Voluntary Formation of Free Trade Area in a Third Country Market Model

This chapter investigates the formation of a multilateral free trade agreement (FTA) through the extension of bilateral FTAs in a third country market model of the Brander and Spencer (1985) type. Two exporting countries are different in their number of domestic firms. The importing country imposes tariff on the imports from the exporting countries. Then, we investigate the possibility of the bilateral FTA in the sense that the importing country agrees to abolish the tariff policy against the country forming the agreement. Our main result is that, in the case where each exporting country adopts a subsidization policy on its domestic firms, it is possible to make a voluntary multilateral FTA by the gradual extension of bilateral FTAs under the assumption that the subsidization policy is also resigned in the country reaching the agreement. However, if there is no subsidization policy in the exporting countries, any bilateral FTA cannot be established voluntarily. Thus, it is impossible to form a multilateral FTA by the gradual extension of bilateral FTA.