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The future of the EU/OCT relationship: options for the OCT

G. Faber

E-mail: g.faber@econ.uu.nl

Utrecht University

Paper prepared for the OCT-2000 Ministerial Conference

Brussels, November 16/17, 2000

List of abbreviations

ACP African, Caribbean and Pacific countries, signatories of the Lomé Convention

CARICOM Caribbean Common Market

CU Customs Union

EU European Union

FTA Free Trade Area

GSP Generalised System of Preferences

MFN Most Favoured Nation

OCT Overseas Countries and Territories

Introduction

The relationship between the European Union (EU) and the Overseas Countries and Territories (OCT) [1] is ruled by the OCT Decision of the EU Council of Ministers of 1991, that was amended by a Decision of the same body in 1997. A new OCT Decision has to be taken as the present arrangement lapses at the end of February 2001. The time has arrived to rethink the EU/OCT relationship. The heads of state and government of the member states added a declaration to the Treaty of Amsterdam in 1997 that says that " the special arrangements for association as they were conceived in 1957 can no longer deal effectively with the challenges of OCT development". A related reason for this review is that in the spring of 2000, the Lomé Convention has been succeeded by the Cotonou Agreement which differs in a number of respects from its predecessor. The OCT Decision has always mirrored the treatment of the ACP countries under the Lomé Conventions. Furthermore, and perhaps as important as the more formal reasons, is, that the world in which the previous OCT Decisions were formulated, has changed dramatically. And last but not least, the OCT themselves have changed. They have become more independent in the formulation of their demands; the Conference for which this paper has been written is a point in case. This begs the question whether the OCT should not reconsider the relationship with the EU in the broader framework of devising a long term strategy to address their development problems in a more effective way.

This is what the present paper tries to do; not by prescribing a new approach for the OCT or by giving a blueprint for the new Council of Ministers OCT Decision, but by presenting and discussing a number of options that the OCT face when they devise their long term development strategy. Given the time and space available, this paper will not deal with every aspect of the EU/OCT relationship. First, it will be assumed that the existing arrangements between the individual OCT and their 'mother countries' or 'member states concerned 'will remain as they are. Although the precise status of the OCT differs, there is much similarity. The entities have a large degree of autonomy in economic and legislative matters. The member state concerned usually retains the powers in the areas of foreign affairs, justice and defence. The status of the OCT has resulted from a democratic process, in many instances in the form of local referendums. [2] Second, the emphasis of the analysis will be on the economic aspects. Trade rules constitute the core of the OCT Decision. Important consequences in terms of development and institutions will flow from the choices to be made in this area. Before these options are presented, a description of the economic situation of the OCT is given (section 2) and an evaluation of the OCT policy up to now is presented (section 3). In section 4 the changing environment of the EU/OCT relationship is painted. All this serves as background for the options for the future of the EU/OCT relationship, to be discussed in section 5. The paper is summarised in section 6, where the different options are combined and conclusions for the new OCT Decision are drawn.

The economic situation of the OCT

The 20 OCT are a very diverse group of countries. Some are small islands with less than 100 inhabitants (Pitcairn, British Indian Ocean Territory), while others have a much larger territory (Greenland has more than 2 million km2) and larger populations (French Polynesia, New Caledonia and the Netherlands Antilles each have more than 200.000 inhabitants). Furthermore, these countries and territories are widely spread over the globe and some are very isolated in the Pacific and the Atlantic Oceans. The OCT have in common that they are all islands, or groups of islands. As a result sea and air transport are facilities that determine to a large extent the possibilities for internal and external communications, necessary for import and export of goods and services like tourism. Isolation and the dispersion of some OCT's territories over many small islands makes transport expensive per unit of weight or per person. At the other hand, this very fact can be attractive for certain sections of tourism. Furthermore, maritime resources (both living organisms and minerals in the economic zones surrounding the islands) are important (potential) resources for economic development. The development of these resources in a sustainable way requires careful management. Natural resources can be depleted or polluted thus depriving the OCT concerned of its future means of income generation. Large investments are often called for in order to create a viable and sustainable exploitation of these natural resources. Given the small absolute size of these economies generally, which is further compounded by a low level of income in some of them, investments from the member state concerned and other countries is necessary to bring about the development the OCT would like to realise.

The figures in this section should be interpreted very cautiously. Reliability is a problem. Due to unavailability for some years for certain OCT, data for one indicator may relate to different years for different countries.

Table 1 OCT: Gross Domestic Product and Income per capita, in US dollars

OCT		GDP mln$	GDP per capita, $

Mayotte	1997	210	1603
New Caledonia	1995	3303	16216
Fr. Polynesia	1997	3934	17683
St. Pierre et Miquelon	1997	74	11000
Wallis and Futuna		29	2026

Aruba	1996	1400	21000
Neth. Antilles	1997	2400	11500

Anguilla	1996	75	7200
Cayman Islands	1996	860	23800
Falkland Islands	1998	53	21324
Br. Virgin Islands	1996	144	11000
Montserrat	1996	43	5000
St. Helena and dep.	1998	16	4261
Turks and Caicos Isl.	1996	110	7700

Greenland	1997	945	16100

Source: Commission of the EC, The Status of OCTs Associated with the EC and Options for "OCT 2000", Brussels 1999, Vol II.

Table 1 shows how different the economies of the OCT are. They differ in absolute size of GDP from more than $ 3 billion (Fr. Polynesia and New Caledonia) to $ 16 million in St Helena and dependencies. Perhaps even more striking are the differences in level of welfare: the Cayman Islands have an average per capita income that is higher than the EU figure; Aruba and the Falklands are about at the EU level, while Mayotte is at seven per cent of the EU income per capita only.

Macro-economic indicators are hard to come by. Growth figures for only one year are not very reliable. As far as inflation is concerned, it can be noted that there is a low to modest inflation in the OCT. Unemployment is alarmingly high in Mayotte, Fr. Polynesia, New Caledonia and the Netherlands Antilles, St. Helena and the Turks and Caicos Islands. Greenland has an unemployment problem as well, at 11.5 per cent.

