Third-country effects on the formation of free trade agreements

The recent proliferation of free trade agreements (FTAs) has resulted in an increasingly complex network of preferential trading relationships. The economics literature has generally examined the formation of FTAs as a function of the participating countries' economic characteristics alone. In this paper, we show both theoretically and empirically that the decision to enter into an FTA is also crucially dependent on the participating countries' existing FTA relationships with third countries. Accounting for the interdependence of FTAs helps to explain a significant fraction of FTA formations that would not otherwise be predicted by countries' economic characteristics.     

Third-country effects on the formation of free trade agreements

The recent proliferation of free trade agreements (FTAs) has resulted in an increasingly complex network of preferential trading relationships. The economics literature has generally examined the formation of FTAs as a function of the participating countries' economic characteristics alone. In this paper, we show both theoretically and empirically that the decision to enter into an FTA is also crucially dependent on the participating countries' existing FTA relationships with third countries. Accounting for the interdependence of FTAs helps to explain a significant fraction of FTA formations that would not otherwise be predicted by countries' economic characteristics.     

Liberalisation and Protection under Overlapping Free Trade Agreements: Dynamic Interplay between Free Trade Agreements and Investment

Two decades into the most recent wave of regionalism many of its implications remain to be fully understood. A vast literature has explored the impacts of free trade agreements (FTAs) on investment flows, but less attention has been given to how existing patterns of investment alter FTA liberalisation. It is contended here that the dynamic interplay between overlapping FTA areas and the investment sunk in them shapes governments' and firms' positions regarding further FTA liberalisation. During trade negotiations, a country may decide to exclude a sector from FTA liberalisation to prevent (concession prevention) future FTA partners from making similar demands. Concession prevention could also occur when a foreign firm, holding a dominant market position in a host country, relinquishes liberalisation demands in an FTA between host and home countries to prevent its current position being eroded if the host country grants similar (or better) concessions to competing firms from other countries in future FTAs. Conversely, investment sunk into a country's sensitive sector in the territory of partners from previous FTAs could pre‐empt (concession pre‐emption) the protectionist position of that country when it subsequently negotiates FTAs with the investment‐source countries. These arguments were tested in the negotiations around the liberalisation of the automotive industry that Thailand and Malaysia had with Japan in their respective bilateral FTAs. The distinct interaction between investment and the FTAs in which these countries participate resulted either in entrenchment of protectionism in the sector or its liberalisation across subsequent FTAs.     

Tariffs and formation of free trade agreements networks

This paper examines the formation of bilateral free trade agreements (FTAs) on the basis of country heterogeneity in the tariff level. We demonstrate that a country's unilateral incentive to form an FTA depends on the relative magnitudes of the (negative) market concession effect and the (positive) market expansion effect, both of which are determined by the tariff levels of the two FTA partner countries. Global welfare is maximised when all country pairs form FTAs. Two countries in equilibrium are more likely to form an FTA when their tariff gap is smaller or when their tariff levels are neither very high nor very low. This finding is robust to several extensions of the model. Our preliminary empirical analysis provides some evidence for the finding.     

Trade-diverting free trade agreements,external tariffs,and feasibility

There has been a proliferation of preferential trade agreements within the last two decades. This paper analyzes the effects of free trade agreements (FTAs) on external tariffs in small economies where protection decisions are made politically. Our model determines tariff rates endogenously instead of assuming they are fixed during or after the formation of FTAs as commonly done in the literature. We show that when an FTA is established, the tariff rates that apply to non-members essentially decline. More importantly, we investigate the interaction between endogenous tariff determination and the feasibility of an FTA. We find that the expectation of tariff reductions under endogenous tariffs could make an otherwise feasible FTA if tariffs were fixed become infeasible. However, if domestic import-competing sectors are relatively smaller and the government places a significant weight on political contributions relative to social welfare, an FTA with endogenous tariffs may be more likely to be feasible than an FTA assumed to fix external tariffs.     

