Bilateralism and free trade

In recent years, there has been a great deal of research on the relative merits of multilateralism and bilateralism and their implications for the nature of the trading regime between countries. In this paper we explore the scope of bilateral free-trade agreements as a foundation for free trade, using recent developments in the theory of strategic network formation. We study a setting with many contries; in each country there are firms, which can sell in the domestic market as well as sell in the foreign markets. The possibility of selling in foreign markets depends on the nature of import tariffs faced by firms. Countries can sign bilateral free-trade agreements which lower import tariffs and thereby facilitate trade. We allow a country to sign any number of bilateral trade agreements. A profile of trade agreements defines the trading regime. We study the nature of trading regimes that are consistent with the incentives of individual countries. Our principal finding is that bilateralism is consistent with global free trade.