Can Bilateral Trade Agreements Help Induce Free Trade

Abstract

There has been growing debate about whether bilateral trade agreements are damaging multilateral efforts to eliminate barriers to international trade. This paper develops a model in which trading blocks always charge optimal tariffs and make trade agreements based on strategic considerations. We ask a very simple question. Does the fact that trading blocs can form bilateral trade agreements make Free trade less likely to occur? The answer is that it depends on the size distribution of the trading blocs. If there is one large trading bloc along with some smaller ones then bilateral trade agreements allow the smaller trading blocs to coalesce and block the monopoly power of large trading blocs. In this case, bilateral trade agreements facilitate the attainment of free trade. Not allowing customs unions leads to more not less protection. If trading blocs are of roughly equivalent size then bilateral trade agreements allow groups of trading blocs to more effectively monopolize world trade in which case they may make free trade less likely. These results suggest that a policy that inhibits the formation of trading blocs may be harmful. We also compute the welfare effects of trade agreements to get some idea of how empirically important these issues are.

JEL Classification: F12, F13