“Size Inequality, Coordination Externalities and International Trade Agreements”
by Nuno Limão and Kamal Saggi
Abstract
Developing countries now account for a signfi
cant fraction of world trade and two thirds of the membership of the World Trade Organization (WTO). However, many are still individually small and thus have a limited ability to bilaterally extract and enforce trade concessions from larger developed economies even though as a group they would be able to
do so. We show that this coordination externality generates asymmetric outcomes under agreements that rely on bilateral threats of trade retaliation such as the WTO but not under agreements extended to include certain
financial instruments. In particular, we find that an extended agreement generates improvements in global efficiency and equity if it includes the exchange of bonds prior to trading but not if it relies solely on ex-post
fines. Moreover, a combination of bonds and fines generates similar improvements even if small countries are subject to financial constraints that prevent them from posting bonds.
Keywords: trade agreements, tariffs, bonds, fines.
JEL Classi cations: F13, F42, K33, O1, O24
The full article is available as a Vanderbilt Working Paper and already appears on the European Economic Review website. Please also note that we have added it to the topic ‘Reforming the World Trading System to Better Integrate Development Countries‘ on the InsTED site.