This paper examines the effects of trade liberalization on merger behavior. We endogenize merger choice among owners in an oligopolistic industry in asymmetric countries to analyze the consequences of trade cost reductions on competitiveness and welfare. In this context, the non-cooperative game supports asymmetric market structures. We also find that trade liberalization is not necessarily pro-competitive in countries with the competitive advantage, even if trade costs are completely abolished. Moreover, the tariff-jumping explanation of international mergers does not necessarily apply. The welfare analysis shows that merger behavior can significantly alter any gains from liberalization. Countries should consider enforcing competition in regional agreements. Specifically, to avoid a reduction in domestic welfare following trade-liberalizing reductions in trade costs, a high-cost country's optimal policy may be to ban international mergers.

It is often thought that a tariff reduction, by opening-up the domestic market to foreign firms, should lessen the need for a policy aimed at discouraging domestic mergers. This implicitly assumes that the tariff in question is sufficiently high to prevent foreign firms from selling in the domestic market. However, not all tariffs are prohibitive, so that foreign firms may be present in the domestic market before it is abolished. Furthermore, even if the tariff is prohibitive, a merger of domestic firms may render it nonprohibitive, thus inviting foreign firms to penetrate the domestic market. Using a simple example, the authors show that, in the latter two cases, abolishing the tariff may in fact make the domestic merger more profitable. Hence trade liberalization will not necessarily reduce the profitability of domestic mergers.