On the different geographic characteristics of Free Trade Agreements and Customs Unions

A striking phenomenon emerges from casual observation of the geographical characteristics of Preferential Trade Agreements (PTAs): while Customs Unions (CUs) are only intra-regional, Free Trade Agreements (FTAs) are both inter and intra-regional. A second striking phenomenon is that FTAs dramatically outnumber CUs. We present a farsighted dynamic model that endogenizes the choice of PTA type and rationalizes the first phenomenon via an FTA flexibility benefit: FTAs are more flexible than CUs because an FTA member is free to form further PTAs with non-members whereas a CU member must engage in further PTAs jointly with all existing members. Our model also suggests that greater distance between countries increases the prevalence of FTAs relative to CUs. Finally, the model relates geography and market size to the order of PTA formation