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Understanding the Welfare Implications of Preferential Trade Agreements

Author

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  • M. Ayhan Kose
  • Raymond Riezman

Abstract

This paper examines various implications of Preferential Trade Agreements (PTAs), namely Customs Unions (CUs) and Free Trade Areas (FTAs), in the context of a multi-country general equilibrium model based on comparative advantage considerations. We calibrate the model to represent countries with symmetric endowments, and compare the impact of those agreements with free trade and a non-cooperative Nash equilibria. Utilizing aggregate and disaggregate welfare change measures, we quantify the welfare effects of trade arrangements. In particular, we develop a numerical approximation procedure to decompose the welfare changes into two components associated with the variations in terms of trade and volume of trade. The results of our analysis indicate that FTAs are better than CUs on welfare grounds for the world as a whole since both member and nonmember economies enjoy welfare benefits in an FTA. Further, we show that, for certain endowment distributions, upon formation of an FTA, nonmember economies get larger welfare benefits than member economies do. Nonetheless, member economies have larger welfare gains in CUs than in FTAS. Our welfare decompositions suggest that a significant fraction of the welfare changes in both member and nonmember countries is explained by the volume of trade effect for both types of PTAS. This implies that, having free access to larger markets, along with greater market power are both important aspects of PTAS. Comparison across endowment distributions indicates that as countries become more divergent in their endowments, the volume of trade effect gets more pronounced for CUs as well as for FTAS. The absence of policy coordination between the members of FTAs decreases the market power of the member economies and induces welfare losses that are associated with the terms of trade effect. However, the ten-ns of trade effect results in significant welfare gains for the members of CUs since they jointly determine their tariff rates.

Suggested Citation

  • M. Ayhan Kose & Raymond Riezman, 1999. "Understanding the Welfare Implications of Preferential Trade Agreements," CSGR Working papers series 45/99, Centre for the Study of Globalisation and Regionalisation (CSGR), University of Warwick.
  • Handle: RePEc:wck:wckewp:45/99
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    Cited by:

    1. T. Huw Edwards & John Whalley, 2002. "Short and Long Run Decompositions of OECD Wage Inequality Changes," NBER Working Papers 9265, National Bureau of Economic Research, Inc.
    2. Carsten Kowalczyk & Raymond Riezman, 2009. "Trade Agreements," CESifo Working Paper Series 2660, CESifo Group Munich.
    3. M. Ayhan Kose & Raymond Riezman, 2000. "Small Countries and Preferential Trade Agreements "How Severe is the Innocent Bystander Problem?"," CESifo Working Paper Series 253, CESifo Group Munich.
    4. Mukunoki, Hiroshi, 2004. "On the optimal external tariff of a free trade area with internal market integration," Japan and the World Economy, Elsevier, vol. 16(4), pages 431-448, December.
    5. Conconi, P., 2000. "Trade Bloc Formation Under Imperfect Competition," The Warwick Economics Research Paper Series (TWERPS) 571, University of Warwick, Department of Economics.
    6. Howard J. Wall, 2002. "Has Japan been left out in the cold by regional integration?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 25-36.
    7. Eric W. Bond & Raymond G. Riezman & Constantinos Syropoulos, 2013. "A strategic and welfare theoretic analysis of free trade areas," World Scientific Book Chapters,in: International Trade Agreements and Political Economy, chapter 8, pages 101-127 World Scientific Publishing Co. Pte. Ltd..
    8. Philipp J. H. Schröder & Allan Sørensen, 2014. "A Welfare Ranking of Multilateral Reductions in Real and Tariff Trade Barriers when Firms are Heterogenous," Review of International Economics, Wiley Blackwell, vol. 22(3), pages 423-443, August.
    9. Ayhan Kose & Christopher M Towe & Guy M Meredith, 2004. "How Has Nafta Affected the Mexican Economy? Review and Evidence," IMF Working Papers 04/59, International Monetary Fund.
    10. Burfisher, Mary E. & Robinson, Sherman & Thierfelder, Karen, 2004. "Regionalism," MTID discussion papers 65, International Food Policy Research Institute (IFPRI).
    11. Kawabata, Yasushi & Yanase, Akihiko & Kurata, Hiroshi, 2010. "Vertical trade and free trade agreements," Journal of the Japanese and International Economies, Elsevier, vol. 24(4), pages 569-585, December.
    12. Edward, T. Huw & Lücke, Matthias, 2011. "Decompositions of wage inequality and growth in an advanced economy open to trade," Kiel Working Papers 1749, Kiel Institute for the World Economy (IfW).
    13. Chang, Yang-Ming & Xiao, Renfeng, 2015. "Preferential trade agreements between asymmetric countries: Free trade areas (with rules of origin) vs. customs unions," Japan and the World Economy, Elsevier, vol. 33(C), pages 28-43.

    More about this item

    Keywords

    General Equilibrium; Trading Blocs; Free Trade Agreements; Customs Unions; Tariffs; Welfare.;

    JEL classification:

    • P16 - Economic Systems - - Capitalist Systems - - - Political Economy of Capitalism
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations

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