Three essays on trade and transfers: country heterogeneity, preferential treatment and habit formation

Abstract : My dissertation is a theoretical and empirical study of international transfers and trade between heterogeneous countries. In the first essay, I use the trade war model developed by Kennan and Riezman (1988) with Stone-Geary preferences and show that free trade is the corner solution to the maximization of the global welfare. This maximization problem yields a candidate solution that corresponds to a tariff-subsidy combination where the South (the small country) applies a tariff against its imports, while the North (the large country) subsidies its imports when countries are asymmetric. This candidate solution is of course rejected as it corresponds to a saddle point. These findings shed light on the inefficiency of the unilateral privileged access that ACP countries enjoyed on the European market under the Lomé and the Cotonou agreements, while keeping their tariffs high. In addition, this paper explains the transition from such treaties to WTO-compatible economic partnership agreements. In the second essay, I develop a standard North-South trade agreement model between two heterogeneous countries. I find that the welfare effects of a free trade agreement (FTA) depends on the type of heterogeneity considered. In the presence of sufficient heterogeneity in the supply functions, the country experiencing supply-side constraints (SSCs) – “the small country” – is worse off, while the bigger is better off. In this case, the transfer flows from the large to the small country. However, when countries are sufficiently heterogeneous with respect to either size or demand functions, the small country is better off, while the large country is worse off. Thus, the small country must compensate the large country for the FTA to be incentive-compatible. This model provides an interesting explanation of the FTA between the ACP countries and the EU (Economic Partnership Agreements, EPAs). Indeed, the EPA provides for technical and financial assistance from the EU to the ACP to enable them to overcome the supply constraints. Testing this prediction with ACP-EU data, I find that the initiation of the interim EPA has a positive effect on foreign aid allocation decision when supply heterogeneity is taken into account. Finally, using a two-period pure exchange model of free trade, in the third essay, I study the welfare effects of foreign aid in the presence of habit formation. Assuming that the North makes a transfer only in the first period, I show that the terms-of-trade effect of the transfer in the second period operates through the habit parameter; in other words, in the absence of habit formation, the transfer does not distort relative prices and thus, there is no transfer paradox. I prove that its existence crucially depends on the growth of total endowments; actually, the transfer paradox occurs when the world endowment of the North's import (the South's export) good increases sufficiently more that of its export (import) good. Moreover, the model shows that the export-enhancing effect of the transfer is short-lived, since the habit formation effect decreases over time. Testing this claim with aid and trade data between France and 32 ACP countries, I find that only one period lagged transfer affects French exports. The contribution of this essay is to describe the process by which foreign aid benefits the donor country through the formation of habits in the recipient country for the good it exports.
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Jean-Marc Malambwe Kilolo. Three essays on trade and transfers: country heterogeneity, preferential treatment and habit formation. Quantitative Finance [q-fin]. École Polytechnique, 2014. English. ⟨tel-01074899⟩

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