The political economy of trade integration: Welfare implications in a trading block model, political sustainability in a pressure group model, and effects of FDI in a gravity model

This dissertation looks at three aspects of increasing trade integration: First, what are the welfare implications of trade integration observed through growing regional trading blocks? Second, what mechanism of sequencing trade integration can improve its political sustainability? Third, what relationship evolved between foreign direct investment and trade?;Chapter I starts by questioning Krugman's (1993) trading block model, which suggested that world trade is increasingly conducted between three trading blocks, which produces a minimum in world welfare. His symmetrical trading block model is extended into a two-sector model, where trade is not only beneficial through increased varieties in a Dixit-Stiglitz framework, but also through comparative advantage. Results show that: (i) regionalism and multilateralism can be compatible and welfare enhancing; (ii) sequential integration can monotonously increase world welfare; (iii) more dissimilar countries have higher potential benefits from integration; (iv) about one third of potential gains from free-trade under average tariffs are already realized in a system of three trading blocks.;Chapter II studies the political sustainability of trade integration. The previous trading-block-model is combined with a political pressure group model, where domestic interest groups lobby their government to proceed with sequential trade integration. Theory shows that trade integration is politically not sustainable when consumers' and producers' interests are opposed, unless a mechanism is designed which links sequential trade integration with factor reallocation and which worsens the best alternative to integration. An application to the case of Central European integration shows that such a mechanism has been implemented, but that special interests in the European Union oppose new memberships.;Chapter III asks whether foreign direct investment (FDI) is a substitute or complement for international trade, since both possibilities are modelled in the theory of multinational firms. A gravity model estimates the cumulative effect for a sample of 63 countries and suggests that FDI inflows reduce overall trade and in some cases deteriorate the trade balance. Three channels are identified in case studies of Spain, Mexico, and Thailand but need to be quantified in further research. Predictions should not be based on the gravity model because it appears structurally unstable.