Vertical Trade Specialization and the Formation of North-South PTAs

Abstract

During the last two decades, the number of preferential trade agreements (PTAs) grew almost exponentially to over 270 by 2010. A majority of these are agreements between developed and developing countries. Existing models provide little economic rationale for these agreements, but the existing literature lumps North-South PTAs together with other types of trade pacts. This article offers an explanation focused on the movement of less capital-intensive manufacturing from North to South, which in turn stimulates the exchange of similar goods differentiated by unit value—also referred to as vertical intra-industry trade. The North exports more capitalintensive goods, while more labor-intensive goods are produced and traded by the South. This kind of specialization creates incentives for governments to support PTAs. The author tests this model using a new measure of vertical trade specialization and finds strong evidence that such specialization promotes PTA formation. North-South PTAs should therefore be seen as part of a broader shift of manufacturing from high- to middle-income countries.