External Trade Diversion, Exclusion Incentives and the Nature of Preferential Trade Agreements

Paul Missios, Kamal Saggi () and Halis Yildiz

MPRA Paper from University Library of Munich, Germany

Abstract: In a game of endogenous trade agreements, we examine whether the pursuit of free trade agreements (FTAs) affects the prospects of global free trade differently than the pursuit of customs unions (CUs). Our analysis is driven by a fundamental difference between these two types of preferential trade agreements (PTAs): while CU members impose jointly optimal common tariffs on non-members, members of an FTA adopt individually optimal external tariffs. This implies that (a) FTAs are relatively more flexible than CUs in the sense that an FTA member can decide to undertake further trade liberalization with respect to non-members on its own whereas a CU member can do so only if all other members also wish to do the same and (b) coordination during tariff setting allows CU members to pool their market power. In our comparative advantage based three country framework, the formation of either type of PTA induces the non-member to lower its external tariffs due to the reduction in the volume of exports flowing from members to the non-member (we call this external trade diversion). While the pursuit of CUs prevents free trade from emerging as a coalition-proof Nash equilibrium, the pursuit of FTAs does not. This key result is driven by the relative flexibility of FTAs; the higher market power of CUs by itself does not undermine the objective of reaching global free trade.

Keywords: Free Trade Agreement; Customs Union; Hub and Spoke Agreements; Free Trade; Optimal Tariffs (search for similar items in EconPapers)
JEL-codes: F12 F13 (search for similar items in EconPapers)
Date: 2014-09-19
New Economics Papers: this item is included in nep-int
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/60063/1/MPRA_paper_60063.pdf original version (application/pdf)

Related works:
Chapter: External trade diversion, exclusion incentives and the nature of preferential trade agreements (2018)
Journal Article: External trade diversion, exclusion incentives and the nature of preferential trade agreements (2016)
Working Paper: External Trade Diversion, Exclusion Incentives and the Nature of Preferential Trade Agreements (2015)
Working Paper: External Trade Diversion, Exclusion Incentives and the Nature of Preferential Trade Agreements (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:60063

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().