Table 2 Selected macro-economic indicators of the OCT, most recent year

OCT	GDP real growth		Inflation rate %		Unemployment rate %

Mayotte	Na		2,1	1997	42	1997
New Caledonia	6	1996	2,1	1997	17,1	1997
Fr. Polynesia	6	1997	1	1997	17,7	1997
St. Pierre et Miquelon	Na		4,7	1997	11	1996
Wallis and Futuna	Na		1,4	1 998	na

Aruba	4	1996	3,2	1996	0,6	1996
Neth. Antilles	-1,3	1997	3,6	1997	13,4	1993

Anguilla	3,4	1996	3,6	1996	7	1992
Cayman Islands	5	1996	2,1	1996	7	1992
Falkland Islands	Na		2,5	1998	na
Br. Virgin Islands	4,5	1996	2,5	1990	3	1995
Montserrat	-20,2	1996	5	1998	6	1998
St. Helena and dep.	-3,2	1998	0,6	1995	14	1995
Turks and Caicos Isl.	3,5	1996	8	1994	15	1996

Greenland	2,8	1996	0,6	1997	11,3	1997

Inflation: increase of consumer price index.

Inflation: consumer price index

Source: see table 1

Table 3 presents the composition of GDP for some OCT. It is striking that for those OCT for which figures are available, the contribution of services to GDP is very high: more than 75 per cent. These countries have a total population of almost 700.000, which is approximately 70 per cent of all OCT inhabitants. This means that the production of services - and the exports of them - are of crucial importance for the generation of income and employment in these economies. A large part of these services is sold to foreigners (financial and business services, tourism). This means that a large section of these economies has to compete in international markets.

It seems likely that the contribution of services to GDP is much lower for a number of OCT. The Falklands and Greenland are probably much more dependent on the production of goods in agriculture and fisheries.

Table 3 Composition of GDP for the OCT, most recent year

OCT	GDP composition %
	agr.	ind.	Services
Mayotte	na	na	na
New Caledonia	1,8	21,9	76,3
Fr. Polynesia	7,8	11,1	81,1
St. Pierre et Miquelon	na	na	na
Wallis and Futuna	na	na	na

Aruba	na	na	na
Neth. Antilles	1	15	84

Anguilla	na	na	na
Cayman Islands	1,4	3,2	95,4
Falkland Islands	na	na	na
Br. Virgin Islands	3	14	83
Montserrat	4,8	18,4	76,8
St. Helena and dep.	na	na	na
Turks and Caicos Isl.	na	na	na

Greenland	na	na	na

Source: see table 1

Table 4 The external economic situation of the OCT, as a percentage of GDP

OCT	Ext. Ec. Situation
	exports%	trade bal %	Ext.debt%
Mayotte	1,7	-68,1	na
New Caledonia	17,1	-12,1	na
Fr. Polynesia	5,9	-18,8	na
St. Pierre et Miquelon	7,1	-85,3	na
Wallis and Futuna	3,1	-110,4	na

Aruba	121,4	-21,4	47,8
Neth. Antilles	54,2	-20,8	81,3

Anguilla	2,4	-67,9	11,3
Cayman Islands	0,4	-38,3	1,7
Falkland Islands	106,7	40,7	na
Br. Virgin Islands	15,1	-71,7	3,1
Montserrat	54,7	-40,2	27,4
St. Helena and dep.	1,9	-51,3	0
Turks and Caicos Isl.	3,2	-86,1	9,2

Greenland	32	-10	25,7

Source: see table 1

Table 4 gives some data on the OCT's external economic relations. One would like to know the composition of the balance of payments in order to see the contribution of goods and services trade to the current account, and to get an impression of foreign direct and portfolio investments and the way deficits are financed. All that can be said on the basis of table 4 is, that some OCT do have a low export value as a percentage of GDP, probably indicating a high dependency on the exports of services. Others have an extremely high level of exports (Falklands and Aruba) which is probably caused by a low level of value added per unit of export. [3] Furthermore, Aruba and the Netherlands Antilles have a high level of external debt.

The goods that the OCT export to the EU are presented in table 5. Some dynamic export products show up: yachts, aircraft (other than planes), diamonds, rice and squid saw a fast increase in exported value. It would have been interesting to compare these figures with exports to other destinations. [4] Although the figures should be interpreted with care, they seem to show that production for export can be expanded quickly in the OCT.

Table 5 The OCT's most important exports to the EU, 1992/97 and their share in total OCT's exports

product name	1992	1997	average 1992/97	Share of exports*
	1000 ECU	1000 ECU	1000 ECU	%

Yachts	7097	400754	186418	17,8
ferro-alliages	109861	113312	113840	10,9
Huiles de petrole	96921	146014	103579	9,9
Autres vehicules aeriens	14225	307750	97279	9,3
Crevettes	102310	73950	82423	7,9
Crevettes preparees	81472	70133	81184	7,7
Diamants	1014	99248	74567	7,1
riz,semi-blanchi	6139	61495	73881	7
Mattes de nickel	40014	65025	50613	4,8
Filets de poissons, congeles	41080	33906	32842	3,1
Seiches sepia officinalis	1756	23042	11452	1,1

Total				88

* share of 1992/97 average

Source: see table 1

This section has presented some data on the economic situation of the OCT. The OCT are a diverse group of small, open economies. Most of them have fairly large economic sectors that compete in world markets, mainly in service sectors. Some have a relatively low level of income per capita. In some OCT (with a large share of the total OCT inhabitants) there are severe employment problems. Exports to the EU of a limited number of products has grown substantially.

The role of the OCT decision

The foundations for the EU/OCT relationship have been laid in Part Four of the Treaty establishing the European Community. This Part (articles 182 - 188) dates back to the first EEC Treaty of 1957. It stipulates that the OCT will be associated with the Community with the purpose "to promote the economic and social development of the countries and territories and to establish close economic relations between them and the Community as a whole" (art. 182). The Association consists of economic arrangements and funds for development aid. Trade, the right of establishment and of the movement of workers are the main subjects of the economic arrangements.

With respect to trade the "member states shall apply to their trade with the countries and territories the same treatment as they accord each other". This was interpreted in the OCT Decision of 1991 to mean totally free access for OCT originating products. Cumulation of origin among the ACP and the OCT remained possible. Furthermore, the OCT have retained the possibility to implement their own trade policy. The only constraint is, that EU exports should not be treated less favourably compared to other developed countries. The trade promoting effect of these trade preferences has gradually decreased as a result of the lowering of MFN tariffs in general and the proliferation of preferential treatment for exports from many other countries. Section 4 will pay more attention to this.

