I.INTRODUCTION

WTO Members are subject to several general obligations set out in the GeneralAgreement on Tariffs and Trade 1994 (GATT 1994).

The Most-Favoured-Nation (MFN) principle requires Members not to discriminate among imported products from other Members. The national treatment principle requires Members not to discriminate against imported products as opposed to domestic products. In regard to market access for goods, Members are required to act in accordance with their scheduled commitments on tariffs and not to apply tariffs beyond the bound levels unless these are renegotiated. In addition, Members are not generally allowed to impose quantitative restrictions (QRs) on market access for goods. Furthermore, Members are required to ensure that their nontariff barriers (NTBs) (such as customs formalities) do not constitute unnecessary obstacles to trade.

Nevertheless, in certain circumstances, WTO Members may derogate from these obligations, provided that they comply with certain conditions. These exceptions include:

  • General exceptions - Right to take measures, for example, necessary to protect human, animal or plant life or health, which may restrict trade in goods (GATT 1994). Such measures cannot constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade. Similar general exceptions also apply to trade in services (General Agreement on Trade in Services (GATS), whereas there are no general exceptions as such under the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS Agreement);
  • Security exceptions - Right to take measures to protect essential national security interests, which may restrict trade in goods (GATT 1994). Similar security exceptions are allowed under the GATS and the TRIPS;
  • Exceptions for Regional Trade Agreements (RTAs)- Right to depart from the MFN principle in order to grant preferential treatment to goods (GATT 1994) or service suppliers (GATS) from trading partners within a customs union or a free trade area without extending such treatment to all WTO Members;
  • Balance-of-payments (BOP) – Right to take measures to safeguard a Member's external financial position and its BOPs; and,
  • Waivers - Temporary waivers granted with the authorization of the other Members, in exceptional circumstances.

EXCEPTIONS / ARTICLES
General Exceptions / ArticleXX of the GATT1994 / ArticleXIV of the GATS / No general exceptions provision under the TRIPS
Security Exceptions / ArticleXXI of the GATT1994 / ArticleXIVbis of the GATS / Article73 of the TRIPS Agreement
RTAs / ArticleXXIV of the GATT 1994; and “Understanding on the Interpretation of ArticleXXIV of the GATT 1994”
Paragraph 2(c) of the Enabling Clause* / ArticleV of the GATS / No provision on RTAs under the TRIPS
BOPs / ArticlesXII & XVIII:B of the GATT 1994; and,
"Understanding of the BOPs Provisions of the GATT 1994" / ArticleXII of the GATS / No BOP provision under the TRIPS
Waivers / ArticleIX:3 of the Marrakesh Agreement Establishing the WTO
(WTO Agreement establishing the WTO)

Besides, remember that Members are allowed to apply trade defence mechanisms to remedy a situation of unfair competition (anti-dumping and countervailing measures) or a surge of imports (safeguard measures) when these are causing injury, subject to certain requirements. Even if these measures are not referred to as exceptions, they allow Members to impose, for example, tariffs above the bound levels or QRs (depending on the measure).

* Paragraph 2(c) of the 1979 Decision on Differential and More Favourable Treatment, Reciprocity and Fuller Participation (the "Enabling Clause") allows developing country Members to conclude among themselves RTAs on trade in goods.

II.REGIONAL INTEGRATION

IN BRIEF

WTO Members are allowed, under certain conditions, to depart from the MFN principle in order to grant preferential treatment to their trading partners within a customs union or a free trade area, without extending such treatment to all WTO Members.

By definition, parties to an RTA offer each other more favourable treatment in trade matters than to the rest of the world (including WTO Members). The coverage and depth of such preferential treatment varies from one RTA to another. Most RTAs go beyond tariff elimination to include regulations on non-tariff barriers and other trade policies areas such as customs matters, standards, trade remedies, and dispute settlement; several agreements also cover services and intellectual property, as well as matters not yet covered by the WTO Agreements, such as competition policy, government procurement, investment and provisions on environment and labour. Depending on the WTO legal provision utilized to notify an RTA, trade barriers may be completely abolished in intra-RTA or merely reduced.

