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A political - economy analysis of free trade areas and customs unions

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  • Panagariya, Arvind
  • Findlay, Ronald
  • DEC

Abstract

The authors analyze the welfare effects of regional integration in a model of endogenous protection. They show that introducing preferential trading leads to an increase in protection against countries outside the preferential trading area. Moreover, the important Meade result of preferential trading breaks down in the presence of endogenous protection. According to the Meade result, if excess demands exhibit net substitutability, the introduction of preferential trading is welfare-improving. In the presence of endogenous protection, because preferential trading is accompanied by increased protection against nonpartners, its effect on welfare is ambiguous. The authors also compare free trade areas and customs unions. They provide the first formal treatment of the argument that a customs union is a more effective instrument for diluting the power of interest groups than is a free trade area. Under a customs union, the tariff available to one country becomes available to all countries in the union. This introduces a free-rider problem in lobbying and all lobbying takes place in one country. The lobby chooses a lower (common) external tariff under a customs unions than under a free trade area. This means that welfare in the country where lobbying takes place is higher under a customs union than under a free trade area, although the same may not hold true for the other country. The level of the common external tariff declines as the number of members in the union increases. Therefore, the larger the number of partners in a customs union, the more likely it will improve the welfare of member countries. But, because of the free-rider problem, lobbies are likely to resist the enlargement of the customs union.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1261.

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Date of creation: 31 Mar 1994
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Handle: RePEc:wbk:wbrwps:1261

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Keywords: TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT; Trade and Regional Integration; Environmental Economics&Policies; Economic Theory&Research; Trade Policy;

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References

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  1. Hillman, Arye L. & Van Long, Ngo & Soubeyran, Antoine, 2001. "Protection, lobbying, and market structure," Journal of International Economics, Elsevier, vol. 54(2), pages 383-409, August.
  2. J. Bhagwati & T. N. Srinivasan, 1979. "Revenue-Seeking: A Generalization of the Theory of Tariffs," Working papers 243, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Lloyd, P. J., 1982. "3 x 3 theory of customs unions," Journal of International Economics, Elsevier, vol. 12(1-2), pages 41-63, February.
  4. Rodrik, Dani, 1986. "Tariffs, subsidies, and welfare with endogenous policy," Journal of International Economics, Elsevier, vol. 21(3-4), pages 285-299, November.
  5. Grossman, G.M. & Helpman, E., 1993. "The Politics of Free Trade Agreements," Papers 14-93, Tel Aviv.
  6. Heinrich W. Ursprung, 1990. "Public Goods, Rent Dissipation, And Candidate Competition," Economics and Politics, Wiley Blackwell, vol. 2(2), pages 115-132, 07.
  7. Riezman, Raymond, 1979. "A 3 x 3 model of customs unions," Journal of International Economics, Elsevier, vol. 9(3), pages 341-354, August.
  8. Paul Krugman, 1989. "Is Bilateralism Bad?," NBER Working Papers 2972, National Bureau of Economic Research, Inc.
  9. Ronald Findlay & Stanislaw Wellisz, 1982. "Endogenous Tariffs, the Political Economy of Trade Restrictions, and Welfare," NBER Chapters, in: Import Competition and Response, pages 223-244 National Bureau of Economic Research, Inc.
  10. Krueger, Anne O, 1974. "The Political Economy of the Rent-Seeking Society," American Economic Review, American Economic Association, vol. 64(3), pages 291-303, June.
  11. de Melo, Jaime & Panagariya, Arvind & Rodrik, Dani, 1993. "The new regionalism : a country perspective," Policy Research Working Paper Series 1094, The World Bank.
  12. Brock, William A & Magee, Stephen P, 1978. "The Economics of Special Interest Politics: The Case of the Tariff," American Economic Review, American Economic Association, vol. 68(2), pages 246-50, May.
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