Proliferation of preferential trade agreements: an empirical analysis

The creation of a preferential trade area (PTA) or the deepening of an existing one can affect adversely excluded countries and induce them to join or create a new PTA (Baldwin, 1993). One such adverse effect is trade diversion, the shift of imports from countries outside the preferential trade area toward member countries. This paper investigates empirically whether countries whose exports are more likely to suffer from trade diversion exhibit a higher likelihood of forming a PTA. I derive a measure of the potential of trade diversion from the trade complementarity index (Michaely (1962)) and estimate a dynamic Probit model of new PTAs formed between 1961 and 2005. The results show that countries facing a larger potential of trade diversion are more likely to form a PTA in the future. The results also support the natural trading partner hypothesis according to which preferential trade agreements are more likely to be formed among countries that are predisposed to trade a lot.