Economics Letters 111 (2011) 188–190

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Economics Letters

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Determinants of successful regional trade agreements☆

Vincent Vicard ⁎Banque de France, 31, rue Croix des petits champs 75001 Paris, France

☆ I thank Nicolas Berman and Jose de Souza for hrepresents the views of the author and should not be inBanque de France.⁎ Tel.: +33 142924261.

E-mail address: vincent.vicard@banque-france.fr.1 In the sense that the likelihood of an RTA is

determinants of trade flows that hinder bilateral trabetween two countries is indeed likely to increase withintegration, related to determinants of bilateral trade sunot included in standard gravity equations.

0165-1765/$ – see front matter © 2011 Elsevier B.V. Adoi:10.1016/j.econlet.2011.02.010

a b s t r a c t

a r t i c l e i n f o

Article history:Received 11 January 2010Received in revised form 14 January 2011Accepted 11 February 2011Available online 18 February 2011

JEL classification:F10F15

Keywords:TradeRegional trade agreementsGravity equation

This paper investigates the determinants of the effectiveness of regional trade agreements (RTAs) inenhancing bilateral trade. Characteristics of both the country pair and other RTA members are found tosignificantly influence the trade creation effect of RTAs. However, North/North, North/South and South/SouthRTAs are found to have similar effects on trade.

elpful suggestions. This paperterpreted as reflecting those of

associated with unobservedde. The likelihood of an RTApotential gains from regionalch as behind the border issues

ll rights reserved.

© 2011 Elsevier B.V. All rights reserved.

1. Introduction

Regional trade agreements (RTAs) are an increasingly importantfeature of the international trading system: as of November 2010,195 RTAs notified to the WTO under Enabling Clause and GATT Art.XXIV were in force. Their form, coverage and the characteristics oftheir members however greatly vary throughout the world (seeTable 1).

Two recent papers have provided consistent estimates of the effectof regional trade agreements (RTAs) on bilateral trade by appropri-ately controlling for the endogeneity of membership in RTAs. Baierand Bergstrand (2007) find an average treatment effect of RTAs onbilateral trade close to 50%, increasing to almost 100% after 10 years.They show that endogeneity biases downward the coefficient on RTA,which suggests that countries choose “well” their RTA partners.1

Carrère (2006) focuses on 7 RTAs and finds that they havesignificantly increased trade among members, generally at theexpense of other partners. The trade creation effect however varies

from one RTA to the other. Together, these papers suggest thatcountry pairs self-select into RTAs and that different RTAs may havedifferent effects. This paper investigates systematically which char-acteristics of an RTA and its members determine the extent to whichtrade increases between members.

I focus on characteristics that are predicted by the trade theory toaffect the gains from trade openness. Those are the basic gravity-likedeterminants of bilateral trade flows: the level and similarity of GDPs,bilateral distance, the fact to share a common border, a commonlanguage or a common colonial history, and GATT/WTO membership.Characteristics of the RTA itself are also likely to affect its effectivenessin enhancing intra-regional trade. Indeed, the effectiveness of tradepreferences depends on other countries to which they are granted.Moreover, since different countries tend to choose to create differentkinds of RTAs (Vicard, 2008), the economic characteristics of allmembers of an RTA should inform on its design and so on itseffectiveness. I thus test whether characteristics of all membersmatter rather than those of the country pair.

As suggested by Baier and Bergstrand (2007), I estimate atheoretically motivated gravity equation with country-and-yeardummies and country pair fixed effects. I refine the measurement ofmembership in RTAs by measuring several characteristics of RTAs andmember countries rather than using a dummy variable to measuremembership. The standard gravity equation is augmented byincluding interaction terms between the dummy for RTAmembershipand the characteristics of both the pair of member countries and allother members of the RTA. The results are then illustrated byestimating the effect of the creation and enlargements of the NorthAmerican Free Trade Agreement (NAFTA) and the European Union(EU) on different pairs of member countries.

Table 1Characteristics of main RTAs (2009).

