Corresponding author: Jeffrey H. Bergstrand, Professor, Department of Finance, Mendoza College of Business and Kellogg Institute for International Studies, University of Notre Dame (Bergstrand.1 nd.edu).
Scott L. Baier, Associate Professor, John Walker Department of Economics, Clemson University; Peter Egger, Professor of Economics, University of Munich, and IFO Institute.
To some, the New Regionalism is also associated with increased depth of certain agreements, such as the European Union’s deepening relative to the original European Economic Community.
The discerning reader, of course, should ask small, relative to what? The statement in the text more precisely requires specification of the counterfactual. In most cases, it would be relative to some quantitative prediction of the difference in trade levels with and without the FTA, that is, a general equilibrium comparative-static effect. The formal specification of such an effect is beyond the scope of this paper. However, many large-scale computable general equilibrium models suggest quantitative impacts. In the context of our paper, we focus on two issues. First, we discuss informally an alternative general equilibrium approach to estimating average FTA treatment effects that weds more closely theory and empirical evidence. Second, we address informally how endogeneity bias in empirical estimation of FTA treatment effects tends to reduce estimated effects.
See Mansfield and Reinhardt (2003) and Moravcsik (2005). Also, Moravcsik argues that competitive liberalization pressures have been the dominant force behind much of European economic integration, with the likely exception of Germany’s motivation in the 1950s.
See, for example, Krugman (1991a & b), Frankel, Stein and Wei (1995 & 1996), and Frankel (1997).
As mentioned, our analysis initially will take as given exogenously the prevailing level of policy-oriented trade barriers, such as tariff rates. In reality, the ideal approach would be to consider the endogenously-determined Nash equilibrium tariff rates pre- and post-integration, as the pre-integration Nash equilibrium tariffs are likely to differ from the post-integration ones. Addressing this limitation, however, is beyond the scope of this paper, especially due to incorporation of asymmetric economic sizes of countries, inter-continental transport costs, and intra-continental transport costs.
In the remainder of the paper, we will often use the terms bilateralism and regionalism interchangeably.
As noted in Anderson and van Wincoop (2004), Anderson (1979) and Anderson and van Wincoop (2003) are conditional general equilibrium models, employing a trade separability assumption where the allocation of bilateral flows across N countries is separable from production and consumption allocations within countries.
See Anderson and van Wincoop (2004) for an excellent survey of the literature on theoretical foundations for the gravity model. In Anderson (1979), all prices were normalized to unity. In Bergstrand (1985, 1989 & 1990), a small-country assumption was employed to treat the other N-1 countries’ price levels as exogenous to the country pair ij. In Anderson and van Wincoop (2003) all countries’ price levels are endogenous.
In our theory, we assume that the decision to have or not have an FTA takes as exogenous the current WTO structure that impedes achieving free trade. We assume, as Bergsten (1996) states, it simply turns out to be less time-consuming and less complicated to work out mutually agreeable arrangements with a few neighbors than with the full membership of well over 100 countries in the WTO, p. 4). This is also consistent with the approach taken in Grossman and Helpman (1995b) that, as in Grossman and Helpman (1994a & 1995a), we suppose the incumbent government is in a position to set trade policy, which means here that it can either work toward a free-trade agreement or terminate the discussions (p. 670). A multilateral trade-policy alternative is ruled out by assumption.
We borrow this useful distinction from Krugman (1991a).
See, for example, Grossman and Helpman (1995b) or Gawande, Sanguinetti, and Bohara (2005).
Even in a monopolistically competitive framework, countries might optimally choose higher tariffs in equilibrium. We assume they do not for three reasons: (1) the spirit of the GATT/WTO, where FTA members are precluded from raising their average external tariffs; (2) the Nash equilibrium may even yield a lowering of external tariffs (see work by Yi, 2000, and Ornelas, 2001); and (3) we have not observed increases in external tariffs (see empirical work by Estevadeordal, Freund and Ornelas, 2005).
Along the same lines, the change in the 1980s in U.S. policy from one wedded to “multilateral” liberalization under the GATT to one allowing regional EIAs likely reflects a “competitive” response to the enlargement of the European Community beginning in 1973. In fact, only 8 years after the EEC was born, the United States and Canada signed a free trade agreement for the automotive sector, and discussions were being pursued for a full U.S.-Canada free trade agreement.
For instance, many would argue of course that eliminating future wars between France and Germany and establishing a united trade agreement among Western European countries to confront the Soviet Union’s military threat were important factors in establishing the original EEC.
As addressed in the text, political factors are likely quite important in the “timing” of agreements.
Baier and Bergstrand are grateful to the National Science Foundation for financial support under grants SES-0351018 (Baier) and SES-0351154 (Bergstrand). Bergstrand and Egger are grateful for funding from the Leibniz Gesellschaft project “How to construct Europe”.