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Free Trade, Time-Consistent Tariff, and Market Size: The Role of GATT/WTO as Commitment Devices

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  • Tsuyoshi Toshimitsu

    ()
    (School of Economics, Kwansei Gakuin University)

Abstract

We examine whether free trade is superior to tariff policy if the government of an importing country cannot precommit to an ex ante optimal tariff rate in the presence of a time lag between production and trade decisions. Based on a simple partial equilibrium model with an export monopoly, we show that the preferable choice between free trade and a time-consistent tariff policy depends on the market size of the importing country. More specifically, if the market size is larger than a certain level, the importing country prefers free trade to the time-consistent tariff policy. However, because a free trade policy is not credible in the presence of a time lag, the government of the importing country requires international organizations and rules such as GATT/WTO as commitment devices. Thus, using a game theoretic approach, we analyze under what conditions becoming a member of the international organizations is a subgame perfect Nash equilibrium and show that a free trade policy under the GATT/WTO regime is Pareto improving for the importing and exporting countries.

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File URL: http://192.218.163.163/RePEc/pdf/kgdp79.pdf
File Function: First version, 2012
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Bibliographic Info

Paper provided by School of Economics, Kwansei Gakuin University in its series Discussion Paper Series with number 79.

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Length: 23 pages
Date of creation: Jan 2012
Date of revision: Jan 2012
Handle: RePEc:kgu:wpaper:79

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Keywords: free trade; time-consistent tariff; time lag; market size; GATT/WTO;

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  1. Choi, Jay Pil, 1995. "Optimal tariffs and the choice of technology Discriminatory tariffs vs. the 'Most Favored Nation' clause," Journal of International Economics, Elsevier, vol. 38(1-2), pages 143-160, February.
  2. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  3. R. W. Staiger & G. Tabellini, 1999. "Do Gatt Rules Help Governments Make Domestic Commitments?," Economics and Politics, Wiley Blackwell, vol. 11(2), pages 109-144, 07.
  4. Lapan, Harvey E, 1988. "The Optimal Tariff, Production Lags, and Time Consistency," American Economic Review, American Economic Association, vol. 78(3), pages 395-401, June.
  5. 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.
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