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A Commitment Theory of Subsidy Agreements

Author

Listed:
  • Daniel Brou
  • Michele Ruta

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 favourable 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. We refer to this as the policy substitution problem. When factors of production are mobile in the long-run but investments are irreversible in the short-run, we show that the government cannot credibly commit vis-à-vis the domestic lobby unless the trade agreement also regulates production subsidies, thus addressing the policy substitution problem. Finally, we employ the theory to analyze the Subsidies and Countervailing Measures (SCM) Agreement within the GATT/WTO system.

Suggested Citation

  • Daniel Brou & Michele Ruta, 2012. "A Commitment Theory of Subsidy Agreements," CESifo Working Paper Series 3945, CESifo.
  • Handle: RePEc:ces:ceswps:_3945
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    References listed on IDEAS

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    1. Grossman, Gene M & Helpman, Elhanan, 1994. "Protection for Sale," American Economic Review, American Economic Association, vol. 84(4), pages 833-850, September.
    2. Giovanni Maggi & Andrés Rodríguez-Clare, 2007. "A Political-Economy Theory of Trade Agreements," American Economic Review, American Economic Association, vol. 97(4), pages 1374-1406, September.
    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.
    5. Tang, Man-Keung & Wei, Shang-Jin, 2009. "The value of making commitments externally: Evidence from WTO accessions," Journal of International Economics, Elsevier, vol. 78(2), pages 216-229, July.
    6. Henrik Horn & Giovanni Maggi & Robert W. Staiger, 2010. "Trade Agreements as Endogenously Incomplete Contracts," American Economic Review, American Economic Association, vol. 100(1), pages 394-419, March.
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    11. Matschke, Xenia, 2008. "Costly revenue-raising and the case for favoring import-competing industries," Journal of International Economics, Elsevier, vol. 74(1), pages 143-157, January.
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    Cited by:

    1. Gene M. Grossman, 2016. "The Purpose of Trade Agreements," NBER Working Papers 22070, National Bureau of Economic Research, Inc.
    2. 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.
    3. 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.

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    More about this item

    Keywords

    trade agreements; trade policy credibility; subsidy rules; GATT; WTO;
    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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