The Implications of A South-South Customs Union On Tariffs, Welfare, and The Prospect of Global Free Trade

Following the failure of multilateral trade negotiations at the Cancun meetingand the Doha Round, developing countries have pursued an alternative in so called"south-south" trade agreements. Since these agreements lead to trade diversionfrom efficient north (developed) countries to less efficient south (developing)partners, there have been widespread concerns regarding their welfare implications.Using a three country oligopoly model of trade, we first examine staticallythe implications of a south-south customs union (CU) on the pattern of tariffs andwelfare. We find that south countries always have incentives to form a CU that reducesthe welfare of the north country. Moreover, when south firms are sufficientlyinefficient relative to north firms, a south-south CU leads to a large trade diversioneffect and reduces world welfare. We further show that, in a repeated interactionmodel, free trade is less likely to be sustainable under the south-south CU relativeto no agreement.