Skip to main content

Do we really know that trade agreements increase trade?

Abstract

This study surveys the empirical literature in which the gravity equation has been used to study the effect of economic integration agreements (EIAs) on international trade flows. We show that most studies either focus on improving the methodology to assess regionalism’s overall impact, or on a small set of well-known agreements without necessarily adopting new methodological improvements. We bridge this gap by providing individual estimates for EIAs on world trade, while employing first-differencing techniques to correct for endogeneity bias and account for phase-in effects. Overall, EIAs promote trade by at most 50 %. Surprisingly, more than half of the EIAs investigated have had no discernible impact on trade at all, while only about one quarter of the agreements are trade promoting. Characteristics of these agreements, such as their institutional quality, design, and their members’ involvement in the World Trade Organisation, shed more light on how this variation can be understood.

This is a preview of subscription content, access via your institution.

Fig. 1
Fig. 2
Fig. 3
Fig. 4
Fig. 5

Notes

  1. According to Kohl et al. (2013), the EEA incorporates a total of 16 policy areas. In contrast, US-Israel FTA covers just slightly more than half that amount.

  2. The user-written Stata packages reg2hdfe and reg3hdfe were used to estimate our linear regression models with high-dimensional fixed effects for the entire dataset. See Carneiro et al. (2012) and Head and Mayer (2014).

  3. The appendix shows that our findings are similar to those of B&B when the dataset is restricted to their sample of 96 countries and 1950–2000.

  4. Foster and Stehrer (2011) provide an interesting exception by investigating both the aggregate and individual impact of several major EIAs on intra-industry trade.

  5. Abbreviations are explained in Table 5.

  6. In related work, Park and Park (2011) find that agreements established under GATT Article XXIV are more effective than those established under the Enabling Clause.

  7. Group means were compared using ANOVA and a Tukey HSD pairwise test. “Mixed” and “All in WTO” are both significantly different to “None in WTO”, but there is no significant difference between the “Mixed” and “All in WTO” groups.

  8. The nine indicators convey information about whether the signatories have agreed to how consultations are to proceed, whether technical issues have been defined in the agreement, whether details about a dispute settlement mechanism are provided, whether an evolutionary clause has been specified, whether the institutional framework has been laid out, the objectives of the agreements formulated, if a plan and/or liberalisation schedule has been specified and whether information is provided as to how the signatories intend for the institutional arrangement to be transparent. See Kohl et al. (2013) for full details.

  9. The 17 provisions are on policy areas such as agriculture, anti-dumping and countervailing measures, capital mobility, competition, customs administration, environmental issues, export restrictions, labour issues, import restrictions, intellectual property rights, investment, public procurement, sanitary and phytosanitary measures, services, state aid, state trading enterprises, and technical barriers to trade. See Kohl et al. (2013) and the online dataset at http://tristankohl.org for more detail about the dataset and for an application of the gravity equation that supports the findings in this section.

  10. This finding raises the idea that EIAs serve a network function, connecting a broad range of countries and commodities. As the global value chain is continually sliced into smaller pieces, it is not the separate parts comprised of EIAs or regions that matter as much for international trade as the sum of these parts in an intertwined, interconnected network of economic integration. This avenue is further explored in Alba et al. (2010).

References

  • Abrams, R. K. (1980). International trade flows under flexible exchange rates. Federal Reserve Bank of Kansas City Economic Review, (March), 3–10.

  • Aitken, N. D. (1973). The effect of the EEC and EFTA on European trade: A temporal cross-section analysis. American Economic Review, 63(5), 881–892.

    Google Scholar 

  • Aitken, N. D., & Obutelewicz, R. S. (1976). A cross-section study of EEC trade with the Association of African Countries. The Review of Economics and Statistics, 58(4), 425–433.

    Article  Google Scholar 

  • Alba, J., Hur, J., & Park, D. (2010). Do hub-and-spoke free trade agreements increase trade? A panel data analysis. World Development, 38(8), 1105–1113.

    Article  Google Scholar 

  • Anderson, J. E., & van Wincoop, E. (2003). Gravity with gravitas: A solution to the border puzzle. American Economic Review, 93(1), 170–192.

    Article  Google Scholar 

  • Baier, S. L., & Bergstrand, J. H. (2002). On the endogeneity of international trade flows and free trade agreements. http://www.nd.edu/~jbergstr/Working_Papers/EndogeneityAug2002.pdf.

