The Optimal Design of Trade Policy Flexibility in the WTO

HEI Working Paper

64 Pages Posted: 7 Dec 2007

See all articles by Kornel Mahlstein

Kornel Mahlstein

Graduate Institute of International and Development Studies (IHEID)

Simon Schropp

University of St. Gallen; Sidley Austin LLP

Date Written: December 2007


This paper is a contribution to the literature on rational design of trade agreements. The World Trade Organization (WTO) is an incomplete contract among sovereign states. Incomplete contracts contain gaps. Ex post, contractual gaps may leave gains from trade unrealized; they may create regret in signatories once unanticipated contingencies or sudden protectionist backlashes have occurred. Trade policy flexibility mechanisms, such as the safeguards clause under Art. XIX GATT, are geared towards seizing ex post regret by allowing parties affected by a protectionist shock to partially and temporarily withdraw from previously made trade liberalization concessions - given that they compensate the victim(s) of such backtracking behavior.

This paper examines the somewhat understudied issue of optimal trade policy flexibility design in the WTO: In particular, we analyze whether ex post escape should be organized by means of a unilateral opt-out clause (a liability rule of escape), or a bilateral renegotiation provision (a property rule of escape). Modeling the WTO as a fully non-contingent tariff liberalization contract with contingencies (or states of nature) asymmetrically revealed, we find that a liability rule backed by expectation remedies payable to the affected victim Pareto-dominates both a renegotiation clause, as well as any other remedy arrangement connected to a liability rule. Only the remedial design of liability-cum-expectation damages yields the desirable incentives to liberalize ex ante, and to default ex post and therewith is able to replicate the outcomes of the hypothetical contracting ideal of the complete contingent contract.

Keywords: Incomplete contracts, remedies, enforcement, WTO

JEL Classification: F02, F13, F51, F53, F55, K00, K33, K42

Suggested Citation

Mahlstein, Kornel and Schropp, Simon, The Optimal Design of Trade Policy Flexibility in the WTO (December 2007). HEI Working Paper, Available at SSRN: or

Kornel Mahlstein (Contact Author)

Graduate Institute of International and Development Studies (IHEID) ( email )

PO Box 136
Geneva, CH-1211

Simon Schropp

University of St. Gallen ( email )

Varnbuelstr. 14
Saint Gallen, St. Gallen CH-9000

Sidley Austin LLP ( email )

Washington, DC
United States

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