Free Trade Networks with Transfers∗

The paper investigates the network of bilateral free trade agreements (FTA) in the context of a network formation game with transfers. Furusawa and Konishi (2002) show that without international transfers, countries with different industrialization levels may not sign an FTA, so that the global free trade network, in which every pair of countries sign an FTA, is not pairwise stable in general. We show in this paper that even if the world consists of fairly asymmetric countries, the global free trade network is pairwise stable when transfers between FTA signatories are allowed. Moreover, it is the unique pairwise stable network unless industrial commodities are highly substitutable from one another. ∗This paper is partly prepared for Konishi’s invited lecture at the Annual Meeting of the Japanese Economic Association at Meiji University, Tokyo, 12-13 October, 2003. We gratefully acknowledge financial support from the Japan Society for Promotion of Science research. Furusawa also gratefully acknowledges financial supports from the Seimeikai Foundation and the Ministry of Education, Culture, Sports, Science and Technology of Japan (the 21st Century Center of Excellence Project on the Normative Evaluation and Social Choice of Contemporary Economic Systems). We greatly benefit from discussions with Tomoya Mori who is working with us on a dynamic extension of this model. We thank Sabina Pogorelec and Yoichi Sugita for their research assistance. †Faculty of Economics, Hitotsubashi University, 2-1 Kunitachi, Tokyo, 186-8601 Japan. (e-mail) [email protected] ‡Department of Economics, Boston College, Chestnut Hill, MA 02467, USA. (e-mail) [email protected]