Global COE Hi-Stat Discussion Paper Series 159

Research Unit for Statisticaland Empirical Analysis in Social Sciences (Hi-Stat)

Unilateral Tariff Liberalisation

Hi-Stat Discussion Paper

Richard Baldwin

January 2011

Hi-Stat
Institute of Economic Research
Hitotsubashi University
2-1 Naka, Kunitatchi Tokyo, 186-8601 Japan
http://gcoe.ier.hit-u.ac.jp

Unilateral tariff liberalisation 1
Richard Baldwin
Graduate Institute, Geneva
19 November 2010
Abstract

Unilateral tariff liberalisation by developing nations is pervasive but our understanding of itis shallow. This paper strives to partly redress this lacuna on the theory side by introducing
three novel political economy mechanisms with particular emphasis is on the role ofproduction unbundling. One mechanism studies how lowering frictional barriers to imported
parts can destroy the correlation of interests between parts producers and their downstream
customers. A second mechanism studies how Kojima’s pro-trade FDI raises the political
economy cost of maintaining high upstream barriers. The third works via a generalequilibrium channel whereby developing country’s participation in the supply chains ofadvanced-nation industries undermines their own competitiveness in final goods, thus making
final good protection more politically costly. In essence, developing nations’ pursuit of theexport-processing industrialisation undermines their infant-industry industrialisation
strategies.
Keywords: Unilateral tariff liberalisation, race-to-the-bottom, political economy
JEL Codes:F1, F13, F15

1This paper was written for a special issue of The International Economy (the journal of the Japan Society ofInternational Economics) in tribute to the late Professor Kiyoshi Kojima. As a great admirer of Professor
Kojima’s work and wisdom, I was honoured to be asked to help commemorate his life’s work with thiscontribution. I would like to thank Caroline Freund, Paola Conconi, Bernard Hoekman, Pierre-Louis Vezina,
Yose Damui, Emanuel Ornelas, an anonymous referee, and Special Issue editor Professor Ruyhei Wakasugi for
helpful comments and suggestions that greatly improved the paper.

0Unilateral tariff liberalisation
Richard Baldwin
Graduate Institute, Geneva
4 December 2010

1.

INTRODUCTION

Trade liberalization for much of the second half of the 20th century was difficult (Zeiler 1997).
It was slow, it involved only rich nations, and it occurred only in the context of reciprocal
bargains – both GATT Rounds and Regional Trade Agreements (RTAs).The reciprocity wascritical; foreign tariffs fall only if domestic tariffs do, so mercantilists lobby against
protectionists in their own nation. As such, governments found it politically optimal to cut
tariffs in reciprocal bargains that they had previously found optimal to impose (Moser 1990).
In the late 1980s, this situation changed. Many nations that had previously eschewed allforms of liberalization began to cut their tariffs autonomously. The World Bank, for instance,
estimates that developing nations unilaterally lowered their average tariffs by something like
14 percentage points between 1983 and 2003 independently of GATT/WTO rounds and
RTAs (Martin and Ng 2004). The evolution of these tariff cuts is illustrated in Figure 1.
While some nations lowered their tariffs starting in mid 1980s, most did the bulk of theirtariff cutting in the mid to late 1990s.
The picture is broadly similar for developing nations in East Asia and Latin America, but themore dramatic Figure 2). Tariffs in Latin America were quite high in the mid-1980s.
Averages were all over 20% and many over 40%. All of these tariffs, however, plummeted
starting in the late 1980s. Most of the national averages are now down around 10%. The story
in East Asia is more mixed. Some – such as Singapore and Hong Kong – have long
maintained low applied MFN tariffs, and even the more protectionist nations in the region
had tariff averages in the five to fifteen percent range. In the late 1980s for most and early
1990s for others, tariffs started to come down. By the turn of the century, average tariffs in
the region were typically 5% or lower.

1

Figure 1: Evolution of average tariff rates in developing nations.
40
35

Percent

30
25
20
15
10
5
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

0

Source: Martin and Ng (2004). Notes: Average developing nation tariffs (three year moving average).

Figure 2: Unilateral tariff cuts in Latin American and East Asia.
90

Applied MFN tariffs (%)
BR

80

PE

70
EC
CO

50
AR
40
30

VE
UY
PY

20

Philippine
Thailand

18

Korea
16

Malaysia

14

China

12

Indonesia

10Singapore

8
6
4

CH
10

Applied MFN tariffs (%)

20

MX

2

BO

0

0

2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001

60

AR
BO
BR
CH
CO
EC
MX
PE
PY
UY
VE

Source: Inter-American Development Bank database and ITC database.

The rise of unilateralism occurred at approximately the same time as the internationalisationof supply chains accelerated (Kimura et al 2007, Campa and Goldberg 1997, Hanson andFeenstra 1997). Specifically, the bundling of most stages of manufacturing within a single
factory within a single nation came undone and some stages were moved offshore either
inside or outside the boundaries of the original manufacturing firm. One very obvious versionof this production unbundling is known as outward processing trade, or vertical specialization2

trade (Ishii and Yi 1997); intermediate inputs are imported and used in goods that aresubsequently exported. Figure 3 shows that this trade was long important in Europe andNorth America but that it boomed in the late 1980s, especially in Asia.

% of world manufactures imports

Figure 3: Outward processing trade, 1967 – 2005.

7
6
5

Tot al4

Asia

3

Europe2

North America

1Latin America

0AfricaSource: Amador and Cabral (2008)

Source: Amador and Cabral (2008).

Internationalisation of the supply chain – also known as production unbundling,fragmentation, trade in tasks, or the second unbundling – is a much broader phenomenon thanoutward processing trade. Hanson and Feenstra (1997) document production unbundlingacross the US-Mexico border, and Ando and Kimura (2005) do the same for intra-East Asian
trade. The densification of this production unbundling can be seen in Table 1, which shows
the international input-output sector for East Asian nations’ manufacturing sectors. In 1985,
Japan was an important supplier of inputs to all other East Asian nations but intermediates
trade among the developing Asian nations was slender (apart from Singapore which was
already a hub of microelectronics production). By 2000, however, the input-output matrix
was much fuller with import supply links among nations such as China, Malaysia andThailand.
Another important – and easily measured – facet of supply-chain internationalisation isforeign direct investment. This also flourished at approximately the same time, namely themid-1980s and early 1990s. Figure 4 illustrates the case of Japanese auto and electricalmachinery plants placed in East Asian nations. The evolution shows a clear acceleration from1985 with another inflection point in the mid-1990s – mostly due to plants placed in China.
3

Table 1: Widening and deepening of Factory Asia, 1985 and 2000.
1985

Indonesia
Malaysia
Philippines
Thailand
China
Taiwan
Korea
Singapore
Japan
RoW
2000

China

Indonesia Malaysia Philippines Thailand Singapore Taiwan Korea Japan

8%
16%

2%

3%

3%
12%
15%

China

Indonesia Malaysia Philippines Thailand Singapore Taiwan Korea Japan

Indonesia
Malaysia
Philippines
Thailand
China
TaiwanKorea
2%Singapore
Japan
2%
RoW
4%

7%
14%
19%

14%
3%

4%
19%

9%
14%

3%

2%
3%
7%
16%

4%
3%
5%
4%
13%
15%
20%

4%

3%
4%
3%
3%
4%
16%
17%

5%
8%
6%
20%
20%

12%
11%
2%
12%
3%
5%
3%
4%
19%
38%

7%
10%

8%
16%

8%

2%

2%
4%
14%
15%

7%
11%

4%

Notes: Share of manufactured inputs bought by column nation’s manufacturing sector from the row nation;
numbers less than 2% are zeroed out; own-nation purchases are also zeroed out. The columns would sum to100% if each nation’s own supply of inputs to its own manufactured sector were included and all entries below
2% had not been zeroed. RoW equals Rest of World. IDE-JETRO is the source of the Asian input-output matrix(7 sectors) for 1985 and 2000; see Inomata, Satoshi and Yoko Uchida (2009) for background.
Source: Baldwin (2006b).

The underlying causes of this new, more complex form of international commerce are notfully understood. I have elsewhere argued that the key was the revolution in information andcommunication technologies (ICT) that occurred in the 1980s (telecoms) and 1990s (internet)– see Figure 5. 2
Figure 4: Number of Japanese auto and electrical machinery plants in East Asia, 1975 –
2004.

2

See Baldwin (2006a) for details and policy implications. See Ariu and Mion (2010) for evidence on the link

between ICT and offshoring.

4

900
800

China

700
600
500
400
300

Thailand200

Malaysia
Indonesia

100
0
1975

Vietnam
1980

1985

1990

1995

2000

2004

Source: Fujita and Hamaguchi (2006).

Figure 5: ICT revolution indicators

Log of telephone subscribers(fixed & mobile)

25
23
21
19
17
15
13
11
9
7
5

1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

10.0
9.8
9.6
9.4
9.2
9.0
8.8
8.6
8.4
8.2
8.0

Sources: World Bank, Doing Business database, and www.isc.org/solutions/survey/history.

The assertion is that the initial clustering of manufacturing stages was not due totransportation costs but rather what might be called ‘coordination costs’. The initial bundlingof manufacturing stages stemmed from the way that the costs of coordinating complex
processes are reduced by physical proximity. This distinction between transportation andcoordination costs is relevant since there is little evidence that the world experienced a sharp
reduction in shipping costs after the 1970s (Hummels 1999).

