T rad e NegotiationsinHistoric alP erspec tive
C
»aglar OÄ z d en¤
E m ory U niversity
J anuary 19 9 9
A bstract
T his paperfocuses on the liberaltrade regimes. W e argue thatthe enforcement
problems areamongthemainobstacles theseregimes havetoovercome.R epeatednature ofthe interaction amongcountries can overcomeunilateralincentives todeviate;
however, coalitionaldeviations can notbe deterred in the presence ofdiscriminatory
tari®s (which impose negative externalities through trade diversion.
) W e argue that
theM ostFavoredN ationclauses(M FN )canovercometheseproblems,inbothbilateral
and multilateralbargainingframeworks and lead toP aretoSuperioroutcomes forall
parties.T hen thecrucialissue becomes tosustain commitmenttothis rulewhich has
been historically provided by the dominanteconomicpowers.H owever,this commitment,established through politicalreputation mechanisms,should beseen as apayo®
maximizing rationalstrategy, nota provision ofpublic good. W e provide historical
evidence from three periods (1 9th century bilateralnetworkoftreaties,trade wars of
theinterwareraand theG A T T regime),tosupportabove arguments.
¤
D epartmentofEconomics,EmoryU niversity,A tlanta,G A 30 322.E-mail:cozden@ emory.
edu.I would
liketothankA nneKruegerforencouragementandguidance,A vnerG reifforvaluablecomments,participants
attheStanfordW orkshop on InternationalT radeandD evelopmentforcomments and theO lin Foundation
for¯nancialsupport.A llerrors aremine.
1
1
In
trod uc tion
Despite the extensive theoretic aland em piric ald em onstrationspointing out their w elf
are
b ene¯ts, lib eraltrad e regim es am ong c ountries have b eenthe exc eptionrather thanthe
norm inhistory. Starting w ith the m erc antilist m otivations inthe pre-19 th c entury era,
m ost governmentstried to im pose restric tionsonthe °ow ofgood sac rosstheir b ord ers.
E vend uringperiod sofrelatively f
ree trad e,governm entsproved them selvesto b e quite ingeniousind evisingsub tle mec hanism sofprotec tion.R egard lessoftheir realm otivations,the
¯nalc onsequence ofthese protec tionist polic ieshasb eenlow er glob aland d om estic w elf
are.
T hus, inalm ost every theoretic aland prac tic alc irc um stance involving trad e b arriers, it is
possib le to ¯nd analternative set ofpolic iesthat w illb ene¯t every c ountry through mutual
lib eralization. G iventhis, the next questionnaturally b ec om esw hat f
ac torsprom ote (or
hind er) the estab lishment ofthese P areto superior regim es.
T hispaper w illb e c oncerned w ith one ofthese f
ac tors,nam elythe institutionalf
eaturesof
lib eraltrad e regimes.E stab lishm ent ofm utuallyb ene¯c ialtrad e regim esw illheavilyd epend
onthe rulesofthe institutionalf
ram ew ork inw hich they are negotiated and m aintained .
Lib eraltrad e institutionsneed to overc om e c ertainc om m itm ent prob lem sand b e c apab le of
ad aptingto c hangesinthe und erlyingec onom ic environm ent to suc c eed and survive.
T he c om m itm ent prob lem arisesinthe f
ollow ing c ontext. Anind ivid ualc ountry of
ten
¯nd sit inher interest to estab lish a m ore lib eraltrad ingrelationship w ith her partnersw here
eac h sid e m utually low erstheir b arriersto ob tainP areto superior outc om es.How ever, her
trad ing partnersc anac t opportunistic ally af
terw ard sand renege ontheir prom iseseither
ind ivid ually or asa group. T hey c anf
orm new trad ing b loc sw ith eac h other or outsid e
partiesw hic h w ould yield anevenlow er payo® (d ue to trad e d iversion) to the ¯rst c ountry
c om pared to the pre-agreem ent levels. W ith the antic ipationofthis ac tionex post, no
c ountry w illever enter a lib eralregim e exante and e± c ient outc om esw illb e m issed .T hese
c oncernsover trad ing arrangem entsare stillvalid tod ay and are re°ec ted inthe rem arks
ofgovernment o± c ialsw orried over increasing numb er ofexc lusionary regionalb loc ksand
2
b ilateraltreatiesinE urope and Am eric a.T hese typesofc om m itm ent prob lem sarise f
rom
the f
ac t that there isno\w orld " c ourt to punish d eviatorsf
rom anagreem ent and those
agreem entsneed to b e self
-enf
orc ing.
F inally, a trad e regime need sto b e °exib le und er changing ec onom ic c ond itions. An
internationalagreement isanincom plete c ontrac t w here it isim possib le to spec if
y ac tions
f
or signatoriesund er allc ontingencies.Anunantic ipated shif
t inthe und erlying ec onom ic
parametersand payo®sm ight rend er a c urrent agreem ent ine± c ient and c reate incentives
f
or a c ountry to w ithd raw and lead to the c ollapse ofa c aref
ully c raf
ted regim e.G iventhis
possib ility,anagreement need sto includ e provisionsto hand le these c irc um stances1 .
T he aim ofthispaper isto show how the lib eraltrad e regim esinthe past attempted
to d ealw ith these prob lems and how their inab ility to solve them led to their d em ise.
Ananalytic alm od elthat c aptures the m ainf
eatures ofinternationaltrad e relationships
w illb e presented and it w illb e supplem ented w ith historic alevid ence. Spec i¯c ally, w e
w illb e looking at the netw ork ofb ilateraltrad e agreem entsofthe late 19 th c entury and
the c urrent multilateralsystem b ased uponthe G eneralAgreem ent onT ari®sand T rad e
(G AT T ) and governed b y the W orld T rad e O rganiz ation(W T O ) assuc c essf
ulexam plesof
trad e lib eraliz ation.O nthe other hand , the interw ar period isa c lassic alexam ple off
ailed
multilateraland b ilateralattem ptsand it w as¯nallyshaped b yd isc rim inatoryregionalb loc s
w hic h w ere partly b lam ed f
or w orseningofthe ec onom ic prob lem softhat era.
T he mainpoint inthispaper isthat the suc c essofa trad ingregim e d epend sonthe rulesof
the f
ram ew orkgoverningit.Am ongthese,the m ost im portant one isthe non-d isc rim ination
rule w hic h isof
tenref
erred to asthe M ost Favored Nation(M F N) c lause intrad e treaties.
T hisrule sim ply saysthat animporting c ountry c annot d isc rim inate am ong her trad ing
partnersand isrequired to apply the sam e treatm ent to their prod uc ts. T he presence of
thisc lause isthe c om m onthread am ongthe suc c essf
ultrad e regim esand itsab sence isone
ofthe mainreasonsb ehind f
ailed b ilateralor multilaterale®orts.T he other im portant rule
1
In some sense, ifwe were to borrowparallelanalogies from game theory, a trade agreementneeds to
"coalition-proof"tosolvethecommitmentproblem and"renegotiation-proof"tosolvethe° exibilityproblem.
3
w e w illf
oc usonrelatesto how the estab lished regim eshand le unexpec ted events. T here
is less c onf
orm ity b etw eenregimes inthis regard . Inb ilateralregim es the prac tic e w as
to renegotiate existing treatiesw hile inG AT T , tem porary exem ptionsf
rom c om m itments
served thispurpose.T hisism ost likely d ue to the c ostsofrenegotiationw hich are expec ted
to b e low er inthe b ilateralc ase.
T he estab lishm ent and the sustainab ility ofthe M F N rule intrad e regim esw ere not
ac c id ental.Although itspresence provid esP areto superior outc om esf
or every c ountry,each
one w illhave the incentive to d eviate ifshe expec tsothersto cheat asw ell.T hisprob lem
isespec ially ac ute ifthe regime ismaintained through b ilateraltreatiesw here f
orm ationof
c oalitionsare relatively easier.T he presence ofa d om inant ec onom ic pow ersc om esinto play
at thispoint. B ritainand France in19 th c entury and the U nited Statesaf
ter the W W II
w ere c om m itted to the M F N principle so that they reinf
orc ed the expec tationsab out its
strength am ong other sm aller c ountries.T he lack ofexpec tationsthat the m ajor ec onom ic
pow ersw illad here to the M F N rule c ontrib uted to the f
ailure ofalllib eraliz atione®orts
d uringthe 1930 s.T he c om m itm ent to M F N w asestab lished through politic alc red ib ility of
these c ountries.W e should note that thisc om m itm ent should not b e seenasthe provisionof
a pub lic good b y a hegem on,w hic h isthe generalc laim b y m any authors(see O lson[199 1]),
b ut asrationalpursuingofselfinterest.
F inally,thispaper hopef
ullyw illshed som e light into the d isc ussionover the relative m eritsofb ilateral,regionaland multilateralapproac hesto trad e lib eraliz ation.T he slow d ow nin
the multilateralapproac h to lib eraliz ationand increasesinthe regionaland b ilateralnegotiationsc reated w id espread c oncernab out the f
uture ofour trad ingsystem am ongec onom ists
and polic ym akers.How ever,thispaper pointsout that the m ainc oncernshould b e w hether
trad e c oncessionsare extend ed w ithout d isc rim inationrather thanhow they are ob tained .
During the rest ofthe paper, w e w illtry to ac c om plish the f
ollow ing: the next sec tion
provid esa historic alb ac kground inm ore d etail.Sec tion3presentsthe generalf
ram ew orkina
three c ountry m od eland looksat the outc om esund er d isc rim inatory regim esw ith b ilateral
4
and multilateralnegotiations. Next sec tions analyz es the b ene¯ts ofnon-d isc rim ination
requirement interm sofe± c iency.Conclusionsf
ollow .
2
Historic alO verview
Duringthe 17th and 18th c enturies,trad e w ith their c oloniesw asm ore im portant f
or m ost
E uropeanc ountriesc om pared to intra-E uropeantrad e w hich led to the trad ing regim e in
E urope b eingd om inated b ym erc antilist polic ies.T he f
ew existingb ilateraltrad e agreem ents
w ere d isc rim inatoryinnature.T hese pref
erentialarrangem entsaim ed at trad e d iversionf
rom
third partiesto the c ontrac ting c ountriesand w ere poorly perc eived b y the ec onom istsof
the time (Irw in[1991]).
