How Does Uncertainty Affect the Choice of Trade AgreementsF

Elie Appelbaum and Mark Melatos

Working Papers from York University, Department of Economics

Abstract: This paper analyzes how uncertainty and the timing of its resolution infuence the formation and design of regional trade agreements. Two sources of uncertainty — in demand and costs — are considered. We compare the case in which uncertainty is resolved “early” (before tariffs are chosen), with the case in which uncertainty is resolved “late” (after tariffs are chosen). These cases are, in turn, compared with the benchmark case of no uncertainty. We demonstrate that, as long as some decisions are made after uncertainty is resolved, trade agreements have option values. These option values differ across agreements, reFecting members’ different degrees of (trade policy) freedom to respond to changes in the trading environment. Moreover, these option values may be sufficiently large as to lead prospective members to opt for a more Fexible trading arrangement(such as a free trade area) over a less Fexible agreement (such as a customs union). Indeed, countries may even prefer to stand alone than join a free trade area under some circumstances. Finally, we show that the timing of the resolution of uncertainty can signiFcantly impact the type of trade agreement that countries wish to form.

Keywords: Trade Agreement; Free Trade Area; Customs Union; Uncertainty; Resolution of Uncertainty (search for similar items in EconPapers)
JEL-codes: D81 F12 F13 F15 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2012-04-17
New Economics Papers: this item is included in nep-upt
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http://dept.econ.yorku.ca/research/workingPapers/w ... _Choice_of_Trade.pdf

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Working Paper: How Does Uncertainty Affect the Choice of Trade Agreements? (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:yca:wpaper:2012_1

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