behind the border issues. Forth, trade agreements are now taking the form of intra-regional agreements, such as between the USA and Singapore or the EU and Chile as well as agreements among countries in a contiguous region.

ASSESSING THE IMPACT There is no consensus on the impact of this new wave of RTAs. Some see it as part of a competitive process of liberalisation, compatible with multilateralism, others see it as creating a ‘spaghetti bowl’ of inconsistent rules of norms (Bhagwati et al., 1999). The well-established and very rich literature on preferential trade agreements provides a partial answer to the question of the impact. This literature is based on the Vinerian model of trade creation and diversion. Although it provides the main body of economic research on preferential agreements there are a number of limitations with this approach. First, there is the problem of determining the counterfactual, in other words what might have happened in the absence of a preferential agreement. Second, the static analysis of the trade creation and diversion effects of RTAs has been ambiguous or has shown that the effects are small, which has raised questions about the motivations behind RTAs if the benefits are so limited. Third, the standard discussion of RTAs proceeds as if tariffs were the only barrier to trade (Winters, 1996). This may still be a reasonable approximation for many of the free trade agreements (FTAs) between developing countries today, but not the newer type of RTA involving developed economies. Even RTAs between developing countries are beginning to include some elements of rulemaking or deeper integration. In terms of the economic effects of deeper integration, the broad view among trade economists is that discriminatory deep integration is unlikely to be harmful except in the sense of the opportunity cost of foregoing the greater gains from nondiscriminatory integration (ibid Winters, 1996: 7; Schott, 2004: 13). In the 1980s, a number of approaches were developed that incorporated assessments of the

Analytical framework for rulemaking 109 dynamic effects of RTAs. Baldwin, for example, showed the medium-term benefits that could be gained from increased competition, resulting in increasing returns on investment, increased investment and thus a higher growth trajectory (Baldwin, 1989: 247–81; CEPR, 1996). There have been some similar assessments of the growth effects of RTAs that increase market size. Adding investment to the assessment of RTAs raises the question of what impact rules on investment, including both liberalisation/access rules and investment protection, will have on investment flows. As there is some evidence that some developing countries have signed RTAs with industrialised countries in order to attract foreign investment (World Bank, 2005), it would seem important to include the effects of RTAs on investment in any analysis. But this is something that is not included in customs union theory. There is a significant body of literature on the systemic effects of RTAs. Krugman initiated a series of articles with his 1991 study on the potential systemic effects of the progressive expansion of RTAs on optimal tariffs (Krugman, 1991: 7–42; 1992). This approach is again based on tariffs and neglects other elements of RTAs. Various other contributions followed Krugman’s and developed the literature, but this literature was characterised more by the elegance of the models than what it can tell us of the impact of the current wave of RTAs.2 There have also been studies that look at the issue of bloc formation and argue, for example, that a region can increase its welfare by integrating when other regions continue to follow the principle of most favoured nation status (Frankel, Stein and Wei, 1995: 61–95). There are also ‘negotiated tariff models’ that seek to identify the ‘discount rate’ at which blocs are indifferent between defecting (from most favoured nation (MFN) and the multilateral system) and cooperation. In other words, these seek to identify at which point regional integration means the countries will cease to have an incentive to cooperate. These models also discuss whether the welfare loss from retaliation by other blocs is enough to keep large blocs in check.3 These approaches all address interesting questions but their ability to provide unambiguous or comprehensive answers to the question of the impact of the current wave of RTAs is doubtful. The models are based on a number of assumptions which may not hold in the current climate. First, they assume rational unitary actors. In other words, that national governments are influenced in their decisions solely by cost benefit analysis. Second, the models are invariably tariff-based and seldom if ever include non-tariff issues, investment or rulemaking issues. Third, the models tend to discount the impact of institutions. This means that they cannot take account of the regulatory harmonisation or regulatory emulation that is arguably one of the factors driving recent RTAs. The structure of RTAs appears to be shaped by existing RTAs and by existing multilateral rules. A quick look at the RTAs concluded by Mexico with its central and southern American neighbours will show that these are more or less carbon copies of the NAFTA. The EU’s agreements with its near neighbours are shaped by the existing EU regulatory regime. Finally, all RTAs have been shaped by rules and approaches developed in the GATT, OECD or WTO (OECD 2002).

110 Stephen Woolcock Bhagwati has called for a dynamic time path analysis approach to RTAs that seeks to ask whether increasing membership of RTAs will ultimately lead to world welfare increases equivalent to what might have been achieved through multilateral liberalisation, or whether RTAs will result in lower world welfare (Bhagwati et al., 1999: 72). Bhagwati has also alerted us to the danger of regional hegemons using their negotiating leverage in bilateral negotiations to achieve relative gains at the expense of smaller trading countries (Bhagwati, 1994). Such an approach could also result in competing regional approaches, a plethora of regional and bilateral agreements and a ‘spaghetti bowl’ of rules that imposes costs for traders and investors and leads to global welfare losses. While the thesis seems to chime with some of the current strategies pursued by the major trading countries, these views on the role of RTAs in the area of rulemaking are generalisations not based on any broad analysis of the specific RTA rules. Bhagwati appears to base his spaghetti bowl analogy on the complex rules of origin that have emerged as a concomitant of preferential agreements. One can certainly argue that different preferential rules of origin represent a costly complication for world trade and investment, but this does not (yet) mean that the same is the case for other areas of rulemaking or deeper integration covering investment, service sectors, technical barriers to trade, etc. Even in the case of rules of origin, recent work suggests that the North American and PanEuro models are finding wider and wider application so that rather than many different rules of origin there will be perhaps four or five. In addition to the trade economists there has also been work on the issue of compatibility of RTAs with the letter and spirit of the multilateral order as embodied in the GATT Articles XXIV and GATS Art. V. These are the exceptions for preferential agreements provided for in the GATT and General Agreement on Trade in Services (GATS). Assessing the consistency of RTAs with the GATT rules has been an important aspect of the WTO’s work (World Trade Organisation, 1995). Indeed, a Committee on Regional Trade Agreements (CRTA) was established in 1995 for this purpose.4 Work in the CRTA has, however, been difficult because of the well-known ambiguities in the GATT wording with regard to RTAs, in particular the requirements that RTAs should cover substantially all trade and that an RTA should not result in an increase in the general incidence of protection. Although there has been some progress in defining the general incidence of protection and substantially all trade for duties, the question of how to apply these GATT and GATS rules to regulatory or rulemaking aspects of RTAs remains largely unanswered. Article XXIV refers to duties (tariffs) and other regulatory restrictions to commerce, but it is not clear yet how this should be applied in the case when diverse national rules are replaced by a single rule for the whole RTA. The need to address these questions has meant that the WTO and lawyers following the debate have begun to look in some detail at the substance of the RTAs.5

Analytical framework for rulemaking 111 THE NEED FOR AN ANALYTICAL FRAMEWORK In other words, while the existing work on RTAs provides a rich source of knowledge, there has been a tendency to focus on tariff-based models or models per se rather than assess the substance of the agreements themselves. In the international organisations such as the WTO and OECD6 work has focused more on the substantive provisions of agreements, but here the vested interests of the governments shape research and output, with the result that there has been little progress in the WTO.7 Given the growing number and detail of the RTAs it is understandable that researchers should seek to avoid detailed assessment of the agreements, but the task of assessing the agreements can be facilitated by an analytical framework similar to the one proposed here. In addition, many RTAs adopt similar if not identical rules. For example, the structure and detailed content of the NAFTA is replicated in numerous FTAs in the western hemisphere and, through FTAs with the USA, also in other regions. Detailed analysis of the substance of the RTAs will enable an assessment of whether they are consistent with an open, multilateral trade and investment system or not. By breaking down the RTAs, and in particular the rulemaking aspects of RTAs, into their component parts it is possible to assess their impact. For example, if the areas in which RTAs go beyond the WTO concern sectoral coverage only then any preference is subject to erosion through future multilateral or other preferential agreements. Although the preference may result in trade or investment diversion in the short to medium term it is unlikely to constitute more of a threat to the multilateral order than tariff preferences. If an RTA goes beyond the WTO in terms of transparency, this is unlikely to constitute a challenge to the system because there is seldom much if any preference in transparency rules, which enhance the flow of information and tend to promote regulatory best practice. If, on the other hand, RTAs include specific regulatory norms or rules they may be less benign. Rules that go beyond the WTO or other existing international standards may result in divergence between regional rules, which could make agreement on future international rules harder.

THE FRAMEWORK Table 6.1 summarises the key elements in any rulemaking exercise, the likely impact of such provisions, the WTO approach to rulemaking in the relevant area and form of preference that may result from regional or bilateral agreements including such deep integration/rulemaking provisions.

Helps guard against regulatory capture by national interests

Some agreements also require (c) and (d)

Facilitates compliance with national rules

(b) Notification of secondary/ implementing regulation

Third parties have no right to participate in consultations or decision-making process

Third parties not provided with information General transparency provisions in all areas, but not always effectively implemented

Promotes best practice in regulation

(a) Notification of relevant legislation

Transparency of rules and procedures

No discrimination between third party suppliers

Third parties do not benefit from non-discrimination WTO rules embody national treatment and MFN principles but with significant exceptions for sectors

Precludes discrimination against foreign suppliers

(a) National treatment

Principles

(b) Most favoured nation status

Preserves regional preference when applied

No provision on preferential rules of origin

Stringent rules preserve preference

Analogous to tariff preference

(a) Limit benefits to regional suppliers or goods

Generally full coverage of legislation but less of secondary regulatory instruments

Rules of origin

(d) Regulatory instruments covered

(c) Type of entity/subject covered (e.g. central, state, local, independent regulator or private entities)

Central government covered and some other levels depending on the issues area

Third parties do not benefit from the greater WTO-plus coverage of sectors, entities or regulatory instruments

Use of positive and negative lists

More extensive coverage implies greater ‘liberalisation’

(a) Coverage of policy area

Coverage

(b) Sector schedules

Nature of preference

Provision in WTO

Likely impact

Typical provisions

Rule element

Table 6.1 Proposal for an analytical framework for rulemaking in trade and investment

Institutional provisions

Substantive measures

(a) Common decisionmaking machinery (b) Intergovernmental institutions to oversee agreement (c) Specialist committees (i.e. for specific policy areas) (d) Technical cooperation and capacity building

(e) Mutual recognition of regulations or test results

(d) Equivalence

(c) Approximation as a general aim

(b) Partial harmonisation

(a) Harmonisation

(e) Obligation on regulator to respond to submissions

(d) Right of access to administrative procedures

(c) Opportunity for all parties to comment

Helps less developed economies develop best practice

Helps identify regulatory barriers before these create disputes

Promotes convergence on rules and/or best practice

(d) and (e) Reduce costs whilst retaining regulatory autonomy

(a) – (c ) Eliminate or reduce ‘frictional ‘costs

Limited resources for technical assistance

continued . . .

Third parties do not benefit from technical assistance provided under RTA General provisions for cooperation and technical assistance Specialist committees in key policy areas

Third parties not involved in more intensive cooperation within the RTA

Preference for partners in mutual recognition

Preference for regional norms or rules over international rules

WTO intergovernmental organisation with large membership

Encourages but does not require mutual recognition or equivalence

Selective harmonisation

(a) Tight limitations on the use of safeguard measures (b) General exceptions permitting discrimination

(a) Legal persons have standing in regional/ bilateral disputes and rules ‘direct effect’

Safeguard

Implementation

(d) Regional dispute settlement

(c) Remedies (e.g. financial penalties)

(b) Independent reviews

Typical provisions

Rule element

Table 6.1 continued

Effective implementation promotes confidence and thus trade and investment flows

State-to-state dispute settlement only, focuses on national legislation (rather than secondary legislation)

Third parties have no recourse to tougher and more immediate remedies and reviews

Loose discipline enables scope to discriminate against third parties

Generally broad exceptions that offer considerable scope for regulatory discretion, but some tightening e.g. SPS agreement

Tight discipline promotes confidence and thus trade and investment Loose wording provides broad scope for exceptions that has a chilling effect on trade and investment

Nature of preference

Provision in WTO

Likely impact

Analytical framework for rulemaking 115 ILLUSTRATION OF THE ELEMENTS OF THE ANALYTICAL FRAMEWORK The following sections explain and illustrate the analytical framework summarised in Table 6.1 with reference to some typical policy areas in which rulemaking is important.

