What are trade agreements for? - Two conflicting stories told by economists, with a lesson for lawyers

Abstract

Economists tell two stories about the function of trade agreements: trade agreements restrain protectionism, or trade agreements restrain the purposeful exploitation of market power, which I call 'terms-of-trade manipulation'. These stories are distinct, because protectionism and terms-of-trade manipulation are distinct, although they are often confused. Logically, trade agreements might restrain both protectionism and terms-of-trade manipulation, but no one holds this view. Protectionism theorists think terms-of-trade manipulation is rare in the real world; terms-of-trade theorists adopt a theoretical perspective in which they prove protectionism is globally efficient and should not be restrained. I analyse the two stories to dispel common conceptual confusions. I show that the protectionism story is superior, empirically and theoretically: countries do not exploit their market power, and the theoretical perspective of the terms-of-trade story is wrong if our concern is to interpret agreements. I reinterpret a theorem from the terms-of-trade story, and combine it with the fact that countries do not exploit market power, to demonstrate that national regulation that is domestically rational (except for not exploiting market power) is globally efficient and hence should not be restrained. This grounds a novel, efficiency-based argument against 'balancing' by dispute tribunals and in favour of substantial deference to non-protectionist regulation. © Oxford University Press 2006, all rights reserved.