The complete free entry on the EU market after 1991 led to increased exports of rice and sugar from the OCT to the EU. As a result of the large margin between world market prices and the internal EU prices, processing and export to the EU made this trade very profitable. The EU had the opinion that this threatened to disrupt the markets for these products in the EU and - after long discussions and even law suits - decided to introduce quotas on the products concerned. [5] In an evaluation of the trade preferences for the OCT the Commission maintains that " such access has not really helped to expand trade, except in the case of a few products from various OCT, and in particular rice and sugar from Caribbean OCT. Likewise, the trade arrangements put in place in 1991 have been unable to make a major contribution towards creating new production lines, processing activities, diversification or exports. In general, the concessions have not resulted in genuine local development based on a strengthening of the economic fabric ". [6] However, "encouraging" results are reported for some OCT, in particular Saint-Pierre et Miquelon. Taking a new look at table 5 in section 2, it can be concluded that some products showed a rapid increase in exports to the EU, notably yachts, aircraft (other than planes), diamonds, rice and squid. It is not clear - with the exception of rice - to which extent these increases have been induced by the preferential access to the EU market. Furthermore, more research is necessary to establish the development effect of these new exports.

The Transhipment arrangement, which gives free access to the EU for goods that are charged levies at least equivalent to the CCP upon entering an OCT, seems to have had promising results. The proceeds of these duties flow into the Treasury of the OCT concerned. [7] Recently, the transhipment stopped, however. Customs officials, backed by the Commission, do not accept the documents of transhipment any longer.

In the area of the right of establishment, the OCT Decision of 1997 stipulates that member states should treat individuals and companies from the OCT on a non-discriminatory basis and that the OCT should do the same. However, in order to promote local employment, the OCT are allowed to derogate from the rules on establishment and services.

With respect to the freedom of movement, the Treaty postponed the regulation of this to later agreements among the member states. These agreements - to be agreed unanimously - have never been realised. Nevertheless, in practice this should not be a problem, as almost all OCT inhabitants have the nationality of the member state concerned. They should enjoy the four freedoms of the Single European Act as soon as they set foot on the territory of the member state concerned. This does not apply reciprocally, as the territory of the OCT is not part of the EU territory. [8]

The OCT - with the exception of Greenland - have received financial support from the EU since 1958. Parallel with the Lomé Conventions and its predecessors, the OCT were granted a share of the European Development Funds (EDFs). This amounted to 94 million Ecu for the 5th EDF (1980/85) to 165 million Ecu in the 8th EDF (1995-00). Of this latter sum, 105 million Ecu is distributed over indicative programmes of three groups of OCT (British, French and Dutch OCTs). [9] The rest can be used for general purposes such as interest rate grants and risk capital. The problems of aid implementation under the EDF are well known: complex and fragmented in terms of objectives, instruments, procedures and institutional mechanisms. This applies for the OCT as well, where the fact that the member state concerned has an important place in the procedure is an extra source of delay. The result is, that aid disbursement is very slow. In mid-2000, only 4 per cent of the 8th EDF had been disbursed.

The aid from the EU - 165 million Ecu over five years - is modest, compared with a GDP of aid receiving countries (so excl. Greenland) of approximately 12 billion dollars. For the relatively poor OCT the EDF allocations can be substantial, however. E.g., the indicative programme for Mayotte totals 6.7 million Ecu for 5 years, while it had a GDP of 210 million $ in 1997.

This brief overview of the OCT regime shows that, even if there would have been a perfect implementation, the contribution of the measures to overall OCT development would have been small. Most of the OCT do not have major comparative advantages in the production of exportable goods. Transport cost do add to this just as well as the fact that for many products preferential margins are low. Safeguard measures have done the rest. So it is no wonder that trade preferences do not produce miracles. Many OCT rely heavily on trade in services. To be competitive in these sectors is a problem that cannot be solved through trade preferences. Competitiveness in these international service sectors is finding the right balance between quality and price in global markets. The same conclusion applies for development aid. The amounts available in the EDF are modest in relative terms, although for the poorer countries they can be important.

A changing environment

The OCT regime dates back to the second half of the fifties of the last century. Given the dynamic international development of the world economy, it is no wonder that the environment in which the association of the OCT with the EU has been implemented, has changed dramatically. As a result, the OCT have to face challenges and have opportunities that were not foreseen in Part four of the Treaty establishing the EC. The most important changes in the world economy will be indicated in this section and the consequences for the OCT and the OCT regime will be discussed.

Liberalisation of the world economy

Briefly after the establishment of the European Community in 1958, the GATT started a series of Rounds of Multilateral Trade Negotiations that ended momentarily with the Uruguay Round. As a result of these negotiations, the average level of import tariffs levied by industrialised countries fell drastically. The average tariff of the EU on imports from developing countries will have decreased to 5.1 per cent and on imports from all countries to 3.6 per cent if all Uruguay Round commitments will have been implemented. For all industrialised economies these figures are 3.9 and 2.6 per cent respectively. [10] At the same time, many countries, mainly the industrialised ones, have introduced new and often more strict and complicated regulations to protect their consumers and their environment. The more recent rounds of trade negotiations mirror this trend: more and more attention is devoted to subjects such as technical barriers to trade, trade and environment, intellectual property rights and trade related investment measures. In this area, trade liberalisation mostly leads to higher or stricter standards. The consequence for the effectiveness of the OCT decision is, first, that the trade preferences have a decreasing stimulating effect as they produce smaller leads on competitors from non-preferred countries. Since the Uruguay Round, this also applies for agricultural products, as the EU is forced to support its farmers less through import barriers and market intervention and more through direct import support. Second, developing country exporters face other entry barriers than tariffs; quality norms and process norms can effectively hamper exports while preferences do nothing to lessen these barriers. This trend will continue: the Millennium Round may not have started in 2000, negotiations continue and a new round will probably be started somewhat later. The upshot is, first, that the OCT should not build their long term strategies on trade preferences granted by the EU - or other industrialised countries. Second, the OCT should try to get support from the EU to meet the norms and standards that are becoming such important trade barriers. This applies for goods and services alike.

