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Preferential Trading and Welfare: The Small-Union Case Revisited

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  • Arvind Panagariya

    (University of Maryland)

Abstract

The welfare analyses of preferential trading arrangements have been characterized by generally inconclusive and messy results. In this paper, I attempt to give order to the analysis of one important case: a union between two small countries. The analysis has two key advantages over the existing literature. First, the model employed is fully general in that it allows for goods that are exported and imported by both partners as well as those that are exported by one and imported by the other partner. Second, the results are derived for finite changes in tariff rates rather than being limited to infinitesimally small changes. The main results of the paper can be summarized as follows. First, assuming all goods to be normal in consumption, if two small countries form a free trade area or exchange some tariff preferences, their joint welfare falls or rises as their joint output, valued at world prices, rises or falls. Second, if, in addition, the numeraire good uses only labor and all other goods use labor and a sector-specific factor, the exchange of preferences or free trade area necessarily lowers the union’s joint welfare. Third, a union member is necessarily hurt by its own preferential liberalization. The higher are its external tariffs and the larger its imports from the partner, the more it loses from extending the preferences. Fourth, in the specific-factors case just mentioned, a union member necessarily benefits from the tariff preference it receives from the partner. The more it exports to the partner and the higher the latter’s tariffs, the greater the gain. Finally, in the specific-factors case, an FTA benefits a member more the larger its bilateral trade surplus with the partner and the lower its external tariffs relative to the partner.

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Bibliographic Info

Paper provided by EconWPA in its series International Trade with number 0308009.

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Length: 345 pages
Date of creation: 18 Aug 2003
Date of revision:
Handle: RePEc:wpa:wuwpit:0308009

Note: Type of Document - Tex/WordPerfect/Handwritten; prepared on IBM PC - PC-TEX/UNIX Sparc TeX; to print on HP/PostScript/Franciscan monk; pages: 345,395,4323247 ; figures: included/request from author/draw your own
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  1. Carsten Kowalczyk, 1990. "Welfare and Customs Unions," NBER Working Papers 3476, National Bureau of Economic Research, Inc.
  2. Bhagwati, Jagdish N, 1971. "Trade-Diverting Customs Unions and Welfare Improvement: a Clarification," Economic Journal, Royal Economic Society, vol. 81(323), pages 580-87, September.
  3. Riezman, Raymond, 1979. "A 3 x 3 model of customs unions," Journal of International Economics, Elsevier, vol. 9(3), pages 341-354, August.
  4. Panagariya, Arvind & Rodrik, Dani, 1993. "Political-Economy Arguments for a Uniform Tariff," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(3), pages 685-703, August.
  5. Sang-Seung, Yi, 1996. "Endogenous formation of customs unions under imperfect competition: open regionalism is good," Journal of International Economics, Elsevier, vol. 41(1-2), pages 153-177, August.
  6. Corden, W. M., 1976. "Customs union theory and the nonuniformity of tariffs," Journal of International Economics, Elsevier, vol. 6(1), pages 99-106, February.
  7. Panagariya, A., 1997. "Preferential trading and the myth of natural trading partners," Japan and the World Economy, Elsevier, vol. 9(4), pages 471-489, December.
  8. Arvind Panagariya, 1996. "The Free Trade Area of the Americas: Good for Latin America?," The World Economy, Wiley Blackwell, vol. 19(5), pages 485-515, 09.
  9. Levy, Philip I, 1997. "A Political-Economic Analysis of Free-Trade Agreements," American Economic Review, American Economic Association, vol. 87(4), pages 506-19, September.
  10. Wilfred J. Ethier, 1998. "Regionalism in a Multilateral World," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1214-1245, December.
  11. Corden, W.M., 1984. "The normative theory of international trade," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 1, chapter 2, pages 63-130 Elsevier.
  12. Paul Krugman, 1989. "Is Bilateralism Bad?," NBER Working Papers 2972, National Bureau of Economic Research, Inc.
  13. Arvind Panagariya, 2000. "Preferential Trade Liberalization: The Traditional Theory and New Developments," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 287-331, June.
  14. Krishna, Pravin & Panagariya, Arvind, 2000. "A unification of second best results in international trade," Journal of International Economics, Elsevier, vol. 52(2), pages 235-257, December.
  15. McMillan, John & McCann, Ewen, 1981. "Welfare Effects in Customs Unions," Economic Journal, Royal Economic Society, vol. 91(363), pages 697-703, September.
  16. Lloyd, P. J., 1982. "3 x 3 theory of customs unions," Journal of International Economics, Elsevier, vol. 12(1-2), pages 41-63, February.
  17. Bond, Eric W. & Syropoulos, Constantinos, 1996. "The size of trading blocs Market power and world welfare effects," Journal of International Economics, Elsevier, vol. 40(3-4), pages 411-437, May.
  18. Richardson, Martin, 1993. "Endogenous protection and trade diversion," Journal of International Economics, Elsevier, vol. 34(3-4), pages 309-324, May.
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Cited by:
  1. Rupa Duttagupta & Arvind Panagariya, 2007. "Free Trade Areas And Rules Of Origin: Economics And Politics," Economics and Politics, Wiley Blackwell, vol. 19(2), pages 169-190, 07.

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