Question: Is the economic and social welfare of small island

developing states (SIDS) most impacted by preferential trade

agreements (PTAs) or multilateral liberalisation through the

WTO? Illustrate using examples.

The number of bilateral and regional agreements has grown

rapidly since the start of the Uruguay Round, a trend which

has accelerated due to the continued impasse in the Doha

Development Round at the World Trade Organisation (WTO).

However, opinions remain divided on whether these preferential

trading agreements (PTAs) serve to facilitate or impede the

progress of multilateral trade liberalisation. Despite this

lack of consensus and the accentuated impact that trade

liberalisation has on small island developing states (SIDS)

due to their openness to and dependence on trade,

comparatively little research exists on the topic (Asafu-

Adjaye & Mahadevan, 2009, p. 511). This paper seeks to address

this gap in research by investigating whether the economic and

social welfare of SIDS is impacted more by multilateral trade

liberalisation or preferential agreements. In terms of

methodology, I will first of all look at why this topic is

relevant for international trade governance, followed by a

definition of small island developing states, a summary of

their trade-related characteristics, and a brief run-down on

perspectives of whether PTAs or the multilateral trading

system (MTS) are the optimal path for trade liberalisation in

general. In consideration of the word length and depth of

analysis, discussion will be limited to four aspects of trade

liberalisation and governance of high relevance for SIDS,

namely reliance on protectionist measures, preferential market

access, the use of PTAs by larger trading partners to exact

WTO-plus concessions, and bargaining power. Comparisons of the

welfare implications of PTAs and the MTS will examined in the

context of each aspect, with an emphasis placed on SIDS

located in the Caribbean and South Pacific regions. It will be

established that both PTAs and the MTS impact the welfare of

small developing states to varying degrees, supporting the

assertion that trade liberalisation in general poses serious

challenges to such states. However, it will be demonstrated

through analysis that multilateralism has a comparatively

lesser impact on welfare in small island developing states and

provides greater protection than asymmetrical preferential

agreements. The paper will conclude with a brief discussion on

ways in which the WTO can address the challenges faced by SIDS

through the implementation of special and differential

treatment (SDT) and SIDS-oriented initiatives such as the

Barbados Programme of Action.

Despite their lack of political and economic potency

pertaining to their small physical size and population, the

number of SIDS exceeds 50, roughly a quarter of all countries

(UN, 2005, cited in von Tigerstrom, 2005, p. 404). SIDS are

recognized as highly vulnerable to the dynamics of

international economics and trade due to their size and

isolation, yet very few studies have been conducted on the

effects of trade liberalisation on the welfare of such

countries (Asafu-Adjaye & Mahadevan, 2009, p 511).

Furthermore, although the impact of free trade is more

pronounced in SIDS than in other states, existing

international agreements have failed to sufficiently recognise

their inherent disadvantages in the context of trade

liberalisation (Connell & Soutar, 2007, p. 41). Accordingly,

the method by which such states pursue (or accept)

liberalisation is crucial to their economic and social

welfare. It is for this reason that the study of whether

preferential agreements or the multilateral system has the

greatest impact on welfare in SIDS is highly pertinent to the

study of contemporary trade liberalisation.

Despite the broad utilisation of the population threshold of

1.5 million set by the Commonwealth Secretariat in 1997 to

classify a state as ‘small’, a single definition of ‘small

developing economy’ has yet to be agreed upon (Bernal, 2001,

p. 2; Heron, 2008, p. 245; von Tigerstrom, 2005, p. 406). For

the ease of analysis and in consideration of the fact that the

vast majority of states in these two regions fit the

historically accepted profile of a small island developing

state, this paper utilizes a liberal interpretation of SIDS

encompassing comparatively larger states such as Jamaica and

Papua New Guinea located in a common geographic area with a

similar level of development to the majority.

Several factors inherent to the majority of SIDS influence

the extent to which they are affected by trade liberalisation.

