The hub-and-spokes effect of overlapping free trade agreements : An analysis using GTAP

Abstract

The proliferation of free trade agreements (FTAs) amidst the stagnation of multilateralism in the recent years has led to overlapping free trade zones or pair-wise hub-and-spokes (HAS) throughout the world. Many countries including the United States, Japan, South Korea, Singapore, Thailand and Australia in the Asia-Pacific region are no exception to this phenomenon. Being avid subscribers to FTAs, these countries have become trade hubs to their partners, which are in turn relegated to spoke status.We ask whether being a hub is welfare optimal for a small and open economy when it can choose to join a single FTA, an exclusive free trade zone or support global free trade instead. Using the Global Trade Analysis Project (GTAP) software suite developed by Purdue University, we examine the welfare impact of a triangular trade relationship between the United States of America, Singapore and Japan facilitated by the US-Singapore Free Trade Agreement (USSFTA), the Japan-Singapore Economic Partnership Agreement (JSEPA), and a hypothetical US-Japan free trade agreement within this context. We also extend our analysis to incorporate a??super-huba?? effects that recognize the spoke countries (that is, the US and Japan) as trade hubs in other pair-wise HAS systems. Our experiment reveals that Singapore is always better off from the benchmark and playing hub is welfare optimal. Japan loses more than the US when both are relegated to spoke status. As a consequence, they have economic motivation to form a bilateral that neutralizes the detrimental effects of the HAS. These findings prove robust in sensitivity analyses involving the market structure, production technologies, a??super-huba?? effects, the depth of integration, and uncertainties in key behavioural parameters.Next, we introduce a partial equilibrium model to examine the issue of overlapping FTAs further. We find that, if the product endowment structure is symmetric across regions, every economy would prefer hub status over all other trading arrangements including global free trade. Replicating the case of US-Singapore-Japan, hub preference continues to hold in the asymmetric case. The theoretical model thus lends weight to our GTAP analysis.Several implications arise from our research. First, although we have established the economic incentives for regions to form FTAs either proactively or as a defensive response to othersa?? FTA pursuits, we express our doubts that these interactions will lead to a global free trade outcome that is beneficial to the world community. However, given the current stalled WTO negotiations, discriminatory trade pacts are second-best remedies for economies highly reliant on trade for survival. Even so, complementary policies would be required to address the downside of FTAs and maximise the potential returns.