Trade Policy, Cross-Border Externalities and Lobbies: Do Linked Agreements Enforce More Cooperative Outcomes?

Abstract

If, in international agreements, governments "link" trade to environmental policy (or other issues with non-pecuniary externalities), will this promote more cooperation in both policies or will cooperation in one policy be strengthened at the expense of the other? We analyze this question in the context of self-enforcing agreements. We show that if the two policies are independent in the government's objective function then linkage - the ability to use both policies to punish non-compliance in either individual agreement - promotes cooperation in one policy at the expense of the other (e.g. strengthens environmental standards at the expense of higher tariffs). However, if the linked policies are not independent in the governments' objective function (e.g. a tariff on cars and an environmental tax on oil) and if these policies are strategic complements then linkage promotes more cooperation in both issues (higher environmental standards and lower tariffs) than no-linkage. The policies are strategic complements only if: (i) the production externality has cross-border effects; (ii) the weight on the externality cost is high; (iii) import competing lobbies are not "powerful".

Keywords: Trade, linkage, environment, labor, cross-border externality, repeated games

JEL Classification: F13, F18, F42, H23, H77