Revisiting the Effects of Free Trade Agreement (FTA) on PPP Using the ESTAR Model: Evidence From South Korea

Abstract

I explore whether the Free Trade Agreement (FTA) has a positive influence on PPP between South Korea and its FTA partners in this study. There are a few studies on the effects of FTA on PPP, but they do not find positive effects of FTA on PPP even though trade barriers, especially, tariffs have decreased or eliminated after FTA. One reason for this may be that the empirical models used in earlier studies were incorrectly specified. In particular, the models are unable to assess whether trade does not occur. By using the Exponential Smooth Transition Autoregressive (ESTAR) model, which separates the case where trade does not occur from the case where trade occurs, I revisit the effects of FTA on PPP between South Korea and its FTA partners in the sample periods over January 1998 to May 2018. It was found that the speed of mean-reversion of price differential is faster after FTA for most ASEAN FTA partners, but the same thing is not observed for other FTA partners. These findings imply that the effects of FTA on PPP are different across FTA partners, which means the effects of FTA on market integration are different across FTA partners.