The Size of Symmetric Free-Trade Blocs and World Welfare
25 Pages Posted: 23 May 2016 Last revised: 29 May 2016
Date Written: May 26, 2016
In a symmetric model of free-trade blocs, the seemingly innocuous normalization rule by setting the world price of a given good as the numéraire will cause asymmetry in the Nash equilibrium. This paper presents a new symmetric tariff game approach and a new price normalization rule that are logically required and consistent in order to examine the effects of changes in the size of free-trade blocs on world welfare. In a symmetric model, a trading bloc does not act on the actions of the rest of the world as a whole but to individual external blocs in a one-to-one fashion. The relative bargaining power between any two blocs is always evenly matched. We show that the optimal tariff schedule is monotonically decreasing in relative bloc size, and the world welfare unambiguously increases if the trading world becomes more integrated. As a result, the pessimal (lowest world welfare) bloc number is much larger than the ones obtained in the Krugman and Bond-Syropoulos models. Our results support Ohyama-Kemp-Wan-Shimomura's findings and strengthen the case for regionalism as a stepping stone (building block) toward a complete world economic integration. The paper thus provides a theoretical foundation for the benefits of economic integration.
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