Preferential Trade Agreements and Welfare: General Equilibrium Analysis

This paper studies the welfare effects of a preferential trade agreement (PTA) within a general equilibrium framework following Eaton and Kortum (2002) and conducts a comparative statics analysis of the equilibrium. The paper provides a closed-form analysis with no assumption of balanced trade and analyzes how a PTA affects the price level, trade flows, and welfare of both member and nonmember countries. We show that a PTA decreases the price level of not only member but also nonmember countries. We also show that a positive coalition externality can arise in that a nonmember country can gain from the establishment of a PTA. Our analysis indicates that countries possessing a large nonmanufacturing sector relative to the economy or a high level of technology are more likely to gain from a coalition externality. Under no assumption of balanced trade, our analysis demonstrates that changes in tariff revenues and labor mobility between tradable and nontradable sectors are a key factor affecting welfare and, thus, countries’ incentives to join a PTA. Finally, using a calibrated model for 38 countries, we estimate price and welfare changes under several scenarios of the Trans-Pacific Partnership (TPP) and numerically demonstrate our theoretical results. equilibrium model to explore how a Trans-Pacific Partnership affects each country’s welfare and trade flows. We decompose the total change of trade flows from member countries into income effects and substitution effects, and investigate the factors that affect trade flows. We demonstrate that a positive coalition externality could exist in that some nonmember countries could gain more than member countries and further investigate under which circumstances it arises.