Economics Letters 111 (2011) 188–190
Contents lists available at ScienceDirect
Economics Letters
j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / e c o l e t
Determinants of successful regional trade agreements☆
Vincent Vicard ⁎
Banque de France, 31, rue Croix des petits champs 75001 Paris, France
a r t i c l e
i n f o
Article history:
Received 11 January 2010
Received in revised form 14 January 2011
Accepted 11 February 2011
Available online 18 February 2011
a b s t r a c t
This paper investigates the determinants of the effectiveness of regional trade agreements (RTAs) in
enhancing bilateral trade. Characteristics of both the country pair and other RTA members are found to
significantly influence the trade creation effect of RTAs. However, North/North, North/South and South/South
RTAs are found to have similar effects on trade.
© 2011 Elsevier B.V. All rights reserved.
JEL classification:
F10
F15
Keywords:
Trade
Regional trade agreements
Gravity equation
1. Introduction
Regional trade agreements (RTAs) are an increasingly important
feature of the international trading system: as of November 2010,
195 RTAs notified to the WTO under Enabling Clause and GATT Art.
XXIV were in force. Their form, coverage and the characteristics of
their members however greatly vary throughout the world (see
Table 1).
Two recent papers have provided consistent estimates of the effect
of regional trade agreements (RTAs) on bilateral trade by appropriately controlling for the endogeneity of membership in RTAs. Baier
and Bergstrand (2007) find an average treatment effect of RTAs on
bilateral trade close to 50%, increasing to almost 100% after 10 years.
They show that endogeneity biases downward the coefficient on RTA,
which suggests that countries choose “well” their RTA partners.1
Carrère (2006) focuses on 7 RTAs and finds that they have
significantly increased trade among members, generally at the
expense of other partners. The trade creation effect however varies
☆ I thank Nicolas Berman and Jose de Souza for helpful suggestions. This paper
represents the views of the author and should not be interpreted as reflecting those of
Banque de France.
⁎ Tel.: +33 142924261.
E-mail address: [email protected].
1
In the sense that the likelihood of an RTA is associated with unobserved
determinants of trade flows that hinder bilateral trade. The likelihood of an RTA
between two countries is indeed likely to increase with potential gains from regional
integration, related to determinants of bilateral trade such as behind the border issues
not included in standard gravity equations.
0165-1765/$ – see front matter © 2011 Elsevier B.V. All rights reserved.
doi:10.1016/j.econlet.2011.02.010
from one RTA to the other. Together, these papers suggest that
country pairs self-select into RTAs and that different RTAs may have
different effects. This paper investigates systematically which characteristics of an RTA and its members determine the extent to which
trade increases between members.
I focus on characteristics that are predicted by the trade theory to
affect the gains from trade openness. Those are the basic gravity-like
determinants of bilateral trade flows: the level and similarity of GDPs,
bilateral distance, the fact to share a common border, a common
language or a common colonial history, and GATT/WTO membership.
Characteristics of the RTA itself are also likely to affect its effectiveness
in enhancing intra-regional trade. Indeed, the effectiveness of trade
preferences depends on other countries to which they are granted.
Moreover, since different countries tend to choose to create different
kinds of RTAs (Vicard, 2008), the economic characteristics of all
members of an RTA should inform on its design and so on its
effectiveness. I thus test whether characteristics of all members
matter rather than those of the country pair.
As suggested by Baier and Bergstrand (2007), I estimate a
theoretically motivated gravity equation with country-and-year
dummies and country pair fixed effects. I refine the measurement of
membership in RTAs by measuring several characteristics of RTAs and
member countries rather than using a dummy variable to measure
membership. The standard gravity equation is augmented by
including interaction terms between the dummy for RTA membership
and the characteristics of both the pair of member countries and all
other members of the RTA. The results are then illustrated by
estimating the effect of the creation and enlargements of the North
American Free Trade Agreement (NAFTA) and the European Union
(EU) on different pairs of member countries.
V. Vicard / Economics Letters 111 (2011) 188–190
Table 1
Characteristics of main RTAs (2009).
