Why Do Countries Pursue Reciprocal Trade Agreements? A Case Study of North America

Trade theory has long argued that while it may be in the best interests of large a country to pursue reciprocal trade agreement to escape from a terms-of-trade driven prisoners’ dilemma, the best course of action for a small country is always unilateral trade liberalization. This prediction is inconsistent with the growing number of reciprocal agreements involving a small country and large country/region. Using simulation results from a quantitative trade model of North America the author is able to shed light on why small and large countries pursue reciprocal trade agreements. The author shows that the noncooperative and cooperative payoffs implicit in recent North American trade agreements between a small country and a large country/region (that is, the CFTA and NAFTA) take on the form of the well-known prisoners’ dilemma. In particular, he finds that irrespective of country size unilateral liberalization makes the liberalizing country worse off, while making its regional trading partner better off, and that cooperative agreements make all liberalizing partners better off.