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Duration and Term Structure of Trade Agreements

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  • Sergei Guriev

    ()
    (New Economic School, Moscow, and CEPR)

  • Mikhail Klimenko

    ()
    (School of Economics, Georgia Institute of Technology)

Abstract

Why are some trade agreements concluded for a limited period of time while others have the form of evergreen contracts supplemented with an advance termination notice clause? We use a dynamic incomplete contracting model to demonstrate that the time structure of the trade agreement is related to the nature of the underlying trade-related investments (or other types of irreversible resource adjustments). If these investments are lumpy and specialized to trade in a particular homogeneous good, the agreements with the fixed term of duration are more likely. The fixed-term agreement provides incentives for the initial investment but leaves the parties the flexibility to revisit the need for future investment by resorting to renegotiation. If the agreement covers trade in goods or services requiring incremental investments with spillovers of the investment benefits across industries, there is a lower risk of overinvestment. Therefore, the parties are more likely to choose an evergreen agreement (with an advance termination notice or an escape clause). We show that these predictions are consistent with the econometric evidence on the trade agreements to which the U.S. is a party.

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Bibliographic Info

Paper provided by Center for Economic and Financial Research (CEFIR) in its series Working Papers with number w0150.

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Length: 39 pages
Date of creation: Jul 2010
Date of revision:
Handle: RePEc:cfr:cefirw:w0150

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  1. Pierpaolo Battigalli & Giovanni Maggi, 2003. "International agreements on product standards: an incomplete-contracting theory," Working Papers 229, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  2. Horn, Henrik, 2006. "National Treatment in the GATT," Working Paper Series 657, Research Institute of Industrial Economics.
  3. Horn, Henrik & Maggi, Giovanni & Staiger, Rikard W., 2007. "Trade Agreements as Endogenously Incomplete Contracts," Working Paper Series 689, Research Institute of Industrial Economics.
  4. Richard Chisik, 2010. "Gradualism in Free Trade Agreements: A Theoretical Justification," Working Papers 018, Ryerson University, Department of Economics.
  5. Bond, Eric W & Park, Jee-Hyeong, 2002. "Gradualism in Trade Agreements with Asymmetric Countries," Review of Economic Studies, Wiley Blackwell, vol. 69(2), pages 379-406, April.
  6. Chisik, Richard, 2012. "Trade disputes, quality choice, and economic integration," Journal of International Economics, Elsevier, vol. 88(1), pages 47-61.
  7. Sergei Guriev & Dmitriy Kvasov, 2005. "Contracting on Time," American Economic Review, American Economic Association, vol. 95(5), pages 1369-1385, December.
  8. McLaren, John, 1997. "Size, Sunk Costs, and Judge Bowker's Objection to Free Trade," American Economic Review, American Economic Association, vol. 87(3), pages 400-420, June.
  9. Krugman, Paul, 1987. "The narrow moving band, the Dutch disease, and the competitive consequences of Mrs. Thatcher : Notes on trade in the presence of dynamic scale economies," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 41-55, October.
  10. Eric W. Bond, 2006. "Transportation Infrastructure Investments And Trade Liberalization," The Japanese Economic Review, Japanese Economic Association, vol. 57(4), pages 483-500.
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