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A commitment theory of subsidy agreements

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  • Brou, Daniel
  • Ruta, Michele

Abstract

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.

Suggested Citation

  • Brou, Daniel & Ruta, Michele, 2012. "A commitment theory of subsidy agreements," WTO Staff Working Papers ERSD-2012-15, World Trade Organization (WTO), Economic Research and Statistics Division.
  • Handle: RePEc:zbw:wtowps:ersd201215
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    References listed on IDEAS

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    1. 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.
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    Citations

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    Cited by:

    1. Leonardo Baccini & Giammario Impullitti & Edmund J. Malesky, 2017. "Globalization and State Capitalism: Assessing Vietnam’s Accession to the WTO," Discussion Papers 2017-10, University of Nottingham, GEP.
    2. David De Remer, 2013. "The Evolution of International Subsidy Rules," Working Papers ECARES ECARES 2013-45, ULB -- Universite Libre de Bruxelles.
    3. Sauré, Philip, 2014. "Domestic policies in self-enforcing trade agreements," European Economic Review, Elsevier, vol. 68(C), pages 19-30.
    4. Kyle Bagwell & Chad P. Bown & Robert W. Staiger, 2016. "Is the WTO Passé?," Journal of Economic Literature, American Economic Association, vol. 54(4), pages 1125-1231, December.
    5. Grossman, Gene, 2016. "The Purpose of Trade Agreements," CEPR Discussion Papers 11151, C.E.P.R. Discussion Papers.
    6. Bernard Hoekman & Douglas Nelson, 2018. "21st Century Trade Agreements and the Owl of Minerva," RSCAS Working Papers 2018/04, European University Institute.
    7. Bayramoglu, Basak & Copeland, Brian R. & Jacques, Jean-Francois, 2018. "Trade and fisheries subsidies," Journal of International Economics, Elsevier, vol. 112(C), pages 13-32.
    8. Ederington,Josh & Ruta,Michele, 2016. "Non-tariff measures and the world trading system," Policy Research Working Paper Series 7661, The World Bank.
    9. Leonardo Baccini & Giammario Impullitti & Edmund J. Malesky, 2019. "Globalization and State Capitalism: Assessing Vietnam's Accession to the WTO," CEP Discussion Papers dp1593, Centre for Economic Performance, LSE.
    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. Ruta, Michael & Brou, Daniel & Campanella, Edoardo, 2009. "The value of domestic subsidy rules in trade agreements," WTO Staff Working Papers ERSD-2009-12, World Trade Organization (WTO), Economic Research and Statistics Division.
    12. Lee, Gea M., 2016. "Optimal international agreement and restriction on domestic efficiency," Journal of International Economics, Elsevier, vol. 99(C), pages 138-155.
    13. Kyle Bagwell & Robert W. Staiger, 2016. "The Design of Trade Agreements," NBER Working Papers 22087, National Bureau of Economic Research, Inc.
    14. David De Remer, 2013. "Domestic Policy Coordination in Imperfectly Competitive Markets," Working Papers ECARES ECARES 2013-46, ULB -- Universite Libre de Bruxelles.

    More about this item

    Keywords

    Trade Agreements; Trade Policy Credibility; Subsidy Rules; GATT/WTO;

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F55 - International Economics - - International Relations, National Security, and International Political Economy - - - International Institutional Arrangements
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior

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