Fourteen of the world´s smallest and most vulnerable economies - the Forum Island Countries (FICs) of the Pacific island region - are in the process of forming themselves into a free trade area (FTA).
This paper begins by reviewing the characteristics of the FICs and their external trade. It is shown that despite their small size this is in many ways a very diverse group of economies. Standard analysis of FTAs suggests that trade creation effects from a FIC FTA are likely to be small and that there may be a substantial risk of trade diversion. Loss of tariff revenue is a major concern, which needs to be addressed by restructuring of tax and tariff systems in some cases. Quantitative studies have confirmed the small size of the trade creation effects and indicated the size of likely tariff losses, but were somewhat reassuring on the issue of trade diversion. Studies have also highlighted the importance of continuing attention to most-favoured-nation tariff reductions in parallel with the formation of the FTAs in order to ensure that welfare effects are positive. A brief outline of the proposed FTA is provided. The proposed FTA should not be evaluated as a "stand-alone" exercise but as part of a wider process of gradually integrating the FICs into the global economy. It must also be seen in the context of the FICs´ existing non-reciprocal free trade arrangements with Australia and New Zealand and the European Union, and the prospective future development of those relationships on a reciprocal basis.