Do Free Trade Agreements Affect Tariffs of Nonmember Countries? A Theoretical and Empirical Investigation

Abstract

We investigate the effects of free trade agreements (FTAs) on tariffs of nonmember countries. In our multi-country model, the formation of an FTA leads members to reduce their exports to the rest of the world. Such external trade diversion weakens the ability of nonmembers to manipulate their terms of trade vis-à-vis FTA members, a mechanism that induces them to lower their tariffs on FTA members. We empirically confirm this insight using industry-level trade data for 192 importing and 253 exporting countries, along with information on all FTAs formed in the world during 1989–2011. (JEL F13, F14)

Dynamic preferential trade agreement formation and the role of political economy

“…Finally, consider the optimal tariffs of the outsider on goods I and J in which each of the FTA insiders are sole exporters. As in Missios et al (2016) and Saggi et al (2018) in competing importers model, we find that the external tariffs on these goods imposed by different importers are strategic complements and thus elimination of internal tariffs via PTA formation leads to external trade diversion, and induces the PTA outsider to lower its external tariffs 22 :…”

“…(2016) and Saggi et al. (2018) in competing importers model, we find that the external tariffs on these goods imposed by different importers are strategic complements and thus elimination of internal tariffs via PTA formation leads to external trade diversion, and induces the PTA outsider to lower its external tariffs 22 : $$${t}_{ki}^{I}\left({g}_{ij}^{\mathit{FTA}}\right)={t}_{kj}^{J}\left({g}_{ij}^{\mathit{FTA}}\right)=\frac{\alpha \left(3\lambda {\rho }_{m}+2\lambda +12{\rho }_{m}\right)}{(4+\lambda )\left(16+2\lambda -\lambda {\rho }_{m}-4{\rho }_{m}\right)}< {t}_{k}^{I}\left({g}_{\phi }\right)={t}_{k}^{J}\left({g}_{\phi }\right)$$$ The general intuition behind this result is as follows. The removal of internal tariffs under an FTA raises the elasticity of export supply of countries i and j facing country k .…”

“…Prominent examples in this strand of literature include papers byKrugman (1991),Bhagwati (1991),Yi (1996),Bagwell and Staiger (1997a, 1997b, 1998,Krishna (1998),Riezman (1999),Bond et al (2004),Goyal and Joshi (2006),Furusawa and Konishi (2007),Aghion et al (2007),Missios et al (2016),Ornelas (2005aOrnelas ( , 2007,Saggi and Yildiz (2010), and Saggi et al (2013, 2018, 2019.3 SeeLevy (1997),Krishna (1998),Ornelas (2005bOrnelas ( , 2005cOrnelas ( , 2007, andStoyanov and Yildiz (2015).4 This is also the case inStaiger (1999) and, although in a less explicit form.5 Chi and Yildiz (2023) uses the same unified framework in a static setting and find coalition proof Nash equilibrium of the FTA game.6 Some prominent works includeSaggi and Yildiz (2010),Saggi et al (2013) andMissios et al (2016). WhileSaggi and Yildiz (2010) andMissios et al (2016) show that FTAs serve as building blocks,Saggi et al (2013) argues that CUs serve as stumbling blocks.7 Consistent withGrossman and Helpman (1995), import subsidies obtain under a multilateral agreement when assigning equal weights in exporting and import-competing sectors.…”

Deep trade agreements and trade costs

“…Here, we focus on the non-tariff costs since the third-country effect of the trade agreement on T A B L 1 0 Intensive margin of depth (WB-DTA 2.0 dataset). tariff is well studied the existing literature (see Saggi et al, 2018). We estimate the following specification:…”

“…In this section, we examine the effect of DTAs on trade costs for non‐member countries directly. Here, we focus on the non‐tariff costs since the third‐country effect of the trade agreement on tariff is well studied in the existing literature (see Saggi et al, 2018). We estimate the following specification:…”