Multilateral,Regional and Bilateral Trade‐Policy Options for the United States and Japan

We have used the Michigan Model of World Production and Trade to simulate the economic effects on the United States, Japan, and other major trading countries/regions of the Doha Round of WTO multilateral trade negotiations and a variety of regional/bilateral free trade agreements (FTAs) involving the United States and Japan. We estimate that an assumed reduction of post‐Uruguay Round tariffs and other barriers on agricultural and industrial products and services by 33 per cent in the Doha Round would increase world welfare by $686.4 billion, with gains of $164.0 billion for the United States, $132.6 billion for Japan, and significant gains for all other industrialised and developing countries/regions. If there were global free trade with all post‐Uruguay Round trade barriers completely removed, world welfare would increase by $2.1 trillion, with gains of $497.0 billion (5.5 per cent of GNP) for the United States and $401.9 billion (6.2 per cent of GNP) for Japan. Regional agreements such as an APEC FTA, an ASEAN Plus 3 FTA, and a Western Hemisphere FTA would increase global and member country welfare but much less so than the Doha multilateral trade round would. Separate bilateral FTAs involving Japan with Singapore, Mexico, Chile and Korea, and the United States with Chile, Singapore and Korea would have positive, though generally small, welfare effects on the partner countries, but potentially disruptive sectoral employment shifts in some countries. There would be trade diversion and detrimental welfare effects on some non‐member countries for both the regional and bilateral FTAs analysed. The welfare gains from multilateral trade liberalisation are therefore considerably greater than the gains from preferential trading arrangements and more uniformly positive for all countries.     

Endogenous free trade agreements and the multilateral trading system

I evaluate in this paper the impact of free trade areas (FTAs) on the world trading system. I use an oligopolistic-political-economy model where the external tariffs of FTA members, as well as the decision to form FTAs, are endogenously determined. In this context, I show that FTAs are primarily beneficial to the multilateral trading system. This conclusion is based, first, upon the finding that FTAs induce their member governments to lower their external tariffs, and to do so deeply enough to enhance trade even between FTA members and non-members. While this ensures gains for the latter, in general FTA members may not gain. I show, however, that governments will endorse only welfare-improving arrangements, in spite of their political motivations; as a result, FTA members benefit from ratified arrangements as well. Finally, I find that FTAs, by reducing the role of special interests criteria in governments' trade regime decisions, also tend to enhance support for further liberalization at the multilateral level.     

Do free trade agreements actually increase members' international trade?

For over 40 years, the gravity equation has been a workhorse for cross-country empirical analyses of international trade flows and — in particular — the effects of free trade agreements (FTAs) on trade flows. However, the gravity equation is subject to the same econometric critique as earlier cross-industry studies of U.S. tariff and nontariff barriers and U.S. multilateral imports: trade policy is not an exogenous variable. We address econometrically the endogeneity of FTAs. Although instrumental-variable and control-function approaches do not adjust for endogeneity well, a panel approach does. Accounting econometrically for the FTA variable's endogeneity yields striking empirical results: the effect of FTAs on trade flows is quintupled. We find that, on average, an FTA approximately doubles two members' bilateral trade after 10 years.     

Free-trade areas and special protection

This paper investigates the impact of free-trade-area (FTA) agreements on the ability of countries to multilaterally cooperate within an economic environment characterized by trade-flow volatility. We show that the parallel formation of different FTAs leads to a gradual but permanent easing of multilateral trade tensions. In particular, we demonstrate that the emergence of the FTAs will be accompanied by a decline in global ‘special’-protection activity, such as safeguard or anti-dumping initiations, but will have less significant implications for most-favored-nation tariffs, or ‘normal’ trade protection.     

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 [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.     

Computational Analysis of the Menu of US‐Japan Trade Policies

We have used the Michigan Computable General Equilibrium (CGE) Model of World Production and Trade to calculate the aggregate welfare and sectoral employment effects of the menu of US‐Japan trade policies. The menu of policies encompasses the various preferential US and Japan bilateral and regional free trade agreements (FTAs) negotiated and in process, unilateral removal of existing trade barriers and global (multilateral) free trade. The welfare impacts of the FTAs on the United States and Japan are shown to be rather small in absolute and relative terms. The sectoral employment effects are also generally small but vary across the individual sectors depending on the patterns of the bilateral liberalisation. The welfare effects on the FTA partner countries are mostly positive though generally small, but there are some indications of potentially disruptive employment shifts in some partner countries. There are indications of trade diversion and detrimental welfare effects on non‐member countries for some of the FTAs analysed. In comparison to the welfare gains from the US and Japan bilateral FTAs, the gains from both unilateral trade liberalisation by the United States, Japan and the FTA partners, and from global (multilateral) free trade are shown to be rather substantial and more uniformly positive for all countries in the global trading system. The US and Japan FTAs are based on ‘hub’ and ‘spoke’ arrangements. We show that the spokes emanate out in different and often overlapping directions, suggesting that the complex of bilateral FTAs may create distortions of the global trading system.     

