Dani Rodrik, surrounded by anarcho-sympathizing libertarians at Cato Unbound, thoughtfully discusses the limits of self-enforcing agreements. In response to Peter Leeson’s claim that we don’t see “shriveling international commerce in the absence of supranational commercial law,” Rodrik writes:

It may be objected that the operation of the global economy is proof in itself that a high level of economic activity can be maintained without political institutions… But Leeson is overlooking several things. First, there is in fact a significant global institutional architecture that supports the international economy: globalization would not have reached this far in the absence of the WTO, IMF, World Bank and a host of regional supranational institutions. The global public sector is not non-existent.

Now the World Bank and IMF cannot claim credit for inducing developed countries to liberalize their trade policies, nor do they get much credit for Indian or Chinese policy shifts, so it seems that the bulk of responsibility for the relatively open global trading system would fall upon the WTO. But even those (Subramanian & Wei) claiming that the WTO promotes trade concede that it doesn’t force countries to liberalize, which is why developing countries remain relatively closed and sensitive sectors “did not witness liberalization.” The WTO is not an effective supranational institution if that term means enforcing policies contrary to participants’ wishes.

In fact, a leading theoretical explanation for the WTO is that it is a successful self-enforcing agreement! Bagwell & Staiger:

[T]he optimal unilateral tariff for a national-income maximizing government of a large country is positive. If both governments behave this way and set positive import tariffs, a Prisoners’ Dilemma situation is created. In the Nash equilibrium, tariffs are too high and trade volumes are too low; hence, a trade agreement that facilitates a reciprocal reduction in tariffs could be mutually beneficial…

The terms-of-trade theory is easily generalized to include political considerations, and it may be directly interpreted in the context of the market-access language that trade-policy negotiators use. This theoretical perspective offers a means by which to interpret the rules of GATT/WTO. For instance, it suggests that a government may hesitate to liberalize unilaterally, since it does not want to face the terms-of-trade loss that such behavior would imply…

Likewise, a government would hesitate to liberalize as part of a reciprocal negotiation, if it were concerned that its negotiating partner might later “cheat” and raise its tariff. We argue that the GATT/WTO enforcement provisions can be interpreted in this light…

As there are no GATT/WTO police, agreements between governments achieved through GATT/WTO negotiations must be self-enforcing. Indeed, the rules of GATT/WTO may be interpreted as a codification of supergame strategies.

Rodrik may be right about the limits of self-enforcing agreements in most circumstances, but the liberalization of international trade seems to be a counterexample to his generalization.

[Of course, Rodrik is also writing about the protection of property rights and enforcement of contracts across national borders, which may indeed depend upon states making legal arrangements, but that’s not the role of the IMF, WB, nor WTO.]

A neat idea I first read about in Fair Trade For All apparently has both a longer history and a richer theoretical exposition than I realized.

In 2002, Mexico proposed that the WTO make retaliatory tariff rights tradable, so that countries that would only hurt themsleves by imposing sanctions might still pose a punitive threat to the subject of complaints at the trade body’s dispute settlement mechanism. This sounds like a great idea to me.

Bagwell, Mavroidis & Staiger have an academic paper on the subject: The Case for Auctioning Countermeasures in the WTO. Their result is a bit surprising:

We then consider an extended auction, in which the home country is also allowed to bid to retire the right of retaliation. The extended auction is again characterized by positive externalities between foreign countries. But the extended auction also features negative externalities, since the home country experiences a negative externality whenever a foreign country wins. In the extended auction, we find that auction failure does not occur; in fact, the home country always wins and the retaliation right is therefore always retired.

It’s an odd outcome, but instituting the auction does result in the violator paying compensation, so it sounds better than the status quo. But Bagwell is cautious (pdf) in making a policy recommendation:

[Bagwell, Mavroidis & Staiger] do not claim to answer this question, though, since a system with tradable retaliation rights would generate additional costs and benefits that are not included in their formal analysis. One un-modeled benefit is that the prospect of auction revenue might enable a small and developing country to attract private legal support for WTO legal actions that it would not otherwise be able to afford. Under the heading of un-modeled costs, it is important to
list the possibility that the revenue generated by auctions could result in nuisance cases and excessive use of the WTO dispute settlement system. Another potential cost is that a system of tradable retaliation rights might cause bilateral trade tensions to grow into multilateral tensions. Acrimony across governments could grow, and future negotiations could be undermined…

The costs of a system with tradable retaliation rights could well exceed the benefits. At this stage, I therefore caution against any explicit change in the DSU to accommodate tradable retaliation rights.

True, there are many costs and benefits not examined by a formal auction model, but how does one research the likelihood of nuisance cases or acrimony? I don’t we’re likely to see significant academic progress on whether auctioning countermeasures would be net beneficial, so policymakers ought to start discussing it seriously.

[The general merits of making tort claims transferrable will be familiar to those who have read David Friedman’s Law’s Order.]