T he lossofthe North Am eric anand other c oloniesinthe sec ond halfof18th c entury
led France and B ritainto opennegotiations and explore b ilateraloptions. T he AngloFrench b ilateralagreem ent in1783 w as lim ited innature and it aim ed at elim inationof
some ofthe prohib itionsand red uc tionofc ertaintari®s.T he result ofthistreaty and other
B ritish negotiationsinvolving P ortugal, Spainand P russia w ere f
ailures. Disc ouraged b y
these and in°uenced b y the French revolutionand the Napoleonic w ars,B ritainstopped the
lib eralizatione®ortsf
or halfa c entury.T he steep f
allinagric ulturalpric esand the d emand
f
or im port protec tionf
or agric ulture f
rom land ow nersled to the passage ofthe P rotec tionist
CornLaw sin1815.Nevertheless,the governm ent w asw ellaw are ofthe im portance off
oreign
m arketsand d uringthe 1830 sand 184 0 s,B ritainagaintried to openf
oreignm arketsthrough
pref
erentialb ilaterald ealsw ith c ountrieslike P russia and P ortugal. T hese e®ortsd id not
b ear any realf
ruitsand f
rustrated w ith the lackofprogress,B ritainrepealed the CornLaw s
in184 6and unilaterally ad opted non-d isc rim inatory f
ree trad e polic iesthat lasted untilthe
b eginning ofthe W orld W ar I.How ever, the B ritish hopesthat other c ountriesw ould see
the b ene¯tsoff
ree trad e and f
ollow the sam e path d id not m aterializ e2 .
2
T he intellectual foundations for the arguments in favor of free debate were established during this
5
France w asa high-tari® c ountry in1815 w henthe pressuresf
or lib eralizationstarted to
show up. During the 1830 sand the 184 0 sthere w ere severalunilateralred uc tionsonthe
d utiesf
or raw inputssuc h asironore.Also,c ertainagric ulturalexport interests(w ine,silk,
b utter) supported the f
ree trad e m ovem ent. (K ind leb erger [1975]) Around the sam e tim e
inthe ¯rst halfof19th c entury, other c ountriesinE urope (P russia, Spain, Denm ark, P ortugal, Norw ay, Sw ed en) started to f
eelthe pressuresf
or lib eraliz ation; although they w ere
b ased ond i®erent sourc es.Low ering ofthe trad e b arriersb etw eenthe sm aller statesthat
f
orm ed G ermany and Italy had ad d ed m om entum to the lib eraliz atione®orts.K ind leb erger
[1975] explainsthe strengthening off
ree trad e pow ersd uring thisperiod ind etail. T here
w ere attem ptsm ainly through b ilateraland d isc rim inatory arrangem ents, b ut allofthese
treatiesw ere short lived and c aused resentm ent am ong other c ountriesw ho w ere d isc rim inated against
F inally, in1860 , France and B ritainagreed to signa c om m erc ialtreaty w hich c apped
m ost d utiesat 2 5% and ab olished allprohib itions.M ost tari®sw ere set around 15% and the
treaty w asto b e renew ed every tenyears.At the tim e, the French parliam ent w asaligned
w ith the im port-c om peting prod uc ersw ho opposed any sort oftrad e agreem ent.T hrough
hisauthority to signb ilateraltreatiesw ithout parliam entary approval, Napoleonm anaged
to im plem ent the tari® c hanges.3 T he m ost unique aspec t ofthistreaty w asitsArtic le 5
w hic h w asessentially anuncond itionalM F N c lause.B oth c ountriesagreed to grant to each
other any f
avor they w ould extend to third parties.Since B ritainhad granted f
ree ac c essto
her marketsf
or most prod uc tsb ef
ore, thisw asa greater ec onom ic c om m itm ent f
or France
(Nye [19 91]and K ind leb erger[1975]).W e should note that thistreaty w asb ased onpolitic al
m otivationsasmuc h asec onom ic ones.Napoleonw anted to keep B ritainneutralw hile he
period byA dam Smith and R icardo.T hedebates overthe Corn L aws provide importantlessons in history
ofeconomicthoughtand politicaleconomy.
3
Interestinglyenough,afterW orldW ar2,theU S presidentusedaanexecutivepowertosigntheG A T T .
T heCongress did notapprove thecreation ofInternationalT radeO rganization (which would betheequivalentofthe IM F forworld trade)due toits reluctance tomake such abigcommitment,G A T T would not
comeintoexistencewithoutthis powerenjoyedbythe president.
6
tried to oppose the Austrianrule inItaly b y f
orc e inthe early 1860 s.B ritainw asinterested
inestab lishing¯rmer tiesw ith c ontinentalE urope asshe realiz ed her f
uture d epend ed m ore
onE urope rather thanthe c oloniesand w anted a c hance to \export"her f
ree trad e polic ies.
T he e®ec t ofthistreaty onthe E uropeantrad e system w asrem arkab le.O ther c ountries
sought treatiesw ith France to guarantee equaltreatm ent w ith the B ritish good sresulting
ina seriesofb ilateraltrad e treatiesallw hich includ ed anM F N c lause.B y 1866, B elgium ,
G erm any, Italy, Austria, Spain, the Netherland s, Sw ed en, Norw ay had signed treatiesthat
low ered their tari®sto the 8-15% range (Irw in[199 1,p.
9 7]).
T ari® d isputesb eganto arise inthe 1870 saf
ter a d ec rease inagric ulturalpric esd ue to
the c heap Am eric angrain.Inthe 1880 s, renew alsofthe expiring treatiesinvolved lengthy
negotiations and tem porary tari® w ars erupted b etw eenFrance and Italy, G erm any and
R ussia, France and Sw itz erland (Irw in, [199 1, p.10 1]).B argaining f
or tari®sb ec am e m ore
c ontentiousand the low tari® equilib rium started to d eteriorate w ith greater levelsofprotec tionimplem ented ineac h round ofrenew als.T he regim e end ed w ith the outb reakofW orld
W ar I.
Duringthe w ar,prohib itions,c ontrolsand variousrestric tionsonthe °ow ofgood sw ere
enac ted .At the Allied E c onom ic Conf
erence of1916,B ritainand France let the other c ountriesknow that the post-w ar ord er w ould not b e the sam e; espec ially the M F N treatm ent
w ould not b e extend ed to G erm any and her allies.(Irw in[19 91, p.10 4 ] and K ind leb erger
[1975]) T he Covenant ofthe League ofNationsallow ed trad e c ontrolsd ue to spec ialnec essitiesofrec overy and d id not includ e the \equality intrad e"principle ofthe W ilson'sf
am ous
FourteenP oints.
T he ec onomic c haosofthe early 192 0 sand the reb uild ing e®ortsd id not provid e the
id ealenvironment f
or a new lib eralregim e.T here w asno c onsensusf
or lib eraliz atione®orts
and state interventioninto every d im ensionofthe d om estic ec onom y c ontinued inm ost
c ountries. Although som e w ar-tim e prohib itionsw ere elim inated , evenhigher tari®stook
their plac e.Inthe late 192 0 ,severalinternationalc onf
erencesw ere organiz ed to c reate som e
7
m om entum f
or trad e lib eraliz ation. Despite their repeated d ec larationsofc om m itm ent to
a lib eraltrad e regime, none ofthe m ajor pow ersad opted the rec om m end ationsofthese
c onf
erencesand a new c om prehensive regim e w asnever im plem ented .Nevertheless,in192 7
France and G erm any signed a minor treaty w ith anM F N c lause c overing severalprod uc ts
and b y 192 8 there w ere f
orty suc h treatiesalthough none ofthem w ere extensive.
In192 9,there w asanother sharp d ec line inagric ulturalpric es.T hisprom pted som e tari®
hikesinG erm any,France and Italy.T he Sm oot-Haw ley tari®sof1930 inthe U S resulted in
another seriesofincreases.T he G reat Depressionstruckthe ¯nalb low to the trad ingsystem
w ith alltari®srising rapid ly.Quotas, prohib itions, exchange c ontrols, regionalagreements
and other d isc riminatory arrangementsw ere instituted to give totalc ontroloftrad e to the
governments(Irw in[1991]).Duringthisperiod ,there w ere num erousmultilateralc onf
erences
held to stop the c ollapse ofthe w orld trad ingsystem ,b ut allofthese attem ptsf
ailed .
Some c ountries,led b y France,B elgium and the Netherland s,stuc kto the gold stand ard
and had to estab lish quantitative restric tionsto stop out°ow ofgold since their c urrency w as
severely overvalued .B ritain,Sw ed en,Norw ay and other sterling-b loc c ountrieslet their c urrency d eprec iate and d ec rease d em and f
or im ports.Centraland E asternE uropeanc ountries
(suc h asG erm any,Austria,Italy,Hungary) regulated f
oreignexc hange transac tions.T hese
c urrency restric tionsled to \b arter" arrangem entsw hic h w ere w orse thanthe c reationof
trad ingb loc s.Initiale®ortsf
or lib eraliz ationappeared inthe m id -19 30 s,led b y B ritainand
the U S, af
ter the w orst part ofthe d epressionw asover.T he U S low ered itstari®saround
2 0 % through 2 0 b ilateralM F N treatiesw ith m inor trad ingpartners.How ever,b y that tim e,
the politic alf
ound ationofE urope had b egunto c ollapse and the w ar had arrived .
T he post-W orld W ar IIregim e w asf
ound ed uponthe G AT T w hic h w asb ased onthe id eas
presented at the B retton-W ood sc onf
erence. T he b ackb one ofthismultilateraltreaty w as
againthe uncond itionalM F N c lause.Duringeach round ofG AT T negotiation,each c ountry
w ould present a list oftari® levelsshe w illim plem ent tow ard sthe exportsofallc ontrac ting
c ountries.T henthe c ountriesb eginto negotiate, w ith the ¯nalagreem ent d eterm iningthe
8
tari® ratesand other trad e polic iesto b e im plem ented untilthe next round ofm eetings.
