New Empirical Insights into the “Natural Trading Partner” Hypothesis for CARICOM Countries

The central notion of the natural trading partner hypothesis is that a Free Trade Agreement (FTA) will be welfare enhancing for members if there is a strong level of bilateral trade complementarity among their trade structures. This paper presents an empirical examination of this issue with reference to a small developing trade bloc–the Caribbean Community (CARICOM) and its trading partners. The trade intensity index model is used to assess the determinants of intra-CARICOM and extra-CARICOM trade, placing focus on trade complementarity. The results showed that intra-CARICOM trade complementarity is low and concentrated in a few primary industries which can provide a possible explanation for the persistent low levels of intra-CARICOM trade. The findings also indicate that trade complementarity is generally low between CARICOM countries and their proposed FTA partners in the European Union (EU) and North America. The best natural trading partners for CARICOM countries are then identified based on a ranking of countries from 7 regions (CARICOM, the EU, North America, Asia, Central America, Latin America and Africa).