Cross‐Country Productivity Asymmetry and the Quest for Global Free Trade

ABSTRACT This paper develops a theoretical model to study how cross‐country productivity asymmetry affects the endogenous formation of global free trade. The main theoretical prediction is that (i) when productivity levels are sufficiently similar, the equilibrium is global free trade; and (ii) when productivity levels are sufficiently asymmetric, the equilibrium outcome is the status quo regime. We empirically confirm the main theoretical prediction using panel data from 195 × 194 country pairs, along with information on all FTAs formed in the world from 1950 to 2017. The empirical results suggest that country pairs with higher productivity asymmetry are less likely to sign a reciprocal trade agreement. Therefore, this paper rationalizes the inclusion of productivity differences in empirical studies on the formation of trade agreements.