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A Commitment Theory of Subsidy Agreements

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  • Brou Daniel

    ()
    (DAN Management and Organizational Studies, The University of Western Ontario, 4425 Social Science Centre, London, ON N6A 5C2, Canada)

  • Ruta Michele

    ()
    (Economic Research and Statistics Division, World Trade Organization, Rue de Lausanne 154, 1211 Geneva 21, Switzerland)

Abstract

Abstract: This paper examines the rationale for the rules on domestic subsidies in international trade agreements through a framework that emphasizes commitment. We build a model where the policy-maker has a tariff and a production subsidy at its disposal, taxation can be distortionary and the import-competing sector lobbies the government for favorable policies. The model shows that, under political pressures, the government will turn to subsidies when its ability to provide protection is curtailed by a trade agreement that binds tariffs only (policy substitution problem). When the factors of production are mobile in the long-run, but the investments are irreversible in the short-run, the government cannot credibly commit vis-à-vis the domestic lobby unless the trade agreement regulates production subsidies in addition to tariffs (policy credibility problem). We employ the theory to analyze the Subsidies and Countervailing Measures (SCM) Agreement within the WTO system. We show that WTO rules on nullification or impairment solves the policy substitution problem, while serious prejudice rules can address the policy credibility problem in sectors with tariff commitments.

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Economic Analysis & Policy.

Volume (Year): 13 (2013)
Issue (Month): 1 (May)
Pages: 239-270

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Handle: RePEc:bpj:bejeap:v:13:y:2013:i:1:p:239-270:n:13

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References

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  1. Nuno Limão & Patricia Tovar, 2009. "Policy Choice: Theory and Evidence from Commitment via International Trade Agreements," NBER Working Papers 14655, National Bureau of Economic Research, Inc.
  2. Grossman, Gene & Helpman, Elhanan, 1993. "Protection for Sale," CEPR Discussion Papers 827, C.E.P.R. Discussion Papers.
  3. Maggi, G & Rodriguez-Clare, A, 1996. "The Value of Trade Agreements in the Presence of Political Pressures," Papers 180, Princeton, Woodrow Wilson School - Public and International Affairs.
  4. Tang, Man-Keung & Wei, Shang-Jin, 2009. "The value of making commitments externally: Evidence from WTO accessions," Journal of International Economics, Elsevier, vol. 78(2), pages 216-229, July.
  5. Horn, Henrik & Maggi, Giovanni & Staiger, Rikard W., 2007. "Trade Agreements as Endogenously Incomplete Contracts," Working Paper Series 689, Research Institute of Industrial Economics.
  6. Brian R. Copeland, 1990. "Strategic Interaction among Nations: Negotiable and Non-negotiable Trade Barriers," Canadian Journal of Economics, Canadian Economics Association, vol. 23(1), pages 84-108, February.
  7. Matschke, Xenia, 2008. "Costly revenue-raising and the case for favoring import-competing industries," Journal of International Economics, Elsevier, vol. 74(1), pages 143-157, January.
  8. Maggi, Giovanni & Rodriguez-Clare, Andres, 2005. "A Political-Economy Theory of Trade Agreements," CEPR Discussion Papers 5321, C.E.P.R. Discussion Papers.
  9. Staiger, Robert W & Tabellini, Guido, 1987. "Discretionary Trade Policy and Excessive Protection," American Economic Review, American Economic Association, vol. 77(5), pages 823-37, December.
  10. Korinek, Anton & Serven, Luis, 2010. "Undervaluation through foreign reserve accumulation : static losses, dynamic gains," Policy Research Working Paper Series 5250, The World Bank.
  11. Daniel Brou & Michele Ruta, 2009. "On the Political Substitutability between Tariffs and Subsidies," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 145(IV), pages 405-410, December.
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Cited by:
  1. Sauré, Philip, 2014. "Domestic policies in self-enforcing trade agreements," European Economic Review, Elsevier, vol. 68(C), pages 19-30.

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