Firstly, SIDS are disadvantaged due to their small

populations, poor factor endowments (natural and human

resources), and limited institutional capacity (Heron, 2008,

p. 243; von Tigerstrom, 2005, p. 407). Two major implications

of small population size relate to the scale and demand of the

domestic market, which is too small for local firms to attain

economies of scale (diseconomies of scale), making such states

unattractive destinations for foreign investment (Armstrong &

Read, 1998, p. 567; Bernal, 2001, p. 7). Small markets by

their nature comprise few producers and thus weak levels of

competition, which engenders inefficiencies thus hindering the

ability of local producers to compete with foreign firms in

free trade scenarios. This is compounded by the structural

openness of SIDS (share of trade as part of GDP often exceeds

100 per cent), their dependence on trade, and consequent

sensitivity to changes in the international trading

environment (Armstrong & Read, 1998, p. 564; Bernal, 2004, p.

1). Another feature of small island developing states is their

comparative advantage and specialisation and agricultural

commodities such as sugar and bananas (Connell & Soutar, 2007,

p. 42). The lack of diversification in exports that is

characteristic of SIDS serves to magnify the effects of trade

liberalisation, particularly in the area of agriculture. In

addition, tariff-lowering liberalisation has a direct impact

on government budgetary resources as such states remain

dependent on trade taxes as a source of national income

(Bernal, 2001, p. 2).

The primary difference between the multilateral system and

preferential agreements is that the latter violates the most

favoured nation (MFN) principle (the according of equal trade

advantages to all states) of the WTO by providing preferences

to states parties to the relevant agreement. The provisions of

General Agreement on Tariffs and Trade (GATT) Article XXIV,

however, permit the establishment of PTAs such as regional

trade agreements (RTAs). The notion of whether PTAs complement

or inhibit multilateral liberalisation continues to polarise

the opinions of trade officials. On the one hand, proponents

of preferential agreements argue that such arrangements enable

small states to acquire certain concessions from larger states

both bilaterally and in regional blocs (Armstrong & Read,

1998, p. 572). Conversely, advocates of multilateral trade

claim that the WTO system helps to correct asymmetries in

global trade (Singh, 2011, p. 12), while criticising PTAs for

diverting trade from cost-efficient to cost-inefficient

countries (Gounder & Prasad, 2011, p. 56). The general opinion

expressed in the academic literature advocates the superiority

of the multilateral system over bilateralism and regionalism

in terms of welfare. The following paragraphs will evaluate

whether this conclusion is valid.

Since quantitative restrictions on imports, or ‘quotas’,

were prohibited in the Uruguay Round, developing countries

have come to rely heavily on tariffs to protect domestic firms

from foreign competitors (Khor, 2005, p. 4). Protective

measures are justified as a means of allowing infant

industries to develop to the point where they are capable of

competing globally (Fernandez de Larriona Areal & Maetz, 2000,

p. 33). The reliance on protective mechanisms such as tariffs

is magnified by the fact that agricultural commodities such as

sugar, which is particularly vulnerable to global market

fluctuations, are among the few exports in which SIDS hold a

comparative advantage (Connell & Soutar, 2007, p. 43). SIDS

are also highly dependent on tariff revenue as a significant

proportion of government income, serving as an efficient form

of taxation compared to generally weak internal taxation

systems (Baldwin & Freund, 2011, p. 122; Milner, Morrissey &

McKay, 2005, p. 346). In developing Caribbean island nations

including the Dominican Republic and St. Lucia, trade taxes

amount to one-third and one-half of total government revenue

respectively (Bernal, 2001, p. 3). Accordingly, any form of

liberalisation which leads to the reduction of tariffs, be it

at the bilateral, regional or multilateral levels, is likely

to pose significant implications to nations such as the SIDS.

Recognisant of this reality, Pacific Island nations have

demonstrated a preference for regional rather than

multilateral liberalisation as the former permits these states

to maintain tariff levels to outsiders in the interests of

safeguarding national welfare (Gounder & Prasad, 2011, p. 57).

