On the Viability of a Multilateral Trade Agreement: A Political-Economy Approach
Trupkin, Danilo R., Journal of Business Strategies
The big picture issue this paper intends to address is on the incentive aspects of a multilateral trade liberalization. The paper builds on a framework originally introduced in Grossman and Helpman's The Politics of Free-Trade Agreements (1995). The aim of that work was to explain the viability of free trade agreements (FTAs) between two countries in a political-economy framework. A simple extension to a three-country setting allows us to analyze whether FTAs are "building blocs" or "stumbling blocs." An illustration with specific functional forms serves to find conditions under which FTAs are, somehow, partial building blocs, i.e., a bilateral liberalization can be feasible when multilateral liberalization is not.
A large number of preferential trade agreements (PTA) do exist nowadays all around the world. According to the World Trade Organization (WTO), more than 200 are in effect today. Almost all major countries are members of at least one PTA, and, most importantly, the majority of these agreements were originated during the last decade.
Bhagwati (1995) has called this scenario a "spaghetti bowl" of tariffs in which countries impose different tariff rates on the same good depending on its origin. In an earlier paper, Bhagwati (1991) addresses this issue by analyzing whether free-trade agreements (FTAs) are building blocs or stumbling blocs to the achievement of a broad multilateral agreement.
Since Viner's (1950) analysis on the welfare effects of customs unions, research interests in this topic have considerably caught the attention of international trade theorists. Viner pioneered the static analysis of trade agreements providing the message that these arrangements could harm both a member country and world welfare, i.e., they can be "trade diverting." (2)
There have been concerns recently in regards to the viability of a successful multilateral trade liberalization in a world that is largely populated by potentially harmful FTAs. (3) In this line, Krishna (1998) asks the political-economy question of whether FTAs have incentives to keep expanding with more members toward a multilateral liberalization, or, instead, they wish to keep new members out. On the other hand, Aghion et al. (2007) address the question of regionalism versus multilateralism by investigating whether multilateral bargaining or sequential bargaining are more likely to lead to global free trade.
The "stumbling-bloc" view of FTAs has been supported, among others, by Bhagwati (1991, 1993) who finds that, even though FTAs may generate static welfare gains, they finally reduce the incentives to seek posterior trade liberalization. Yet, others such as Summers (1991) argue that deeper integration within a subset of countries may raise the chances for successful multilateral negotiations. An interesting recent work by Saggi and Yildiz (2006) finds both stumbling-bloc and building-bloc effects, and illustrates cases in which trade agreements are "partial building blocs," i.e., FTAs can improve welfare when multilateral liberalization is not attainable.
The focus of this paper is both on the incentive aspects that explain the formation of trade blocs and on the viability of a multilateral agreement. The approach followed belongs to the political-economy theory literature on international trade. In particular, this paper builds on a framework, first introduced in Grossman and Helpman (1995). They analyze the viability of an FTA between two countries approaching the political-economy problem by emphasizing the interaction between lobbies and an incumbent government. That paper considers both the case when the FTA must cover all bilateral trade and the case when some politically sensitive industries can be excluded from the agreement.
In Grossman-Helpman (1995), international relations involve two distinct stages of strategic interaction. In the initial stage, political competition among special interests in each country--the lobbies--determines the government's trade policy preferences. …