ENDOGENOUS PROTECTION AND TRADE DIVERSION

Traditional positive analysis of preferential trading areas has focused on the trade-offs between (beneficial) trade creation and (potentially harmful) trade diversion. We consider the latter phenomenon in the formation of a free-trade area (FTA) between countries where tariffs against non-members are set endogenously. We show that such tariffs will fall consequent to the formation of FTAs and trade diversion is likely to become trade creation. This is illustrated in a model in which tariffs are levied to maximize a political support function. We conclude with some comments on the generality of this result and directions for future research.