Preferential trade agreements harm third countries

In this paper, we study market liberalization in an imperfectly competitive environment in the presence of price effects. For this purpose, we build a three-country model of international trade under monopolistic competition with endogenous prices and wages. The neighboring effect translates how the size effect propagates across countries. When some country increases in size, its relative wage increases, as well as that in a small and near country, while that in a large and distant country falls. We also show that a preferential trade agreement increases the relative wage, the welfare, and the terms-of-trade in the partner countries, where the integration effect dominates, while it lowers those in the third country.