5

As some of these coordination costs are related to communications, the ICT revolution
fundamentally changed the balance between agglomeration and dispersion of manufacturing
stages (Baldwin and Venables 2010). Coordination at distance became cheaper and morereliable and this made it economically feasible to offshore some manufacturing stages
without hindering the overall functioning of the supply chain. As the factor intensity of
manufacturing stages can vary greatly within a single production process, and factor prices
variable greatly across nations, trade in parts and components flourished as rich-country
manufacturers offshored labour-intensive stages to emerging economies. Foreign direct
investment and other more subtle forms of cross-border corporate control also boomed.
This paper is an effort to understand the political economy of unilateral liberalization and -in particular -- its association with the ICT revolution and production unbundling; plainly thiscannot account for all the unilateralism and the stories work best for trade among themembers of what has been called ‘Factory Asia’, and by extension trade among the membersof Factory North America, and Factory Europe. The paper presents three novel mechanismsthat can account for unilateral liberalisation of tariffs that occurs in tandem with production
unbundling.
Each mechanism tackles the “liberalisation paradox” directly. As Baldwin and Baldwin(1996) note, tariff liberalisation is something of a paradox. Assuming policy choices areendogenous, the initial tariff must have been optimal, so why would removing the tariff also
be optimal? Any complete model unilateralism thus requires three elements: an explanationof why protection was politically optimal in the first place, a shock that changes the political
and/or economic setting, and an explanation of why the shock makes a lower tariff politically
optimal. Arguing that governments removed tariffs because they finally understood that free
trade was in their nation’s own best interest is insufficient as one then must then explain why
governments failed to understand this previously. The rest of the introduction provides averbal description of the three economic logics.
Unilateral liberalisation and Kojima’s pro-trade FDI
The first mechanism assumes the (developing country) government is a ‘development state’,i.e. interested in industrialisation per se. If the weight the government applies toindustrialisation versus general welfare is high enough, the initial situation is one of hightariff barriers on final manufactured goods as well as their parts and components – i.e. a
policy of infant industry protection. This starting point is meant to represent the 1960s and61970s when most developing nations pursed import substitution policies and most industries
in developed nations were clustered spatially – often in a particular city or region.
From the perspective of developing nations – especially those geographically close toindustrial powerhouse nations like Japan, the US and Germany – this opened a new pathway
to industrialisation. Rather than developing domestic capacities over a span of decades (aswas done in the US, Germany, Japan, Korea and others) offshoring allowed nations likeThailand and the Philippines to set up sophisticated manufacturing facilities in a matter ofmonths, or years.
In the model, this new form of industrialisation changes the political economy problem facing
the developing nation government. The shock is that the ‘pro-trade FDI’ shifts the developing
nation’s comparative advantage; the nation switches from being an importer (or potential
importer if tariffs were prohibitive) to being an exporter of the product concerned – be it apart, component, or final good. In addition to directly rendering import tariffs on the newly
exported good useless, the new production shifts the government’s view on upstream tariffs.
Protection of upstream inputs always harms downstream production, but the newly
established factory expands the marginal cost of any given upstream tariff. Thus whatever the
optimal tariff was on parts before the offshoring, it becomes lower in response to the protrade FDI. In this way, pro-trade FDI fosters unilateral liberalisation by developing nations. A
slight twist on this – so-called race-to-the-bottom unilateralism – considers the possibility thatthe multinational establishing the new factory may have a variety of location choices and so
may bargain for a zero tariff on upstream inputs. 3
One reaction to this change could be more nuanced than a lowering of the MFN applied tariff.
Governments could – and many did – set up export processing zones where tariffs inimported parts were zero or subject to a duty drawback scheme that had the same effect. This
would allow the nation to both exploit the new industrialisation opportunities offered by protrade FDI while simultaneously maintaining high infant-industry tariffs for production
destined for the domestic market. We return to this point in the third mechanism.
Infant industry protection and production unbundling3

Baldwin (2006b) informally sketches the logic Vezina (2010) presents empirical that the mechanism was inaction in East Asia.

7

The second model of unilateral tariff liberalisation focuses on trade in parts and components
per se – abstracting from offshore investment by high-technology nations. The developing
country government in this model is assumed to be of the Grossman-Helpman “Protection forSale” (PFS) type (Grossman and Helpman 1994).
In this sort of political economy setting, a positive tariff on imported intermediates ispolitically optimal only if the protection somehow lowers the local cost of the intermediates.
The point is that price-rising protection of upstream segments of the production chain isworse than a zero sum game when it comes to profits (and thus political contributions in the
PFS set up). Given that the government cares about the sum of contributions and this is tied
to the sum of profits, the optimal upstream tariff is zero (Cadot, de Melo and Olarreaga 2004).
To explain the presence of high tariffs on parts and components as well as final goods, aneconomic model where protection may lower local prices is needed, i.e. where infant-industry
protection makes economic sense. Parts production, it is assumed, is subject to economies ofscale; local production is only economic if it takes place on a sufficiently large scale. This
creates multiple equilibria and the easiest way to model it is to assume external economies ofscale. Without a sufficiently high tariff on parts, there would be little domestic parts
production and marginal production costs would be high forcing domestic final goods
producers to import parts. Even if imported parts are cheaper in foreign nations (FOB), it isassumed that frictional barriers (coordination, communication, etc.) make importing parts
very costly for developing nation final good producers. In this situation, a tariff on parts canstimulate domestic production and thus actually lower the domestic costs of parts (as local
production avoids the frictional barriers). In this setting, lobbying for a tariff on parts islobbying for lower priced parts, not higher priced parts. For this reason, final goods producers
and parts producers find their interests aligned; high tariffs on both are politically optimal. 4
As our goal is to explain historical policy choices, we only need that the government andfinal good producers believe that protection of parts will lower costs. Here it is worth notingthat the efficacy of infant-industry protection was a mainstream belief in the 1950s and 1960s,
even if such faith is rare in the modern world. In the early days of the post-war trade system,

4

The simple model in this paper focuses on one set of assumptions that generates infant-industry protection, butthere are many more. For example there are several new economic geography models where protection lowers
domestic prices by fostering an industrial cluster that would not have otherwise existed (Venables, 1985, 1987).

8the merits of industry-creating protection were regarded as clear cut. For example, the 1958
Haberler Commission – which examined the problems of developing nations in the world
trade system – summarises the pervasive belief in the need for and effectiveness of infantindustry protection. We can see this belief in a contemporary review of the Report publishedin the Quarterly Journal of Economics. “Referring to the underdeveloped countries in a
general way, the authors recognize that, in their case, special considerations justify a rather
greater use of trade controls and of protection than in the highly industrialized countries. Few
economists will disagree with this view.” (Richter 1959). 5
Taking this economic model as given, the initial political equilibrium features high tariffs on
both upstream and downstream goods. The trigger for unilateral tariff liberalisation is a dropin the frictional trade costs due to the ICT revolution. When these costs fall enough to makeimported parts cheaper than locally made parts the correlation of interests between final andparts producers breaks down. When it does, full liberalisation of parts is the PFS equilibrium,
at least if both parts and final goods makers are organised.
The death of infant-industry industrialisation strategies
As mentioned, pro-trade FDI need not result in the removal of infant industry tariffs directly
if they government can segment imports between domestic-oriented production and exportoriented production. The third mechanism introduced in this paper combines the first two in a
way that explains the demise of government’s faith in infant industry protection. The basic
story is simple.
In the 1960s and 1970s, many developing nations (especially in East Asia) pursued dual trackindustrialisation strategies (Ando and Kimura 2005). The first track was import substitutionthat encouraged the development of the full supply chain behind tariff barriers. The second
track was to encourage export processing activities where the nation’s low-cost labour wasused by multinational corporations to lower the cost of their components. As the production
unbundling proceeded and the offshoring of segments of the value added chain spread, the5The authors comprised three of the most eminent trade economists of the time – Gottfried Haberler, James

Meade and Jan Tinbergen – and that it was commissioned by GATT members which included all the major
Western powers and many developing nations. The Report’s conclusions provided important intellectual
underpinnings for the rather general exceptions that developing nations were granted in the GATT (Title IV) to
refrain from making reciprocal tariff cuts in GATT Rounds.

9relative competitiveness of infant-industry goods was undermined. In essence, developing
nations’ participation in international supply chains undermined their own competitiveness infinal goods.
To put it differently, observe that before unbundling, manufacturing involved a collection oflabour intensive stages and knowledge intensive stages. This bundling tended to mutecomparative advantages. Competitiveness of the, say, Japanese carmakers was hindered by
the fact that labour-intensive stages had to be done by high-wage Japanese. When production
unbundling became possible, the cost of the Japanese production fell since offshoring
allowed Japan to borrow elements of developing nation’s comparative advantage in labourintensive activities. Importantly, this was not mutual. The developing nation automakers did
not enjoy a corresponding ‘borrowing’ of the Japan’s comparative advantage in knowledgeintensive stages. The net result is that production unbundling heightens the rich nation’s
comparative advantage in cars as its costs fall but the developing country carmaker’s costs
did not.
As far as the mechanism is concerned, the key point is that the shift in competitivenesstended to raise the political economy cost of infant-industry protection in two ways. First, bylowering the world price of cars, offshoring raised the domestic welfare costs of any given
level of final good production. The politically optimal response would be some lowering of
final good protection. Second, if developing country car marker hoped to maintain theircompetitiveness, they would have to purchase components from the lowest cost source rather
than favouring local parts makers created by infant-industry policies. This increases politicalpressure to reduce tariffs on parts and components. To put it differently, maintaining the samerate of effective protection in the face of offshoring-induced drops in final-good prices would
require a reduction in upstream tariffs. As this process proceeds, maintenance of the samelevel of effective protection leads to a progressive hollowing out the infant-industry cluster,
starting for the beginning of the supply chain and working down towards the final good. In
the extreme, the only thing that ‘infant industry’ protection can salvage is the assembling of‘knock-down kits’ (i.e. imported kits that contain all the necessary parts and components tomake the final automobile). At this point, faith in the eventual maturation of the infant may
be fatally eroded with the result that the nation decides to turn itself into one big export
processing zone and jettison its infant-industry track.

10

1.1.

