Are Preferential Trade Agreements with Non-trade Objectives a Stumbling Block for Multilateral Liberalization?

Nuno Limão , Review of Economic Studies 74(3) , 821-855 , July 2007.

In many preferential trade agreements (PTAs) countries exchange not only reductions in trade barriers but also cooperation in non-trade issues such as labor and environmental standards, intellectual property, etc. We provide a model of PTAs motivated by cooperation in non-trade issues and analyze its implications for global free trade and welfare. We find that such PTAs increase the cost of multilateral tariff reductions and thus cause a stumbling block to global free trade. This occurs because multilateral tariff reductions decrease the threat that can be used in PTAs and thus the surplus that can be extracted from them. By explicitly modeling the interaction between preferential and multilateral negotiations we derive a testable prediction and provide novel econometric evidence that supports the model’s key prediction. The welfare analysis shows that the current WTO rules allowing this type of PTAs may be optimal for economically large countries, thus the model can predict the rules we observe. We also analyze alternative rules that constitute a Pareto improvement.

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