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Understanding the Welfare Implications of Preferential Trade Agreements

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  • M. Ayhan Kose
  • Raymond Riezman

Abstract

This paper examines various implications of Preferential Trade Agreements (PTAs), namely Customs Unions (CUs) and Free Trade Areas (FTAs), in the context of a multi-country general equilibrium model based on comparative advantage considerations. We calibrate the model to represent countries with symmetric endowments, and compare the impact of those agreements with free trade and a non-cooperative Nash equilibria. Utilizing aggregate and disaggregate welfare change measures, we quantify the welfare effects of trade arrangements. In particular, we develop a numerical approximation procedure to decompose the welfare changes into two components associated with the variations in terms of trade and volume of trade. The results of our analysis indicate that FTAs are better than CUs on welfare grounds for the world as a whole since both member and nonmember economies enjoy welfare benefits in an FTA. Further, we show that, for certain endowment distributions, upon formation of an FTA, nonmember economies get larger welfare benefits than member economies do. Nonetheless, member economies have larger welfare gains in CUs than in FTAS. Our welfare decompositions suggest that a significant fraction of the welfare changes in both member and nonmember countries is explained by the volume of trade effect for both types of PTAS. This implies that, having free access to larger markets, along with greater market power are both important aspects of PTAS. Comparison across endowment distributions indicates that as countries become more divergent in their endowments, the volume of trade effect gets more pronounced for CUs as well as for FTAS. The absence of policy coordination between the members of FTAs decreases the market power of the member economies and induces welfare losses that are associated with the terms of trade effect. However, the ten-ns of trade effect results in significant welfare gains for the members of CUs since they jointly determine their tariff rates.

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Bibliographic Info

Paper provided by Centre for the Study of Globalisation and Regionalisation (CSGR), University of Warwick in its series CSGR Working papers series with number 45/99.

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Date of creation: Oct 1999
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Handle: RePEc:wck:wckewp:45/99

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Postal: Centre for the Study of Globalisation and Regionalisation (CSGR) University of Warwick Coventry CV4 7AL, U.K.
Phone: +44 (0) 1203 572 533
Fax: +44 (0) 1203 572 548
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Web page: http://www.warwick.ac.uk/fac/soc/CSGR/
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Related research

Keywords: General Equilibrium; Trading Blocs; Free Trade Agreements; Customs Unions; Tariffs; Welfare.;

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Cited by:
  1. M. Ayhan Kose & Raymond Riezman, 2000. "Small Countries and Preferential Trade Agreements "How Severe is the Innocent Bystander Problem?"," CESifo Working Paper Series 253, CESifo Group Munich.
  2. Wall, Howard-J, 2002. "Has Japan Been Left Out in the Cold by Regional Integration?," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 20(2), pages 117-134, April.
  3. Conconi, P., 2000. "Trade Bloc Formation Under Imperfect Competition," The Warwick Economics Research Paper Series (TWERPS) 571, University of Warwick, Department of Economics.
  4. Burfisher, Mary E. & Robinson, Sherman & Thierfelder, Karen, 2004. "Regionalism," MTID discussion papers 65, International Food Policy Research Institute (IFPRI).
  5. Carsten Kowalczyk & Raymond Riezman, 2009. "Trade Agreements," CESifo Working Paper Series 2660, CESifo Group Munich.
  6. Edwards, T Huw & John Whalley, 2003. "Short and Long Run Decomposition of OECD Wage Inequality Changes," Royal Economic Society Annual Conference 2003, Royal Economic Society 72, Royal Economic Society.
  7. Kawabata, Yasushi & Yanase, Akihiko & Kurata, Hiroshi, 2010. "Vertical trade and free trade agreements," Journal of the Japanese and International Economies, Elsevier, vol. 24(4), pages 569-585, December.
  8. Mukunoki, Hiroshi, 2004. "On the optimal external tariff of a free trade area with internal market integration," Japan and the World Economy, Elsevier, Elsevier, vol. 16(4), pages 431-448, December.
  9. M. Ayhan Kose & Christopher M. Towe & Guy Meredith, 2004. "How Has Nafta Affected the Mexican Economy? Review and Evidence," IMF Working Papers 04/59, International Monetary Fund.
  10. Bond, Eric W. & Riezman, Raymond G. & Syropoulos, Constantinos, 2004. "A strategic and welfare theoretic analysis of free trade areas," Journal of International Economics, Elsevier, Elsevier, vol. 64(1), pages 1-27, October.

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