T hrough the eight G AT T round s, the numb er ofm em b er c ountriesincreased f
rom 2 3 to
12 8 w ith the average tari®s onind ustrialprod uc ts d ec reasing f
rom 4 5%
to 5%
(Staiger
[199 5]).During the last ¯f
ty years, G AT T hasevolved into a trad ing system w ith c om plex
and intric ate legalrules regard ing m any aspec ts oftrad e polic ies such as the treatm ent
c ustom sunions,d ispute settlement proc ed ures,agric ulturalpolic iesand role ofc om petition
and environm entalpolic iesasprotec tionist m easures.Inthe ¯nalU ruguay round , m emb er
c ountries agreed to the c reationofthe W orld T rad e O rganization(W T O ) w hic h w ould
oversee internationaltrad e w ith equalstature asthe W orld B ank and the IM F .
Despite thissuc c ess, the G AT T hasf
ac ed m any prob lem sinthe past and m any others
remainto b e resolved .E ac h round ofnegotiationstakesm any yearsto c om plete - U ruguay
round w asc om pleted ineight years- and isc onclud ed w ith m ore c om plic ated agreem ents.
T here are increasingd eb atesover intellec tualproperty rights,agric ulturalpolic iesand trad e
inservic es.T he d ispute settlement system hasyet to hand le a seriousc on°ic t b etw eenmem b ersw hile R ussia and China are b e integrated into the system .Ab ove all,the G AT T /W T O
system never f
ac ed a glob alec onom ic c risesc om parab le to the G reat Depression.G iventhat
w e are alread y f
ac ingincreased regionalism and c reative m ethod sofprotec tionism ,there are
w orriesab out how w ellthe multilateraltrad ing regim e w ould w ithstand suc h anec onom ic
shoc k.
Lib eraltrad ingregim esare hard to c reate and m aintainasthe three m entioned period s
c anprove.Nevertheless,low er trad e b arriersare c ruc ialf
or ec onom ic e± c iency and d evelopm ent.Inthe next sec tions, w e w illshow the strengthsand w eaknessesofregim esb ased on
b ilateraland multilateralagreementsthrough ananalytic alm od eland historic alevid ence.
9
3 M od el
T he settingisextrem elystylistic ,b ut c apturesthe m ainpointsoftrad e negotiationsb etw een
a group ofc ountries. W e w illc onsid er a c om plete and perf
ec t inf
orm ationenvironm ent
w ith three c ountriesthat are d enoted w ith the c apitallettersfA;B ;C g and there w illb e
three good sfa;b;c
g. G ood a isimported b y c ountry A f
rom the other tw o c ountriesand
respec tive trad ing patternshold f
or the other tw o good s.W e w illlet ¿ij (w here i6
= jand
i;j2 fa;b;c
g) d enote the tari® im posed b y I onthe im portsofgood if
rom J. W e w ill
also assume the availab ility ofane± c ient transf
er m ec hanism b etw eenthe c ountriesw here
! ij d enotesthe net transf
er f
rom I to J.Although w e rarely see e± c ient transf
ersb etw een
c ountries, the existence ofsuc h a m ec hanism w illm ake analysismuc h c learer.O ne ofthe
reasons that c ountries negotiate over their respec tive tari® levels is the ab sence ofsuch
e± c ient transf
ers.O therw ise, they w ould sim ply set the tari®sto z ero (w here presum ab ly
joint w elf
are ismaxim iz ed ) and share the surplusthrough transf
ers.W e w illsee shortly that
the availab ility ofsuc h m ec hanism sd o not overc om e the c om m itm ent prob lem sinherent in
these b argainingsettings.T he payo®sf
or the governm entsare givenb y
W A (¿;!) =
UAa (¿ab;¿ac) + UAb (¿ba ;¿bc) + U Ac(¿ca;¿cb) ¡! ab ¡! ac
W B (¿;!) =
UB a (¿ab;¿ac) + UB b (¿ba ;¿bc) + UB c(¿ca;¿cb) + ! ab ¡! bc
W C (¿;!) =
UC a (¿ab;¿ac) + UC b (¿ba ;¿bc) + UC c(¿ca;¿cb) + ! ac+ ! bc
(1)
ersto I 'spayo® f
rom sec tor jand (¿;!) are the
w here f¿ijg 2 [0 ;¿]:FunctionUI j(:;:) ref
tari® and transf
er vec tors.For sim plic ity, w e w illassum e that the export payo® f
unctions
(UAa ;UB b;UC c) are id entic alto eac h other and sym m etric intheir param eters.T he im port
payo® f
unctionsw illb e id entic alinterm softhe tari®sf
ac ed b y the c ountry'sprod uc t and
the c om petitor'sprod uc t.
W e ref
er to these f
unctionsas governm ents' ob jec tive f
unctions rather thand om estic
w elf
are f
unctionssince w e w ant to includ e the politic al-ec onom yf
orc esinthe d ec isionm aking
proc ess. K rugm an[19 91] ref
ersto the ob served m otivationsofthe governm entsintrad e
10
negotiationsas\enlightened m erc antilism " w hose principlesare (1) exportsare good , (2 )
importsare b ad and (3)other thingsequal, anequalincrease inim portsand exportsare
good .Furtherm ore,eventhe language ofthe G AT T c allstari® red uc tionsas\c oncessions"
and that \theyneed to b e"c om pensated w ith rec iproc al\c oncessions"f
rom trad ingpartners.
Furthermore, ina seriesofpapersG rossm anand Helpm an[19 94 , 19 95] provid e a politic al
ec onomy f
ramew ork w here suc h anob jec tive f
unctionc anarise inequilib rium through the
interac tionoflob b y groupsand governm ent. T he literature onthe sourc esofgovernm ent
incentivesthat d o not nec essarily m axim ize d om estic w elf
are isextensive and the task is
b eyond the sc ope ofthe paper. W e w illsim ply take that b ehavior asgivenand use the
w ord sc ountry and governm ent interc hangeab ly.(See R od rik[1995]f
or anextensive survey.)
u u u u u u
W e w illassum e that the optim alunilateralpolic iesare givenb y¿u= (¿ab
;¿ac;¿ba ;¿bc;¿ca;¿cb)
and !u = 0 w hereassoc ially optimaltari®s(m axim izing joint payo®softhe governm ents)
are d enoted b y the vec tor ¿s.T he payo® f
unctionsw illhave the f
ollow ingproperties:
@ UI j
@U I j
@ UI i
> 0;
< 0;
> 0 f
or i6
= j6
= k and i;j;k2 fa;b;c
g
@¿ij
@ ¿ji
@¿jk
(2 )
so that the interestsofthe exportersand the im portersare opposingeach other and ,theref
ore,a mutuallow eringoftheir respec tive tari®sw illprovid e P areto gainsf
or b oth.Furtherm ore,the interestsofthe tw o exportersofthe sam e good are also opposed since a low er tari®
f
or c ountry I c reateshigher d emand f
or her export and im provesher w elf
are at the expense
ofthe other exporter:T he possib ility ofsuch externalitiesim posed onthird partiesw ho is
not part ofa treaty isthe mainreasonb ehind m ost ofthe resultsinthispaper.T he c ruc ial
questionishow the low eringisnegotiated .T he next sec tionsad d ressthe severalalternative
f
ram ew orks.
3.
1
B il
ateralNegotiation
s
T hroughout thissec tion,w e w illassum e that c ountrieshave alread y estab lished unilaterally
optim altari®sat the b eginning ofthe gam e. Since, these ratesare not P areto e± c ient,
11
governmentshave incentivesto negotiate and mutually low er them . T he negotiationsare
hand led through b ilateraltreaties.At the end ofperiod t,c ountry A ism atched w ith B (if
tisd ivisib le b y three).T he tw o c ountries¯rst d ec id e to negotiate or not.Ifthey negotiate,
they d etermine tentative tari® ratesand a transf
er f
or period t+ 1:T hese agreem entsare
m ad e pub lic so that C the know sthe d ealm ad e b etw eenA and B .Ifone ofthem ref
usesto
negotiate,thenno treaty issigned .At the b eginningoft+ 1,A and B d ec id e to im plem ent
the tari®sd ec id ed earlier inthe treaty or new ones(such asthe unilaterally optim alones)
and the transf
ersare paid .T he tari® ratesim plem ented inperiod tare givenb y the vec tor
¿ t and the assoc iated payo®sare fW At;W Bt;W Ctg = fW A (¿ t);W B (¿ t);W C (¿ t)g.At the end
ofperiod t+ 1 (t+ 2 ) ,C ism atc hed w ith A (B ) and the ab ove proc essisrepeated .
W e w illnot m ake any spec i¯c assum ptions ab out the ac tualb argaining gam e played
b etw eentw o c ountriesinany givenperiod . W e w illsim ply assum e that the negotiations
take plac e b ehind c losed d oors(insom e high sec uritygovernm ent b uild ing) and the outsid ers
only ob serve the outc om es.W e w illonly im pose the requirem ent that the outc om e ofthe
negotiationsb etw eentw o c ountriesare P areto e± c ient inthe sense that no f
urther gains
are availab le to either party w ithout hurtingthe other one.Inthisc ase, it isequivalent to
statingthat A and B ,f
or example,choose (¿ab;¿ac;¿ba ;¿bc) so that they m axim ize their joint
¡ AB AB AB AB ¢
payo®.T hese tari®sw illb e d enoted b y ¿ab
;¿ac ;¿ba ;¿bc w here
¡ AB AB AB AB ¢
¿ab ;¿ac ;¿ba ;¿bc =
argm ax W A (¿) + W B (¿)
(¿ab;¿ac;¿ba ;¿bc)
Ifthe gam e w asplayed only once w here A and B negotiated , thenthey w ould sim ply im plem ent the ab ove tari®sand solve the rest ofthe b argaining prob lem through the d irec t
transf
er m ec hanism . G iventhis;C w ould sim ply set her tari®sto the unilaterally optim al
levels.W e w illlet the tari® levelsofa period charac terized b ya treaty(or c ollusion) b etw een
¡ AB AB AB AB u u¢
A and B b e givenb y ¿AB = ¿ab
;¿ac ;¿ba ;¿bc ;¿ca;¿cb .Sim ilar vec torsw illb e d e¯ned f
or
period sw here A and C or B and C c ollud e at the expense ofthe c ountry lef
t outsid e.