Plan of the paper

As it turns out, the particular modelling choices for the three mechanisms make it moreconvenient to address the second mechanism first, followed by the first and then the third.
Before turning the new theory, the next section, Section 2, extensively reviews the existing
literature as a to situate this paper’s contribution into the ongoing effort to understand thepolitical economy of unilateral tariff liberalisation. After that Section 3 introduces basic
issues by working through a protection-for-sale (PFS) political economy model in thepresence of a simple supply chain. Section 4 presents the two basic models, and thesubsequent section discusses a number of obvious extension and combinations of the two that
may account for various aspects of the observed liberalisation. The penultimate section
sketches out a model of the ‘death of dual track development’ and the final section present
some concluding remarks.

2.

LITERATURE REVIEWThe political economy logic of reciprocal liberalisation is well understood. As Cooper (1971p.410) puts it: “The principle of reciprocity is designed to hold out the promise of export
gains to certain sectors of the economy, and thereby to establish a counterweight to those whowill be hurt by increased imports. Reciprocity attempts to build pluralistic support for tariff
reduction.” 6Reciprocity, in short, harnesses mercantilists in each nation to the task oflobbying against their own protectionists – a political economy realignment that means
governments find it political optimal to negotiate down tariffs they previously found optimal
to put up. Liberalisation continue due a ‘juggernaut effect’ whereby tariff cuts strengthen
exporters and weaken import competitors in all nations. After a few years of industrial
adjustment, governments once again find it optimal to bargain down tariffs they previous
found optimal to preserve in earlier rounds. 7 This accounts for the GATT’s success, but not
6

Well known to trade negotiators, this point was surely not novel to Cooper and many have made it

subsequently including Roesseler (1978), Blackhurst (1979), and Baldwin (1980). For an early formal treatment
see Moser (1990), or Hillman and Moser (1992); the political economy logic in these early papers was brought
to the attention of the broad community of trade scholars via the parameterisation introduced by Grossman andHelpman (1995).
7

The juggernaut effect, i.e. the idea that initial tariff cuts trigger a second round of cuts after industrial

adjustment, is due to Baldwin (1994 p. 73); Baldwin and Robert-Nicoud (2008) provide a mathematicaltreatment. Baldwin (2010) uses the framework to structure the historical narrative of the GATT’s 50 years of11

unilateralism; reciprocity played no direct role in developing nations’ autonomous tariff
cutting.
Given the pervasiveness of unilateralism, and the fact that has been going on since the mid
1980s, there is remarkably little theoretical literature exploring the political economy ofunilateral trade liberalization. In the economics literature, most discussions of unilateralism
consist of practical accounts of how and why various nations undertook such measures (e.g.
Garnaut 1991, Young 1996, Edwards and Lederman 1998, Richardson 2001, and Sally 2008).
The political economy theories that account for unilateralism include Coates and Ludema(2001), Krishna and Mitra (2008), and very recently Ludema, Mayda and Mishra (2010), andConconi and Perroni (2010). Ethier (2002) presents a model of unilateral protection (socalled aggressive unilateralism) but his model does not work in reverse to explain unilateral
tariff cutting.
Coates and Ludema (2001) work in the tradition that borrows industrial organisation modelsof collusion between firms, relabeling the firms as nations, and cooperative price-setting ascooperative tariff-setting (see Dixit 1987 for an early example). Coates and Ludema (2001)
borrow a set-up akin to the Porter and Green (1984) model of collusion with imperfectmonitoring and uncertain demand where an unobservable shock may disturb what would
otherwise be a standard dynamic game of collusion. Coates and Ludema (2001) assume thattwo nations sign a reciprocal tariff-cutting agreement, but its ratification in one nation isunsure in the short-run – although it is 100% certain in the long run. Using a repeated gameset-up, they show that the partner nation might unilaterally implement its side of thereciprocal agreement in the first period, even if the other nation fails to ratify the agreement
right away.
There are two difficulties in using Coates and Ludema (2001) to structure our thinking about
the late 1980s and 1990s unilateralism. First their model is about not really about
unilateralism; it is about temporary unilateral implementation of a reciprocal trade agreement.
Second, their model works in the ‘self-enforcing’ trade agreement tradition which is marredby a fatal flaw when applied to tariff liberalisation. 8

tariff cutting success. Empirical support can be found in Fugazza and Robert-Nicoud (2010).
8

The self-enforcing liberalisation model was first explained in modern terms by Dixit (1987) and Jensen andThursby (1984); Bagwell and Staiger (1990) extended the model and brought it to the attention of the broad

12

The flaw shows up even in the simplest self-enforcing model. Define Wc, Wn, and Wd as anation’s welfare when, respectively, the trade agreement is implemented (‘c’ being amnemonic for cooperation), when all play is non-cooperative (‘n’ for Nash), and when thenation in question unilaterally deviates from the cooperative equilibrium (‘d’ for deviation).
Under standard assumptions, the stage-game is a prisoners’ dilemma, i.e. Wd>Wc>Wn.
Cooperation is sustained by the threat of a permanent revision to Wn the period after
deviation is observed. Formally, the present value of cooperating forever, and of playing
Nash forever after any deviation are, respectively, Wc/(1-δ) and δWc/(1-δ), where δ equals
1/(1+ρ) and ρ is the discount rate. Price collusion in an industrial organisation model, andreciprocal tariff cutting in the self-enforcing trade agreement model works if and only if Wc >(1-δ)Wd+δWn. The maximum sustainable cooperation can be measured by Wc-Wn.
For any given annual discount rate, say 5%, the key to this condition is the length of theperiod in which deviation can occur without retaliation. If a nation can maintain the high,deviation-tariff while others keep theirs at the cooperative level for, say a year, δ is about
0.95; if the deviation is detected and punished quickly, say after one day, then δ is 0.999863.
The maximum sustainable cooperation that can be explained by this approach – which isequal to (1-δ)(Wd-Wn) – limits to zero as the non-detection period shortens to zero.
In industrial organisation models, this is not a problem since collusion involves prices (orquantities) that are hard to observe; prices are often in private contracts struck between one
producer and her customers, neither of which has an incentive to reveal the information to theother producers. By contrast, this is fatal flaw when applied to tariffs as the non-detection
period is a matter of hours. 9 Foreign companies who pay the deviation-tariff know about it
immediately and have an incentive to report it to their own government who can thenimplement the punishment strategy at the stroke of a pen. Thus δ essentially equals unity intariff games. This means that self-enforcing tariff agreement models – such as Coates andcommunity of trade scholars.
9

For example, the surprise announcement of a 10% US tariff hike on 15 August 1971 wasmade on national television by President Nixon; the nightly news coverage a few hours later
included the reaction of European and Japanese policy makers. The deviation was detectedeven before the deviation tariff was applied.

13

Ludema (2001) – cannot account for tariff cooperation, i.e. (1-δ)(Wd-Wn)=0. Cooperation
does, of course, occur, but we need a different approach to explain it.
Ludema, Mayda and Mishra (2010) develop a model whereby firms influence government’s
tariff choices by transmitting information about the value of protection via cheap-talkmessages and costly lobbying. They apply this to a particular form of temporary unilateralism
in the US known as ‘tariff suspensions’. Their model does not help us understand the mass
shift to unilateralism, as it fails to tackle the paradox of liberalisation. The model opens withan exogenously set tariff on an intermediate good and in the first period the government may
decide to rescind the tariff. The heart of the model lies in the political competition between
upstream and downstream firms, but if rescinding the tariff is politically optimal in period
one, why was it in place in period zero?
A much more promising mechanism is presented in Krishna and Mitra (2008). This paper
presents an appealing account of the basic political economy forces behind unilateral tariff
cutting, or more specifically of ‘reciprocated unilateralism’ whereby a unilateral tariff
liberalisation by one nation triggers unilateral tariff liberalisation in another. When bothnations’ trade policies are determined endogenously, multiple equilibriums arise; either bothliberalise or neither do. The basic logic can be thought of as picking up half way through thejuggernaut effect; instead of trade talks triggering a reciprocal tariff cut that then induces
industrial restructuring which in turn sets the scene for further tariff cutting, this model starts
the juggernaut rolling with an autonomous foreign tariff cut.
In the Krishna-Mitra model, a nation’s tariff is the outcome of a domestic struggle between
pro-unilateral-liberalisation interests in the export sector (they want to lower the cost ofimports) and anti-unilateral-liberalisation interests in the import-competing sector. If anation’s trade partner removes its tariffs unilaterally, the additional foreign market access
shifts economic resources from the pro-tariff group to the anti-tariff group. As political poweris linked to a sector’s economic size, the result is unilateral liberalisation of a type that might
be called ‘contagious’ unilateralism.
This insightful logic is very appealing and almost surely plays an important role inunderstanding some aspects of the observed unilateral tariff cutting. For example, it explains
how shifted political power among domestic special interest groups can make low-tariffs selfenforcing without relying on the flawed self-enforcement approach discussed above.
14

There are, however, a couple of difficulties in using this analytic framework to understand thefacts discussed above. The first could easily be remedied. Krishna and Mitra (2008) do notdirectly tackle the liberalisation paradox, but it is easy to imagine an extension which it did.
Their foreign nation could be taken as the collection of advanced nations whose tariffs were
liberalised by a juggernaut mechanism in GATT rounds. The foreign unilateralism inKrishna-Mitra could then be taken as the MFN extension of GATT Round tariffs cuts todeveloping nations.
The second is more serious as it concerns timing of the unilateralism. The rich nations –whose markets are the main destination for developing nation exports – lowered their tariffs
progressively from 1948, with major steps in the 1950s, 1960s (Kennedy Round), and 1970s(Tokyo Round), and 1990s (Uruguay Round); see Figure 6 for the facts for the US, which arebroadly in line with those of the EU and Japan (imports of these three accounted for over
70% of world imports up to 1995).
Presuming that Krishna and Mitra (2008) have this GATT-driven liberalisation by richnations in mind, the fact that the timing of the unilateral cuts in developing nations does notmatch the timing of the rich nations’ cuts is a problem. The general point is clear in thecomparison of Figure 1 and Figure 6, and even clearer in the charts for Latin America andEast Asia in Figure 2. The major MFN tariff cutting in the advanced economies occurred in
the late 1960s and 1970s. As the developing nation unilateralism started a decade later, it issomewhat strained to view rich-nation tariff cutting in the GATT Rounds as the main triggerof developing-nation unilateralism.
Another line of reasoning that surely is part of the complete story of global unilateralism
concerns ‘spillover’ effects from reciprocal liberalisation. Two economic mechanisms havebeen highlighted in the literature that link preferential liberalisation done in reciprocal RTAs
to unilateral MFN liberalisation. The first links RTAs to unilateral MFN liberalisation. The
second looks at how a RTA can lower or raise a nation’s ‘effective’ MFN tariff rate.

