Jeffrey H. Bergstrand
Professor of Finance, University of Notre Dame
Kellogg Institute Faculty Fellow
One of the most notable international economic events over the past 50 years has been the “growth of regionalism”—referring to the proliferation of free trade (and other forms of economic integration) agreements over this period. Some have argued that the growth of regionalism is attributable to governments having pursued a policy of “competitive liberalization”—implementing bilateral and regional free trade agreements (FTAs) to enhance trade creation, but also to preempt potential trade diversion. Guided by new comparative statics from the numerical general equilibrium monopolistic competition model of FTA economic determinants in Baier and Bergstrand (2004), we augment their parsimonious logit (and probit) model of the economic determinants of bilateral FTAs to incorporate “multilateral indexes” of countries’ FTA memberships to examine the influence of existing memberships on subsequent memberships, i.e., competitive liberalization. The model can predict correctly 90 percent of the bilateral FTAs within five years of their formation, while still predicting “No-FTA” correctly in 90 percent of the observations when no FTA exists, using a sample of over 350,000 observations for pairings of 146 countries from 1960–2005. Even imposing the higher correct prediction rate of “No-FTA” of 97 percent in Baier and Bergstrand (2004), the parsimonious model still predicts correctly 75 percent of these rare FTA events; only 1 percent of the observations reflect a transition of a country pair from having no FTA to having an FTA. Moreover, the results suggest that previous gravity-equation studies that have found little evidence of trade diversion in actual trade flows may be attributable to the endogenous growth of regionalism to prevent potential trade diversion, that is, competitive liberalization.
Paper coauthored by Scott L. Baier, Clemson University, and Ronald Mariutto, University of Notre Dame