Source: Global Times    Published: 2016-7-26

Since the beginning of the 21st century, various regional free trade agreements (FTAs) have played a prominent role in international trade. But the UK referendum result deciding to withdraw from the EU serves as a warning to world economies that they must reckon with both the costs and benefits of joining trendy regional FTAs, and Brexit could even slow or reverse the ascendant trend of regional FTAs.

China has rolled out a series of plans for regional economic integration and is pushing forward the implementation of the One Belt and One Road initiative. Brexit has also alerted us to consider the possibility of directing the Belt and Road initiative toward the direction of FTAs. I advise China not to become too ambitious in pursuing the goal of regional economic integration, but to focus more on accomplishing the initiative`s five major goals: policy coordination, infrastructure connectivity, unimpeded trade, financial integration and stronger people-to-people bonds.

A major reason for the robust development of regional FTAs is the stagnation of the Doha Round multilateral trade talks, the latest round of trade negotiations among World Trade Organization (WTO) members. Under such circumstances, many countries have regarded regional FTAs as replacements for the multilateral FTAs formed under the WTO and are willing to participate in regional FTAs when certain economic and political powers propose them.

But regional FTAs are inherently flawed, especially for larger economies.

First, signing one FTA may satisfy most of the foreign trade demand of a country with small economic scale and trade volume, but it falls far short of satisfying the overall foreign trade demand of a larger economy. Because China`s economy is one of the world`s largest in both scale and trade volume and because its economy is still growing at a comparatively rapid pace, the fact that a country`s development is sometimes hampered by regional FTAs especially resonates with China. This also serves to explain why Japan has been less enthusiastic about regional FTAs since the 1980s.

Second, while joining regional FTAs has become trendy, joining these pacts often leaves participant countries with reduced gains and increased costs. The most typical problem is the "spaghetti bowl effect," a problem in an FTA`s rules of origin, which determine which country a product is from. Since one county might sign different FTAs with different countries, each of which has different rules of origin, companies from a participant country that export products to multiple countries often need to prepare multiple different certificates of origin for the same product, resulting in higher business and administration costs.

In addition, in order to enjoy the preferential tariffs or the lowest tariffs of a target market, exporters often have to transfer their products from one country to another in a convoluted network of routes that resembles spaghetti getting entangled in a bowl. Industries that are more capital-intensive and technology-intensive usually have bigger economies of scale, thus the spaghetti bowl effect causes even greater distortions in these industries` production layout and trade flows, so the extra costs to these firms will be greater.

Third, existing regional FTAs necessitate greater market openness in various areas than is required by WTO pacts, and founding members of regional FTAs normally must offer an even higher degree of openness than other member countries to attract others` participation. This could potentially lead to the accelerated "hollowing out" of the country`s domestic industries and would greatly impact the country`s middle class.

To be practical, the EU offers more to its members than other regional FTAs, bound as it is by similar religious and cultural traditions, and even though there are internal economic and social gaps among its member countries, these disparities are not as big as those among the members of other FTAs. However, the majority of UK citizens have voted to leave the EU to avoid the negative effects of regional economic integration. Differences among countries along the route of the Belt and Road are far greater than those among EU members, so if China is too ambitious about achieving regional economic integration, the outcome will be difficult to predict.

Countries involved in the Belt and Road initiative range from Central Asia, South Asia, West Asia, Southeast Asia, Europe to Northeast Africa. Some are middle-income countries or newly industrializing economies, such as China and some Central and Eastern European countries; some are low-income countries like India and Pakistan. There are also least-developed countries like Afghanistan and high-income countries like Singapore and some Gulf nations. Given that there are some intense and irreconcilable political conflicts between certain countries involved in the initiative, it would be difficult for China to coordinate member countries` various interests within an FTA while ensuring an overall degree of liberalization and openness higher than that of the WTO.

Ultimately, China`s comparatively enormous trade volume and industrial scale suggests that it should depend more on the global multilateral trading system rather than on regional economic integration.

Besides, China has fewer relevant legal professionals than the US and Europe and therefore wouldn`t be wise to follow the US` example of establishing multiple regional economic integration organizations.

The author is a research fellow with the Chinese Academy of International Trade and Economic Cooperation.