Figure 6: US tariff reductions, 1948 to 2005.

15

US average tariffs (%)

16

Ratio of duties
collected todutiable imports
Ratio of duties
collected to total
imports

14
12
10
8
6
4
2

1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004

0

Source: Historical Statistics of the United States, Colonial Times to 1970, www.census.gov

The first approach was motivated by the Latin American experience where regional tariff
cutting was accompanied by unilateral MFN tariff cutting. As Figure 7 shows, the time pathof reciprocal tariff cutting in the many Latin American RTAs bears a striking resemblance tothe time path of Latin American MFN unilateralism shown in Figure 2. The question thatstructures this literature is: What is the impact of an RTA on a nation’s unilaterally optimal
MFN tariff? Intuitively, the answer turns on whether preferential tariffs are “political”
complements or substitutes for MFN tariffs.
The easiest way to organise the various mechanisms in this literature is to start from Meade’s
formula for the welfare impact of any trade policy change in a Walrasian economy, namely
TdM minus Mdp* where T is the specific tariff vector, M is the bilateral import matrix, andp* is the border price vector (see Baldwin and Venables 1995). A nation choosing its bilateral
tariffs optimally would view this as a first order condition and set it to zero to find its optimal
tariff. Solving the first order condition, the optimal bilateral tariff vector is
Tod = M od (dp *) , where the destination nation ‘d’ imposes the tariff Tod on goods fromdM od

origin nation ‘o’.

Figure 7: Average preferential tariffs in Latin America, 1985 – 2006.
16

80

Average Preferential Tariff (%)

70
AR
BO

60

BR
CH

50

CO
EC

40

MX
PE

30

PY
UY

20

VE

10

0

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

Source: Inter American Development Bank.

In general, anything can happen to Tod when the nation signs a free trade agreement since thedirect and cross-good income and substitution effects of the FTA-induced price changes
could raise or lower the right-hand side. This ambiguity has been resolved by several
mechanisms in the literature. The first mechanism turns on the general principle that taxes
become more distortionary when the cross-product variance of rates increases. As bilateral
tariff cutting increases the variance of tariffs across suppliers, it increases inefficiency andcreates an efficiency-based argument for reducing tariffs on third-nation imports, i.e. forunilateralism. Ornelas (2005a) makes the point very cleanly in a Brander-Krugman model of
two-way trade with three nations.
As second mechanism turns on the Mod term. RTA-induced price changes typically reduce
trade with third nations (trade diversion). If the slope of the import supply curve from third
nations is not increasing too fast, the reduction in Mod will bring down the optimal Tod forthird nations, i.e. induce unilateralism. Richardson (1993) presents a related argument that
focuses on tariff revenue losses. Ornelas (2005b, c) make a similar argument that links MFN
unilateralism to the exogenous implementation of an RTA. As preferential tariff cutting
typically undermines the import competing industry to some extent, it also undermines
political demand for tariffs on third-nation imports. This induces the government to reoptimise external tariffs in a downward direction. Other contributions in this line include
Estevadeordal et al. (2008), Calvo-Pardo et al. (2009).
17

The big advantage to using this line of argument to understand the massive unilateralism of
the 1980s and 1990s is that it fits the timing. The big drawback, however, is logical. Thesemodels do not answer the ‘liberalisation paradox’ but rather pushes it back one step. They do
not explain why preferential tariff cutting became politically optimal when previously it wasnot.
Conconi and Perroni (2010), a paper that was still in draft form when this article went topress, relies on a Krishna-Mitra-like mechanism to explain why unilateralism might becontagious. That is, foreign liberalisation shifts resources out of the import-competing sector
in equilibrium and this makes it easier for the home government to sustain unilateral free
trade. Specifically, Conconi and Perroni (2010) work with the asymmetric lobbying set-up of
Baldwin and Robert-Nicoud (2002) where entry eliminates quasi-rents and thus all incentives
to lobby whenever tariffs are constant over time. To this they add a credibility problem
whereby the government has an incentive to raise the tariff by surprise as a means of
temporarily creating quasi-rents in the import-competing sector. As the size of the temporary
quasi-rents increases with the pre-surprise size of the import-competing sector, and this size
is reduced by foreign tariff liberalisation (due to the Krishna-Mitra-like resources shift),
foreign unilateral tariff liberalisation tends to make it easier for the home government to stick
to a path of free trade. In this sense, unilateral liberalisation is contagious. However, foreign
liberalisation also reduces the difference between the free-trade and the opportunistic-tariffs
paths. Thus foreign liberalisation has an ambiguous impact on the sustainability of free trade.
More specifically, the authors’ assumptions generate a standard time-inconsistency problem;the small-country government would like to commit to permanent free trade, but faces atemptation to announce such a policy and then renege. If the free-trade path is credible, freeentry implies that there are no rents to lobby for (as per the Baldwin-Robert-Nicoud result)and thus no lobbying. 10 This is why credible free trade is politically optimal (recall that the
PFS objective function reverts to the social welfare function without lobbying). If the free
trade path it is not credible, lobbying occurs on the margin so – even though there are noquasi-rent in equilibrium (free entry eliminates them) – the outcome is a positive, timeinvariant level of protection. As this is inferior to the free trade path, the government faces a10

See discussion of asymmetric lobbying in Grossman and Helpman (1996), and Baldwin (1993) for theoriginal presentation of the idea.

18

classic a repeated prisoner’s dilemma game. As noted above in the discussion of CoatesLudema paper, the ‘cooperative’ outcome (free trade in this application) is sustained if andonly if the one-shot value of deviating is not too much higher than the non-cooperative
outcome (permanent protection in this application). 11 In symbols, free trade can beunilaterally sustained when Wc exceeds (1-δ)Wd+δWn. As foreign liberalisation reduces Wd
but raises Wn, the net effect on free-trade sustainability is unclear.
There are three problems in using this political economy logic to understand real world
unilateralism. First, the authors do not explore the class of parameterisations leading to thereal-world outcome (i.e. nations embrace unilateral free trade) and they note that standard
parameterisations (e.g. linear demand) leads to the rather un-useful result that foreign
liberalisation has no impact on domestic liberalisation. Second, the paper does not confront
the ‘liberalisation paradox’ directly, i.e. why nations that previously found it optimal toprotect unilaterally now find it optimal to liberalise unilaterally. Third, even if the first two
were fixed, the deep fundamentals of the Conconi-Perroni mechanism would be those of
Krishna-Mitra and thus subject to the timing problem that rich nations liberalised a decade
before developing nations.
A final line of argumentation in the economics literature – one that is often viewed as
explaining unilateralism in Africa and India – is the ‘conditionality approach’. This focuseson that fact that the IMF typically used their leverage during crisis-linked interventions toforce nations to unilaterally cut tariffs. . The conditionality attached to extending loans
frequently requires nations to reduce trade barriers (Stone 2004, Borgatti 2006).
In the International Relations literature, the rise of democracy is often painted as a key driver.
For example, Milner and Kubota (2005) argue that democratisation of the political system
reduces the ability of governments to use trade barriers as a strategy for building politicalsupport.
Discussion in the final section suggests how the new arguments in this paper could be
combined with elements of the existing literature to provide an account of real world
unilateralism.

11

Note that the zero-detection delay problem does not appear here as the basic periodicity is linked to theelection cycle which is typically many years.

19

3.

POLITICAL ECONOMY OF UNILATERAL TRADE LIBERALIZATION

The three questions raised by the liberalisation paradox are: why protection was politically
optimal to start with, what shock changed the economic and/or political setting, and how theshock produces the policy reversal. For most forms of trade liberalisation the first question isthe easiest – typically some form of “Olson’s Asymmetry” explains why economicallyinefficient protection is chosen (Olson 1965); when protection’s winners are organised while
its losers are not, politically motivated governments choose too much protection. When it
comes to the unilateral liberalisation of parts and components, however, the first question is
the hard part.
As it turns out, using the standard parameterisation of Olson’s Asymmetry (Grossman andHelpman 1994), protection on parts and components should not happen – assuming that both
final goods makers and parts makers are politically organised. The point is demonstrated
explicitly below, but the basic result has been widely known since Cadot, de Melo andOlarreaga (2004). Tariffs that raise intermediate input prices shift profits from downstream to
upstream firms; this is zero sum if there are no imports and no substitution, but less than zerosum if imports are positive. Profit-linked lobby contributions are thus maximised by settingintermediate tariffs to zero.
In the next section, we introduce two modifications to the PFS approach that explains why
protection of parts and components could be politically optimal in the first place. Before
turning to the models, we introduce notation and fix ideas by demonstrating that theequilibrium tariff on parts is indeed zero in the simple PFS approach.
3.1.

