Market presence, contestability, and the terms-of-trade effects of regional integration

This paper examines the impact of market presence and contestability on the price behavior of US exporters in Brazil’s market when MERCOSUR and MFN trade liberalization take place. Using detailed panel data on trade and tariff rates, we find that both the preferred supplier’s market presence and threat of entry lower (raise) the US price reaction to MFN (preferential) trade liberalization, with similar quantitative effects. Thus, presence in, or threat of entry into, partners’ markets implies lower optimal MFN tariffs, and regional agreements can have pro-competitive effects in contestable markets. We also examine the ‘symmetry’ hypothesis between the effect of tariffs and exchange rates.