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Preferential Trade Agreements and Global Sourcing

Grant Bickwit, Emanuel Ornelas and John Turner

No 13264, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We study how a preferential trade agreement (PTA) affects international sourcing decisions, aggregate productivity and welfare under incomplete contracting and endogenous matching. Contract incompleteness implies underinvestment. That inefficiency is mitigated by a PTA, because the agreement allows the parties in a vertical chain to internalize a larger return from the investment. This raises aggregate productivity. On the other hand, the agreement yields sourcing diversion. More efficient suppliers tilt the tradeoff toward the (potentially) beneficial relationship-strengthening effect; a high external tariff tips it toward harmful sourcing diversion. A PTA also affects the structure of vertical chains in the economy. As tariff preferences attract too many matches to the bloc, the average productivity of the industry tends to fall. When the agreement incorporates "deep integration" provisions, it boosts trade flows, but not necessarily welfare. Rather, "deep integration" improves upon "shallow integration" if and only if the original investment inefficiencies are serious enough. On the whole, we offer a new framework to study the benefits and costs from preferential liberalization in the context of global sourcing.

Keywords: Hold-up Problem; Incomplete Contracts; Matching; regionalism; sourcing; trade diversion (search for similar items in EconPapers)
JEL-codes: D23 D83 F13 F15 L22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-int
Date: 2018-10
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