Coverage Policy area coverage An obvious question to start with is whether RTAs go beyond the WTO in terms of their coverage of policy areas. There are often not straightforward answers to this question. For example, there are no general provisions covering all investment in the WTO, but the GATS covers investment in services and some GATT articles, such as Article III national treatment and Article XI, have been interpreted as covering aspects of investment policy in the Trade Related Investment Measures (TRIMs) agreement. Schedules It is convenient to compare the sectoral coverage of RTAs with that of the WTO. If the RTAs go beyond the WTO, this could be an indicator of their effectiveness in opening markets and their contribution to wider liberalisation efforts. Such assessments must be made on a case-by-case basis. The WTO coverage varies between the policy areas. In the case of services, for example, the WTO’s GATS framework agreement requires non-discrimination for all services, but then includes schedules and exceptions which effectively determine the coverage of the agreement. For example, Article II of the GATS provides for exceptions from the principle of most favoured nation (MFN) treatment (Art. II). This provision has been used by all WTO members to exclude sensitive sectors. In addition to such specific exemptions, the GATS agreement provides for a combination of positive and negative list-based schedules to determine coverage. Positive lists specify which sectors are covered by the framework agreement, but coverage of subsectors is then determined by negative lists. Thus, most WTO members include financial services in their positive lists, but then exclude certain aspects of regulation, such as certain categories of insurance. This complex approach was devised to satisfy the often competing objectives of retaining control over liberalisation and ensuring reciprocity. Regional agreements also use positive and negative lists to determine coverage. The use of the negative list approach as employed in NAFTA is generally considered to be more liberal because all activities not specifically listed are liberalised. But detailed analysis of schedules is needed before one can draw conclusions because exclusions can still be significant with negative listing. RTAs that use negative listing would generally be seen as going beyond the WTO, which uses a combination of positive and negative listing. The type of listing of exceptions is

116 Stephen Woolcock also important in investment where there are extensive provisions in RTAs but no comprehensive regime in the WTO. Another example of the use of schedules to define coverage and satisfy the demand for reciprocity can be found in the public procurement. Here the reference point for comparison is the plurilateral 1994 Government Purchasing Agreement (GPA) negotiated under GATT/WTO auspices. As with the GATS agreement, the GPA consists of a framework agreement and schedules determining coverage. Coverage of RTAs can therefore be compared to the WTO and to each other, by comparing schedules. Greater coverage of an agreement or the use of negative lists, will imply that an agreement is more liberal. The nature of preferences is fairly clear-cut in such cases and is analogous to tariff preferences. Entities covered The case of public procurement also illustrates how an analysis of the coverage of rulemaking provisions must also take account of the type of entity subject to the disciplines embodied in the rules. For example, the 1979 GPA covered only national government agencies engaged in purchasing. The 1994 GPA and an increasing number of RTAs also include state/provincial, some local government and some even private entities that benefit from special and exclusive rights granted by government that could be used as leverage to influence purchasing decisions. The deeper the coverage the more entities included and thus the greater the potential market opening. RTAs that go deeper into national public purchasing than the plurilateral rules of the WTO could therefore be said to go beyond the WTO and offer a regional preference. The case of technical barriers to trade (TBTs) also illustrates how coverage can be defined by the entity subject to rules. The WTO rules on TBTs are binding for regulations or standards issued by central government only. Sub-central government is subject to the non-binding ‘best endeavours’ rules and there is only a non-binding Code of Conduct for private standards-making bodies. An analysis of RTAs must therefore consider the types of entity covered by rules. In terms of the potential impact of greater entity coverage, the presumption would be that greater coverage means greater reach of non-discriminatory rules, greater predictability, more transparency and thus more open markets. A regional or bilateral preference would exist when a larger number of entities is bound by rules on national treatment or other provisions under an RTA than under equivalent WTO rules. For example, while sub-central government might be bound by an RTA not to discriminate against suppliers from within the region, they would be able to discriminate against suppliers from third countries. The degree of preference is therefore not very clear-cut here. In a (very) few cases there may be a formal preference, such as a price preference for national or regional suppliers in public procurement contracts. In most cases, however, it is simply the case that the entity concerned has more scope to exercise discretion in its treatment of third party suppliers. As many rules concern fairness and transparency in procedures, the question becomes whether national regulators will find it worth their while to apply

Analytical framework for rulemaking 117 different rules to third party suppliers? The experience in various RTAs suggests that they will not and will use the same procedures for third country suppliers so there will be no clear preference. Regulatory instruments covered Coverage can also be measured in terms of the type of regulatory instrument used; for example, legislation, an implementing regulation by a government department or regulatory agency, or a code of conduct or voluntary standard. Legislation will generally set out the broad policy aims and determine, for example, the scope of liberalisation and the regulatory norms and standards that must be protected. The day-to-day implementation of these objectives is then generally delegated to a regulatory agency that then takes decisions, issues guidelines, adopts standards or promulgates directives. Such decisions may be generally applicable to the whole sector or they may relate to specific companies, but all will shape market access. For example, in the field of technical barriers to trade, technical regulations are generally mandatory and adopted in legislation setting down norms for health and safety. Legislation may also establish the procedures for conformance assessment, although this is not always the case. In addition to such mandatory regulations there are, however, a large number of voluntary standards, generally developed and promulgated by private standards bodies. These are often used as one means of showing conformance with mandatory standards. In the field of services trade, day-to-day responsibility for the regulation of competition in many sectors rests with a regulatory agency, such as the US Federal Communication Commission (FCC) that takes decisions on who can operate in the market and on what conditions. The same applies in other service sectors such as financial services. In some service sectors professional bodies regulate key aspects of the market. Coverage of any system of rules must therefore include an assessment of what type of regulatory instrument is covered by their discipline. Greater coverage suggests a more liberal regime, because the disciplines of the rules are applied to more instruments. For example, if rules only cover legislative acts, there will remain scope for discrimination against non-national suppliers when it comes to the use of secondary instruments. A regional preference would therefore take the form of greater coverage with respect to regulatory instruments within an RTA than for third parties. As with the entity coverage, the degree of preference will depend very much on how the scope for discrimination in the use of secondary instruments is used. If regulatory bodies establish practices or procedures based on the objective pursuit of the aims of regulatory policy as set out in legislation regardless of who is the supplier or market participant, there is no preference. If discretion available in the use of secondary instruments is used to favour suppliers from the region or the bilateral partner, then there is discrimination and a preference.

118 Stephen Woolcock

Rules of origin Rules of origin are used in all areas of trade and investment policy to preserve a preference. Therefore they find application in the field of regulatory measures. The restrictive use of rules of origin can constitute a protectionist instrument. In the case of non-tariff measures or rulemaking, origin rules are used to defend a preference just as they are in the case of tariffs. But they have not been used as extensively in this field and tend to be more liberal than in their application to tariffs. In the services sector origin rules are used to limit the benefits of market access rules to service suppliers from the region. For example, NAFTA provides that service suppliers from outside the NAFTA region may benefit from the nondiscrimination and access rules under NAFTA provided they have substantial business activities within a party to the agreement. But here as in the GATS there have (as yet) been no closer definition of origin criteria. In government procurement RTAs also include rules of origin, for example, the EU rules on public purchasing in the utilities field enable purchasers to discriminate against non-EU suppliers if the goods to be supplied under any public contracts are not above a set percentage of EU content. But regional preferences are not possible in all aspects of public purchasing because the 1994 GPA prohibits rules of origin for purchasing by central government.

Principles Provisions in trade agreements on rulemaking are, as with border measures, covered by the non-discrimination principles of national treatment and most favoured nation treatment. National treatment means that foreign products or suppliers are treated the same as national suppliers. This is simply stated but becomes more complex in its implementation. Most favoured nation status means that regulators cannot discriminate between foreign products or suppliers. The conclusion of a regional or bilateral agreement that offers preferential treatment to signatories is, of course, in breach of the MFN principle. Although much attention is focused on national treatment in trade agreements it cannot necessarily be equated with liberalisation. If, for example, there is a national monopoly provider of a specific service, national treatment simply means that foreign competitors will be treated the same as national competitors of this supplier. In other words they will not be allowed into the market. Agreements have provided for national treatment of technical regulations for many years without this resulting in open markets. Indeed, the introduction of new regulations and standards that conformed to national treatment obligations can still result in progressive market closure. Even within regions with deep integration such as the EU national treatment had proved to be inadequate. National treatment measures have therefore either been supported by rigorous implementation and enforcement measures, or augmented by policy approximation, harmonisation or mutual recognition.

Analytical framework for rulemaking 119 The nature of preference with regard to national treatment is very clear-cut. If an RTA or bilateral agreement only extends national treatment to preferential partners there is a clear preference. With regard to MFN, any provision that discriminates between different foreign products or suppliers represents a preference.

Transparency Transparency in national policy-making and regulation has long been recognised as an important first step towards facilitating more open markets. Consequently, all agreements include some form of transparency rule, but they vary in their scope. It is therefore helpful to differentiate between obligations to provide information on statutory measures/legislation, secondary measures, and decision-making procedures, or ‘due-process’ as it is termed in American literature. The latter relates to opportunities for interested parties to make submissions and comments on regulatory decisions. Transparency requires, at a minimum, that information on all statutory measures be published. It is also standard practice to include a requirement on notification of national statutory measures to the WTO or to the relevant institution in a regional or bilateral trade agreement. While statutory instruments generally set out the objectives of regulatory policy, the day-to-day implementation of policy takes the form of decrees, executive orders and guidelines from regulatory agencies, administrative guidance from ministries, judicial or arbitral decisions. For effective transparency in rulemaking it is therefore necessary to include secondary instruments that can set precedents and thus shape market access. For example, the conditions for interconnection to telecommunications networks are laid down by the relevant regulatory agencies. The GATS agreement and equivalent measures in RTAs on basic telecommunications therefore require notification of such conditions. In public procurement, statutory measures set out procedures to be followed in placing public contracts, but the key information for potential suppliers comes in the form of calls for tender issued by a large number of public bodies that set out the qualifying conditions for prospective tenders and contracts. For foreign suppliers to have any chance of competing, transparency with respect to these subsidiary instruments is essential. Likewise, information on modifications to technical regulations or health standards is essential in the fields of TBT and SPS. In competition policy, precedence set in dealing with cases influences the evolution of policy, therefore transparency may need to include information on all decisions or judgments. Without effective transparency with regard to these subsidiary instruments of regulatory policy it will be, at best, very costly for foreign suppliers to follow the detailed developments in policy. At worst, close links between domestic suppliers and regulators can result in the exclusion of foreign suppliers. Some agreements may require prior notification of any legislation or change in norms or regulatory standards. If prior notification is provided, foreign suppliers

120 Stephen Woolcock will have an opportunity to re-tool production or modify their product or service to comply from day one with the new rules. The absence of prior notification or short notification periods may disadvantage some foreign suppliers. National producers will be more aware of changes in the rules as they will probably have been consulted by the regulatory agency. They will therefore have an opportunity to conform from day one. Small foreign suppliers, especially those in developing countries are unlikely to have the capacity to monitor regulatory policy and could, as a result, lose market share to national suppliers during the period they are unable to comply. This is an issue in sanitary and phytosanitary measures, for example. Prior notification facilitates consultation and rules may provide for parties to an agreement to comment on any decision or regulation. This ability to comment is generally extended to the state authorities. With deeper integration the right to comment may be extended to all those potentially affected by regulation, including legal persons (i.e. companies, consumers or other civil society NGOs) in other countries. Transparency in decision-making can be taken one step further if regulatory agencies are required to give consideration to the views of market participants or provide a reasoned response to the comments made. NAFTA, for example, requires the responsible agency in each country to respond to submissions from interested parties. This form of procedural transparency can promote best practice by ensuring that the experience of all market participants is included in any decision. The input of foreign suppliers may also help to correct the usual information bias in favour of domestic suppliers and hence help guard against regulatory capture by dominant national suppliers. Finally, some agreements, such as NAFTA, provide for open decision-making or what is equivalent to national treatment in regulatory procedures. For example, under US administrative procedures, private entities generally have extensive rights to make submissions and have regulators respond to their comments. This model has been used in NAFTA, which extends the same rights to private entities regardless of their origin. This kind of provision promotes confidence that national regulatory policies are genuinely carried out in a non-discriminatory fashion. When combined with recourse to legal remedies in cases of non-compliance, they can help to ensure that national treatment or non-discrimination is effectively implemented in regulatory policy. Transparency rules can therefore facilitate improved regulatory practice, reduce uncertainty and thus enhance market access and give investors confidence to invest in the market concerned. Transparency rules do, however, involve costs for the national regulators. Notifying the many thousands of implementing decisions in regulatory policy can be very costly. This is one reason for the resistance to rulemaking in some policy areas such as competition and public procurement. Increased use of information technology may reduce these costs, but the costs may still be high relative to the gains, especially for small countries. WTO provisions on transparency typically include obligations to publish and notify legislative changes. In some policy areas there are also transparency rules covering subsidiary regulatory instruments, but here coverage is not as great. The

Analytical framework for rulemaking 121 WTO Agreement on Technical Barriers to Trade and the Agreement on Sanitary and Phytosanitary Measures also require prior notification of statutory measures, but there is no requirement for prior notification under the GATS. A number of WTO agreements require regulators to take note of comments from national governments, but not from private parties. In general, WTO provisions are not very strong and have not always been implemented effectively. The degree of preference embodied in transparency rules is generally not significant, but it can vary between different types of transparency. If transparency takes the form of publication of statutory and subsidiary regulatory measures, then there is no preference, since this information will be available to all. However, regional or bilateral agreements often include channels for cooperation between regulatory bodies. These could well result in more effective mutual exchange of information than is possible at the multilateral level. Such regulatory cooperation is likely to be especially important for developing country parties concluding an RTA with a developed economy, because the technical expertise and resources available in the developed partner can help ensure effective dissemination of information. There is more clearly a regional preference when participation in regulatory decision-making is limited to preferential partners. If this preference is used to facilitate collusion between the regional partners to keep out third country suppliers then the degree of preference could be important. On the other hand if the involvement of parties from within the region helps guard against regulatory capture and helps to promote best practice in regulation, this will benefit all comers and there will be no effective preference.