PFS with a domestic supply chain

To illustrate the basic issues as simply as possible, we work with the standard assumptions of
the simplified PFS model and add a stylized supply chain. 12 Specifically, we assume a smallopen, Ricardo-Viner economy with three sectors, the numeraire good A, the parts sector Y,
and the final goods sector Z (Y and Z are chosen as mnemonics – Y comes before Z just as
the production for upstream Y comes before the production downstream Z). There are three
productive factors (labour and the Y and Z sector-specific capital). Perfect competition and

12

The simplifications of the PFS model we exploit are explained in Baldwin and Robert-Nicoud (2006).

20

constant returns is assumed for all sectors; A and Y are made from primary factors while Z is
made from Y and primary factors.
The per-capita indirect utility function is:

e + ∑i =1 s i [ p i ]n(1)where n is the number of non-numeraire sectors, the si is the sub-indirect utility functions foreach non-numeraire sector, and ‘e’ is expenditure. Expenditure equals the sum of labour andcapital income.
The government’s objective function Ω is a weighted sum of social welfare W, and lobbying
contributions, C:Ω = aW + Σ j∈Λ C i [ p i ](2)where capital lambda, Λ, is the set of sectors that are organised politically (and thus can makepolitical contributions) and Ci is the contribution of sector i. Each lobby’s contribution
schedule is assumed to be ‘truthful’ – specifically it is sector operating profits minus aconstant that is determined in equilibrium (this assumes that lobbyists ignore price effects
beyond their own sector).
We introduce the supply chain by assuming that each final good requires one part as an input
in addition to labour. 13 We have two nations, Home and Foreign, that compete in both parts(Y) and final goods (Z); but we start by taking Home to be “small”, i.e. it takes border prices
as parametric. We assume that Home would be an importer of both parts and final goods
under free trade, so protection of both sectors is a real issue. The Home nation has acomparative advantage in the numeraire (untaxed) good. This and the small open economy
assumption pins down the Home wage rate; it must be such that the domestic price of thenumeraire good exactly matches the exogenously given world price. Choosing units of thenumeraire good, this result allows us to normalise the Home wage to unity (thus wage does
not appear explicitly in cost or profit functions).

13

For analysis of more complex supply relationships, see Cadot, de Melo and Olarreaga (2004).

21

3.1.1.

Free trade in final goods and parts

We open the analysis by considering the outcome when all Home tariffs are zero. The left
panel shows the supply and demand diagram in the parts market; SY is the supply curve and
DY is the demand curve. Demand for Y is derived demand, i.e. it is based on the output of thedomestic final sector given that each unit of final good Z requires one unit of Y.

euros

euros

SZ
SY

E3

w

P Z

PYw

P wZ
MC

E3

DZ
DY
QY≠QZ

Quantityof parts

QZ

Quantityof final
goods

Figure 8: Trade in parts and final goods

The right panel shows the market for the final good, Z; the demand curve for Z depends upon
consumer optimization in the usual fashion; however the supply curve is linked to the price ofparts, Y. Final-goods technology is such that there is a rising marginal cost of turning parts
into final goods. This marginal cost curve is shown as MC in the right panel. The supply
curve for Z – i.e. the full marginal cost curve – is MC plus the price of Y. That is why the Z
supply curve, SZ, starts at PY where PY is the equilibrium price of parts and rises in line withMC (recall we assume one part is required per final good).
With free trade, the price in the Y market is set by the world price PwY and so the Home
output of Y, QY, is not tied to QZ.
The diagram shows the fundamental tension within the domestic supply chain. Any tariff on
the upstream Y good would help Y producers but harm Z producers by even more. Moreover,22

as domestic Y production is independent of Z production, upstream Y producers have nointerest in supporting downstream Z-sector production on the margin. In other words, there isno correlation of interest among sectors in the domestic supply chain.
3.1.2.

Supply chains and tariffs: PFS approach

The politically optimal tariffs solve the government’s two first order condition (i.e. for the Y
and Z sectors). Taking account of the non-negativity constraint on tariffs, the government’s
first order conditions are:dπ [ p , p ]  dπ [ p , p ]0 ≥ a NrZ '[ pZ ] + NsZ '[ pZ ] + Z Y Z  + Z Y Z
dpZ
dpZ


dπ y [ p y ] dπ Z [ pY , pZ ]  dπ Y [ pY ] dπ Z [ pY , pZ ]

 +
+
+
0 ≥ a NrY '[ pY ] + NsY '[ pY ] +
dpY
dpY
dpY
dpY



Note that, for notational convenience, the choice is with respect to the domestic price rather
than the tariff directly; the equilibrium tariff is backed out of the optimal domestic price using
the exogenous world price. Here N is the mass of citizens, and ri and si are the per capita
tariff revenue and consumer surplus functions, and πi is sector-i operating profit, i.e. theRicardian surplus that is the reward to the sector specific capital.
By direct calculation and the envelope theorem:

Nri ' [ p i ] = M i + t i

dπ y
dM i
dπ z
dπ z
= Qy ;= −Q z ;= Qz; Ns i ' [ p i ] = − Di ;
dp i
dp y
dp y
dp z

where Mi, Di, and Qi are sector-i imports, demand, and domestic production respectively;
dMi/dpi is the change in imports in response to a domestic price change. Using these
relationships to simplify the first order conditions, we have:0 ≥ at Z

dM Z+ QZ ;
dp Z

0 ≥ at Y

dM Y
− MY
dpY

(3)

The first expression says that the politically optimal tZ is positive. That is, as the first term isnegative (due to dMi/dpi<0) and the second term is positive (as Qz>0), tz must be positive forthe sum to be zero. The second expression says that the equilibrium ty is zero; both terms arenegative for any positive value of ty, so complimentary slackness tells us that the corner
solution is the answer.
The intuition for these results is simple; Olson’s asymmetry applies to final goods but not toparts. The whole logic of protection in the PFS approach is to transfer income from23

unorganised interest groups to organised ones. This requires that some of the losers fromprotection are unorganised politically. Tariffs on parts are zero because both parts and final
good producers are organised, so free trade in parts is best both for social welfare and thegovernment. Tariffs on final goods are positive as the losers from tz>0, i.e. consumers, are notorganised politically.

4.

UNBUNDLING AND UNILATERAL TRADE LIBERALIZATION: TWO MODELSThe Cadot, de Melo and Olarreaga (2004) tariff escalation result – which we illustrated in theprevious section in a simple model – implies that some additional elements must be added tothe standard lobbying model to account for the observation that so many developing nations
protected both parts and final goods as part of their infant-industry trade policies. In thissection, we sketch out two modifications that could account for the initial protection of parts
and its subsequent removal induced by an unbundling-related shock.
4.1.

Infant industries and price-lowering protection

The first model explains the initial protection by introducing a ‘price lowering protection’mechanism. The mechanism is scale economies in a setting where import-substitution polices
make economic sense.
euros

MCy
E1

p yw+τyE2

py
p yw+τ’y
Dy
Quantity of parts(industry output)

Figure 9: Multiple equilibrium in the parts market with external economies
This model embraces all the assumptions of the PFS model in Section 3.1 with one exception.
Parts production is still marked by constant returns at the firm level but now we introduce
24external economies at the industry level. The Y and Z sector technologies are reflected in thecost and profit functions Cz[py,z], Cy[y,Y], Πz[pz,py], and Πy[py,Y] where lower-case y and z
represent firm-level output while their upper-case correspondents represent industry-level
output. As usual, profits are increasing in own price and decreasing in the price of inputs.
4.1.1.

Parts protection and multiple political economy equilibriums

We start from the initial situation where tariffs are zero and domestic parts production is zero.
We assume that the external economies are such that domestic parts production is
uncompetitive in this situation. Specifically, marginal costs in Y evaluated at Y=0 exceed
pyw+τy, where pyw is the world price of y and τy is the frictional trade barrier. Here frictional
trade barriers is meant to capture all manner of the difficulties involved in buying parts fromdistant suppliers, e.g. coordination costs, problems with unpredictable delivery delays, andshipping costs. The situation is shown in Figure 9 at point E1.
To consider the political economy around E1, we suppose that the Home Z industry takes thissituation as given – more precisely, it believes that its actions can only move the equilibriumin the neighbourhood of E1. In this case, it will lobby for tariffs in its own sector but against
tariffs on Y and – as we saw above – the result will be a positive Z tariff, but a zero Y tariff.
This, however, is not the only conceivable outcome. The presence of external scale effects
means that protection of domestic parts production may actually lower the domestic price ofparts.
If the firm-level marginal cost of production in Y falls initially as industry output expands, it
is possible that there is a second stable equilibrium, E2, where domestically produced parts
are cheaper than imports. If the Z sector understands the presence of external economies, theywould lobby for a prohibitive tariff in parts in order to shift the outcome from E1 to E2. This,of course, is just the sort of economic setting in which import-substitution policies makesense economically.
More formally, we characterise the government political economy choice under the twooutcomes. In the standard PFS set up, the domestic price py varies smoothly with the tariff on
y, specifically py = pyw+τy+ty. In the current situation, however, there is a discontinuity in theformula, py = pyw+τy+ty. When py<pyw+τy, changes in ty have no effect on py. This requires us
to look directly at the government’s tariff choice. Doing this, the government’s first ordercondition for ty is:
25


dπ
dπ Z  dp y  dπ Y dπ Z  dp y++
0 ≥ a NrY '[ pY ] + NsY '[ pY ] + Y +dpY
dpY  dt y  dpY
dpY  dt y(4)

In the first situation, E1, dpy/dty=1 and Z firms do not take account of external economies in
the Y sector. Consequently, the politically optimal Y tariff is zero. In the E2 situation,
dpy/dty=0 as the government’s choice of Y tariff has no impact on domestic Y prices (i.e.
there are no imports). What this means is that the first order conditions could be satisfied at
E1 with ty=0, or at E1 with ty being prohibitive. 14 To select the correct solution, thegovernment has to evaluate its objective function at the two points. As Z sector profits rise aspy falls –and this for level of pz – it is clear that the government would prefer the situation at
E2 with positive tariffs in Y.
Notice that even though the domestic price of y is lower at E2 than the trade-cost-laden priceof imports, Home is not competitive in the world market as it too faces the frictional trade
cost τy.
4.1.2.

