On the Relationship between Preferential and Multilateral Trade Liberalization: The Case of Customs Unions

Abstract

This paper analyzes a game of trade policy (called Bilateralism) between three countries in which each country chooses whether to liberalize trade preferentially in the form of a Customs Union (CU), multilaterally, or not at all. We also analyze a restricted version of this game (called Multilateralism) under which countries do not have the option to form CUs. The analysis sheds light on the relationship between multilateral and preferential trade liberalization as sanctioned by GATT Article XXIV. We …nd that when countries have symmetric endowments, global free trade can be achieved without permitting CUs. Allowing for asymmetry, we isolate circumstances where Article XXIV helps further the cause of multilateral liberalization as well as when it does not. Furthermore, we show that Article XXIV's stipulation-that countries forming a CU not raise tari¤s on outsiders-fails to make multilateral liberalization any more attractive to countries. However, such a tari¤ restriction does lower the adverse impact of a CU on the non-member.

Essays on the interaction between multilateral tariff bindings and the formation of preferential trade agreements

“…4 Our simple formulation of a CU's tariff choice is intuitively appealing and consistent with much of existing literature, even with asymmetric countries and transfers excluded (e.g. Saggi et al (2013)). Moreover, our results merely rely on the one period CU payoff possibly exceeding the one period FTA payoff.…”

“…Joint welfare maximization implies that the exclusion incentive is stronger under a CU relative to an FTA and thus τ u (λ) > τ (λ) for all λ. Here, it is important to note that Saggi et al (2013) show under symmetry that there exists no exclusion incentive under a CU formation game in a competing exporters model when tariff bindings are not taken into account. Our result confirms this finding under " no tariff binding scenario" but goes one step further and suggests that this result fails to hold when countries are constrained in imposing their optimal tariffs due to sufficiently tight tariff bindings.…”

“…Relying on free riding incentives in endogenous FTA formation setting, Saggi and Yildiz (2010) show the incentive to free ride on FTA formation is weaker than the incentive to free ride on MFN liberalization of other countries and, hence, FTAs can be a "building bloc" to global free trade. In contrast, Saggi et al (2013) rely on an exclusion incentive and show the incentive of CU members to exclude the non-member can be stronger than the MFN free riding incentive and, hence, CUs can be a "stumbling bloc" to global free trade. We extend this literature by examining the degree of exclusion incentives and free riding incentives as tariff bindings fall and determining whether these incentives are exercised in the equilibrium.…”

“…Ultimately, multilateralism acts as a stumbling bloc to 5 Bagwell et al (2016) made an excellent survey of economic literature addressing various trade agreements (including WTO and PTAs) and their relative role in trade liberalization from the "terms-of-trade" theory perspective. 6 Prominent examples in this strand of literature include papers by Krugman (1991), Bhagwati (1991), Yi (1996), Bagwell and Staiger (1997a, 1997b, 2005a, 2005b, Krishna (1998), Riezamn (1999), Bond et al (2004), Goyal and Joshi (2006), Furusawa and Konishi (2007), Aghion et al (2007), Missios et al (2016), Ornelas (2005Ornelas ( , 2007, Saggi (2006), Saggi andYildiz (2010, 2011), Saggi et al (2013Saggi et al ( , 2018, Stoyanov and Yildiz (2015) and Lake (2017).…”

“…In contrast, countries are continuously forming PTAs on the surface of the global trade policy landscape and, in doing so, choosing whether to form FTAs or CUs. Primarily based on Saggi and Yildiz (2010) and Saggi et al (2013), Maggi (2014) hypothesizes that CU formation constrains the prospects of global free trade but argues such a conclusion requires a model where countries endogenously choose between CU and FTA formation. Chapter 5 indeed address Maggi's hypothesis by developing a model where countries endogenously choose between FTA and CU formation and asking the following question: does a given type of PTA improve or hurt the prospects of global free trade relative to the outcome if this type of PTA was banned?…”