TARIFF REVENUE COMPETITION IN A FREE-TRADE AREA

This note argues that important consequences for the analysis of free trade areas (FTAs) follow from the observation that, with no transport costs, producer prices must be equalised across member countries of a FTA, even if external tariffs differ. In particular, the well-known tariff externality of a FTA is exacerbated by internal trade deflection and competition for external tariff revenues. Consequently, a FTA will involve lower external tariffs than might otherwise be expected. We illustrate an extreme case of a FTA between identical partners wherein equilibrium, if it exists at all, is one of zero external tariffs.