Trade disputes, quality choice, and economic integration

Recent work demonstrates the importance of developing high quality output in order to compete in export markets and other recent studies verify the prevalence of fixed and ongoing trade costs while participating in those markets. I consider the joint choice of quality and export promotion costs when trade relationships are subject to temporary disputes. When transparency is low and macroeconomic instability is high, disputes arrive more frequently and, therefore, firms may inefficiently choose lower levels of quality and export promotion. These, in turn, build shallower trading relationships with less trade volumes and higher tariffs, and generate greater trade reductions during the more common trade disputes. Several institutional features of the WTO dispute settlement mechanism that are generally lacking in preferential trade agreements such as improved transparency, dispute investigation, and the provision to recommend asymmetric continuation payoffs can ameliorate these inefficient quality choice outcomes. Hence, lower quality output and lower quality trading relationships may be more endemic to countries that depend on preferential trading areas as opposed to the WTO.