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 re ‡ects the relatively ‡exible 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 tari¤. By diverting members'exports away from the non-member, both types of trade agreements induce the non-member to voluntarily lower its import tari¤s.
This paper compares equilibrium outcomes of two games of trade liberalization. In the Bilateralism game, countries choose whether to liberalize trade preferentially via a customs union (CU), multilaterally, or not at all. The Multilateralism game is a restricted version of the Bilateralism game in that countries cannot form CUs and can only undertake non-discriminatory trade liberalization. When countries have symmetric endowments, global free trade is the only stable equilibrium of both games. Allowing for endowment asymmetry, we isolate circumstances where the option to form CUs helps further the cause of multilateral liberalization as well as where it does not. (JEL F12, F13)
We develop an equilibrium theory of trade agreements in which both the degree and the nature (bilateral or multilateral) of trade liberalization are endogenously determined.To determine whether and how bilateralism matters, we also analyze a scenario where countries pursue trade liberalization on only a multilateral basis. We …nd that when countries have asymmetric endowments or when governments value producer interests more than tari¤ revenue and consumer surplus, there exist circumstances where global free trade is a stable equilibrium only if countries are free to pursue bilateral trade agreements. By contrast, under symmetry, both bilateralism and multilateralism yield global free trade.
We develop an equilibrium theory of trade agreements in which both the degree and the nature (bilateral or multilateral) of trade liberalization are endogenously determined. To determine whether and how bilateralism matters, we also analyze a scenario where countries pursue trade liberalization on only a multilateral basis. We find that when countries have asymmetric endowments or when governments value producer interests more than tariff revenue and consumer surplus, there exist circumstances where global free trade is a stable equilibrium only if countries are free to pursue bilateral trade agreements. By contrast, under symmetry, both bilateralism and multilateralism yield global free trade.
This paper compares stable Nash equilibria of two games of trade liberalization. In the FTA game, each country can form an FTA with either one of its trade partners, or both of them, or none of them. By contrast, in the No FTA game, each country must choose either no agreement or free trade. Under symmetry, free trade is uniquely stable under the No FTA game whereas the FTA game also admits a bilateral FTA as an equilibrium. However, there exist patterns of cost asymmetry for which the freedom to pursue bilateral FTAs is necessary for achieving global free trade.
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