Small Is Beautiful: Preferential Trade Agreements and the Impact of Country Size, Market Share, Efficiency, and Trade Po

October 1996 The smaller the volume (or share) of imports from the trading partner, the larger the impact of a preferential trade agreement on home country welfare - because the smaller the imports, the smaller the loss in tariff revenue. And the home country is better off as a small member of a large bloc than as a large member of a small bloc. There has been a resurgence of preferential trade agreements (PTAs) partly because of the deeper European integration known as EC-92, which led to a fear of a Fortress Europe; and partly because of the U.S. decision to form a PTA with Canada. As a result, there has been a domino effect: a proliferation of PTAs, which has led to renewed debate about how PTAs affect both welfare and the multilateral system. Schiff examines two issues: the welfare impact of preferential trade agreements (PTAs) and the effect of structural and policy changes on PTAs. He asks how the PTA's effect on home-country welfare is affected by higher demand for imports; the efficiency of production of the partner or rest of the world (ROW); the share imported from the partner (ROW); and the initial protection on imports from the partner (ROW). Among his findings: ° An individual country benefits more from a PTA if it imports less from its partner countries (with imports measured either in volume or as a share of total imports). This result has important implications for choice of partners. ° A small home country loses from forming a free trade agreement (FTA) with a small partner country but gains from forming one with the rest of the world. In other words, the home country is better off as a small member of a large bloc than as a large member of a small bloc. This result need not hold if smuggling is a factor. ° Home country welfare after formation of a FTA is higher when imports from the partner country are smaller, whether the partner coun...