From the d e¯nitionsofthe payo® f
unctionsin(2 ),w e c and erive the f
ollow ing:
AC
u
BC
s
AB
¿ab
> ¿ab
= ¿ab
> ¿ab
> ¿ab
12
(3)
B w illrec eive the b est treatm ent (low est ¿ab) f
rom A w henthey c ollud e and rec eive the
w orst w henhe islef
t out. Soc ially optim altari® islow er thanunilaterallevelb ut higher
thanc ollusive level.Similar relationshipsw illhold f
or allthe other tari® rates.G iventhe
ab ove relationshipsb etw eenthe tari® ratesin(3),w e w illhave the f
ollow ingf
or the payo®s
exc lud ingthe transf
ers::
UAAB = UAAC > UAs > UAu > U AB C
w here U A = UAa (:;:) + UAb(:;:) + UAc(:;:) asd e¯ned in(1). Againsim ilar propertiesw ill
hold f
or the other c ountries.
T he gam e c ontinues ind e¯nitely and the totalpayo® f
or a c ountry is the sum ofthe
d isc ounted present valuesofper-period payo®s.T he c om m ond isc ount f
ac tor is± and our
aim isto ¯nd the equilib ria ofthisrepeated gam e.T he equilib rium ofthe stage gam e w here
the c ountriesim pose ¿ u isalso anequilib rium ofthe repeated gam e asw ell.T he question
isw hether ifit ispossib le f
or them to im prove uponthisoutc om e. T he f
ollow ing lem m a
estab lishesthe existence ofstrategiesw hich lead to b etter outc om esf
or only a sub set ofthe
c ountriesand d eter unilaterald eviations.
u ¡U AB + U u ¡U AB
(U Aa
Aa
Bb
Bb )
); the follow ingstrategy form s
AB
AB ¡U u
(U B a ¡U Bua + U Ab
Ab)
a subgame perfec t equilibrium: Country A signsa treaty to im plem ent ¿AB w ith country B
Lem m a 1 : For all± > ±¤ (w here ±¤ =
intheir respec tive negotiationperiod s, and they agree to a net transfer am ount ! ab.Inother
period s, A and B refuse to negotiate w ith C and they only implem ent ¿AB inevery period
w hile C implementsthe unilaterally optim altari® s.T he net transfer is! ab betw eenA and
B but it iszero w ith C :IfA (B ) d eviates, thenB (A) revertsto her unilaterally optim al
strategy.
P roof
: T o show that these strategiesf
orm a sub gam e perf
ec t equilib rium , w e need to
show that one stage d eviationsd o not increase the w elf
are f
or any ofthe c ountries. T he
per period payo®sifeveryb od y w ere to f
ollow these strategiesare W A = UAAB ¡! ab;W B =
UBAB + ! ab;W Y = UCAB :Country C w illget the sam e payo® alongthe equilib rium path and
13
hisac tionsw illnot c hange hisoutc om e, so he hasno incentive to d eviate. T he gainto
Af
rom d eviating isUAu¡UAAB and the payo® af
ter that isUAu.It isoptim alf
or A not to
¡ u
¢
¡
¢
AB
AB
u
d eviate if± > UAa ¡UAa
= UAb
¡UAb
¡! ab .T he one period gainto B isUBu¡UBAB and
¡
¢ ¡
¢
the payo® af
ter that isUBu and he w illnot d eviate if± > U Bub ¡UBABb = UBABa ¡UBua + ! ab
T hese tw o c ond itionsim ply
¡ AB
¢ ¡ u
¢
¡ u
¢
¡
¢
u
AB
± UAb
¡UAb
¡ UAa ¡UAa
UB b ¡UBABb ¡± UBABa ¡UBua
> ! ab >
±
±
T hisw illb e not true f
or allvaluesof± only w hen
u
u
AB
AB
UAa
+ UAb
+ UBua + U Bub > UAa
+ UAb
+ UBABa + UBABb
Since ¿AB m axim iz estheir joint payo® ,w e have U AAB + UBAB > UAu+ UBu.T hisim pliesthat
f
or all± > ±¤ w here ±¤ =
u ¡U AB + U u ¡U AB
U Aa
Aa
Bb
Bb
AB
AB ¡U u ;
U B a ¡U Bua + U Ab
Ab
suc h ! ab and theref
ore anequilib rium inthe
ab ove strategiesw illexist.¥¥¥
A c orollary ofthe ab ove lem m a is that w e c anc onstruc t sim ilar c ollusive strategies
b etw eenA and C or B and C . T he repeated nature ofthe gam e allow sthe c ountries(at
least A and B ) to ob tainhigher payo®sc om pared to the single period gam e.T he threat of
punishm ent inthe f
uture period skeepsthe c ountriesonthe equilib rium path and prevents
them f
rom c heating unilaterally inthe c urrent period . T he d raw b ack isthat thise± c ient
equilib rium (f
rom A'sand B 'sperspec tive) isat the expense ofC w ho isw orse o® c om pared
to the single stage game outc ome.T histhreat to revert to the unilateralstrategies(asthe
m ec hanism sustaining thisequilib rium ) hasb eenem phasiz ed inthe literature quite of
ten.
(see Dixit [1987] and Staiger [199 1]).M oreover, thisthreat isa legalpart ofm any treaties
(b ilateralor multilateral).For exam ple,Artic le 2 3ofG AT T statesthat ifa b ene¯t ac c ruing
to a c ountry is\nulli¯ed or impaired b y another c ontrac tingc ountry asa result off
ailure to
c arry out anob ligation,"thenthe ¯rst c ountry c ansuspend hisc oncessionsaf
ter c onsulting
w ith other parties. As Dam [1970 , p.
79] points out, \the essence ofthe G AT T system
liesnot inthe ab strac t legalrelationshipsc reated b y a tari® c oncessionb ut rather inthe
enf
orc em ent m ec hanism ..
.c onsequence ofnonperf
orm ance isthusthe reestab lishm ent .
..of
14
the preexistingsituation(although the retaliatorysuspensionm ayb e onitem snot originally
negotiated w ith the o®end ing c ontrac ting party).
" Ingam e theoretic term s, ifa c ountry
reneges ona c omm itment, other c ountries punish her b y increasing their tari®s to their
originallevels.Furtherm ore, ac c ord ingto Dam , \the b est guarantee that a c om m itm ent of
any kind w illb e kept .
..isthat the partiesc ontinue to view ad herence to their agreem ent as
intheir mutualinterest..
..retaliation,sub jec ted to estab lished proc ed uresand kept w ithin
presc rib ed b ound s,ism ad e the heart ofthe G AT T system .
"
T he threat ofpunishm ent c anb e m ad e m ore severe d ue to the struc ture ofthe gam e
since c ountriesc and ec id e w ith w hom to f
orm a c oalitionand exploit thispositionto their
ad vantage.T he punishm ent im posed uponB (or A) w illb e m ore severe ifA (or B ) w ere to
signa treaty w ith C since UBu > UBAC (or sim ilarly UAu > UAB C ).T he f
ollow inglem m a show s
how thisnew threat off
orminga new c oalitionc ansustainanequilib rium against unilateral
d eviations:
Lem m a 2 For ± > ±¤¤ (w here ±¤¤ =
u ¡U AB + U u ¡U AB
(UAa
Aa
Bb
Bb )
); the follow ing
u ¡U B C + U AB ¡U u + U u ¡U B C
+ U Ac
(
Ac
Ba
Ba
B c B c)
strategy formsa subgame perfec t equilibrium: Country A signsa treaty to im plement ¿AB
AB
U Ab
BC
¡U Ab
w ith country B intheir respec tive negotiationperiod s, and B agreesto a net transfer amount
! ab.Inother period s, theyrefuse to negotiate w ith C and onlyim plem ent ¿AB ineveryperiod
w hile C implementsthe unilateralpolic ies.T he net transfer is! ab betw eenA and B but it is
zero w ith C :IfA (B ) d eviates, thenB (A) form sa parallelagreem ent w ith C includ ingthe
implementationof¿B C (¿AC ) and a net transfer of! bc(! ac) startinginthe next period .As
longasA and B d o not d eviate C im plementsthe unilaterally optimaltari® sand transfers
zero, otherw ise she formsa collusionw ith the non-d eviatingparty.
P roof
: Follow ingthe same line ofreasoninginthe proofofthe previouslem m a,w e c an
¡ u
¢ ¡ AB
¢
AB
BC
u
BC
show that it isoptimalf
or A not to d eviate if± > UAa
¡U Aa
= UAb ¡UAb
+ U Ac
¡UAc
¡! ab .
¡
¢ ¡
¢
C
Similar c ond itionf
or B is± > UBub ¡UBABb = UBABa ¡UBua + UBuc¡UBB c
+ ! ab .T he d i®erencesare d ue to the f
ac t that d uring the punishm ent stages, the d eviating c ountry gets
15
payo®sf
rom the c ollusionofthe other tw o c ountriesinstead ofthe payo®sf
rom unilateral
strategies.T hese tw o c ond itionsim ply
¡ AB
¢ ¡ u
¢
BC
u
BC
AB
± UAb
¡UAb
+ UAc
¡UAc
¡ UAa ¡UAa
>
±
¡ u
¢
¡
¢
C
UB b ¡UBABb ¡± UBABa ¡UBua + UBuc¡UBB c
<
±
! ab and
! ab
T hisw illb e not true f
or allvaluesof± only w hen
u
BC
BC
C
AB
AB
u
UAa
+ U Ab
+ UAc
+ UBua + UBub + UBB c
> UAa
+ UAb
+ UAc
+ UBABa + UBABb + UBuc
Since ¿AB m axim iz estheir joint payo® , w e have UAAB + UBAB > UAB C + UBB C .T hisim plies
that f
or all± > ±¤¤ w here ±¤¤ =
AB
U Ab
BC
¡U Ab
u ¡U AB + U u ¡U AB
U Aa
Aa
Bb
Bb
uch
u ¡U B C + U AB ¡U u + U u ¡U B C ; s
+ U Ac
Ac
Ba
Ba
Bc Bc
! ab and theref
ore
anequilib rium inthe ab ove strategiesw illexist.¥¥¥
Inthisnew equilib rium , w e have m ore enf
orc em ent pow er since the punishm ent to the
d eviator isstronger. T he sourc esofincreased enf
orc em ent pow er are the externalitiesim posed onthe c ountry outsid e a treaty through trad e d iversionary e®ec ts. A c ountry loses
m ore inthe punishment stagesw henthe other one c ollud esc om pared to w henthey sim ply
play their unilateralstrategies.T he increase inthe enf
orc em ent pow er c anb e seenf
rom the
f
ac t that ±¤ > ±¤¤ thusf
or low er valuesof±; equilib rium c anb e sustained b etw eenA and B .
