Preferential Trade Agreements, The Metzler Paradox, and Trade Diversion: An Interpretation of the GATT Article XXIV

Tari¤ Concessions in a Preferential Trade Agreement (PTA) are likely to divert trade from non-participating countries. Consequently, their welfare will deteriorate if the tari¤ rates of the incumbents remain the same. In a general equilibrium framework with multiple goods and multiple regions, this paper clari...es the determinants of the trade diversion. Similarity between the excess supply structures of countries is the key factor in determining the welfare e¤ect on non-participating countries as well as the key condition to precluding the Metzler paradox. Under a certain similarity condition for the excess supply structures among countries, a PTA will erode the welfare of neighboring non-participating countries unless a participating country is a transit port for the commodity whose tari¤ is reduced. The required tari¤ rate reduction for the export of a non-participant will be determined by the relative size of the regions separated by the tari¤ wall. If a participant in a PTA is a transit port or “entrepôt”, then the formation of a PTA will be bene...cial to neighboring countries.