The contraposition of tariff-based protectionism, however,

is that maintaining such defensive policies reduces export

competitiveness and creates domestic market inefficiencies

which result in higher prices (Bernal, 2003, pp. 206-207).

Higher prices affect economic welfare by placing upward

pressure on inflation and downward pressure on demand, thus

impacting social welfare due to ensuing higher unemployment

levels. Hoekman and Kostecki (2009, p. 32) argue that

protection engenders production and consumption distortions;

economic theory dictates that high prices encourage greater

production while discouraging consumption. Reconciling the

need for protectionism as a mechanism for both safeguarding

domestic firms and revenue generation with the inefficiency

implications of such policies is a crucial task for SIDS

governments in a fast liberalising world.

The question therefore is which method of tariff

liberalisation has the least negative impact on the welfare of

these states? According to the tariff argument, the approach

which leads to minimal tariff reductions would continue to

provide the domestic firms in SIDS with a level of protection

from foreign competitors, thus retaining local jobs and

ensuring the flow of tariff revenue, allowing governments to

continue to provide and maintain public goods. RTAs provide

preferential conditions including lower tariffs to only a

select group of states and permit the relevant state to

maintain tariff levels applicable to outsiders. However,

regional free trade agreements are generally not comprised of

economically equal states. Taking into account the small

market size of SIDS, even one large economy could dislodge

local producers if granted unrestricted access to the market

of the relevant small island nation (Connell & Soutar, 2007,

p. 54). A theoretical example of this scenario is the proposed

PACER-Plus agreement between the Pacific Islands and larger

economies of Australia and New Zealand. The impact of this

agreement on the smaller states parties to it, if concluded,

would be two-fold. Firstly, unfettered access to the markets

of small Pacific Island nations by comparatively more

efficient Australian producers would likely displace local

producers through cost advantages. The effects on welfare

include higher unemployment and potential foreign monopolies

which would eventually drive prices up. Secondly, although the

loss of tariff revenue would likely be greater in a

multilateral scenario, providing tariff free market access to

major trading partners such as Australia would in any case

result in significant losses. The depleted public coffers of

Pacific Island governments due to the deprivation of tariff

revenue would complicate the provision of public services,

which they already struggle to provide (Australian Fair Trade

& Investment Network, 2015, n.p.).

Meanwhile, tariff reductions resulting from multilateral

liberalisation are broader, applying to all WTO members. The

commonality of both the PTA and MTS scenarios is both involve

a certain degree of tariff liberalisation. Given that PTAs

allow SIDS to maintain tariffs to outsiders, the tariff

argument dictates that such agreements would be best suited

for such states that rely on protection. However, according to

free trade theory, protection is disadvantageous to states in

the long run. Protection provided by PTAs insulates local

firms from global competition, resulting in production

inefficiencies. These inefficiencies are, according to theory,

best rectified by exposure to competition from abroad.

Although immediate multilateral liberalisation would likely be

detrimental to firms in SIDS by forcing them to compete with

vastly more efficient foreign companies, the WTO system does

have the capacity to provide developing states with adequate

protection apart from tariffs while governments undertake

efficiency improving measures in their markets to prepare

firms to compete globally. Gradual trade liberalisation is

viewed as the optimal way for SIDS to enjoy the benefits of

comparative advantage and therefore maximise national welfare

(Gounder & Prasad, 2011, p. 61). Multilateral liberalisation,

furthermore, opens up more export markets for SIDS producers,

thereby facilitating the realisation of economies of scale and

overcoming the small market limitations characteristic of

SIDS.

Historically, SIDS have demonstrated a reliance on

preferential market access for key exports, in particular

agricultural factor endowments such as bananas and sugar (von

Tigerstrom, 2005, p. 420). The Lomé Convention, established

with the intention of integrating former European colonies

into the global economy, granted non-reciprocal trade

preferences (in effect, a percentage of the EU market) on such

products to African, Caribbean and Pacific Island (ACP)

countries (Spiegel, 2001, cited in Gerrick, 2004, p. 131).

