On necessarily welfareenhancing free trade areas.

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On necessarily welfare-enhancingfree trade
areas.

• By
• Panagariya and Krishna

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Purpose

• To show the impact on welfare of forming trading
  blocks between nations, focusing on free trade
  areas.

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Past Research

• An answer to the welfare question was stated by
  Kemp and Vanek, then proven by Ohyama, Kemp, and
  Wan.
• They proved that when 2 or more countries freeze
  their net external trade vector with the rest of
  the world through a set of common external
  tariffs and eliminate barriers to internal trade,
  the welfare of the union improves and that the
  welfare of the rest of the world does not fall.

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Research (custom union)

• The logic behind the previous theory is that by
  fixing the combined, net extra-union trade vector
  of member countries at its pre-union level, it is
  guaranteed that non-members will maintain their
  original level of welfare.

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Research (cont.)

• It was stated that the joint welfare of the union
  is maximized by equating the MRS and the MRT for
  each pair of commodities to each other and across
  all agents in the union.
• This implies the elimination of all internal
  distortions.
• What they created has a common internal price
  vector implying a common external tariff and is
  therefore a customs union.

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Purpose (cont.)

• This study shows a result for FTAs that can be
  compared to the result for custom unions.
• This study differs from previous works in that it
  allows for members of the trade agreement to set
  their own tariffs for foreign goods.

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Purpose (cont.)

• As long as goods produced within the union move
  free of duty across member-country borders, a
  welfare-enhancing FTA can be constructed even if
  the goods prices differ across member countries.

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Outline

• 1. Introduction
• 2. Partial equilibrium analysis
• 3. Full general equilibrium and a proof
• 4. inclusion of intermediate inputs
• 5. rules of origin
• 6. conclusion

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Introduction

• The FTA for this study has the property that
  member countries within the FTA individually
  import the same vector of quantities in the
  post-FTA equilibrium as the pre-FTA equilibrium.

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Partial Equilibrium Analysis

• Graph 1a and 1b w/out internal production
• Graph 2a and 2b with internal production

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Proof in general case

• They assume that the utility of foreign in post
  FTA is fixed at its pre FTA level through a lump
  sum transfer.
• e(pf,uf) e(pf,u0) they use this inequality to
  come to this equation
• (pfA pfA)(X0A N0A) (pfB pfB)(x0B n0B)
  0
• This inequality along with the fact that domestic
  output must be at least as large as the exports
  to the union partner proves the first inequality
  which means that the FTA increases member welfare
  and does not decrease non member welfare.

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Intermediate inputs

• In this model intermediate inputs receive the
  same duty free status within the FTA as final
  products, as long as the final stage of
  production takes place within the FTA.
• Intermediate goods are taken through the same
  proof shown in the previous section and the
  result was identical.

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Rules of Origin

• The importance of this section is that the model
  must include specific rules of origin to prevent
  countries w/in the FTA from importing cheap
  foreign goods and selling them to member
  countries for profit.
• The reason this was possible is that in an FTA
  each country can set its own foreign tariff
  levels.

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Rules of Origin

• A good wholly produced w/in the union FTA is
  given duty free access to all countries w/in the
  FTA.
• If a good contains foreign intermediate parts it
  is allowed duty free access if it differs from
  any of the intermediates it contains and is a
  good that existed prior to the existence of the
  FTA.
• New goods are given duty free access if they are
  produced completely w/in the FTA.

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conclusion

• This study illustrated a model of a FTA in which
  the tariff structure is set up in a fashion that
  member countries welfare improved while the
  welfare of the rest of the world did not fall, it
  is not the authors contention that all FTA act
  in this manner.

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• Questions or comments?
• Thank you