Trade among countries takes place only when marginal trade benefits exceed marginal trade costs. Market integration among FTA members can reduce trade costs including tariff and non-tariff barriers, providing FTA members with more opportunities for arbitrage with each other. More opportunities for arbitrage may in turn lead to a decrease in or an elimination of price differentials among FTA members that occurs at a faster pace.
We employ a Self-Exciting Threshold Autoregressive model (SETAR) to consider Heckscher's (1916) commodity points - thresholds delineating a region where trade does not take place. This model allows us to analyze how both transaction costs and the speed of price adjustment change after the FTA.
Using a SETAR model, we examine whether the FTA reduces trade costs, and how changes in trade costs that South Korea experienced depend on its FTA partners. In addition, we explore whether price adjustment becomes faster and if the speed of adjustment varies by FTA partner.
The results demonstrate that South Korea experienced different effects of the FTA on market integration. We find that for South Korea, the degree to which trade costs decrease and the speed of price adjustment changes varies across its FTA partners. These results may help evaluate the extent to which, in the period following the FTA agreement, market integration has intensified between South Korea and its FTA partners.