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The world trading system has exhibited two important trends since the
First is the proliferation of preferential trade agreements (PTAs). In
1980, there were only about 20 agreements in force. This number has
grown over tenfold in three decades, increasing to 223 as of 2010
Database. Related to this,
the structure of PTAs has also changed throughout the years. Majority
of earlier PTAs are among countries in the same level of development;
that is, among developed or among developing countries, while more
recent (late 1990s and onwards) ones are between developed and
Second is the increase in importance of trade in intermediate goods,
which can be mainly attributed to the rise in international production
fragmentation (IPF). The production of many manufactured goods has
taken the character of international division of labor as firms seek
to find the lowest cost producers of different components of a final
good across the globe. Aggregate indicators of IPF have shown its
rapid growth since the early 1980s (UNCTAD 2006). From 1982 to 2005,
gross product associated with international production and foreign
affiliate sales worldwide increased faster than global GDP and global
exports. Outward FDI stock, albeit an imperfect measure of
international production, likewise increased.
We set two goals in this study.
First, we juxtapose aforementioned trends and investigate whether the
latter can help explain the former. Blanchard (2005), Chase (2005),
Cheng, Liu, and Yang (1998), Cantwell (1994), and Milner (1993) argued
that trade policies of a country are influenced by the international
economic activities of its firms, which essentially recognize that
trade policy is endogenous. Traditional studies on endogenous trade
policy focus on the political process of trade policy formation (see
for instance Magee et al. 1989). Likewise, most domestic firms modeled
are import-competing, where trade policy is motivated to protect them
and extract rents from foreign competitors. More recent theoretical
work on endogenous trade policy have shown that when countries have
more firms involved in international production, there is more
pressure for trade liberalization since trade barriers are additional
Second, we consider that the impact of different economic and
political factors on the formation of PTAs may be different across
periods and countries in different levels of development, which most
previous studies have assumed to be the same. Thus, we disaggregate
PTAs into North-North, South-South, and North-South; and consider
whether they were formed in the period 1981-1995 or 1996-2006. The
fact that earlier PTAs (1981-1995) are North-North and South-South and
the more recent ones (1996-2006) are North-South suggest that
motivations of countries in joining PTAs may have changed.
We develop a simple model where trade policy is formed by governments
or social planners in countries with firms involved in international
division of labor through IPF. We apply the IPF models of Jones and
Kierzkowski (1990) and Ethier (1982) in the context of PTAs. A North
country is an exporter of a final manufactured good that is highly
dependent on imported inputs from a South country. Even with
transportation and other trade costs, firms prefer to import the
inputs from a particular South country, which we refer to as original
South, since the latter can produce the inputs at lower costs. To
further lower the costs for its firms, the social planner in the North
country can negotiate a PTA with original South. Meanwhile, given the
possibility that firms in other South countries may try to compete,
the social planner in original South has an incentive to enter into a
PTA with the North country in order to secure its trading relationship
with the North. Merely the threat of firms in other South countries
stealing the market of the North will give the social planner in
original South a motivation to initiate a PTA negotiation with the
North to secure its position as the low-cost input provider of the
latter. Consumers in both countries benefit due to the lower price of
the final manufactured good. Thus, a PTA between countries involved in
international division of labor maybe welfare-improving.
We use sequential probit and multinomial logit to predict the
probability of countries forming North-North, South-South and
North-South PTAs given a set of economic and political factors.
Empirical results of our study help explain the major changes in the
world trading system.
First, most countries choose PTA partners with which they have a
history of trading, but more recent trading relationship is more
important. This suggests that PTAs are formed by countries in order to
strengthen the already existing trading relationship and not
necessarily to dramatically increase the volume of trade. This is most
especially true of PTAs formed in more recent years.
Second, earlier PTAs formed among countries in the same level of
development (North-North and South-South) have more political
motivation than PTAs formed between developed and developing countries
(North-South) and in more recent years (1996-2006). We find that in
general, PTAs formed in more recent years have more economic
Finally, disaggregating trade of countries into inter- and
intra-industry trade shows that while inter-industry trade is mostly
statistically significant in the formation of PTAs, intra-industry
trade has a positive and significant impact only for North-North and
North-South PTAs. The significance of intra-industry trade in the
formation of North-North PTAs is due to North-North trade in different
varieties of the same good. The significance of intra-industry trade
in the formation of North-South PTAs, meanwhile, can be attributed to
North-South trade in intermediate goods. The latter result supports
the proposition put forth that developments in international division
of labor have contributed to the formation of North-South PTAs.
Our results suggest that disaggregating PTAs into North-North,
South-South and North-South can give valuable insights as to the
different motivations of countries when they formed PTAs with
different countries in different periods. Whether PTAs formed in more
recent years are more welfare-enhancing than earlier ones is an
interesting area left for future research.
Blanchard, Emily (2005). “Foreign Direct Investment, Endogenous
Tariffs, and Preferential Trade Agreements.” SSRN Working Paper
Cantwell, J. (1994). “The Relationship Between International Trade and
International Production,” D. Greenaway and L.A. Winters, Surveys in
International Trade. Oxford: Basil Blackwell.
Chase, Kerry A. (2005). Trading Blocs: States, Firms, and Regions in
the World Economy. Ann Arbor: The University of Michigan Press.
Cheng, Wen Li, and Meng-chun Liu, and Xiaokai Yang (2000). “A
Ricardian Model with Endogenous Comparative Advantage and Endogenous
Trade Policy Regimes.” The Economic Society of Australia, 76, 172-82.
Ethier, Wilfred (1982). “National and International Returns to Scale
in the Modern Theory of International Trade.” American Economic
Review, 72(3), 389-405.
Jones, Ronald and Henryk Kierzkowski (1990). “The Role of Services in
Production andInternational Trade: A Theoretical Framework,” in R.W.
Jones and A.O. Krueger, eds., The Political Economy of International
Trade. Oxford: Basil Blackwell.
Magee, Stephen P. and William A. Brock and Leslie Young (1989). Black
hole tariffs and endogenous policy theory: Political economy in
general equilibrium. Cambridge: Cambridge University Press.
Milner, Helen (1993). “Trading Places,” in J. S. Odell and T.D.
Willet, eds., International Trade Policies: Gains from Exchange
Between Economics and Political Science. Ann Arbor: The University of
Michigan Press, 141-172.
Parcon, Hazel C. (2008). "Disaggregating PTAs and the Role of
International Division of Labor on PTA Formation", University of
Hawaii at Manoa, Department of Economics, Working Papers Series n.
UNCTAD (2006). World Investment Report 2006: FDI from Developing and
Transition Economies: Implications for Development.
1.Associate Professor, School of
Economics, De La Salle University, Manila, Philippines. back to text
Hazel C. Parcon is an
Associate Professor at the School of Economics of the De La Salle
University in Manila, Philippines. She is also a Research Fellow at the
Anghelo King Institute of the university. She has written and taught
subjects on international trade theory and policy, globalization,
foreign direct investments, labor markets, and macroeconomics.
Ms. Parcon was a Post-Doctoral Research Fellow at the College of
Tropical Agriculture and Human Resources, University of Hawaii. She
earned her Ph.D in Economics from the University of Hawaii.