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The Self-enforceability of Trade Agreements in the Presence of Trade Costs

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  • Christian Soegaard

Abstract

This paper sets up a two-country model of oligopoly to analyse the relationship between trade costs and trade policy cooperation. Acting non-cooperatively, the two countries are caught in a prisoner’s dilemma in which import tariffs are used to improve one country’s terms of trade and to shift profits towards its domestic market at the expense of the other. The incentive to do this is higher when trade costs are lower. Cooperative trade policy, on the other hand, is concerned with minimising losses in transit, such that internationally efficient tariffs are lower when trade costs fall. Hence, there is a conflict of interest between unilateral and cooperative trade policy in response to reductions in trade costs. I then analyse trade policy cooperation which must be sustained by a reputational mechanism. I first demonstrate that, provided the two countries care sufficiently about the future, lower import tariffs are more self-enforceable when trade costs are lower. I also find that global free trade can be supported for a larger range of discount factors in response to falling trade costs, provided firms interact strategically.

Suggested Citation

  • Christian Soegaard, "undated". "The Self-enforceability of Trade Agreements in the Presence of Trade Costs," Discussion Papers 11/26, University of Nottingham, GEP.
  • Handle: RePEc:not:notgep:11/26
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    File URL: http://www.nottingham.ac.uk/gep/documents/papers/2011/11-26.pdf
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    References listed on IDEAS

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    1. Grossman, Gene M & Helpman, Elhanan, 1995. "Trade Wars and Trade Talks," Journal of Political Economy, University of Chicago Press, vol. 103(4), pages 675-708, August.
    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. Bond, Eric W. & Syropoulos, Constantinos & Winters, L. Alan, 2001. "Deepening of regional integration and multilateral trade agreements," Journal of International Economics, Elsevier, vol. 53(2), pages 335-361, April.
    4. Dennis Novy, 2013. "Gravity Redux: Measuring International Trade Costs With Panel Data," Economic Inquiry, Western Economic Association International, vol. 51(1), pages 101-121, January.
    5. Ben Zissimos, 2011. "Why are Trade Agreements Regional?," Review of International Economics, Wiley Blackwell, vol. 19(1), pages 32-45, February.
    6. Sang-Seung, Yi, 1996. "Endogenous formation of customs unions under imperfect competition: open regionalism is good," Journal of International Economics, Elsevier, vol. 41(1-2), pages 153-177, August.
    7. Furusawa, Taiji & Lai, Edwin L. -C., 1999. "Adjustment costs and gradual trade liberalization," Journal of International Economics, Elsevier, vol. 49(2), pages 333-361, December.
    8. Ludema, Rodney D., 2002. "Increasing returns, multinationals and geography of preferential trade agreements," Journal of International Economics, Elsevier, vol. 56(2), pages 329-358, March.
    9. CHRIS MILNER & DANNY McGOWAN, 2013. "Trade Costs And Trade Composition," Economic Inquiry, Western Economic Association International, vol. 51(3), pages 1886-1902, July.
    10. Brander, James A., 1981. "Intra-industry trade in identical commodities," Journal of International Economics, Elsevier, vol. 11(1), pages 1-14, February.
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