The effect of free trade agreements on international trade

This paper examines how free trade agreements (FTAs) affect bilateral trade flows and if this effect differs between developed and developing countries. To conduct the empirical analysis, a panel dataset is used that contains 31 developed and 31 developing countries over the 1995-2014 period. The regression models are based on the gravity equation and are estimated using the ordinary least squares (OLS) estimation technique with time and bilateral country fixed effects, where the latter addresses the issue of endogeneity of FTAs. The results show a 6 percent increase in trade due to the presence of a FTA between countries. Furthermore, concerning the difference between developed and developing countries, the results shows that the effect of FTAs on trade flows increase, the more developed the two countries involved become. Furthermore, if the exporting country has a higher development status than the importing country, trade will increase. On the other hand, if the exporting country has a lower development status relative to the importing country, this may negatively affect trade if this difference is sufficiently large, while it could be positive when this difference is small. Robustness checks on the difference between the two groups of countries showed relatively similar result, increasing the robustness of the conclusions.