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A Commitment Theory of Subsidy Agreements

  • Daniel Brou
  • Michele Ruta

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.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2012/wp-cesifo-2012-09/cesifo1_wp3945.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3945.

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Date of creation: 2012
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Handle: RePEc:ces:ceswps:_3945
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  1. Korinek, Anton & Serven, Luis, 2010. "Undervaluation through foreign reserve accumulation : static losses, dynamic gains," Policy Research Working Paper Series 5250, The World Bank.
  2. Maggi, G & Rodriguez-Clare, A, 1996. "The Value of Trade Agreements in the Presence of Political Pressures," Papers 180, Princeton, Woodrow Wilson School - Public and International Affairs.
  3. Xenia Matschke, 2005. "Costly Revenue-Raising and the Case for Favoring Import-Competing Industries," Working papers 2005-28, University of Connecticut, Department of Economics, revised Apr 2007.
  4. Brian R. Copeland, 1990. "Strategic Interaction among Nations: Negotiable and Non-negotiable Trade Barriers," Canadian Journal of Economics, Canadian Economics Association, vol. 23(1), pages 84-108, February.
  5. Gene M. Grossman & Elhanan Helpman, 1992. "Protection For Sale," NBER Working Papers 4149, National Bureau of Economic Research, Inc.
  6. Henrik Horn & Giovanni Maggi & Robert W. Staiger, 2006. "Trade Agreements as Endogenously Incomplete Contracts," NBER Working Papers 12745, National Bureau of Economic Research, Inc.
  7. Maggi, Giovanni & Rodriguez-Clare, Andres, 2005. "A Political-Economy Theory of Trade Agreements," CEPR Discussion Papers 5321, C.E.P.R. Discussion Papers.
  8. Man-Keung Tang & Shang-Jin Wei, 2009. "The Value of Making Commitments Externally: Evidence from WTO Accessions," Working Papers 152009, Hong Kong Institute for Monetary Research.
  9. Nuno Limão & Patricia Tovar, 2009. "Policy Choice: Theory and Evidence from Commitment via International Trade Agreements," NBER Working Papers 14655, National Bureau of Economic Research, Inc.
  10. 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.
  11. 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.
  12. 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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