Name Regional/totaltrade (%)

Shareof worldtrade (%)

Form Date ofcreation

Nbr ofmembers

Population(million)

Andeancommunity

8 0.6 CU 1988 4 99

ASEAN freetradeagreement

25 6.1 PA 1992 10 601

EuropeanUnion

66 37.0 CM 1958 27 501

MERCOSUR 16 1.6 CU 1991 4 267NAFTA 39 15.0 FTA 1994 3 457

Table 2Gravity estimates with country-and-year and bilateral fixed effects.

Dependent variable (1) (2) (3) (4) (5)

tijt=(ln Impijt+ln Impjit)/2

RTA 0.36a

(0.04)1.40a

(0.31)0.99a

(0.37)1.33a

(0.48)0.13(0.92)

RTA*avg ln GDP 0.11a

(0.03)0.12a

(0.03)0.06c

(0.04)0.08c

(0.04)RTA*ln GDP diff −0.05b

(0.02)−0.04c

(0.02)−0.05b

(0.02)−0.05b

(0.02)RTA*ln bil.dist −0.22a

(0.04)−0.20a

(0.04)−0.19a

(0.05)−0.15a

(0.05)RTA*contiguity dum. −0.05

(0.10)−0.05(0.10)

−0.06(0.11)

RTA*common language dum. 0.43a

(0.09)0.35a

(0.09)0.41a

(0.10)RTA*colony dum. −0.29b

(0.15)−0.17(0.14)

−0.24c

(0.14)RTA*common colonizer dum. −0.29b

(0.13)−0.28b

(0.13)−0.25c

(0.13)RTA*GATT/WTO membership dum. −0.01

(0.06)0.06(0.06)

0.06(0.07)

RTA*ln nbr of members in RTA −0.09(0.15)

0.04(0.17)

RTA*ln total GDP in RTA (i's and j'sGDP)

−0.11b

(0.05)−0.15b

(0.06)RTA*bilateral RTA dum. −1.33b

(0.54)−1.85b

(0.74)RTA*std. dev. of GDP in RTA 0.18a

(0.05)0.23a

(0.07)RTA*avg contiguity in RTA 0.03a

(0.01)0.02b

(0.01)RTA*avg common language in RTA −0.00

(0.00)−0.00(0.00)

RTA*avg colony in RTA −0.02(0.04)

−0.04(0.04)

RTA*avg common colonizer in RTA −0.00(0.00)

−0.00(0.00)

RTA*avg GATT membership −0.49a

(0.18)−0.44b

(0.19)RTA*ln avg GDP per capita −0.01

(0.05)RTA*ln GDP per capita diff −0.03

(0.02)RTA*ln avg GDP per capita in RTA 0.16

(0.11)RTA*std. dev. of GDP per capita inRTA

−0.11(0.09)

Observations 35536 35536 35536 35536 35536Number of groups 8404 8404 8404 8404 8404R-squared 0.73 0.73 0.73 0.74 0.74

Note: Heteroscedasticity- and autocorrelation-robust standard errors in parentheses.Coefficients on the intercept and country-and-time fixed effects not reported.

a Significance at the 1% level.b Significance at the 5% level.c Significance at the 10% level.

189V. Vicard / Economics Letters 111 (2011) 188–190

2. Empirical Specification

Baier and Bergstrand (2007) argue that the self-selection ofcountry pairs into RTAs create a downward bias on estimates of theeffect of RTAs on trade. Based on the treatment effect literature(Heckman, 2001 and Wooldridge (2002, chap.18)), they suggest touse panel data with country pair and country-and-time fixed effects toproperly estimate the average treatment effect (ATE) of entering anRTA. This methodology yields consistent estimates of the ATE of RTAson bilateral trade but it does not allow to investigate which kinds ofcountry pairs gain more from regional trade integration. To this end, Iintroduce interaction variables between country economic charac-teristics and the RTA membership dummy. The following equation isthus estimated:

tijt = α + β RTAijt + γ RTAijt Xijt + Iit + Ejt + Bij + �ijt ð1Þ

where tijt is the log of bilateral trade flows between country i andcountry j at time t, RTAijt is a dummy equal to 1 if countries i and jbelong to an RTA at time t, and Xijt is a set of country-pair and RTAcharacteristics. Finally, Iit and Ejt are country-and-year fixed effects,and Bij is a country pair fixed effect. All country specific variables(multilateral resistance terms, GDP) and time invariant country pairspecific variables (distance, contiguity, common language or colonialhistory) are dropped due to the inclusion of the latter fixed effects.

