by Varsha Ramachandran
It is important to not to look at bilateral and multilateral engagements as being mutually exclusive of one another. In fact, bilateralism is the first step towards broader economic integration.
For a country to enhance its national power in the era of globalisation, it is important that it has strategic, yet unbiased economic agreements with countries across the globe. Taking this idea of economic integration further is the concept of one global economy which involves unification of economic policies, monetary policies, abolishing tariffs and taxes between various countries, and providing promising prospects of peaceful livelihood.
To engage internationally, a country can enter into several kinds of agreements. Such agreements can be classified into two categories based on the number of countries involved. Bilateral agreements are the ones that exist between only two countries, while multilateral agreements exist between several countries. Both these agreements can further be classified as Free Trade Agreements (FTAs), which does not involve any kind of tariff or non-tariff barriers to trade, or Preferential Trade Agreements (PTAs) which involves partial elimination of tariff or non-tariff barriers.
The debate on advantages and disadvantages of bilateral and multilateral trade agreements has existed for many decades in the field of international trade. Numerous studies have been conducted, using empirical data, to determine the success or failure of bilateralism and multilateralism. While the general consensus among economists is that multilateralism is more effective in the long run, this is sharply contrasted by the failure of the WTO multilateral agreements in the past few years and the success of multiple bilateral agreements instead. Economists who believe in multilateralism however point out that although bilateralism and regionalism increases trade, it harms the welfare of the world trade system.
The first half of nineteenth century saw a more closed global economy where nations engaged in bilateral agreements. Studies have noted that bilateralism contributed majorly towards harming the world trade during the inter war period. Economists argued that the highly discriminatory agreements made war inevitable. Similar opposition towards bilateral trade occurred post the Great Depression where it was argued that discriminatory agreements created vicious cycles of rising prices which further deepened economic depression.
The “Bandwagon Effect”, a situation where the non-trading partners will try to enter an existing bilateral agreement, thus rendering the original agreement less meaningful, is considered to be the biggest shortcoming in bilateralism. Creation of bilateral agreements can immensely complicate the trading environment due to creation of multiple rules. Most of these agreements have their own specific rules of origin which only complicate the production process and thus business and trade. At the same time, this also complicates the functioning of customs union as they have to assess same product differently for different countries. In the words of Professor Bhagawati, this is known as the “Spaghetti Bowl” phenomenon.
There is enough evidence to prove the failure of bilateral arrangements made way for openness among economies around the globe thereby leading to the formation of International Monetary Fund, World Bank, GATT, etc. Multilateralism soon gained popularity among policymakers as they started to explore the benefits of multilateral trade by removing stringent discriminations.
Though bilateralism allows countries to venture into different territories of similar interests, facilitate trade diversification and provides for simplified processes, multilateralism is often preferred because the risks and responsibilities associated with it get distributed among the members. Multilateralism acts as a central point to systematically deal with global concerns such as environment. Multiple countries can achieve better results than single countries working independently. Transaction costs reduce when nations pool in their resources. Multilateralism leads towards the realization of “one world, one law” with minimal complications and complete cooperation among all nations. It ensures that all nations participate in the management of global affairs.
Is multilateralism then the best option? Unfortunately, no!
The economic and geopolitical multilateral cooperation of eight countries of South Asia, SAARC, is a perfect example of the failure of a multilateral setup. Two of the largest economies of the SAARC, India and Pakistan have had inherent and long standing political tensions. The Indo-Pakistan dispute over Kashmir has proved to be one of the biggest impediments in the progress of SAARC. This shows that failure of a strong bilateral relationship between two countries will only cause a multilateral agreement including the same two countries to fail.
Economists have also pointed out some rather interesting shortcomings of multilateral arrangements. For instance, the United States was accused of having become increasingly dominant and inclined towards acting unilaterally, thus, making a number of developing nations question the very relevance of multilateralism. It is much more complicated and challenging as it involves many nations coming to a consensus which may become a tedious task. It may even happen that certain issues remain unresolved due to lack of cooperation among few countries.
Despite bilateralism and multilateralism, both, having strong drawbacks, bilateralism is believed to be here to stay. The fact is that bilateralism has always been around makes it very unreasonable to believe that it will cease to exist. The need of the hour is to identify how best bilateral trade can be used in the ultimate goal of reaching complete free trade. Practical ways of how integrate the two can be identified. For instance, a stronger multilateral system that has a bigger control over bilateral trade agreements, which are used to supplement the multilateral trading system by addressing issues that are more specific to countries and regions.
Multilateralism is necessary to reach a world of free trade. The first step towards multilateralism is, of course, bilateralism. Better regulation and a robust policy framework will educate nations engaged in bilateral agreements to expand their horizons and become part of multilateral trading blocs.
Varsha is an intern at the Takshashila Institution.