Is Small Beautiful? Trade Shares and Trade Creation with Differentiated Products
In a small open economy model where imports (exports) are differentiated by region of origin (destination), the welfare effects of a preferential trade agreement (PTA) are considered. Trade creation is found to be a concave function of pre-union partner trade shares. This contrasts with earlier results in the homogeneous goods case whereby the smaller the pre-PTA volume of trade with a potential partner the smaller is trade diversion and the more beneficial is a PTA. An applied general equilibrium model of Egypt demonstrates the theoretical findings for a PTA with the European Union. As Egypt's trading patterns are not heavily focused on the EU, gains from a PTA would likely be modest.
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