Working Paper: NBER ID: w14812
Authors: Kyle Bagwell
Abstract: This paper considers self-enforcing trade agreements among privately informed governments. A trade agreement that uses weak bindings (i.e., maximal tariff levels) is shown to offer advantages relative to a trade agreement that uses strong bindings (i.e., precise tariff levels). Consistent with practice, the theory also predicts that governments sometimes apply tariffs that are strictly below their bound rates. When private information is persistent through time, an enforcement "ratchet effect" is identified: a government reveals that it is "weak," and thus that it is unlikely to retaliate in an effective manner, when it applies a low tariff. This effect suggests that a government with a low type may "pool" at an above-optimal tariff, in order to conceal weakness. It also suggests a new information-based theory of gradualism in trade agreements.
Keywords: Trade Agreements; Private Information; Tariff Policy; Self-Enforcement
JEL Codes: D82; F13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Governments applying low tariffs (F13) | signaling to other governments that they are weak and unlikely to retaliate (F52) |
| Design of trade agreements (weak vs. strong bindings) (F13) | expected joint welfare of governments (D69) |
| Weak bindings allow for greater expected joint welfare (D69) | better matching between applied tariffs and political pressures (F13) |
| Persistence of private information (D89) | ability of governments to support self-enforcing agreements (H11) |
| More patient governments (H19) | better positioned to maintain cooperation (F55) |
| Initial tariff applications (L97) | reveal information about future political pressures (D72) |
| Initial actions (Y20) | subsequent negotiations and outcomes (F51) |