North-South customs unions and international capital mobility

We examine the implications of a North-South trade accord where investments in the Southern partner nation exhibit country risk. Our analysis demonstrates that North-South trade accords can serve as credibility-enhancing mechanisms that induce additional foreign capital inflows into Southern partner nations. We also demonstrate that the presence of sovereign risk changes the trade-offs between trade creation and diversion, enhancing the potential for regional trade accords to increase the welfare of accord members. However, sovereign risk also introduces a novel channel through which non-partner Southern nations can have their welfare reduced by regional trade accords. (C) 1998 Elsevier Science B.V. All rights reserved.