717

1.3. Explaining protectionist tendencies

.::s brings us to the task of explaining why the world is as it is; why,
';larent utter ignorance of good sound economic theory, most countries
: -: :o far-or protection rather than unhampered trade: why " an increase in
S.

:i
>-

-rrIe-is a victory, and an increase in imports-no matter how many

releases for other uses-is a defeat" (Krugman 17997, p.114]).

*:.es it

' i::icrt as a Prisotters' Dilemma

-: :u-rssibility is that-like the arguments made for protection in Sec- -:.1.1 and in Chapter L7-some amount of protection for every country
. :=e.1 a "best response": free trade rs not the unilaterally best policy in
r-= ambient second-best world. Of course, such a reaction undoubtedly
- .-:-' l:i tlrcr country: the move to protection in our country reduces trad: : --ssibilities for another. Howevel, the argument does not end there: it
, --',- rhe case that the other country (perhaps for similar reasons) would
: I --' txlpose protection as well, and this hurts our country. The resulting
-:. -lre is r-erv much like a Prisoners' Dilemma [see the Appendix 1 (at the
: -: :he book) on game theory]: if one country "cGoperates" by having a
-:-.rr,'i regime, the other country "defects" by imposing protection. The
. -..-: S equilibrium of the game is where both countries impose protection.
-:: both countries be worse off relatirre to free trade, as in the Pris:.-: Diiemma in which the mutual defection outcome (here read protecr-r

-s ;ominated by the cooperative outcome (read free trade)? They surely

. ::.e negative externalities created by protection outweigh the gains to

: --- -:iitrr- that is doing the protecti.g (see, for example, Staiger t19951).
.: -::er\ ation that the combination of several countries, each rationally en--: I :'I marim tzrrrg its own welfare, can lead to a situation in which all
: >: --.'untries are worse off was first made by Tibor Scitovsky. Scitovsky
-

-. -t-rnjectured somethi^g stronger, which may also be true under

cer---:.-:nlstances: tte optimum degree of protection chosen may vary pos'. -tr the levels of protection chosen by other countries. The
outcome
a situation would look like an escalating tartff war (Scitovsky 11942,

- -, -

: :-

,-.:: :anff rr-alls have been erected all around, those who started the process
.-:.; some of their initial advantage gone; but they are also likely to find that
--=' :::. irnpro\-e their position by raising tariffs further, even if they initially
--: -l= ---r1; use of their monopolistic position. As tariff walls rise, conferences
-:

=-::- t.. al1 concerned.

18.2. Restricted Trade

779

Presence of complete markets), the theorem is only a statement

about

o,erail
gains' In many situations, especially in those
wheie trade stems from significant diffurences in factor endowment, international
exchange brings gains
and losses to different groups. Lr generar,
factors that are used intensivery
in the production of import-competLg goods lose
income, while factors that
yr"d,,il u:sively- in exportables g-ui.. Mo.uorrer, controlling for income
i:._"eftects, all individuals must gain frori
trade as consumers.
Thus the gains from trade must be distributed
if the gains are to
h f:lr.Py all. In principle, this can be aor,e. t raocorrectly
ao", !,,pu,a'p.oar.tio^
possibilities in the aggregate, so the overall
resources u,ruitubt"'to society
must have gone up. This=rneans, in effect,
that the gainers itrr'lun *o*
than the losers' To some clegree, this is rike
comparing apples and oranges:
horr do we compare the inirease in happiness
of o.,J g.orp to the loss of
happiness of another? However, *rere
is'J tiiue more to it than that: there is
actuallt'more purchasing power floating
aroufld than there was before trade.
>ome of that purchasing porarer could
bie transferred from the grir,"., ,o trru
lLr-rs to compensate trreloru., for their loss
relative to the no]trade world,
and the gainers would stiilbe better
off.
Hor'ever, the foregoing statement is a statement
only "in principle.,, I/
s"r-iit and accurate compensation courd
be paid, ,
,ro truau 10.
-oo"'f.o*
:artial trade, even) to free trade wourd ..urt"
improvement
for all. The
e=-phasis is on the r.,,ord ,,if,,: in practice,
".,
compens
be
=.--rlate. the gainers mav be difficult to ideniify, an
t be
.f*p"n-sation *"1, b" an impossibiUtf f* uff
p;;
l_*
:er'ce' rree trade continues to have ambiguous
connotations for welfare. we
a;e in the r'orld of the "second-best,"
in #hi.h t.r*p-sum taxes u.riiru.rrr".,
=:e not possible, and policy analysis in this context is much harder
(see,
:--: erample, Feenstra ind iewis
tor-u model in the context of trade
isstl
-:t -:c..i' Even if it were socially appropriate to ignore ,the distributive
aspects,
='e icrbbies n'ith vested intereits ihat seek to anect the direction ur,a irrte.rsrty
rr.temational
,.:
exchange would not be eliminated.