Substantive measures The ineffectiveness of national treatment in dealing with regulatory policy issues has led to the inclusion of other substantive measures in trade agreements. As set out in Table 6.1 these can take a number of forms such as harmonisation, approximation, equivalence or mutual recognition of test results or of national regulation per se. The perceived failure of national treatment to facilitate – let alone guarantee – effective market access has led to efforts to harmonise rules such as in the EU, but also to a lesser degree in other RTAs and in the WTO. Harmonisation comes at a cost in terms of lost policy autonomy, which is important if countries have significantly different policy preferences, such as agreements that include developed as well as developing countries. Economists also argue that welfare losses can result from harmonisation and that less rigid approaches, such as institutional or policy competition are preferable in principle. Agreements have therefore opted for partial harmonisation focused on the most important sectors or areas in which producers feel there is most to gain from deep integration. Trade agreements may also have approximation as a general aim, without any detailed commitments on implementation. Alternatively, agreements may provide for harmonisation as a long-term aim, such as in the case of the

122 Stephen Woolcock Euro-Med agreements, but include little by way of concrete means of achieving such an objective. Another alternative to harmonisation is equivalence, which is preferred to harmonisation or mutual recognition in NAFTA. This approach encourages the parties to accept each other’s regulatory norms or standards as equivalent. The attraction of this approach is that it dispenses with most of the detailed substantive rules and institutions involved with harmonisation or mutual recognition and thus limits compliance costs and entails much loss of regulatory autonomy. But there is as yet little evidence that such equivalence approaches have been effective in opening markets. National regulators retain considerable discretion that can frustrate market access. Another difficulty is that with no policy cooperation in setting norms or standards, equivalence may, in practice, simply mean that the standards or regulatory norms of the dominant market are adopted. While this provides enhanced access for the smaller parties, they also have to carry all the costs of adjustment. The complement to harmonisation preferred in the EU has been mutual recognition. Outside the EU mutual recognition refers to mutual recognition of compliance assessment or test results, not full mutual recognition of regulatory policy. Mutual recognition of conformance assessment means that the regulators in the importing country recognise the results of conformance assessment carried out in the exporting country. It is important to bear in mind that this generally still means that the exporter must conform to the norms or standards in the importing country. Mutual recognition of conformance assessment therefore simply means that the costs of compliance are reduced. It does not necessarily overcome potential barriers to market access resulting from different national regulations or standards. Even this limited application of mutual recognition is not without its drawbacks. Some agreements leave the regulator in the importing country a safeguard that permits rejection of products or services even when they have been certified in the exporting country as complying with the importing countries standards. This is the case for TBT provisions in NAFTA although NAFTA does require parties rejecting test results elsewhere to justify such a refusal. Another difficulty with mutual recognition is that importing countries expect assurances that conformance assessment systems in the partner countries are up to standard before they are ready to recognise test results from the country concerned. This can mean the inclusion of obligations in mutual recognition agreements that are tantamount to accepting the conformance assessment norms or accreditation procedures of the dominant party. The EU, for example, requires the adoption of conformance assessment equivalent to EU conformance assessment in all its bilateral mutual recognition agreements. With full mutual recognition of regulatory policy the importing country accepts that if a product or service can be safely sold in a foreign market it can be sold in the home market, thus effectively removing any barrier to market access. In practice, this generally requires de facto approximation or convergence of regulation and has only been applied in regional agreements between countries at broadly the

Analytical framework for rulemaking 123 same level of development, such as in the EU and the ANZCERTA (Australia and New Zealand). A number of agreements envisage such mutual recognition but only after what in practice is likely to be a long transition period of close regulatory cooperation in order to establish such confidence. The WTO includes a good deal of hortatory language on the use of common international standards, such as in the TBT and SPS agreements. The SPS agreement is built on the foundations of harmonised standards for food safety in the shape of the CODEX Alimentarius. The Trade Related Intellectual Property rights (TRIPs) agreement of the WTO also requires the adoption of harmonised standards of protection for intellectual property. There is also partial harmonisation of regulatory norms in services, such as in the sector agreements on telecommunications and financial services adopted in 1997 and the WTO explicitly encourages mutual recognition with respect to technical barriers to trade and services. What constitutes a preference in this area of harmonisation and mutual recognition? A regional preference could be said to exist if regional standards or regulatory norms are developed that diverge from existing international standards. If no international standards exist, regional standards could be seen as a preference, but one that would be eroded once an agreed international standard is adopted. The impact of regional standards on third parties may, however, be positive even if such a ‘preference’ exists. The adoption of one regional norm or standard may mean lower (friction) costs in trading with the region, because exporters need only comply with one standard rather than a range of different national standards. The systemic impact of such regional norms may, however, be less benign, since the evolution of conflicting regional norms may prevent or slow the adoption of genuine international norms or standards. Whether this is indeed happening is one of the central research questions with regard to the new wave of regionalism. Partial or selective harmonisation may represent a form of preference in the sense that harmonisation may be focused on those sectors in which the regional producers feel they stand to gain most from harmonisation or approximation. A regional preference may arise in the case of equivalence or mutual recognition if this approach means, in effect, the adoption of the dominant norm or standard in the region and this differs from agreed international norms. Finally, any mutual recognition agreement could be said to constitute a preference. It has been argued that this is the case and that the spread of mutual recognition agreements initiated by the EU will result in a ‘two tier’ trading system (Baldwin, 1989). The preference embodied in a mutual recognition agreement could be subject to ‘erosion’ if all parties that can satisfy the requirement and obligations of a mutual recognition agreement are allowed to negotiate accession. In practice, this will depend on how stringent the obligations are with regard to harmonisation of essential common standards, conformance assessment and accreditation.

124 Stephen Woolcock

Institutional provisions Trade agreements generally include institutional provisions ranging from common decision-making machinery at one end of the spectrum through to technical assistance at the other end. Common decision-making machinery is generally only found where there is a high degree of policy integration, such as in the EU. In the EU statutory provisions are adopted at the EU level and in some cases there are common, supranational regulatory bodies, i.e. the European Commission, that implement the common rules. This is, for example, the case in competition policy. In most policy areas, however, national legislation implements the aims of EU policy that are set out in directives and competent authorities in the EU member states deal with day-to-day regulatory issues. The rule for trade agreements and most customs unions is intergovernmental institutions. These may have general responsibility for development and implementation of the agreement, such as in the case of the WTO General Council, or the committees or councils that are created in most trade agreements. The EU RTAs with third countries create, for example, Association Councils. NAFTA has a Free Trade Commission. These are high-level bodies that meet relatively infrequently, usually once or twice a year, and have responsibility for the overall functioning of the trade agreement. Trade agreements also often set up specialist committees or commissions to deal with specific policy areas such as technical barriers to trade, government procurement or services. Such committees monitor implementation of the trade agreements in the relevant policy area, act as a forum for extending provisions, exchange information on developments and may provide a forum for initial consultations on disputes. These kinds of committees have been established in multilateral, regional or bilateral agreements, but in the WTO there are, of course, far more participants and regional level committees are likely to provide a more intimate setting facilitating more effective cooperation. Finally, trade agreements may provide for technical cooperation and capacity building. As with the other institutional provisions discussed above, this type of provision can be found on all levels. But financial and other resources available for technical cooperation are much more thinly spread in the WTO than at the regional levels. Linking technical cooperation and capacity building with regional trade objectives may also unlock more resources. Hub or core trading entities, such as the EU and US, are more likely to provide funds if they have substantial control over the use of the funds and they serve policy objectives in a regional or bilateral setting. Closer links between partners in regional trade agreements are also likely to lead to greater availability of technical expertise or twinning arrangements between regulatory agencies. Technical cooperation and capacity building are particularly important for developing countries and can help establish the institutional infrastructure (e.g. competent and perhaps independent regulatory agencies) needed if regulatory reform and thus regulatory barriers are to be tackled effectively. Technical assistance and funds for capacity building may help to create the institutional capacity

Analytical framework for rulemaking 125 needed to implement provisions in such policy areas as TBT, SPS, competition or services. What is the impact of such institutional provisions on preferences? Preference dilution occurs when the more liberal states succeed in pressing for common policies that are more liberal than those of other partners in the agreement. Preference concentration occurs when the parties to a regional arrangement opt for trade diversion by liberalising among themselves and maintaining or perhaps even raising barriers vis-à-vis third countries. The question of preference dilution or concentration has been most pertinent for the EU because of the scope of its common decision-making machinery. But the same question can also be posed in each preferential agreement. More generally, cooperation can also help to promote regulatory best practice and thus contribute to improved economic performance in the countries concerned and to the evolution of an open trading system. On the other hand, cooperation may be used as a means of promoting the detailed specific standards of a dominant partner and can thus result in a regional preference and be detrimental to wider multilateral trade and investment. Institutional provisions can therefore create regional preferences if they result in preference concentration. An assessment of this can only be carried out after detailed study of specific cases. More generally, third parties are clearly excluded from the cooperation procedures between parties to an agreement, so this can be seen as a form of preference. Finally, third parties are unlikely to benefit from the enhanced technical assistance or financial provisions included in regional or bilateral agreements.

Safeguards All trade agreements contain safeguards. Governments are reluctant to make openended commitments to liberalisation. Thus, the GATT has always had and retains scope for safeguard actions under Article XIX. Every regional or bilateral trade agreement also has safeguards for border measures such as tariffs and quotas. It must come as no surprise then that governments wish to ensure they have scope to take safeguard measures for liberalisation of behind the border or regulatory policies. Governments have therefore included safeguard provisions that offer scope for the use of discretion in regulatory policy in regional and bilateral trade agreements. For example, the Treaty of Rome, as amended, requires the removal of all measures that have equivalent effect to quotas in restricting trade within the EU. Over the years this has been interpreted as including all regulatory policies. But Article 30 provides an exception that enables national governments to discriminate in regulatory policies or to pursue other legitimate policy objectives. Such safeguards are hedged by wording that requires such discretionary measures to be ‘proportional’ and not a disguised restriction on trade, and to use the ‘least trade restrictive’ or ‘less trade restrictive’ measures to pursue such policy objectives.

126 Stephen Woolcock The issue with such safeguard provisions for regulatory policy in regional trade agreements is therefore how much discretion exists. Tight wording will mean limited discretion for regulators to pursue a range of social, environmental or other policy objectives. Loose wording will provide discretion for regulators, which could be abused to keep out competition. Within the GATT/WTO system this has taken the form of a general exception to national treatment and MFN under Article XX of the GATT that enables governments to discriminate against foreign suppliers. The scope of this GATT safeguard for regulatory policies is drawn very wide as the original intention of the GATT was not to cover deep integration or regulatory policies. In recent years, however, concern about the abuse of the discretion offered by Article XX has led to efforts to draft tighter rules. This has found expression in the efforts over the years to tighten up the provisions of the TBT agreement and in particular the conclusion of the SPS agreement in the Uruguay Round. The latter significantly reduces the discretion available to national regulators to control or prohibit imports of food and agricultural products on the grounds of protecting human, animal and plant health. A preference in this context would then exist if the RTA provisions were WTO plus and regulators within the region were able to discriminate vis-à-vis suppliers from third countries with regard to such safeguard measures. This would result in greater uncertainty for third country suppliers and is likely to have a chilling effect on trade and investment. Scope to discriminate against third country suppliers might also be abused to protect the national or regional markets against competition from third countries.

Implementation How rules are applied is crucial. Provisions on dispute settlement or conciliation are therefore critical because they shape who interprets the rules and how. With regard to interpretation of rules, RTAs could be said to go beyond the WTO if they interpret general exceptions to non-discrimination, such as those in GATT Article XX or equivalent provisions in regional/bilateral agreements more restrictively than the multilateral rules. Regional agreements also contribute to the evolution of trade rules by codifying the criteria for exemptions in the texts of agreements, or interpreting such criteria in judicial or quasi-judicial procedures, such as the European Court of Justice in such cases as Dassonville and Cassis de Dijon. Regional agreements sometimes include their own dispute settlement provisions. Some of these are highly developed. The EU, for example, has its own European Court to interpret European law, which prevails over national law on issues relating to the European single market. NAFTA also offers a comprehensive tripartite dispute settlement mechanism including conciliation as well as quasi-judicial panels analogous to that of the WTO. Other regional agreements may rely more on conciliation and consultation in the regional or bilateral councils that oversee agreements. Specific regional dispute settlement is likely to facilitate more rapid processing of disputes than in the WTO and thus contribute to better implementation of trade commitments at the regional level than the multilateral level.

Analytical framework for rulemaking 127 Agreements may also offer reviews and remedies in cases where regulatory decisions are thought to be discriminatory. For example, the GATS agreement on basic telecommunications provides that suppliers, both domestic and foreign, should have recourse to a review of decisions concerning interconnection to the network, a key area affecting market access. In government procurement the plurilateral GPA provides aggrieved parties that believe they have been unfairly treated in the granting of a public contract with the option of mounting a ‘bid challenge’. If reviews are independent then these can help to ensure that regulatory policy is non-discriminatory. If remedies are readily available they can ensure swift enforcement and prevent delay and prevarication when it comes to compliance. In measuring the RTAs against the WTO standard of provision, it will therefore be necessary to assess whether an RTA offers more effective or more immediate remedies than the WTO. There is also the question of who has the right to bring a case in any dispute. In the WTO only states can bring cases, but in deeper integration agreements there may be rights for legal persons (i.e. companies, trade associations, NGOs, etc.) to bring cases. This is the case within the EU, where actions can be initiated against national implementation of European regulation under ‘direct effect’. It is also the case in NAFTA and NAFTA-type FTAs that provide for investor–state dispute settlement. If actively used such rights of action for legal persons, combined with regional level dispute settlement, can represent as great a challenge to national regulatory autonomy and state sovereignty as harmonisation. Dispute settlement provisions at the regional level may result in more effective implementation. When the regional agreements mirror multilateral provisions, as is frequently the case, this can mean that regional actions result in more effective implementation of the multilateral principles. But if regional interpretations go beyond what is generally accepted in the WTO, this raises the question of how to reconcile regional and multilateral interpretations in the future. The WTO provides a fairly strong dispute settlement system. Following the Uruguay Round the establishment and adoption of WTO panels is now more or less automatic. There is also an Appellate Body to rule on questions of WTO law. The WTO also offers scope for consultation and conciliation. Given the strength of the WTO system, countries participating in regional trade agreements are likely to wish to retain their right to bring cases in the WTO. What the WTO does not offer, however, is rapid review and remedies or investor–state dispute settlement. Although WTO dispute settlement cases have to be processed in line with a tight timetable, cases can still take 18 months to complete. If one adds to this the time taken by governments to comply with decisions, it is likely to be years before actors can get any redress for discriminatory application of regulatory policies under the WTO. Preference in the area of dispute settlement therefore takes the form of more immediate and rapid remedies for states and companies from participating states compared to third parties as well as the potential for divergent regional interpretations of key issues, such as proportionality or least trade restrictive provisions.

