The Most Favored Nation Principle: Passive Constraint or Active Commitment?
15 Pages Posted: 16 Feb 2015 Last revised: 29 Oct 2015
Date Written: October 28, 2015
This paper examines how the welfare implication of the "most-favored-nation" (MFN) principle has changed as the trade agreement mode has shifted from the "one-shot-multilateral-trade-agreement" to "sequential-bilateral-trade-agreements.'' In particular, it emphasizes that the MFN principle works as 'passive constraints' in the former but 'active commitments' in the latter. It demonstrates that under the latter, (i) the importing country strategically takes a cost-efficient country as the first (second) trading partner when the MFN principle is (is not) embedded, and (ii) embedding the MFN clause improves both trade surplus of the importing country and world economy. That the MFN principle is utilized as a commitment device to encourage production by the cost-efficient country causes a reversal of the welfare implication in the previous literature.
Keywords: Most-Favored-Nation Principle, Sequential Trade Agreements, Commitment
JEL Classification: F12, F13
Suggested Citation: Suggested Citation