Are Preferential Trade Agreements with Non-trade Objectives a Stumbling Bloc for Multilateral Liberalization?

Increasingly, in regional agreements, large economies, e.g. U.S. and E.U., offer lower trade barriers in exchange for cooperation by small economies in environmental, intellectual property and other issues. What is the effect of such agreements on multilateral trade liberalization? We show that, even in the absence of trade creation or diversion, such preferential agreements increase the cost of multilateral tariff reductions for the goods exported from small to large countries. This occurs because multilateral tariff reductions decrease the threat that large countries can use in preferential agreements causing a loss in their bargaining power. The result is due to current exceptions in the WTO to the most-favorite-nation rule which allow for lower than MFN tariffs, e.g. art. XXIV and GSP. By explicitly modeling the interaction between preferential and multilateral negotiations we analyze the effects on multilateral tariffs and welfare of strengthening the MFN rule and show that large and small countries may not prefer the same regime of rules.