128 Stephen Woolcock CONCLUSIONS This chapter has set out to fulfil the modest objective of identifying the core elements in any trade agreement and, in particular, in agreements that include elements of rulemaking. Through illustrative examples, it has shown that the framework can be applied to all policy areas or cases, although some will tend to fit the framework better than others. In one chapter it has not been possible to apply the framework fully to a specific case, but this has been done elsewhere (Woolcock, 2004). The approach provides a framework for a qualitative but systematic assessment of the impact of the current wave of regional and bilateral trade and investment agreements. It facilitates assessments of where such agreements go beyond the existing WTO rules and thus their likely impact on both market opening and domestic regulatory autonomy. The framework also facilitates an initial assessment of the likely degree of preference in such regional level rules. For example, if the regional rules go beyond WTO rules with respect to procedural measures such as transparency, institution building or cooperation, they are less likely to constitute a significant degree of preference than when they go beyond international agreed norms or standards with regard to substantive measures. Within these two broad categories the framework also offers a means of differentiating between those elements of RTAs that are compatible and those that are likely to create more difficulties for multilateral trade and investment. NOTES 1

2 3 4

5

6

7

There is an important issue of terminology. In this chapter we shall use regional trade agreements to include both agreements between countries within the same region and free trade agreements between countries in different regions that may in some cases be bilateral agreements. An alternative and more general term would be to simply use preferential agreements. See Winter (1996) for a summary of this work. See Bond and Syropoulos (1996). The tasks of the Committee on Regional Trade Agreements are in fact: (1) to provide legal analysis of the RIAs (and their compatibility with GATT rules); (2) to make horizontal comparisons (inventories of RIA provisions covering no-tariff barriers have been produced); and (3) to debate the context and economic aspects of RTAs. See, for example, Joel Trachtman ‘Towards open regionalism? Standardisation and Regional Integration Under Article XXIV of the GATT’ paper presented to the WTO Seminar on ‘The Changing Architecture of the Global Trading System; Regionalism and the WTO’, April 2002, WTO, Geneva and Aaditya Mattoo and Carsten Fink ‘Regional Agreement and Trade in Services: Policy Issues’, paper for the WTO Seminar, April 2002, WTO. For an example of the OECD work see Ken Heydon ‘RTA Market Access and Regulatory Provisions: Regulatory Provisions in Regional Trade Agreements: “Singapore Issues”’ paper for the WTO Seminar on Regionalism and the WTO, 26 April 2002, WTO. After ten years there are signs of progress in the WTO Committee on Regional Trade Agreements that point to improvements in the transparency with regard to RTAs, but there are still difficulties reaching an agreed interpretation of the key GATT provisions that would facilitate assessments of whether RTAs are GATT-compatible.

Analytical framework for rulemaking 129 REFERENCES Baldwin, R. (1989) ‘The Growth Effects of 1992’, Economic Policy, 9: 247–81. Bhagwati, J. (1994) ‘Threats to the World Trading System, Income Distribution and the Selfish Hegemon’, Journal of International Affairs, 48. Bhagwati, J., Panagariya, A. and Krishna, P. (1999) (eds) Trading Blocs, Cambridge: MIT Press. Bond, E.W. and Syropoulos, C. (1996) ‘The Size of Trading Blocs, Market Power and World Welfare Effects’, Journal of International Economics, 40: 411–37. CEPR (1996) ‘Growth and European Integration: Towards an Empirical Assessment’, CEPR Paper Series, 1393. Frankel, J.A., Stein, E. and Wei, S.-J. (1995) ‘Trading Blocs and the Americas: The Natural, the Unnatural and the Supernatural’, Journal of Development Economics, 47: 61–96. Hettne, B. (1996) ‘Globalisation, the New Regionalism in East Asia’, in T. Tanaka and T. Inoguchi Globalisation and Regionalism, selected papers of the UNU Global Seminar 96 Shonan Session, 2–6 September 1996. Krugman, P. (1991) ‘The Moves Towards Free Trade Zones’, in Policy Implications of Trade and Currency Zones, Federal Reserve Bank of Kansas City, 7–42. Krugman, P. (1992) ‘Is Bilateralism Bad?’, in E. Helpman and A. Razin (eds) International Trade Policy, Cambridge: MIT Press. OECD (2002) Regional Trade Agreements and the Multilateral Trading System, November 2002. Schott, J. (2004) (ed.) Free Trade Agreements. US Strategies and Priorities, Washington: Institute of International Economics, 13. Winters, A. (1996) ‘Assessing Regional Integration Arrangements’, World Bank Research Working Papers. Woolcock, S. (2004) ‘The Interaction Between Levels of Rulemaking in Public Procurement’, paper presented on the LSE/CRIS Workshop on Interaction Between Levels of Rulemaking in Trade and Investment, Brussels, London School of Economics, International Trade Policy Unit, 16 December 2004. Online. Available HTTP: . World Bank (2005) Global Economic Prospects 2005: Trade Regionalism and Development. World Trade Organisation (1995) Regionalism and the World Trading System, Geneva: WTO.

7

Comparative fiscal integration indicators Philippe De Lombaerde and Ana-Cristina Costea

INTRODUCTION The literature on decentralisation and fiscal federalism presents us with a relatively sophisticated theoretical framework and a set of policy-relevant analytical tools to study the relations between different policy levels in a national environment. The aim of this chapter is to explore to what extent these conceptual and theoretical tools can be translated into a toolbox which is adapted to a multilevel government setting with supra-national (macro-regional) government levels. We will first present an overview of the conceptual framework offered by fiscal federalism theory and the technical tools which have been designed to analyse (fiscal) decentralisation processes. We will then explore how these tools could be adapted in order to be used for the monitoring and comparative analysis of regional integration processes and discuss the specific methodological and practical issues and problems that we envisage.

DECENTRALISATION AND INTEGRATION IN FISCAL FEDERALISM THEORY Since the late 1970s and 1980s, administrative and/or political decentralisation have attracted a lot of attention, not only in academia but also in actual public administration practice and politics, both in the North and in the South. Different reasons explain this phenomenon: 1 2 3 4

an almost general (global) tendency towards more democratic forms of government in the post-war period, the apparent relative failure of centralised development models and the need for structural adjustment, the supporting role of multilateral organisations, especially in developing countries, the new surge of neo-liberal ideology and its view on the role of the (central) state,

Comparative fiscal integration indicators 131 5

the development of fiscal federalism theory and its ‘demonstration’ of the (causal) linkages between decentralisation, on the one hand, and efficiency and democracy, on the other.

Although fiscal federalism is obviously concerned with a broader area than strict budgetary matters, we will primarily focus on these. As Oates put it: ‘As a subfield of public finance, fiscal federalism addresses the vertical structure of the public sector. It explores, both in normative and positive terms, the roles of the different levels of government and the ways in which they relate to one another through such instruments as intergovernmental grants’ (Oates, 1999: 1120). The theories of fiscal federalism are thus concerned with the functioning of multilevel government structures. This includes the allocation of taxation powers and control over public expenditure among the different levels of government, but also the relations between the different levels in the form of grants and credits. Although the theories of fiscal federalism have been developed in the context of public finance in national economies in federalist states, it is justified to consider them as more general theories of vertical government structures (Oates, 1999). They are therefore important building blocks of a theoretical framework for the analysis of the macro-regional policy level and its linkages with other (national, sub-national) government levels.1

Basic fiscal federalism theory and decentralisation The theories of fiscal federalism draw on concepts and theories from public finance, economic geography and public choice (Samuelson, 1954, 1955; Musgrave, 1959; Oates, 1972; Tiebout, 1956, 1961; Brennan and Buchanan, 1977, 1978, 1980; Buchanan, 1980). The so-called basic or traditional theory of fiscal federalism consists of a general normative framework for the assignment of powers and functions and the corresponding fiscal instruments to different levels of government (Musgrave, 1959; Oates, 1972). This assignment depends on the optimal level of provision of public goods. On the basis of the principle of allocative efficiency, a multilevel government system is normally superior to a centralised government system. This explains why the theory, in a context of (relatively) centralised states, has mainly been used to justify decentralisation policies. In addition, fiscal federalism theories have been associated with neo-liberal ideology; one of the theses of fiscal federalism being that decentralisation leads (and should lead) to less government intervention and a smaller state. According to the basic theory, the efficient level of output of a ‘local’ public good is the level where the sum of residents’ marginal benefits equals marginal cost. This level will normally vary across jurisdictions for two reasons: 1 2

cost differentials, determining differences in marginal costs, differences in preferences, determining differences in marginal benefits.

The normative proposition which follows from this is known as the ‘decentralisation theorem’ and can be formulated as follows:

132 Philippe De Lombaerde and Ana-Cristina Costea ‘in the absence of cost-savings from the centralised provision of a [local public] good and of interjurisdictional externalities, the level of welfare will always be at least as high (and typically higher) if Pareto-efficient levels of consumption are provided in each jurisdiction than if any single, uniform level of consumption is maintained across all jurisdictions’. (Oates, 1972: 54) It is further understood that information asymmetries exist between central and decentralised levels of government, only the latter having access to perfect information on preferences and cost conditions, and/or that political constraints exist that prevent a diversified supply of local public goods (Oates, 1999). Although mobility of the subjects of the jurisdictions is not a necessary condition for the precepts of fiscal federalism in favour of multilevel (decentralised) government to hold, it does make the case stronger. In the Tiebout model (1956), mobile households choose to reside in the jurisdiction which offers the mix of public goods and taxes which is closest to their preferences. Local governments ‘compete’ with each other and produce a first-best solution.2 Brennan and Buchanan (1980), build further on the Tiebout model and combine it with insights from monopoly theory and public choice theory. In their view, internal mechanisms make that governments (‘Leviathans’) seek their own growth through the extraction of more and more resources from the economy. Decentralisation is an efficient alternative to explicit fiscal rules (constraints) on the taxing power of governments because it promotes intergovernmental competition. It is believed that at the local level a market solution exists which determines the optimal level of expenditure on public goods, which is a departure from the views of Samuelson and Musgrave. Unlike Tiebout, Brennan and Buchanan do not present this as a first-best solution and they are conscious of the political economy aspects of intergovernmental relations. For Brennan and Buchanan decentralisation is assimilated with democracy. A logical implication of Brennan and Buchanan’s views is that decentralisation (multilevel government) minimises the overall size of the public sector. Hence, both macro-economic and micro-economic efficiency are reached with decentralisation.3 Fiscal federalism also addresses the optimal choice of the type of fiscal instrument (tax) for each government level (the ‘tax assignment problem’). It is shown that this choice should basically depend on the mobility of the economic units. A system of multilevel government is usually characterised by additional financial flows in the form of grants (transfers) or credits. Grants can be conditional, placing conditions on their use by the recipient government, or unconditional. Fiscal federalism theory prescribes that conditional matching grants should be in place to the extent that inter-jurisdictional external effects occur. A system of unconditional grants should exist for redistributive (fiscal equalisation) purposes, which is a form of cohesion policy, or for revenue-sharing purposes when local taxation is not efficient.

Comparative fiscal integration indicators 133 As Oates (1999) rightly points out, the precepts of fiscal federalism should be seen more as general ‘guidelines’ than firm ‘principles’. The theories do not permit to unambiguously determine the optimal level of any specific collective good.4 This point of view can be extended to the tax assignment issue and the design of a system of transfers. The basic theory of fiscal federalism does not provide us either with clear principles on the optimal geographical extention of jurisdictions. It only suggests that there will be a trade-off between the need to internalise positive and negative spillovers (supporting larger jurisdictions) and the need for local differentiation (supporting smaller jurisdictions). Basic fiscal federalism theory is a static theory, providing arguments in favour of a decentralised multilevel government structure. There is no theoretical model available that establishes a long-run relationship between decentralisation and economic growth or development. Empirical evidence is not straightforward. Although decentralisation may contribute to development in a particular stage of development, decentralisation should also be seen as a consequence of complex economic and political development processes. As pointed out by Prud’homme (1995) and others, in a developing country context, the hypothesis of efficient local governments is not necessarily valid. The potential contribution of decentralisation to economic development depends on the historical, institutional and political contexts and the design of local fiscal instruments, intergovernmental transfers and intergovernmental debt financing instruments. More recent advances include the incorporation of political goals in the objective function (Inman and Rubinfeld, 1997a, 1997b) and the reinterpretation of the optimality of the decentralised state from a neo-institutional perspective (Weingast, 1995; McKinnon and Nechyba, 1997). It has been shown that in the presence of economies of scope in the provision of public goods, a centralised government can be optimal (Alesina and Spoalore, 2003: 26–29).

