Are Regional Trading Partners “Natural”?

Abstract

A central statement of the theory of natural trading partners is that preferential trading with regional trading partners is less likely to be trade diverting and therefore geographically proximate partners are to be considered "natural" partners for preferential arrangements. This paper examines this question empirically. The analytical framework involves a general equilibrium model of preferential trade and an econometric model with tight links to this theory. This framework is used to implement tests of the natural trading partners hypothesis using U.S. trade data for the years 1964-95: Welfare changes that would result from preferential tariff reductions by the United States against various trading partners are first estimated, and correlations with bilateral "distance" measures (with and without controls for income levels) are then examined. Since the argument for "natural" trading partners is based on the greater likelihood of geographically proximate countries to be more significant trading partners, correlations between the welfare change estimates and bilateral trade volume are examined as well. Both geographic proximity and trade volume are found to have no effect. Thus this paper is unable to find any support for the natural trading partners theory in U.S. data.

Regional Trade Agreements

“…Furthermore, a country could be better off forming an RTA with a distant rather than a proximate country. Krishna (2003) addresses this point by using detailed U.S. trade data to estimate the welfare effects from 24 hypothetical bilateral trade agreements in a general equilibrium framework and then correlating the estimated welfare changes with geographical variables and trade volumes. Neither geography nor trade volume is found to be significantly correlated with welfare gains, suggesting that they are not good indicators of the gains from trade, as the natural trade blocs approach would suggest.…”

The Political Economy of Free Trade Agreements: an Empirical Investigation

“…Krishna (2003), however, does not find empirical support for the welfare-improving effects from US data. The estimation strategy of our paper is not based on a structure model and bilateral trade simply enters the regression as a control variable.…”

“…The estimation strategy of our paper is not based on a structure model and bilateral trade simply enters the regression as a control variable. Due to many differences in the data and methods, the results of Krishna (2003) and ours are not really comparable. But we believe that the endogeneity problem of trade flows can be better addressed in a general equilibrium framework as in Krishna (2003).…”

North-South Technology Diffusion, Regional Integration, and the Dynamics of the “Natural Trading Partners” Hypothesis

“…Schiff (2001) shows that these analyses are incorrect because of a failure to take the relationship between the partner country and the rest of the world into account, and that no conclusion can be drawn about the impact of being "natural trading partners" on the benefits of forming a RTA. Krishna (2003) uses a different approach to test the "natural trading partners" hypothesis. He first estimates the welfare impact of RTAs between the US and twenty four developed and developing countries, and then regresses the welfare impact on the trade volume and on the distance between the RTA members.…”