Third-Country E¤ects in the Formation of Free Trade Agreements

The proliferation of regional economic integration has resulted in a complex and continually expanding network of free trade agreements (FTAs). In explaining the formation of these agreements, the literature has generally focused on the e¤ect of country-pair characteristics and ignored the role of existing FTA network. In this paper we investigate, both theoretically and empirically, how third countries a¤ect nations’incentives to form new FTAs in various types of network. We …nd the e¤ect varies signi…cantly with the network architecture. Compared to an empty network where there is no FTA between countries, having an exclusive FTA with a third country raises a country’s incentives to form new FTAs but weakens the incentives of others to reciprocate. A new FTA will therefore only be jointly supported when the country with exclusive FTA partners has a su¢ ciently large market size and high marginal cost of production. In a hub-and-spoke network, however, where two countries are mutually linked to a third country, the existence of the mutual FTA partner raises both nations’incentives to form an agreement leading to an unambiguous increase in the probability of jointly supported FTAs.