Free‐Trade Areas and Welfare: An Equilibrium Analysis

This paper examines the welfare effects of the formation of a free‐trade area. When a country is constrained to charge lower tariffs on imports from some countries, it is in its interest to reduce external tariffs as well. In alinear‐quadratic model of intraindustry trade, the reduction in external tariffs induced by free‐trade agreements is sufficiently large to make nonmember countries better off. Since only privately beneficial free‐trade agreements are signed voluntarily, the formation of a free‐trade area is a Pareto improvement. Owing to free‐riding problems, however, the global free‐trade area may not be a stable outcome.