Bilateral trade agreements and the feasibility of multilateral free trade,” mimeo

What is the relationship between preferential and multilateral trade liberalization? Does the option to form free trade agreements (FTAs) reduce the likelihood of obtaining global free trade? In a three-country model of intraindustry trade, we show that when the degree of cost asymmetry between countries is small, global free trade is less likely to occur when FTAs are permissible (stumbling bloc effect). However, when the degree of cost asymmetry is sufficiently high, global free trade is infeasible whereas welfare improving FTAs are feasible. In fact, there exist circumstances where (i) FTAs can even yield higher world welfare than global free trade and (ii) multilateral free trade is an equilibrium only if countries have the option to form FTAs (build-ing bloc effect)