Why join a common market? ∗

This paper develops a theory of the endogenous formation of a common market in a three–country, two–factor political economy model. Ex ante policies in each of the prospective members are the result of majority voting, and equilibrium outcomes may include both import restrictions as well as subsidies. The decision to participate in the integration process is modelled as a simultaneous move game between the two prospective members. Several interesting results emerge. In a common market, factors moving between the members are more likely to gain, the bigger is the import demand of one country as compared to the factor supply of the exporting partner. Factors which instead do not relocate are more likely to see their return decrease when factor flows are big and import demands are inelastic. Importantly, for the common market to emerge as an equilibrium, some factors must continue to experience enhanced pro-tection when the integration process is completed. This result highlights the potential tension between social desirability and political feasibility of the integration process