\orr

let's think about the interest groups that

might form. Consumers

s'''lrelr- gain trom unrestricted imports,

p".ia"r'r." l,:wer."Howerr"., .or,r,r*"r"

group andthey are clifficult to organiz". Cj.

:111t*Sul:ebulous
AL oUr",
rand, specific industries tfrlt are rikely to
be hurt uy #aae *ouitiru ,t urr,-trls {a!-ve]1ea9ity and lobby hardlr for protection.
[1927], foreshadowing th" lut". inhuentiat work

of otson [1965],

.u*Prll"j|,

In order to explain how those who champion

protection make themserves heard

it is necessary to add a consideration that applies

to social movements
generally ' ' ' ' If a certain measure u{
is the case of the loss of one franc to each
so easily,

' Pareto ll9L7, p.

3791, quoted

in Bhagwati [i990].

Chapter 18: Multilateral Approaches to Trade Polian

718

diagram, F"'-'-'
Figure 18.1 illustrates the possibility of a tariff war. In this
or high' Par o-=
countries choose their leveis of protection: none, medium,
a cu-rrr'rePresents
to each country are given in parentheses for each celI that
bination of actions.
respon-ie '- l
Note that when one country chooses n-o protection, the best
proteclc:
of
level
high
not
but
mod.erate
a
the other country is to choose
of pro:''leYel
moderate
a
chooses
country
one
when
This situation changes
ste:---'=
tion: the other then wishes to go even further. The affows sho$'the
-::
econom\-il'-a''
.ature of responses in this example: they lead the w'orld
\\-:-'::in
rcgirne
;' free-tra.r" puyoffs of (100, 100) do*r'r to a high-tartff
Prisoners'Dilem::-:
the
of
logic
=:-offs are (40,+o),yet by thb inexorable
.:.
self-interesi
own
its
iurther
to
- -country is making rational decisions
study a special case of this argument ir. a r--:
tion 1g.3.5, *"

"*plicitly

different context.
:
scitovsky foresaw the ernergence of GATT and its con-ie;;.:: - e
i
interactir
'r'
tance. If free trade were truly the equilibrium in sotr.e
orEa:-j::- - : - - nations, then there would be no need for an international
trade.
as GATT or the world rracle Org anrzatton to oversee
lnterest grouPs
protectionist tendencies can build up in a country despite the fa'-:
Chapter
are overall prod,uction gains to be made in tradi.g, h'r
true ta-<
is
theorem
gains-from-trade
the
served that even when
,

Country A
No

'tr

Tariff

Medlum

Tariff

(3o,eo)

(100,L0o)

High Tariff

-.

aE
cE

{7a,,7o

-J

OE
og

(20,90)

.E

o
F

(80,30)

(4o,,1o)

.C,

.9)

Figure L8.1. Reggar-thy-neighbor tariff escalntiorts.