The new trade theory underlines that opening up to a partner witha larger and more similar GDP should lead to larger trade flows. RTAsbetween proximate countries are likely to lead to more trade creationthan trade diversion (Krugman, 1991a,b; Frankel et al., 1996). Finally,I include interaction variables with the GDP per capita of countries inthe pair to investigate the relative effectiveness of North/North,South/South and North/South RTAs.

3. Results

Table 2 presents the results of the estimation of Eq. (1) on 10periods at 5 year intervals between 1955 and 2000. I find that large,similar and geographically close countries tend to benefit more fromjoining an RTA in terms of trade creation. Regarding other traditionalgravity determinants of trade, the fact of sharing a common languageincreases the effectiveness of RTAs. Finally, an RTA created betweentwo countries sharing a colonial history (sharing a common colonizerand, to a lesser extent, ever in a colonial relationship) increasesbilateral trade by less. RTAs between countries sharing a colonialhistory may indeed have been created for non-trade reasons. Beingcontiguous and joint membership in GATT has no significant effect onbilateral trade creation.

Controlling for characteristics of other members of the RTA doesnot change qualitatively the coefficients on country pair's charac-teristics (column (4) and (5)). Other members of the RTA howevermatter for explaining bilateral trade creation. The presence of large

third countries in an RTA reduces bilateral trade creation, because itreduces the competitive advantage granted by tariff reduction. Notethat the negative coefficient on the bilateral agreement dummy doesnot mean that bilateral RTAs are less trade creating; it roughly offsetsthe average negative impact of other members' GDP. In addition, thenumber of members in the RTA has no significant impact but their sizedistribution (measured as the standard deviation of the GDPs of allmembers) has. Everything else equal, an RTA between moreasymmetric countries increases bilateral trade by more. Indeed,asymmetric countries trade less with each other, reducing thepotential competition from third RTA members. Together, theseresults show that bilateral trade creation between any two membersof an RTA will be larger when the potential trade creation amongother partners is lower. Moreover, an RTA created by contiguouscountries increases intra-regional trade by more. It suggests that RTAsbetween contiguous countries allow dealing with transnational

Table 3Quantification: the NAFTA and the EU.

Totaleffect

Contribution of

country pair's characteristics RTA's characteristics

(i) (ii) (iii) (iv)

NAFTAUSA Canada 1990 1.43 0.11 0.40 0.32 0.72USA Mexico 1995 0.97 0.05 −0.02 0.23 0.67Canada Mexico 1995 0.78 0.05 0.04 −0.02 0.42

European UnionNetherlands France 1960 0.57 0.25 0.24 0.28 0.01Netherlands Germany 1960 0.54 0.34 0.21 0.28 0.01Netherlands Italy 1960 0.46 0.16 0.15 0.27 0.00Netherlands Denmark 1975 0.69 0.32 0.31 0.01 0.07Netherlands UK 1975 0.77 0.38 0.37 0.03 0.08Netherlands Greece 1985 0.46 0.08 0.07 −0.05 0.08Netherlands Spain 1990 0.65 0.21 0.20 −0.16 0.13Netherlands Portugal 1990 0.54 0.11 0.10 −0.16 0.12Netherlands Austria 1995 0.78 0.31 0.30 −0.22 0.17Netherlands Finland 1995 0.63 0.16 0.15 −0.22 0.17Netherlands Sweden 1995 0.76 0.29 0.28 −0.22 0.17

Note: Predicted from specification (4) in Table (2). (i) bilateral GDP and distance, (ii) all country pairs' characteristics, (iii) the number of partners, their GDP and the bilateralagreement dummy, and (iv) all characteristics at the RTA level.