ArticleXXIV of the GATT 1994 and ArticleV of the GATS allow WTO Members to depart from the MFN rule to grant more favourable treatment to their trading partners within a customs union or a free trade area without extending such treatment to all WTO Members, subject to certain requirements.

In addition, paragraph 2(c) of the 1979 Decision on Differential and More Favourable Treatment, Reciprocity and Fuller Participation of Developing Countries (the "Enabling Clause") allows developing country Members to conclude among themselves RTAs on trade in goods subject to more flexible requirements than those contained in ArticleXXIV of the GATT 1994. The Enabling Clause also provides for some preferential schemes, other than RTAs, subject to certain circumstances.

On 6 February 1996, the General Council established the Committee on Regional Trade Agreements (CRTA).

Regional Trade Agreements: Some Figures...
The number of RTAs involving WTO Members has increased in the recent years. As of November 2008, 418 RTAs have been notified to the GATT or the WTO, 227 of which are currently in force against only 101 in 2005 *. The total number of RTAs currently in force and involving WTO Members is however estimated to be significantly higher, since not all RTAs have been notified. As of November 2008, more than half of all WTO Members were party to three or more RTAs. Free trade areas are more prevalent than customs unions and account for 82 per cent of all RTAs currently in force. Regional Trade Agreements (RTAs) concluded among developing countries account for 36 per cent of the total.
* The number includes notifications made under ArticleXXIV of the GATT 1994, the Enabling Clause and ArticleV of the GATT 1994.

II.A.THE WELFARE EFFECTS OF REGIONAL TRADE AGREEMENTS (RTAS)

The reduction in intra-regional trade barriers stimulates intra-regional trade. Trade among the parties of a RTA is thus bound to increase (this is known as "trade creation"). To the extent that this expanded trade substitutes imports for higher cost domestic products, economic efficiency is increased. But part of the intra-regional trade expansion may be at the expense of trade from cheaper sources outside of the RTA (causing "trade diversion").

If the additional trade among the partners is a result of trade diversion, a country can suffer a welfare loss. Whether a country gains or loses from entering into an RTA will depend on the balance between the trade creating and trade diverting effects of the RTA. To know more, see the example provided in the box below.

TO KNOW MORE... REGIONAL TRADE AGREEMENTS: TRADE CREATION AND TRADE DIVERSION


Consider a three-country model, where the home country (Medatia) is assumed to be small compared to its partner (Vanin) and the rest of the world (W). Medatia faces an infinitely elastic supply at prices pp and pw; that is, at these prices Medatia can import whatever quantity it demands, but it cannot affect the price. Before forming a free trade agreement (FTA), Medatia is assumed to have a non-discriminatory ad valorem tariff (t) on imports. Assume Tristat is the least-cost source of foreign supply, before the FTA. Then, Medatia will import Do-Qo at the price Ph = Pw(1+t).
Suppose now that Medatia and Vanin form a FTA. Medatia will now import from Vanin, since pp is less than ph (since as a result of the FTA, Medatia's goods do no pay any tariff when imported to Vanin). Consumers will now pay pp and imports will rise to D1-Q1. As a result of the FTA, overall imports increase by Qo-Q1 plus D1-Do and domestic prices fall.
  • Consumers gain as they can consume a higher quantity for a lower price (the area A+B+C+D represents this gain).
  • Producers lose (area A).
  • Government loses tariff revenue (area C+G).
The area B + D represents the welfare increase from the trade creation effect of the FTA.
BUT What about the loss represented by area G ?
The area G represents the welfare loss from the trade diverting effect of the FTA.
Area G represents the additional cost of importing Do-Qo from the higher-priced (pp) partner instead of the cheaper (pw) world market.
The overall welfare effects of an FTA will depend on the difference between the increased welfare from trade creation (areas B + D ) and the decrease in welfare from trade diversion (area G). In this example, the FTA increases overall trade, but the welfare effect is ambiguous.
Based on: World Trade Organization (WTO), World Trade Report 2007, Geneva: WTO, pages 138 – 139.

