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Duration and Term Structure of Trade Agreements

Author

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  • Sergei Guriev

    () (New Economic School, Moscow, and CEPR)

  • Mikhail Klimenko

    () (School of Economics, Georgia Institute of Technology)

Abstract

Why are some trade agreements concluded for a limited period of time while others have the form of evergreen contracts supplemented with an advance termination notice clause? We use a dynamic incomplete contracting model to demonstrate that the time structure of the trade agreement is related to the nature of the underlying trade-related investments (or other types of irreversible resource adjustments). If these investments are lumpy and specialized to trade in a particular homogeneous good, the agreements with the fixed term of duration are more likely. The fixed-term agreement provides incentives for the initial investment but leaves the parties the flexibility to revisit the need for future investment by resorting to renegotiation. If the agreement covers trade in goods or services requiring incremental investments with spillovers of the investment benefits across industries, there is a lower risk of overinvestment. Therefore, the parties are more likely to choose an evergreen agreement (with an advance termination notice or an escape clause). We show that these predictions are consistent with the econometric evidence on the trade agreements to which the U.S. is a party.

Suggested Citation

  • Sergei Guriev & Mikhail Klimenko, 2010. "Duration and Term Structure of Trade Agreements," Working Papers w0150, Center for Economic and Financial Research (CEFIR).
  • Handle: RePEc:cfr:cefirw:w0150
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    1. Klimenko, Mikhail & Ramey, Garey & Watson, Joel, 2008. "Recurrent trade agreements and the value of external enforcement," Journal of International Economics, Elsevier, vol. 74(2), pages 475-499, March.
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    12. Pierpaolo Battigalli & Giovanni Maggi, 2003. "International agreements on product standard: an incomplete contracting theory," NBER Working Papers 9533, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Panu Poutvaara & Tuomas Takalo & Andreas Wagener, 2017. "The Optimal Duration of Contracts," CESifo Working Paper Series 6808, CESifo Group Munich.
    2. repec:eee:reveco:v:54:y:2018:i:c:p:274-288 is not listed on IDEAS

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