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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

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, January.
  • Handle: RePEc:bpj:bejeap:v:13:y:2013:i:1:p:239-270:n:8
    DOI: 10.1515/bejeap-2012-0061
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    References listed on IDEAS

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    3. Nuno Limão & Patricia Tovar, 2018. "Policy choice: Theory and evidence from commitment via international trade agreements," World Scientific Book Chapters, in: Policy Externalities and International Trade Agreements, chapter 6, pages 179-198, World Scientific Publishing Co. Pte. Ltd..
    4. 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. 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.
    2. Maggi, Giovanni, 2014. "International Trade Agreements," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 317-390, Elsevier.
    3. Grossman, Gene, 2016. "The Purpose of Trade Agreements," CEPR Discussion Papers 11151, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    trade agreements; trade policy credibility; subsidy rules; WTO; F13; F55; H25; D72;
    All these keywords.

    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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