Trading blocs and the Americas: The natural, the unnatural, and the super-natural

Abstract

Is world trade becoming more regionalized, as a result of preferential arrangements such as NAFTA, the Andean Pact and MERCOSUR? If so, is this deviation from the principle of MFN (non-discriminatory trade policies) good or bad? This paper attempts to answer both questions. Using the gravity model to examine bilateral trade patterns throughout the world, we find evidence of trading blocs in the Western Hemisphere and elsewhere, as in earlier work. Intra-regional trade is greater than could be explained by natural determinants: the proximity of a pair of countries, their sizes and GNP/capitas, and whether they share a common border or a common language. Within the Western Hemisphere, MERCOSUR and the Andean Pact countries appear to function as significantly independent trading areas, but NAFTA much less so (as of 1990). The intra-regional trade bias within MERCOSUR increased the most rapidly during the 1980s. In East Asia, on the other hand, increased intra-regional trade can be explained entirely by the rapid growth of the economies. We then turn from the econometrics to an analysis of economic welfare. Krugman has supplied an argument against a world of three trading blocs (that they would be protectionist), in a model that assumes no transport costs. He has supplied another argument in favor of trading blocs, provided the blocs are drawn along ‘natural’ geographic lines, in a model that assumes prohibitively high transportation costs between continents. In this paper we attempt to resolve the Krugman vs. Krugman debate. We complete the model of the welfare implications of trading blocs for the realistic case where inter-continental transport costs are neither so high as to be prohibitive nor zero. We consider three applications of the model. 1. Continental Free Trade Areas (FTAs). We show that it is not only Krugman's ‘unnatural’ FTAs that can leave everyone worse off than under MFN, but that under conditions of relatively low inter-continental transport costs, FTAs that are formed along natural continental lines can do so as well. We call such welfare-reducing blocs super-natural. 2. Partial regionalization. We find that partial liberalization within a regional Preferential Trading Arrangement (PTA) is better than 100 percent liberalization. In the super-natural zone the regional trading arrangement, in contrast to the Article 24 provision of the GATT, reduces welfare. It occurs for combinations of low inter-continental transport costs and high intra-bloc preferences, i.e., when the regionalization of trade policy exceeds what is justified by natural factors. 3. The formation of several sub-regional PTAs on each continent. We find that multiple FTAs on each continent could lower welfare, but that multiple PTAs, with partial internal liberalization, would raise welfare. We conclude the paper with an attempt to extract estimates of transportation costs from the statistics. Estimates suggest that trading blocs on the order of the EC are in fact super-natural.