Why are trade agreements regional? A theory based on noncooperative networks

This paper argues that free trade agreements (FTAs) are regional because, in their absence, optimal tari¤s are higher against (close) regional partners than (distant) countries outside the region. Optimal tari¤s shift rents from foreign firms to domestic citizens. Lower transport costs imply higher rents and therefore higher tari¤s. So regional FTAs have a higher pay- o¤ than non-regional FTAs. Therefore, only regional FTAs may yield positive gains when sponsoring a FTA is costly. To analyze equilibrium, standard the- ory of non-cooperative networks is extended to allow for asymmetric players. Naive best response dynamics show that ‘trade blocks can be stepping blocks’ for free trade.