Name
Andean
community
ASEAN free
trade
agreement
European
Union
MERCOSUR
NAFTA
189
Table 2
Gravity estimates with country-and-year and bilateral fixed effects.
Form Date of Nbr of
Population
Regional/total Share
creation members (million)
trade (%)
of world
trade (%)
8
0.6
CU
1988
4
99
25
6.1
PA
1992
10
601
66
37.0
CM
1958
27
501
16
39
1.6
15.0
CU
FTA
1991
1994
4
3
267
457
Dependent variable
(1)
(2)
RTA
RTA*avg ln GDP
RTA*ln GDP diff
RTA*ln bil.dist
0.36a 1.40a
(0.04) (0.31)
0.11a
(0.03)
− 0.05b
(0.02)
− 0.22a
(0.04)
RTA*contiguity dum.
RTA*common language dum.
RTA*colony dum.
2. Empirical Specification
Baier and Bergstrand (2007) argue that the self-selection of
country pairs into RTAs create a downward bias on estimates of the
effect of RTAs on trade. Based on the treatment effect literature
(Heckman, 2001 and Wooldridge (2002, chap.18)), they suggest to
use panel data with country pair and country-and-time fixed effects to
properly estimate the average treatment effect (ATE) of entering an
RTA. This methodology yields consistent estimates of the ATE of RTAs
on bilateral trade but it does not allow to investigate which kinds of
country pairs gain more from regional trade integration. To this end, I
introduce interaction variables between country economic characteristics and the RTA membership dummy. The following equation is
thus estimated:
tijt = α + β RTAijt + γ RTAijt Xijt + Iit + Ejt + Bij + ijt
ð1Þ
(3)
(4)
(5)
0.99a
(0.37)
0.12a
(0.03)
− 0.04c
(0.02)
− 0.20a
(0.04)
− 0.05
(0.10)
0.43a
(0.09)
− 0.29b
(0.15)
− 0.29b
(0.13)
− 0.01
(0.06)
1.33a
(0.48)
0.06c
(0.04)
− 0.05b
(0.02)
− 0.19a
(0.05)
− 0.05
(0.10)
0.35a
(0.09)
− 0.17
(0.14)
− 0.28b
(0.13)
0.06
(0.06)
− 0.09
(0.15)
− 0.11b
(0.05)
− 1.33b
(0.54)
0.18a
(0.05)
0.03a
(0.01)
−0.00
(0.00)
−0.02
(0.04)
−0.00
(0.00)
−0.49a
(0.18)
35536
8404
0.73
35536
8404
0.74
0.13
(0.92)
0.08c
(0.04)
− 0.05b
(0.02)
− 0.15a
(0.05)
− 0.06
(0.11)
0.41a
(0.10)
− 0.24c
(0.14)
− 0.25c
(0.13)
0.06
(0.07)
0.04
(0.17)
− 0.15b
(0.06)
− 1.85b
(0.74)
0.23a
(0.07)
0.02b
(0.01)
−0.00
(0.00)
−0.04
(0.04)
−0.00
(0.00)
−0.44b
(0.19)
−0.01
(0.05)
−0.03
(0.02)
0.16
(0.11)
−0.11
(0.09)
35536
8404
0.74
tijt = (ln Impijt + ln Impjit)/2
RTA*common colonizer dum.
RTA*GATT/WTO membership dum.
RTA*ln nbr of members in RTA
RTA*ln total GDP in RTA (i's and j's
GDP)
RTA*bilateral RTA dum.
RTA*std. dev. of GDP in RTA
RTA*avg contiguity in RTA
RTA*avg common language in RTA
RTA*avg colony in RTA
RTA*avg common colonizer in RTA
where tijt is the log of bilateral trade flows between country i and
country j at time t, RTAijt is a dummy equal to 1 if countries i and j
belong to an RTA at time t, and Xijt is a set of country-pair and RTA
characteristics. Finally, Iit and Ejt are country-and-year fixed effects,
and Bij is a country pair fixed effect. All country specific variables
(multilateral resistance terms, GDP) and time invariant country pair
specific variables (distance, contiguity, common language or colonial
history) are dropped due to the inclusion of the latter fixed effects.
