Do Labor Clauses in Regional Trade Agreements Reduce the Trade Creation Effect?

We empirically test the hypothesis that labor clauses (LCs) in regional trade agreements (RTAs) reduce the trade creation effect of RTAs. We estimate a structural gravity model using a panel of bilateral trade data for the sample of 190 countries/regions for the 25-year period of 1990–2014. Using the Poisson pseudo-maximum likelihood estimator, we find that legally enforceable LCs are likely to enhance the trade creation effect of RTAs, whereas legally unenforceable LCs could reduce it, on average. We also find that these impacts of LCs on the RTAs’ trade creation effect are heterogeneous among the types of country pairs: the positive impact of legally enforceable LCs is significant for trade between developed countries but insignificant for trade between developing countries; and the impact of legally unenforceable LCs is significantly negative for trade between developed countries, although it is rather positive for trade to developing importers. Moreover, we find that, when we deal with the endogeneity issue, the estimated impacts of LCs become insignificant, suggesting that countries may selectively decide whether they include LCs in the negotiated RTAs considering their potential impacts on trade with the RTA partners.