The Theory of Preferential Trading

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Contributions of Jagdish Bhagwati to The Theory of Preferential Trading Arvind Panagariya The literature on the theory of preferential trade areas (PTAs)[1] and the contributions of Jagdish Bhagwati to it can be divided into two distinct phases with 1990 as the approximate dividing line. Phase I starts with the pioneering treatise The Customs Unions Issue by Jacob Viner in 1950 and focuses principally on what Jagdish has called “static” welfare questions. Phase II starts in the early 1990s and focuses instead on the political-economy considerations behind PTAs and the “dynamic” time path question of whether PTAs are building or stumbling blocks of multilateral freeing of trade. Jagdish has made important contributions to the former literature and seminal contributions to the latter. This paper outlines the main developments in each Phase, drawing attention to Jagdish’s role in particular while highlighting the work of others as well, including my own given my longstanding interest in this area of research. Phase I: Static Theory Deploying the Traditional Tools Four distinct approaches can be identified in the pre-1990s literature: 1. The Vinerian welfare analysis using the influential concepts of trade creation and trade diversion; 2. The Kemp-Wan approach focusing on identifying customs unions that would be necessarily welfare improving; 3. The Cooper-Massell-Johnson-Bhagwati analysis of a customs union to minimize the cost of industrialization; and 4. Bhagwati-Brecher approach to analyzing the effect of changes in the exogenous variables such as the external tariff and the terms of trade on individual members of the union. Viner set out to answer the question why many free traders and protectionists agreed on the desirability of PTAs. In the process, he developed the important distinction between trade creating and
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