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Free Trade Area and Welfare: Is A Bigger Trade Diversion More Detrimental?

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Juyoung Cheong and Kar-yiu Wong

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Working Paper

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Kar-yiu Wong(¤ý®aÆk)

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This paper analyzes how the welfare of a member country is affected by the formation of a new FTA. In particular, we examine whether a change in a member country¡¦s welfare is related to the volume of trade diverted from a non-member country to another member country. It has been long and widely believed that a bigger trade volume diverted from a non-member country to another member country is an indication that the welfare of country has been deteriorated to a greater extent. This assumption can be traced back to Viner (1950), and has been used in many empirical studies and policy recommendations. This paper investigates the validity of this assumption. We show that this assumption is not necessarily true, espically if imperfect competition exists in trade. Our result do not support Krishna¡¦s (1998) finding that a bigger trade volume diverted implies a higher likelihood of an FTA to be approved.

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