Tools for enforcing trade agreements

What are the appropriate tools for enforcement of trade agreements? What are the lessons from game theory on designing enforcement mechanisms?

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One Response to “Tools for enforcing trade agreements”

  1. rstaiger Says:

    The answer to this question depends in part on what problem(s) trade agreements are attempting to solve for the member governments. There are two schools of thought on this in the economics literature.

    According to the “terms-of-trade” theory, governments use trade agreements to provide a means by which the harm done to foreign exporters when an importing country imposes a tariff can be “internalized” in the trade-policy choices of the importing government, thereby preventing countries from succumbing to international cost-shifting incentives when making trade policy choices. The idea is that if a foreign exporting government has the opportunity to offer “payment” to the domestic importing government to avoid this harm, the importing government will be induced to take account of the harm done to foreign exporters in its tariff choices, and it will be willing to reduce its tariffs to internationally efficient levels (in exchange for this payment) as a consequence. In the GATT/WTO, the payment to the domestic importing government by the foreign exporting government typically takes the form of a reciprocal tariff cut offered by the foreign government on products exported by the domestic country (thereby offering a reciprocal gain to the domestic government’s exporters). Empirical evidence supporting this school of thought can be found here:

    http://faculty.chicagobooth.edu/christian.broda/website/research/unrestricted/Broda_OptimalTariffs_ForthcomingAER.pdf

    According to the “commitment” theory, governments use trade agreements to make external commitments to their own private sectors (e.g., labor unions, lobbyists, etc.), thereby solving a commitment problem that governments face with their own constituents. The idea is that a government may wish to “stand firm” against pressures for import protection from various quarters, but may have difficulty credibly committing to follow through with a tough stance when confronted with a crisis of trade-induced dislocation and harm. Such a government then may find a trade agreement attractive as a way to “tie its hands” and make credible its promise of liberal trade policies. Empirical evidence on this school of thought can be found here:

    http://www3.interscience.wiley.com/cgi-bin/fulltext/119083343/PDFSTART

    As might be expected from the description of these two schools of thought, the appropriate tools for enforcement of trade agreement and design of enforcement mechanisms are likely to be very different depending on which of these purposes is primarily being served by a trade agreement. If commitment is the goal, then maximal punishments for deviating from policy commitments made in the trade agreement is likely to be attractive: in this case, that last thing governments would want is a trade agreement that is toothless or soft when it comes to punishing deviations from the agreed commitments, since any external commitment role played by the agreement would then be lost. On the other hand, if preventing trade policy decisions that succumb to international cost-shifting is the goal, then a lighter touch is likely to be attractive to governments when it comes to the enforcement of commitments negotiated under trade agreements: in this case, the point of a trade agreement is not to provide a straightjacket, but to simply ensure that trade policy choices are made with a perspective that internalizes the harm that will be done to foreign exporters.

    In the GATT/WTO, it is probably fair to say that many of the design features – including the enforcement/dispute settlement features – look more appropriate for dealing with the international cost-shifting problem than with the commitment problem. In particular, the emphasis on the “withdrawal of equivalent concessions” as the ultimate enforcement tool suggests that the GATT/WTO is seeking a light touch, not a straightjacket. Even here, a simple application of the theory of repeated games would suggest that maximal punishments can support greater cooperation, and so from this perspective it is puzzling that the GATT/WTO seems to put a lid on permissible retaliation rather than attempting to enhance its magnitude: the resolution of this puzzle may be that the disputes we actually observe are not about enforcement so much as about adjusting the bargain, while the real enforcement threat – the breakdown of the entire GATT/WTO system and an all out trade war – remains “off equilibrium.” This is important, because it suggests that the enforcement provisions of the GATT/WTO may be designed less to secure strict adherence to commitments than to permit “efficient breach” from those commitments. A paper that articulates this interpretation of the enforcement provisions of the GATT/WTO is here:

    http://www.law.uchicago.edu/Lawecon/WkngPprs_126-150/143.AOS.wto.pdf

    An interesting question is whether similar statements could be made about the enforcement provisions of preferential trade agreements such as NAFTA and the EU. I don’t think there is much work on this, but it may be that the answer is “no,” and this may reflect to some extent a difference in emphasis across multilateral and preferential agreements, with the former perhaps more concerned with international cost-shifting and the latter perhaps often more concerned with commitment.

    One may also ask whether formal retaliation with trade sanctions is even the critical tool for the enforcement of trade agreements, or whether instead less formal “reputation/international obligation” mechanisms are really the heart of enforcement. A paper that empirically addresses this question and suggests that the capacity to retaliate with trade sanctions is crucial to enforcement is here:

    http://people.brandeis.edu/~cbown/papers/outcome.pdf

    An implication of this finding is that the enforcement of their rights in trade agreements may be particularly problematic for small/developing countries who may not have the capacity to retaliate effectively with trade sanctions against their large trading partners. A paper that describes the broad challenges that small/developing countries may face in the GATT/WTO according to the terms-of-trade theory is here;

    http://www.stanford.edu/~rstaiger/jel.book.review.113005.pdf

    while a paper that uses auction theory to explore the (Mexican) proposal to allow for tradeable rights of retaliation in the WTO as a partial response to the enforcement problems of small/developing countries is here:

    http://www.stanford.edu/~rstaiger/Auctionation082205.pdf

    Finally, an interesting question is whether the main focus of the dispute settlement procedures in the GATT/WTO is enforcement or rather the interpretation and “completing” of an incomplete contract. A paper that explores some of the possible non-enforcement roles of GATT/WTO disputes is here:

    http://www.stanford.edu/~rstaiger/maggi_staiger_dsp_10_07_08.pdf

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