International Trade, Regional Free Trade Agreements, and Economic Development

Krugman (1991a,b) illustrated that natural (regional) free trade agreements (FTAs) are likely welfare enhancing if intercontinental transport costs are prohibitively high, but are likely welfare reducing if such costs are zero. Frankel, Stein and Wei (1995) extended the analysis to consider positive but nonprohibitive transport costs. We extend these models to allow for countries of different economic size. Large countries will tend to have higher relative wages, influencing the relative gains and losses from natural FTAs. For even modest differences in size, intracontinental FTAs are welfare enhancing for larger countries, regardless of strong preferences for diversity or low intercontinental transport costs