The second unbundling and unilateral liberalisation

As discussed in the introduction, reductions in the cost of organising complex activities at
distance fostered the unbundling and geographic dispersion of manufacturing production. We
parsimoniously capture these changes in the model by lowering the frictional trade costs forparts, i.e. τy.
Given the logic supporting the protectionist outcome E2, it is clear that small reductions in τyneed not have any effect on the equilibrium ty. However once τy falls to the point where parts
could be bought more cheaply abroad than domestically, the correlation of Y and X sector
interests disappears and we revert to the Section 3.1 logic where ty=0 while tz>0. For example
it falls to τ’y as shown in Figure 9, any tariff on Y will help Y-firms while harming Z-firms.
As we saw in the initial analysis, this means that the political economy equilibrium reverts
immediately to free trade in Y.
This is a story where the underlying shock that fosters international trade in parts also triggers
a political economy response that results in a complete unilateral liberalisation of tariffs on

14

The assumption that the government imposes a prohibitive tariff on parts is somewhat arbitrary. The idea isthat in a more fully specified dynamic model, where development of the parts sector took time and the outcome
was uncertain, a prohibitive tariff on Y gives the greatest incentive to private agents to move to E2.

26

parts. Notice that this story has the tariffs falling suddenly and for all sectors where theshipping and/or coordination costs of buying parts and components abroad falls.
4.2.

The ‘development state’ and offshoring industrialisation

The PFS model – with its profit-based lobbying – is not the only reasonable model ofgovernment choices when it comes to trade policy. Many developing nation governments
seem largely interested in fostering industrialisation per se. A common label for this is the“development state” – a term introduced by the political scientist Chalmers Johnson (Johnson
1982). The second of model linking unbundling to unilateral liberalisation embraces a
modified version of the PFS model that has strong ‘development state’ features. We assume
that – as in the PFS model – the government chooses trade policy to maximise a modifiedsocial welfare function. However the modification involved industrial value added rather thanindustrial operating profits. Specifically:Ω d = aW + Σ j∈ΙVi [ pi ](5)where Vi is the value added in i at world prices, and i is the set of industrial sectors. 15
To streamline the analysis we work with the economy as described in the previous model, so
the objective function is Ω d = aW + ( p z w − p y w ) S z + p y w S y , where the Si are the supply
functions of Y and Z. Note that the supply of Z depends upon pz-py while the supply of Y
depends on py. Before studying the solution to the government’s maximisation problem, notethat a simple rearrangement of the objective function yields: Ω d = aW + p z w S z − p y w M ysince My=Sz-Sy. In this form, it is clear that the development state has a much greater intrinsic
interest in limiting the import of parts than does the the PFS government.
Choosing tariffs via domestic prices, the government’s first order conditions are:

dπ 
w
w dS
0 ≥ a NrZ ' [ p Z ] + Ns Z ' [ p Z ] + Z  + ( p z − p y ) Z
dp
dp Z
Z 


dπ
dπ 
w
w dS
w dS y0 ≥ a NrY ' [ pY ] + Ns Y ' [ pY ] + Y + Z  + ( p z − p y ) Z + p y
dpY dpY 
dp y
dp y

15

The specification of such government objective functions is necessarily somewhat arbitrary as it is not linked

to individual optimization. The choice of using industry value added at world prices is directed bycomputational convenience, but the basic results would, I conjecture, go through with an objective function thatdefine industry in terms of employment or industrial value added at domestic prices.

27which, using the standard cancellations and the definition of My, can be written as: 16
0 ≥ at z

dM z
w
w dS
+ ( pz − py ) z ;
dp z
dp z

(6)

dM Y
w dS zw dM y0 ≥ at Y
+ pz
− py
dpY
dp y
dp y

The tariff chosen in Z will be positive for the usual reasons (although likely to be lower thanin the PFS model as the government cares about value added in Z rather than profits). The
tariff in Y will be positive as long as ( p z w − p y w ) dS z < p y w
dp z

dS y

is true. This says that thedp yslope of the Y supply curve weighted by world prices exceeds the slope of the Z supply curve
weighted by the Z sector value added at world prices. We presume that condition holds, soty>0 in the initial equilibrium.
If the government is a pure development state – i.e. it cares only about industrial value addedin the sense that the parameter ‘a’ is zero – then both ty and tz will be chosen to be prohibitive.
The point is easily seen. If a=0, then the derivatives of Ωd with respect to the tariffs are
everywhere positive, so raising the tariffs raises the objective function. The connection isbroken, of course, when all imports cease as at that point tariffs have no further impact on
domestic prices.
4.2.1.

Pro-trade FDI and unilateral liberalisation

Starting from this situation of positive tariffs on parts and final goods, consider the impact of
production unbundling on tariffs. Specifically, suppose exogenous changes occur (e.g. the
ICT revolution) that allow the offshoring of Z production by Foreign multinational
corporations. We assume this is Grossman-Rossi-Hansberg type offshoring where themultinational brings superior technology with it and so the host-nation’s comparativeadvantage is shifted. That is, they can now combine their superior Z-sector technology with
the Home’s low-cost labour by building a factory in Home. In principle this could occur inboth Z and Y, but in the spirit of international production unbundling, we focus on the case

16

This relies on the fact that dSz/dpy=- dSz/dpz – a result that stems from the input-output linkages assumed. My

thanks to an anonymous referee for point this out.

28

where it occurs only in Z. This creates a situation where Home becomes part of a Foreignfirm’s supply chain, importing parts to which it adds value and then exports. 17
This exogenous change opens an alternative route to industrialisation. Instead of usingbarriers to reserve domestic sales for domestic Z-producers, the nation can join aninternational supply chain and produce Z for the wider world market.
If the domestic government does allow the offshoring production to be set up in Home, then
the nation becomes an exporter of Z in the case we consider. This of course renders its Z
tariffs useless. More interestingly, it also shifts the endogenous tariff decision in the parts
sector in a pro-liberalisation direction.

euros

euros

Sz

Sy
P wz

Pwz+t z

E1

Szos

E2

w

P z
Pyw+tyDz
Dy
Qy

Quantityof parts

Qz

Quantityof final
goods

Figure 10: Offshoring and the development state’s tariff choices

17

Taking the Y and Z structure literally, this becomes what might be called the ‘China’ case, i.e. where Home isthe assembly location for final goods that are then mostly sold onward to third nations. Alternatively, we canview Y and Z as any two adjacent links in a value added chain in which case it is more natural to view Y asparts and Z as components used in the manufacture of some final good not specified. Doing this formally would
require some modifications to the reasoning as then Z would not be purchased by Home nation consumers, but
the basic results would go through.

29

Recall that pre-offshoring, the government balanced the damage that a marginal Y tariffincrease did against the value added it created in Y. The marginal damage consisted of theusual Harberger Triangles (captured by the negative term atydMy/dpy) plus the marginal
reduction in Z sector output (captured by the negative term pzwdSz/dpy). After offshore
production of Z is established and Home’s supply curve rotates down to the point where it
becomes an exporter, it is clear that the marginal damage to Z sector value added from any
marginal rise is the Y tariff becomes greater.
For example Figure 10 shows the situation where the tariff on parts has not been modified
after the offshoring of Z production from Foreign to Home has occurred. The question iswhether this situation is an equilibrium or whether the Home government would find a lower
ty to be politically optimal after the offshoring. What is clear from the diagram is that any
change in Z sector technology that allows the nation to become an exporter will involve a
flatter supply curve in the Z sector. In other words, Z production becomes more sensitive tothe price of parts and thus the marginal damage from raising ty is higher at any level of ty. By
inspection of the first order conditions, this tells us that the Home government will find it
optimal to lower the Y tariff after the offshoring.
In short, output of the offshored Z factory is more sensitive to parts prices than was the oldHome Z industry, and this raises the marginal cost of maintaining the same level of ty. In thisway, the new offshoring factors induce a reduction in domestic tariffs on parts.
4.2.2.

Race to the bottom unilateralism

The analysis hereto has presumed that Foreign multinationals have no choice in the locationof offshored factory. They are either placed in the other nation or stay at home. This affords
the Home government a free hand in setting its parts tariffs (presuming that the offshoring
factories remained profitable).
If we expand the model and allow multiple ‘home’ nations, it is clear that the multinational
would be in a position to bargain over each nation’s tariff on parts. As every reduction in theparts tariff raises its profitability, it would prefer to locate in a nation with a zero parts tariff.
The game is quite analogous to that played by internationally mobile capital and nations thatwish to attract it. In the public finance literature, such situations are labelled “race to thebottom” as there is a tendency for governments to lower taxes on mobile factors to zero.
Applying the same logic to the model at hand, we see that there will be a tendency for ‘home’30nations to set their tariffs to zero as a means of attracting offshored factories. Baldwin(2006b) calls this “race to the bottom” unilateralism.

5.

EXTENSIONS OF THE BASIC MODELSThe two models introduced above lay out basic explanations for why production unbundling
was associated with unilateral liberalisation. Both fundamentally turn on the reduction in
frictional barriers to international commerce. The first focuses on the frictional barriers(including coordination costs) of trade in parts and components. The second focuses onfrictional barriers to investment in offshore parts and components production.
In the first model, the trigger of unilateral liberalisation is the lower of frictional barriers toorganising production in spatially separated facilities. That is, as the cost of coordinatingcomplex activities at distance falls sufficiently, imported parts switch from being more
expensive than local parts to less expensive. This returns the setting that the standard PFS
situation where free trade in parts is the political equilibrium. In the second, the trigger is thelowering of frictional barriers to what Kojima (1977) called “pro-trade FDI”. Here the shockis assumed to affect more than the cost of moving goods across space and coordinating the
production process in which they are involved. Here the shock also concerns the economic
feasibility of offshoring production from high-wage-high-technology nations to low-wagelow-technology nations while still using the high-wage nation’s technology.
In this section, we consider a number of extensions and combinations of the two fundamental
political economy mechanisms.
5.1.

