Uncertainty and Trade Agreements

47 Pages Posted: 12 Jan 2013 Last revised: 17 Jan 2013

See all articles by Nuno Limão

Nuno Limão

University of Maryland - Department of Economics

Giovanni Maggi

Yale University; National Bureau of Economic Research (NBER); Yale University - Cowles Foundation

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Date Written: January 2013

Abstract

In this paper we explore the potential gains that a trade agreement (TA) can provide by regulating trade-policy uncertainty, in addition to the more standard gains from reducing the mean levels of trade barriers. We show that in a standard trade model with income-risk neutrality there tends to be an uncertainty- increasing motive for a TA. With income-risk aversion, on the other hand, the uncertainty-managing motive for a TA is determined by interesting trade-offs. For a given degree of risk aversion, an uncertainty- reducing motive for a TA is more likely to be present when the economy is more open, the export supply elasticity is lower and the economy is more specialized. Governments have stronger incentives to sign a TA when the trading environment is more uncertain. As exogenous trade costs decline, the gains from decreasing trade-policy uncertainty tend to become more important relative to the gains from reducing average trade barriers. We also derive simple "sufficient statistics" to determine the direction of the uncertainty motive for a TA and the associated welfare gains, and we apply them to the trading relationship between US and Cuba before 1934. Finally, we examine how the uncertainty motive for a TA is affected by the presence of ex-ante investments, and examine conditions under which an uncertainty-reducing TA will increase investment in the export sector.

Suggested Citation

Limão, Nuno and Maggi, Giovanni, Uncertainty and Trade Agreements (January 2013). NBER Working Paper No. w18703. Available at SSRN: https://ssrn.com/abstract=2199779

Nuno Limão (Contact Author)

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States
301-405-7842 (Phone)
301-405 3542 (Fax)

Giovanni Maggi

Yale University ( email )

New Haven, CT 06511
United States
203-432-3569 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yale University - Cowles Foundation

Box 208281
New Haven, CT 06520-8281
United States

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