James Lake and Pravin Krishna
In recent decades, there has been a dramatic proliferation of preferential trade agreements (PTAs) between countries that, while legal, contradict the non-discrimination principle of the world trade system. This raises various issues, both theoretical and empirical, regarding the evolution of trade policy within the world trade system and the welfare implications for PTA members and non-members. The survey starts with the Kemp-Wan-Ohyama and Panagariya-Krishna analyses in the literature that theoretically show PTAs can always be constructed so that they (weakly) increase the welfare of members and non-members. Considerable attention is then devoted to recent developments on the interaction between PTAs and multilateral trade liberalization, focusing on two key incentives: an “exclusion incentive” of PTA members and a “free riding incentive” of PTA non-members. While the baseline presumption one should have in mind is that these incentives lead PTAs to inhibit the ultimate degree of global trade liberalization, this presumption can be overturned when dynamic considerations are taken into account or when countries can negotiate the degree of multilateral liberalization rather than facing a binary choice over global free trade. Promising areas for pushing this theoretical literature forward include the growing use of quantitative trade models, incorporating rules of origin and global value chains, modeling the issues surrounding “mega-regional” agreements, and modelling the possibility of exit from PTAs. Empirical evidence in the literature is mixed regarding whether PTAs lead to trade diversion or trade creation, whether PTAs have significant adverse effects on non-member terms-of-trade, whether PTAs lead members to lower external tariffs on non-members, and the role of PTAs in facilitating deep integration among members.