Beyond trade creation: Preferential trade agreements and trade disputes

• Published date: 01 February 2021
• Author: Tan Li,Larry D. Qiu
• Date: 01 February 2021
• DOI: http://doi.org/10.1111/1468-0106.12314

ORIGINAL MANUSCRIPT

Beyond trade creation: Preferential trade

agreements and trade disputes

Tan Li

1

| Larry D. Qiu

2

1

School of International Business,

Southwestern University of Finance and

Economics, Chengdu, China

2

Department of Economics, Lingnan

University, Tuen Mun, Hong Kong

Correspondence

Larry D. Qiu, Department of Economics,

Lingnan University, Tuen Mun, Hong

Kong.

Email: larryqiu@gmail.com

Funding information

National Natural Science Foundation of

China, Grant/Award Number: NSFC:

71703128

Abstract

This study investigates the effects of preferential trade

agreements (PTA) on bilateral trade disputes. We con-

struct a unique and comprehensive dataset on inter-

country trade disputes from 1995 to 2007. The dataset

covers 110 countries and 1,162 bilateral country-pair trade

disputes. Using this dataset in a gravity-type model of

trade dispute analysis, we find that countries belonging to

the same PTA tend to experience fewer trade conflicts

among themselves than with non-member countries. By

studying various types of PTA with different dispute

settlement mechanisms, we further find that the dispute-

reducing effect only comes from PTA with specific provi-

sions on dispute settlement mechanisms. Moreover, the

effect is stronger if those PTA explicitly stipulate that

members can also resolve their disputes via the WTO Dis-

pute Settlement Body. However, having PTA that do not

address how members should resolve their disputes may

lead to more dispute initiations than in cases without PTA.

1|INTRODUCTION

Trade disputes and conflicts occur frequently between trading partners. Based on our collected data,

1,162 trade disputes involving 110 countries ensued from 1995 to 2007. Trade conflicts transpire

even between “friendly”countries with preferential trade agreements (PTA).

1

For example, 83 trade

disputes occurred between Canada and the USA from 1995 to 2007. Undoubtedly, trade dispute mat-

ters economically and politically. Even a small trade dispute can have enormous political conse-

quences. For instance, the well-known banana war between the EU and Latin American countries

caused considerable hidden damage.

2

Received: 16 May 2017 Revised: 15 March 2019 Accepted: 25 June 2019

DOI: 10.1111/1468-0106.12314

Pac Econ Rev. 2021;26:23–53. wileyonlinelibrary.com/journal/paer © 2019 John Wiley & Sons Australia, Ltd 23

Since its inception in 1995, the WTO Dispute Settlement Body (DSB) has been receiving dispute

complaints from member countries. By the end of 2015, the DSB had received more than 500 dispute

complaints, which dwarfed the total of all disputes under the entire period of the General Agreement

on Tariffs and Trade (GATT) (1947–1994). The recent two decades have seen increasing numbers of

established PTA. Similar to the WTO, which has a DSB for member countries to solve trade dis-

putes, many PTA have certain dispute settlement provisions. What factors affect the frequency of

trade disputes and how the formation of PTA affects the occurrence of trade conflicts among member

countries must be determined. Prior research on PTA since Viner (1950) has provided rich analyses

focusing largely on trade creation versus trade diversion effects. Our study investigates the effect of

PTA formation beyond trade creation/diversion from a different perspective; that is, the effect on the

occurrence of trade disputes.

Extensive empirical research explores the determinants of trade disputes. However, almost all of

these studies are based on WTO disputes (including GATT disputes); that is, disputes registered with

the WTO Secretariat (or the GATT for GATT disputes). Among all possible trade disputes, which

we call primary trade disputes (or simply trade disputes when no confusion exists), WTO disputes

are “not just the tip, but the tip of the tip of the iceberg”(Horn & Mavroidis, 2006). Based on our cal-

culations, WTO disputes from 1995 to 2007 account for only 34% of the total trade disputes. There-

fore, no inference about the determinants of trade dispute initiations can be drawn on the basis of

conclusions obtained from the existing studies.

3

One of the objectives of our study is to fill this gap

in the literature by analysing what determines disputes, using a large set of trade disputes. To this

end, we construct the first dataset of all possible trade disputes through a keyword search in Factiva,

one of the largest global digital business archives worldwide. Factiva provides access to news articles

appearing in over 36,000 newspapers, trade presses, magazines, newswires, television and audio

transcripts, and web and social media in 200 countries. Based on certain criteria (discussed in detail

later), we obtain 1,162 bilateral country-pair trade disputes from 1995 to 2007 involving

110 countries.

Several important results emerge from our research. First, friendship (or relationships in general)

matters. Using our primary trade disputes dataset, we find that countries belonging to the same PTA

tend to experience fewer trade conflicts among themselves than with non-member countries. We also

confirm previous findings that size matters. A “larger”country (GDP, GDP per capita or trade vol-

ume) is more likely to initiate trade disputes than a smaller country, and a more rapidly growing

country is more likely to be the target of trade disputes than its slowly growing counterpart. Second

and perhaps most importantly, dispute settlement mechanisms are crucial. The dispute-reducing

effect of PTA is only associated with those that include dispute settlement mechanisms. PTA that

clearly and explicitly state that member countries can utilize the WTO DSB in settling their disputes

have the largest dispute-reducing effect. However, PTA that do not provide a forum for or address

how member countries should resolve their disputes could induce more trade dispute initiations than

is the case without PTA. Finally, we address the issue of endogeneity and show the importance of

controlling for unobservables.

This research makes several important contributions to the literature. First, this study is the first to

use the most comprehensive data on trade disputes in a systematic empirical analysis. Empirical liter-

ature on the determinants of countries' participation in trade disputes and conflicts is available, but

most studies are based exclusively on GATT/WTO disputes. Horn, Mavroidis, and Nordstrom

(1999) were the first to study the participation issue in WTO dispute settlement. The number of trade

dispute initiations can be explained fairly well by the volume of trade and the diversity of trade part-

ners (Horn et al., 1999). Bown (2005) substantially refines the study of Horn et al. (1999) and

24 LI AND QIU