Economic Integration and the Welfare of Those Who Are Left Behind: An Incentive-Theoretic Approach

This paper analyzes the impact of regional integration on outside countries as well as member countries, using a simple model with product differentiation and increasing returns to scale. Major findings include: (i) economic integration surely benefits the member countries but definitely worsens the welfare of the rest of the world even if the integrating countries do not raise the external tariff rates (i.e., Article XXIV of the GATT is not enough to keep the third countries from incurring a loss); and (ii) incentives emerge for the outside countries to form a countervailing free trade area to compensate for the loss of welfare due to the formation of the original union. The results shed light on the recent development of regionalism, such as EU, NAFTA, EAEC, and APEC.J. Japan. Int. Econ.March 1998,12(1), pp. 25-48. Research Institute for Economics and Business Administration, Kobe University, 2-1 Rokkodai-Cho, Nada-Ku, Kobe 657, Japan and Economic Growth Center, Yale University, P.O. Box 208 269, New Haven, Connecticut 06520.Copyright 1998 Academic Press. Journal of Economic LiteratureClassification Number F15.