Welfare Effect of Free Trade Agreements: A Theoretical Note
| DOI | 10.1177/0015732519831806 |
| Published date | 01 May 2019 |
| Date | 01 May 2019 |
| Subject Matter | Commentary |
Welfare Effect of Free
Trade Agreements:
A Theoretical Note
Avijit Mandal1
Abstract
Kemp and Wan (1976, Journal of International Economics, 6(1), 95–97) show that
customs unions can be welfare enhancing if the imports from the rest of the world
(ROW) by the union members are fixed both before and after the formation of the
union. This note extends their argument to the case of (a) two small open econo-
mies (SOEs) joining a free trade agreement (FTA) and (b) a single SOE joining a
pre-existing FTA among similar economies. The particular compensation principle
considered is the one suggested by Grinols (1981, Journal of International Economics,
11(2), 259–266). According to this argument, welfare gain is ensured if tariff revenue
rises in the post-FTA situation. For our case, this compensation principle translates
to the following: welfare gain can be ensured only when import from ROW (with
whom the FTA was not signed) rises. Since this will amount to a (meaningless)
negative trade diversion effect in the context of the FTA, the source of any such
revenue rise has to be external. The general conclusion of the article is therefore
that it may be impossible for an FTA per se to ensure increased welfare for SOEs.
JEL Codes: F13, F15
Keywords
Free trade agreement, compensation principle, economic welfare, import elasticity,
rest of the world, lump-sum transfers
Introduction
The impact of any free trade agreement (FTA) on the economic welfare of coun-
tries depends on a host of factors. There is a long list of research articles that deal
with this issue.1 The literature draws upon well-known results in welfare economics.
In fact, if we wish to trace the results from their core theoretical underpinnings in
Commentary
1 Maulana Azad College, Kolkata, West Bengal, India.
Corresponding author:
Avijit Mandal, Maulana Azad College, 8 Ra Ahmed Kidwai Road, Taltala, Kolkata, West Bengal
700013, India.
E-mail: a_mand@rediffmail.com
Foreign Trade Review
54(2) 115–125, 2019
© 2019 Indian Institute of
Foreign Trade
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DOI: 10.1177/0015732519831806
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