II.B.REGIONAL INTEGRATION IN THE GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT) 1994

For trade in goods, ArticleXXIV of the GATT 1994, complemented by the Understanding on the Interpretation of ArticleXXIV of the GATT 1994 (the "Understanding"), contains the rules and disciplines applicable to customs unions and free trade areas, as well as to interim agreements that lead to the formation of a customs union or a free trade area.

ArticleXXIV:4 provides that a customs union, free trade area or an interim agreement should aim to facilitate trade between the constituent territories and not to raise barriers to the trade of third parties. The purposive language contained in ArticleXXIV:4 sets out two main requirements that the parties to an RTA have to meet in order for their agreement to benefit from the MFN derogation; the first one is an internal requirement relating to what is expected from the parties with respect to intra-trade liberalization; the second one is an external requirement relating to the avoidance of negative effects to third parties as a result of the formation of the RTA.

II.B.1.CONDITIONS FOR THE FORMATION OF CUSTOMS UNIONS AND FREE TRADE AREAS UNDER THE GATT 1994: INTERNAL REQUIREMENTS

Conditions for the Formation of RTAs under ArticleXXIV of the GATT 1994: Internal Requirements
ArticleXXIV allows WTO Members to depart from the MFN principle in order to grant preferential treatment to their trading partners within a customs union or a free trade area subject to the following internal requirements:
  • For free trade areas and customs unions: apart from a few exceptions permitted under certain other Articlesof the GATT 1994 (XI, XII, XIII, XIV, XV and XX), the duties and other restrictive regulations of commerce are to be eliminated with respect to substantially all the trade between the parties of a customs union or free trade area or at least with respect to substantially all the trade in products originating in such territories (ArticleXXIV:8); and,
  • only for customs unions: in addition, to qualify as a customs union its members should apply substantially the same duties and other regulations of commerce to trade with non-members.

ArticleXXIV:8 states that apart from a few exceptions permitted under certain other Articlesof the GATT 1994 (XI, XII, XIII, XIV, XV and XX), the duties and other restrictive regulations of commerce are to be eliminated with respect to substantially all the trade between the parties of a customs union or free trade area or at least with respect to substantially all the trade in products originating in such territories. In addition, to qualify as a customs union its members should apply substantially the same duties and other regulations of commerce to trade with non-members. In practice, this condition implies a common external tariff and trade policy.

There is no agreement as to what it is required by the parties to an RTA in order to fulfil the conditions set out in ArticleXXIV:8. Disagreement persists on the precise meaning of "substantially all the trade" (SAT) and on what constitutes "other restrictive regulations of commerce" since neither ArticleXXIV nor the Understanding defines these concepts. With respect to the latter it is clear that the RTA must eliminate restrictive trade regulations on intra-party trade, however, disagreement persists among Members on whether this list of bracketed exceptions is exhaustive or merely illustrative. In particular, the fact that ArticleXIV on the imposition of safeguard measures is not included has been interpreted by some Members to mean that safeguard actions are not allowed in an RTA (and by extension neither are allowed other trade remedies such as anti-dumping). However, this view is not shared by all Members and the practice indicates that most RTA do indeed contain provisions on intra-RTA trade remedies.

With respect to the SAT requirement, there exists neither an agreed definition of the percentage of trade to be covered by a WTO-consistent RTA, nor an agreed methodology for the calculation of the SAT requirement, i.e. whether the assessment should be made on the basis of a percentage of liberalized tariff lines, trade values or both. Another issue of disagreement is whether such term would imply that no particular sector - or major sector - should be excluded; the Uruguay Round added a reference, in the Preamble of the Understanding, to the fact that the contribution of regional trade agreements to the expansion of world trade is "increased if the elimination between the constituent territories of duties and other restrictive regulations of commerce extends to all trade, and diminished if any major sector of trade is excluded". However, the practice of excluding sensitive sectors from RTA liberalization continues and the issue is yet to be resolved.

Likewize the interpretation of SAT remains outstanding in spite of some clarification with respect to the term given by the Appellate Body in Turkey – Textiles, where it held that "substantially all trade" is not the same as all the trade but is something considerably more than merely some of the trade (Turkey – Textiles, Appellate Body Report, para. 48).

