Domestic Policies in Self-Enforcing Trade Agreements

30 Pages Posted: 3 May 2012 Last revised: 24 Sep 2012

See all articles by Philip U. Sauré

Philip U. Sauré

Johannes Gutenberg University Mainz - Gutenberg School of Management and Economics; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: May 2, 2012

Abstract

If all cross-country externalities travel through the terms-of-trade, efficient trade agreements target the terms-of-trade but ignore domestic policies. This argument has been advanced by prominent studies on trade agreements. The present paper shows that its logic fails if production possibilities are intertemporally linked -- for example, under dynamic factor accumulation. In this case, past policies shape current production possibilities and thus affect defection temptations. Therefore, self-enforcing trade agreements that leave the choice of domestic policies to individual countries risk that countries abandon the zone of voluntarily cooperation while optimizing their policies. Consequently, trade agreements that target only the terms-of-trade suffer inefficiencies that are absent in trade agreements that target policies directly. The losses are strictly positive except for knife-edge cases, which existing studies have focussed on.

Keywords: self-enforcement constraint, state variable

JEL Classification: F10, F13

Suggested Citation

Sauré, Philip U., Domestic Policies in Self-Enforcing Trade Agreements (May 2, 2012). Available at SSRN: https://ssrn.com/abstract=2049902 or http://dx.doi.org/10.2139/ssrn.2049902

Philip U. Sauré (Contact Author)

Johannes Gutenberg University Mainz - Gutenberg School of Management and Economics ( email )

Germany

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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