When does coordination for free trade regimes fail?☆

a r t i c l e i n f o JEL classification: F13 F42 F51 Keywords: Trade war out of fear Risk-dominant equilibrium Global game in trade policies Strategic complementarity Trade retaliation strategies This paper examines why the recent efforts to arrange free trade regimes have failed repeatedly focusing on the increased uncertainties in economic fundamentals and the asymmetric political economic characteristics of trading countries reflected in the hawkish trade retaliatory tendencies. We demonstrate that, under infor-mational barriers due to economic uncertainties, a slight negative change in economic fundamentals as well as the signals about the economic fundamentals can lead to the collapse of free trade regimes. Moreover, the fear of a trading partner's deviation to protectionist policies might trigger preemptive protectionist measures resulting in a trade war when trade policies show strategic complementarity. However, a free trade regime is more likely to be sustained when it is commonly known that each country has strong symmetric retaliatory tendencies in case trade friction occurs. Nonetheless, if the asymmetry in retaliatory tendencies of trading countries increases the preemptive incentive, a free trade regime is more likely to collapse to a trade war. After the launch of the WTO in 1995, efforts to make progress in multilateral trade liberalization have been repeatedly thwarted due to continuous deadlock of the Doha Development Agenda (DDA) since negotiations started in 2001. The deadlock in multilateral trade liberalization has been aggravated by the latest advent of the global financial and fiscal crisis and the resulted increased uncertainty in economic fundamentals since the global financial crisis in 2008 and the European fiscal crisis in 2011. The increased uncertainty in economic fundamentals due to the financial and fiscal crisis initiated a vicious circle of protective trade policies and the resulted trade wars within the downgrading economic fundamentals. To mitigate the vicious circle between the worsening economic fundamentals and protectionist trade policies and to avoid the global trade war, a wide range of international efforts have been made to arrange credible enforcement mechanisms for countries involved in trade agreements to prevent their deviation to non-cooperative policies such as protectionist trade policies and non-cooperative devaluation of currencies in the format of G20 for an example. Notwithstanding these global efforts to arrange an international coordination mechanism to prevent the deviation to protectionist trade policies, deviation to non-cooperative policies, as well as the resulting collapse of coordination mechanisms, has often been observed. …