Working Paper: CEPR ID: DP8253
Authors: Paola Conconi; Carlo Perroni
Abstract: We consider a small open economy that faces a commitment problem in trade liberalization. We examine how the relationship with a large trading partner affects the ability of the small countrys government to sustain free trade through a reputational mechanism. If the small country's government is patient enough, it can overcome its domestic commitment without the help of the large country. Unconditional liberalization by the large trading partner has an ambiguous effect on the small country's dynamic incentives. Liberalization through a reciprocal trade agreement, in which the large country lowers its tariffs conditionally on the small country doing the same, unambiguously dominates unconditional liberalization by the large country as a way of boosting trade reforms and reinforcing policy credibility in the small country. However, if capacity in the import-competing sector can only be reduced gradually, a conditional, reciprocal agreement may require an asynchronous exchange of concessions, with the large country liberalizing before the small country.
Keywords: commitment; conditionality; developing countries; trade concessions
JEL Codes: D72; D78; F13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Patience of the small country's government (H11) | Ability to sustain free trade (F10) |
| Unconditional liberalization by the large country (F69) | Ambiguous effect on small country's dynamic incentives (F29) |
| Reciprocal trade agreements by the large country (F10) | Ability of small country to maintain free trade (F10) |
| Reciprocal trade agreements by the large country (F10) | Overcoming the small country's commitment problem (F55) |
| Reciprocal trade agreements by the large country (F10) | Enhancing small country's credibility in trade policy (F19) |