Trade Bargaining & Enforcement International Political Economy Prof. Tyson Roberts 1.

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Trade Bargaining & Enforcement

International Political EconomyProf. Tyson Roberts

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Puzzle

• Comparative advantage: free trade good for all nations, in aggregate

• Then why do governments pursue protectionist policies?

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Some possible answers

• Government leaders have “Wrong ideas” and believe protectionism helps– Mercantilism, etc.

• Protectionism may hurt in short-run but help in long-run (Lecture 8)

• Government leaders concerned more about losers from trade than winners from trade (Today and Lectures 6-7)

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Review of Comparative Advantage

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The basic Ricardo model

• Two countries• Two products• One factor of production (e.g., labor)

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Home

• 1200 labor units• 30 labor units to make iPods– Can produce up to 40 iPods

• 5 labor units to make pair of running shoes– Can produce up to 240 pairs of shoes

• Opportunity cost ≈ Price– “Price” of 1 iPod is 6 pairs of shoes– “Price” of 1 pair shoes is 1/6 iPod

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Production possibility frontierHome

Shoes 240

40

iPods Slope = -1/6

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Foreign

• 720 labor units• 12 labor units to make iPods– Can produce up to 60 iPods

• 4 labor units to make pair of running shoes– Can produce up to 180 pairs of shoes

• Opportunity cost ≈ Price– “Price” of 1 iPod is 3 pairs of shoes (12 hours/4 hours)– “Price” of 1 pair of shoes is 1/3 iPod (4 hours/12 hours)

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Production possibility frontierFrontier

Shoes 180

iPods

60

Slope = -1/3

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Another example

• Now assume that demand curves in Home & Foreign are such that the international price of shoes per iPod is 5 (and price of iPods per shoes is 1/5)

• What is the new PPF for Home and Frontier after trade?

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Production possibility frontier: Home with trade

Home can make 240 shoes and buy 240/5 = 48 iPods

Shoes 240

40

iPods

48

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Production possibility frontier: Foreign with trade

Foreign can make 60 iPods and buy 60 x 5 = 300 pairs shoes

Shoes 180

iPods

60

300

BUT Home cannot make 300 shoes!

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Home can only make 240 pairs shoes

Shoes 240

40

iPods

48

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Production possibility frontier: Foreign with tradeSo Foreign can make 48 iPods and trade for 48 x 5 = 240 Shoes

Then Foreign can take the remaining 720 – (48 x 12) = 144hours and make 144/4 = 36 Shoes

Shoes 180

iPods

60

300

Foreign can buy 240 Shoes and make 36 ShoesTotal possible shoes = 276

240 276

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Return to the Price = iPod for 4 shoes scenarioHome can trade 240 shoes for 60 iPods

Shoes 240

40

iPods

60

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Foreign can trade 60 iPods for 240 shoes

Shoes 180

iPods

60

240

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If International Price = 4 shoes/iPod

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

60 iPodsForeign:

240 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

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If International Price = 4 shoes/iPod

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

60 iPodsForeign:

240 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal? Offer, Offer

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Some Game Theory Terminology

• Pareto Improvement: At least one player is better off and no players are worse off

• Pareto Efficient/Optimal: No Pareto Improvements available

• Pareto Inefficient/Sub-Optimal: Pareto Improvements are available

Trade enables Pareto Improvements for Pareto Sub-Optimal Situations

Vilfredo Pareto

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If International Price = 4 shoes/iPod

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

60 iPodsForeign:

240 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal? Offer, OfferIs this a Nash Equilibrium?

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Solving simultaneous games in game theory

• Left actor chooses row, top actor chooses column

• Payoff for left actor is on left, payoff for top actor is on right of each cell

• Actors get payoff from cell determined by joint choices

• Simultaneous: Each actor does not know what other actor will choose

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Nash Equilibrium

• No player has anything to gain by changing his own strategy unilaterally

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Best Home strategy if Foreign offers?

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

60 iPodsForeign:

180 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

What are the equilbria?

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Best Home strategy if Foreign offers?Offer

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

60 iPodsForeign:

180 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

What are the equilbria?

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Best Home strategy if doesn’t offer?

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

70 iPodsForeign:

180 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

What are the equilbria?

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Best Home strategy if doesn’t offer?Offer or Consume

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

70 iPodsForeign:

180 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

What are the equilbria?

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Best Foreign strategy if Home offers?

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

70 iPodsForeign:

240 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

What are the equilbria?

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Best Foreign strategy if Home offers?Offer

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

70 iPodsForeign:

240 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

What are the equilbria?

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Best Foreign strategy if Home offers?

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

70 iPodsForeign:

180 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

What are the equilbria?

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Best Foreign strategy if Home offers?Offer or consume

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

70 iPodsForeign:

180 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

Which outcomes are Pareto optimal?

What are the equilbria?

