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Abstract
This compilation of essays explores the economics of preferential trade agreements (PTAs) under imperfect competition. Chapter one investigates the possible permanent effects of PTAs on trade flows and welfare. Chapter two explores the interaction between multilateral tariff reduction and preferential trade negotiation. And chapter three uses data from the European Community to test some of the theoretical predictions from the model in chapter one.
Chapter one examines the long run effect that PTAs have on trade. We find that with sunk costs, trade in an imperfectly competitive good will flow disproportionately between the original members even after the union is dissolved. They secure a higher level of welfare than late entrants and they obtain a higher welfare level than they would have had free trade been achieved multilaterally. Non-members, however, attain a higher level of welfare if free trade is achieved by multilateral negotiation. A surprising result is that world welfare during free trade is actually expanded by the early exclusion of other countries.
Chapter two explores the interaction between preferential trade agreements and multilateral tariff reduction. Starting from the optimal tariff equilibrium we examine the incentive for multilateral tariff reduction and the incentive for preferential tariff reduction. We find that if tariffs are reduced multilaterally the incentive to join a PTA rises. We then look at the enforceability of tariff reduction in a repeated game. It turns out that PTAs are more likely to be enforceable at low tariff levels. Thus, as tariffs decline both the incentive to join a PTA and the likelihood that the agreement is enforceable rise. This may help to explain the current trend towards PTAs.
One of the main implications of the model described in chapter one is that the original members of an expanding trade block continue to trade more with each other even after the union expands. In chapter three, we test this prediction using data from the European Community. The results are striking. The original members of the European Union are over 50% more likely to trade with each other in 1980, 1986, and 1992. The industries responsible for their increased trade in all of the years are: manufactures, chemicals, and raw materials.