Fragmentation and unilateral liberalisation

The first extension concerns a pure ‘fragmentation’ mechanism of the type emphases by
Deardorff (1989a, b), Venables (1999), Kohler (2004a), Rodriguez-Clare (2007), Markusen(2006), Antràs et al. (2006), and most recently Grossman and Rossi-Hansberg (2006, 2008).
In these models, a sector is initially considered as a single good from the point of view oftrade – and presumably – from the political economy perspective. An exogenous change thenmakes it possible to separate the production stages into two or more segments with tradepotentially occurring in the sub-product corresponding to the segments.
In the simplest political economy setting of Section 3.1, such production unbundling will be
associated with pressures to reduce the tariff on the upstream parts. To see this, note that the31pre-unbundling situation would be like Z and Y being merged into one inseparable
production process. According to the standard Olson’s Asymmetry logic, the government
would find it politically optimal to protection the combination as the losers of protection are
not organised while the winners are. Fragmentation would then shift the situation to the one
modelled in Section 3.1 where we saw that the political optimal tariff on the upstream
segment, sector Y, is zero. This may help account for the observation that fragmentation isoften correlated with unilateral trade liberalisation.
Note that if this occurred, we should observe a densification of the tariff schedule as part of
the unilateral liberalisation. That is, as the unbundling occurs, we should see nations defining
their tariff lines more narrowly. In the example at hand, the single tariff line applied to the
combined Y, Z sector would turn into two tariff lines as part of the effort to protection Z andliberalise Y.
5.2.

Firm-specific parts and components: Export processing

In the simple models explored in Sections 3 and 4, Y and Z were homogenous goods in thespirit of the Walrasian models employed. When it comes to manufacturing, however, this is
not the only reasonable assumption. For example, seats produced for a particular Toyota
sedan do not fit into a local made sedan, say Malaysia’s Proton. As it turns out, we can use acombination of the models to study this sort of situation.
To be concrete, consider a three segment supply chain where parts (X) are used in making
components (Y) which are used in making final goods (Z). Initially, coordination costs are
such that all production segments are bundled in all nations, and we have some production inboth Home and Foreign. Furthermore, suppose that Home has poor technology, butcompensates for this with low wages.
The shock we focus on is an exogenous change that makes offshoring feasible. Given thewage differences, the advanced nation, Foreign, finds is economically advantageous tooffshoring the production components to Home as this allows the Foreign firm to combine its
advanced technology with low cost labour. However given the firm-specificity of parts, theoffshored component factory that is established in Foreign must import all the parts it needs.
Moreover, since the components are useless to Home producers of Z, all the output of theoffshored industry is exported. This is outward processing trade.

32

What happens to tariffs in reaction to the offshored factory? The imported parts pose no
threat to the local parts producers so a tariff would bring no political benefits (apart from thetariff revenue) and raising the tariff would actually harm the production of offshoredcomponents. If the local government cares a lot about industrial jobs and not very much about
tariff revenue, the politically optimal tariff on Foreign parts is zero. This is true whether the
local government is interested in promoting local industrial employment, value added or
profits.
However, what if it is not possible to define the tariff schedule finely enough to distinguishparts destined for the Foreign and domestic component manufacturing? Here the analysis of
the role of friction barriers helps sort things out. The specificity of parts can be modelled as alarge frictional ‘barrier’ to using Foreign parts in domestic component-making. The analysis
in Section 4.1.1 showed that domestic intermediate goods suppliers can be competitive
locally even when their fundamental costs are higher. In Figure 9 for example, tariffs arenecessary to shift the equilibrium from E1 to E2, but once the economy is at E2, the tariff canbe removed. The frictional barrier separating domestic and Foreign parts is sufficient
protection to keep the domestic parts competitive in the domestic economy. If we interpretthe frictional costs as a measure of parts-specificity, we can see that it is possible that a zeroparts tariff could be politically optimal – even if it is not possible to distinguish between
domestic and Foreign parts in the tariff schedule. In this situation, the arrival of the offshoredcomponents factory could provide the spark necessary to lower the parts tariff.
The basic point is that if the economy starts at E2, removal of the tariff has no impact on
domestic production and prices as long as the product-specificity-linked frictional barriers
imply that local parts are cheaper for the local Z producers than imported parts. Tariffs oncomponents are irrelevant to the offshored production of components as they are all exported,
so whatever tariff was optimal previously continues to be after the offshoring.
5.3.

Switch in government type

Many accounts of unilateral tariff liberalisation in the international relations literature stressthe importance of ideas. As the political scientist Razeen Sally puts it: “… practicalobservation teaches us that the prevailing climate of ideas, interacting with interests andevents, can entrench or sway this-or-that set of policies. A policy consensus on importsubstitution, state planning and foreign aid was strongly embedded in developing-country
33

governments and international organisations up to the 1970s. … This set of ideas was
overturned by what came to be called the Washington Consensus, which reflected seachanges in political ideology and in development economics.” (Sally 2008).
It is easy to capture such effects by combining our formal models. If a government starts witha ‘development state’ objective function as in Section 4.2 but switches to a PFS objectivefunction as in Section 3.1, it will find it politically optimal to remove tariffs that it previously
found optimal to impose. Less radically, the government could start with a development state
objective function and raise the weight it places on social welfare, i.e. the ‘a’ parameter.

6.

DUAL TRADE DEVELOPMENT AND THE DEATH OF IMPORT SUBSTITUTION

The final stylised fact that we wish to address is the fact that import substitution seems tohave disappeared as a viable development strategy at approximately the same time as thesecond unbundling got going in manufacturing. Here we present the outlines of model thatsuggests the two are related. We consider a model in which production unbundling per se
renders import substitution policies ineffective. This is relevant to unilateral liberalisation
since developing countries rather rapid turnaround on the merits of industrial tariffs is verymuch associated with a switch in industrialisation strategy.
For example, countries in East Asia have long followed a dual-track industrialisation strategy.
On one hand, they pursued import substitution in an effort to create industries via importprotection. On the other hand, they encouraged export platforms that employed their workers
to produce goods for exports – often employed direct or indirectly by multinationals. As the
1980s and 1990s proceeded, the classic import substitution track failed increasingly while theexport-oriented track increasingly succeeded.
The model presented here shows how the offshoring-track renders the import-substitution
track less viable. The basic story is that the widespread offshoring of labour-intensive tasks
lowers the marginal cost for Foreign final goods and this makes it harder for the developing
country to compete in the final good market.
6.1.

The model

The basic model is that of Chapter 2.5 in Baldwin et al (2003), which is itself based on the‘footloose capital’ model of Rogers and Martin (1995). There are two regions, two sectors,
and two productive factors. The regions are symmetric in terms of tastes, but may differ in34

terms of technology and openness to trade. The two sectors are referred to as industry andagriculture. Industry is marked by increasing returns, monopolistic competition and iceberg
trade costs. The agricultural sector is assumed to produce a homogeneous good underWalrasian conditions (constant returns and perfect competition) and its output is tradedcostlessly. Assuming that both nations produce some A in equilibrium, this will equalise
prices and thus indirectly connect wages in the two nations. That is, w*aA*=pA= waA, where
the w and w* are northern and southern wages (southern variables are indicated with anasterisk), and aA* and aA are the respective unit labour input coefficients. With this, we seethat the high technology nation (south) will have a higher wage measured in units of thenumeraire, viz. w*/w= aA/aA* >1.
The productive factors are physical capital K and labour L, with K being international mobile
while labour is immobile. As capital owners are immobile across regions, physical capitalmoves but all of its reward is repatriated to its country of origin. Worldwide supplies ofcapital and labour are fixed, with the world’s endowment denoted as Lw and Kw.
Because physical capital can be separated from its owners, the region in which capital’s
income is spent may differ from the region in which it is employed. We must therefore
distinguish the share of world capital owned by northern residents (we denote this as
sK≡K/Kw) from the share of world capital employed in the north. Because each industrial
variety requires one unit of capital, the share of the world capital stock employed in a region
exactly equals the region’s share of world industry. Consequently, we can use north’s
industry share, i.e. sn≡n/(n+n*), to represent the share of capital employed in the north andthe share of all varieties made in the north.
The cost function of a typical industrial firm in the FC model is non-homothetic; that is to say,the factor intensity of the fixed cost differs from the factor intensity of the variable cost. To
keep things simple, we make the extreme assumption that the fixed cost involves only capitaland the variable cost only involves labour. More specifically, the cost function is: π + w L a m x
where π and wL are the rewards to capital and labour, am is the variable unit input
requirement, and x is firm-level output.
The representative consumer in each region has preferences given by:

35

V=

E
;
P

P ≡ p 1A− µ (∆ ) ; ∆ ≡ ∫
−a

nw

i =0

p i1−σ di, a ≡

µ
σ −1

(7)

where , nw is the mass (roughly speaking, the number) of industrial varieties available
worldwide, µ is the expenditure share on industrial varieties, and σ is the constant elasticity
of substitution between any two varieties. Also, E is northern expenditure, P is perfect priceindex, pA is the price of A, pi is the consumer price of industrial variety i (the variety
subscript is dropped where clarity permits).
The last assumption concerns factor migration. Physical capital moves in search of thehighest nominal reward (i.e. measured in terms of the numeraire) rather than the higher real
reward (i.e. deflated by a price index) since its income is spent in the owner’s region
regardless of where the capital is employed. 18 Inter-regional factor flows are governed by the(π − π *)(1 − sn ) sn .
ad hoc “migration” equation sn =6.1.1.

