A strategic and welfare theoretic analysis of free trade areas

We construct a three-country model to determine how the formation of free trade areas (FTAs) affects optimal tariffs and welfare. We find that, at constant rest of the world (ROW) tariffs, the adoption of internal free trade induces union members to reduce their external tariffs below the Kemp–Wan [...

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Bibliographic Details
Published in:Journal of international economics 2004-10, Vol.64 (1), p.1-27
Main Authors: Bond, Eric W., Riezman, Raymond G., Syropoulos, Constantinos
Format: Article
Language:English
Subjects:
Economic models
Economic theory
Economics
Free trade
Free trade areas
International economics
Kemp–Wan tariff adjustments
Regionalism
Strategic interactions
Strategic planning
Studies
Tariffs
Welfare
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Summary:We construct a three-country model to determine how the formation of free trade areas (FTAs) affects optimal tariffs and welfare. We find that, at constant rest of the world (ROW) tariffs, the adoption of internal free trade induces union members to reduce their external tariffs below the Kemp–Wan [J. Int. Econom. 6 (1976) 95–97] level, and causes ROW's terms of trade to improve and its welfare to rise. When ROW also behaves optimally, its policy response to the formation of the FTA is to raise tariffs. Generally, FTA members prefer to liberalize internal trade partially and find regional integration appealing only if their collective size is sufficiently large. We also demonstrate how FTAs may undermine the attainment of global free trade.
ISSN:0022-1996
1873-0353
DOI:10.1016/S0022-1996(03)00078-3