Equilibrium Trade Regimes: Power- vs. Rules-Based

Motivated by the recent weakening of the multilateral trading system, we examine the sustainability of a rules-based trade regime in a dynamic model in which the leading country chooses the trade regime and leadership evolves over time. We show that a hegemon is required to establish a rules-based regime, but not to sustain it: once in place, such a regime may be upheld even by non-hegemonic leaders that would otherwise prefer a power-based system, especially if they anticipate losing dominance. But a rules-based equilibrium exists only under a delicate set of conditions: the costs of establishing it must be moderate, countries must be sufficiently patient, and leadership turnover must be frequent. In a bipolar state, free-riding and market-power forces pose additional challenges to sustaining rules-based equilibria. We also characterize the trade-offs involved in redesigning the multilateral trading system to preserve its viability. If the leading country becomes shortsighted and threatens to dismantle it, the system must become more efficient, grant greater discretion to the leader, or exclude it altogether.