This paper examines the formation of bilateral free trade agreements (FTAs) on the basis of country heterogeneity in the tariff level. We demonstrate that a country's unilateral incentive to form an FTA depends on the relative magnitudes of the (negative) market concession effect and the (positive) market expansion effect, both of which are determined by the tariff levels of the two FTA partner countries. Global welfare is maximised when all country pairs form FTAs. Two countries in equilibrium are more likely to form an FTA when their tariff gap is smaller or when their tariff levels are neither very high nor very low. This finding is robust to several extensions of the model. Our preliminary empirical analysis provides some evidence for the finding.
|Number of pages||27|
|Early online date||27 Nov 2019|
|Publication status||Published - Jan 2020|
Bibliographical noteThis project was financially supported by the Research Grant Council Competitive Earmarked Research Grant 2012–2014 (No. HKU751812B) of the Hong Kong Special Administrative Region Government. We also benefited from a seminar at the University of International Business and Economics (China) and conference presentations in Asia‐Pacific Trade Seminars 2016 and IEFS China 2016.
- free trade agreement
- FTA formation
- FTA incentive
- FTA network
- global welfare