Preferential Trade Agreements = Preferential treatment is not given to all member countries
of the WTO, but only to the member countries of the Preferential Trade Agreement.
Two forms:
● Free Trade Area (FTA): zero internal tariffs and the member countries have an
individual external trade policy.
● Customs Union (CU): zero internal tariffs and the member countries have a common
external trade policy.
PTA violate two principles of the WTO:
● Multilateral approach to trade liberalisation
● Most Favoured Nation (MFN) principle
Conditions apply:
- Completely free trade within the PTA
- The PTA must apply practically to at least 90-95% of all trade.
- PTA is not allowed to raise overall tariffs towards non-members of the PTA.
Static welfare effects of PTA:
● Trade creation = amounts to the additional trade that is caused by replacing more
expensive local production in favour of imports from a producer with lower pre-tariff
prices from within the PTA. Generates a positive welfare effect (lower price and
higher demand) due to an improvement in allocation.
● Trade diversion = amounts to replacing cheaper imports from outside the PTA by
more expensive imports from within the PTA. This generates a negative welfare
effect due to a worsening in allocation.
Three remarks:
- PTA clearly represent a move towards free trade
- PTA must not be welfare-improving.
- PTA are second-best: multilateral trade liberalisation is first-best.
Preferential Trade Agreements welfare effects
Country A is inefficiënt.
of the WTO, but only to the member countries of the Preferential Trade Agreement.
Two forms:
● Free Trade Area (FTA): zero internal tariffs and the member countries have an
individual external trade policy.
● Customs Union (CU): zero internal tariffs and the member countries have a common
external trade policy.
PTA violate two principles of the WTO:
● Multilateral approach to trade liberalisation
● Most Favoured Nation (MFN) principle
Conditions apply:
- Completely free trade within the PTA
- The PTA must apply practically to at least 90-95% of all trade.
- PTA is not allowed to raise overall tariffs towards non-members of the PTA.
Static welfare effects of PTA:
● Trade creation = amounts to the additional trade that is caused by replacing more
expensive local production in favour of imports from a producer with lower pre-tariff
prices from within the PTA. Generates a positive welfare effect (lower price and
higher demand) due to an improvement in allocation.
● Trade diversion = amounts to replacing cheaper imports from outside the PTA by
more expensive imports from within the PTA. This generates a negative welfare
effect due to a worsening in allocation.
Three remarks:
- PTA clearly represent a move towards free trade
- PTA must not be welfare-improving.
- PTA are second-best: multilateral trade liberalisation is first-best.
Preferential Trade Agreements welfare effects
Country A is inefficiënt.
