Preferential Trade Agreements, Technology Adoption and the Speed of Attaining Free Trade

Abstract

For developing countries, a technological catch-up is sometimes a prerequisite for endorsement of trade agreements. This paper compares sequential trade liberalization through a preferential trade agreement (PTA) and one-shot multilateral trade liberalization with respect to the speed with which countries attain multilateral free trade. We build a three-country oligopoly model, including one developing country whose domestic firm initially uses old technology. Firm-level adoption of new technology and country-level conclusions of trade agreements are endogenously determined. When a PTA is feasible whereas multilateral free trade is infeasible prior to technology adoption, a free trade area (FTA) that includes a developing country speeds up technology adoption and the realization of multilateral free trade, whereas a customs union (CU) delays them. The opposite case is obtained if PTAs are infeasible prior to technology adoption, or they are formed between developing countries. Even if faster realization of free trade via an FTA improves world welfare, a developed country may prefer liberalization via a CU.