The ‘Peripherality Point’

The location of industry this economic geography model depends upon relative market sizes
and on the degree of domestic and foreign openness (see Baldwin et al, 2003,Chapter 2.5).
Here we add a third concern, namely comparative advantage. A convenient way to study theinteraction of all these forces is to calculate the ‘peripherality point’, i.e. the smallest market
size that permits the small/poor nation to attract at least some industry.
To be concrete we consider the north to be the small (poor) nation that is struggling topromote industrial development when all industry is initially located in the large (rich)south. 19 To add an important real world element to the equation, we allow for technology
differences by assuming that the ratio of labour input coefficients differs in the two nations.
In particular we assume that the north’s ratio aM/aA differs from the south’s aM*/aA*, where
the ai’s are sectoral unit labour requirements using our standard notation.
With this modification, the rewards to capital are: 20

18

Nominal versus real here means the reward in terms of the numeraire rather than reward in terms of theconsumption bundle CA1-µCmµ19

In New Economic Geography models, real incomes depend upon industrial location and openness. If bothcountries are equally open, then, as usual, the small country will have less industry and thus a higher price index.
In other words, the small country will also be the poor country.
20

Details of the calculation of the peripherality point can be found in Chapter 11.4 of Baldwin et al (2003).

36

s
∆

π = b( E +φ * (1 − s E )∆*) χ ; π * = b(

φs E
∆

+

1 − sE
);
∆*

χ ≡(

aM
aM *

(8)

where

∆ = χs n + φ (1 − s n ), ∆* = φ * χs n + 1 − s nand χ (a mnemonic for comparative advantage) measures comparative advantage with χ>1indicating a comparative advantage for the north in industry; sE is the share of world
expenditure in the north, and φ is the free-ness of trade, i.e. it equals τ1-σ where τ is theiceberg trade cost. Note that sE, is exogenous as L is immobile and K’s income is repatriated.
Solving the location condition π=π* for the spatial division of industry, sn, allowing fordifferences in size, openness, and comparative advantage, we have:sn =((1 − sE )φφ * + sE )χ − φ(9)( χ − φ )(1 − χφ *)where, as usual, this is only valid for economically relevant shares; if the right-hand side
exceeds unity or is less than zero, then sn is one or zero as appropriate.
Although our expressions are general, we will be particular interested in the case where χ>1,
i.e. where the small/poor/un-industrialised nation actually has a fundamental comparativeadvantage in industry. The interest lies in the fact that in a neoclassical model, the small northwould always have some industry regardless of trade costs. In an economic geography model,
by contrast, market access considerations can allow a pattern of specialisation that contradicts
comparative advantage. Furthermore, since wages are equalised yet north has a lower labour
input coefficient in industry, the unit cost of industrial production is lower in the north.
To find the peripherality point, we view sE as a parameter and search for the sE where sn isjust equal to zero, i.e. where the core-in-the-south is just barely sustained. Solving sn=0, we
get the critical market size of the rich/northern market to be:
sE =
P

φ
1
( − φ*)*
1 − φφ χ(10)

where sEP is the peripherality point, i.e. the size of the small northern market that implies it
has no industry. Since is increasing in sE, we know that north will be without industry (i.e.
will be the periphery) for any market size that is less than sEP.
A particularly salient feature of the peripherality point is that even if the north has a native
comparative advantage in industry (χ>1) – so that the unit labour cost of producing in north isbelow that of the big south – industry can still be fully concentrated in the south. In otherwords, this is an example of agglomeration producing a trade pattern that contradicts thepattern predicted by comparative advantage.
37

The expression for sEP conveniently organises the various forces that foster industrial
underdevelopment. By inspection, sEP is decreasing in χ and in φ*, and increasing in φ. Thismeans that the greater is the north’s comparative advantage in manufacturing, the smaller its
market must be to sustain peripherality. Moreover protection of the big market (the south in
this case) makes location in the small north less advantageous, so higher big-market
protection (dφ*<0) allows northern peripherality at a higher northern market size.
6.2.

Dual track interaction: export promotion extinguishes importsubstitution

To relate this to the matter at hand, it suffices to note that χ would – in a more complete andmore complex model with intermediate inputs – depend upon the cost of producing thoseintermediate inputs. If we start from a world where all production is spatially bundled – i.e.
both nations must produce all their own intermediate inputs – the expression for the
peripherality point is exact. Now suppose that exogenous changes such as the ICT revolution
make it feasible to geographically separate the manufacture of some intermediate inputs andthe higher-technology southern firms can bring their superior technology with them if they
set up factories in the low-wage north. For the south this would look like the offshoring ofindustrial jobs; for the north it would look like part of their export-oriented development
strategy.
The result will be that southern firms will now see the cost of their intermediate inputs fall,
while the costs facing northern firms are unchanged. In terms of the model, this will raise χ,i.e. it will exaggerate the native Ricardian comparative advantage enjoyed by south. Given
the formula for the equilibrium peripherality point, we see that the offshoring of parts
production to the north has worsened prospects for the north’s downstream industry. Indeed if
the shift in χ is large enough, the poor north may see its “infant industry” (the downstream
industry) completely wiped out. This, of course, is the result we were trying to illustrate.
6.2.1.

Discussion

While the model used to illustrate this point is rather special – and indeed not fully worked
out here – my conjecture is that the basic economic logic is quite robust. Developing nations
who participate in the global supply chains of advanced nation manufactures of, say,automobiles, are indirectly making it harder for their final automobile makers to survive.
38

7.

CONCLUDING REMARKS

Unilateral tariff liberalisation by developing nations is a curiously universal phenomenon.
There has been, however, very little theoretical work to shape our thinking on why this isoccurring. This paper is an attempt to redress this lacuna by introducing three novel
mechanisms that could account for unilateral tariff liberalisation by developing nations that
previously embraced import substitution policies. The particular emphasis is on the role ofproduction unbundling as a trigger of this unilateralism.
One mechanism focuses on the way that reduced frictional barriers to trade in parts andcomponents can undermine the correlation of interests between developing country parts
producers and their downstream customers. A second mechanism focuses on the way that
Kojima’s pro-trade FDI – a critical component of production unbundling – raise the marginalpolitical economy cost of maintain high upstream barriers. The third mechanism works via amore general equilibrium channel. The idea is that developing country’s participation in the
supply chains of advanced-nation industries tends to undermine the developing country’s
competitiveness in final good production. The eroded final-good competitiveness raises themarginal cost of final good protection, so the developing nation government may find it
politically optimal to marginally lower final good tariffs.
These economic logics most naturally fit the unilateralism seen in East Asia, Mexico, andCentral Europe. Unilateral tariff liberalisation, however, is an almost universal phenomenon.
The autonomous tariff cutting has also occurred in agriculture goods, and a broad range ofnations as Table 2 shows. All developing nations ranked among the 50 largest importers in
the world in 2009 are listed. The first pair of columns shows the bound tariffs – i.e. the tariffceilings they have agreed to as WTO members. The high bound rates typically reflect theimport substitution tariffs of the 1960s and 1970s which were not negotiated down asdeveloping nations did not play reciprocally in the GATT rounds. 21 The fact that the applied
rates (i.e. the tariffs actually charged in 2009) are generally far below the bound rates is agood indication of the extent of unilateral tariff cutting.

21

Following the logic of the Haberler Report discussed in the introduction, the GATT granted ‘special anddifferential’ treatment to developing nations that allowed them to free ride on the MFN clause duringmultilateral trade negotiations. As a consequence, they did not lower their bound rates.

39

Accounting for this broad set of facts surely requires a combination of mechanisms. The
novel mechanisms highlighted in this paper, for example, cannot explain tariff cutting in
agriculture and developing nation not particularly involved in manufacturing. The basic
Krishna-Mtira story, which suggests that unilateralism is contagious, probably comes in toplay. Also important in several cases in Africa and in the Indian case was the conditionality
imposed by the IMF. It would also seem important to consider Ornelas’s approach that
focuses on the why that selective cutting tariffs raises the variance of the tariff structure andwith this, the inefficiency of the status quo tariff structure. This in turn could produce newpolitical pressures to even out the tariff structure by lower tariffs not directly affected byliberalisation mechanism discussed in this paper.
Table 2: Leading developing importers: Applied and bound tariffs, 2009
Agricultural goods
Non-agricultural goods
MFN applied
Bound
MFN appliedHong Kong
0
0
0
0
Iran
n.a.
28.9
n.a.
25.6
Russia
n.a.
14.2
n.a.
10.2
Ukraine
11.1
13
5
4.4
China
15.8
15.6
9.1
8.7
Chinese Taipei
17.8
16.9
4.8
4.5
Vietnam
18.5
24.2
10.4
15.7
Saudi Arabia
20.7
7.1
10.5
4.9
UAE
25.4
7.1
13.1
4.7
Singapore
29.1
0.2
6.3
0
Argentina
32.5
10.3
31.8
11.9
Philippines
34.7
9.7
23.4
5.7
Brazil
35.5
10.2
30.8
14.1
Thailand
42.7
25.2
25.6
8.2
Mexico
44.2
22.9
34.9
11.1
Indonesia
47.1
8.5
35.6
6.7
Venezuela
55.7
16.8
33.6
12.8
Korea
59.3
49
10.2
6.6
Turkey
60.1
42.2
16.9
4.8
Malaysia
83.4
14.7
14.9
8
Egypt
96.1
66.4
27.7
9.6
India
114.2
32.2
34.7
10.1
Source: WTO Tariff Profiles, 2009 (on line database); Russia and Iran were not WTO members in 2009 and so
Boundhave no bound rates.

This pastiche of mechanisms is a long way from a clear and convincing account of thepolitical economy driving the massive, unilateral, and near-universal tariff liberalisation thathas swept the developing world since the late 1980s. Plainly more theoretical work is needand more empirical work is needed to guide it.

40

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