Fiscal federalism and regional integration Fiscal federalism theories are perfectly capable of including supra-national (regional) government levels in the analysis. This is particularly relevant when there are relatively high (or growing) levels of intra-regional mobility of capital and labour (consumers, taxpayers), which widen the scope for externalities. Nevertheless, their application to regional integration problems has been relatively limited, although their influence on the design of the European fiscal arrangements should not be underestimated.5 Tinbergen (1954) and Cooper (1977, 1995) extended the general ideas of optimum policy levels and functional federalism to an international macro-regional context. According to Tinbergen (1954), the optimal (efficient) policy level is based on two criteria: 1

the level should be ‘low enough’ in order to minimise transaction costs and maximise citizens’ participation, and

134 Philippe De Lombaerde and Ana-Cristina Costea 2

the level should be ‘high enough’ so that all those affected by the policy measures are covered, or, in other words, so that external effects are minimised.

Cooper (1977, 1995) states that for the provision of certain public goods (and only for public goods), regional integration can be Pareto-optimal in view of reaching the social goals. He stresses that a variety of factors influence the determination of the optimal level of government intervention; some of them point in the direction of high levels (large jurisdictions, although not global), other in the direction of low levels (small jurisdictions). The first category of factors includes: technical economies of scale (depending on the concerned good), positive or negative external effects (which usually also constitute a case of economies of scale, for example, when the marginal cost of additional consumption of public services is almost zero), and the mobility of the subjects of restrictive (regulatory or redistributive) policies. The second category of factors includes individual preference diversity in relation to collective goods. These goods can be ‘systemic’ (policy regimes, value systems, etc.) or ‘specific’ (science parks, infrastructural projects, etc.). This logic leads to a system of functional federalism in which the optimal level of provision of the collective goods by the public agent is determined for each good individually. Such a system is complex and is characterised by overlapping jurisdictions and partial sovereignties. Although there are several examples of supra-national (macro-regional) cooperation in order to provide specific public goods (regional central banks, regional development banks, specific regional organisations) and although functional federalism may be optimal from a static point of view, this is not necessarily the case from a dynamic perspective. As acknowledged by Cooper, as technology and preferences vary with time, functional federalism would imply frequent changes in the integration schemes, causing transition costs and possibly generating conflicts with the bureaucratic interests of the existing schemes. In addition, with fiscal federalism, the possibility exists to negotiate and to seek political deals on hierarchically higher levels in relation to the provision of collective goods on lower levels, independently from local interests. Fiscal federalist thinking logically implies that if there is a long-term tendency towards the mobilisation of goods, services, production factors and information, and towards deeper interdependence, more regional integration initiatives might be expected.6 The relationship between country size and economic integration is a two-way relationship. While the incentive for economic integration is greater for smaller countries, facing smaller domestic markets, because of the liberalising aspects of RIAs, regional integration reduces the size of viable countries (economies) (Alesina and Spoalore, 2003: 81). As the authors show, this becomes clearer when a distinction is made between the political size of a country and the size of its market. Only in a world with complete autarky, do these two concepts coincide. Casella presents a dynamic version of fiscal federalism with spatial and institutional dimensions. Her thesis is that market integration requires centralised regional institutions in order to minimise transaction costs and in order to provide

Comparative fiscal integration indicators 135 an adequate level of policy coordination. With deepening integration, the roles of the different regional components of the macro-region are being redefined and competition among them increases. This may lead to a more heterogeneous demand for public goods and a revision of the allocation of powers and their provision within the macro-region (Casella, 1994). The logic of the development of market-based integration leads also to a system of functional federalism (Casella and Frey, 1992). As a final remark, fiscal federalism and related theories explain the optimal policy level in a multilevel government structure. To the extent that actual policy levels differ from the optimal levels, the normative implication of the theories points in the direction of decentralisation or integration. Theoretically speaking, subsidiarity is thus not a necessary implication of fiscal federalism. In addition, since optimal policy levels change in time (because the ‘needs’ of the markets and the citizens change in time), integration (and, therefore, decentralisation) should logically be seen as a reversible process. This is opposed to the political debates where integration (and decentralisation) is usually presented as a unidirectional cumulative process.

FISCAL DECENTRALISATION INDICATORS In this chapter we are not overly concerned with the validity of fiscal federalism as a normative theory. For our purpose, the importance of fiscal federalism lies in the fact that, in order to test the theory, a toolbox with concepts, techniques and indicators has been designed to analyse the vertical aspects of public finance. The measurement tools that have been developed to analyse multilevelled fiscal relations range from simple descriptive measures to more analytical measures. Obvious indicators include those that allow the monitoring of the relative importance of each governance level, measured on the income or expenses side. Usually, complex and country-specific combinations of transfer and borrowing mechanisms are in place within federations in order to preserve the political stability of federal systems and to allow all the components of the government system to perform their assigned tasks adequately. These arrangements are the consequence of the existence of so-called vertical and horizontal imbalances. Vertical imbalances follow from an unequal distribution of revenues and expenditures (fiscal capacity) among various levels of government within a federation. Horizontal imbalances reflect the differences between fiscal capacities of a given governance level (Ahmad and Craig, 1997: 76). These are equally relevant from a fiscal federalism perspective, because it is often both technically and politically easier to address these imbalances when a superior governance level (and thus vertical payments) is involved than through a – theoretically possible – horizontal system of equalisation payments. Cross-country comparisons are made difficult because of differences in the institutional and legal frameworks, data quality and availability, public accounting principles and practices.7 The work done by the World Bank in constructing

136 Philippe De Lombaerde and Ana-Cristina Costea Table 7.1 The World Bank’s list of fiscal decentralisation indicators Categories

Indicators

Main indicators

Sub-national expenditures (% of total expenditures) Sub-national revenues (% of total revenues) Vertical imbalance (%) Sub-national expenditures (% of GDP) Sub-national revenues (% of GDP)

Composition of sub-national revenues and grants

Tax revenue (% of total sub-national revenues and grants) Transfers from other levels of government (% of total sub-national revenues and grants)

Composition of sub-national expenditures

General public services (% of total sub-national expenditures) Defence (% of total sub-national expenditures) Public order and safety (% of total sub-national expenditures) Education (% of total sub-national expenditures) Health (% of total sub-national expenditures) Social security and welfare (% of total sub-national expenditures) Housing and community amenities (% of total sub-national expenditures) Recreational, cultural and religious affairs and services (% of total sub-national expenditures) Fuel and energy (% of total sub-national expenditures) Agriculture, forestry, fishing and hunting (% of total sub-national expenditures) Mining and mineral resources, manufacturing and construction (% of total sub-national expenditures) Transportation and communication (% of total sub-national expenditures) Other economic affairs and services (% of total sub-national expenditures) Other expenditures (% of total sub-national expenditures)

Source: World Bank (sd).

indicators and setting up a database has been very important in this respect (World Bank, sd). Table 7.1 presents an overview of the indicators included in the Bank’s database. They are organised in three categories: 1 2 3

main indicators, indicators showing the composition of sub-national revenues and grants, and indicators showing the composition of sub-national expenditures.

FISCAL INTEGRATION INDICATORS: A PROPOSAL In this section we present a list of possible fiscal integration indicators. They have been inspired by the decentralisation indicators of the World Bank, in turn derived from IMF’s Government Finance Statistics.

Comparative fiscal integration indicators 137 Supra-national expenditures (as per cent of total expenditures)

=

TOTEXPr − CURTRAr − CAPTRAr *100 ∑ TOTEXPj − CURTRAj − CAPTRAj

j =l , p ,c ,r

where: TOTEXP = total expenditures CURTRAj = current transfers from level j to all other governance levels CAPTRAj = capital transfers from level j to all other governance levels l = local level p = provincial (or departmental, regional) level, i.e. refers to the intermediate sub-national levels of governance c = central (national) level r = regional (supra-national, macro-regional) level. Correspondingly, national expenditures (as percentage of total expenditures)

=

∑

TOTEXPi − CURTRAi − CAPTRAi

∑

TOTEXPj − CURTRAj − CAPTRAj

i =l , p ,c

*100

j =l , p ,c ,r

⎞ ⎛ TOTEXPr − CURTRAr − CAPTRAr ⎜ = 100 − * 100⎟ ⎜⎜ ∑ TOTEPj − CURTRAj − CAPTRAj ⎟⎟ ⎝ j=l,p,c,r ⎠ Regional revenues (as percentage of total revenues)

=

TOTREVr * 100 ∑ TOTREVj

j =l , p ,c ,r

where: TOTREV = total revenue. Correspondingly, national revenues (as percentage of total revenues)

∑

⎛ ⎞ TOTREVr ⎜ = * 100 = 100 − * 100⎟ ⎜⎜ ∑ TOTREVj ⎟⎟ ∑ TOTREVj ⎝ j =l , p ,c ,r ⎠ j =l , p ,c ,r i =l , p ,c

TOTREVi

138 Philippe De Lombaerde and Ana-Cristina Costea Vertical imbalance (per cent)

∑

TRAi, r

i =l , p ,c

=

∑

TOTEXPi

* 100

i =l , p ,c

where: TRAi,r = transfers from levels i to the regional governance level. Supra-national expenditures (as percentage of regional GDP)

TOTEXPr * 100 ∑ GDPc

=

c=1..C

where: C = number of countries in the regional integration grouping. Supra-national revenue (as percentage of regional GDP)

=

TOTREVr * 100 ∑ GDPc c =1..C

For each level of government, the composition of expenditures (per cent)

EXPs * 100 TOTEXP

= where:

EXPs = specific expenditures category. As far as the composition of revenues is concerned, the following indicators are relevant: Tax revenue (as percentage of total revenues) at the regional level

=

TAXREVr * 100 TOTREVr

Transfers from other levels of government (as percentage of total revenues)

Comparative fiscal integration indicators 139

=

∑

TRAi, r

i =l , p ,c

TOTREVr

* 100

Horizontal imbalances (per cent), measured in terms of transfers

=

∑ ∑ TRAi, j

i =1..C j =1..C

∑ TOTEXPi

* 100

i =1..C

Alternatively, horizontal imbalances (as percentage of expenditures) in terms of fiscal balances

=

∑

i =1..C

TOTREVi − TOTEXPi

∑ TOTEXPi

* 100

i =1..C

Similar indicators can be constructed, substituting TOTEXP by TOTREV or GDP in the denominator. FISCAL INTEGRATION INDICATORS: ISSUES The construction of a comprehensive database with comparable fiscal data at the regional level and the calculation of the proposed fiscal integration indicators is not an easy task. From a first exploration of available data we arrived at the following set of considerations on the possible scope of such an exercise and the problems that are likely to present themselves.8

Regional integration and public finance: initial remarks Looking at regional integration through a budgetary lens allows us to have an idea of the relative political importance of the regional governance level, the degree of actorness of the regional organisation and the degree of intra-regional cohesion and solidarity (horizontal imbalances), and is therefore an interesting complement to existing comparative indicators of regional integration processes.9 It makes the regional integration processes also more transparent which, in turn, might increase participation in the processes and hence their sustainability. The fiscal lens allows us to get an idea of the functions that regional finances are fulfilling; for example, following Musgrave’s categorisation: allocative, redistributive or stabilising function. The fiscal lens also reflects the institutional architecture at the regional level. The existence and development of a supra-national institutional framework, the establishment of a customs union, the creation of a common agricultural policy, etc. all have a crucial incidence on fiscal integration.

140 Philippe De Lombaerde and Ana-Cristina Costea The degree of fiscal autonomy of the regional institutions (or, importance of ‘own resources’) is also a crucial factor. In the real world, the supra-national level draws most or all of its revenue from transfers and not from regional taxes. It is likely, however, that with the further development of the regional government level the ‘tax-assignment problem’ (McLure, 1983) in the fiscal federalism literature will receive also more attention in regional integration studies. Finally, compared to the national and sub-national governance levels, regional governance levels tend to be less stable. In addition, there is a trend towards more instability and a more complex distribution of shared competences (Laffan, 1997: 19). This makes a systematic monitoring and the comparison of figures crosscountry and over time more difficult.

Regional budgets complexity and the type of regional organisation Regional budgets have also evolved according to the ‘wave’ or ‘generation’ of regionalism to which the organisation belongs. In the ‘first generation’ of regionalism – based upon the idea of a linear process of economic integration involving the combination of separate (national) economies into larger economic regions – the regional budget was mostly limited to the expenses related to the functioning of a small Secretariat and a Council of Ministers, with the possibility of creating supplementary budgets approved by the Council to meet extraordinary expenditures of the Secretariat.10 In the ‘second generation’ regional integration or ‘new regionalism’, integration can also imply other matters than pure trade creation such as social policies, political integration, justice, security, culture. The creation of new political institutions with autonomous status and often a smaller membership than the main bodies of the regional organisation – such as regional Parliaments and regional Courts of Justice – has consequences for finances at the regional level involving the creation of additional budgets, which often operate through different rules than the core budget of the community/regional organisation. As an example, while the core Southern African Development Community (SADC) budget is financed through member states’ contributions based on a formula combining GDP and the population of one country, the SADC Parliamentary Forum – an autonomous regional institution of the Southern African Development Community – is financed through annual and mandatory equal contributions of US30,000 by each of the 12 member Parliaments of the Forum. In some cases, following a monitoring of the evolution of the new institutions, measures are taken in order to allow these new budgets to be integrated into the main budget of the regional organisation in question. Also, with the move towards increased integration, many regional organisations have followed the European model with the creation of funds for cohesion, infrastructure development, and project financing next to the core budget of the regional organisation, with a different governance structure and membership. Examples include: the Fund for Cooperation, Compensation and Development of

Comparative fiscal integration indicators 141 the Common Market for Eastern and Southern Africa (comprising an Infrastructure Fund and an Adjustment Facility); the Fund for Cooperation, Compensation and Development of the Economic Community of West African States; the South Asian Development Fund, the ASEAN Fund (consisting of a Seed Fund Account invested to realise income for the ASEAN Fund and a Projects Fund Account). Not much analysis has been performed yet on the budgetary effects of these funds for the different member countries of a regional organisation given their relatively recent implementation in most cases as well as the difficult task of tracking country shares in multinational projects.

