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date: 21 January 2021

Abstract and Keywords

This article provides a concise guide for policy-makers to the economic theory of free trade agreements (FTAs) and the modeling methods used to assess their effects. The article is organized as follows. Section I discusses the underlying economic theory of FTAs, focusing on the static net welfare effects. This begins with analysis of the basic conceptual model developed by Viner (1950), which details the fundamental concepts of trade creation and trade diversion, and the modern analysis of FTAs. Next, it discusses the “dynamic effects” of an FTA and covers other issues that are relevant to anticipating the economic effects of an FTA (that is, “ex-ante assessment”). It explains the theoretical features of a computable general equilibrium (CGE) model that simulates the potential impact of an FTA. These CGE models have become the most popular tool for evaluating the economic implications of an FTA. The practical strengths and limitations of CGE analysis in evaluating an FTA are also considered. Section II analyzes ex-post approaches, in particular import-growth models and the gravity model. Section III considers extensions of our analysis to the special case of developing countries. Finally, Section IV offers brief concluding remarks.

Keywords: economy theory, free trade agreements, computable general equilibrium, import growth models, gravity model, developing countries

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