Againw e c anc onstruc t similar equilib ria b etw eenA and C or B and C .
Inthese typesofsettings, w e also need to w orry ab out the joint d eviationofA (or B )
w ith C against the other one. From the sym m etry ofthe payo® f
unctions, A (or B ) is
ind i®erent b etw eenpartnerssince hispayo® isthe sam e ineach period .O nthe other hand ,
the c ountry outsid e the b ilateraltreaty, C , hasallthe incentive to c onvince A to b reak up
the treaty and signa new one w ith her instead .T he next lem m a presentsoutc om e und er
c oalitionald eviations:
Lem m a 3 No bilateraltreaty betw eenA and B canbe sustained against a joint d eviation
by a member country and C .
16
P roof
: T he per-period -payo® f
or A and B f
rom their b ilateraltreaty are UAAB ¡! ab
and UBAB + ! ab respec tively, w hile C 'spayo® isUCAB :IfA w ere to signa treaty w ith C ;
their payo®sw ould b e U AAC ¡ ! acand UCAC + ! ac.T o d eter d eviationb yA w ith C , w e need
UAAB ¡! ab + UCAB > UAAC + UCAC .Sim ilar c ond itionf
or B isUBAB + ! ab + UCAB > U BB C + UCB C .
B ut w e know that UAAB + UCAB < UAAC + UCAC and UBAB + UCAB < UBB C + UCB C b y d e¯nition
ofoptimalb ilateraltreaties. T husthe no-d eviationc ond itionsc annot b e simultaneously
satis¯ed f
or A and B .Since the m ost e± c ient (optim al) treaty c annot b e sustained b etw een
A and B ,no othersc anb e sustained either.¥¥¥
T hislem ma isstatingthat the equilib ria f
orm ed b yb ilateraltreatiesare not stab le against
d eviations w ith outsid ers. W e c anc onstruc t m ore interesting equilib ria inthe f
ollow ing
sense: A and B agree to negotiate inperiod t; w hile Aand C (or B and C ) negotiate in
period t+ 1 (or t+ 2 ). Ineac h period , the negotiating governm entsagree to im plem ent
their jointly optim altari®sf
or the next period (the treatieslast only one period ) w hile the
outsid er im plem entsher unilateralpolic ies.T he net transf
ersare non-zero b etw eenthe treaty
partnersw hile the outsid er d oesnot rec eive or pay a transf
er.Ifany one ofthe c ountries
d eviate,the other tw o f
orm a b ilateraltreaty every period af
ter that.
Asit isthe c ase w ith alm ost allrepeated gam es,w e c anc onstruc t alm ost in¯nite numb er
ofequilib ria.T he reasonb ehind the ab ove equilib rium isto show that the c hoic e ofequilib rium b ec omesunpred ic tab le w ith d isc rim ination.W e c ango evenf
urther and c onstruc t
equilib ria w here a b ilateralc oalitionlastsa rand om numb er ofperiod sand a new one gets
f
orm ed af
ter that. W e should also note that the punishm ent to sustainthisequilib rium
(c om pared to the c asesinthe ¯rst tw o lem m as) isthe sam e,b ut the gainf
rom not d eviating
issm aller b ec ause a c ountry w illb e outsid e a treaty inevery three period s.T heref
ore the
d isc ount f
ac tor required to sustainab ove equilib rium w illb e higher inthisc ase, or sim ply
w e w illhave ±b> ±¤¤.W e w illtalk more ab out thisissue insec tion3.3.
T hese lem masshow that, onone hand , the availab ility ofanoutsid er m ore thanw illing
to joina treaty increasesthe enf
orc em ent pow er insid e a treaty against unilaterald eviation,
17
b ut onthe other hand the stab ility ofa treaty isend angered since the d eviator c analso
signa treaty w ith the outsid er asw ell.T histhreat ofc oalitionald eviationsb ec om esm ore
c lear ifone notic esthat, at any point inthe gam e, givenany tari® vec tor, it ispossib le
to ¯nd a new vec tor that w illim prove the w elf
are oftw o c ountries(at the expense ofthe
third one) and theref
ore c anget im plem ented .T he availab ility ofc ollusionw ith anoutsid er
und erm inesanytari® vec tor and m akesc ollusionveryd i± c ult.T husthisgam e w illnot have
any renegotiation-proofequilib ria.
T he eventsofthe late 18th and early 19 th c enturiesresemb le the non-stab le equilib rium
w e d esc rib ed ab ove.T he m ajor ec onom ic pow er ofthe era w asB ritainw ho sought b ilateral
treatiesw ith her m aintrad ing partners. T he VergennesT reaty in1786 w ith France w as
one ofthe ¯rst examples. Later on, France pub lic ly c om plained that they f
elt cheated
since similar c oncessionsw ere givento other c ountriesaf
ter that and the treaty lasted only
six years. T he interesting f
ac t is that B ritainhad previously signed a treaty provid ing
pref
erence to P ortuguese w ine,and P ortugalm ad e the sam e ac c usationsagainst B ritainaf
ter
the Vergennestreaty (Nye [19 95]).O ther negotiationsb etw eenB ritainand her other m ajor
trad ing partnerssuc h asP ortugal, Spain, P russia w ere either never f
ully resolved or short
lived . During the 182 0 sB ritainsought other tari® red uc tionsb ut m aintained high tari®s
onsugar, c o®ee and w ine f
or b argaining purposes(Irw in[19 91]) and o®ered d isc rim inatory
treatm ent f
or their importsb ut no c ountry ac c epted . In1836, the negotiationsf
or low er
tari®s onB ritish textiles inreturnf
or low er tari®s onP russiantimb er w ere rejec ted b y
P russia b ec ause ofthe non-c red ib ility ofthe prom ise. T he P russiano± c ialsw ere w orried
that the sam e term sw ould b e extend ed to R ussia and m ake the initiald ealw orthlessto
P russia. W .
E .G lad stone, f
uture B ritish P rim e M inister, rec allsthe 1830 s and 184 0 sas
\period sofac tive negotiationsw ith E uropeanc ountriesf
or rec iproc alred uc tionsintari®s,
b ut inevery c ase B ritainf
ailed .T he tend ency am ong the other c ountriesw asto m eet the
B ritish e®ortsw ith d istrust and suspic ion." (Irw in[19 91]).Allthese c ountriesw ere exporters
ofraw m aterialsand importersofB ritish m ac hinery and textiles. T hey w ere reluc tant to
low er their tari®sf
or the f
ear ofB ritish cheatingontheir prom isesoflow er tari®sand signing
18
similar d ealsw ith their neighb orsthuselim inatingthe originalb ene¯tsto them .
T he perc eptionthat the d isc rim inatorytari®sare synonym ousw ith b ilateralnegotiations
isonly partially true.Countriesof
tenseek suc h arrangem entsinmultilateralsettingsand
there isac tually no guarantee that non-d isc rim inationac tually isP areto e± c ient.It isquite
possib le that the tari® vec tor that m axim izes the joint w elf
are ofthe c ountries c alls f
or
d i®erent tari® ratesonthe sam e c omm od ities.E spec ially, inour m od elone w ould ac tually
expec t suc h treatiesto appear asthe equilib rium outc om e ofmultilateraltrad e negotiations
since the totalsurplusc anb e d ivid ed through the transf
er m ec hanism s.Next sec tionanalyses
thisissue.
3.
2
M ul
til
ateralnegotiation
s
W e w illd e¯ne the multilateralnegotiationsinthe f
ollow ing sense. Allc ountriesm eet at
the end oftim e tand jointly agree ona tari® and a transf
er vec tor. At the b eginning
oft+ 1, eac h one d ec id es to im plem ent the tari®s d ec id ed earlier inthe treaty or new
ones(suc h asthe unilaterally optim alones) and thenthe other c ountriesim plem ent their
transf
ers.T he tari® ratesf
or period tare givenb y the vec tor ¿ t and the assoc iated payo®s
are fW At;W Bt;W Ctg = fW A (¿ t);W B (¿ t);W C (¿ t)g.
T he tari® ratesc hosenina multilateralnegotiationw illb e the soc ially optim alones(¿s)
and d istrib utional(b argaining) issuesw illb e hand led through the e± c ient transf
ers.Asin
the previousc hapter,w e w illsee that unilaterald eviationsf
rom the soc ially optim altari®s
c anb e d eterred through a sim ple m ec hanism .
Lem m a 4 For ± > ±¤¤¤ (w here ±¤¤¤ =
(Z
Ab+
Z
(¡Z Aa ¡Z B b¡Z C c)
+ Z B a + Z B c+ Z C a + Z
Ac
C b)
;Z
Ij
= UIsj ¡UIuj), the
follow ingstrategies form a subgame perfec t equilibrium: Countriesnegotiate to implem ent
the soc ially optimaltari® s¿ s and the transfer vec tor ! = (! ab;! ac;! bc) inevery period .If
a country c heatsinperiod t, everybod y revertsto playingthe unilaterally optim alstrategies
and transfersare set to zero after that.
