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Free trade: what are the terms-of-trade effects?

In: International Trade Agreements and Political Economy

Author

Listed:
  • Carsten Kowalczyk

    (The Fletcher School, Tufts University, Medford, MA 02155, USA)

  • Raymond Riezman

    (Department of Economics, University oflowa, Iowa City, IA 52242, USA and GEP, University of Nottingham, Nottingham, UK and CES-ifo, Ludwig Maximilian University, Munich, Germany)

Abstract

Changes in trade policy affect a nation's economic welfare through terms-of-trade and volume-of-trade effects. A move to global free trade would imply higher world economic welfare equal to the sum of all nations' volume-of-trade, or efficiency, effects. Since the sum of the terms-of-trade effects across all nations is zero, terms-of-trade effects are contentious. Konishi, Kowalczyk and Sjöström (2003) have shown that if customs unions do not affect trade with non-member countries, immediate global free could be achieved if free trade were proposed together with international sidepayments equal to the terms of trade effects. How large would these terms of trade effects, and hence transfers, be? This paper presents estimates from a simple computable general equilibrium model of a world economy of perfect competition. We show that, in some cases, terms-of-trade effects are small compared to efficiency gains, and transfers are not necessary for free trade. In other cases, terms-of-trade gains may account for more than 50% of a country's gains from free trade and transfers could be large.

Suggested Citation

  • Carsten Kowalczyk & Raymond Riezman, 2013. "Free trade: what are the terms-of-trade effects?," World Scientific Book Chapters, in: Raymond Riezman (ed.), International Trade Agreements and Political Economy, chapter 10, pages 149-164, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789814390125_0010
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    References listed on IDEAS

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    1. Raymond RIEZMAN, 2013. "Customs Unions and the Core," World Scientific Book Chapters, in: Raymond Riezman (ed.), International Trade Agreements and Political Economy, chapter 3, pages 33-43, World Scientific Publishing Co. Pte. Ltd..
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    3. Jones, Ronald W, 1969. "Tariffs and Trade in General Equilibrium: Comment," American Economic Review, American Economic Association, vol. 59(3), pages 418-424, June.
    4. Kowalczyk, Carsten & Sjostrom, Tomas, 2000. "Trade as transfers, GATT and the core," Economics Letters, Elsevier, vol. 66(2), pages 163-169, February.
    5. Kowalczyk, Carsten & Sjostrom, Tomas, 1994. "Bringing GATT into the Core," Economica, London School of Economics and Political Science, vol. 61(243), pages 301-317, August.
    6. John Kennan & Raymond Riezman, 2013. "Optimal Tariff Equilibria with Customs Unions," World Scientific Book Chapters, in: Raymond Riezman (ed.), International Trade Agreements and Political Economy, chapter 5, pages 53-66, World Scientific Publishing Co. Pte. Ltd..
    7. Carsten Kowalczyk & Raymond Riezman, 2013. "Trade Agreements," Palgrave Macmillan Books, in: Daniel Bernhofen & Rod Falvey & David Greenaway & Udo Kreickemeier (ed.), Palgrave Handbook of International Trade, chapter 13, pages 367-388, Palgrave Macmillan.
    8. Earl L. Grinols & Kar-yiu Wong, 1991. "An Exact Measure of Welfare Change," Canadian Journal of Economics, Canadian Economics Association, vol. 24(2), pages 428-449, May.
    9. Kowalczyk, Carsten, 2000. "Welfare and Integration," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(2), pages 483-494, May.
    10. Raymond Riezman, 1999. "Can Bilateral Trade Agreements Help Induce Free Trade," Canadian Journal of Economics, Canadian Economics Association, vol. 32(3), pages 751-766, May.
    11. John Kennan & Raymond Riezman, 2013. "Do Big Countries Win Tariff Wars?," World Scientific Book Chapters, in: Raymond Riezman (ed.), International Trade Agreements and Political Economy, chapter 4, pages 45-51, World Scientific Publishing Co. Pte. Ltd..
    12. Kemp, Murray C. & Wan, Henry Jr., 1976. "An elementary proposition concerning the formation of customs unions," Journal of International Economics, Elsevier, vol. 6(1), pages 95-97, February.
    13. Constantinos Syropoulos, 2002. "Optimum Tariffs and Retaliation Revisited: How Country Size Matters," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 69(3), pages 707-727.
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    Cited by:

    1. Earl Grinols & Peri Silva, 2011. "Rules of origin and gains from trade," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 47(1), pages 159-173, May.
    2. Carsten Kowalczyk & Raymond Riezman, 2013. "Trade Agreements," Palgrave Macmillan Books, in: Daniel Bernhofen & Rod Falvey & David Greenaway & Udo Kreickemeier (ed.), Palgrave Handbook of International Trade, chapter 13, pages 367-388, Palgrave Macmillan.
    3. Daniel Bernhofen & Raymond Riezman, 2009. "Introduction: ‘New directions in international trade theory’," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 41(1), pages 1-3, October.
    4. Nayef Al-Shammari & Shaha Al-Obaid, 2018. "Linkages of Global Financial Crisis and Trade Direction in an Oil Based Economy," International Journal of Economics and Financial Issues, Econjournals, vol. 8(3), pages 250-259.
    5. Chang, Winston W. & Chen, Tai-Liang & Saito, Tetsuya, 2021. "Formation of symmetric free-trade blocs, optimal tariff structure, and world welfare," Journal of Asian Economics, Elsevier, vol. 77(C).
    6. Koumtingué, Nelnan, 2010. "Proliferation of preferential trade agreements: an empirical analysis," MPRA Paper 68917, University Library of Munich, Germany, revised 08 Aug 2014.
    7. Yoshitomo Ogawa, 2012. "The structure of Nash equilibrium tariffs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 51(1), pages 139-161, September.
    8. Moïse Nken & Halis Murat Yildiz, 2022. "Implications of multilateral tariff bindings on the extent of preferential trade agreement formation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 73(1), pages 301-347, February.

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    More about this item

    Keywords

    International Trade; Political Economy; Theory of International Free Trade Agreements; Customs Unions; Tariff Dynamics; Storable Votes;
    All these keywords.

    JEL classification:

    • P16 - Political Economy and Comparative Economic Systems - - Capitalist Economies - - - Capitalist Institutions; Welfare State
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations

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