Small is Beautiful : Preferential Trade Agreements and The Impact of Country

1668 The smaller the volume (or share) of imports from the trading partner, the larger the impact of a preferential trade agreement on home country welfare—because the smaller the imports, the smaller the loss in tariff revenue. And the home country is better off as a small member of a large bloc than as a large member of a small bloc. Summary findings There has been a resurgence of preferential trade agreements (PTAs) partly because of the deeper European integration known as EC-92, which led to a fear of a Fortress Europe; and partly because of the U.S. decision to form a PTA with Canada. As a result, there has been a domino effect: a proliferation of PTAs, which has led to renewed debate about how PTAs affect both welfare and the multilateral system. Schiff examines two issues: the welfare impact of preferential trade agreements (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 demand for imports; the efficiency of production of the partner or rest of the world (ROW); the share imported from the partner (ROW); and the initial protection on imports from the partner (ROW). Among his findings: • An individual country benefits more from a PTA if it imports less from its partner countries (with imports measured either in volume or as a share of total imports). This result has important implications for choice of partners. • A small home country loses from forming a free trade agreement (FTA) 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 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 (or less harmful) for a country with lower import demand. A PTA is also more beneficial for a country with a more efficient import-substituting sector, as this will result in a lower demand for imports. • A small country may gain from forming a PTA when smuggling …