The terms-of-trade theory of trade agreements holds that trade agreements are useful to governments as a means of facilitating an escape from a terms-of-trade-driven Prisoners' Dilemma. In the PI's previous work, the PI's extended this theory in order to interpret and evaluate the design of the WTO. This work provided an economic interpretation for the principle of reciprocity, the most-favored nation (MFN) rule, and the role of retaliatory tariffs in sustaining a selfenforcing trade agreement. The PI's also extended the theory to evaluate proposed and actual WTO rules that concern labor and environmental policies, competition policies, export and domestic subsidies, and preferential trading agreements.
With the basic theoretical structure in place, this proposal moves forward and considers three fundamental questions. First, does the theory have empirical support? While some recent work has provided important evidence, to the PI's knowledge there has not yet been an attempt to investigate empirically the central prediction of the terms-of-trade theory of trade agreements, namely, that governments use trade agreements to escape from a terms-of-trade-driven Prisoners' Dilemma. Building on their past theoretical work, the PI's provide a characterization of this prediction: countries that are relatively bigger importers of a product in the non-cooperative Nash equilibrium should agree to larger negotiated tariff reductions on that product in a trade agreement. The PI's then formulate an empirical strategy that begins with the observation that a number of countries bound their tariffs for the first time in the Uruguay Round. Interpreting the (un-bound) tariffs that these countries reported at the beginning of the round as their non-cooperative tariffs, the PI's propose an empirical investigation of the hypothesis that those countries that import a greater share of world exports for a given product at the beginning of the Uruguay Round also offer a larger concession (ad valorem tariff reduction) for that product at the conclusion of the Uruguay Round. Their initial empirical findings offer support for the terms-of-trade theory, and they propose several important extensions of our basic empirical strategy.
While models of asymmetric information have generated numerous insights in other fields, very little attention has been given to the potential role that private-information considerations may play in the design and implementation of trade agreements. This omission may reflect the fact that trade agreements are self-enforcing, and it is only recently that game-theoretic tools have been developed with which to derive predictions in dynamic games with private information. The PI's second key question is thus: Does the inclusion of private information generate new interpretations and evaluations of WTO rules? To address this question, the PI's propose a repeated trade-policy game in which governments have privately observed political shocks. Using this model, the PI's then offer new interpretations of the weak-binding rule and the WTO Safeguard Agreement. The PI's also propose new work that considers the design of anti-dumping rules.
The WTO dispute settlement procedures (DSP) are widely admired but also raise important concerns. In light of these concerns, the PI's ask a third question: What are the implications of the terms-of-trade theory for key concerns that have been raised with respect to the WTO DSP? The PI's first consider the Mexican proposal that retaliation rights be made tradable. This proposal comes from a concern that the DSP is not effective for small and developing countries. To better understand the potential implications of the Mexican proposal, the PI's construct a model in which retaliation rights are auctioned. The PI's propose to evaluate different auction formats according to revenue and efficiency criteria. The PI's consider the WTO agreement on subsidies and countervailing measures (the SCM Agreement). A concern here is that the agreement may block the use of a subsidy that may be an efficient instrument with which to achieve a legitimate domestic objective (e.g., income stabilization for farmers). The terms-of-trade theory provides some support for this concern, and the PI's propose research that would highlight the advantage of an alternative approach that emphasizes "rebalancing". The PI's propose to show that a DSP that emphasizes re-balancing would embody a familiar notion from law and economics: efficient breach.
Broader Impacts: The PI's expect that their empirical work will establish an empirical foundation for the terms-of-trade theory and encourage a number of new empirical evaluations of the predictions of this theory. Their proposed work on trade agreements with private information will generate new understandings of the benefits and possible costs of certain WTO rules and thereby offer constructive theoretical input toward the design of a better world trading system. In the same spirit, the analysis of the DSP will provide constructive theoretical input for important and on-going debates with regard to the optimal design of the WTO. The new theoretical work will also provide methodological contributions that should facilitate future work by other trade-policy theorists. ThePI's will also continue to develop their interactions with WTO legal scholars, in order to gain from their expertise and provide opportunity for their research to find influence in legal circles as well. Finally, the PI's will teach the proposed research in their respective graduate trade classes, and they will continue to produce Ph.D. students whose research analyzes the economics of the WTO.