Regional integration

Many OCTs have traditionally been orientated towards their member state concerned and the EU. They expect the main development stimuli from these countries. However, since the eighties, regionalism has been a main characteristic in the development of the world economy. As a result, the majority of the members of the WTO is also member of a regional trade arrangement. The OCT are far from Europe; there may be regional integration schemes in their immediate environment that are creating large unified markets. Taking part in these arrangements may offer certain OCTs export opportunities and sources for cheap imports. [11] By doing this, OCT will have to open their own markets for their regional partners and will have to discriminate against the EU member states.

Services

Services have a growing importance in the international economy. World trade in services has been growing faster than trade in goods, and is now more than a quarter of the value of goods and services exports together. [12] As many services cannot be traded, but can only be delivered locally through establishments, a large share of foreign direct investment is involved as well. The growth of services in international trade is driven by innovations in the information and communication technology, by increasing specialisation and product differentiation, the changing relationship between goods and services and government policies of liberalisation and deregulation. A number of OCT is already using the increased opportunities to trade services internationally. Business services (call centres, software engineering, financial and administrative services etc) and tourism are good examples. Information technology can be used as well to import services at world market prices for businesses and for educational purposes.

How can the OCT regime be utilised in this respect? The trade preferences do not have much of an impact here. Opening up to the world in order to create a competitive environment in terms of prices and adoption of new technologies necessary to export services and developing qualified institutions and training persons are basic conditions that must be fulfilled. The EDF could play a stimulating role. Investments in ICT infrastructure, exchange programmes with European training institutions and setting up service institutes with the financial support of the EDF could stimulate this development. Furthermore, business and financial services are heavily regulated. To have success in exports, the regulating and monitoring institutions of the OCT could profit from technical support and advice from their European counterparts.

Changing EU external policies

The EU has a long tradition of non-reciprocal preferences, embodied in agreements with the ACP and Mediterranean countries, in the GSP and in the OCT Decision. However, since the beginning of the 1990s, non-reciprocity is being replaced by reciprocity. The EU is doing this under the influence of a number of factors. The first factor is that the EU has run into problems in the WTO. The banana regime under the Lomé Convention combined with the unification of the Internal Market brought the non-reciprocal preferences for a specific group of countries selected on historical and geographic grounds, under severe criticism. [13] Complaints against the EU in the Dispute Settlement Body of the WTO led to panel reports requiring the EU to change the system. As a result, the EU and the ACP have agreed under the Cotonou Agreement to arrive at WTO compatible trade arrangements in 2008, either GSP like solutions of reciprocal FTAs. The same applies for the Mediterranean Agreements that have already introduced reciprocal trade arrangements for some countries.

Second, this change has also been stimulated by the disappointing results of the non-reciprocal arrangements. As non-reciprocal preferences do not by themselves create competition effects (see more under section 5), the trade stimulating effects remained limited.

Third, the position of the EU in the world economy is changing. The EU is getting more open, more dependent on external markets. [14] In a world of regional trading arrangements, the EU has an increasing interest in the enforcement of multilateral trade rules, such as art. XXIV GATT that requires preferential arrangements to be reciprocal.

The conclusion of this section is, that multilateral trade liberalisation and increased reciprocity will make the Internal Market of the EU an increasingly competitive place. Decreasing and already relatively small preferential margins make trade preferences ineffective. Trade in services in growing rapidly and may offer some OCT good opportunities for growth. Trade preferences do not have much to stimulating effects in this area, however.

Options for the future

This sections discusses the choices that the OCT can make for their relationship with the EU. Before these options are presented and discussed some remarks should be made. First, the OCT have a special relationship with a particular member state - often indicated as 'the member state concerned'. This is the reason for their particular relationship with the EU. The OCT Decision takes the relationship with the member state concerned for granted. So does this paper. Second, the options are discussed against a background of realism. This implies that the options are those that the OCT can choose themselves. No options are presented that would follow from an EU offer that would take all the demands of the OCT on board, but which cannot realistically be expected from the EU. Although less than before, the OCT Decision is largely a unilateral decision by the EU. E.g., it is not assumed in any option that the EU relinquishes the safeguard measures on imports of certain agricultural products from the OCT that are in force at the moment. Third, as indicated above, the OCT differ to a large extent in level of welfare, size in population, natural resources and geography. As a result, the options presented below will give different results for different OCT. It does not seem to be fruitful to force all OCT in exactly the same option; a 'framework approach' could be more adequate. In such an approach the OCT Decision can formulate the principles and common instruments of the EU/OCT relationship while offering the room of manoevre for tailor-made solutions for the individual OCT.

In defining the options one has to distinguish between the relationship of the OCT with the EU at the one hand and with third countries on the other. These two are interrelated, which makes it necessary to discuss the ramifications of an option for EU/OCT relations for the other relations.

The EU/OCT relationship

Maintaining the status quo

This could be considered as a base scenario. The existing non-reciprocal trade preferences are continued, including the rules of origin and the safeguards and the transhipment system. The drawbacks of this option have been described earlier in this paper. First, the OCT's preferential position in the EU is being eroded as a result of ongoing trade liberalisation. Economic activities that are undertaken solely on the basis of differential trade policy treatment by the EU are not viable in the long run: as soon as the preferential margin falls under a critical limit, the activity concerned no longer generates profits. Second, the rules of origin are complex and unreliable. For sensitive products the EU will most probably continue to use safeguard measures to limit access to the EU for a number of sensitive products in the area of agriculture. Third, this option does not reinforce the incentives for both private and public actors to better adapt to the changes that are taking place in the world economy. Looking at the results of this approach, the preferences have not generated the diversification that was hoped for.

At the other hand, the status quo has the short run advantage of not creating major disturbances. Existing export flows to the EU will be continued - everything else being constant. [15] Furthermore, the OCT retain their sovereignty over trade policy matters which enables them to levy import tariffs and auction import quotas the proceeds of which may serve to pay for the budgets. Therefore, it could be argued that the status quo can serve as a transition phase. Furthermore, the status quo gives the OCT the freedom to enter into regional integration, although this freedom has not been much used. Additionally, the OCT can use this option for liberalising in a non-discriminating way by lowering import barriers unilaterally together with a broader package of reforms. The problem is, that governments in many countries do not receive the incentives to undertake and sustain this on their own initiative.