19
P roof
:T he method isid entic alto the previousproof
s..W e show that it isnot optim al
f
or a c ountry to d eviate unilaterally.W e d erive three c ond itionsthat need to b e satis¯ed b y
the transf
er vec tor and sum them up to d erive the ab ove c ond itionon±:¥¥¥
T hrough the threatsto revert to low er unilateralpayo®s,the soc ially optim altari®sc an
b e sustained inequilib rium .Furtherm ore, w e c and erive a result parallelto Lem m a 2 that
show sthe increased e± c iency through the threatsofc oalitionalpunishm ents.How ever, no
threat isstrong enough to d eter c oalitionald eviationsw here tw o c ountriessigna b ilateral
and d isc rim inatory treaty.T he f
ollow inglem m a estab lishesthisresult:
Lem m a 5 Soc ially optimaltari® vec tor cannot be sustained inequilibrium ifw e are to
allow coalitionald eviations.
P roof
: W e need to satisf
ythe f
ollow ingto prevent anypair ofgovernm entsf
rom f
orm ing
b ilateralc oalitions:
UAs + U Bs ¡! ac¡! bc >
UAAB + UBAB
UAs + UCs ¡! ab + ! bc >
UAAC + UCAC
UBs + UCs ¡! ac¡! bc >
UBB C + UCB C
(4 )
B ut f
rom the d e¯nitionofoptim altari®sf
or c oalitionsw e have
UAs + UBs <
U AAB + UBAB
UAs + UCs <
U AAC + UCAC
UBs + UCs <
U BB C + UCB C
T hus,allofthe restric tionsto prevent b ilaterald eviationsin(4 ) c annot b e satis¯ed simultaneously.Coalitionald eviationsw ould c om pletely und erm ine anequilib rium w ith soc ially
optim altari®s.¥¥¥
Since b ilateraltreatiesare sustainab le asequilib ria,asw e show ed inthe previouslemm as,
these c oalitionalincentivesto d eviate are realand need to b e overc om e b y any multilateral
20
treaty. How ever, the b iggest joint payo® is stillnot large enough to d eter allb ilateral
d eviations. T hisresult isparallelto the ob servationw e m ad e inthe previoussec tions(in
Lem ma 3) that f
or every tari® vec tor,w e c an¯nd a new one that isP areto superior f
or som e
c oalition.T he third c ountry d oesnot have enough enf
orc em ent pow er to d eter the d eviation
b y a c oalitionand thusthe ab ility to im plem ent d isc rim inatory tari®spreventsc ountries
rec eiving soc ially optim aloutc om es.Asw e have m entioned b ef
ore, eventhe availab ility of
e± c ient transf
er mec hanismsd oesnot solve the d ilem m a f
ac ed b y the c ountriesw henthere
are externalitiespresent.
T he period b etw eenthe tw o W orld W arsisanexam ple ofhow the availab ility ofd isc rim inatory polic iesund erm ined alle®ortsf
or a multilateralagreem ent onsoc ially e± c ient tari®
rates.T he initialB ritish and French oppositionto M F N agreem entsinthe early 19 2 0 sas
a w ay to punish G erm any and her alliesf
or the W ar shaped the initialstagesofthe trad e
negotiations(Irw in[19 91]).O nce it w asc lear that a group ofm ajor c ountriesw ere goingto
o®er d isc rim inatory treatiesto their trad ing partners, no other c ountry had any incentive
to pursue and o®er M F N treatiesto alltrad ing partnersasm any d id inthe sec ond halfof
the 19th Century.T he W orld E c onom ic Conf
erence in19 2 7w asone ofthe multilateralef
f
ortsto low er trad e b arriersand som e progressw asm ad e w here c ountriesagreed to low er all
their (d isc riminatory) tari®sb y¯xed perc entages.Nevertheless,these agreem entsw ere never
implemented and trad ing b loc ksw ere f
orm ed b y m ajor c ountriesand their naturaltrad ing
partners (m ostly ex-c olonies and geographic neighb ors) to c omb at the G reat Depression.
T he arrangementsw ithinthese b loc sre°ec ted the pref
erencesofthe b igger c ountries.For
example,France and her partnerspref
erred a gold -stand ard regim e and em ployed quantitative restric tionssince their overvalued c urrenciesled to trad e imb alances.B ritainand her
partnerstook the sterling o® the gold stand ard , d eprec iated their c urrenciesand m anaged
their ac c ount b alancesthrough d ec reased im ports. G erm any and other c entralE uropean
c ountriesinstalled c ontrolsonf
oreignexchange transac tionsand estab lished b arter arrangem entsam ongst themselves.B etw een19 2 9 and 1934 , the share im portsf
rom the c ountries
w ithintheir b loc ksincreased to 4 2 % (f
rom 30 % ) f
or B ritain,to 4 0 % (f
rom 2 0 % ) f
or G erm any,
21
to 33% (f
rom 12 % ) f
or France and to 2 8% (f
rom 16% ) f
or J apan.
W hile these d isc riminatory arrangem entsw ere put inplac e, at the League ofNations
and other internationalf
orums,there w asc ontinuousem phasisonnon-d isc rim inatory trad e
prac tic es. How ever, large c ountriesref
used to extend M F N treatm ent to other c ountries
unless they rec eived the low est tari®s f
rom others. For exam ple, the U s signed several
b ilateraltreatiesw ith sm aller trad ing partnersw here the M F N treatm ent w asextend ed on
a c ond itionalb asisto rec eive maximum ad vantage.T he sm aller c ountriesw ere evenm ore
reluc tant since they w ere af
raid oflosing their privilegesw ith their m aintrad ing partners.
R ealiz ingthat multilaterale®ortsw ere f
ailing,inlate 1930 ,Sec ond E uropeanConf
erence f
or
E c onomic Ac tion,suggested b ilateraltreatiesb ut only ifthe agreem entsw ould b e extend ed
to othersw ith uncond itionalM F N.In19 32 , Netherland sand B elgium agreed to low er all
tari®sb y 50 % b ut ref
used the M F N restric tion.B ritainref
used to low er her tari®sunless
she rec eived the low est tari®s.B ritish P rim e M inister c laim ed that B ritainw ould not ob tain
any new b ene¯tsaslongasHolland and B elgium tari®sto France w ere low er thanthe ones
to B ritain. Againthe m ainb arrier inf
ront oftrad e lib eraliz ationw asthe availab ility of
d isc rim inatory polic ies,not the mod e ofnegotiations.
M id 1930 sw itnessed increased U nited Statesac tivism inthe trad e area.T he U S played
a key role at the M ontevid o c onf
erence f
or trad e c ooperationam ong the c ountriesinthe
Americ asw hic h laid the ground to f
urther b ilateralnegotiations. During the rest ofthe
d ec ad e, the tari®sw ere low ered b y 2 0 % onaverage through b ilateraltreaties, m ostly w ith
other c ountriesinLatinAmeric a and Canad a.M ost ofthese treatiesinclud ed M F N c lauses
and these partners w ere inthe proc ess ofnegotiating sim ilar d eals w ith each other. A
relatively stab le trad e regime struc tured around the U S and b ased onb ilateraltreatiesw as
inthe proc essofc reation. Another im portant event w asthe 1938 Anglo-Am eric antreaty
w hic h f
ormed the f
ound ationf
or the B rettonW ood sc onf
erence.Asthese e®ortsw ere gaining
m om entum f
or low eringtari®s,the politic alb alance inE urope w asb eginningto c rumb le w ith
the rise ofNazism and the w ar arrived soon.T he trad e issuesw ere put onhold untilthe
end ofthe year asthe governm entsstarted to m anage their ec onom iesm ore d irec tly f
or the
22
w ar e®orts.T he post-W ar trad e regim e w asgoingto look very d i®erent.
3.
3 Disc rim in
ationan
d Di®eren
t O utc om es
Asw e explained ab ove, the d isc rim inatory arrangem entstook a d i®erent f
orm inthe 1830 s
and 184 0 sc om pared to the interw ar period .Inthe 19 th c entury,c ountries,espec iallyB ritain,
signed b ilateraltreatiesw hic h had short lif
e spansuntilthe f
am oustreaty w ith France in
1860 .O nthe other hand , c ountriesf
orm ed regionaltrad ing b locksinthe 19 2 0 sand 1930 s
w hic h seem ed relatively stab le giventhe chaotic ec onom ic environm ent.T he appearance of
these tw o very d i®erent equilib rium pathsc anb e only partly explained b y our m od elb ut
other f
ac torsofthe und erlyingec onom ic sc ene w illshed m ore light onthisissue.T he period
b etw een1815 and 184 6 (w henthe CornLaw sw ere repealed inB ritain) w asrelatively a
peac ef
ulone and w asc harac teriz ed b y the lossofc oloniesb y m ajor pow ersw ho realized the
importance ofintra-E urope trad e f
or their w elf
are (Irw in[19 95] and K ind leb erger [1975])).
B ritaind om inated the ind ustrialsec tor and other c ountriesw ere m ainlythe exportersofraw
m aterialsor simpler m anuf
ac tures.AsK ind leb erger [19 75] provid esam ple evid ence, there
w as increasing d esire f
or trad e lib eraliz ationinallofthe m ajor E uropeanc ountriesand
the negotiationsw ere held c ontinuously.How ever, thisperiod w asalso w henthe c ountries
w ere resolving their d omestic prob lem s. U ni¯c ationinItaly and G erm any, the d ec line of
the land ow ner c ontrolinthe B ritish politic sand struggle b etw eenNapoleonand the French
legislature oc c urred inthisperiod .Foreignalliancesc ould not really help the c ountriesw ith
their d om estic prob lems and there w ere no reasonto estab lish them . T he m aintrad ing
c ountries, espec ially B ritain, opted f
or the short term and unstab le b ilateraltreatiesuntil
B ritish reversionto unilateralf
ree trad e.