Overlapping free trade agreements and international trade: A network approach

In our work, we have analysed the effect of the hub‐and‐spoke nature of free trade agreements (FTA s) on trade. Contrary to previous analyses, we have considered the effects of the country's position in the FTA network on the bilateral trade of the hub country. We have conducted an in‐depth analysis of the global network of FTA s, focusing particularly on its evolution in the last 15 years. We have utilised a panel data set covering the period 1960–2010 to investigate the effects of the hub‐and‐spoke on trade. Our results show that the countries that are more connected to FTA s export more than those that are less involved, although not all the partner countries you can connect with are the same. An increase in the number of spokes that have no link between them has, on average, a negative effect on the trade of the hub, which indicates that signing FTA s with every country is not the optimal strategy for increasing trade. However, if we consider the way new FTA s change the relative position of a country, we can see that if new FTA s make the country more central or less constrained in the network, these new agreements have a strongly positive and significant pro‐trade effect.     

Rue the ROOs: Rules of origin and the gains (or losses) from trade agreements

ABSTRACT

This article provides three-good, three-country examples of trade in both intermediate inputs and final goods. These show the adverse effects that rules of origin (ROOs) can have, even in a world where every country has a free trade agreement (FTA) with every other country. ROOs may cause ubiquitous FTAs to yield a level of welfare, for everyone, that is worse than if there were no FTAs at all, and all trade were subject to common nondiscriminatory tariffs. Thus, the move to an ever increasing number of FTAs may be reducing world welfare.     

Computational Analysis of the US FTAs with Central America,Australia and Morocco

We use the Michigan Model of World Production and Trade to assess the economic effects of the US bilateral FTAs negotiated with Central America, Australia and Morocco. The model covers 18 economic sectors in each of 22 countries/regions and is based on version 5.4 of the GTAP database for 1997 together with specially constructed estimates of services barriers and other data on sectoral employment and numbers of firms. The distinguishing feature of the model is that it incorporates imperfect competition in the manufacturing and services sectors, including monopolistic competition, increasing returns and product variety. The modelling focus is on the effects of the bilateral removal of tariffs on agriculture and manufactures and services barriers. Rules of origin and other restrictive measures and the non‐trade aspects of the FTAs are not taken into account due to data constraints. The computational results indicate that the benefits of bilateral FTAs for the United States and partner countries are rather small in both absolute and relative terms, and that far greater benefits could be realised if the United States and its FTA partners adopted unilateral free trade and especially if multilateral free trade was adopted by all countries/regions in the global trading system.     

Trade creation and diversion effects in the Mediterranean area: Econometric analysis by gravity model

Since the early 1990s, the world has seen a proliferation of free trade agreements (FTAs). A major goal of free trade is to develop trade between its signatories. The gravity model is used to analyze the bilateral trade data against the variables of the relative size of the pair of countries involved in trade, distance, common border and language and dummies for each of the FTAs. This article focuses on the studying of the influence of the FTAs in the Mediterranean countries in which we integrate the role of the regional dummy EU-15, Economic and Monetary Union (eurozone), the Arab Maghreb Union and AGADIR Agreement (FTA between Jordan, Egypt, Tunisia and Morocco) in trade flows. In addition, this work aims to detect the impact of the global financial crisis on export flows between the FTAs in the Mediterranean region. The use of regional variables in gravity models designed to determine whether the FTAs contribute to the creation or trade diversion. This study examines a cross section and panel (static and dynamic) of 27 countries for 1980–2011. The results show the existence of a strong relationship between the factors of FTAs and trade flows.     

The potential of African trade integration – Panel data evidence for the COMESA-EAC-SADC Tripartite

ABSTRACT

The COMESA-EAC-SADC Tripartite FTA, formed in 2011, is supposed to be a milestone towards Africa's continental trade integration. This study analyzes the impact of regional integration among the Tripartite countries on their bilateral imports before that date to evaluate the latest integration efforts. We estimate an extended gravity model on a large panel of 51 African countries using yearly observations from 1995 to 2010. We proxy existing formal trade barriers by sample average tariff data on imports from the world as well as indicator variables for the membership in regional FTAs. We consider different estimation techniques and discuss distinct sets of fixed effects. The PPML regression results indicate that remaining tariffs are significantly negatively correlated with imports throughout the preferred multiplicative models. An FTA status does not show a clear-cut import enhancing effect. In the specifications that control for country-year effects, the EAC coefficient is positively correlated with imports, and the COMESA and SADC FTA membership show a positive relation to imports within some reduced-sample robustness checks.     

