Summary: Standard theory says that a country's welfare is unaffected by being excluded from a small regional trade agreement. But for most products, "small" countries and regional trade agreements do have some measure of market power. Such market power can arise if (1) supply is geographically concentrated; (2) tastes differ; (3) there is product differentiation (such as quality); (4) transport costs are high; (5) the principal importing countries impose quantitative restrictions; and (6) there is hysterisis because of irreversible costs. The authors show, based on two case studies, that regional trade agreements among small countries may have negative welfare implications for outside countries. In the first case, they find that Argentina's cattle and beef exports to Peru fell when Peru formed a regional trade agreement (the Andean Pact) with various countries, including Colombia, and exporter of the same products. Argentina also lost because of the higher unit price it received on its exports to Peru. Interestingly, Venezuela's entry into the Andean Pact (that is, the formation of a larger bloc) seems to have resulted in a welfare gain for the outside country (Argentina). In the second case, rather than examine whether formation of the Central American Common Market (CACM) had a negative impact on outside countries (for which they lacked data), they examine the impact of the CACM's breakdown on member countries. Although the CACM has essentially been trade-diverting for manufactures, it seems to have been trade-creating for white maize, with both importing and exporting member countries gaining from the regional trade agreement. So, one would expect that a breakdown of the CACM, which resulted in member countries becoming relatively more "outsiders" to the bloc, may have led to a decline in the welfare of both the exporting and importing member countries. This is supported by the data, and implies that if one of the five member countries had been left out of the CACM, it would have been worse off where white maize was concerned.
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