Tightening or Loosening? The Effects of Uncertainty on the Design of Preferential Trade Agreements – Cambridge University Press & Assessment

1. Introduction

Recent global uncertainty spikes, including the 2008 financial crisis, the COVID-19 pandemic, and the Russian invasion of Ukraine, have triggered protectionist responses in many countries. Contrary to expectations that uncertainty would foster international cooperation, it often amplifies unilateral measures aimed at safeguarding national interests. Governments tend to hesitate in joining international institutions that may limit their sovereignty during uncertain times. However, evidence indicates that during such periods, governments may enter into deeper preferential trade agreements (PTAs) with stronger commitments.

Examples include Japan-Vietnam’s comprehensive PTA in 2008 amid economic uncertainty, China-Costa Rica’s trade and investment agreement in 2010 following political shifts, and Turkey-Singapore’s deep PTA in 2015 during political and economic instability. These agreements often contain numerous binding provisions, which is counterintuitive given the expectation for flexibility under uncertainty.

While existing literature suggests uncertainty leads to institutional flexibility allowing governments to adjust commitments, this study argues that sharp uncertainty spikes instead prompt governments to sign deeper PTAs with stronger institutional commitments. Deep PTAs provide legal certainty and information through provisions on investment protection, intellectual property rights (IPRs), competition rules, and regulatory cooperation, thereby mitigating uncertainty and fostering sustainable economic development aligned with Sustainable Development Goals (SDGs) such as Decent Work and Economic Growth (SDG 8) and Industry, Innovation, and Infrastructure (SDG 9).

This report investigates the effects of uncertainty spikes on PTA design, emphasizing the role of SDGs in promoting resilient and inclusive international economic cooperation.

2. Preferences on Institutional Design

2.1 Economic Gains and PTA Depth

Modern PTAs derive economic benefits less from tariff reductions and more from harmonizing domestic regulations, removing non-tariff measures (NTMs), and protecting foreign investment. PTA depth, defined by the extent to which agreements constrain domestic trade obstacles, has become a key indicator of liberalization ambition. Deep PTAs include provisions on technical standards, food safety, IPRs, and competition rules, which are crucial for sustainable trade and investment practices supporting SDG 9 (Industry, Innovation, and Infrastructure) and SDG 12 (Responsible Consumption and Production).

2.2 Flexibility in PTAs

Flexibility provisions, such as escape clauses allowing temporary suspension of commitments, coexist with depth to balance administrative and political costs. These provisions help governments manage domestic political pressures and economic shocks while maintaining long-term cooperation. Flexibility supports SDG 16 (Peace, Justice, and Strong Institutions) by enabling adaptive governance mechanisms.

2.3 Role of Firms and Industry Preferences

Globally operating firms, especially multinational corporations (MNCs), are significant beneficiaries of PTAs and influential in shaping trade policies. They prioritize investment protection over traditional tariff reductions, seeking stability and predictability in international markets. Deep PTAs mitigate risks related to expropriation and discriminatory policies, aligning with SDG 8 (Decent Work and Economic Growth) by fostering stable investment climates and economic growth.

3. Deep PTAs: Credibility and Uncertainty Mitigation in Hard Times

Uncertainty, encompassing political, economic, or combined factors, increases risks for firms operating internationally. Events such as the 2008 financial crisis, geopolitical conflicts, and the COVID-19 pandemic have heightened uncertainty, impacting trade and investment decisions. Deep PTAs serve as tools to mitigate these risks by:

1. Signaling stronger commitments: Provisions on investment protection and IPR enforcement enhance trust and reduce political risks, supporting SDG 16 (Peace, Justice, and Strong Institutions).
2. Improving regulatory cooperation: Mechanisms to prevent new NTMs facilitate smoother trade flows, contributing to SDG 9 (Industry, Innovation, and Infrastructure) and SDG 17 (Partnerships for the Goals).
3. Enhancing global value chain resilience: Deep PTAs provide information and diversification opportunities to firms, supporting SDG 8 (Decent Work and Economic Growth) and SDG 9.

Heightened uncertainty motivates firms to intensify lobbying for deeper PTAs, as these agreements provide institutional safety nets essential for sustainable economic activity.

