Vannetelbosch ”Networks for Free Trade Agreements among Heterogeneous Countries,” Working Paper 2006029 (2006), Université catholique de Louvain, Département des Sciences Economiques

Université catholique de Louvain. CORE DISCUSSION PAPER 2006/53 The paper examines the formation of free trade agreements as a network forma-tion game. We consider a three-country model in which international trade occurs between economies with imperfectly competitive product markets. Labor markets can be unionized and non-unionized in each country. We show that if all countries are of the same type (all of them are either unionized or non-unionized), the global free trade network is both the unique pairwise stable network and the unique efficient net-work. If some countries are unionized while others are non-unionized, other networks apart from the global free trade network are likely to be pairwise stable. However, the efficient network is always the global free trade network. Thus, a conflict between stability and efficiency may occur. Moreover, starting from the network in which no country has signed a free trade agreement, all sequences of networks due to continu-ously profitable deviations do not lead (in most cases) to the global free trade network, even when global free trade is stable