External trade diversion, exclusion incentives and the nature of preferential trade agreements

In a game of endogenous trade agreements between three countries, we show that while the pursuit of customs unions (CUs) prevents global free trade from emerging as a coalition-proof Nash equilibrium, the pursuit of free trade agreements (FTAs) does not. This result reflects the relatively flexible...

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Bibliographic Details
Published in:Journal of international economics 2016-03, Vol.99, p.105-119
Main Authors: Missios, Paul, Saggi, Kamal, Yildiz, Halis Murat
Format: Article
Language:English
Subjects:
Customs union
Customs unions
Free trade
Free trade agreement
Game theory
Hub and spoke agreements
Optimal tariffs
Studies
Tariffs
Trade agreements
Trade liberalization
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Summary:In a game of endogenous trade agreements between three countries, we show that while the pursuit of customs unions (CUs) prevents global free trade from emerging as a coalition-proof Nash equilibrium, the pursuit of free trade agreements (FTAs) does not. This result reflects the relatively flexible nature of FTAs: whereas each FTA member can independently undertake further trade liberalization with respect to the non-member, CU members must do so as a group due to their common external tariff. By diverting members' exports away from the non-member, both types of trade agreements induce the non-member to voluntarily lower its import tariffs. ••A free trade agreement (FTA) is more flexible than a customs union (CU).••The exclusion incentive of a CU is relatively stronger.••The formation of either type of PTA causes external trade diversion.••Such trade diversion induces the non-member to lower its external tariffs.••While the pursuit of CUs prevents free trade, the pursuit of FTAs does not.
ISSN:0022-1996
1873-0353
DOI:10.1016/j.jinteco.2016.01.002