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Nash Equilibrium: No player has anything to gain by changing his own strategy unilaterally

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

60 iPodsForeign:

240 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

What are the equilbria if international price = 4 shoes/iPod?ANSWER: (1) Offer, Offer(2) Consume, Consume

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If Price is outside the range of 3 and 6 shoes per iPod (e.g., 8 shoes per iPod), no trade will occur

Foreign

Offer iPods for shoes Consume own shoesHome Offer shoes for

iPodsHome:

30 iPodsForeign:

480 shoesHome:

40 iPodsForeign:

180 shoes

Consume own iPods

Home:40 iPods

Foreign:180 shoes

Home:40 iPods

Foreign:180 shoes

What are the equilbria if international price = 8 shoes/iPod?ANSWER: (1) Consume, Consume

But there is an opportunity for Pareto improvementsForeign can offer a lower price for iPods than 6 shoes

Starting endowment

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Summary

• Comparative advantage enables mutual gains from trade

• If no mutual gains are available, countries will not trade

• Therefore, trade is always Pareto efficient– Assumes voluntary, fully informed decisions– Ignores long-term effects, externalities, etc.

• Prices will adjust until no Pareto improvements are available (invisible hand)

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If Robinson lives alone, he does everything himself

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If a second person arrives, one can specialize in coconuts and the other can specialize in fish,

and they can benefit from trade

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If each actor is “fully informed,” trade results in a Pareto Improvement

Friday

Don’t trade Trade

RobinsonDon’t trade 0, 0 0, 0

Trade 0, 0 1, 1

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However, each actor may have an incentive to cheat

Friday

Cheat Stay true

RobinsonCheat 0, 0 2, -2

Stay true -2, 2 1, 1

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Cheat, Cheat is the Nash EquilibriumStay true, Stay true would be Pareto Improvement

Friday

Cheat Stay true

RobinsonCheat 0, 0 2, -2

Stay true -2, 2 1, 1

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Institutions to prevent cheating

1. Long-term relationships based on reciprocity and trust

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What is/are the Nash Equilibrium/a?

Friday

Cheat

Stay true first trade;Cease trading if cheated

RobinsonCheat 0, 0 2, -2

Stay true first trade;Cease trading if cheated

-2, 2 1+1+1+…, 1+1+1+…

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The prospect of repeated interactions converts cooperation into a Nash Equilibrium

(But Cheat, Cheat also remains a Nash Equilibrium!)

Friday

Cheat

Stay true first trade;Cease trading if cheated

RobinsonCheat 0, 0 2, -2

Stay true first trade;Cease trading if cheated

-2, 2 1+1+1+…, 1+1+1+…

Which Nash Equilibrium is Pareto Efficient?

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The prospect of repeated interactions converts cooperation into a Nash Equilibrium

(But Cheat, Cheat also remains a Nash Equilibrium!)

Friday

Cheat

Stay true first trade;Cease trading if cheated

RobinsonCheat 0, 0 2, -2

Stay true first trade;Cease trading if cheated

-2, 2 1+1+1+…, 1+1+1+…

Which Nash Equilibrium is Pareto Efficient? Stay true, Stay true

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If the coconut seller gets a bad fish, he knows who sold it to him. He can refuse to trade again

until he is compensated

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As the distance and complexity of trade increases, potential for trade benefits increase,

but cheating is more difficult to monitor

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Necessary conditions for cooperation

• Repeated interaction• Reciprocity strategy (e.g., tit-for-tat)– If you cheat me today, I will cheat you tomorrow– You might get 2 today, but you’ll get 0 every day

after that

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Necessary conditions for cooperation

• Repeated interaction• Reciprocity strategy (e.g., tit-for-tat)• Sufficient value of future payoffs– If value of future payoffs is too low, then cheat will

remain the dominant strategy

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What is/are the Nash Equilibrium/a?

Friday

Cheat

Stay true first trade;Cease trading if cheated

RobinsonCheat 0, 0 2, -2

Stay true first trade;Cease trading if cheated

-2, 2 1+1/10 + 1/100…, 1+1/10 + 1/100…

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What is/are the Nash Equilibrium/a?Cheat, Cheat

Friday

Cheat

Stay true first trade;Cease trading if cheated

RobinsonCheat 0, 0 2, -2

Stay true first trade;Cease trading if cheated

-2, 2 1+1/10 + 1/100…, 1+1/10 + 1/100…

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Necessary conditions for cooperation

• Repeated interaction• Reciprocity strategy (e.g., tit-for-tat)• Sufficient value of future payoffs

• These conditions can but do not necessarily lead to cooperation– Cheat, cheat is still a Nash Equilibrium

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Doha Example

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Factor Endowments & Comparative Advantage

• Europe: High endowments of capital vs. land• G20: High endowments of land vs. capital• Food is land intensive• Manufactured goods are capital intensive• Europe: comparative advantage in

manufactures• G20: comparative advantage in agriculture

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Comparative advantage and policy preferences

• Each country prefers to – Protect products with comparative disadvantage

(high tariff), and – Liberalize products with comparative advantage

(low tariff)

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Starting point (Status Quo policy) for Doha Round

• High tariffs on agricultural goods in developed countries – Rice in Japan, sugar in US, wheat in Europe, etc.

• Relatively high tariffs on manufactured goods in developing countries

• Non-tariff barriers– Subsidies, barriers to investment, etc.