The new trade theory underlines that opening up to a partner with
a larger and more similar GDP should lead to larger trade flows. RTAs
between proximate countries are likely to lead to more trade creation
than trade diversion (Krugman, 1991a,b; Frankel et al., 1996). Finally,
I include interaction variables with the GDP per capita of countries in
the pair to investigate the relative effectiveness of North/North,
South/South and North/South RTAs.
RTA*avg GATT membership
RTA*ln avg GDP per capita
RTA*ln GDP per capita diff
RTA*ln avg GDP per capita in RTA
RTA*std. dev. of GDP per capita in
RTA
Observations
35536 35536
Number of groups
8404
8404
R-squared
0.73
0.73
Note: Heteroscedasticity- and autocorrelation-robust standard errors in parentheses.
Coefficients on the intercept and country-and-time fixed effects not reported.
a
Significance at the 1% level.
b
Significance at the 5% level.
c
Significance at the 10% level.
3. Results
Table 2 presents the results of the estimation of Eq. (1) on 10
periods at 5 year intervals between 1955 and 2000. I find that large,
similar and geographically close countries tend to benefit more from
joining an RTA in terms of trade creation. Regarding other traditional
gravity determinants of trade, the fact of sharing a common language
increases the effectiveness of RTAs. Finally, an RTA created between
two countries sharing a colonial history (sharing a common colonizer
and, to a lesser extent, ever in a colonial relationship) increases
bilateral trade by less. RTAs between countries sharing a colonial
history may indeed have been created for non-trade reasons. Being
contiguous and joint membership in GATT has no significant effect on
bilateral trade creation.
Controlling for characteristics of other members of the RTA does
not change qualitatively the coefficients on country pair's characteristics (column (4) and (5)). Other members of the RTA however
matter for explaining bilateral trade creation. The presence of large
third countries in an RTA reduces bilateral trade creation, because it
reduces the competitive advantage granted by tariff reduction. Note
that the negative coefficient on the bilateral agreement dummy does
not mean that bilateral RTAs are less trade creating; it roughly offsets
the average negative impact of other members' GDP. In addition, the
number of members in the RTA has no significant impact but their size
distribution (measured as the standard deviation of the GDPs of all
members) has. Everything else equal, an RTA between more
asymmetric countries increases bilateral trade by more. Indeed,
asymmetric countries trade less with each other, reducing the
potential competition from third RTA members. Together, these
results show that bilateral trade creation between any two members
of an RTA will be larger when the potential trade creation among
other partners is lower. Moreover, an RTA created by contiguous
countries increases intra-regional trade by more. It suggests that RTAs
between contiguous countries allow dealing with transnational
190
V. Vicard / Economics Letters 111 (2011) 188–190
Table 3
Quantification: the NAFTA and the EU.
Total
effect
Contribution of
country pair's characteristics
RTA's characteristics
(i)
(ii)
(iii)
(iv)
NAFTA
USA
USA
Canada
Canada
Mexico
Mexico
1990
1995
1995
1.43
0.97
0.78
0.11
0.05
0.05
0.40
−0.02
0.04
0.32
0.23
−0.02
0.72
0.67
0.42
European Union
Netherlands
Netherlands
Netherlands
Netherlands
Netherlands
Netherlands
Netherlands
Netherlands
Netherlands
Netherlands
Netherlands
France
Germany
Italy
Denmark
UK
Greece
Spain
Portugal
Austria
Finland
Sweden
1960
1960
1960
1975
1975
1985
1990
1990
1995
1995
1995
0.57
0.54
0.46
0.69
0.77
0.46
0.65
0.54
0.78
0.63
0.76
0.25
0.34
0.16
0.32
0.38
0.08
0.21
0.11
0.31
0.16
0.29
0.24
0.21
0.15
0.31
0.37
0.07
0.20
0.10
0.30
0.15
0.28
0.28
0.28
0.27
0.01
0.03
−0.05
−0.16
−0.16
−0.22
−0.22
−0.22
0.01
0.01
0.00
0.07
0.08
0.08
0.13
0.12
0.17
0.17
0.17
Note: Predicted from specification (4) in Table (2). (i) bilateral GDP and distance, (ii) all country pairs' characteristics, (iii) the number of partners, their GDP and the bilateral
agreement dummy, and (iv) all characteristics at the RTA level.
infrastructure issues, which are difficult to deal with without
international coordination. Finally, RTAs between GATT/WTO members are less trade creating. The initial level of tariffs of non GATT/
WTO members is indeed likely to be higher.
