Free Trade Agreements and External Tariffs

There has been a proliferation of preferential trade agreements within the last two decades. In this paper I analyze the effects of free trade agreements (FTAs) on external tariffs under a political economy setup. I extend the Grossman and Helpman (1995) model by determining tariff rates endogenously instead of assuming they are fixed during or after the formation of FTAs. I show that for an exogenously established FTA, the tariff rates that apply to non-members essentially decline once the FTA is formed. More importantly, I investigate the interaction between endogenous tariff determination and the feasibility of an FTA. I find that the expectation of tariff reductions under endogenous tariffs makes an otherwise feasible FTA under fixed tariffs become infeasible. However, if domestic import-competing sectors are relatively smaller, an FTA is more likely to be feasible as compared to fixed tariffs.