Duration and Term Structure of Trade Agreements

38 Pages Posted: 4 Feb 2009 Last revised: 27 Jul 2010

See all articles by Sergei Guriev

Sergei Guriev

Sciences Po; Centre for Economic Policy Research (CEPR)

Mikhail M. Klimenko

Georgia Institute of Technology - School of Economics

Date Written: July 21, 2009

Abstract

Why are some trade agreements concluded for a limited period of time while others have the form of evergreen contracts supplemented with an advance termination notice clause? We use a dynamic incomplete contracting model to demonstrate that the time structure of the trade agreement is related to the nature of the underlying trade-related investments (or other types of irreversible resource adjustments). If these investments are lumpy and specialized to trade in a particular homogeneous good, the agreements with the fixed term of duration are more likely. The fixed-term agreement provides incentives for the initial investment but leaves the parties the flexibility to revisit the need for future investment by resorting to renegotiation. If the agreement covers trade in goods requiring incremental investments with spillovers of the investment benefits across industries, the risk of overinvestment is more diversified. Therefore, the parties are more likely to choose an evergreen agreement (with an advance termination notice or an escape clause). We show that these predictions are consistent with the econometric evidence on the trade agreements to which the U.S. is a party.

Suggested Citation

Guriev, Sergei and Klimenko, Mikhail M., Duration and Term Structure of Trade Agreements (July 21, 2009). Available at SSRN: https://ssrn.com/abstract=1337231 or http://dx.doi.org/10.2139/ssrn.1337231

Sergei Guriev (Contact Author)

Sciences Po ( email )

27 rue Saint-Guillaume
Paris Cedex 07, 75337
France

HOME PAGE: http://econ.sciences-po.fr/staff/sergei-guriev

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Mikhail M. Klimenko

Georgia Institute of Technology - School of Economics ( email )

781 Marietta Street, NW
Atlanta, GA 30332
United States

HOME PAGE: http://www.econ.gatech.edu/docs/klimenko_vita0904.pdf

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