  • Baier, S. L., & Bergstrand, J. H. (2007). Do free trade agreements actually increase members’ international trade? Journal of International Economics, 71(1), 72–95.

    Article  Google Scholar 

  • Baier, S. L., & Bergstrand, J. H. (2009). Bonus vetus OLS: A simple method for approximating international trade-cost effects using the gravity equation. Journal of International Economics, 77(1), 77–85.

    Article  Google Scholar 

  • Baier, S. L., Bergstrand, J. H., Egger, P., & McLaughlin, P. A. (2008). Do economic integration agreements actually work? Issues in understanding the causes and consequences of the growth of regionalism. The World Economy, 31(4), 461–497.

    Article  Google Scholar 

  • Baier, S. L., Bergstrand, J. H., & Vidal, E. (2007). Free trade agreements in the Americas: Are the trade effects larger than anticipated? The World Economy, 30(9), 1347–1377.

    Article  Google Scholar 

  • Balassa, B. (1967). Trade creation and trade diversion in the European Common Market. Economic Journal, 77(305), 1–21.

    Article  Google Scholar 

  • Baldwin, R. E. (2010). Unilateral tariff liberalisation. (NBER Working Paper 16600). Cambridge, MA: National Bureau of Economic Research.

  • Bayoumi, T., & Eichengreen, B. (1998). Is regionalism simply a diversion? Evidence from the EU and EFTA. In T. Ito & A. Krueger (Eds.), Regionalism versus multilateral trade arrangements. Chicago: University of Chicago Press.

    Google Scholar 

  • Bergstrand, J. H. (1985). The gravity equation in international trade: Some microeconomic foundations and empirical evidence. The Review of Economics and Statistics, 67(3), 474–481.

    Article  Google Scholar 

  • Bhagwati, J. (2008). Termites in the trading system: How preferential trade agreements undermine free trade. Oxford: Oxford University Press.

    Book  Google Scholar 

  • Brada, J. C., & Mendez, J. A. (1983). Regional economic integration and the volume of intra-regional trade: A comparison of developed and developing country experience. Kyklos, 36(4), 589–603.

    Google Scholar 

  • Brada, J. C., & Mendez, J. A. (1985). Economic integration among developed, developing and centrally planned economies: A comparative analysis. The Review of Economics and Statistics, 67(4), 549–556.

    Article  Google Scholar 

  • Carneiro, A., Guimarães, P., & Portugal, P. (2012). Real wages and the business cycle: Accounting for worker, firm, and job title heterogeneity. American Economic Journal: Macroeconomics, 4(2), 133–152.

    Google Scholar 

  • Cheng, I.-H., & Wall, H. J. (2005). Controlling for heterogeneity in gravity models of trade and integration. Federal Reserve Bank of St. Louis Review, 87, 49–63.

    Google Scholar 

  • Egger, P. H., & Wamser, G. (2013a). Multiple faces of preferential market access: Their causes and consequences. Economic Policy, 28(73), 143–187.

    Article  Google Scholar 

  • Egger, P. H., & Wamser, G. (2013b). Effects of the endogenous scope of preferentialism on international goods trade. (CESifo Working Paper No. 4208). CESifo: Munich.

  • Eicher, T., Henn, C., & Papageorgiou, C. (2012). Trade creation and diversion revisited: Accounting for model uncertainty and natural trading partner effects. Journal of Applied Econometrics, 27(2), 296–321.

    Article  Google Scholar 

  • Elkan, P. G. (1975). Measuring the impact of economic integration among developing countries. Journal of Common Market Studies, 14(1), 56–68.

    Article  Google Scholar 

  • Feenstra, R. C. (2004). Advanced international trade: Theory and evidence. Princeton, MA: Princeton University Press.

    Google Scholar 

  • Feenstra, R. C., Markusen, J. A., & Rose, A. K. (2001). Using the gravity equation to differentiate among alternative theories of trade. Canadian Journal of Economics, 34(2), 430–447.

    Article  Google Scholar 

  • Ffrench-Davis, R. (1977). The Andean pact. A model of economic integration for developing countries. World Development, 5(1–2), 137–153.

    Article  Google Scholar 

  • Foster, N., & Stehrer, R. (2011). Preferential trade agreements and the structure of international trade. Review of World Economics/Weltwirtschaftliches Archiv, 147(3), 385–410.

    Article  Google Scholar 

  • Frankel, J. A., & Rose, A. K. (2002). An estimate of the effect of common currencies on trade and income. The Quarterly Journal of Economics, 117(2), 437–466.