4. Empirical Analysis

4.1 Measuring Uncertainty Spikes

The study analyzes 251 bilateral PTAs negotiated between 1990 and 2020, using the World Uncertainty Index (WUI) to measure country-specific uncertainty. An uncertainty spike is defined as a two-standard-deviation increase in uncertainty within a country during the negotiation period. This approach captures sharp rises in uncertainty that significantly influence firm behavior and government decision-making, relevant to SDG 8 and SDG 17.

4.2 Control Variables

Models control for factors influencing PTA design, including:

• Past PTA depth to account for institutional path dependency.
• Political variables such as veto players and regime type.
• Economic variables including GDP, GDP per capita, trade flows, and foreign direct investment (FDI) stock.
• International factors like WTO membership and military alliances.
• Global uncertainty levels to isolate dyad-specific effects.

4.3 Model Specification

Multivariate regressions and Heckman selection models assess the impact of uncertainty spikes on PTA depth, measured by DESTA indices capturing tariff cuts, investment, standards, IPRs, services, government procurement, and competition provisions. Robust standard errors clustered at the country-dyad level ensure reliable inference.

5. Discussion of the Results

Results robustly support the hypothesis that uncertainty spikes lead to deeper PTAs:

• PTAs negotiated during uncertainty spikes are approximately 11-16% deeper than those without such spikes.
• World uncertainty levels alone do not significantly affect PTA depth, emphasizing the importance of dyad-specific uncertainty.
• Economic development (GDP per capita) positively correlates with PTA depth, aligning with SDG 8 and SDG 9.
• Political variables such as veto players show no significant effect under uncertainty spikes.

These findings suggest that in times of uncertainty, countries prefer stronger institutional commitments to enhance predictability and cooperation, supporting sustainable economic growth and resilient institutions (SDG 8, SDG 16, SDG 17).

6. Sensitivity Checks

6.1 North–South Dynamics

Analysis confirms that the positive effect of uncertainty spikes on PTA depth is not driven solely by North–South agreements or the presence of advanced economies. South–South PTAs tend to be shallower on average, but uncertainty spikes similarly increase their depth, indicating a universal phenomenon supporting inclusive and sustainable trade partnerships (SDG 10: Reduced Inequalities).

6.2 Different Uncertainty Specifications

Extending the time window for uncertainty spikes and considering gradual uncertainty rises yield consistent results, reinforcing the robustness of the findings.

6.3 Addressing Selection Bias

Heckman selection models reveal that uncertainty spikes slightly increase the likelihood of PTA formation but do not bias the observed positive effect on PTA depth. This underscores the strategic role of deep PTAs in managing uncertainty and promoting sustainable economic cooperation (SDG 17).

7. The Uncertainty–Flexibility Nexus

Contrary to expectations from institutional design literature, uncertainty spikes do not robustly increase flexibility provisions in PTAs. Flexibility, often in the form of escape clauses, allows temporary suspension of commitments to manage shocks. However, during uncertainty spikes, governments and firms prioritize depth over flexibility to ensure credible commitments and market stability.

This prioritization aligns with the need to uphold open trade policies and maintain investor confidence, supporting SDG 8 and SDG 16. The findings suggest that depth and flexibility, typically complementary, may diverge under high uncertainty, with depth taking precedence to mitigate political and economic risks.

8. Conclusion

This report demonstrates that uncertainty spikes prompt countries to negotiate deeper PTAs rather than more flexible ones. Deep PTAs strengthen commitments to market liberalization and investment protection, mitigating risks of protectionism and fostering stable international economic relations. Recent agreements such as the EU-Japan PTA and EFTA-Mercosur PTA exemplify this trend.

The findings contribute to institutionalist theories by highlighting credible commitments as vital in turbulent times, reflecting a positive outlook for bilateral trade cooperation despite multilateral challenges. This dynamic supports multiple SDGs, including:

• SDG 8: Promoting sustained, inclusive economic growth and decent work through stable trade and investment frameworks.
• SDG 9: Facilitating industry innovation and infrastructure via regulatory harmonization and investment protection.
• SDG 16: Strengthening institutions by enhancing rule of law and predictable governance.
• SDG 17: Encouraging global partnerships through deepened bilateral agreements.

