《On necessarily welfare-enhancing free trade areas》.pdfVIP

Journal of International Economics 57 (2002) 353–367 /locate/econbase On necessarily welfare-enhancing free trade areas a b , * Arvind Panagariya , Pravin Krishna a Department of Economics, University of Maryland, College Park, MD 20742, USA bBrown University, Department of Economics, Providence, RI 02912, USA Received 18 May 1999; received in revised form 15 May 2001; accepted 13 June 2001 Abstract The well-known Kemp–Vanek–Ohyama–Wan proposition establishes that if two or more countries form a customs union (CU) by freezing their net external trade vector through a common external tariff and eliminating internal trade barriers, the union as a whole and the rest of the world cannot be worse off than before. Owing to the fact that a Free Trade Area (whose member countries impose country specific external tariff vectors) does not equalize marginal rates of substitution across its member countries (in contrast to a CU), the literature has been unable to provide a parallel demonstration regarding welfare improving Free Trade Areas (FTAs). The present paper eliminates this gap. In extending the result to the case with intermediate inputs, the paper also sheds new light on the rules of origin required to support such necessarily welfare enhancing FTAs. We show here that provided no trade deflection is permitted, all that is required by way of rules of origin is that the goods produced within the union – whether final or intermediate – be allowed to be traded freely. The proportion of domestic value added in final goods does not enter as a criterion in the rules of origin.  2002 Elsevier Science B.V. All