A Commitment Theory of Subsidy Agreements

37 Pages Posted: 3 Oct 2012

See all articles by Daniel Brou

Daniel Brou

University of Western Ontario

Michele Ruta

Economic Research Division, WTO; Columbia Business School - Economics Department; International Monetary Fund (IMF)

Multiple version iconThere are 2 versions of this paper

Date Written: September 28, 2012


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.

Keywords: trade agreements, trade policy credibility, subsidy rules, GATT/WTO

JEL Classification: F130, F550, H250, D720

Suggested Citation

Brou, Daniel and Ruta, Michele, A Commitment Theory of Subsidy Agreements (September 28, 2012). CESifo Working Paper Series No. 3945, Available at SSRN: https://ssrn.com/abstract=2155607

Daniel Brou

University of Western Ontario ( email )

London, Ontario N6A 5B8
519-661-2111 x84815 (Phone)

HOME PAGE: http://publish.uwo.ca/~dbrou/

Michele Ruta (Contact Author)

Economic Research Division, WTO ( email )

Rue de Lausanne 154
CH-1211 Geneva

HOME PAGE: http://www.iue.it/Personal/Fellows/MicheleRuta/Welcome.htm

Columbia Business School - Economics Department ( email )

420 West 118th Street
New York, NY 10027
United States

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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