    Article  Google Scholar 

  • Frankel, J. A., Stein, E., & Wei, S. J. (1995). Trading blocs and the Americas: The natural, the unnatural and the supernatural. Journal of Development Economics, 47(1), 61–69.

    Article  Google Scholar 

  • Frankel, J. A., & Wei, S. J. (1997). Regionalization of world trade and currencies: Economics and politics. In J. A. Frankel (Ed.), Regional trading blocs in the world economic system. Washington, DC: Institute for International Economics.

    Chapter  Google Scholar 

  • Ghosh, S., & Yamarik, S. (2004a). Does trade creation measure up? A reexamination of the effects of regional trading arrangements. Economics Letters, 82(2), 213–219.

    Article  Google Scholar 

  • Ghosh, S., & Yamarik, S. (2004b). Are regional trading arrangements trade creating? An application of extreme bounds analysis. Journal of International Economics, 63(2), 369–395.

    Article  Google Scholar 

  • Hamilton, C. B., & Winters, L. A. (1992). Opening up international trade with Eastern Europe. Economic Policy, 7(14), 77–116.

    Article  Google Scholar 

  • Head, K., & Mayer, T. (2014). Gravity equations: Workhorse, toolkit, and cookbook. In G. Gopinath, E. Helpman, & K. Rogoff (Eds.), Handbook of international economics, Vol. 4, Amsterdam: Elsevier

  • Hewett, E. A. (1976). A gravity model of CMEA trade. In J. C. Brada (Ed.), Quantitative and analytical studies in East-West economic relations. Bloomington: International Development Research Center.

    Google Scholar 

  • Horn, H., Mavroidis, P. C., & Sapir, A. (2010). Beyond the WTO? An anatomy of EU and US preferential trade agreements. The World Economy, 33(11), 1565–1588.

    Article  Google Scholar 

  • IMF (2013). Direction of trade statistics. Washington, DC: International Monetary Fund. Retrieved November 2013.

  • Kohl, T., Brakman, S., & Garretsen, J. H. (2013). Do international trade agreements stimulate trade differently? Evidence from 296 trade agreements. (CESifo Working Paper Series 4243). CESifo: Munich.

  • Linnemann, H. (1966). An econometric study of international trade flows. Amsterdam: North-Holland.

    Google Scholar 

  • Lizano, E., & Willmore, L. N. (1975). Second thoughts on Central America: The Rosenthal report. Journal of Common Market Studies, 13(2), 280–307.

    Article  Google Scholar 

  • Magee, C. (2003). Endogenous preferential trade agreements: An empirical analysis. Contributions to Economic Analysis & Policy, 2(1), 1–19.

    Google Scholar 

  • Magee, C. (2008). New measures of trade creation and trade diversion. Journal of International Economics, 75(2), 349–362.

    Article  Google Scholar 

  • Mayer, T., & Zignago, S. (2011). Notes on CEPII’s distances measures (GeoDist). (CEPII Working Paper 2011-25). Paris: Centre d’Études Prospectives et d’Informations Internationales.

  • McGill (2009). PTA database. http://ptas.mcgill.ca. Retrieved October 2009.

  • McLaren, J. E. (1997). Size, sunk costs, and Judge Bowker’s objection to free trade. American Economic Review, 87(3), 400–420.

    Google Scholar 

  • Mölders, F., & Volz, U. (2011). Trade creation and the status of FTAs: Empirical evidence from East Asia. Review of World Economics/Weltwirtschaftliches Archiv, 147(3), 429–456.

    Article  Google Scholar 

  • Oguledo, V. I., & MacPhee, C. R. (1994). Gravity models: A reformulation and an application to discriminatory trade arrangements. Applied Economics, 26(2), 107–120.

    Article  Google Scholar 

  • Orefice, G., & Rocha, N. (2014). Deep integration and production networks: An empirical analysis. The World Economy, 37(1), 106–136.

    Article  Google Scholar 

  • Park, I., & Park, S. (2011). Best practices for regional trade agreements. Review of World Economics/Weltwirtschaftliches Archiv, 147(2), 249–269.

    Article  Google Scholar 

  • Pelzman, J. (1977). Trade creation and trade diversion in the Council for Mutual Economic Assistance: 1954–1970. American Economic Review, 67(4), 713–722.

    Google Scholar 

  • Pomfret, R. (2007). Is regionalism an increasing feature of the world economy? The World Economy, 30(6), 923–947.

    Article  Google Scholar 

  • Rose, A. K. (2004). Do we really know that the WTO increases trade? American Economic Review, 94(1), 98–114.

