Chapter 8 Tariff Adjustments in Preferential Trade Agreements

Purpose – This chapter examines how preferential liberalization between a pair of countries affects the terms of trade and welfare of the liberalizing countries and on the rest of the world (ROW). We adopt a model with symmetric countries that generalizes previous work by relaxing assumptions on functional forms, which allows for the possibility that exports of member countries are complements for exports of the ROW. Methodology/approach – This chapter uses general equilibrium welfare analysis for a three-country trade model. Findings – We show that Kemp–Wan tariff adjustments require a decrease (increase) in the external tariff of members in a preferential trade agreement to accompany internal liberalization in the neighborhood of internal free trade when member goods are substitutes (complements) for non-member goods. However, the adjustment path of the external tariff to reductions in the internal tariff could be non-monotonic when preferences are not of the CES type. Practical implications – Our results are of interest for the design of rules for multilateral trade agreements with respect to preferential liberalization, since they indicate how tariffs must be adjusted to eliminate negative impacts on non-member countries.