720

Chapter 1g: Multilateral Approaches

to Trade policy

of a thousand persons, and of a thousand

franc gain to one individuar, the latter
expend a great deal of energy, whereas
the iormer *itt ."rirr**.y,
urra it
is likely that' in the end, the person
who is attempting to secure the thousand
francs via u{ will be successful.
A protectionist measure provides large
benefits to a small number of people,
and causes a very great number of
cons-umers a slight loss. This circumstance
makes it easier to put a protection
measure into practice.

will

Affecled groups wilr invariabry lobby

government to

further their own

interests'a The government may
r.qri"r.L iy offering them an implicit subsidy in one f.rm or another. tnihe
contex, ril"r"."r,'1;;#";j.ups
that
are likely to be hurt by international
trade often demand this sub-sidy in
the
form of a protective tariff or a quota
10r, i, u variant of mo,le recent vintage,
they

might demand that other countries toughen

their labor raws or enr.i_
ronmental standards before they are
allowed to export, _ir.n-rrlrra u pr""
for protection dressed up in ethically
pleasing
pronouncements).

At this point we run into u p.oUi"_. fie'pareto_Olson-r-rir.rr".r,

."r_
tainly tells us why diffuse gtorp, (such
as consumers) with relativelv lorr
might not touuy very hard for free traje,

l-Tr,5r:lpita
mlssrng: we cann

tr

from thi
ns.

why

but,il;;'j,*p

,i:"IiXi;::{,,X,li|,i

the dir"ection or
oPen up new ma
d, gover
as those
tfr"i"it"J
states have actually courted.(dom"estic)
"f
export.interests in an attempt
to gar_
ner countervailing force against the
protectionist camp, and it can f,e argued
that in many countries (such as Ko.ea
,"J jrpr";, export interests ha'e been
actively promoted. Nevertheress, history
i"ti, ,, that the most successfui
trade lobbies are protectionist, which
is an interesting bias that is certaini'
not explained by pareto,s observations.

il

., .Rod.rl- [1995] pointed out that there is littre in the economics literature
that actually explores this bias.
\4ost moders
urrr^" tnut p.oi".tio.,i.t
groups are the robbyists or yield predictions"i,h",
that suggest *,ut'"*po.t,.rtsidies are just as likely (a priori) as
tariffs. one possibility is that potentlar
exPorters may be just as diffuse a group
as consumers. onty after a market
is opened abroad or an export suusiayis
offered will exporters ,,come intt

being": existing producers will be joined

by new ones. so export interests
form more of a potential
than a n actuai group, and many would_be
er._
porters may be engaged,group
in other occupationsl Thus it mry ue *r.r,
r,o.a",
to organize an export robby. In contiast, the

"import .o*p"t"rr;

ulrea.i..,

r In the
theory of internatio,al trade, these considerations
ha'e been emphasized in the r.,o:_i :
writers such as Krueger l7974l,Bhagwati
frSS,, irSii,;;stra
and Bhagwati [1982], Findtar .::-:
wellisz [1984]' Maver [1984r, Hillman
w8r,.#a;;;'',.^oli,'un.r young [1e8e], ancr Grossman

Helpman [1994].

..-.

18.2. Restricted

exist; they
them.s

Trnde

721

will protect their interests fiercely and even

seek

to

advance

This sort of reasoning does not completely

solve the puzzle, but does
push it back one step further. The foregoirrg
argument

ass

urnesthat the sta-

svmmetric, tariffs may represent a

sidies, because tariffs bring in add

export

subsidy

policies may have an

are interestins specu-

lt

,*T"I,ilH:
Our broad
policv may be
that r+.ould

is that much of protectionist

ell-org anized interest groups

be

trade.

coordination game

ltffj i:X::1T::l"Yltt

sive in to interest groups that lobby

ti;;;;;;;;

ents .i
not to
fo give
oirrp in
in ln
rf not
",
to *hni-:*r^.-^^r
their urterest groups,
this
will increas"
elT[nent
rrunent ln
in clttesfinn
n^+ t^
J^ so
A r ,I
queshon not
^irr^ ^-- At
^A either.
to do
the same
.

tl"

world

p.;r;;