190 V. Vicard / Economics Letters 111 (2011) 188–190

infrastructure issues, which are difficult to deal with withoutinternational coordination. Finally, RTAs between GATT/WTO mem-bers are less trade creating. The initial level of tariffs of non GATT/WTO members is indeed likely to be higher.

Finally, column (5) shows that North/North, South/South or North/South RTAs have similar effects on trade. Indeed, the coefficients onthe level of GDP per capita and the difference in GDP per capita areinsignificant at the country pair as well as the RTA level.

4. Quantification: the NAFTA and the EU

The previous results allow to estimate the effect of regionalintegration on specific pairs of countries. This section focuses on theeffect of the creation and enlargement of the NAFTA and the EU onnew members.2 Table 3 reports estimated trade creation effects fromspecification (4) of Table 2. The four last columns of Table 3 report, incomparison to the average effect, the contribution of: (i) bilateral GDPand distance, (ii) all country pairs' characteristics, (iii) the number ofpartners, their GDP and the fact that the RTA is a bilateral agreement,and (iv) all characteristics at the RTA level.3

The effect of NAFTA ranges from a 143% increase in bilateral tradebetween the USA and Canada, to a 78% increase between Canada andMexico. This difference is explained by the fact that Canada and theUSA share a common language and, more importantly, the fact thatthey initially granted trade preferences only to each other.4 Moreover,the lower effect on trade between Canada and Mexico reflects the factthat NAFTA grants the same trade preferences to a much largercountry, the USA.

The successive enlargements of the EU further underline thesignificance of third members. Due to space limitation, only theestimated effects between Netherlands and all other EU-15 countriesare reported.5 The effect of third member countries is found to

2 The methodology used here allows to estimate the effect of the entry into force ofan RTA between two countries, but not any additional longer-term effect.

3 The contribution is computed as the difference with respect to the average countrypair entering an RTA in the sample, for the variables considered.

4 The NAFTA is considered here as the enlargement of the Canada/US free tradeagreement established in 1989.

5 Belgium and Luxembourg are not included since they have been, together withNetherlands, part of Benelux since 1947.

decrease with successive enlargements (column (iii)). The increa-singly uneven distribution of GDP among EU members neverthelessdampens the negative effect of the increasing number and size of thirdmembers (column (iv)).

5. Conclusion

This paper shows that the effectiveness of an RTA in enhancing tradebetween two countries varies depending on both the economiccharacteristics of the country pair and the characteristics of all othermembers of the RTA. In particular, the size and distribution of GDPbetweenmembers are crucial: an RTA increases bilateral trade bymorewhen the two countries are large and symmetric and other RTAmembers are small and asymmetric. In addition, North/North, North/South and South/South RTAs are found to have similar effects on trade.

References

Baier, S.L., Bergstrand, J.H., 2007. Do free trade agreements actually increase members'international trade? Journal of International Economics 71 (1), 72–95.

Carrère, C., 2006. Revisiting the effects of regional trade agreements on trade flowswithproper specification of the gravity model. European Economic Review 50, 223–247.

Frankel, J.A., Stein, E., Wei, S.-J., 1996. Regional trading arrangements: natural orsupernatural? American Economic Review 86 (2), 52–56.

Heckman, J.J., 2001. Micro data, heterogeneity, and the evaluation of public policy:Nobel lecture. Journal of Political Economy 109 (4), 673–748.

Krugman, P., 1991a. International trade and trade policy. In: Helpman, Elhanan, Razin,Assaf (Eds.), Is Bilateralism Bad? MIT Press, Cambridge, MA. Ch.

Krugman, P., 1991b. Themove towards free trade zones. Federal Reserve Bank of KansasCity, Economic Review 76 (6), 5–25.

Vicard, V., 2008. Trade, conflicts and political integration: explaining the heterogeneityof regional trade agreements. CES Working Papers, p. 22.

Wooldridge, J.M., 2002. Econometric Analysis of Cross Section and Panel Data. MITPress, Cambridge, MA.