For the study of economic integration, it is costumary to use a three countryworld,
where two of the countries may introduce forms of closer economic cooperation. In
the present model, we follow this tradition but put special emphasis on the role of
credit and entrepreneurship. Our model is of the standard neoclassical type, with the
addition that production takes time and is subject to uncertainty. Also, firms must use
the financial system in order to buy inputs; the cost of credit may differ among countries
and industries, reflecting their basic patterns of uncertainty.
Following the Newbery-Stiglitz approach, we show that in such model we may
exhibit cases of Pareto inferior trade and, in particular, Pareto inferior economic
integration. More specifically, we show that integrating countries of very different
economic size may give rise to adverse effects on welfare, whereas integration of
countries with a more similar economic structure and size tends to have beneficial
effects for the parties.
Keywords: trade, uncertainty, Pareto inferior trade, regional integration.
JEL classification: F11, F15, F3
