Production Sharing and Regional Integration

Preferential trade agreements between dissimilar economies are known to encourage inter-industry specialization, but when they take place between developed and developing countries, they also change the nature of intra-industry trade by facilitating cross-border production sharing. When such arrangements liberalize foreign direct investment as well as trade, production is internationalized and component or intra-product trade increases. Using a standard trade model, this paper derives the conditions under which integration of this type improves competitiveness and raises employment, output, and welfare.