Vertical and horizontal imbalances Theoretically, vertical imbalances are not necessarily accompanied by horizontal imbalances, although in practice this will usually be the case. Horizontal imbalances refer to differential fiscal capacities of states (within a regional scheme), which can be accompanied by equalisation transfers between states or from (via) the macro-regional level. In a national context, horizontal imbalances are only measured in very few cases (e.g. Australia, Canada, Germany) (Ahmad and Craig, 1997: 76). Thus, in the fiscal federalism literature, the concept of horizontal imbalances does not refer to the redistributive role of the centre (national state) in general; it is a more specific concept. The discussion on net contributions in the EU, for example, is therefore broader in scope. It should also be noted that establishing the redistributive or equalising role of regional finances, supposes the choice of an evaluation criterion. Different criteria are available (per capita GDP, GDP, population, fiscal base, etc.) and can be picked according to political inclinations and agendas. Horizontal ‘equilibrium’ or ‘neutrality’ are therefore not unique concepts. The measurement of horizontal imbalances is difficult and depends on whether one focuses on fiscal capacities or on equalising payments, and whether one only includes direct (visible) flows or also indirect (invisible) flows, and whether one includes only horizontal flows or also flows that pass through the regional level. In existing regional integration schemes, horizontal payments are (still) practically non-existent. As is the case in certain federal countries like Australia and Canada, when an integrated system of equalisation grants exists and simultaneously addresses vertical and horizontal imbalances (Ahmad and Craig, 1997: 77), it might be very difficult to disentangle the two types of imbalances.

‘Net’ contributions This is a particularly sensitive issue and an issue for domestic electoral use. It has certainly been a sensitive one in Europe. In the European case, the issue has caused many discussions, especially originating in ‘net contributing countries’ like the UK, Germany and the Netherlands (Laffan, 1997: 18, 47–60). It is technically difficult to calculate the value added of a regional integration scheme and the ‘net contribution’ or ‘net benefit’ for individual member states.

142 Philippe De Lombaerde and Ana-Cristina Costea Many economists will share the view that a calculus based on fiscal data does not make much sense, provided that a large part (if not the largest part) of the benefits of regional integration is simply not visible when looking at the fiscal accounts. The benefits of free trade and capital movements, of more competition, of larger domestic markets, of more political stability, etc. cannot be assessed in fiscal terms. And even if one looks at the fiscal picture, indirect effects, which should not be underestimated, are not captured.11 If a calculation of net contributions is undertaken anyway, several problems appear. On the income side, the calculus is particularly difficult when own (regional) resources exist. On the expenses side, although part of the expenses at the regional level is assignable to member states, part is necessarily general in nature.

In-kind contributions For a number of regional organisations, in-kind contributions from, for example, the host country of the regional organisation’s headquarters or from the regional hegemon, although of limited importance in absolute terms, can be important in relative terms, especially when the regional organisations have limited budgets. These in-kind contributions can cover secondment of (national or sub-national) government officials, provision of facilities and support for functioning of the headquarters and other regional institutions, tax benefits or exemptions for the regional organisation, etc. Failing to take these contributions into account distorts the fiscal picture.

Extra-regional funding External funding for regional organisations can be important, especially for developing countries. The assistance received from donors towards the financing of various programmes can significantly influence the performance of the regional organisation. As an example, ECOWAS received in 2002 external funding from the Japanese government, the Canadian government (child protection), USAID (gas pipeline project), the ADB, the European Union and IFAD (ECOWAS/ UEMOA project). In other cases, funds with single country contribution from inside or outside the organisation are sometimes set up under the name of the regional organisation in order to answer different needs: e.g. the ASEAN Cultural Fund of five billion yen financed by the Japanese government and managed by two banks established in ASEAN countries.

Transparency, public accounting standards and data availability The comparison of fiscal integration indicators is complicated by differences in public accounting standards and differences in the categorisation of revenue

Comparative fiscal integration indicators 143 and expenses, both cross-country and from a vertical perspective. When different budgetary rules are followed from one regional organisation to another (for example, rules for carrying over commitment and/or payment appropriations), comparison is made more difficult. If there is no rule of unity, the coexistence of several regional organisations will complicate the compilation of data on total budgets. This consolidation is usually not undertaken by regional organisations. On the other hand, when budgetary rules exist (and are followed), they can be used to check the quality of the data.12 Except for the EU, few other organisations have tried to increase transparency by publishing their budgets systematically on websites or in the Annual Reports issued by the Secretariats. In the cases where such reports exist, often there is no detailed breakdown which might allow for a fiscal federalism analysis based on country contributions and receipts from the regional budget. In a few cases, the annual budgets of the organisations are presented online by the audit firms in charge of assessing the regional organisation in question. Reports by the international firms of external auditors, such as PriceWaterhouseCoopers13 for SICA and Ernst&Young for the Association of Caribbean States, are useful tools for research. General materials such as the Yearbook of International Organisations, published by the Union of International Associations14 give only the total budget of regional organisations It should be noted, finally, that the role of regional parliaments in controlling the regional organisations’ budgets, is in most regions still non-existent or – at best – in its early stages.

CONCLUSIONS The toolbox of concepts and indicators that has been produced as a by-product of the fiscal federalism approach, in order to empirically assess vertical fiscal relations at the country level, can be adapted to cover also the supra-national (macro-regional) level without major problems. These types of fiscal integration indicators would be a welcome complement to existing indicators of economic integration and interdependence. However, a first exploration of the possibilities of constructing such a system of indicators encounters a series of problems. These are related to the existence of different regional institutional architectures and financing arrangements, accounting standards, different data qualities, different degrees of extra-regional funding, and so on. The introduction of a uniform reporting format should be encouraged.

NOTES 1 For an exploratory application of fiscal federalism to the global level see, for example, Boadway (2003). 2 See also Buchanan and Goetz (1992).

144 Philippe De Lombaerde and Ana-Cristina Costea 3 For critical positions on this point see, for example, Anderson and Tollison (1988), Flowers (1988) and González (1994). 4 On this issue in a developing country context see also Shah (1994). 5 There was, for example, a clear influence of fiscal federalism on the MacDougall Report (1977) and the Sound Money: Stable Finances Report of 1993 (Laffan, 1997: 29). 6 Bureau and Champsaur (1992) raised the issue of redistribution policies in a macroregion (the EU) characterised by increasing taxpayer mobility. 7 See also Ter-Minassian (1997). 8 We analysed fiscal data for the EU, COMESA, SADC, ACS, SICA, APEC, ASEAN and Pacific Islands Forum. 9 On the relevance of a fiscal approach to regional integration in the Europan context, see Laffan (1997: Chapter 2). 10 See, for instance, COMESA Treaty, Chapter 30, Financial Provisions, Art. 166 §7. ECOWAS Treaty, Art. 71. 11 For example, structural funds flowing from the regional level to Spain might well be translated into benefits for Germany in the form of exports of capital goods, a more (politically) stable export market, etc. 12 See Laffan (1997: 36–40) on the European case. 13 PriceWaterhouseCoopers, Estados financieros de la Secretaría General del Sistema de la Integración Centroamericana, 2002, San Salvador, 28 March 2003. 14 The Union of International Associations, Yearbook of International Organisations, Vol. 1, 1998–1999, München: KG Saur.

REFERENCES Ahmad, E. and Craig, J. (1997) ‘Intergovernmental Transfers’, in T. Ter-Minassian (ed.), Fiscal Federalism in Theory and Practice, IMF, Washington DC, 73–107. Alesina, A. and Spoalore, E. (2003) The Size of Nations, Cambridge (Mass.): MIT Press. Anderson G. and Tollison, R. (1988) ‘Legislative Monopoly and the Size of Government’, Southern Economic Journal, 54(3): 529–45. Boadway, R. (2003) ‘National Taxation, Fiscal Federalism and Global Taxation’, WIDER Discussion Paper (WDP 2003/87). Brennan, G. and Buchanan, J. (1977) ‘Towards a Tax Constitution for Leviathan’, Journal of Public Economics, 8: 225–73. Brennan, G. and Buchanan, J. (1978) ‘Tax Instruments as Constraints on the Disposition of Public Revenues’, Journal of Public Economics, 9: 301–18. Brennan, G. and Buchanan, J. (1980) The Power to Tax: Analytical Foundations of a Fiscal Constitution, Cambridge: Cambridge University Press. Buchanan, J. (1980) ‘Federalism and Fiscal Equity’, in Grewal et al., The Economics of Federalism, Australian National University Press. Buchanan, J. and Goetz, C. (1992) ‘Efficiency Limits of Fiscal Mobility: An Assessment of the Tiebout Model’, Journal of Public Economics, 23: 25–43. Bureau, D. and Champsaur, P. (1992) ‘Fiscal Federalism and European Economic Unification’, American Economic Review Papers and Proceedings, 82: 88–92. Casella, A. (1994) ‘Trade as an Engine of Political Change: A Parable’, Economica, 61: 267–84. Casella, A. and Frey, B. (1992) ‘Federalism and Clubs: Towards an Economic Theory of Overlapping Political Jurisdictions’, European Economic Review, 36: 639–49. Cooper, R. (1977) ‘Worldwide versus Regional Integration. The Optimum Size of the

Comparative fiscal integration indicators 145 Integrated Area’, in F. Machlup (ed.), Economic Integration Worldwide, Regional Sectoral, International Economic Association – Macmillan, London, 41–53. Cooper, R. (1995) ‘Worldwide Regional Integration: Is There an Optimal Size of the Integrated Area?’, in R. Garnaut. and P. Drysdale (eds), Asia Pacific Regionalism. Readings in International Economic Relations, Sydney: Harper Educational, 11–19. Flowers, M. (1988) ‘Shared Tax Source in a Leviathan Model of Federalism’, Public Finance Quarterly, 16(1): 67–77. González, J.I. (1994) ‘Un ordenamiento territorial de corte fiscalista’, in N.A. Cifuentes et al., Diez años de descentralización. Resultados y perspectivas, Bogotá: FESCOL, 99–126. Inman, R.P. and Rubinfeld, D.L. (1997a) ‘The Political Economy of Federalism’, in: D. Mueller (ed.), Perspectives on Public Choice: A Handbook, Cambridge: Cambridge University Press, 73–105. Inman, R.P. and Rubinfeld, D.L. (1997b) ‘Rethinking Federalism’, Journal of Economic Perspectives, 11(4): 43–64. Laffan, B. (1997) The Finances of the European Union, Basingstoke: Macmillan Press. McKinnon, R.I. and Nechyba, T. (1997) ‘Competition in Federal Systems: The Role of Political and Financial Constraints’, in J. Ferejohn and B. Weingast (eds), The New Federalism: Can the States be Trusted?, Stanford: Hoover Institution Press, 3–61. McLure, C.E. Jr. (ed.) (1983) Tax Assignment in Federal Countries, Canberra: Australian National University Press. Musgrave, R.M. (1959) The Theory of Public Finance, New York: McGraw-Hill. Oates, W.E. (1972) Fiscal Federalism, New York: Harcourt Brace Jovanovich. Oates, W.E. (1999) ‘An Essay on Fiscal Federalism’, Journal of Economic Literature, XXXVII: 1120–49. Prud’homme, R. (1995) ‘On the Dangers of Decentralisation’, The World Bank Research Observer, 201–10. Samuelson, P. (1954) ‘The Pure Theory of Public Expenditures’, Review of Economics and Statistics, XXXVI(4): 387–89. Samuelson, P. (1955) ‘Diagrammatic Exposition of a Pure Theory of Public Expenditures’, Review of Economics and Statistics, XXXVII(4): 350–56. Shah, A. (1994) The Reform of Intergovernmental Fiscal Relations in Developing and Emerging Market Economies, World Bank, Washington DC. Ter-Minassian, T. (1997) ‘Intergovernmental Fiscal Relations in a Macroeconomic Perspective: An Overview’, in T. Ter-Minassian (ed.), Fiscal Federalism in Theory and Practice, IMF, Washington DC, 3–24. Tiebout, C. (1956) ‘A Pure Theory of Local Expenditures’, Journal of Political Economy, 64: 416–24. Tiebout, C.M. (1961) An Economic Theory of Fiscal Decentralization in Public Finance: Needs, Sources and Utilization, Princeton NJ: Princeton University Press. Tinbergen, J. (1954) (2nd edn 1964) International Economic Integration, Amsterdam: Elsevier. Weingast, B.R. (1995) ‘The Economic Role of Political Institutions: Market-Preserving Federalism and Economic Development’, Journal of Law, Economics and Organisation, 11: 1–31. World Bank (sd) Fiscal Decentralisation Indicators, World Bank, Washington DC.

