Bilateral versus Multilateral Free Trade Agreements: A Welfare Analysis

Abstract:     
Why do we observe proliferation of bilateral free trade agreements (FTAs) between certain types of countries instead of having progress in attaining global free trade through a multilateral FTA? We answer this question by exploring the enforceability of different types of FTAs through comparing minimum discount factors that are necessary to sustain them in an infinitely repeated game framework. We also search for the globally welfare maximizing trade agreements that are sustainable under different conditions. The results depict that transportation costs, differences in country sizes and comparative advantages are all obstacles for having a multilateral FTA. Accordingly, we suggest that international policies conducted for the removal of such obstacles should be the main goal toward achieving a multilateral FTA, which we show to be the first-best solution to the maximization problem of global welfare.

Number of Pages in PDF File: 35

Keywords: Free Trade Agreements, Self-Enforcing Rules, Transportation Costs, Country Size, Comparative Advantage, Repeated Game

JEL Classification: C72, C73, D60, F15

working papers series