Essays on Uncertainty and Escape in Trade Agreements

Abstract: This thesis comprises three theoretical essays on trade agreements."Can Self-Destructive Trade Agreements Be Optimal?" focuses on the impact of hidden information on strategic interaction in the context of trade agreements. In an infinitely repeated tariff setting game between two symmetric countries, informational asymmetry is introduced by letting the weight a government attributes to present vis-à-vis future payoffs be stochastically determined and non-observable to the trading partner. It is demonstrated that countries may face a tradeoff, when higher degrees of liberalization are associated with decreasing probabilities of cooperation being maintained. It may nevertheless be optimal to agree on a degree of liberalization such that there is a strictly positive likelihood of cooperation breaking down in finite time."Escape and Optimal Compensation in Trade Agreements" addresses the issue of safeguard provisions in trade agreements. In an infinitely repeated Prisoner's Dilemma tariff setting game between two countries, shocks influencing the incentive to deviate are introduced. Under asymmetric information about these shocks, liberalization is associated with a positive probability of cooperation breaking down in finite time. By introducing an escape clause allowing for temporary deviation while compensating the trading partner, cooperation can be sustained for any degree of trade liberalization. If the optimal fixed compensation cost scheme is implemented, the expected per-period payoff increases for any given degree of liberalization. Moreover, the scope for liberalization unambiguously increases as compared to the case when there is no escape clause."Optimal Time Limits on Safeguards in Trade Agreements" addresses the issue of having time limits on how long countries should be permitted to withdraw liberalization commitments under a trade agreement. It is shown that, by limiting the time the safeguard can be applied, the interests of winners and losers from liberalization are balanced across countries. However, an ex ante agreed-upon finite time limit on the use of the safeguard will eventually be perceived as too restrictive.