Enlargement of Trade Blocs: National Welfare Effects If Trade Is Liberalized

Small countries may benefit from the formation of a trade bloc, since their combined market power will enable them to manipulate the terms of trade. The question of interest is whether countries will benefit from the enlargement of a trading bloc, if trade liberalization induces countries to substitute domestic support measures for conventional border protection. The paper deals with this question by analyzing the conditions for positive welfare effects resulting from the enlargement of a trade bloc. Based on a partial equilibrium trade model, we consider a game in production taxes/subsidies between two trade blocs. The tax/subsidy instrument may capture the production effect which can be induced by a combination of environmental, health or safety rules. The paper demonstrates that national welfare effects from the enlargement of a trading bloc depend crucially on a member country's net trade flow and the relative market power of the trade bloc. The theoretical analysis is supplemented by a numerical analysis estimating the potential welfare gains of EU enlargement on the major grain crop markets. Based on the scenarios that the EU operates either as a monopoly or competes with the rest of the world within a duopoly, upper and lower bounds of potential welfare effects resulting from enlargement are estimated. The results suggest that welfare effects on the major European grain markets are very small in proportion to the total production value. We thereby conclude that political reasons are likely to remain the main motivation for further EU enlargement.