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The EU ideal point is high tariffs in their market for agriculture

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The EU ideal point is High tariffs in their market for agricultureAnd Low tariffs for the G-20 Goods Market

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The G-20 ideal point is Low tariffs in the EU market for agriculture

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The G-20 ideal point is Low tariffs in the EU market for agricultureAnd High tariffs for their own Goods Market

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Each country would have a higher utility if they could negotiate a policy that is closer to their ideal point than the existing Status Quo policy

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Lower US/EU tariffs on Ag benefits G-20 (but harms US/EU interests)Lower G-20 tariffs on Manu benefits US/EU (but harms G-20 interests)

Each resists unilateral liberalization, but can benefit from joint liberalization

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G20

Liberalize (manu) Protect (manu)

EULiberalize (agr) 5, 5 -10, 10

Protect (agr) 10, -10 -5, -5

What is the Nash Equilibrium?

Is it Pareto Efficient?

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G20

Liberalize (manu) Protect (manu)

EULiberalize (agr) 5, 5 -10, 10

Protect (agr) 10, -10 -5, -5

What is the Nash Equilibrium? Protect, Protect

Is it Pareto Efficient? No

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Institutions to prevent cheating

1. Long-term relationships based on reciprocity and trust– Works best in smaller groups because of

repeated interactions

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Methods to achieve cooperation in Prisoners’ Dilemma

• Cooperation – Repeated interaction– Reciprocity strategy (e.g., tit-for-tat)– Sufficient value of future payoffs

• Belief system/ideology• Third-party enforcer– Imperial powers can play this role, but nation-states are

(officially) sovereign

Treaties such as GATT/WTO help with first 2 criteria of cooperation.

International Decision-Making Rules

• Anarchic– Unilateral or negotiated decisions based on self interest and power. – Lack of cooperation => War

• Hegemonic Institution(s)– Hegemon’s law backed by power (empire, gunboats)

• Multilateral Institution (official)– Majoritarian– Weighted voting– Consensus

• Multilateral institution (unofficial)– Invisible weighting/ informal agenda setting

Scope of GATT

• Trade in most manufactured goods liberalized quickly– Exceptions: Clothes, textiles, some cars, etc.

• Services & agriculture initially left alone• Focus on tariffs and trade quota• Developing countries given waivers or extra

time to comply• GATT had weak enforcement teeth

GATT decision making rules

• Officially: majoritarian• Unofficially: Informal consensus– Launching rounds: law-based bargaining– Closing rounds: increased power-based bargaining

Sources of bargaining power

• Patience– Willingness to live with status quo

• Outside option – Related to market size (US can produce for self) &

international relations• Agenda setting – Access to “Green Room”

• Ability to act collectively– OECD, G-20

Organized Hypocrisy

Consensus in the GATT/WTO• Naked power available as

alternative• Consensus rules provide

legitimacy and information gathering to powerful nations – stable, low cost method to achieve goals

• Some votes bought with pay-offs• Weaker nations unlikely to

protest openly if hypocrisy not too blatant

Multiparty elections in authoritarian regimes

• Naked power available as alternative

• Multiparty elections provide legitimacy & information gathering to ruling elites – stable, low cost method to achieve goals

• Some votes bought with pay-offs• Opposition unlikely to protest

openly if hypocrisy not too blatant

Bargaining in the Shadow of Law or Power(Steinberg 2002)

The Tokyo Round (1973-79) closed with law-based bargaining• LDC’s outside option: Trade with Soviet Bloc• Result: Exceptions for LDCsUruguay Round (1986-94) closed with power-based bargaining• No outside option for LDCs• Result – uniform rules in WTO

Scope of WTO

• Liberalization of all goods (including textiles & agriculture) and services

• Rules extended to subsidies, intellectual property, investment, regulations & standards

• All members (including developing countries) bound to comply

• Enforcement teeth: appellate court to decide disputes – authorizes dispute winner to retaliate

Cotton Wars

• Does the cotton dispute indicate law-based or power-based decision making?

• Does the cotton dispute indicate that international regimes change outcomes?

• How do sub-national interest group politics play a role in determining the outcome?

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GATT/WTO Benefits – WorldwideTrade & GDP per capita growth

Source: PWT for countries w/1950 data only; not sure about Maddison

BW Post-BW

GATT/WTO Benefits - Distribution

• International: – According to some studies, developed countries

benefited more from WTO (Uruguay Round) than developing countries

– According to some studies, some developing countries are net losers from WTO (diminished development policy space)

– Other developing countries are winners, e.g. China and India

GATT/WTO Benefits - Distribution

• Intranational:– Trade integration has contributed to income

inequality in the US (but technological change likely played a larger role)

– Inequality has also increased in China and India– Low-skilled workers in labor-intensive

manufacturing sectors were first losers in US; higher skilled workers in services may follow

Takeaways

• All countries can benefit from free trade• Within countries, there are winners and losers• Domestically, potential losers from free trade (e.g.,

producers) can solve collective action problem, which enables successful lobbying

• Institutions such as WTO facilitate cooperation for mutual benefit (at the country level)

• WTO increases role of law, but power still plays a role (e.g., availability of outside options)– Some countries may be net losers from WTO