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Title: Preferential Trade Agreements and Global Sourcing

Author(s): Grant Bickwit, Emanuel Ornelas and John Turner

Publication Date: October 2018

Keyword(s): Hold-up Problem, Incomplete Contracts, Matching, regionalism, sourcing and trade diversion

Programme Area(s): International Trade and Regional Economics

Abstract: We develop a new framework to study the welfare consequences of preferential trade agreements (PTAs) under global sourcing, incomplete contracts and endogenous matching. We uncover several new channels through which PTAs affect global welfare. There are effects stemming from intensive margin changes---i.e., changes in investment and production in existing vertical chains---and from extensive margin relocations---i.e., due to the formation and destruction of vertical chains. In each case, there are potential trade creating, trade diverting and relationship-strengthening forces. The first two are reminiscent of the classical Vinerian approach, but take different forms under global sourcing. The third is entirely new in the regionalism literature and arises because PTAs affect the severity of hold-up problems in sourcing relationships. We characterize those forces and show circumstances when PTAs are necessarily welfare-enhancing or welfare-decreasing. In particular, we show that, because of the relationship-strengthening effect, PTAs can improve global welfare even when all types of trade creation forces are absent.

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Bibliographic Reference

Bickwit, G, Ornelas, E and Turner, J. 2018. 'Preferential Trade Agreements and Global Sourcing'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13264