In Discussion Paper No. 1317, Eric Bond, Constantinos Syropoulos and Research Fellow Alan Winters consider a simple three-country, multi-commodity trade model. Two union members, having successfully co-ordinated their external tariff policies, are in the process of deepening the integration of their internal markets through the removal of tariffs on intra-union trade. The goal of the paper is to examine how this deepening of integration affects the set of incentive compatible/self-enforcing tariff agreements with the third country, given history-dependent strategies and inability of all countries to sign binding trade agreements. Conditions under which Kemp-Wan adjustments in the external tariffs of union members are sustainable are derived and used as a frame of reference to evaluate the actual tariff-setting incentives of trading partners.

The analysis reveals that the deepening of integration may enlarge the set of sustainable agreements with the outside country, and that this possibility crucially depends on the degree of substitutability in consumption. It is extended to welfare effects of integration and effects of political economy factors. With this study, the authors intend to elucidate the effects of the single European market programme on the multilateral trading system. Their analysis suggests that European integration will set up forces that lead the EU to liberalize its trade with the rest of the world, but that, depending on economic parameters, this may or may not leave the rest of the world worse off.

Deepening of Regional Integration and Multilateral Trade Agreements
Eric W Bond, Constantinos Syropoulos, and L Alan Winters