On the Value of Preferential Trade Agreements in Multilateral Negotiations

This paper explores the effects of preferential trade agreements (PTAs) on multilateral negotiations using a three-country, noncooperative bargaining model. PTAs are treated as outside options of the multilateral negotiation, with the feature that they continue to negotiate after they form. The organization of a PTA, whether into a customs union (CU) or free-trade area (FTA), is crucial. CUs benefit from the strategic commitment afforded by common external trade barriers, but this benefit is reduced by asymmetry between the CU partners and by discounting. It is also affected by externalities that any additional PTAs impose on members of the first. FTAs reduce the multilateral bargaining outcome effectively to one of simultaneous bilateral bargaining, whereas CUs result in a large share going to the country that has the first option of forming one. By way of example it is shown that, when CUs and FTAs are considered together, the distribution lies in between the pure FTA and CU outcomes, and there is no general presumption that relatively large countries will prefer a regime that permits PTAs to one that does not.