On The Advantages of Piecemeal Integration: A model of trade with several countries where local integration benefits all

For the study of economic integration, it is costumary to use a three countryworld,where two of the countries may introduce forms of closer economic cooperation. Inthe present model, we follow this tradition but put special emphasis on the role ofcredit and entrepreneurship. Our model is of the standard neoclassical type, with theaddition that production takes time and is subject to uncertainty. Also, firms must usethe financial system in order to buy inputs; the cost of credit may differ among countriesand industries, reflecting their basic patterns of uncertainty.Following the Newbery-Stiglitz approach, we show that in such model we mayexhibit cases of Pareto inferior trade and, in particular, Pareto inferior economicintegration. More specifically, we show that integrating countries of very differenteconomic size may give rise to adverse effects on welfare, whereas integration ofcountries with a more similar economic structure and size tends to have beneficialeffects for the parties.Keywords: trade, uncertainty, Pareto inferior trade, regional integration.JEL classification: F11, F15, F34