8

Indicators of real economic convergence José Villaverde Castro

INTRODUCTION Whether poor economies tend to converge towards rich ones or else to diverge over time is an issue that has attracted the attention of policy-makers and academics alike for some decades. Economic convergence or divergence is a topic of considerable interest and debate, not only for validating or otherwise the two leading and competing growth models (the neoclassical and the endogenous growth approaches) but also for its policy-oriented implications. Generally speaking, the presence of convergence is considered as a valid test in favour of the neoclassical growth model as opposed to the endogenous models that predict divergence in most cases. The convergence issue has been revived in the past two decades thanks to the seminal works by Abramovitz (1986), Baumol (1986) and Barro and Sala-i-Martin (1991, 1992), to name just a few. Convergence analysis has even gained momentum by the development of endogenous growth models that allow a major role for economic policy. Unfortunately, the available empirical evidence does not provide unambiguous support for either of the two aforementioned growth frameworks, although it does point to the existence of conditional convergence. At the regional level, the issue of economic convergence is also much debated. A look at growth performances of member countries of integration schemes in Europe, Asia and Latin America over a relatively long period of time does not show unambiguous empirical support for the convergence hypothesis either (De Lombaerde, 2002). This is in sharp contrast with the fact that, as in the case of the EU, for the majority of commentators, economists and politicians economic convergence is an expected (if not necessary) outcome of regional economic integration processes (Meeusen and Villaverde, 2002b). The empirical assessments of the effects of the elimination of barriers to flows of goods, services and production factors on growth (and its spatial distribution) and the debate on cohesion policies in the EU have considerably contributed to the development of the conceptual framework and the methodological toolbox for studying economic convergence.1 According to the Oxford Dictionary, ‘convergence’ is a tendency to become similar or identical. Although this definition is somehow illuminating, when

Indicators of real economic convergence 147 economists talk about convergence they usually refer to what is known either as nominal or real convergence.2 Nominal convergence relates to the process of nominal variables approaching stability levels. It is mainly concerned with such things as, for instance, convergence in interest rates and inflation rates, but also stability in the exchange rate, the government deficit and/or the government debt, both as a percentage of GDP. Broadly speaking, real convergence is understood to mean the approximation in the levels of economic welfare or development across economies. Thus, real convergence relates mainly to the time performance of variables such as per capita income, productivity, unemployment rate and so on.3 In its simplest form, real convergence implies a long-run tendency towards the equalisation of per capita income levels across economies (Abramovitz, 1986). Nevertheless, the relevant point is that real convergence is a multifaceted concept that, as it has been posed by Quah (1997: 27) ‘reflects on – among other things – polarisation, income distribution and inequality’. The focus of this chapter is on real convergence.4 That is with the long-term process of reducing inequalities across economies. One difficulty is that because there are different concepts of convergence, there are also different ways to measure it. The two most popular approaches, according to the terminology coined by Barro and Sala-i-Martin (1991, 1992), are the so-called σ -convergence and β-convergence. Albeit different, these two concepts are not only complementary (in that they respond to different questions), but, as Sala-i-Martin (1996) has shown, they are also closely related: some type of β-convergence is a necessary but not sufficient condition for σ-convergence. This chapter will not only explore σ-convergence and β-convergence approaches, but will also examine other less standard concepts like convergence as reduction of inequality, stochastic (or time-series) convergence, dynamics distribution convergence and spatial analysis convergence.5 The chapter is organised as follows. The following section reviews convergence from the point of view of the inequality literature; this includes the σ-convergence approach. The next section portrays a simple description of the well-known β-convergence approach. Subsequent sections contain the main traits of the timeseries approach to convergence and a general view of the spatial analysis convergence. In all these four sections, the objective is how best to measure real economic convergence. The final section gives a summary and presents the conclusions.

CONVERGENCE AS A REDUCTION OF INEQUALITY The simplest concept of economic convergence refers to the reduction of per capita income inequality across a sample of economies (countries, regions, states, provinces, etc). In order to measure it, a whole array of inequality indicators has been proposed, the three most popular being some summary measure of dispersion, the Gini index and the Theil index. In particular, it is said that there exists σ-convergence if the dispersion of the income per capita in a cross-section of economies diminishes over time. In

148 José Villaverde Castro other words, if σt+T < σt, where σ is the indicator of dispersion, there exists σconvergence. To test for σ-convergence either the variance, the standard deviation or the coefficient of variation6 are conventionally used. By far the most frequently employed summary statistics for measuring dispersion are the variance and the standard deviation. However, these two indicators are unsatisfactory descriptive measures of dispersion in that their value is related to the units of measurement. Instead, the coefficient of variation is independent of the units of measurement, and this is why it is used here as an indicator of σ-convergence. As is well known, the conventional coefficient of variation, CV1, is defined as

CV1 =

V1 Y

(8.1)

where V1 stands for the variance

⎡ 1 ⎢V1 = N ⎣

∑ (Yi − Y ) N

i =1

2

⎤ ⎥, ⎦

Yi the per capita income of the i-th economy, Y᎐ the mean per capita income and N the size of the population sample. CV1 is a non-weighted measure of inequality as it does not incorporate the population size of each economy. This index can be transformed into a new weighted one (CV2) by simply employing a weighted variance V2 given by the expression

V2 =

1 N

∑ (Yi − Y ) ( pi − p), N

2

i =1

where pi refers to the population’s share of the i-th economy. Thus

CV2 =

V2 Y

(8.2)

A very popular inequality indicator is the Gini coefficient. This is derived from the Lorenz curve (Figure 8.1), a cumulative frequency curve which plots the cumulative share of population of the economies in the sample on the X-axis and the cumulative share of total income of these same economies on the Y-axis. In both cases the economies are ranked according to their per capita income from bottom to top. The Gini index (G) corresponds to twice the area between the Lorenz curve and the 45º line. Its general expression is given by

G=

1 2Y

N

N

∑ ∑ pi pj Yi − Yj i =1 J =1

(8.3)

1 2 3 4 5 6 7 8 9 0 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45

Cumulative % of income

Indicators of real economic convergence 149

Cumulative % of population

Figure 8.1 Lorenz curve

where all symbols have already been defined. The Gini coefficient ranges from 0 (complete equality) to 1 (complete inequality). The Theil inequality index, on the other hand, is derived from the notion of entropy in information theory. The T(1) version is given by the expression

T (1) =

1 N

N

⎛Y ⎞

⎛Y ⎞

∑ ⎜⎝ Yi ⎟⎠ log ⎜⎝ Yi ⎟⎠

(8.4)

1

Among other interesting properties,7 the Theil index T(1) is additively decomposable,8 meaning that – among other possibilities – it can be decomposed in a way such that K K ⎛Y ⎞ T (1) = ∑ skT (1)k + ∑ sk log ⎜ k ⎟ ⎝Y ⎠ k =1 k =1

(8.5)

where the first term describes inequality within each of the K population groups in the sample and the second term measures inequality between these groups; sk is the income share of group k in total income. Finally, it is interesting to consider the notion of polarisation. Although this notion is closely related to that of inequality, it is different from it. According to Esteban and Ray (1994: 821) the concept of polarisation emerges because ‘the axioms of inequality measurement (. . .) fail to adequately distinguish between “convergence” to the global mean and “clustering” around local means’. Polarisation – a concept used to compare the homogeneity of a group with the

150 José Villaverde Castro

1

2

3

4

5

6

Figure 8.2 Per capita income distribution – polarisation versus inequality

overall heterogeneity of the sample population (across groups) – refers to the formation of clusters around local poles. The difference between inequality and polarisation can be easily applied to the case of per capita income distribution. For example, assume that this distribution is uniform over income levels 1 to 6 (Figure 8.2). Now, consider a transformation that causes the income of all. The economies with an income level between 1 and 3 to converge to 2 and the income of all the economies with an income level between 4 and 6 to collapse to 5. Although the Theil index will show a decline of inequality, polarisation (clustering around two poles, the poor economies at an income level of 2 and the rich economies at income level 5) will increase. A simple index of polarisation (PI) is given by: N

N

PI = ∑ ∑ pi1+α pj Yi − Yj

(8.6)

i =1 j =1

where pi (j) stands for the weight of population of economy i(j) in the sample and α is an index between 1 and 1.6 that measures the polarisation sensitivity. The smaller the sensitivity to polarisation, the closer the notion of polarisation is to that of inequality. CROSS-SECTION CONVERGENCE (β-CONVERGENCE) The concept of β-convergence implies that poor economies grow faster than rich economies. Accordingly, a statistical negative relationship between the growth rate of per capita income and its initial level is expected to be found in a cross-section

1 2 3 4 5 6 7 8 9 0 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45

Indicators of real economic convergence 151 analysis of these economies. Neoclassical growth theory (Solow, 1956), assuming that technology exhibits diminishing returns to physical and human capital, predicts β-convergence:9 this is because the further an economy is away from its steady-state level of capital per capita, the faster is the growth of capital and income levels. The neoclassical model not only predicts convergence of each economy to its steady-state level but also that the speed of convergence is inversely related to the distance from its steady-state position or long-run equilibrium. β-convergence may be absolute or conditional. The difference is related to the existence of key parameters in the economies that compose the sample: technology, savings rate, population growth rate and depreciation rate. If these parameters are identical for all the economies, neoclassical growth theory predicts absolute (or unconditional) β-convergence. This is often referred to as catchingup theory. If, on the contrary, the aforementioned parameters differ across economies, neoclassical growth theory predicts conditional β-convergence. In the first case, all the economies tend to have the same per capita income in the steady-state whereas in the second, each economy tends to its own steady-state or long-run equilibrium.10 When some economies do not converge to the same steady-state but certain groups of countries converge to a particular steady-state, it is said that they form a convergence club. Within each club, economies converge to each other, but convergence does not happen across different clubs. Chatterji (1993) and Chatterji and Dewhurst (1996) have proposed a simple methodology to estimate the existence of convergence clubs (see below). As has been shown by Barro and Sala-i-Martin (1995) the transitional growth process in the neoclassical model can be represented as

(1/T )log(YiT /Yi 0 ) = α + β log(Yi 0 ) + ε iT

(8.7)

where i indexes the economy, Y is, once again, per capita income, 0 and T are the initial and final year of the sample and ε is the error term. Thus, typically, the existence of absolute β-convergence is tested by regressing the growth in per capita income on its initial level for the cross-section of economies under consideration.11 If β 0, then it is said there is β-divergence. It can be shown that β = [(1–ebT)/T], where b represents the rate of convergence. That is, b indicates the speed at which per capita income approaches its steady-state level. The number of years needed to fill in half the gap to the steady state is then given by the expression 0.5 = exp–bT. The regression approach generally used to test the existence of β-convergence has been criticised by some economists – the seminal papers are Friedman (1992) and Quah (1993a). They point out that the aforementioned technique can produce biased estimates of β-convergence because it is subject to the Galton’s fallacy. To solve the problem, Friedman (1992) proposes the use of the coefficient of variation, suggesting that it provides an unbiased estimate of β-convergence; this is the notion of convergence that has been previously referred to as σ-convergence.

152 José Villaverde Castro Quah (1993a) proposes a completely different measure of convergence (the analysis of the dynamics of evolving cross-country distributions of per capita income), which will be discussed below. Another proposal to solve the bias of the regression approach has been put forward by Boyle and McCarthy in two papers (1997, 1999). These authors propose an indicator of rank concordance (Kendall’s index of rank concordance), labelled as γ-convergence, which, in addition to σ-convergence, offers a good test for β-convergence. This new indicator also has the virtue of capturing the changes in the ordinal ranking of the economies in the per capita income distribution. The index can be computed either in a multi-annual version or in a binary version. In the second case, the index is given by the expression

γ = Variance (RPCYiT + RPCYi 0 )/Variance ( 2 * RPCYi 0 )

(8.8)

where RPCYi. refers to the ranks of per capita income of the i-th economy. This rank concordance index ranges from 0 to 1, the closer the index is to 0 the greater the mobility within the income distribution. Simple regression models of the type shown in equation (8.7) rule out the possibility that some particular groups of economies may form a convergence club. As was pointed out above, there exists a convergence club when a specific group of economies tend to converge among themselves but diverge from economies belonging to other group(s). Fortunately, as Chatterji and Dewhurst (1996) have shown, equation (8.7) can be modified in order to incorporate the possibility of the existence of convergence clubs. This implies rewriting equation (8.7) so that the key variable is the natural log of the relative per capita income.13 That is:

(1/T )[log(YiT /Yi 0 ) − log(YAT /YA 0 )] = α + β [log(Yi 0 ) − log(YA 0 )] + ε iT (8.9) If, for simplicity, we drop α and εiT in (8.7) and denote by ziT = [log(YiT/Yi0)–log (YAT/YA0)] and by zi0 = [log (Yi0)–log(YA0)], equation (8.9) can be rewritten as

(1/T )ziT = βzi 0

(8.10)

In order to allow for the existence of multiple (k) convergence clubs, equation (8.10) can be reformulated as K

(1/T )zit = ∑ βk ( zi ,t −T )k = φ( zi ,t −T )

(8.11)

k =1

where the functional form φ depends on the data. A graph of ziT against zi0, shows the gap of each economy to the average at the final and initial years. If this line is then compared to a 45º line (Figure 8.3), four different situations become apparent. If the initial situation is between E1 and E3 the gap to the average will tend to decline and the economy will converge to the equilibrium point E0. On the other

1 2 3 4 5 6 7 8 9 0 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45

Indicators of real economic convergence 153 Zit

E4

E3

45˚

E0

E1

E2

Zi0

Zt = ΦZ0

Figure 8.3 Convergence clubs

hand, if the initial gap is greater than E1 (E3), then the gap will tend to increase over time and will converge to E2 (E4). This implies the existence of multiple steady states or locally stable states. In other words, this implies the existence of different convergence clubs.

