Regional Agreements and Welfare in the South: When Scale Economies in Transport Matter

By taking into account scale economies in transport, this paper challenges the accepted pessimistic view that regional preferential trade agreements (PTAs) between developing countries are harmful in welfare terms. In this paper, we assume the adoption of new transport technology when trade increases and show that, given the standard effect of a PTA on regional trade, the welfare would be higher than that usually claimed due to the induced effect on the regional transport network. Moreover, there is evidence that with such sunk costs in transportation, the sequence of trade liberalisation matters: the free trade achieved under a regional PTA would lead to permanently higher welfare than the one achieved under multilateral liberalisation. A standard model of inter- and intra-industry trade is used and augmented by a ‘hub-and-spoke’ transport network structure, where transport costs depend on the distance between trade partners, the volume of trade and the level of development. Under a plausible parameterisation for scale economies in transport, regional liberalisation will have persistent effect on trade flows through an irreversible effect on regional transport costs that improve welfare.