Opting out of the OCT-decision

The association of the OCT was devised in1957 to link the then colonial empires of some member states to the EC. The OCT of the time and the member states concerned were dependent on each other in several ways. The introduction of the Common Commercial Policy (CCP) would create a protective wall around the common market which cut off the colonial trade flows. The association was meant to prevent this. The colonies got duty free access to the market of the EC. At the same time the EDF was established. At present, it may be asked whether the OCT status still bestows net benefits on all OCT. The trade regime has lost its preferential margins for many products as the CCP has been liberalised on an MFN basis. For those OCT that export to the EU products for which this is the case, the original raison d'etre of the association under part IV of the Treaty, has disappeared. If funds from the EDF are not a substantial benefit - which is the case for those OCT that have a relatively high level of income - one can seriously discuss whether remaining in the OCT-Decision has any sense for certain OCT.

Opting out would be weighed by the existence of financial and trade benefits. Maybe there are other advantages for certain OCT from the OCT Decision. Even if the financial and trade advantages are zero it could perhaps be argued that there are political advantages of being under the OCT Decision. It may reinforce the position of the OCT concerned with respect to the member state concerned in negotiations over financial and constitutional matters. It may broaden the social and cultural exchange between the OCT and European countries.

An EU/OCT Free Trade Area

FTAs create free trade among the participating countries while leaving the powers over trade policies with respect to third countries in the participating states. This enables the OCT to enter into regional integration schemes or to liberalise in a multilateral way. The major difference with the status quo is the reciprocity that is implied by an FTA. The disadvantages of this option are the following. First, an FTA needs rules of origin to prevent trade deflection, which is a major drawback of this option. [16] If the EU is willing to maintain the present rules of origin the disadvantages given for the status quo apply here as well. More likely, in a formal FTA these rules become more strict; this has the side effect of more reliability. Second, for most OCT an FTA with the EU has the disadvantage that they will have to give free access to EU imports while they will not see their access to the EU market improving. Most likely, an FTA will lead to complete free trade in manufactured products, while trade liberalisation in agricultural products will be given on a case-to-case basis if the FTA is modelled on existing FTAs the EU has concluded . [17] This also implies that domestic industries will have to adapt to the increased competition from EU imports. After a period of adjustment, a more efficient, i.e. a more competitive domestic economy may result, but the adjustment itself may be a painful process. Furthermore, imports from the EU will no longer produce tariff revenues to pay for public expenditures.

An advantage of the FTA option is, that it produces incentives for public and private parties to invest in those activities that are competitive in terms of competition with the EU. The existence of a formal, reciprocal agreement accepted by the OCT concerned and the EU makes it a reliable arrangement.

An FTA could have positive economic effects. These effects of economic integration are subdivided in static and dynamic effects. The static effects flow from a better utilisation of the present resources which lowers prices for consumers. These effects of regional integration (trade creation, consumption expansion and trade diversion) are generally considered to be small. Most economists consider the dynamic effects of integration to be more substantial. In the following paragraphs three dynamic effects of regional integration are briefly discussed: economies of scale, positive external economies, increased competition and reduced monopoly power. Finally some 'non-traditional effects' are reviewed.

Economies of scale

In many industries companies have make large investments that they can not recover if they leave the industry. Industries with high sunk costs have in common that costs per unit decrease if companies produce more, often associated with gains in market share. This has been an important argument in the 1980s to speed up the integration process in the EU. Because the competitors of EU industry had large domestic markets in the US and Japan, they were able to compete more efficiently on the world market. Regional integration provides companies with larger markets which often lowers production costs. Will economies of scale be important for firms in the OCT? Although detailed empirical research would be needed to answer this question, it is relevant to stress that in this case a small market is integrating with a very large one, which offers the possibility to produce large quantities for the EU. At the same time it should not be forgotten that this has been possible under the former OCT Decision as well. The main stimulus resulting from an FTA to benefit from scale economies could come from the increased reliability of the EU/OCT relationship, the possibility for companies in the OCT to import inputs from the EU fully free and the more efficient environment in services and public policy.

Positive External Economies

Positive external economies are created if the size of the industry reduces the costs of production for the individual firm. Reasons for this may be learning-effects, spill-over effects of economic clustering and better integration of economic activities over the stages of the production process. Some of the OCT have recognised the importance of positive external economies by setting up export-zones. It is this clustering of activities that may result in positive spill-over of technology and learning-by-doing. By concluding an FTA these effects could become more general as some of the processing zone conditions are spread over the OCT at large.

Increased Competition and the Reduction of Monopoly Power

Increased competition from partner countries - the EU - may lead to a better allocation of resources. One of the most important aspect of this is the reduction of monopoly power. Because of the small size of domestic markets in relation to sunk investments, monopoly power of "national champions" (in many cases state-owned) is large. If barriers to trade are lowered, much of the actual and potential competition may come from imports from the EU. The integration process speeds up the restructuring process but also makes it more painful. A side effect may be that the privatisation process will be more difficult because of the negative effects of regional integration on the profitability of state-owned monopolies.

Non-traditional Effects

Regional integration can have effects beyond the static and dynamic welfare effects. These non-traditional effects have in common that they increase the credibility of the countries' policies in ways that cannot be realised through unilateral or multilateral liberalisation. [18] Two main non-traditional effects are distinguished in relation to the EU/OCT FTA, the effects of overcoming time inconsistency and signalling. [19] An FTA can help to overcome time inconsistency by introducing reciprocity in reforms that makes withdrawal costly as it will be followed by loss of market access in partner countries. A reciprocal regional trade arrangement, by making the cost of even a small deviation from an agreed trade liberalisation large, either by forcing the country to exit from the agreement or by having members punish the deviating country, makes it easier to overcome small temptations that culminate in a greatly distorted economy overall. It can be concluded that an FTA will contribute to overcoming time inconsistency of policy reforms:

·	if the first best policy in a country is time inconsistent and
·	if the FTA binds the government to the time inconsistent policy and if a policy reversal - in extreme cases an exit of the FTA - has a cost that is higher than the benefits of the policy reversal.