Future research may explore the uncertainty-depth relationship in other domains such as environmental governance, public health, and security cooperation, further advancing sustainable development goals globally.

1. Sustainable Development Goals (SDGs) Addressed or Connected to the Issues Highlighted in the Article

1. SDG 8: Decent Work and Economic Growth
   • The article discusses the impact of economic uncertainty (e.g., financial crises, pandemics) on trade agreements and investment protection, which directly relates to promoting sustained, inclusive, and sustainable economic growth and productive employment.
2. SDG 9: Industry, Innovation, and Infrastructure
   • The focus on preferential trade agreements (PTAs) that include regulatory harmonization, investment protection, and intellectual property rights (IPRs) supports building resilient infrastructure, promoting inclusive and sustainable industrialization, and fostering innovation.
3. SDG 10: Reduced Inequalities
   • Deep PTAs aim to reduce trade barriers and create predictable investment environments, which can help reduce inequalities between countries by facilitating fairer trade and investment flows.
4. SDG 17: Partnerships for the Goals
   • The article’s core theme on international cooperation through PTAs aligns with strengthening the means of implementation and revitalizing global partnerships for sustainable development.

2. Specific Targets Under Those SDGs Identified Based on the Article’s Content

1. SDG 8: Decent Work and Economic Growth
   • Target 8.2: Achieve higher levels of economic productivity through diversification, technological upgrading, and innovation.
   • Target 8.3: Promote development-oriented policies that support productive activities, decent job creation, entrepreneurship, creativity, and innovation.
   • Target 8.10: Strengthen the capacity of domestic financial institutions to encourage and expand access to banking, insurance, and financial services for all.
2. SDG 9: Industry, Innovation, and Infrastructure
   • Target 9.1: Develop quality, reliable, sustainable, and resilient infrastructure, including regional and transborder infrastructure, to support economic development and human well-being.
   • Target 9.3: Increase the access of small-scale industrial and other enterprises to financial services, including affordable credit, and their integration into value chains and markets.
   • Target 9.b: Support domestic technology development, research, and innovation in developing countries.
3. SDG 10: Reduced Inequalities
   • Target 10.a: Implement the principle of special and differential treatment for developing countries, in particular least developed countries, in accordance with World Trade Organization agreements.
   • Target 10.b: Encourage official development assistance and financial flows, including foreign direct investment, to states where the need is greatest.
4. SDG 17: Partnerships for the Goals
   • Target 17.10: Promote a universal, rules-based, open, non-discriminatory, and equitable multilateral trading system under the World Trade Organization.
   • Target 17.11: Significantly increase the exports of developing countries, in particular with a view to doubling the least developed countries’ share of global exports.
   • Target 17.16: Enhance the global partnership for sustainable development, complemented by multi-stakeholder partnerships.

3. Indicators Mentioned or Implied in the Article to Measure Progress Towards the Identified Targets

1. Indicators for SDG 8
   • Trade agreement depth index (DESTA depth index) measuring the comprehensiveness and ambition of PTAs, including tariff cuts, investment protection, and regulatory harmonization.
   • Foreign direct investment (FDI) stock as a measure of investment flows and economic openness.
   • Levels of bilateral trade flows between countries, indicating economic integration and market access.
2. Indicators for SDG 9
   • Provisions on intellectual property rights (IPRs) protection within PTAs, supporting innovation and technology transfer.
   • Regulatory cooperation and harmonization provisions in PTAs that reduce non-tariff measures (NTMs) and technical barriers to trade (TBTs).
   • Measures of supply chain resilience and global value chain (GVC) functioning, implied by the discussion on PTAs enhancing GVC stability.
3. Indicators for SDG 10
   • Inclusion of special and differential treatment clauses or provisions favoring developing countries in PTAs (implied by discussion on South–South and North–South agreements).
   • Economic asymmetry indicators such as GDP gap between PTA partners.
4. Indicators for SDG 17
   • Number and depth of preferential trade agreements signed, reflecting international cooperation and partnerships.
   • Membership status in WTO or GATT, indicating commitment to multilateral trade rules.
   • World Uncertainty Index (WUI) used to measure political and economic uncertainty affecting trade cooperation.

4. Table of SDGs, Targets, and Indicators Relevant to the Article

Source: cambridge.org