Regional Agreements and Welfare in the South:When Scale Economies in Transport Matter

This paper evidences that the accepted pessimistic view, in terms of welfare, of regional trade agreements between developing countries can be challenged by scale economies in transport. This paper focuses on two main issues. First, how is the standard welfare analysis of regional trade agreement affected by the endogeneity of transport costs (i.e. by the joint determination of trade quantities and transport costs)? Second, what are the long-run consequences of endogenous transport costs for welfare if worldwide free trade is achieved through preferential trade agreements? This paper extends the Spilimbergo and Stein (1998)'s model of interindustry trade (generated by relative factors endowment differences) intraindustry trade (generated by scale and product-diversity effects) and iceberg transport costs. In addition of assuming a "hub-and-spoke" transport network structure, we also consider that transport costs depend on the distance between trade partners (three types of costs are defined: regional, continental and across ocean) and on their development level. Most importantly, we allow for an explicit treatment of the transport sector. The main conclusion is that, with scale economies in transport, regional liberalization will have persistent effect on trade flows through irreversible effect on regional transport costs that improve the final welfare, for a developing country, under regional free trade agreement as well as under worldwide free trade.