A Commitment Theory of Subsidy Agreements

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in A Commitment Theory of Subsidy AgreementsAbstract 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. JEL-Code: F130, F550, H250, D720.

Non-Tariff Measures and the WTO

“…In the model of Brou and Ruta (2013), the fundamental reason for signing a trade agreement that commits a government to free trade is the same as that in Maggi and Rodriguez-Clare (1998) and in Potipiti (2012). But the novel twist in the model of Brou and Ruta is that a commitment to free trade by itself will induce the government to simply turn more intensively to production subsidies in its political relationship with the import-competing lobbies -the policy substitution problem -and the resulting distortions are welfare-reducing (and recall that the country is assumed to be small, so there is no terms-of-trade reason for the government to distort its domestic subsidy once its tari¤ is constrained and no sense in which a "market access preservation rule" could …x this problem).…”

The Purpose of Trade Agreements

“…23 As p at home and p abroad, and a world price, p w . 24 They de…ne again a "political optimum" as the policies that the governments would choose in a Nash equilibrium if, for some reason, they were to ignore the welfare enhancing e¤ects of a terms-of-trade improvement, given local prices at home and abroad. That is, their benchmark arises when all governments choose policies to satisfy their …rst-order conditions, but in the process act as if G pw (p; p ; p w ) 0.…”

Non-Tariff Measures and the WTO

“…16 16 Limao and Tovar (2011) also study the role of trade agreements as commitment devices when governments have both tari¤s and behind-the-border NTMs at their disposal, but their focus is on the possibility that international commitments to lower tari¤s will impact the use of behind-the-border NTMs, and on whether tari¤ agreements can still be attractive to governments when these impacts are present. Unlike Brou and Ruta (2011), Limao and Tovar do not consider the possibility that international commitments might be extended to cover behind-the-border NTMs, and the way in which this extension might best be designed.…”

“…In the model of Brou and Ruta (2011), the fundamental reason for signing a trade agreement that commits a government to free trade is the same as that in Maggi and Rodriguez-Clare (1998) and in Potipiti (2006). But the novel twist in the model of Brou and Ruta is that a commitment to free trade by itself will induce the government to simply turn more intensively to production subsidies in its political relationship with the import-competing lobbies -the policy substitution problem -and the resulting distortions are welfare-reducing (and recall that the country is assumed to be small, so there is no terms-of-trade reason for the government to distort its domestic subsidy once its tari¤ is constrained and no sense in which a "market access preservation rule" could …x this problem).…”

“…As Brou and Ruta (2011) demonstrate, their model is capable of providing a commitmenttheory based explanation of some of the important features for handling domestic subsidies that are contained in the WTO SCM agreement and that the terms-of-trade theory has di¢ culty explaining. And in particular, the …ndings of Brou and Ruta can provide a rationale for the need to pursue deep integration with regard to behind-the-border NTMs.…”