These preferences were deemed illegal by the WTO, resulting in

widespread implications for the welfare of SIDS due to the

crippling of local agriculture following the loss of

preferences, a prominent example being St Kitts and Nevis, in

which the sugar industry was forced to close in 2005 at the

expense of 1400 jobs as 50% of the sugar industry had been

protected by EU preferences (Connell & Soutar, 2007, pp. 46-

47). The Lomé Convention was replaced by the Cotonou Agreement

in 2003, which oversaw the phasing-out of non-reciprocal trade

preferences theretofore enjoyed by the ACP states, replacing

them with non-discriminatory, WTO-compliant Economic

Partnership Agreements (EPAs) (Gerrick, 2004, p. 138). While

presenting benefits such as development support, EPAs are

inherently inferior to the Lomé Convention and its

preferences, and have greater impacts on welfare. The welfare

implications of EPAs are magnified by the vulnerability of

small states to the removal of preferences for factor

endowment exports on which local producers are so dependant.

Furthermore, EPAs require that SIDS open their markets up to

EU exporters in a reciprocal arrangement that provides no

mechanism to assist local producers in competing with foreign

companies.

In the world of trade negotiations, concessions are not made

without a ‘quid pro quo’, or in other words, no concessions

are given unconditionally (Fernandez de Larrinoa Areal &

Maetz, 2000, p. 39). Accordingly, states such as SIDS can no

longer expect larger economies to provide benefits such as

preferential access without attaching conditions which, in

reality, create trade asymmetries benefitting the more

powerful state. In a bilateral or regional trade scenario,

smaller states have little choice but to accept

disproportionate terms in exchange for the market access their

exports so depend on. In the multilateral scenario, the MFN

principle prohibits preferential access as rule, and any

liberalisation progress is applied across the board to all

members indiscriminately. As PTAs attach conditions to market

access and the WTO prohibits preferences altogether,

evaluating the course of liberalisation with the greatest

impact on state welfare is a complex task. However, based on

the dependency and free trade theories, the welfare of SIDS

would be benefitted in the long run by breaking its reliance

on one or two major export markets, thereby eliminating the

need for preferential access. The multilateral system and WTO

can and should facilitate SIDS in this regard.

PTAs, in particular bilateral free trade agreements (FTAs),

have been utilized by developed nations including the US and

Japan for several decades to exact the concessions they failed

to achieve at the WTO (Khor, 2005, p. 3; Mayne, 2005, p. 1).

Concessions pursued through bilateral channels largely involve

subjects which have polarized WTO members or have been

vehemently opposed by developing countries, which include

greater intellectual property protection, services

liberalisation, as well as labour and environmental standards

(Tussie & Saguier, 2011, p. 12). The vulnerabilities and lack

of influence inherent to SIDS are amplified in preferential

agreements. Albert Hirschman (1945, cited in Tussie & Saguier,

2011, p. 14) points out that small states reliant on a large

trading partner as destination for the majority of their

exports are highly susceptible to coercion. In a bilateral

scenario, the larger state wields tremendous influence and the

smaller state will invariably feel obligated to accept highly

disadvantageous terms with broad implications for national

welfare in exchange for market access to ensure continued

viability for local exporters. Potential exclusion from

markets is another central reason why small states such as the

SIDS enter into PTAs. There is a fear of being left behind as

other developing states, particularly those in the same

region, conclude free trade agreements with large markets as a

defensive strategy (Khor, 2005, p. 6; Manger, 2009, p. 5;

Singh, 2011, p. 12).

Concessions conceded through trade liberalisation pose

potentially serious implications for the economic and social

welfare of SIDS by reducing their policy space, which is

defined as the “’scope for domestic policies, especially in

the areas of trade, investment and industrial development’

which might be ‘framed by international disciplines,

commitments and global market considerations’” (Page, 2007, p.

