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A Commitment Theory of Subsidy Agreements

Author

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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.

Suggested Citation

  • Brou Daniel & Ruta Michele, 2013. "A Commitment Theory of Subsidy Agreements," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 13(1), pages 239-270, May.
  • Handle: RePEc:bpj:bejeap:v:13:y:2013:i:1:p:239-270:n:13
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Leonardo Baccini & Giammario Impullitti & Edmund J. Malesky, 2017. "Globalization and State Capitalism: Assessing Vietnam’s Accession to the WTO," Discussion Papers 2017-10, University of Nottingham, GEP.
    2. Kyle Bagwell & Chad P. Bown & Robert W. Staiger, 2016. "Is the WTO Passé?," Journal of Economic Literature, American Economic Association, vol. 54(4), pages 1125-1231, December.
    3. Ruta, Michael & Brou, Daniel & Campanella, Edoardo, 2009. "The value of domestic subsidy rules in trade agreements," WTO Staff Working Papers ERSD-2009-12, World Trade Organization (WTO), Economic Research and Statistics Division.
    4. repec:eee:inecon:v:112:y:2018:i:c:p:13-32 is not listed on IDEAS
    5. Lee, Gea M., 2016. "Optimal international agreement and restriction on domestic efficiency," Journal of International Economics, Elsevier, vol. 99(C), pages 138-155.
    6. David De Remer, 2013. "The Evolution of International Subsidy Rules," Working Papers ECARES ECARES 2013-45, ULB -- Universite Libre de Bruxelles.
    7. Gene M. Grossman, 2016. "The Purpose of Trade Agreements," NBER Working Papers 22070, National Bureau of Economic Research, Inc.
    8. Kyle Bagwell & Robert W. Staiger, 2016. "The Design of Trade Agreements," NBER Working Papers 22087, National Bureau of Economic Research, Inc.
    9. Sauré, Philip, 2014. "Domestic policies in self-enforcing trade agreements," European Economic Review, Elsevier, vol. 68(C), pages 19-30.
    10. David De Remer, 2013. "Domestic Policy Coordination in Imperfectly Competitive Markets," Working Papers ECARES ECARES 2013-46, ULB -- Universite Libre de Bruxelles.
    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.
    12. Basak Bayramoglu & Brian Copeland & Jean-François Jacques, 2016. "Trade and Fisheries Subsidies," Working Papers 2016.08, FAERE - French Association of Environmental and Resource Economists.
    13. Bernard Hoekman & Douglas Nelson, 2018. "21st Century Trade Agreements and the Owl of Minerva," RSCAS Working Papers 2018/04, European University Institute.
    14. Ederington,Josh & Ruta,Michele, 2016. "Non-tariff measures and the world trading system," Policy Research Working Paper Series 7661, The World Bank.

    More about this item

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F55 - International Economics - - International Relations, National Security, and International Political Economy - - - International Institutional Arrangements
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior

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