Domestic Policy Coordination in Imperfectly Competitive Markets

Many international trade agreements regulate the use of domestic policies. Oneapproach is "deep" integration, in which governments contract directly over domesticpolicies. An appealing alternative is "shallow" integration, in which nations contractover market access and avoid negotiations over speci c policies. I generalize the shallowintegration approach to a two-country di¤erentiated-product setting. Governmentschoose trade policies and two domestic policies: a wage subsidy and a policy reducingthe capital requirement for rm entry. I show that the sole source of internationaline¢ ciency is terms-of-trade manipulation and that the appropriate terms-of-tradede nition here is a world price index. Shallow integration works because changesin domestic policies and trade policies that preserve market access also preserve theterms of trade. I discuss potential obstacles for shallow integration. Absent trade policycooperation, direct negotiations over the wage subsidy cannot bene t governments, butdirect negotiations over the entry policy provide a second-best bene t. The e¢ cientagreement in theory di¤ers signi cantly from the shallow integration approach of theGeneral Agreement on Tari¤s and Trade (GATT).