It might well be that these conditions are fulfilled in some OCT. However, it remains to be seen whether the EU would punish an OCT if it retreats from its obligations under an FTA, e.g. by reducing aid allocations. This might be too sensitive in political terms for the EU.

The second non-traditional effect is signalling. By entering into an FTA a government may convey a message to foreign actors, e.g. investors, about the economic policy preferences of the government (make it clear that there is now a liberal government), about the condition of the economy (e.g. the export sector is competitive) or the future relationships of the country with its neighbours (conflicts will be solved by peaceful means). This effect will occur if two conditions are fulfilled:

·	there has to be a significant information asymmetry: e.g. there is substantial doubt about the government's commitment to reform;
·	there has to be a significant cost to enter the FTA which cannot be recovered at leaving, e.g. the negotiating cost, adaptation of laws and regulations, restructuring of the economy.

It might well be the case that signalling effects are relevant for certain OCT. Concluding an FTA with the EU with the ensuing restructuring of the economy and introduction of new laws and regulations, will require a major effort from the local government. Withdrawal from the FTA would have made these efforts pointless and thus lead to a major loss of political capital.

An EU/OCT Customs Union

This option goes an important step further, as the OCT will give up their sovereignty over their trade policies with respect to third countries. They will apply the Common Commercial Policy (CCP) of the EU as they will form one customs territory with the EU. In terms of external economic policy, the OCT would come close to the status of the EU's Ultra Peripheral Regions (UPR). This seems very straightforward. However, it is difficult to imagine that the OCT will adopt the CCP as far as agricultural products are concerned. It is more likely that this section of trade is excepted from the CU. A practical example of this is found in the CU between the EU and Turkey.

The CU option has a number of disadvantages. First, it makes the OCT part of a large customs territory. This has the result that the OCT will not be able to conclude regional trade agreements with third countries. Thus, OCT that would like to become a member of, e.g., Caricom, could no longer do so. [20] The only solution would be an FTA between the EU and Caricom. This is not unrealistic: the EU is negotiating an FTA with Mercosur and intends to do so with regional groupings of ACP countries. [21] However, such FTAs are negotiated by the EU at large; the interests of the OCT would have a relatively small weight in the whole set of trade-offs that would lead to the EU proposals in the negotiations. A related question is, whether the OCT that have a status of developing country can continue to export under the GSP of industrialised countries if they have become part of the EU customs area or, of the Internal Market area. [22] Second, the OCT will have to apply the CCP to a very large extent - only agricultural products can probably be excluded. This will have mixed effects. For certain categories of products, the OCT will have to increase protection. This applies for sensitive manufactured products such as clothing, textiles, footwear and trucks. The resulting trade diversion gives rise to welfare losses. For most other products, protection will fall which will bring an even stronger restructuring compared to the FTA option, because there will be more import competition from third countries. Third, being part of the EU's customs territory will raise the issue of the application of the acquis communautaire as far as the Internal Market is concerned. Real free circulation entails the application of the EU's product norms and standards and competition policies.

There are advantages as well. First, there will no longer be rules of origin. All products that have lawfully entered the CU's customs territory, or have been produced there, are in free circulation (except for the products or sector that has been excluded from the CU). Second, for many OCT, the introduction of free trade with the EU and of the CCP will bring about a lowering of import barriers with respect to imports from the EU and from third countries respectively. This will bring a restructuring of economic activities in the short run; however, in the long run, economic activities will be more founded on comparative advantages. This increases the efficiency and competitiveness of the OCT's economies, more than was the case in the FTA option. Second, the dynamic effects will be stronger as well as far as the CCP will allow more competition from imports from third countries - stronger competition effects and the breakdown of monopolies. Investors from both the EU and third countries may find it attractive to use the OCT a production base, now that they can import inputs into the OCT under the CCP and export freely to the EU. Third, the non-traditional effects will probably be stronger. This applies for the signalling effect in particular. The OCT government concerned has to invest a large amount of political capital in a CU with the EU, which involves giving up national powers over trade policy. This gives a clear signal that the OCT is liberalising its markets and policies.

The relations between the OCT and third countries

As has already been hinted at in section 5.1, the options for the EU/OCT relationship cannot be isolated from the trade regime the OCT want to have for their relations with third - i.e. non-EU, non-OCT - countries. There is a mutual interference between the two sets of relations. The options for the relations with third countries will be indicated below and the potential effects will be discussed.

The first question an OCT has to answer is, whether it want to use discriminatory trade policies vis-à-vis third countries or not. In the latter case, the OCT will use the same trade barriers irrespective of the origin of imports. This applies in any case for those OCT that occupy a very isolated geographic position. In the other case, the OCT will combine regional integration through FTAs or CUs with global economic co-operation. Several possibilities arise for this combination.

Global co-operation only

In this option, the OCT retain the authority over their trade policy with third countries. In their execution of these authorities they are bound by the WTO. This applies for the maximum levels of tariffs (bound through bindings), the use of safeguard measures and anti-dumping duties etc. The influence of the OCT in the WTO is of course very small. At the same time the WTO offers small countries the protection of a rule system, including dispute settlement. However, this is not an advantage that belongs to this option only. As a member of a regional integration body a country can also belong to the membership of the WTO.

A disadvantage of this option may be that an OCT does not take part in regional integration processes. This may result in a deterioration of the market access of the OCT concerned in the region. As politics and economics are difficult to separate, isolation may spill-over to other spheres beyond the pure trade area. Furthermore, the regional integration body will probably enter into trade negotiations with other trading blocs, such as NAFTA, Mercosur or the EU. The OCT that does not participate in regional integration is excluded from these wider negotiations as well. A second disadvantage of this option is, that there is less 'locking in' of policy reforms. Liberalisation can easier be undone if it has been introduced in the WTO framework than if liberalisation is withdrawn in a reciprocal, regional agreement. [23] In the latter case, the partners will retaliate if the OCT concerned does not meet its obligations in a reciprocal regional agreement.

On the positive side of this option is, that liberalisation towards all third countries (on MFN basis) does not bring the potential negative effects of economic integration: mainly trade diversion and polarisation. To put it differently: regional integration can force a country to buy the relative expensive products from partner countries instead of importing from the cheapest source. Polarisation might lead to a concentration of production and investment in a particular member of an FTA or CU; if an OCT happens to outside such a centre, regional integration could marginalise the country. A second positive effect is, that by eschewing regional integration an OCT may concentrate its limited negotiating power in a limited number of fora: the relations with its member state concerned, the EU and the multilateral organisations such as WTO, IMF and World Bank.