1). A WTO agreement widely criticized for restricting the

policy space of developing nations is the Trade-Related

Aspects of Intellectual Property Rights (TRIPS). This

agreement essentially protects the interests of multinational

pharmaceutical firms, largely based in developed countries, by

obligating governments in developing states to ratify

legislation that protects the patents of these multinationals,

thus prohibiting the production of generic medicines in

developing countries. This in turn leads to monopolisation of

the market by foreign pharmaceutical giants and subsequent

prohibitive pricing, which engenders health-related issues

owing to the inaccessibility of necessary medications.

Despite the serious welfare implications engendered by the

TRIPS agreement, PTAs have the potential to exacerbate the

impact of TRIPS through TRIPS-plus measures. Such measures, a

feature of US bilateral FTAs, effectively undermine the Doha

Declaration on TRIPS and Public Health by further restricting

access to medicines in developing states (Mayne, 2005, p. 7).

This is achieved by restricting or even eliminating

flexibilities contained in the WTO TRIPS agreement such as

compulsory licensing; the ability to produce a patented

product without the consent of its owner (Mayne, 2005, p. 19).

Compulsory licensing becomes crucial in the event of a

national health emergency, and its elimination in PTAs has

severe consequences for health-related welfare in developing

states. As the majority of SIDS do not possess the

technological capacity to produce generics of patented

products, compulsory licensing in itself has little

significance. However, paragraph 6 of the Doha Declaration on

the TRIPS Agreement and Public Health, referred to as the

‘Motta Text’, allows states incapable of manufacturing

generics to import them under the compulsory licensing

provision (given that certain conditions are met such as

proving incapacity to manufacture the corresponding drug),

allowing the import of medicines in the event of a national

emergency or situation of urgency (Abbott, 2005, p. 317).

TRIPS-plus measures seek to remove these options, and

therefore pose a potentially greater impact on national

welfare than the TRIPS agreement of the WTO.

Developed states also seek to utilize PTAs to gain WTO-plus

concessions related to labour and environmental standards.

Discussion of the above non-trade standards at the WTO has

been continually rejected by developing countries (Khor, 2005,

p. 2), and the WTO itself has reiterated that labour standards

are beyond its mandate and should be addressed solely by the

International Labor Organization (ILO). Preferential

agreements provide an avenue through which powerful states

offer tariff-free access to their markets in exchange for

alterations to the domestic policies of smaller trading

partners to improve certain standards, which potentially serve

as non-tariff barriers to trade (NTBs), constraining producers

in SIDS and ultimately benefitting the larger trading partner

(Park, 1998, p. 474). Deeper integration which incorporates

labour and environment standards generally reflects the larger

country’s interests and ignores the impact of changes to

standards on the welfare of smaller states such as SIDS or the

capacity of governments to make such amendments (Panagariya,

1999, p. 38). The multilateral system better protects the

welfare of SIDS by allowing them to collectively resist

coercion by developed states to bring non-trade subjects to

the agenda.

Finally, the SIDS are at a distinct disadvantage in regard

to their level of bargaining power in trade negotiations at

the bilateral, regional and multilateral levels. As price

takers in global trade, their influence on proceedings is

minimal. Resource limitations such as government funding for

trade negotiations and the dispatch of adequately qualified

trade officials place further burdens on the ability of SIDS

to effectively participate in negotiations and dispute

resolution (Schiff, 2002, p. 12; Bernal, 2004, p. 3). The

difficulties SIDS face in engaging in multilateral level

negotiations are exacerbated by the proliferation of PTAs,

which divert resources from WTO rounds, placing a strain on

the public sector in SIDS and weakening their already frail

bargaining power.

