482. Preferential Trade Agreements and Welfare: General Equilibrium Analysis

Juyoung Cheong, Shino Takayama and Terence Yeo, School of Economics Discussion Paper No. 482 July 2013, School of Economics, The University of Queensland. Australia.

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Abstract

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.