Finally, column (5) shows that North/North, South/South or North/
South RTAs have similar effects on trade. Indeed, the coefficients on
the level of GDP per capita and the difference in GDP per capita are
insignificant at the country pair as well as the RTA level.
4. Quantification: the NAFTA and the EU
The previous results allow to estimate the effect of regional
integration on specific pairs of countries. This section focuses on the
effect of the creation and enlargement of the NAFTA and the EU on
new members.2 Table 3 reports estimated trade creation effects from
specification (4) of Table 2. The four last columns of Table 3 report, in
comparison to the average effect, the contribution of: (i) bilateral GDP
and distance, (ii) all country pairs' characteristics, (iii) the number of
partners, their GDP and the fact that the RTA is a bilateral agreement,
and (iv) all characteristics at the RTA level.3
The effect of NAFTA ranges from a 143% increase in bilateral trade
between the USA and Canada, to a 78% increase between Canada and
Mexico. This difference is explained by the fact that Canada and the
USA share a common language and, more importantly, the fact that
they initially granted trade preferences only to each other.4 Moreover,
the lower effect on trade between Canada and Mexico reflects the fact
that NAFTA grants the same trade preferences to a much larger
country, the USA.
The successive enlargements of the EU further underline the
significance of third members. Due to space limitation, only the
estimated effects between Netherlands and all other EU-15 countries
are reported.5 The effect of third member countries is found to
2
The methodology used here allows to estimate the effect of the entry into force of
an RTA between two countries, but not any additional longer-term effect.
3
The contribution is computed as the difference with respect to the average country
pair entering an RTA in the sample, for the variables considered.
4
The NAFTA is considered here as the enlargement of the Canada/US free trade
agreement established in 1989.
5
Belgium and Luxembourg are not included since they have been, together with
Netherlands, part of Benelux since 1947.
decrease with successive enlargements (column (iii)). The increasingly uneven distribution of GDP among EU members nevertheless
dampens the negative effect of the increasing number and size of third
members (column (iv)).
5. Conclusion
This paper shows that the effectiveness of an RTA in enhancing trade
between two countries varies depending on both the economic
characteristics of the country pair and the characteristics of all other
members of the RTA. In particular, the size and distribution of GDP
between members are crucial: an RTA increases bilateral trade by more
when the two countries are large and symmetric and other RTA
members are small and asymmetric. In addition, North/North, North/
South and South/South RTAs are found to have similar effects on trade.
References
Baier, S.L., Bergstrand, J.H., 2007. Do free trade agreements actually increase members'
international trade? Journal of International Economics 71 (1), 72–95.
Carrère, C., 2006. Revisiting the effects of regional trade agreements on trade flows with
proper specification of the gravity model. European Economic Review 50, 223–247.
Frankel, J.A., Stein, E., Wei, S.-J., 1996. Regional trading arrangements: natural or
supernatural? American Economic Review 86 (2), 52–56.
Heckman, J.J., 2001. Micro data, heterogeneity, and the evaluation of public policy:
Nobel lecture. Journal of Political Economy 109 (4), 673–748.
Krugman, P., 1991a. International trade and trade policy. In: Helpman, Elhanan, Razin,
Assaf (Eds.), Is Bilateralism Bad? MIT Press, Cambridge, MA. Ch.
Krugman, P., 1991b. The move towards free trade zones. Federal Reserve Bank of Kansas
City, Economic Review 76 (6), 5–25.
Vicard, V., 2008. Trade, conflicts and political integration: explaining the heterogeneity
of regional trade agreements. CES Working Papers, p. 22.
Wooldridge, J.M., 2002. Econometric Analysis of Cross Section and Panel Data. MIT
Press, Cambridge, MA.