TIME-SERIES CONVERGENCE (STOCHASTIC CONVERGENCE) Standard tests of β-convergence are carried out by using cross-sectional techniques. Bernard and Durlauf (1995, 1996), for example, consider the so-called unit root or stochastic convergence. According to these authors, stochastic convergence applies if per capita income disparities between two economies follow a stationary process, with a zero mean. This implies that the two economies have reached their own steady state and that shocks are not persistent but short-lived. Obviously, when per capita income differences between these two economies contain a unit root, stochastic convergence fails to hold. There are at least three interrelated concepts of stochastic (or times-series) convergence. The concept of strong convergence – or asymptotically perfect convergence according to Bernard and Durlauf (1995) – holds when the difference between two time series Yit and Yjt, where i and j are any pair of economies within

154 José Villaverde Castro the sample, contain neither a unit root nor a time trend, either deterministic or stochastic. In formal terms

limT →∞ E(YiT − YjT ξ0 ) = 0

(8.12)

where ξ0 captures all relevant information at time T. This implies that between the two series there exists a cointegration vector (1, –1). This concept of convergence has been criticised because it is rather strict: for the strong convergence to exist it is necessary that the long-run expected value (forecast) of the per capita income differences between the two economies is equal to zero. Thus, this concept of convergence is not very useful when the objective is to determine whether convergence has taken place in the past or not. An alternative, weaker concept of stochastic convergence (sometimes called asymptotically relative convergence) implies that the aforementioned disparities between any two economies within the sample do not need to converge to zero but to a finite constant. Following Bernard and Durlauf (1996: 165), this definition ‘considers the behaviour of the output differences between two economies over a fixed time interval and equates convergence with the tendency of the difference to narrow’. This can be written as

E(Yi ,T − Yj ,T ξt ) < (Yi ,0 − Yj ,0 )

(8.13)

where 0 refers to the present and T to some year in the future. According to this definition, the difference between the two time series should also be stationary, but now the time trend can be deterministic. Once again, the only cointegration vector between these two series can be (1, –1). Finally, the less strict concept of stochastic convergence holds when, although the two time series have different trends, there exists a functional relationship between them in such a way that

limT →∞ E(YiT − βYjT ξ0 ) = 0; β > 0

(8.14)

In this case, both series are also cointegrated, but the cointegration vector is now (1, – β). Although the stochastic approach to convergence solves some of the problems of the standard, cross-section convergence approach, it also has some important shortcomings. Of particular relevance to our case, and as is widely known, unit root tests (augmented Dickey–Fuller14 and/or Phillips–Perron) suffer from low statistical power in finite samples, which implies that they might lead to failures in rejecting the null-hypothesis of non-stationarity. This is closely related to the existence of gaps (or structural breaks) in the series, in which case it is possible to accept the existence of unit roots when they do not exist. Under these circumstances, it is possible to wrongly admit or reject the existence of convergence. Recently, more powerful tests (panel unit root tests) have been proposed to address the issue of low statistical power of univariate unit root tests.

1 2 3 4 5 6 7 8 9 0 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45

Indicators of real economic convergence 155 DISTRIBUTION DYNAMICS As has been previously mentioned, both standard σ and β-convergence approaches, but mainly the latter, have been heavily criticised on the grounds that they incur in Galton’s fallacy. This implies that negative β coefficients are compatible with the absence of convergence (Quah, 1993a). Although Sala-i-Martin (1994) argues that β-convergence offers interesting insights about the mobility of income within a given distribution and that σ-convergence shows how the distribution evolves over time, it is true that standard convergence analysis is, as a general rule, uninformative about the dynamics of per capita income distribution across countries. A cross-section regression cannot capture the essence of a convergence process in that it has implicitly a dynamic component; at best, the cross-section regression approach can just approximate this process. Quah’s approach is, in this regard, much more promising in that it offers additional insights into the phenomenon of convergence by emphasising not only a particular snapshot of the income distribution but the evolution of the entire income distribution over time. In particular, the distribution dynamics approach involves estimating both the density functions associated with the entire income distribution at each point in time and tracking how it evolves over time. A density function f(y) is the mathematical counterpart of a smooth curve that represents the probability distribution of a continuous random variable Y, where y refers to a specific value of Y. The density function f(y) informs about the location, shape and other external characteristics of the income distribution Y at a given point in time. The external shape of the density function may be unimodal, bimodal or multimodal. This shows whether there is convergence, polarisation or stratification. In the typical case of bimodality, or twin-peakedness studied by Quah (1996) there is a clear polarisation between a group of rich economies and a group of poor economics, whereas the middle-income class economies tend to disappear. Generally speaking, density functions are estimated non-parametrically by using the kernel method. This implies the substitution of the boxes in a histogram by smooth ‘bumps’. The kernel function determines the shape of the ‘bumps’, a crucial element being the bandwidth that controls the smoothness of the density. Silverman (1986) has proposed a method for selecting the bandwidth that is currently the most widely used in density function estimations. Regarding intra-distribution dynamics, a standard methodology currently employed to trace movements within a distribution is based on the computation of transition probability matrices. Thus, if FO and FT refer to the initial and final distribution, the link between them can be defined as FT = MT*FO where MT represents the transition probability matrix. Operator MT is approximated by dividing the income distribution into intervals or ‘income states’. Due to the lack of sound theoretical methods to obtain an appropriate partition of the income distribution, the selection of ‘income states’ is somewhat arbitrary. After having divided the distribution into ‘income states’, it is necessary to observe how many of the economies which are in a given income state in the initial period end up in that very state or elsewhere. Thus, each entry in the transition matrix refers to the

156 José Villaverde Castro probability that an economy in a given state income transits to another different state or stays in the initial one. The interpretation of the transition matrix is, then, as follows: the elements (probabilities: row probabilities add up to 1) on the diagonal indicate persistence while all the other elements in the matrix represent mobility. If we assume that t → ∝, the transition matrix allows us to take a longrun view of the evolution of the entire distribution, if nothing structural were to change in the system being analysed: the result is the so-called ‘ergodic’ distribution15 or long-run steady state. The main drawback of this approach is the arbitrariness when choosing the number and size of the ‘income states’. The stochastic kernel approach solves this problem by replacing the discrete income states by a continuum of states: thus, a stochastic kernel can be interpreted as the counterpart of a transition probability matrix with an infinite number of rows and columns. The stochastic kernels are represented as three-dimensional diagrams and contour plots (Overman and Puga, 2002), as shown in Figure 8.4. To read the three-dimensional diagram it is useful to think of period 0(T) axis as the rows (columns) of the transition matrix. Then, starting from any point on the 0-axis, any slice parallel to the T-axis traces out a probability density, describing the likelihood of transition, over T years, into different parts of the income space, conditional on beginning at a specific income (point) at time 0. On the other side, the lines on the contour plots connect points of the same height (density) on the corresponding three-dimensional diagrams. Then, on the contour plots it is easy to understand that: 1

GDP 0

50

100

150

200

250

2

if the probability mass concentrates along the positive slope diagonal, this indicates persistence; if the probability mass concentrates along the negative slope diagonal, this indicates overtaking of the economies in the ranking;

GDP 0 GDP 0

50

100

150 GDP 0

Figure 8.4 Stochastic kernel

200

250

1 2 3 4 5 6 7 8 9 0 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45

Indicators of real economic convergence 157 3

4

if the probability mass runs parallel to the T-axis, this indicates that the probability of being in any state at period T is independent of their position in the initial (O) period; and if the probability mass runs parallel to axis T, this indicates convergence.

The main shortcoming of this approach is that its interpretation is not as direct and clear-cut as that of the transition probability matrix because it does not offer quantitative information about the degree of mobility (or persistence); it only offers qualitative information.

SPATIAL ANALYSIS CONVERGENCE In all the aforementioned notions of convergence, the spatial dimension of the data under consideration is completely neglected. Because these spatial effects are largely ignored, problems of model misspecification in the previous convergence analysis may arise; in particular, OLS estimates ignoring spatial effects – as in the standard β-convergence approach – will be inefficient and/or biased (Anselin, 1988). Spatial effects refer to spatial dependence (autocorrelation) and/or spatial heterogeneity, it not being an easy task to differentiate between them from a practical point of view. Spatial autocorrelation implies that the observations (economies) in cross-sectional data are not independent. Following Anselin (1988: 11), it means ‘the existence of a functional relationship between what happens at one point in space and what happens elsewhere’. Spatial dependence can originate either as a result of a true spatial interaction among the economies (substantive spatial dependence) or as a measurement error problem (nuisance spatial dependence). Spatial heterogeneity comes from the lack of homogeneity of the economies under consideration. The statistical device usually employed to test for the presence of spatial effects (spatial dependence) is the Moran’s I statistic expressed as n

n

∑ ∑ wij yit yjt ⎛ n⎞

It = ⎜ ⎟ ⎝ s0 ⎠

i =1 j =1 n n

(8.15)

∑ ∑ yit yjt i =1 j =1

where wij is an element of a weight matrix W, n is the number of economies, yit is the log of per capita income of the economy i in year t, and s0 is equal to the sum of all elements of the matrix W.16 W is a non-stochastic square matrix of which the elements represent the intensity of the interdependence between each pair of economies; in the simplest case wij = 1 if the economies i and j are neighbours and 0 otherwise.

158 José Villaverde Castro When the Moran’s coefficients are statistically significant, they provide support for the hypothesis of global spatial effects or global spatial dependence.17 This being the case, the β-convergence approach needs to be reformulated in order to consider the effects of this spatial dependence. There are three main alternative specifications of the β-convergence unconditional equation in order to consider spatial dependence:18 the spatial error model, the spatial lag model and the spatial cross-regressive model. The first alternative takes place when the error term follows a spatial autoregressive process expressed as εt = λW εt + ut, where λ is a scalar spatial error coefficient and ut is normally distributed with a zero mean and a constant variance. The β-convergence equation becomes

(1/T )log(YiT /Yi 0 ) = α + β log(Yi 0 ) + ( I − λW )uiT

(8.16)

In the second specification of spatial dependence – coming from actual interaction among economies – the regression equation is

(1/T )log(YiT /Yi 0 ) = α + β log(Yi 0 ) + ( ρW /T )log(YiT /Yi 0 ) + εT

(8.17)

where ρ is the scalar lag parameter. Finally, in the third model specification – where the spatial variable is the independent variable – the spatial lag of the starting incomes is added to the original β-convergence unconditional equation, which becomes

(1/T )log(YiT /Yi 0 ) = α + β log(Yi 0 ) + τW log(Yi 0 ) + ε iT

(8.18)

SUMMARY AND CONCLUSIONS This chapter has addressed the topic of how to measure real economic convergence. Importantly, it has shown that there are different concepts of convergence and that each one is in need of its own type of measurement technique. However, the concepts of σ-convergence and β-convergence continue to be the most popular methods of measurement. The former method evaluates convergence through the time evolution of a summary measure of dispersion and the latter method through the estimate of cross-section regression. As has been shown, there are other ways to evaluate the convergence process that are also illuminating. Among these are the Gini and Theil inequality measures. These indices permit the disaggregation of the convergence process (or divergence) in different components. The extension by Chatterji and Dewhurst to deal with the potential existence of convergence clubs is also particularly interesting. This same topic is addressed, although from a different perspective, in the works pioneered by Quah. Density functions not only allow the estimation of the external form of the distribution but also the potential existence of convergence clubs. This same approach, via the estimate of either transition matrices or stochastic kernels, also gives insights into the degree of mobility within the distribution. Finally, and in

Indicators of real economic convergence 159 order to take into consideration the spatial dimension of the income distribution, spatial dependence can also be included in the analysis, rendering in this way a more accurate estimate of the convergence process.

NOTES 1 For recent overviews see, for example, Meeusen and Villaverde (2002a), Funck and Pizzati (2003) and the other papers in the Special Issue on EMU and Cohesion of the Journal of Common Market Studies, 41(5), 2003. 2 The relationship between nominal and real convergence has also been the subject of considerable debate and attention. For a summary, see Viñals (1994). 3 For simplicity of notation and exposition we will always refer to per capita income convergence, although it should be evident that the same principles carry over to other relevant economic variables. 4 From now on we will always refer to real convergence. 5 A straightforward application of some of these approaches can be seen in Villaverde (2003), Villaverde and Sánchez-Robles (2002) and Villaverde and Maza (2003). 6 For an interesting review of the different conclusions that may be obtained when using different indicators of dispersion see, for instance, Dalgaard and Vastrup (2001). 7 The T(1) index, as a member of the generalised entropy family, satisfies the axioms of symmetry (or anonymity), population replication, mean independence (homogeneity) and Dalton–Pigou principle of transfers. In order to normalise T(1) between 0 and 1, it suffices to divide T(1) by log(N). 8 Although it is less commonly used, the Gini coefficient can also be decomposed in three terms: a within group term, a between group term and an interaction or residual term. For a recent reference, see Dickey (2001). 9 For a critical view of β-convergence as being considered either as a useful test of the neoclassical growth theory or a robust measure of convergence (or divergence), see Cheshire and Carbonaro (1995). Endogenous growth models (Romer, 1986 and Rebelo, 1991) consider that income convergence is just one possible outcome. The main point of these models is that, although individual inputs can be subject to decreasing returns, the positive externalities associated with some of these inputs (technology, human capital, etc.) that have public good characteristics can result in constant or increasing returns at the aggregate level. 10 Although plausible and illustrative, conditional β-convergence is also a weaker and less robust concept than absolute β-convergence. 11 The model can be modified to include in the RHS the term ψ Xi0, where Xi0 denotes a set of control variables at the initial year, with associated coefficients ψ , determining the individual equilibrium rates of the economies. A negative value for β is considered to imply conditional convergence. 12 Chatterji (1993) maintains that this result is representative of weak convergence, the existence of strong convergence requiring both the existence of a steady state in which per capita income is equalised and the presence of dynamic forces driving the economy, in the long run, to this steady state. For this to happen, Chatterji (1993) shows that –2