Changes in trade policy affect a nation’s economic welfare through terms-of-trade and volume-of-trade effects. A move to global
free trade would imply higher world economic welfare equal to the sum of all nations’ volume-of-trade, or efficiency, effects.
Since the sum of the terms-of-trade effects across all nations is zero, terms-of-trade effects are contentious. Konishi, Kowalczyk
and Sjöström (2003) have shown that if customs unions do not affect trade with non-member countries, immediate global free
could be achieved if free trade were proposed together with international sidepayments equal to the terms of trade effects.
How large would these terms of trade effects, and hence transfers, be? This paper presents estimates from a simple computable
general equilibrium model of a world economy of perfect competition. We show that, in some cases, terms-of-trade effects are
small compared to efficiency gains, and transfers are not necessary for free trade. In other cases, terms-of-trade gains may
account for more than 50% of a country’s gains from free trade and transfers could be large.
Keywords WTO - Multilateralism - Free trade - Customs unions - Free trade areas - Transfers
JEL Classification F00 - F02 - F10 - F11 - F13 - F15
Prepared for the conference “New Directions in International Trade Theory” at the University of Nottingham’s Leverhulme Center.
We are grateful to our discussant, Eric Bond, to conference participants, and to two anonymous referees for helpful comments.
We also appreciate comments at Vanderbilt, Buffalo, the Midwest Trade Meetings, Singapore Management University, City University
of Hong Kong, and Copenhagen Business School. This paper is part of the Globalization Project at the University of Aarhus.