Why are trade agreements regional? A theory based on noncooperative networks

Abstract

This paper argues that free trade agreements (FTAs) are regional because, in their absence, optimal tariffs are higher against (close)regional partners than (distant) countries outside the region. Optimal tarffs shift rents from foreign firms to domestic citizens. Lower transport costs imply higher rents and therefore higher tarffs. So regional FTAs have a higher pay-off than non-regional FTAs. Therefore, only regional FTAs may yield positive gains when sponsoring a FTA is costly. To analyze equilibrium, standard theory of non-cooperative networks is extended to allow for asymmetric players. Naive best response dynamics show that ‘trade blocks can be stepping blocks’ for free trade