;i"

time, the observa-

over are cavi.s in to political lobbies will

I?: it]i:illlteasler tor any one
government

to do th" ,u-o
hat rs at stake here is a gqme as well,
but a rrlore complicated one. It
lme in H'hich goverrunents interact through
their trade policies, but in
ocess they interact with lobbyists as
well. B".rrse the ,rilr. of being a
; government might depend on how malry
other strong governments
lre' this suggests a view of the world ,r u
coordination game: an offer
I trade may be met by u correspondingry
open response, but in which
:ctr'e attitude might spark off a simitlr'reaction.
ontrast the preceditg argument with
our earlier view of trade inter1 as a Frisoners' Dilemma. Accordi.g
to that view free trade is not a
shot) equilibrium of the interactive "Ia*" "
played across countries. In
rrrent view, free trade rs an equilibrium,
bui constantly subject to the
aspect of this ,,status qu

is not known just which

ercisgs at the end of this
, tariff revenues in the United States provided
)ms countries in which income taxes
contribu,"
ruch the same situation today, and
customs duties serve as an irresistible
source of revenue.

l.l*::i;].T:i*'r1i;?:?::j*:"**l:

722

Chnpter 78: Multilnteral Appronches to Trntie

danger that there are other equilibria as r,vell. We came 'across this sort
interaction before in an entirely different context (see Chapter 5 as v*,ell
Appendix 1 at the end of the book).
Figure 78.2, which is analogous to Figure 18.7, describes another r-,u-.trative exarnple with exactly the same strategies as before (no, mode:i:.
and high tariffs). As we've already noted, the interaction of this.secfi.-:.
-:
more complex and a rePresentation of it as a game piaved bet.,.r-eer, :-,.. :
governments is simplistic; nevertheless some relevant aspects of the sl:-.=tion are communicated. The nttmbers in the matrix of Figure 1E.l repres:..
the government's own "direct" puyoffs from any particular corlfigurairlr have chosen the numbers to deliberateiy negate the Prisoners' Diler:^,::la
=,fect stuqlied earlier. With only these payoffs to worry about, free traeie ::=
-.
only equilibrium.
Now look at the algebraic nurnbers (A, A'),(8,B,),and (c, c r T:.=s= rr:
additional payoffs accruing to the governrnent from listenine tc -:s:: -=-tive lobbies. Payoffs A and A'result when the other go\/einrr,.en: -r i;:::---to free trade. If these payoffs are small sin'rply beciuse the E,r,,er;1-:r. :
dealing in an overall atnnosphere of free trade and therefpre ;in;= -: .r:-:-.:rassing or inconvenient to respond to lobbies, then the best resrt-r_.= :_ n::
trade is free trade as i,vell. The numbers ts and B'are goinr rr- :,= -:::=_with the other governrnent imposing moderate trade reslraints -: -.=: - :-:":
more "acceptable" for our government to feed our lobbies as ir-ell -1::-:
if the government's desire to rnaintain some international paritr- is i:r--::
Country A
No

Tariff

Medium

Tariff

High Tariff

.C

(100,100)

(50, 8o+41

(30,5o+n1

zo

O'E

hE

trE

=f,
oE
()o

(EO+4, 59;

(4O+3,4O+37 (25+c,3o+B')

.E

tc

(50+.4',30)

(30+6', ZJ+c) (20.16',3O+C)

.9

Figure 18.2. Interest groups: protection as a coordination

game.

