Preferential Trade Agreements: Regionalism and Its Discontents

The Spaghetti Bowl

In 2017, a Bangladeshi t-shirt crossing a border might have faced one tariff rate under a bilateral free trade agreement, a different rate under a regional agreement, and a third rate under the WTO’s most-favored-nation schedule — depending on where it was going and which rules of origin it qualified for.

Jagdish Bhagwati coined the term “spaghetti bowl” to describe the overlapping tangle of preferential trade agreements that now covers most of world trade. With over 350 regional trade agreements in force, the global trading system has become a complex web of bilateral and plurilateral deals, each with its own tariff schedules, rules of origin, and dispute mechanisms.

This proliferation raises a fundamental question for trade economics: do preferential trade agreements create wealth or redistribute it? The answer, as Jacob Viner showed in 1950, depends on whether they create trade or merely divert it.

I. Trade Creation vs. Trade Diversion: Viner’s Framework

When countries form a preferential trading area — eliminating tariffs among themselves while maintaining external tariffs against third countries — two effects occur simultaneously:

Trade creation: Some domestic production is replaced by cheaper imports from partner countries. This improves welfare because consumers buy at lower prices, and resources shift to more productive uses. This is economically beneficial — it’s what free trade theory predicts.

Trade diversion: Some imports from efficient third-country producers (who now face tariffs) are replaced by imports from less efficient partner countries (who don’t). A Canadian widget-maker captures market share from a cheaper Taiwanese producer because the Taiwanese faces a tariff and the Canadian doesn’t. This is economically harmful — it redirects production away from the most efficient global source.

Whether a preferential agreement improves welfare depends on which effect dominates. Viner’s insight is that preferential agreements are neither obviously good nor obviously bad — they require case-by-case analysis.

Rules of origin are the practical mechanism through which this plays out. To benefit from preferential tariffs, goods must “originate” in the partner country — not simply be re-exported there after crossing from a third country. Rules of origin requirements can be simple or extraordinarily complex, creating compliance costs that sometimes exceed the tariff savings for small exporters.

II. NAFTA and USMCA: North American Integration

The North American Free Trade Agreement (1994) was the most studied regional trade agreement in economics. Its effects became a laboratory for testing trade theories.

What happened with NAFTA:

US-Mexico trade roughly tripled over 25 years
US manufacturing employment in some sectors declined (consistent with comparative advantage predictions)
Mexican agricultural employment also fell — as US corn (heavily subsidized) entered the Mexican market and undercut smallholder farmers
Cross-border production networks — particularly in automotive — became deeply integrated
The maquiladora system (factories in Mexican border zones producing for US export) expanded dramatically

NAFTA’s legacy is contested. Economists generally find it raised aggregate welfare in all three countries. But it accelerated deindustrialization in specific US regions and contributed to rural displacement in Mexico (some economists link it to increased Mexican migration pressure in the late 1990s and 2000s — exactly the migration we discussed in Session 5).

USMCA (2020) replaced NAFTA with updates on digital trade, intellectual property, financial services, and — controversially — automotive rules of origin. The new rules require that 75% of automotive content originate in North America (up from 62.5%) and that 40–45% of content be produced by workers earning at least $16/hour. This was explicitly designed to reduce incentives to shift production to Mexico’s lower-wage regions — a protectionist element embedded in a free trade agreement.

III. RCEP: Asia’s Mega-Deal

The Regional Comprehensive Economic Partnership (RCEP), signed in 2020 and entered into force in 2022, covers 15 countries: ASEAN-10 plus China, Japan, South Korea, Australia, and New Zealand. It represents approximately 30% of world GDP and 30% of world population.

RCEP is primarily a tariff-reduction agreement — it does not include rules on labor standards, environmental standards, or government procurement at the level of US-style agreements. This reflects the negotiating preferences of its members, particularly China, which strongly resists “behind-the-border” regulatory harmonization.

Geopolitically, RCEP is significant because it includes China but not the United States (which withdrew from its predecessor negotiation, the TPP, in 2017). It also excludes India, which pulled out of negotiations in 2019 over concerns that Chinese imports would flood its market.

Whether RCEP accelerates Asian economic integration primarily on Chinese terms — creating a trading hub that reinforces China’s central position in regional supply chains — is one of the key geopolitical questions in international trade.

IV. CPTPP: The Agreement the US Left Behind

The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) is the remnant of the Trans-Pacific Partnership (TPP) — a 12-country deal negotiated over eight years that the US withdrew from on its third day under President Trump in January 2017.

The original TPP was designed partly as a strategic counterweight to China — creating high-standard trade rules in the Pacific Rim that would exclude China and pull regional supply chains toward US-aligned partners. The Obama administration framed it explicitly in geopolitical terms: “We can’t let countries like China write the rules of the global economy.”

After US withdrawal, the remaining 11 countries (Canada, Mexico, Japan, Australia, New Zealand, Singapore, Vietnam, Malaysia, Brunei, Peru, Chile) agreed to proceed — suspending some provisions that had been US priorities (particularly pharmaceutical IP protections) and signing CPTPP in 2018.

The CPTPP entered into force with member ratifications and has grown with the UK’s accession in 2023. China has applied to join; the US has not rejoined.

The US exit from TPP is widely viewed in retrospect as a strategic error — ceding influence over Pacific trade rules while China has moved aggressively to shape regional agreements.

V. The Future of Trade Agreements

The proliferation of regional and bilateral agreements raises questions about whether multilateral trade governance can be rebuilt:

Convergence or fragmentation? Some economists argue that regional agreements gradually converge toward common standards and eventually get multilateralized. Others argue the spaghetti bowl creates permanent fragmentation that disadvantages smaller countries without the bargaining power to negotiate favorable bilateral terms.

Deep integration vs. shallow integration. Modern FTAs increasingly address “behind-the-border” measures — investment rules, intellectual property, digital trade, regulatory standards, labor and environment. These provisions create genuine welfare gains (and sometimes raise standards) but also constrain domestic policy space. The tension between trade liberalization and regulatory sovereignty is one of the defining political economy conflicts of the current era.

US re-engagement? The Biden administration negotiated the Indo-Pacific Economic Framework (IPEF) as a partial substitute for TPP — but explicitly excluded tariff reductions to avoid Congressional ratification requirements. Critics argued this produced an agreement without meaningful market access benefits.

Why It Matters

Preferential trade agreements are not simply about economics — they are geopolitical instruments. RCEP, CPTPP, USMCA, and the EU’s network of FTAs all reflect strategic calculations about alignment, influence, and rules-setting in an era of great power competition.

For investors and companies, the relevant question is increasingly: which supply chains comply with which agreements’ rules of origin, and how do those rules shift as the geopolitical landscape evolves?