Regional integration

Regional integration is a viable option for a number of OCT, primarily those in the Caribbean. The Pacific OCT have this option as well, although geographic distances are so large for some OCT concerned, that regional integration can not be a decisive solution. Finally, some OCT do not have neighbours that are sufficiently near to establish a viable FTA or CU.

The possible gains and losses from regional integration for the OCT are in fact largely the mirror images of the gains and losses given under multilateral co-operation (section 5.2.1).

Advantages may consist of trade creation (the restructuring of domestic industries leading to more competitive production), the dynamic and the non-traditional effects. Second, small countries may be able to more effectively influence the conditions that determine their development through uniting with their neighbours. The combined bargaining power will be stronger as long as the group has a sufficient degree of common interests and of institutional capacity. [24]

The disadvantages of regional integration might be trade diversion and polarisation. If these effects give rise to a lowering of welfare of certain partners, or a large gap in growth rates, the FTA or CU can only be viable if there are mechanisms to redistribute the gains from integration in part towards the country or countries that stand to lose.

Discussion of the options and the new OCT decision

This section winds up the discussion of the different option and, on the basis of the foregoing, draws conclusions on the new OCT Decision. These conclusions with respect to the new OCT Decision do not add up to a blueprint. Many issues of the new decision have not been discussed in this paper. Only the options and their consequences are taken into account.

Feasible combinations of options

The preceding section presented a large number of options for the design of the trade relations of the OCT, both for the EU/OCT relationship and for the OCT/rest of the world relations. How do these two sets of options interrelate? Table 6.1 gives an overview of the possible combinations of options.

Table 6.1 Options for the OCT trade regime

1. EU/OCT option	OCT third country options
	2. Regional	3. Global
Status quo	CU or FTA	Only with regional FTA
Opting out	Idem	Idem
FTA	FTA	Possible
CU	No options	No options

The table makes clear that choosing one option in a particular column may have far reaching consequences for another set of relations. This is due to the fact that trade policy - in a broad definition - cannot be compartmentalised; it is an interdependent set of instruments. The option of a CU illustrates this very well. A country cannot be member of two CUs. To become a member of one CU means the loss of national sovereignty over the national trade policy. An OCT that wants to enter into a regional CU, loses the powers to give the EU or any other country free entry on its markets or to negotiate on trade arrangements. [25] There is of course the possibility that the regional CU concludes an FTA with the EU, but this is not discussed here. [26] As the table indicates, a regional CU could be combined with non-reciprocal EU trade preferences (the status quo) and with the opt-out from EU trade preferences. Entering a regional CU makes it impossible for an OCT to conclude FTAs or CUs with other countries or the EU, and would put the relations with the WTO in the hands of the regional integration body as well. A regional FTA would offer some more flexibility because it leaves the powers over trade policy with respect to third countries in the hands of the OCT. A regional FTA could be combined with both the status quo, the opt-out and the FTA options in EU/OCT relations. At the same time, the OCT can decide on global trade co-operation, such as MFN liberalisation in the WTO framework. It can be concluded that an OCT first has to determine which set of relations is given priority, those with the EU or with the region/other third countries. From the column of first priority in table 6.1 one can move to the other two columns to find out which combinations are possible. The cases presented in the box offer illustrations of the choices and their interdependence.

Finally it should be remarked that if an OCT would opt for far-reaching changes in its external economic relations, time is needed to bring this about. The status quo could be used as a transition scenario; this would offer the time needed to prepare for the changes in terms of the use of policy instruments, legislation and the preparation of workers and entrepreneurs.

Box 6.1 How options may be combined

Case 1
Assume an OCT that is strongly dependent on global markets - e.g., for tourism and financial and business services - while EU trade preferences play a marginal role in its development perspectives. The latter may be caused by an export orientation towards other countries, by exports that enter the EU at zero or very low tariffs anyway or by a low level of exports in general or by a combination of these possibilities. In this case, a strong preference will exist for optimal long run possibilities for adaptation to global economic trends. Regional integration is attractive only if it does not put the global competitiveness of the service sectors in jeopardy - which means only open, non-protectionist FTAs or CUs might be considered. In case of a regional CU, the OCT should have the guarantee that the CU's common trade policy will be open. For the short run, the OCT will probably be advised to maintain the trade preferences of the EU, the status quo for the time being.

Case 2
At the other extreme is the OCT that is heavily dependent on exports that receive substantial preferential margins upon their entry into the EU. It clear that the OCT will profit from the continued existence of the EU trade preferences. For the long run, the OCT has to define a development strategy that makes clear whether the EU orientation is viable in the long run (when preferential margins will disappear) and to which extent this orientation should be combined or replaced by a regional or a global orientation. If the OCT wants to firmly cement its relations with the EU in order to get a maximum access to the Internal Market and if free entry of the EU to its market produces long run beneficial effects in terms of competitiveness and investments, a CU with the EU could be preferred. This would bring down the OCT's sovereignty over its trade policy to zero. An FTA would not have this effect, but brings less non-traditional effects. If the OCT concludes that its long run development perspectives depend on closer relations in its region, it should first opt for a regional trade agreement and decide on the EU relation subsequently. A regional FTA would give several options for the relationship with the EU - status quo, opt-out or FTA- while a regional CU would make an FTA between the OCT concerned and the EU impossible. If the OCT decides on a more global long run strategy, it could combine open regionalism in the shape of an FTA with multilateral co-operation and liberalisation.

The new OCT Decision

This paper does not answer the question which option a particular OCT or the group as a whole should choose. In order to answer the first question, detailed research per OCT is needed; it is very unlikely that there is one set of options which is best for all OCT. Given the latter conclusion, it should be asked how the new OCT Decision could accommodate the different combinations of options that the OCT might choose for their long term strategy. The following elements are necessary:

1. The OCT Decision should offer different ways of organising the relations between the EU and the OCT. Most attention will probably be paid to short run issues such as the safeguard measures. However, for the longer run it would be essential that reciprocal arrangements are offered as an alternative to the present system of non-reciprocal preferential access to the EU. Opting out of the trade part of the OCT Decision should be kept open as well.