18.2. Restricted Trade

then B (the payoff corresPonding to a rnoderate response) is high whereas

B,
(the payoff corresPonding to the "hawk response") still may be low. Finally,

if the other government is highly protective, then the internal demands for
protection may be very strong and so may be the government's willingness
to accede to them, so that C' is high. You easily can see that this gives rise
to the possibility of three equilibria, in r,vhich the international community
behaves in quite different ways. If there are a large number of countries involved (instead of just 'two), it may be difficult to negotiate one's way out of
the low-cooperation "equilibrium traps.',
In the next section, I am going to argue that these two views go well rvith
the notion of GATT, both as a device for coordination as well as an attempt
to maintain cooPerative outcomes by rneans of appropriate punishments.
The role of a multilateral organization
There is very little a multilateral organization such as GATT or the World
Trade Organization can do except to create and to rnaintain the incentives
for freer trade across countries. In particular, the international legal structure of these matters is highly problernatic. It is difficult to see, for instance,
how countries or grouPs of countries can be stopped from pursuing policies in their own self-interest, at least up to a point. International policing
can perhaps stop one country from wreaking unprovoked yzar upon another
through the use of punitive economic sanctions or military action, but we
know that even such gross violations go unpunished unless (i) the countries
involved are small relative to the superpowers and (ii) it is in the interest of
other countries to punish the deviant (lamentably often, it is not).
Thus it is best to see multilateralism as a way to clarify a method of
international negotiation by setti.g down procedures that (a) assist in coordination of policies across countries, (b) provide for some limited (incentivecomPatible) sanctions in the event of a deviation frorn the agreed-upon policy, and (c) increase the visibility of a potential deviant by miking deviations
transparent (in the light of the existing procedures).
Consider the view of protection as a Prisoners' Dilemma. In Appendix 1
(at the end of the book), we see how it is possible to sustain the cooperative outcome as the equilibrium of a repeated interaction. The idea is very
simple: countries may agree to honor free trade as long as other countries
in' the agreement do so. Of course , dt each stage of this ugr."*ent there are
incentives to deviate by imposing protection (because we assumed that the
situation is one of a Prisoners' Dilemma). Hor,vever, deviations will be met
by suitable punishments in later periods. The fear of these punishments may
be strong enough to maintain cooperation, provided that the countries are
farsighted enough.

to Trade Poliry
Chn|lter 18: Mtiltilnternl Approaches

724

gtrraranand others observed' the best

Thus, as Dam [1970], Staiger l1g95l'
to
adherence
consrder
that all parties
tee that an agreemen, *ifiil"i.""redls
jails
are
and
courts
because
interest' This ii
the agreement to be t" in"it "*"
situation' In particular' GATT must
i"1"*utional
itt'u'"t
of limited relevance

indeedinclude,.'a".,'u.u."thenotionofretaliation:,,...retaliation,subiect
bounds' is made the
to establishea p.ot"a'i* uttJ rcpt'within^glescribed
p' 81])'
tr"uit of the GATT system" (Dam [1970' hard to run' The ultimate obiective
This double-"ag"a iy;t"[t'"L" ""'y
to this
retariations.and fights are antithetical
is to work toward tr"" iiua"^ so
de
be n
may
tit-lt\:""1'ationithere
idea, but without the pttttitittylCeTt
to
procedu

dispute settlement
at all. As Staiger poittt"Jo't'
ral
/entilr
role of retaliatbry threats
acknowledge tt't"
to
aversion
an
""""tiui
-tht";;iobut at the same tim
deviations from the "g;;;""it
of
15011)'
p'
5'
out" (Staiger t
u"
actually allowing th"':'
-*tti"a
Worid Tiacte Organization will
new
the
that
course, this is a *ulot *nt"tn
have to cope with'- ..
(as in Figure
nnr hpsr res,onse
response aqainst free trade
When ]ree trade is not a best
t"u'ot' The entire list of'conihis
multilaterat systems can fail for

""'i
of a retaliaiorv tariff' or an antidumping

18.1),

tingencies ,.ta"t *niln'tt'"-t""

