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Trade agreements can keep global economies stable

International trade relationships have kept the global economy running since ancient times. In the last 40 years, the processes and regulations governing international trade have become more organized and structured. Now countries create trade agreements to establish standards for which countries can freely trade without tariffs and other barriers.

However, these agreements aren't always permanent. New from Georgia Tech published in the Review of International Economics can predict the stability of trade relationships between countries.

According to School of Economics Professor Tibor Besedes, there are two broad types of trade agreements: shallow and deep. Shallow agreements, such as reducing tariffs, are straightforward. The United States-Mexico-Canada Agreement—a trade agreement between the U.S. and its northern and southern neighbors—is shallow because it focuses on reducing tariffs. Conversely, a deep agreement is more comprehensive and involves integration between countries' economic systems.

"Often in deep agreements, countries start to harmonize standards; for example, car emission regulations are identical across all the countries signing the agreement, which makes it easier for goods to travel between borders," Besedes said.

The European Union (EU) is a textbook example of a deep agreement. The EU countries' level of integration extends to their basic currency, ensuring all EU members use the euro and making trade easier.

Using the United Nations commodity trade database and Baier and Bergstrand's trade agreements database—some of the most comprehensive datasets in the field—the researchers formulated a mathematical model to determine whether trade depth affects stability. The results were surprising.

While both deep and shallow agreements result in less stable relationships, the effects of shallow agreements are larger than deep ones. Though both types of agreements allow firms to experiment in international trade because costs are reduced, those experiments often fail and create some instability that can lead to dissolution. Think of Brexit, when the U.K. left the EU in 2020.

"Shallow agreements reduce the cost of trading," Besedes noted. "When a country signs a trade agreement, it reduces tariff rates. That reduces the cost of trading in the long run because the country has already established that relationship, and it's now even easier to trade future products."

Trade agreements generally last years, though some long-established international agreements may change in the current political climate.

"Tariffs going up could make existing relationships less stable, and it's more likely that we'll stop trading a particular product or stop importing product," Besedes said. "On the flip side, it also means that other countries could impose tariffs on the U.S., and there will be less of an opportunity for American businesses to export their products."

While no one can fully predict how global trade relationships will change in the coming years, the stability the world has come to expect could be a thing of the past.