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How Does Uncertainty Affect the Choice of Trade AgreementsF

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  • Elie Appelbaum

    ()
    (Department of Economics, York University, Toronto, Canada)

  • Mark Melatos

Abstract

This paper analyzes how uncertainty and the timing of its resolution infuence the formation and design of regional trade agreements. Two sources of uncertainty — in demand and costs — are considered. We compare the case in which uncertainty is resolved “early” (before tariffs are chosen), with the case in which uncertainty is resolved “late” (after tariffs are chosen). These cases are, in turn, compared with the benchmark case of no uncertainty. We demonstrate that, as long as some decisions are made after uncertainty is resolved, trade agreements have option values. These option values differ across agreements, reFecting members’ different degrees of (trade policy) freedom to respond to changes in the trading environment. Moreover, these option values may be sufficiently large as to lead prospective members to opt for a more Fexible trading arrangement(such as a free trade area) over a less Fexible agreement (such as a customs union). Indeed, countries may even prefer to stand alone than join a free trade area under some circumstances. Finally, we show that the timing of the resolution of uncertainty can signiFcantly impact the type of trade agreement that countries wish to form.

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File URL: http://dept.econ.yorku.ca/research/workingPapers/working_papers/2012/Uncertainty_Affect_the_Choice_of_Trade.pdf
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Bibliographic Info

Paper provided by York University, Department of Economics in its series Working Papers with number 2012_1.

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Length: 27 pages
Date of creation: 17 Apr 2012
Date of revision:
Handle: RePEc:yca:wpaper:2012_1

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Keywords: Trade Agreement; Free Trade Area; Customs Union; Uncertainty; Resolution of Uncertainty;

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  1. Caroline Freund & Emanuel Ornelas, 2010. "Regional trade agreements: blessing or burden?," CentrePiece - The Magazine for Economic Performance 313, Centre for Economic Performance, LSE.
  2. Carlo Perroni & John Whalley, 2000. "The new regionalism: trade liberalization or insurance?," Canadian Journal of Economics, Canadian Economics Association, vol. 33(1), pages 1-24, February.
  3. MARTIN, Alberto & VERGOTE, Wouter, 2007. "On the role of retaliation in trade agreements," CORE Discussion Papers 2007089, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  4. Dasgupta, Partha & Stiglitz, Joseph E, 1977. "Tariffs vs . Quotas as Revenue Raising Devices under Uncertainty," American Economic Review, American Economic Association, vol. 67(5), pages 975-81, December.
  5. Jennifer Pédussel Wu, 2005. "Trade Agreements as Self-Protection," Review of International Economics, Wiley Blackwell, vol. 13(3), pages 472-484, 08.
  6. Caroline Freund, 2010. "Third‐country Effects of Regional Trade Agreements," The World Economy, Wiley Blackwell, vol. 33(11), pages 1589-1605, November.
  7. Riezman, Raymond, 1985. "Customs unions and the core," Journal of International Economics, Elsevier, vol. 19(3-4), pages 355-365, November.
  8. Giovanni Maggi, 1999. "The Role of Multilateral Institutions in International Trade Cooperation," American Economic Review, American Economic Association, vol. 89(1), pages 190-214, March.
  9. Horn, Henrik & Maggi, Giovanni & Staiger, Robert, 2007. "Trade Agreements as Endogenously Incomplete Contracts," CEPR Discussion Papers 6037, C.E.P.R. Discussion Papers.
  10. Wilfred J. Ethier, 2002. "Unilateralism in a Multilateral World," Economic Journal, Royal Economic Society, vol. 112(479), pages 266-292, April.
  11. Caroline Freund & Emanuel Ornelas, 2009. "Regional trade agreements," LSE Research Online Documents on Economics 28697, London School of Economics and Political Science, LSE Library.
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