Intra-bloc tariffs and preferential margins in trade agreements

• Published in: Journal of international economics 2022-09, Vol.138, p.103643, Article 103643
• Main Authors: Ornelas, Emanuel, Tovar, Patricia
• Format: Article
• Language: English
• Subjects: Article XXIV; Customs unions; Free trade agreements; GATT; Latin America; Regionalism; Tariff complementarity
• ISSN: 0022-1996; 1873-0353
• DOI: 10.1016/j.jinteco.2022.103643

•When forming PTAs, governments want to keep intra-bloc tariffs strictly positive.•Preferential margins are higher in customs unions than in free trade agreements.•In customs unions, preferential margins decrease with intra-bloc imports.•We test and confirm those predictions using data for Latin American countries.•Enforcing the WTO constraint on abolishing intra-PTA tariffs is socially desirable. We study how countries choose intra-bloc tariffs and preferential margins in Preferential Trade Agreements (PTAs). Our model indicates that countries should set systematically lower preferential margins when the bloc takes the form of a free trade area, relative to a customs union. Moreover, in customs unions (but not necessarily in free trade areas) preferential margins should increase with the supply of partner countries and decrease with the level of preferential imports. These relationships reflect, respectively, the internalization of political-economy goals within the bloc and the desire to curb trade diversion. Using a sample that covers most PTAs formed by Latin American countries in the 1990s, we find empirical support for each of those predictions. These findings rationalize why governments often keep intra-bloc duties strictly positive. We show that this tends to worsen the welfare consequences of PTAs, and that requiring the elimination of internal tariffs would be socially desirable.