How Does Import Market Power Matter for Trade Agreements?
65 Pages Posted: 10 May 2018 Last revised: 15 Oct 2021
Date Written: September 20, 2021
Abstract
Trade agreements are often viewed as mechanisms that prevent each signatory from using its import market power to manipulate its terms of trade to the detriment of the other signatories. Under a fully efficient trade agreement, therefore, negotiated restrictions on the policy space must be independent of each country's market power. Under the WTO, however, negotiated tariffs are significantly correlated with the import market power of the importing country, which is a manifestation of inefficiency in trade agreements under neoclassical models of trade. We evaluate two potential causes of deviation from the first-best outcome in WTO negotiations: (i) a free-riding problem that may be caused by the WTO's nondiscrimination requirement, and (ii) asymmetric information about government preferences. Theories based on the above two causes generate starkly different predictions about the pattern of negotiated tariffs. Using WTO tariff data, we find that the pattern of negotiated tariffs is consistent with the implication of a negotiation model under asymmetric information. Finally, we use the model together with data on negotiated and applied tariffs under the WTO to predict the tariff rates that politically-motivated governments would choose in the absence of WTO commitments.
Keywords: Tariff Overhang, Tariff Binding, MFN/Nondiscrimination Clause, Free-Riding
JEL Classification: F13, D82, D02
Suggested Citation: Suggested Citation