Trading Blocs: The Natural, the Unnatural, and the Super-Natural

Is the world breaking up into three trading blocs, one in the Americas, one in Europe and one in Pacific Asia? If so, is this deviation from the principle of MFN (nondiscriminatory trade policies) good or bad? This paper attempts to answer both questions. Using the gravity model to examine bilateral trade patterns throughout the world, we find evidence of trading blocs in the European Community, the Pacific, and the Western Hemisphere, as in earlier work. Intra-regional trade is greater than could be explained by natural determinants: the proximity of a pair of countries, their sizes and GNP/capitas, and whether they share a common border or a common language. Within the Western Hemisphere, MERCOSUR and the Andean Pact countries appear to function as significantly independent trading areas, but NAFTA much less so (as of 1990). The strongest grouping in most years is APEC (Asia Pacific Economic Cooperation,which includes the U.S. and Canada along with the Asian Pacific countries). The intra-regional trade bias within MERCOSUR increased the most rapidly during the 1980s. In East Asia, on the other hand, increased intra-regional trade can be explained entirely by the rapid growth of the economies. We then turn from the econometrics to an analysis of economic welfare. Krugman has supplied an argument against a world of three trading blocs (that they would be protectionist), in a model that assumes no transport costs. He has supplied another argument in favor of trading blocs, provided the blocs are drawn along the "natural" geographic lines of the continents, in a model that assumes prohibitively high transportation costs between continents. In this paper we attempt to resolve the Krugman vs. Krugman debate. We complete the model of the welfare implications of trading blocs for the realistic case where intercontinental transport costs are neither so high as to be prohibitive nor as low as the costs among neighbors. We consider three applications of the model. (1) Continental Free Trade Areas (FTAs). We show that it is not only Krugman's "unnatural" FTAs that can leave everyone worse off than under MFN, but that under conditions of relatively low intercontinental transport costs, FTAs that are formed along natural continental lines can do so as well. We call such welfare-reducing blocs supernatural. (2) Partial regionalization. We find that partial liberalization within a regional Preferential Trading Arrangement (PTA) is better than 100 percent liberalization, in contrast to the Article 24 provision of the GATT. The super-natural zone, where the regional trading arrangement reduces welfare, occurs for combinations of low inter-continental transport costs and high intra-bloc preferences, i.e., when the regionalization of trade policy exceeds what is justified by natural factors. (3) The formation of several sub-regional PTAs on each continent. We find that multiple Mks on each continent could lower welfare, but that multiple PTAs, with partial internal liberalization, would raise welfare. We conclude the paper with an attempt to extract estimates of transportation costs from the statistics. Estimates suggest that trading blocs on the order of the EC are in fact super-natural.