    Article  Google Scholar 

  • Rose, A. K., Lockwood, B., & Quah, D. (2000). One money, one market? The effects of common currencies on international trade. Economic Policy, 15(30), 7–46.

    Article  Google Scholar 

  • Rosen, H. (2004). Free trade agreements as foreign policy tools: The US-Israel and US-Jordan FTAs. In J. J. Schott (Ed.), Free trade agreements: US strategies and priorities. Washington, DC: Institute for International Economics.

    Google Scholar 

  • Sapir, A. (1981). Trade benefits under the EEC generalized system of preferences. European Economic Review, 15(3), 339–355.

    Article  Google Scholar 

  • Soloaga, I., & Winters, L. A. (2001). Regionalism in the nineties: What effect on trade? North American Journal of Economics and Finance, 12(1), 1–29.

    Article  Google Scholar 

  • Subramanian, A., & Wei, S. J. (2007). The WTO promotes trade, strongly but unevenly. Journal of International Economics, 72(1), 151–175.

    Article  Google Scholar 

  • Tinbergen, J. (1962). Shaping the world economy: Suggestions for an international economic policy. New York: The Twentieth Century Fund.

    Google Scholar 

  • Tomz, M., Goldstein, J. L., & Rivers, D. (2007). Do we really know that the WTO increases trade? Comment. American Economic Review, 97(5), 2005–2018.

    Article  Google Scholar 

  • Trefler, D. (1993). Trade liberalization and the theory of endogenous protection: An econometric study of U.S. import policy. Journal of Political Economy, 101(1), 138–160.

    Article  Google Scholar 

  • Tuck (2009). Trade agreements database. http://wits.worldbank.org/gptad/trade_database.html. Retrieved October 2009.

  • Vaitsos, C. V. (1978). Crisis in regional economic cooperation (integration) among developing countries: A survey. World Development, 6(6), 719–769.

    Article  Google Scholar 

  • Wooldridge, J. M. (2002). Econometric analysis of cross section and panel data. Cambridge, MA: The MIT Press.

    Google Scholar 

  • World Bank (2011). Global preferential trade agreements database. http://wits.worldbank.org/gptad. Retrieved December 2011.

  • World Bank (2013). World development indicators. http://data.worldbank.org/indicator. Retrieved December 2013.

  • WorldTradeLaw.net (2009). FTA database. http://www.worldtradelaw.net/fta/ftadatabase/ftas.asp. Retrieved October 2009.

  • WTO (2013a). Regional trade agreements information system. http://rtais.wto.org. Retrieved December 2013.

  • WTO (2013b). Members and observers. http://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm. Retrieved December 2013.

Download references

Acknowledgments

The author thanks Rob Alessie, Jeffrey Bergstrand, Steven Brakman, Harry Garretsen, Will Martin, Peter van Bergeijk, participants at the Spring Meeting of Young Economists (Groningen), International Trade and Finance Association’s Annual Conference (Eilat) and the Conference on Globalisation, Strategies and Effects (Koldingfjord), three anonymous referees and the editor for valuable comments.

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Tristan Kohl.

Appendix

Appendix

In order to ensure that the data and econometric approach are consistent with B&B, the dataset can be conditioned on the EIAs, 96 countries and 1950–2000 (in 5-year intervals) covered in B&B. Estimating Eq. 4 (fixed effects) gives the results outlined in Table 6; Eq. 5 (first differences) yields Table 7. The number of observations is somewhat lower than in B&B, which makes it unlikely to find exactly the same parameter estimates. This difference in the number of observations could be attributed to changes in the IMF (2013) or World Bank (2013)’s methods of estimating bilateral trade flows and GDP (deflators), respectively. Nevertheless, the parameter estimates in both tables are highly comparable to those provided in B&B. In particular, the inclusion of additional lags leads to a steady rise in the Total ATE. Moreover, the Total ATEs are of comparable orders of magnitude. Finally, the assumption of strict exogeneity is not violated.

Table 6 Benchmark estimates with fixed effects
Table 7 Benchmark estimates with first differences

About this article

Cite this article

Kohl, T. Do we really know that trade agreements increase trade?. Rev World Econ 150, 443–469 (2014). https://doi.org/10.1007/s10290-014-0188-3

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10290-014-0188-3

Keywords

  • Economic integration agreements
  • Gravity model
  • International trade flows
  • Endogenous trade policy

JEL Classification

  • F13
  • F15
  • F5