Essays on product differentiation, interdependence and preferential trade agreements

Abstract

This dissertation consists of three essays discussing the determinants of preferential trade agreements (PTAs) and economic integration areas (EIAs), the effects of the formation of these agreements in goods and services on the level and type of bilateral trade flows along with the role of interdependence across preferential agreements. We also analyze the relationship between the heterogeneous trade effects of preferential agreements and their economic depth. In the first essay, we consider the role played by trade in differentiated inputs in the country-pair decision to form a PTA in goods, and in their decision to expand it to trade in services with varying degrees of coverage, which transforms a preferential agreement into an Economic Integration Area (EIA). Our baseline model is very successful in predicting the formation of preferential agreements. Our model correctly predicts 82.6% of the country-pairs with PTAs in our dataset and can successfully predict the 83.1% of the country-pairs that do not form a PTA. Moreover, among those country pairs with a PTA, our model successfully predicts 66% of the observations involving country pairs belonging to an EIA when a PTA exists. In the second essay, we investigate the effects of the formation of preferential trade agreements in goods and services on the level and type of bilateral trade flows. We also consider the role of interdependence across preferential agreements in determining the level of bilateral trade flows. Our empirical results show that the bilateral decision to form a preferential trade agreement in goods directly increases bilateral trade flows, particularly manufactured-differentiated inputs, with a 30% rise after ten years. Furthermore, extending an agreement to include goods and services leads to an even more significant direct effect, increasing bilateral trade of manufactured-differentiated inputs increases by 42% using the same timeframe. Notably, the interdependence among preferential agreements matters: the total effect of the formation of preferential trade agreements on bilateral trade of manufactured-differentiated inputs increases to 50% once we consider the indirect impact of preferential agreements formed by third-country pairs. These results highlight the importance of the type of agreement and their interdependence in promoting trade flows. In the third essay, we analyze the relationship between the heterogeneous trade effects of preferential agreements and their economic depth. Our empirical results show that forming a PTA in goods only increases the bilateral trade of two members in differentiated inputs by 15% for FTA and 18% for CU. In contrast, when we add services to the mix, the direct effect of trade in goods and services shows that forming a PTA increases the bilateral trade of two members in differentiated inputs by 48% for CU but only 15% when services are included in an FTA. Both these effects are significant. These results confirm that only CUs that involve goods and services promote more trade among members than FTAs i.e., for CUs to generate higher grains, we need to have services also included in the model. We find that interdependence amongst agreements matters; the total effect on trade in manufactured-differentiated inputs increases by around 88% once we consider the indirect impact of preferential agreements formed by third-country pairs. These results highlight the importance of the type of agreement and their interdependence in promoting trade flows. Our empirical results also show that PTAs have significant heterogeneous effects on trade. We find that the trade in differentiated manufactured input increased by 1917% due to NAFTA and 455% due to the EU.