Trade Agreements under Political Pressures

We study in this paper the welfare effects of different types of trade agreements and the equilibrium outcome of trade negotiation, when the objective of each government is politically motivated. We explore a three-country and three-good trade model with endogenous tariffs and export subsidies in a political economy framework. In this context, we suggest that the welfare effects of both bilateral free trade agreements and a multilateral trade agreement (MTA) are ambiguous, which depend on the extent of relative concern about the political contribution of each government (γ) and the endowment ratio between different sectors in each country (x). We further introduce a trade negotiation game to investigate the equilibrium outcome of trade negotiation, in which each country endogenously decides whether to participate in bilateral or multilateral trade liberalisation. We find that the result also depends on the two factors mentioned above. For given value of x, multilateral free trade is achieved through a MTA if γ is relatively small and it makes the welfare of all countries improve. Otherwise, there is no agreement achieved at all. On the other hand, an increase in the value of x can enlarge the range of γ in which the MTA is approved.