O nthe other hand , the 192 0 sand 1930 sw ere the G reat Depressionera w hend e°ation,
unem ploym ent and ¯nancialc risesw ere c om m onprob lem sto allc ountries.T rad e restric tions
and b eggar-thy-neighb or type c ompetitive d evaluationsw ere im plem ented asm eansof\exporting"these prob lemsto the other c ountries.Ac c ord ingto G ord on[194 1],allattem ptsf
or
23
multilateralac tionf
ailed b ec ause none ofthe m ajor c ountriesw anted to c om m it to polic ies
w hic h w ould lim it their ab ility to c omb at d epression.T he f
orm ationofstab le b loc saround
larger c ountriesw hile increasinginter-b locktrad e and other d isc rim inatorym easuresseem ed
to b e the ob viousm ethod sto pursue other m onetary polic iessuch asexchange rate c ontrols
and b alance ofpaym ents.Inshort,these tw o period spoint to the f
ac t that f
ailure to estab lish e± c ient trad ingregim esresult f
rom the inab ility ofthe c ountriesto c om m it them selves
to im plem ent non-d isc rim inatorytari® polic ies.T he eventuald isc rim inatoryequilib rium ,on
the other hand ,seem sto d epend onthe other c om plim entary aim sand polic iesthat need ed
to b e pursued .
4
T he Non-Disc rim in
ationCl
ause
Although it appeared inc om m erc ialtreatiessince the sixteenth c entury,the non-d isc rimination
c lause (M F N) b ec am e w id espread inthe latter halfofthe 19 th c entury (see Viner [1951]f
or
aninteresting history ofthe M F N c lause inthe c om m erc ialtreaties). Initsgeneralf
orm ,
it provid esa c omm itm ent onthe part ofthe c ontrac ting partiesthat they w illgrant the
m ost f
avored treatm ent to eac h other am ong alloftheir treatiesw ith third parties. Ina
netw orkofb ilateraltreatiesw ith thisc lause and ina multilateralf
ram ew ork,thisc ond ition
b oilsd ow nto non-d isc rim inationam ong trad ing partners.Inthissec tion, w e w illanalyze
the e®ec tsofthisc onstraint onthe b ilateraland multilateralnegotiationsw e have d esc rib ed
previously.T hen,w e w illd isc ussthe outc om esoftrad e negotiationsw ith thisc lause w ithin
the historic alc ontext.
W e had initially assumed that the c ountriesw ere sym m etric , thusthe tari® levelson
s
any good that m axim iz e the totalpayo® w illb e equalto each other (f
or exam ple. ¿ab
=
s
¿ac
:) Countriesc anset their M F N tari®sto these levelsand hand le the d istrib utionofthe
totalpayo® through the transf
ers. From Lem m a 3, w e know that a threat to revert to
unilateralstrategiessustainsthe soc ially optim altari®sasanequilib rium f
or all± > ±¤¤¤.
T he important questionw e f
ac e w hether ifthese soc ially optim altari®sc anb e sustained
24
against c oalitionald eviations assum ing the d eviating c ountries w illstillhonor the M F N
ob ligationsto the third c ountry.T he f
ollow inglem m a answ ersthisquestion:
Lem m a 6 Assume countriescannot d eviate from the M F N obligation.T hen, the strategies
that d eter unilaterald eviations(for ± > ±¤¤¤) w illalso d eter coalitionald eviationsand soc ially
optimaltari® sw illbe sustained .
s
s
P roof
:W e know that ¿as ´¿ab
= ¿ac
= argm axUAa (¿a ;¿a )+ UB a (¿a ;¿a )+ UC a (¿a ;¿a ) and
¿a
@U Aa =@¿a > 0 ;@UB a =@¿a < 0 and @ UC a =@¿a < 0 w hen¿a = ¿as:Sim ilar propertieshold f
or ¿bs
s
and ¿c
:So ifA and B w ere to d eviate and change their tari® rates¿a and ¿b,they w ould only
increase them.How ever,w e have show ed that unilateralincreasesare not optim altheref
ore
joint increasesw illnot b e either.T hus,c oalitionald eviationsw illb e d eterred .¥¥¥
T hislem ma show sthat the c ountriesc ansustainsoc ially optim altari®sagainst unilateraland b ilaterald eviationsund er the M F N c onstraint. W ith d isc rim inatory tari®s, tw o
c ountriesc ansign¯nd it intheir interest to m ake a sid e d ealsince they c angainat the expense ofthe third one.Inthisc ase,how ever,any tari® change w illa®ec t the tw o im porting
c ountriessim ilarlyand their incentivesw illb e aligned against the exportingc ountry.A tari®
d ec line w illb ene¯t the outsid er w hile anincrease w illhurt the c oalitionand theref
ore there
w illb e no incentivesto f
orm separate c oalitions. T he M F N c lause perf
orm sthe role ofa
c om mitm ent m ec hanism against renegotiatinga new d ealw ith one ofher trad ingpartners4 .
W e should note that the ab ove result d oesnot d epend onthe kind ofnegotiationsthese
soc ially e± c ient outc omesw ere ob tained f
rom .It isob viousthat ina m ultilateralsetting,
aslong asthey are enf
orc eab le, soc ially e± c ient tari®sw illb e choseninequilib rium since
provid e the unique P areto e± c ient payo®s.T he c ountriesc anshare thistotalpayo® through
the transf
ers.Inthe b ilateralc ase, w e need to b e m ore c aref
ul.Suppose A and B m eet at
4
T he importance ofcommitmentagainstopportunisticrenegotiation has been emphasized in othercon-
texts (forexample see M cA fee and Schwartz [1 994]modelon a monopolistsupplierand many customers)
and theroleofnon-discriminatoryarrangements has been identi¯ed.
25
time tand estab lish their respec tive tari® ratesw ith the M F N c lause.Inthe next period A
and C w illmeet and w e w ould like to see ifC w ould d em and the sam e tari® levelasw ell.
T hisisequivalent to saying w hether if¿acthat m axim iz estheir joint payo® ishigher than
the ¯xed tari® ¿ab w ith B .How ever since A and C 'sjoint payo® isd ec reasingin¿ac,theyw ill
try to low er it asmuc h aspossib le w hic h is¿ab inthisc ase.T hus,no m atter w hat the agreed
tari® isb etw eenA and B is, C w illd em and it asw ell. F inally, inperiod t+ 2 , B and C
w illsigna sim ilar treaty w ith the M F N c lause b ec ause ofthe sam e reasons.Since w e know
the responsesinthese tw o period sto the previousones, w e c and o b ackw ard sind uc tion
and c alculate the tari® levelsinthe initialstage. T he tari® outc om e inthe multilateral
and b ilateraloutc omesw illb e id entic alat the soc ially optim allevels,how ever the transf
ers
m ight d i®er5.Inthe ab sence oftransf
ers,w e w ould expec t the tari® outc om esinb ilateraland
multilateralnegotiationsto d i®er d ue to strategic issues.How ever,thisisa c om plic ated task
and w e w illnot ad d resshere.Nevertheless,it stillb e valid that non-d isc rim inationprovid es
c om mitm ent against renegotiationand im provesw elf
are und er b oth b argainingf
ram ew orks.
F inalquestionw e need to answ er isw hy the c ountriesw ould ¯nd it intheir interest to
ab id e b y the M F N ob ligationsat all.T hisrule need sto b e selfenf
orc ing asw elland this
point c anb e prob lem atic .T here are severalargum entsw e c anpresent onthisissue.IfA
and B knew f
or sure that their b ilateraltreaty w ould b e sustained inevery period thenthey
w ould have no incentive to signM F N treatiesw ith each other since they b oth b ene¯t f
rom
d isc rim inatingagainst C .How ever there are three d isc rim inatory(and stab le) equilib ria and
one ofthe c ountriesislef
t out ineac h one.Ifw e assum e that each c ountry hasa prob ab ility
of2 /3 ofb eing ina treaty and 1/3 ofb eing outsid e, thenshe w ould rather c om m it to the
M F N principle since her payo® w ould b e higher.Inother w ord s, M F N provid esprotec tion
against b eing lef
t outsid e a treaty. W e c analso f
oc usonthe equilib ria w here the pair of
5
T hese willdepend on the details ofthe bargainingenvironmentwhich we have totally ignored in this
model. T here are many models thatdealwith multilateralbargaining overa ¯xed pie and theirresults
depend heavilyonthespeci¯cassumptions oftheunderlyingstrategicform game(seeSerranoand Krishna
[1 996]
)
26
c ountriessigning a b ilateraltreaty changesevery period asinLem m a 3.T henit m ight b e
inthe interest ofthe c ountriesto c om m it them selvesexante to the M F N polic iessince they
w illob tainhigher overallpayo®.
A c lose analysisofthe trad e regim esgoverned b y the non-d isc rim inationprinciple reveals
that their most striking f
eature istheir relative stab ility.A m ajor exam ple isthe late 19th
Centuryregime w asb ased onthe netw orkofb ilateraltreatiesstartingw ith the Anglo-French
treaty of1860 . T he artic le inthe treaty onthisissue stated that eac h ofthe c ontrac ting
partiesengagesto extend to the other any f
avor,any privilege or d im inutionoftari® w hich
either ofthem m ay grant to a third party inregard to the im portationofgood sw hether
m entioned or not mentioned inthe treaty of1860 ". At the tim e, B ritainhad unilateral
f
ree trad e f
or tw o d ec ad esand w asnot interested inf
urther b ilateralnegotiations.T hisone
sid ed e®ort f
or a long period oftim e estab lished their reputationand c om m itm ent against
renegotiationoftheir treaties.T he French c om m itm ent to non-d isc rim inationprovid ed the
m om entum f
or the m ovem ent f
or f
ree trad e.T hisc om m itm ent w asprovid ed b y Napoleon's
politic alm otivationsto estab lish B ritainasanally. Deviationf
rom thisprinciple w ould
d am age that relationship and in°ic t great politic alharm .F inally the ad d itionofZollverein
to thisgroup w ith (also w ith some politic alm otivations) provid ed the nec essaryE urope-w id e
c om mitm ent to non-d isc riminationand led to the c reationofa relatively lib eralregim e.