As has been illustrated, small states are at a disadvantage

in bilateral or regional scenarios involving large market

powers, which take advantage of their own influence and the

weakness of the smaller state to force the acceptance of

asymmetric terms. In contrast, it is widely recognised that

the WTO provides conditions more favourable for the bargaining

power of SIDS (Singh, 2011, p. 12). The nature of the WTO

allows states of a similar size, level of development and

trade interests to band together as a collective to augment

their influence in negotiations and share expenses. Alliances

of developing states have already been successful in excluding

items such as investment, labour and environmental standards

pushed by developed countries from negotiations through their

collective power. An example relevant to the SIDS is the

Caribbean Community Secretariat (CARICOM), a grouping that

facilitates the pooling of resources and formulation of

negotiation stances among the small island nations of the

Caribbean (Schiff, 2002, p. 12). Preferential agreements do

not provide states with the opportunity to compensate for

bargaining weaknesses due to size, which results in markedly

more asymmetrical outcomes (Tussie & Saguier, 2011, p. 12).

The WTO also provides a dispute settlement mechanism (DSM) and

rules that prevent larger economies from taking advantage of

the power differential between them and smaller states

(Bernal, 2004, p. 3). This contrasts with the potential

precariousness of PTAs which generally lack mechanisms

designed to safeguard the interests and welfare of small

states such as the SIDS.

SIDS require arrangements and concessions that compensate

for reduced protection and preferences resulting from

multilateral liberalisation. One arrangement is special and

differential treatment, which was institutionalised in Part IV

of the GATT (“Trade and Development”), providing legal

recognition of the disadvantaged status of developing

countries (Kishore, 2014, p. 376). SDT provisions exempt small

developing countries from certain multilateral disciplines,

giving them greater trade-related flexibility (Tussie &

Saguier, 2011, p. 6). This contrasts with the strictly

reciprocal basis of PTAs, which invariably embody the uneven

balance of power of the states parties to such agreements

(Tussie & Saguier, 2011, p. 6; Khor, 2005, p. 2). While SDTs

appear to be the ideal mechanism for protecting the welfare of

SIDS in the process of multilateral liberalisation, developed

countries have shown little propensity to conform to their

non-binding provisions (Kishore, 2014, p. 375). Therefore, the

challenge for the WTO is to strengthen the SDT regime in line

with the Millennium Declaration, in which UN members “resolve

to address the special needs of small island developing

states” (von Tigerstrom, 2005, p. 401). Another way of

accommodating the needs of SIDS is to incorporate the progress

of the Barbados Programme of Action for the Sustainable

Development of Small Island Developing States, a program

administered by the UN Office of the High Representative for

Least Developed Countries, Landlocked Developing Countries and

Small Island Developing States, which among other tasks has

the objective of addressing the economic and developmental

vulnerabilities of island states (von Tigerstrom, 2005, p.

402).

This paper has sought to examine whether the economic and

social welfare of SIDS is impacted more by preferential trade

agreements or multilateral liberalisation. Analysis has shown

that while all forms of trade liberalisation present

implications to the SIDS due to their inherent trade-related

vulnerabilities, the multilateral system has a demonstrably

lesser negative impact on their economic and social welfare.

It has been found that while the infant industry argument

presents a strong case for protection, SIDS are ultimately

benefitted in the long run by efficiency gains resulting from

multilateral liberalisation. We have also determined that

preferential market access ties SIDS to larger markets in a

relationship of dependency. Free trade theory dictates that

the welfare of SIDS would be best served by diversification of

trading partners, thereby eliminating the need for

preferences. The multilateral system clearly provides the

optimal path in this regard. Moreover, this paper has

established that not only do PTAs serve the interests of large

developed states as mechanisms for acquiring WTO-plus

concessions, they also divert precious resources from

multilateral engagement. Bilateral and regional trade

agreements governed by reciprocity reflect the asymmetrical

power balance of large-small states, and present substantial

welfare consequences for the latter. In contrast, the

multilateral system allows states such as the SIDS to augment

their influence by amalgamating resources with states of a

similar profile to raise their collective bargaining power.

Despite the underwhelming progress of the WTO in embracing the

developmental challenges of SIDS, the architecture of the

multilateral system is fundamentally better structured to

safeguard the interest of such states comparative to

preferential agreements.

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