A Firm Delocation Theory of WTO Subsidy Rules

I construct a theory of trade agreements in which nations negotiate over both domestic policies and trade policies in a monopolistically competitve setting. My theory contributes to two trade policy questions: …rst, what problems do trade agreements solve? Second, what explains the evolution of domestic subsidy rules between the GATT and the WTO? I show that trade agreements must solve a …rm-delocation problem –a prisoners’dilemma arising when nations use domestic subsidies to attract …rm entry within their borders. This problem persists even when nations have both import and export policies at their disposal. GATT nonviolation complaints, designed to prevent domestic policies that undermine market access commitments, do not support e¢ cient agreements when countries have su¢ ciently strong political economic motivations. This ine¢ ciency leaves a role for additional remedies against subsidies, such as countervailing duties and WTO disputes forcing removal of "trade-distorting" subsidies. Address: 527 W 121st St. #31, New York, N.Y. 10027, USA, telephone: 617-835-8358, e-mail: [email protected]. The author is grateful to Kyle Bagwell, Donald Davis, and Jonathan Vogel for advice and suggestions and to participants at the 2009 Congress of the European Economic Association and the Columbia International Trade Colloquium for helpful comments.