Scandinavian Working Papers in Economics

Working Papers,
Copenhagen Business School, Department of Economics

No 02-2010: Flexibility in Trade Bloc Design

Mark Melatos and Stephanie Dunn

Abstract: A key characteristic of any trade bloc is its “flexibility” – the extent to which it can be modified or augmented by existing members. This paper investigates how prospective trade bloc members value the flexibility of proposed trade agreements in a changing trading environment. We demonstrate that country characteristics as well as the nature of the trade shock influence a nation’s desire for trade bloc flexibility. Our model of endogenous coalition formation yields predictions that are consistent with three stylized facts which characterize regionalism: (i) overlapping trade agreements, (ii) the popularity of free trade areas relative to customs unions and (iii) renegotiation or disbandment of existing trade agreements is rare. Finally, for the first time in the literature, we provide clear predictions about the identity of “hub” and “spoke” trade bloc members when overlapping free trade areas arise in equilibrium.

Keywords: Trade agreement flexibility; optimal trade bloc design; regional trade agreements; free trade areas; customs unions.

JEL-codes: F12; F13; F14; F15

24 pages, February 23, 2010

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