Logic of an Australia-South-Africa FTA

Abstract

ustralia, previously a strong supporter of multilateral trade liberalisation, recently began negotiating a series of free trade agreements with countries in the Asia-Pacific region. This paper explores, at a conceptual level, the question of whether there is an argument for expanding the geographical scope of these negotiations to include a link to our neighbouring southern continent of Africa. The argument involves a development of the ‘hub-and-spoke’ framework to indicate that a ‘hub-to-hub’ agreement between Australia and South Africa would bring benefits both in terms of increased bilateral trade, and provide strategic advantages through enhanced investment and intra-industry trade. Free Trade Agreements (FTAs) between two countries are a ‘second best’ approach to achieving gains from liberalisation of trading arrangements compared with multilateral reductions in tariffs and other trade barriers. However, this approach has proliferated in recent years due to difficulties in achieving further multilateral reductions after the failure of the Cancun negotiations, and particularly in response to the growth in Regional Trading Agreements (RTAs) throughout the world. RTAs have emerged strongly in Europe and the Americas. Asian region countries have been late in entering such arrangements but recently there has been an upsurge in activity in this region (Lloyd and MacLaren, 2004). There is a possibility that, as they proliferate, FTAs will coalesce into a tripolar system of trading blocs based on Europe, North America and Asia (Lloyd and McLaren, 2004). The economic theory of preferential trading systems or trade blocs essentially concerns changes to world economic welfare arising from a move to discriminatory trading arrangements. Welfare change is the net effect of trade creation (positive welfare) and trade diversion (negative welfare). Trade creation occurs between members of the bloc as cheaper imports from one member replace higher cost local production, such that net welfare of members of the bloc increases as all countries benefit from production and allocation efficiencies. Trade diversion occurs when lower cost imports from a non-member are replaced with higher cost imports from a member, who differentially benefits from the reduction in protection, such that net welfare of members and non-members falls. It is further assumed that as the number of blocs falls and each bloc becomes larger, they can use their market power to raise, or lower more slowly, relative tariffs against non-members thus accentuating both negative trade diversion and positive trade creation effects. Consequently, as FTAs coalesce into RTAs, the net welfare effect is ambiguous as the number of trading blocs decreases and the market power of each bloc increases. Further, it is argued that the welfare