Recurrent Trade Agreements and the Role of External Enforcement

This paper considers the negotiation and enforcement of trade agreements in an environment where countries negotiate repeatedly through time. The idea that countries choose trade policies repeatedly through time has been widely applied in the literature on trade agreements, and has motivated the use of subgame perfect equilibrium as a mechanism for enforcing agreements. We argue that this same logic should be applied to the process whereby countries negotiate their agreements. Since negotiation is ongoing in practice, any bargaining procedure used to select an agreement in an initial period ought to be applied when the agreement is reevaluated in future periods. We show that once this point is recognized, the use of subgame perfect equilibrium as an enforcement mechanism becomes drastically curtailed, and external dispute-settlement institutions come to play a central role in providing incentives to follow through with agreements. ∗Klimenko: Graduate School of International Relations and Pacific Studies, UC San Diego; Ramey: Department of Economics, UC San Diego; Watson: Department of Economics, UC San Diego. E-mail: [email protected]