The issue of interpretation and clarification of the WTO legal text on RTAs and in particular of the terms referred to earlier form the subject of discussion among Members in the context of the Doha Round of Negotiations.

II.B.2.CONDITIONS FOR THE FORMATION OF CUSTOMS UNIONS AND FREE TRADE AREAS UNDER THE GATT 1994: EXTERNAL REQUIREMENTS

Conditions for the Formation of RTAs under ArticleXXIV of the GATT 1994: External Requirements
ArticleXXIV allows WTO Members to depart from the MFN principle in order to grant preferential treatment to their trading partners within a customs union or a free trade area subject to the following external requirements:
  • For free trade areas: the duties and other regulations of commerce imposed on third –parties at the formation of the free trade area or an interim agreement leading to it should not be higher or more restrictive than those existing prior to its formation (ArticleXXIV:5(b)); and,
  • for customs unions: the duties and other regulations of commerce shall not on the whole be higher or more restrictive than the general incidence of the duties and other regulations of commerce applied prior to its formation (ArticleXXIV:5(a)).

As mentioned earlier, ArticleXXIV:4 provides that the purpose of a customs union or of a free trade area should be to facilitate trade between the constituent territories and not to raise barriers to the trade of other Members. In Turkey – Textiles, the Appellate Body interpreted that ArticleXXIV:4 informs the other relevant paragraphs of ArticleXXIV, including paragraph 5 (Turkey – Textiles, Appellate Body Report, para. 57). The Understanding on ArticleXXIV explicitly reaffirms this purpose and states that the constituent members should "to the greatest possible extent avoid creating adverse affects on the trade of other Members".

For customs unions, the Understanding provides that the comparison under ArticleXXIV:5(a) of the level of protection shall be based upon an overall assessment of weighted average of tariff rates and of customs duties collected prior to, and at, the institution of the customs union or the interim agreement leading to the customs union. For this purpose, the duties and charges to be taken into consideration shall be the applied tariffs. For other regulations of commerce, whose quantification and aggregation may be difficult, the examination of individual measures, regulations, products covered and trade flows affected may be required.

II.B.3.OTHER REQUIREMENTS FOR THE FORMATION OF CUSTOMS UNIONS AND FREE TRADE AREAS UNDER THE GATT 1994

In addition to the conditions set out in ArticleXXIV:8 and XXIV:5, other requirements include provisions on interim agreements and transition periods, tariff renegotiations in the context of the formation of a customs unions, and transparency provisions (see below).

With respect to the former, ArticleXXIV:5(c) states that an interim agreement must include a plan and schedule for the formation of a customs union or a free trade area within "a reasonable length of time," defined by paragraph 3 of the Understanding as not exceeding 10 years except in exceptional circumstances.

As for tariff renegotiations in the context of the formation of a customs unions, ArticleXXIV:6 provides that in cases where, in the context of the formation of a customs union, a Member proposes to increase any bound rate, the procedures for modification of schedules set forth in ArticleXXVIII shall apply. As clarified by the Understanding, the following requirements apply:

  • The process of negotiation must be commenced before tariff concessions are modified or withdrawn upon the formation of a customs union or an interim agreement leading to a customs union (paragraph 4);
  • the negotiations will be entered into in good faith with a view to achieving mutually satisfactory compensatory adjustment (paragraph 5);
  • affected Members shall take due account of reductions of duties on the same tariff line made by other parties of the customs union. Only if such reductions do not provide the necessary compensatory adjustment, the customs union would provide compensation, which may take the form of reductions of other tariff lines (paragraph 5); and,
  • where an agreement cannot be reached within a reasonable period, the customs union shall be free to modify or withdraw the concession and affected Members shall then be free to withdraw substantially equivalent concessions (paragraph 5).

Paragraph 12 of the Understanding states that the provisions regarding dispute settlement may be invoked with respect to any matters arising from the application of those provisions of ArticleXXIV relating to customs unions, free trade areas or interim agreements.