T he b ilateraltreatiesw ere valid f
or ¯xed tim e period s(generally tenyears) and negotiated againaf
terw ard s.Any c ountry c ould term inate the agreem ent w ith ad vance w arning
(generally one year).T hisregim e saw a relative d ec line startinginthe late 1870 sand som e
trad e w arsinthe 1880 s.How ever,these w ere m ostly d ue to the shif
tsinthe und erlyingec onom ic environment and c ertainm ac roec onom ic shockssuch asthe increase inagric ultural
output and d rop intheir pric es. T hese d isruptionsw ere never inthe sam e m agnitud e as
w e w ould see inthe 19 30 s.A m ac roec onom ic shock m ight change the und erlying ob jec tive
f
unctionsand governmentsmight ¯nd it intheir interest to sim ply ab and onthese treaties.
T hisd oesnot im plythat the initialrulesthat led to the treatiesisine± c ient,b ut sim plythe
optim aloutc ome hasc hanged .T he possib ility ofthe renegotiationofthe treatiesprovid ed
27
the °exib ility that the system need ed .T he d isputesofthe era includ ed sharp tari® increases
onc ertainprod uc ts(suc h asagric ulturalprod uc tsinSw itzerland , France and B elgium ),
b ut the non-d isc riminationprinciple w asnever questioned .T he d eteriorationofthe system ,
although notic eab le c ompared to the 1860 s, w asvery m ild evenifw e w ere to c om pare to
rec ent d evelopmentsinthe G AT T .
M F N b ec om esm ore visib le inthe G AT T w here it f
orm sArtic le I.It statesthat \..
.any
ad vantage, f
avor, privilege or immunity granted b y any c ontrac ting party to any prod uc t
originating inor d estined f
or any other c ountry shallb e ac c ord ed im m ed iately and unc ond itionally to the like prod uc t originating inor d estined f
or the territoriesofallother
c ontrac ting parties" (see J ac kson[1969] f
or a d etailed history ofthe G AT T regim e).W ith
thisartic le, M F N b ec am e the single f
und am entalprinciple ofour c urrent trad e system as
w ell6.T he c om mitm ent to non-d isc rim inationinthe post-w ar era w asprovid ed through the
initiativesofthe U S.In19 4 5,the U S ac c ounted f
or the m ajority ofthe w orld trad e and had
estab lished non-d isc rim inationasthe c enterpiec e ofAm eric antrad e polic y f
or the last tw o
d ec ad es7.Furtherm ore, the rest ofthe w orld and espec ially the E uropeanc ountriesneed ed
the Am eric ansupport inthe rec onstruc tione®ortsaf
ter the w ar. Am eric anpolic ym akers
b elieved the c om petitive superiority oftheir prod uc tsand insisted ona multilateraland f
ree
trad e system .T he Americ anpositionprovid ed the nec essaryc om m itm ent f
or the M F Nprinc iple and the G AT T f
ram ew ork.T he rem arkab le suc c essofthe G AT T system ind uc ed m ore
c ountriesto joinit ineac h round and led to the c reationofW T O asthe sole international
organizationto governw orld trad e.
Another interesting f
ac t isthat m ost ofthe prob lem sf
ac ed b y the G AT T regim e arise
d ue to d isc rim inatory prac tic es.Inagric ulturalprod uc ts,m ost c ountriesw anted to provid e
6
W e should note that the G A T T allows several major exceptions to the M FN principle. T he most
importantone is the permission to create free trade areas and customs unions whose members willhave
discriminatory preferences forothermembers.A lthough,these are technicallyincompatible with the M FN
principle,theywere believed tobringcountries towards freertrade.
7
T heU S sometimes used aconditionalM FN clause in herbilateraltreaties.
28
protec tiontow ard stheir d om estic sec torsand m any w ere allow ed to set d isc rim inatory polic iesusing quota b ased measures. Ac tually, m ost G AT T rulesinclud ed exc eptionsf
or the
agric ulturalprod uc tsand now it seem sim possib le to reverse the trend . O nissuesrelated
to intellec tualproperty rights, lab or and environm entalstand ard s, extensive changesare
required inthe d om estic law softhe c ountriesto reach agreem ents.It isd i± c ult to estab lish non-d isc rim inatory polic iesonthese issuessince it isalm ost im possib le to im plem ent
id entic ald om estic law sinevery c ountry.
F inally,w e should point out the mechanism sw ithinthe G AT T to d ealw ith changesinthe
ec onom ic parameters.T he c reatorsofG AT T w ere quite aw are ofthe d angersthat m ight b e
posed b y these c hangesand the saf
eguard provisionsofG AT T w ere put inplac e to give the
right to raise protec tioninthe event ofunf
oreseenevents.Artic le 19 ,spec i¯c ally statesthat
a c ountry c an\w ithd raw a c oncessionor suspend anob ligation..
.ifthe prod uc t isim ported
insuc h increased quantitiesto c ause seriousinjury..
." T he c ountry c antake any nec essary
ac tionim m ed iately w ith a simple noti¯c ationofthe a®ec ted parties.T he artic le explic itly
spec i¯esa supply shoc kofthe sort w e m entioned ab ove and provid esa saf
ety m echanism so
that the w hole system d oesnot c ollapse d ue to a shock to one party.Furtherm ore,B agw ell
and Staiger [1990 ]argue that the \c reative"protec tionist polic iessuch asVoluntary E xport
R estraints(VE R ) and O rd erly M arket Arrangem ents(O M A) serve the sam e purpose. At
timesofhigh im port volum e, they help to c reate spec ialprotec tionand m aintainthe rest
ofthe system . T he f
ac t that b oth exporters and im porters agree to the term s ofthese
temporary \m anaged "trad e mec hanism sisf
urther evid ence that these m ec hanism sare part
ofthe equilib rium proc essw hic h b oth sid esw ant to preserve.
5 Con
cl
usions
Inthispaper,w e attempted to analyz e c ertainf
eaturesoftrad e regim esusingananalytic al
m od eland historic alevid ence.T he three m ainperiod sw e f
oc usonare the b ilateralsystem
oflate 19th c entury, the trad e w arsofinterw ar era and c urrent m ultilateralG AT T /W T O
29
regime.W e argued that the estab lishm ent and survivalofa mutuallyb ene¯c ialtrad e regim e
d epend sonthe rulesund er w hic h the negotiationsare c ond uc ted and outc om esim plem ented .
Amongthese rulesthe m ost important one isthe non-d isc rim inationc lause w hich prevents
anim portingc ountry f
rom treatingthe exportingc ountriesd i®erently.
Since there are no w orld c ourtsto punish d eviators, trad e agreem entsneed to b e self
enf
orc ingand c ountriesshould ¯nd it intheir interest to perf
orm their ob ligations.W e have
argued that the repeated nature ofthe trad e relationshipsc anoverc om e unilateralincentives
to d eviate,how ever, no m ec hanism c anprevent allc oalitionald eviations.B y thisw e m ean
that a sub set ofc ountriesmight signa new agreem ent that w illb ene¯t them at the expense
ofthe rest ofthe w orld . Formationofsuch trad ing b lockslow erssoc ialw elf
are since the
b ene¯tsto the m emb ersare lessthanthe lossesofthe outsid ersw here these gainsand losses
arise f
rom the d iversionoftrad e. T he availab ility ofd isc rim inatory tari®slead sto these
d iversionsand isthe mainreasonb ehind the incentivesto estab lish such b locks. T rad ing
regime inthe ¯rst halfofthe 19th c entury and the inter-w ar period w ere charac teriz ed b y
d isc rim inatory arrangem entsw hic h w ere d etrim entalto allc ountriesinthe end .How ever,
the equilib ria that appeared inthe ab sence ofnon-d isc rim inationd i®ered inthe tw o period s
and w e argued that thisd epend sonthe other m otivationsofthe c ountries.T he presence of
regionalb loc ksinthe 19 30 sserved c ertainm onetary and f
oreignexchange polic iesw hereas
the aim w assim ple trad e d iversioninthe 19th Century.T hisisthe reasonw hy they w ere
short lived .
Ifthe c ountriesw ere to agree to im plem ent only non-d isc rim inatory tari®s,thisprob lem
ofc oalitionald eviationsd isappears. Since allthe b ene¯tsneed to extend ed to everyb od y
w ithout d isc rimination, no c oalitionw ill¯nd it pro¯tab le inequilib rium to c hange their
polic ies. How ever, a new prob lem arisessince thisrule need sto b e enf
orc ed asw ell. W e
argued that inthe 19 th c entury, the c om m itm ent to thisrule w asprovid ed b y the m ajor
ec onom ic pow ersthrough other politic alincentives.Inthe post-w ar era,it w asthe Am eric an
c om mitm ent that served the sam e purpose.O nce it b ec om esexpec ted that thisrule w ould
b e inplac e,allc ountriesw ill¯nd it intheir interest to ab id e b y it.T he lackofc om m itm ent
30
to non-d isc rim inationinthe interw ar period w asone ofthe m ainreasonsb ehind the f
ailure
ofalle®ortsf
or lib eraliz ation.W e should ad d that the c om m itm ent m ec hanism sc reated b y
the d om inant pow ers(the U S or B ritainand France) should b e seenasac tionsofa rational,
w elf
are m aximizingac tor rather thanasthe provisionofa pub lic good b y a hegem on.
W e also argued that the repeated renegotiationofthe b ilateraltreatiesinthe 19th c enturyand the saf
eguard c lausesofthe G AT T agreem ent provid ed the °exib ilitythese system s
need ed to hand le the c hangingmac roec onom ic and other relevant param etersthat a®ec t the
optim aloutc om e.F inally,w e should note that the m ost im portant issue f
or a suc c essf
ullib eraltrad e regim e isthe non-d isc rim inatory nature ofthe negotiations.T he ¯nalagreements
onthe tari® ratesd id not result w hether the negotiationsw ere b ilateralor m ultilateralin
our m od eld ue to the availab ility oftransf
er m echanism s. Intheir ab sence, there w illb e
multiple P areto e± c ient tari® pairsand ,asw e argued inc hapter 2 and 3,the outc om e w ill
d epend onthe b argaininggam e played .W ithout the M F N rule,onthe other hand ,none of
the P areto e± c ient outc om esc anb e im plem ented .
31
R ef
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