On Subsidies in Trade Agreements∗

The role of production subsidies in trade agreements has long been neglected by trade economists. To fill this gap, Bagwell and Staiger (2006) analyze this issue and show that, quite generally, the sole variable efficient trade agreements need to address is market access and that, moreover, the de facto prohibition of subsidies by prevailing WTO legislation is inefficient. The present paper shows that their argument fails when trade agreements are required to be self-enforceable. Under the self-enforcement constraint, welfare-maximizing trade agreements entail subsidy rules. Moreover, in a scenario argued to be the most realistic one, production subsidies are prohibited by the efficient trade agreement. Any trade agreement that addresses market access only is necessarily inefficient. In this sense, the paper makes a strong case for the WTO subsidy rules.