We examine the formation of trade agreements when markets are characterized by
imperfect competition and governments can alter the strategic interaction between
oligopolistic …rms through the use of import tari¤s and export subsidies. Using a simple
three-country model of intra-industry trade, we show that whether preferential trade
agreements are stepping stones or stumbling blocs towards the attainment of multilateral
cooperation depends on the degree of product di¤erentiation and industry concentration.
However, when import tari¤s are the only available policy instrument, global free trade is
always sustainable. Our analysis provides a rationale for the recent attempts to strengthen
international rules against the use of export subsidies. It also suggests that focusing on one
dimension of strategic interaction only might result in drawing incorrect conclusions about
the outcome of the trade negotiations.
KEYWORDS: Imperfect Competition, Trade Negotiations.
JEL Classi…cation: F12, F13.
Address for correspondence:
Department of Economics
University of Warwick
Coventry, CV4 7AL, United Kingdom.
Tel: +44 (0)24 7657 2857.
Fax: +44 (0)24 7652 3032.