Working Paper: CEPR ID: DP5160
Authors: Rodney D. Ludema; Anna Maria Mayda
Abstract: The Most-Favored Nation (MFN) clause has long been suspected of creating a free rider problem in multilateral trade negotiations. To address this issue, we model multilateral negotiations as a mechanism design problem with voluntary participation. We show that an optimal mechanism induces only the largest exporters to participate in negotiations over any product, thus providing a rationalization for the Principal supplier rule. We also show that, through this channel, equilibrium tariffs vary according to the Herfindahl index of export shares: higher concentration in a sector reduces free riding and thus causes a lower tariff. Estimation of our model using sector-level tariff data for the US provides strong support for this relationship.
Keywords: free riding; most-favoured nation; MFN clause; principal supplier rule
JEL Codes: D70; F13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Exporter concentration (F10) | Tariffs (F19) |
| MFN clause (F23) | Free rider problem (H40) |
| Free rider problem (H40) | Tariffs (F19) |
| Higher concentration among exporters (F14) | Reduced tariffs (F13) |
| Optimal mechanisms (D47) | Participation of largest exporters (F10) |
| Principal supplier rule (D10) | Response to free rider problem (H40) |