Departmental Bulletin Paper Trade Costs and Welfare-worsening Free Trade Agreement

Yanase, Akihiko  ,  Tsubuku, Masafumi

(E15-6) 2015-10 , 名古屋大学大学院経済学研究科附属国際経済政策研究センター
This paper examines the effects of concluding a free trade agreement (FTA) in the presence of international trade costs between countries. In the traditional arguments, the optimal external tariffs set by the FTA members are always lower than the pre-FTA optimal tariffs, which implies that there are the tariff complementarity effects as the FTA forming. To reexamine this argument, we construct a simple three-country model of imperfect competition with endogenously determined (external) tariffs, and demonstrate that in the presence of trade costs, the member countries may employ the higher external tariff as they form the FTA. That is the tariff complementarity effects disappear. We also find that in contrast to traditional argument, the non-member country's welfare may worsen even if there are tariff complementarity effects. Furthermore, the findings show that the FTA is likely to result in the deterioration of the member countries' welfare, depending on the trade costs.

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