Small is beautiful : preferential trade agreements and the impact of country size, market share, efficiency, and trade policy

There has been a resurgence of preferential trade agreements (PTAs). This has led to renewed debate about how PTAs affect both welfare and the multilateral system. The author examines two ideas: the welfare impact of PTAs and the effect of structural and policy changes on PTAs. He asks how the PTA's effect on home-country welfare is affected by higher imports demand; the production efficiency of the partner or rest of the world; the share imported from the other partner; and the initial protection on imports from the partner. There are several findings. An individual country benefits more from a PTA if it imports less from its partner countries. A small home country loses from forming a free trade agreement with a small partner country, but gains from forming one with the rest of the world. In other words, the home country is better off as a small member of a large bloc than as a large member of a small bloc. This result need not hold if smuggling is a factor. Home country welfare after formation of a free trade agreement (FTA) is higher when imports from the partner country are smaller, whether the partner country is large or small. Welfare worsens as imports from the partner country increase. In general a PTA is more beneficial for a country with lower import demand. A PTA is also more beneficial for a country with an efficient import-substituting sector. A small country may gain from forming a PTA when smuggling is a factor.