Why are trade agreements regional?

Abstract

This paper shows how distance may be used to coordinate on a unique equilibrium in which trade agreements are regional. Trade agreement formation is modeled as coalition formation. In a standard trade model with no distance between countries a familiar problem of coordination failure occurs, giving rise to multiple equilibria; any one of many possible trade agreements can form.With distance between countries, regional trade agreements generate larger rent-shifting effects than nonregional agreements. Countries use these effects to coordinate on a unique equilibrium.