Economic Determinants of Free Trade Agreements Revisited: Distinguishing Sources of Interdependence

Published date01 February 2014
DOIhttp://doi.org/10.1111/roie.12095
AuthorRonald Mariutto,Jeffrey H. Bergstrand,Scott L. Baier
Date01 February 2014
Economic Determinants of Free Trade
Agreements Revisited: Distinguishing Sources
of Interdependence
Scott L. Baier, Jeffrey H. Bergstrand, and Ronald Mariutto*
Abstract
One of the most notable international economic events since 1990 has been the enormous increase in the
number of free trade agreements (FTAs).While Baier and Bergstrand were the first to show empirically the
impact of a country-pair’s economic characteristics on the likelihood of the pair having an FTA, the litera-
ture has been extended to demonstrate the importance empirically of FTA “interdependence”—the effect
of other FTAs on the probability of a pair having an FTA.In the context of the Baier–Bergstrand frame-
work, this paper delves deeper into the sources of interdependence—an “own-FTA” effect and a “cross-
FTA” effect.The authors argue that the own-FTA effect (the impact on the net welfare gains of an FTA
between two countries owing to either already having other FTAs) likely dwarfs the cross-FTA effect (the
impact on the net welfare gains of an FTA between the pair owing to other FTAsexisting in the rest of the
world, or ROW).Augmenting a parsimonious logit model with simple “multilateral FTA” and “ROWFTA”
terms to differentiate the own and cross effects empirically, it is shown that the marginal impact on the
probability of a country-pair having an agreement of either country having one more FTA with a third
country is 50 times that of one more FTA between another pair in ROW.The results suggest that “domino
(own-FTA) effects” have far exceeded“competitive liberalization (cross-FTA) effects” in the proliferation
of FTAs.
1. Introduction
One of the most notable economic events since 1990 has been the large increase in
the number of bilateral and regional free trade agreements (FTAs) in existence from
year to year.1In this period, international trade economists have mostly debated
related normative questions—such as whether such agreements are on net welfare
increasing or decreasing for member countries and/or for nonmembers—and related
positive questions—such as whether preferential agreements are “stumbling” or
“building” blocks toward global free trade. However, the profession has begun to
provide empirical models that actually explain which pairs of countries have FTAs in
a given year, starting with Baier and Bergstrand (2004).
* Bergstrand: Department of Finance,Mendoza College of Business, and Kellogg Institute for International
Studies, University of Notre Dame, Notre Dame, IN 46556 USA and CESifo, Munich, Germany. E-mail:
bergstrand.1@nd.edu. Baier: John E. Walker Department of Economics, Clemson University, Clemson, SC
29634 USA. Mariutto:ConAgra, 1 Conagra Drive, Omaha, NE 68102 USA. Baier and Bergstrand are grate-
ful to the National Science Foundation for financial support under grants SES-0351018 (Baier) and SES-
0351154 (Bergstrand). We are also grateful for comments from an anonymous referee and participants at
presentations at the Midwest International Economics Meetings, University of Notre Dame,and ETH Uni-
versity in Zurich. We thank Adam Ayers, R. Ethan Braden, Francisco Briseno, Emma Buckley, Brandon
Caruthers,Tom Foote,Mitch Gainer, Pedro Gimenez, Nick Goode,Drew Hill, Christine Hsieh, TahirImtiaz,
Humberto Kravetz, Cherrica Li, Lindsey Lim, Ben O’Neill, Mo Sabet, James Schappler, Andrew Weiler,
Alex Wheeler,and Chris Wittman for excellent research assistance on construction of the EIA data base.
Review of International Economics, 22(1), 31–58, 2014
DOI:10.1111/roie.12095
© 2014 JohnWiley & Sons Ltd
Baier and Bergstrand (2004), or BB, used a numerical version of a Krugman-type
general equilibrium monopolistic competition model of international trade to show
that the net economic welfare gains for two countries of having an FTA in a given
year were related positively to the two countries’ economic sizes (gross domestic
products, or GDPs), similarity of GDPs, proximity to each other, joint remoteness
from the rest of the world (ROW) and relative capital–labor ratios (up to a point).
Motivated by comparative statics from this six-country theoretical model, BB
employed a qualitative choice model to explain the likelihood of country-pairs having
FTAs using these variables. The model explained 73% of the cross-sectional variation
for 1996 among 1431 pairings of 54 countries, all RHS variables had the expected
coefficient signs as suggested by theory and 85% (97%) of the country-pairs with
FTAs (without FTAs) were predicted correctly.
However, BB did not address systematically the influence on the likelihood of a
particular country-pair ij forming an FTA of i’s or j’s existing FTAs with “third coun-
tries” k(ki,j)or the influence on this likelihood of existing FTAs among other
“country-pairs” kl in the ROW (k,li,j).2The purpose of this paper is to delve
deeper into the sources of FTA “interdependence” and distinguish empirically two
such sources for helping to explain the proliferation of FTAs—which we will term
“own-FTA” and “cross-FTA” effects—and in the context of the BB theoretical frame-
work. The own-FTA effect refers to the impact on the net welfare gains of an FTA
between two countries owing to either already having other FTAs (“third country”
effects). For example, this would be the effect of an FTA between Canada and the
USA on the likelihood of an FTA forming between Mexico and the USA.The cross-
FTA effect refers to the impact on the net welfare gains of an FTA between the pair
owing to other FTAs existing in the ROW (“third country-pair” effects). For example,
this would be the effect of an agreement between France and Germany on the likeli-
hood of an FTA forming between Canada and the USA; observers in the 1980s ques-
tioned whether the growing European Community fostered the formation of the
Canadian–USA FTA in 1989.While this is not the first paper to address FTA interde-
pendence empirically, it is the first to distinguish empirically between these two com-
plementary sources of interdependence simultaneously—and, in particular, their
relative quantitative importance. The issue is important because early arguments
about “domino (own-FTA) effects” (cf. Baldwin, 1993, 1995) concerned whether an
FTA formation between a pair of countries was influenced by one of the countries
already having an FTA with a “third country” (e.g. Economic Community expan-
sions), whereas early arguments about “competitive liberalization (cross-FTA
effects)” (cf. Bergsten, 1996) concerned whether an FTA formation between a pair of
countries was influenced by formations of FTAs between other “country-pairs” in the
ROW (e.g. Economic Community’s expansion influencing the formation of North
Atlantic Free Trade Agreement (NAFTA)).
While the notions of FTA domino effects, competitive liberalization, contagion and
interdependence have existed since 1993, only three papers have attempted to quan-
tify its importance. However, none of the three has addressed precisely the relative
quantification of third country (domino) effects from third country-pair (competitive
liberalization) effects, which is our goal. The first paper to address empirically the
influence of FTA interdependence on the likelihood of countries iand jhaving an
FTA (FTAij) in a subsequent year is Egger and Larch (2008), or EL. Motivated by
Baldwin’s domino theory of potential trade diversion of nonmembers, EL argued that
the existence of an FTA between countries kand l(a “third country-pair”) would
increase the likelihood of FTAij (either by joining an existing one or forming a new
32 Scott L. Baier, Jeffrey H. Bergstrand, and Ronald Mariutto
© 2014 JohnWiley & Sons Ltd

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT