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A Commitment Theory of Subsidy Agreements

Author

Listed:
  • Daniel Brou
  • Michele Ruta
Abstract
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.

Suggested Citation

  • Daniel Brou & Michele Ruta, 2012. "A Commitment Theory of Subsidy Agreements," CESifo Working Paper Series 3945, CESifo.
    • Handle: RePEc:ces:ceswps:_3945
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    References listed on IDEAS

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    1. Giovanni Maggi & Andrés Rodríguez-Clare, 2007. "A Political-Economy Theory of Trade Agreements," American Economic Review, American Economic Association, vol. 97(4), pages 1374-1406, September.
    2. Daniel Brou & Michele Ruta, 2009. "On the Political Substitutability between Tariffs and Subsidies," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 145(IV), pages 405-410, December.
    3. Tang, Man-Keung & Wei, Shang-Jin, 2009. "The value of making commitments externally: Evidence from WTO accessions," Journal of International Economics, Elsevier, vol. 78(2), pages 216-229, July.
    4. Giovanni Maggi & Andres Rodriguez-Clare, 1998. "The Value of Trade Agreements in the Presence of Political Pressures," Journal of Political Economy, University of Chicago Press, vol. 106(3), pages 574-601, June.
    5. Korinek, Anton & Servén, Luis, 2016. "Undervaluation through foreign reserve accumulation: Static losses, dynamic gains," Journal of International Money and Finance, Elsevier, vol. 64(C), pages 104-136.
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    7. Michael Spence & Danny Leipziger, 2010. "Globalization and Growth - Implications for a Post-Crisis World : Commission on Growth and Development," World Bank Publications - Books, The World Bank Group, number 2440.
    8. Henrik Horn & Giovanni Maggi & Robert W. Staiger, 2010. "Trade Agreements as Endogenously Incomplete Contracts," American Economic Review, American Economic Association, vol. 100(1), pages 394-419, March.
    9. Matschke, Xenia, 2008. "Costly revenue-raising and the case for favoring import-competing industries," Journal of International Economics, Elsevier, vol. 74(1), pages 143-157, January.
    10. Nuno Limão & Patricia Tovar, 2018. "Policy choice: Theory and evidence from commitment via international trade agreements," World Scientific Book Chapters, in: Policy Externalities and International Trade Agreements, chapter 6, pages 179-198, World Scientific Publishing Co. Pte. Ltd..
    11. Brian R. Copeland, 1990. "Strategic Interaction among Nations: Negotiable and Non-negotiable Trade Barriers," Canadian Journal of Economics, Canadian Economics Association, vol. 23(1), pages 84-108, February.
    12. Marc Bacchetta & Michele Ruta (ed.), 2011. "The WTO, Subsidies and Countervailing Measures," Books, Edward Elgar Publishing, number 13513.
    13. R. W. Staiger & G. Tabellini, 1999. "Do Gatt Rules Help Governments Make Domestic Commitments?," Economics and Politics, Wiley Blackwell, vol. 11(2), pages 109-144, July.
    14. Staiger, Robert W & Tabellini, Guido, 1987. "Discretionary Trade Policy and Excessive Protection," American Economic Review, American Economic Association, vol. 77(5), pages 823-837, December.
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    Cited by:

    1. Baccini, Leonardo & Impullitti, Giammario & Malesky, Edmund J., 2019. "Globalization and state capitalism: Assessing Vietnam's accession to the WTO," Journal of International Economics, Elsevier, vol. 119(C), pages 75-92.
    2. Bayramoglu, Basak & Copeland, Brian R. & Jacques, Jean-Francois, 2018. "Trade and fisheries subsidies," Journal of International Economics, Elsevier, vol. 112(C), pages 13-32.
    3. Lee, Gea M., 2016. "Optimal international agreement and restriction on domestic efficiency," Journal of International Economics, Elsevier, vol. 99(C), pages 138-155.
    4. David De Remer, 2013. "The Evolution of International Subsidy Rules," Working Papers ECARES ECARES 2013-45, ULB -- Universite Libre de Bruxelles.
    5. Gene M. Grossman, 2016. "The Purpose of Trade Agreements," NBER Working Papers 22070, National Bureau of Economic Research, Inc.
    6. Maggi, Giovanni, 2014. "International Trade Agreements," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 317-390, Elsevier.
    7. Sauré, Philip, 2014. "Domestic policies in self-enforcing trade agreements," European Economic Review, Elsevier, vol. 68(C), pages 19-30.
    8. Basak Bayramoglu & Brian Copeland & Jean-François Jacques, 2018. "Trade and fisheries subsidies [Le commerce international et les subventions à la pêche]," Post-Print hal-02624649, HAL.
    9. Pramila Crivelli & Luca Rubini, 2019. "“Flying High in a Plane” Appellate Body Report, European Communities and Certain Member States – Measures Affecting Trade in Large Civil Aircraft (WT/DS316/AB/RW)," RSCAS Working Papers 2019/78, European University Institute.
    10. David De Remer, 2013. "Domestic Policy Coordination in Imperfectly Competitive Markets," Working Papers ECARES ECARES 2013-46, ULB -- Universite Libre de Bruxelles.
    11. Sang-Kee Kim & Young-Han Kim, 2020. "Welfare implications of upstream subsidy in the presence of countervailing duties under limited verifiability," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 27(3), pages 643-663, June.
    12. Daniel Brou & Michele Ruta, 2009. "On the Political Substitutability between Tariffs and Subsidies," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 145(IV), pages 405-410, December.
    13. Ederington,Josh & Ruta,Michele, 2016. "Non-tariff measures and the world trading system," Policy Research Working Paper Series 7661, The World Bank.

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    More about this item

    Keywords

    trade agreements; trade policy credibility; subsidy rules; GATT; WTO;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F55 - International Economics - - International Relations, National Security, and International Political Economy - - - International Institutional Arrangements
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior

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