Preferential Trade, Sunk Costs, and the Path-Dependent Expansion of Exports

In the presence of sunk costs to exporting, preferential tariff liberalization may have a prolonged, dynamic effect on the pattern of a beneficiary country’s exports. In particular, when preferential market access helps overcome product specific fixed costs to exporting, preferential tariff liberalization might trigger a geographic spread of exports to third markets outside the preferential trading area. I test this hypothesis for the pattern of Mexican exports between 1993–1997, after the inception of NAFTA, to several Latin American and European trading partners, respectively. After controlling for product specific shocks and the overall trend in export growth, the evidence is consistent with the hypothesis that initial exports to the United States further prompted exports to third markets. The results suggest a significant impact on exports to large or geographically proximate countries (Argentina, Brazil, Peru, Costa Rica, Guatemala, Honduras and Panama). The geographic spread of trade is strongest for sophisticated goods at the high end of products’ skill or technology content. Simultaneously, the findings document the existence of considerable tariff-induced trade diversion for goods with little skill or technology content.