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In this paper, I estimate the economic effects of adopting a customs union in the context of an oligopolistic market with multinational firms, tariffs and non-tariff barriers. Specifically, I estimate a model of demand and supply for cars in Argentina and Brazil and I look at the consequences of adopting MERCOSUR, a regional trade agreement to be fully implemented in 2006. I develop a model of the strategic behavior of multinational firms in the presence of active trade intervention in the form of tariffs and non-tariff barriers and I show how a particular form of trade balance restriction applied at the firm level can lead to an increase in trade flows in the presence of intra-firm strategic trade. I propose a minimum-distance estimator that allows for the joint estimation of production costs and shadow costs of the NTBs without making functional form assumptions on the cost side. To explore the effects of the trade policy, I derive equilibrium conditions for firms under the changed policy parameters and I use the estimates of demand and costs to predict the outcome in these counterfactual equilibria. I decompose the effects on prices, volumes of trade, profits and consumer welfare into the separate impacts of two simultaneous changes in policy: the removal of NTBs and the adoption of a common external tariff.

A Customs Union with Multinational Firms: The Automobile Market in Argentina and Brazil