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Welfare effects of preferential trade agreements under optimal tariffs

  • Saggi, Kamal
  • Yildiz, Halis Murat

In a three country model with endogenous tariffs, this paper evaluates and contrasts the welfare effects of free trade agreements (FTAs) and customs unions (CUs) — the two most commonly occurring preferential trade agreements (PTAs). We show that if the external tariff of a PTA is not too high, it benefits both members and non-members. We also highlight the implications of a key (but commonly ignored) distinction between the two types of PTAs: while an FTA member can form an another (independent) FTA with an existing non-member, a CU member cannot. Under a pair of independent bilateral FTAs, the common member’s welfare is higher than that under free trade. Furthermore, if the common member is relatively efficient compared to the other two countries, such a ‘hub and spoke’ pattern of FTAs can yield higher global welfare than free trade. By contrast, such an outcome is never possible under a CU.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 17562.

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Date of creation: 15 Dec 2005
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Handle: RePEc:pra:mprapa:17562
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  2. Kyle Bagwell & Robert W. Staiger, 1993. "Miltilateral Tariff Cooperation During the Formation of Customs Unions," Discussion Papers 1070, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  4. John Kennan & Raymond Riezman, 2013. "Do Big Countries Win Tariff Wars?," World Scientific Book Chapters, in: International Trade Agreements and Political Economy, chapter 4, pages 45-51 World Scientific Publishing Co. Pte. Ltd..
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  15. Bohara, Alok K. & Gawande, Kishore & Sanguinetti, Pablo, 2004. "Trade diversion and declining tariffs: evidence from Mercosur," Journal of International Economics, Elsevier, vol. 64(1), pages 65-88, October.
  16. Barbara J. Spencer & James A. Brander, 1982. "Tariff Protection and Imperfect Competition," Working Papers 517, Queen's University, Department of Economics.
  17. Won Chang & Winters, L. Alan, 1999. "How regional blocs affect excluded countries - the price effects of MERCOSUR," Policy Research Working Paper Series 2157, The World Bank.
  18. Emanuel Ornelas, 2005. "Rent Destruction and the Political Viability of Free Trade Agreements," The Quarterly Journal of Economics, MIT Press, vol. 120(4), pages 1475-1506, November.
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