Preferential trading areas: investment and welfare effects when countries differ in their size

Abstract

This paper examines the investment and welfare effects of a preferential trading area (PTA) on member and non-member countries when countries differ in their relative size. I numerically solve a three-country and two-good model to characterize equilibria pertaining to investment diverting and creating effects of a preferential trade area. I conclude that welfare benefits of a preferential trade area are non-negative for the member countries, and could go either way for the non-member countries depending on their relative size. There exist equilibria which, given the parameter values and the relative size, result in welfare improvement in non-member countries