Rodney D. Ludema

Economic geography and the fiscal effects of regional integration

In models of economic geography, plant-level scale economies and trade costs create incentives for spatial agglomeration of production into a manufacturing core and agricultural periphery, creating regional income differentials. We examine tax competition between national governments to influence the location of manufacturing activity. Labour is imperfectly mobile and governments impose redistributive taxes. Regional integration is modeled as either increased labour mobility or lower trade costs. We show that either type of integration may result in a decrease in the intensity of tax competition, and thus higher equilibrium taxes. Moreover, economic integration must increase taxes when the forces of agglomeration are the strongest.

Optimal international trade agreements and dispute settlement procedures

Abstract This paper explores the limits of international trade cooperation in the presence of a dispute settlement procedure. The dispute settlement procedure is modeled as set of conditions imposed on the punishment equilibria of a repeated tariff game, conditions that are consistent with the WTO principles of conciliation and reciprocity. The resulting equilibria are “renegotiation-proof” in the sense of Pearce [Renegotiation-proof equilibria: collective rationality and intertemporal cooperation. Yale Cowles Foundation Discussion Paper: 855, Yale University, 1987]. We find that tariff agreements cannot achieve free trade in the presence of the dispute settlement procedure, although the cost of this limitation becomes small for high discount factors. Quota agreements can achieve free trade under the dispute settlement procedure; however, countries would always prefer to settle disputes with tariff sanctions, if given a choice. These results are related to recent dispute settlement reforms.

Regional Integration, Trade, and Migration: Are Demand Linkages Relevant in Europe?

We examine the consequences of increased economic integration between nations within a region. We adopt Krugman’s economic-geography model in which demand linkages can generate agglomeration of manufacturing activity. Manufacturing labour is assumed to be imperfectly mobile between countries. This constrains the forces of agglomeration within the region and suggests that the model may be applicable to Europe. We show that trade liberalisation may lead initially to partial agglomeration, then a re-industrialisation of the periphery. This argues in favour of a sequential approach to integration, with trade barriers being eliminated prior to a reduction in impediments to factor mobility.

The Effects of Non-Tariff Measures on Prices, Trade, and Welfare: CGE Implementation of Policy-Based Price Comparisons

The global economic effects of eliminating certain significant categories of nontariff measures (NTMs) are estimated in a CGE context. As a first step, a database of institutional information identifying alleged instances of NTMs for particular products and countries is constructed based on WTO, U.S. Government, and EU sources, and compared with the UNCTAD policy inventory. This database is then concorded to a GTAP-feasible multiregion, multisector aggregation. Retail price data from the EIU CityData database, similarly concorded, are analyzed econometrically, taking into account systematic deviations from purchasing-power parity, to determine whether and to what extent the presence of alleged NTMs is associated with significantly higher prices. The estimated price effects are then used to calibrate a CGE simulation in order to obtain simulation estimates of trade and welfare effects of their removal, which can be disaggregated. Removal of the categories of NTMs under consideration yields global gains on the order of

Do Countries Free Ride on MFN

90 billion. These gains arise notably from liberalization by Japan and the European Union by region, and from liberalization of apparel and machinery/equipment by sector.

Increasing returns, multinationals and geography of preferential trade agreements

The Most-Favored Nation (MFN) clause has long been suspected of creating a free rider problem in multilateral trade negotiations. To address this issue, we model multilateral negotiations as a mechanism design problem with voluntary participation. We show that an optimal mechanism induces only the largest exporters to participate in negotiations over any product, thus providing a rationalization for the Principal supplier rule. We also show that, through this channel, equilibrium tariffs vary according to the Herfindahl-Hirschman index of export shares: higher concentration in a sector reduces free riding and thus causes a lower tariff. Estimation of our model using sector-level tariff data for the U.S. provides strong support for this relationship.

A theory of trade policy leadership

Abstract This paper uses a model of horizontal multinational enterprises to explore the relationship between transportation costs and trade policy cooperation. Tariffs have the effect of attracting foreign direct investment to the benefit of consumers in the host country. As transport costs fall, the incentive to impose tariffs falls and the benefits to cooperation rise. Thus, in a repeated game in which cooperation is limited by a self-enforcement constraint, a reduction in transport costs facilitates free trade. This logic is applied to a three-country model to examine preferential trade agreements. It is found that if any country is too distant from the others, then global free trade is not attainable. Rather, if two of the countries are within a critical distance of each other and distant from the third country, then the unique outcome is an exclusive free trade agreement between the two adjacent countries. Thus, the model predicts a strong regional bias in preferential trade agreements.

Do Terms-of-Trade Effects Matter for Trade Agreements? Evidence from WTO Countries

Abstract This paper constructs a two-country model of bilateral trade negotiations in the presence of political uncertainty to demonstrate that unilateral trade liberalization may be an optimal policy for a large country. The political uncertainty is due to producer opposition to trade-agreement ratification in the foreign country. Unilateral liberalization by the home country has a salutary effect on negotiations, because it mitigates the pain of potential ratification failure on the foreign country. It also promotes foreign ratification, because it effectively punishes foreign import-competing producers for lobbying against an agreement. These benefits are shown to outweigh (up to a point) the terms-of-trade cost that the home country must suffer when it actually liberalizes unilaterally. In equilibrium, therefore, we see a pattern in which the home country unilaterally liberalizes for several periods, until ratification in the foreign country succeeds, at which point foreign country finally reciprocates. We also demonstrate that, contrary to the standard optimal tariff result, there may be an inverse relationship between the home countrys monopoly power and its optimal unilateral tariff.

Protection for Free? The Political Economy of U.S. Tariff Suspensions

In the literature on the economics of international trade institutions, a key question is whether or not terms-of-trade effects drive international trade agreements. Recent empirical work addressing terms-of-trade effects has been restricted to non-WTO countries or accession countries, which differ markedly from existing WTO members and account for only a tiny fraction of world trade. This paper investigates whether MFN tariffs set by existing WTO members in the Uruguay round are consistent with the terms-of-trade hypothesis. We present a model of multilateral trade negotia-tions featuring free riding on MFN that leads the resulting tariff schedule to display terms-of-trade effects. Specifically, the model predicts that the level of the importer’s tariff resulting from negotia-tions should be negatively related to the product of exporter concentration, as measured by a Her-findahl-Hirschman index (sum of squared export shares), and the importer’s market power, as measured by the inverse elasticity of export supply, on a product-by-product basis. We test this hy-pothesis using data on tariffs, trade and production across more than 30 WTO countries and find strong support. We estimate that the internalization of terms of trade effects through WTO negotia-tions has lowered the average tariff of these countries by about 20% compared to its non-cooperative level.

Market collusion and the politics of protection

This paper studies the political influence of individual firms on Congressional decisions to suspend tariffs on U.S. imports of intermediate goods. We develop a model in which firms influence the government by transmitting information about the value of protection, via costless messages (cheap-talk) and costly messages (lobbying). We estimate our model using firm-level data on tariff suspension bills and lobbying expenditures from 1999-2006, and find that indeed verbal opposition by import-competing firms, with no lobbying, significantly reduces the probability of a suspension being granted. In addition, lobbying expenditures by proponent and opponent firms sway this probability in opposite directions.