Non-Enforceability of Trade Treaties and the Most-Favored Nation Clause: a Game Theoretic Analysis of Investment Distortions.∗

We model agents’ incentives to invest in production of export goods when governments are commitment constrained with respect to their trade obligations. Once irreversible investments have been undertaken, the governments have incentives to renegotiate the tariff rates to higher values. The renegotiations are costly; the greater the tariff rate adjustment, the greater the expenses. We find that in the presence of government commitment imperfections, bilateral trade agreements can be welfare superior to multilateral ones. With multilateral agreements efficiency loss is two-fold: renegotiation costs are higher, and investment incentives are more distorted.