A theoretical framework of regional integration with reference to trade creation and trade diversion

Amid rapid globalization and evolvement of complex market behaviours, Regional Trade Agreements (RTAs) have mushroomed across the globe to compete with these dynamic market conditions, and to help the countries group themselves to the best of their advantages. The process of being regionally integrated and forming an RTA has certain favourable and adverse implications on the concerned countries; among the favourable effects, there is Trade creation, and under adverse effects, there is Trade diversion. This paper defines a theoretical background which explains the role of Regional Integration in affecting creation and diversion of trade, and identifying the determinants that create and divert trade among the member countries, by critically evaluating the empirical studies identified in the literature. The studies are distributed based on distinct methodologies and models adopted over time; the paper segregates the work done on each model. Some of the factors influencing creation and diversion of trade during estimation are found to be the treatment of zero trade flows, country-specific economic and demographic conditions, type of commodity being traded, strength of the structure of agreement, and various others. It is concluded that the exact nature of effect RTAs have on members’ trade is ambiguous; some agreements tend to be trade creating, some are trade diverting, and others have vague outcomes.