Thus the
almost impossible to enumerate'
orocedure, or a punltive duty is
to serve
coopted
aggressivelv and unilaterallv
fighting
'":::t #,1;.;il;;;;;;
for
not
and
agenda
as instrument, ft' t;;;'J;;Tp*""i:nist
growth
rapid
the
on
rem"arked
arready
deviations f.om f.""-ilJ". w"'n"i"
the creXXrV
Argicle
under
cerr p"t^itted
of NTBs worldwide' ;'*l;;t
not have
in h"''"ttt" that such zones did the
t'""-t*J"
regional
ation of
counat
'ones'
to lower protection "g;;;; r'-J".n".nu"tt,:t9" 'o^"'
thernselves'
eliminate trad'e barr
tries in question "suistantially"
the books' a lot can be done with
But once a word lik"j:il;;'{ttji7;;;
of trade barriers is open: the
it. Moreover, the time pJoa to' "1i'nination
oi t*r"r" regional arrangements-has
European Union-th'J ,#;il;rr';i
often accomPaThese regional aqreements are
been at it now fot tq'iv years'
the"rest of the world' we return

nied by high tariff (eiiiffii#;;;;li'1;

to tH"t:fflXl;:hope,
trade as
view of
then, that in-the long run the
-freeto be the
out
turns
Dilemma
as a Prisoneri
a coordination gurn! utta not

can surely make it so' As Bhagwalill993'

right one. Enlightened govemment
known
Will

U*t"Jitites

Trade Representative

eg'""*"*l to Es-vPt
"would
i;;j;;;;;;J; ti;i;"J"
h
tt'*ttlt' indeed' he

o. 45'l writes,

one to

t to the
Istael) and to the 'tsiertl
in
government
a
with
been dis"o""'"d there
moon and Mars if only life had
agreeplace to negotiate

*lti-''" ntott's willingness to negotiate

a free trade

menttour,ygo""**"''ttl"t"'"'t"ainta'lkingabout"itsuSEestssomebaseline
go""*^="ts *"t" committed
that
commitment to free trade provided

otli"'

78.3. lssues in Trade Liberalization

725

to it as well. I have used the resulting increase in any one government's

ability to deal with domestic political pressure as only one .**ple of how
a coordination game can be generated; there are cle arly others. An international system along the lines of GATT can help as well. It is likely that an
explicit setting-out of procedure-the creation of a transparent system that's
somehow perceived to be irnpartial-generates in governments an additional
sense of obligation: a need to honor arrangements made in this way.7

78.3. /ssues in trade liberalization

78.3.1. Introduction
So fat, we have studied the possible causes of a fractured world. tradsystem. We have argued that-Adam Smith, David Ricardo, and ]ohn
Stuart MiIl notwithstanding-the world is riddled with pressures for protection. Although some of these pressures may be justified in the context of
market failures elsewhere (and we do not deny the importance of these considerations), other forces stem from well-or ganLzed interest groups that seek
protection as a means to further their own economic interest, and that do
more harm than good to society as a whole.
The GATT measures have fostered, or at least enable d, a surge in multiiateral tariff reductions o\rer the last five decades. Welve also noted that
such reductions have begn accompanied by u proliferation of various NTBs:
"special" cases that have become the rule rather than the exception and have
slowed down or stalled the move to free trade. But one feature that stands
out is the .mushrooming of free-trade arrangements in regions all around the
world. There are examples of such arrangements within clusters of developed
countries (north-north), clusters of developing countries (south-south), ind
across developed and developing countries (north-south).
This move toward regionalism has been encour aged,, in a sense, by the
principle of multilateralism enshrined in the GATT charter: the most-favorednation (MFN) principle, which declares that trade concessions made to any
country must be automatically extended to all other member countrieS as
well.s However, many countrils that wish to sign preferential arrangements
with one another, perhaps as much for political as for economic reasons,
do not wish to see such arrangements automatically extended to all other
countries by virtue of the MFN clause. So it whs that Article XXIV of GATT
was used, and repeatedly so: MFN need not be observed if some subset of

irg

See Jackson [1989], Hudec lTgg}), Kovenock and

Thursby llgg1), and Staiger [1995].

origins of the MFN principle to the Anglo-French commercial treaty
of 1860, in which Britain adopted the position of making its tariff reduitions to France availadle to
all her trading partners. France adopted a weaker version of this principle, and there were favorable
echo effects throughout Europe until World War I put an end to all that in 1914.
8Irwin

11993) traced back the