This paper examines the welfare effects of the formation of a free-trade area. When a country is constrained to charge lower tariffs on imports from some countries, it is in its interest to reduce external tariffs as well. In a linear-quadratic model of intraindustry trade, the reduction in external tariffs induced by free-trade agreements is sufficiently large to make nonmember countries better off. Since only privately beneficial free-trade agreements are signed voluntarily, the formation of a free-trade area is a Pareto improvement. Owing to free-riding problems, however, the global free-trade area may not be a stable outcome. Copyright 2000 by Blackwell Publishing Ltd.
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