2. The OCT Decision should leave the OCT free to choose for a particular form of regional co-operation. This could lead to discrimination in favour of OCT's regional partners and against EU member states, including the member state concerned. The multilateral trade policy of the OCT should not be affected either.

The OCT Decision should not only enable the OCT to devise their long term strategies, it should also actively support the OCT to do so. This applies for the formulation of long run strategies and their implementation. As indicated above, detailed empirical research is needed in order to enable the OCT to make well-informed choices for their future development. The OCT should be in the driver's seat as far as the objectives and constraints of these research projects are concerned. The OCT Decision should offer the funds and framework for this research. The member state concerned should be involved as well: these countries often provide substantial contributions to the administrative capacity and development programmes of the OCT. Furthermore, many OCT lack the institutional capacity to integrate in the world economy. Regulatory barriers in the trade in goods and in services are becoming more of a burden for many countries than tariffs and quantitative restrictions. Hygienic standards of food products, supervision of banking and insurance companies are relevant examples. These regulations may hinder trade even in the presence of an FTA, CU or non-reciprocal trade preferences. The OCT Decision should offer support in the form of technical assistance and institutional capacity for the OCT that want to meet the standards of their (potential) markets for their exports of goods and services. The EU has a comparative advantage in the supply of this assistance, as it is the regulating much of the internal and external trade in the EU. This support is important for all OCT, irrespective of their welfare levels. This lead two more conditions for the new OCT Decision:

3. The OCT Decision should offer sufficient financial support for research to enable the OCT to devise well-informed long term development strategies in which decisions are taken with respect to the options for their trade arrangements. The OCT should be in a position to determine the research questions and the constraints of the research.

4. The OCT decision should offer assistance to the OCT to meet technical norms and standards in their exports of goods and services. The institutional capacity of the OCT to participate in regional and global trade negotiations should be increased. Aid should be used as well to create infrastructures that are necessary to create a viable service sector.

In line with the increased powers of the local OCT institutions (governments and parliaments), it is only a natural development to create EU/OCT institutions to monitor the implementation of the new OCT Decision. Such institutions - common in all bilateral trade agreements of the EU - could be fora for discussions on the strategies of the OCT, on the problems that may arise in the relations between the EU and the OCT in the different areas of co-operation and on common reactions on developments in the world economy or international politics that are of influence on their relation. This leads to the fifth condition for a new OCT Decision:

5. The new OCT Decision should create common institutions of the EU and the OCT to monitor the implementation of the Decision. The OCT authorities should be represented and there should be timely opportunities for discussions.

Noten

[1] See Annex 1 for a list of the OCT.

[2] The assumption of a constant relationship with the member state concerned is made to concentrate on the future options for EU/OCT relations. Of course this does not deny the fact that some OCT have a status with built-in dynamics. The position of New Caledonia as a French OCT is a good example. The 1998 Nouméa Agreement, confirmed by a local referendum, gives the territory a new status that will gradually lead to independence in a 20 year period.

[3] Exports are measures at total value, GDP is the sum total of value added of the economy.

[4] Furthermore, it is not clear to the author how large the re-export content of some exports is. For some products, production may have taken place elsewhere, e.g. fish catched by vessels under the flag of the Netherlands Antilles.

[5] The effects and merits of these measures are discussed in: Netherlands Economic Institute, Impact of the OCT/EU trade arrangement on the economies of the Netherlands Antilles and Aruba and the Common Agricultural Policy of the EU (Rotterdam, 1997).

[6] Commission of the European Communities, The Status of the OCTs Associated with the EC and Options for "OCT 2000" (Brussels, 1999), Com(1999)163final, Vol. I, p. 24.

[7] Idem. The advantage for exporters to the EU may be that, if duties are levied over the CIF-value, the duties are lower as a result of lower transport cost. Important as well is, that no rules of origin apply.

[8] Commission of the European Commission, The European Union and the overseas countries and territories (Luxembourg, 1999), p. 26/27.

[9] Greenland does not receive financial aid.

[10] The difference is to be attributed to differences in the composition of trade flows and the respective tariff levels. W. Martin and L.A.Winters (eds), The Uruguay Round and the developing countries (Cambridge, 1996), p. 65.

[11] Of course, some OCT are so isolated, that this is no option.

[12] B. Hoekman, Assessing the General Agreement on Trade in Services, in: Martin and Winters (eds), op. cit., p. 89.

[13] J.H. Mathis, The Community's External Regional Policy in the WTO, in: P. van Dijck and G. Faber (eds), The External Economic Dimension of the European Union (The Hague/London/Boston, 2000), ch. 6.

[14] P. van Dijck and G. Faber, The EU in the world economy: new policies and partnerships, in: P. van Dijck and G. Faber (eds), The External Economic Dimension of the European Union (The Hague/London/Boston, 2000), ch. 1.

[15] Which is not the case, as was shown in section 4.

[16] Trade deflection is the concentration of an FTA's imports through the member state having the lowest trade barriers.

[17] This is the way the FTA agreements with Eastern European countries, with South Africa and the Mediterranean countries have been formulated.

[18] J.F. Francois, External Bindings and the Credibility of Reform, in: A. Galal and B. Hoekman (eds), Regional Partners in Global Markets: Limits and Possibilities of the Euro-Med Agreements (Cairo and London, 1997).

[19] P. Collier and J.W. Gunning, Trade Policy and Regional Integration: Implications for the Relations between Europe and Africa, in: The World Economy, vol 18, no. 3, pp. 387-410.

[20] Montserrat is a full member of Caricom. It is difficult to see how this could be made compatible with a CU between Montserrat and the EU.

[21] This is one of the options of the future trade arrangements under the Cotonou Agreement. The negotiating history has made clear that the EU prefers this option.

[22] This is relevant for those OCT that export to industrialised countries outside the EU.

[23] See section 5.1.3 under Non-traditional effects for arguments for this effect.

[24] On the other hand, some small countries have shown that development is possible without participation in formal systems of regional integration.

[25] In a transition period, when CU members may still have their own trade policy vis-a-vis third countries, this does not apply.

[26] An FTA between CARICOM and the EU is in fact a rather realistic option, implied by the Cotonou Agreement.