Trade-creation and trade-diversion effects of regional trade arrangements: low-income countries

ABSTRACT

Although the number of regional trade arrangements (RTAs) among the lowest-income developing countries is surging, the literature on their welfare effects is still scarce, and the few that exist fail to provide conclusive results. Furthermore, these RTAs are dominated by countries with a small share of total exports destined for intraregional trade flows. Our study focuses on the welfare effects of RTAs (pertaining to trade creation and trade diversion) among this group of countries. We use a theoretically justified gravity model to estimate welfare effects, focusing on trade creation and trade diversion and deviating from the norm in related studies, accounting for heterogeneity in third countries. Using ECOWAS as a sample, we estimate welfare effects on 1992–2012 annual bilateral imports for 14 countries from 169 countries. Contrary to conventional expectations in the literature, we find that economic integration among small and relatively low-income countries that have a small share of total trade with each other is welfare-improving for the members as a group, for the majority of the individual member countries, and for some third countries. Accounting for heterogeneity in third countries reveals that an RTA among low-income countries has a particularly robust trade-creation effect.

KEYWORDS:

• Preferential trade agreements
• south–south trade
• gravity model
• ECOWAS
• trade-creation
• third country heterogeneity

JEL CLASSIFICATION:

• F13
• F14
• F15

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ For example, the United States has launched negotiations for the Transatlantic Trade and Investment Partnership (involving 11 countries) and Trans-Pacific Partnership (with the EU) (http://www.trade.gov/fta/).

² See Krugman (1987) for further discussion on free-trade policies.

³ Based on the World Bank ranking of countries by per capita income, 10 of the 15 ECOWAS-member countries are among the lowest-income countries of the world, and the remaining five fall into the lower-middle-income country group (data obtained 11/13/14 from http://data.worldbank.org/about/country-and-lending-groups#Low_income).

⁴ For a more detailed overview of ECOWAS, see Cernicky (2007), Hoppe and Aidoo (2012), and Tobi (2013). Furthermore, Langhammer and Hiemenz (1990) provide a detailed overview of the rationale and obstacles associated with economic integration among developing countries in general.

⁵ For a review of gravity models, see Kepaptsoglou, Karlaftis, and Tsamboulas (2010).

⁶ See Anderson and Van Wincoop. (2003) for more details.

⁷ UEMOA (the West African Economic and Monetary Union) is an economic integration scheme involving Benin, Burkina Faso, Cote d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo.

⁸ Based on 2010 GDP, countries with a GDP of $186 billion or more, $32 billion to $185 billion, and less than $32 billion are classified as high-income, middle-income, and low-income countries, respectively.