Optimal Rules of Origin with Asymmetric Compliance Costs under International Duopoly

We examine the optimal rules of origin (ROO) in a free trade area/agreement (FTA) by employing a stylized three-country partial equilibrium model of an international duopoly. We incorporate compliance costs of the ROO into the model. In particular, compliance costs are higher for a firm located in a non-member country of the FTA than for a firm (an internal firm) located in an FTA member country, whereas marginal production costs are lower for the former. The FTA member countries set the optimal level of ROO to maximize their joint welfare. An importing country within the FTA imposes tariffs on imports that do not comply with the ROO. We show that the optimal ROO may have a protectionist bias in the sense that they are set for only the internal firm to comply. ROO may also cause low utilization of FTAs when they are set such that even the internal firm does not comply with them. These cases arise depending on parameter values.     

Free Trade Areas in East Asia: Discriminatory or Non‐discriminatory?

The debates on regional trade arrangements in East Asia focus on whether the RTAs can be net trade creating or diverting, and whether they impede multilateral trade liberalisation or not. This paper attempts to answer these questions by quantitatively estimating the economic impact of possible East Asian free trade areas based on a bilateral gravity model, and evaluating the main characteristics of the proposed FTAs. We find that the trade creation effect expected from the proposed East Asian FTAs such as a China‐Japan‐Korea or an ASEAN plus three (China, Japan, Korea) FTA will be significant enough to overwhelm the trade diversion effect. We also judge that East Asian FTAs will likely be a building block for a global free trade.     

The importance of heterogeneity in determining the effects of preferential trade agreements on Foreign Direct Investment

This paper investigates the importance of PTA formation in attracting inflows of foreign direct investment (FDI). In particular, we examine the heterogeneous effects of different types of PTAs (FTAs or CUs) on the extensive and intensive margins of FDI and on how the interdependence among various PTAs may affect a country's ability to attract FDI inflows. We find that the larger the preferential markets to which a country has access, the larger the FDI inflows the country receives. Furthermore, we find that the type of PTA matters in determining FDI inflows. In this case, we find that the formation of CUs tends to promote more FDI inflows than the formation of FTAs. Our findings also indicate that the formation of PTAs significantly affects FDI through the intensive margin, rather than through the extensive margin. Importantly, notice that these effects are driven by the preferential markets to which a country has access and that have not established a PTA with the FDI-originating (home) country, confirming that PTA interdependence matters in determining FDI inflows.     

Thai Trade Policy: From Non‐discriminatory Liberalisation to FTAs

FTAs have dominated Thai trade policy recently, reflecting the general trend in east Asia. But they also reflect domestic political changes, especially the decision‐making style of the Thaksin government. Thai FTAs have become very politicised. In particular, the US‐Thai FTA negotiations have run into a storm of domestic protest. The first section of the paper surveys the national trade‐policy framework. It highlights the slowdown of unilateral trade and FDI liberalisation after the Asian crisis, though a descent back into protectionism was successfully resisted. Thailand punches well below its weight in the WTO, and not very forcefully in ASEAN, because political attention and negotiating resources have switched to FTAs. The second section identifies the main actors in Thai trade policy, and briefly describes the trade‐policy decision‐making process as well as recent developments during the Thaksin administration. The following central section deals with Thailand's FTAs. These have been driven by vague foreign‐policy goals, while credible economic strategy has been lacking. The residual commercial logic is narrowly mercantilist and ‘trade‐light’, seeking an exchange of concessions in a narrow range of sectors rather than comprehensive, trade‐creating FTAs. Weak and partial FTAs are the result. The sole exception has been the Thailand‐USA FTA negotiations, as the USA wants a strong, deep‐integration FTA. However, negotiations were suspended in 2006 in the wake of the Thai political crisis. Overall, Thai trade policy post‐Asian crisis is highly unbalanced. It stands on a shaky FTA leg, while the other WTO leg has gone to sleep and the ASEAN arm is limp. Above all, core unilateral liberalisation and related regulatory reform are lacking.