International coordination of trade and domestic policies

The past half century has seen a dramatic multilateral reduction in tariff barriers under General Agreement on Tariffs and Trade (GATT) negotiations. However, as tariff barriers have fallen, attention has shifted to the use of domestic policies as secondary trade barriers. A primary concern is that, as countries sign trade agreements that constrain their ability to pursue trade goals through trade policy, there will be unilateral incentives for governments to distort their domestic policies as a secondary means of protection.1 Increasingly, international trade disputes revolve around a country's use of internal regulations as a means of restricting trade. The United States has successfully challenged the system of liquor taxes in both Japan and Korea as discriminating against imported liquor, while Venezuela and Brazil have challenged American standards for reformulated and conventional gasoline as trade protection masquerading as environmentalism. GATT contains several articles concerning the international regulation of domestic policies, but the question of how to fully incorporate domestic policies within GATT negotiations (and other international trade agreements) remains contentious. Indeed, at both the Ministerial Meeting in 1994 (at the close of the Uruguay round) and the recent unsuccessful Ministerial Conference in Seattle, many GATT delegates renewed demands for the relationship between trade and various domestic policies (e.g., environmental policy, labor standards, or competition policy) to be examined. Despite the importance that has recently been placed on international cooperation over domestic policies, no theoretical basis exists for considering how to cooperate over both trade and domestic policies within an international agreement. Previous papers on negotiation over two instruments of protection (e.g., Copeland, 1989, 1990; Thomas L. Hungerford, 1991) have assumed asymmetric limitations on cooperation (i.e., they assume that one of the two instruments is either nonobservable or nonnegotiable). This paper extends such work by investigating cooperation over two negotiable instruments of protection under symmetric limitations on cooperation, and provides insight into the design of international trade agreements that incorporate cooperation over domestic policies. I adopt the view that enforcement issues are central to the understanding of international cooperation. One of the challenges of international cooperation is the absence of a central authority to enforce the terms of an agreement. Without access to an external enforcement mechanism, international agreements are viable only as long as member countries view continued cooperation to be in their own self-interest (i.e., the benefits from cooperating outweigh the potential gains from cheating).2 While the GATT/ * Department of Economics, University of Miami, P.O. Box 248126, Coral Gables, FL 33124 (e-mail: ederington@miami.edu). I would like to thank Bob Staiger, Bob Baldwin, Wolfgang Keller, Phillip McCalman, Jenny Minier, seminar participants at the NBER Conference on Trade, the Environment and Natural Resources, and two anonymous referees for comments on earlier versions of this paper. Any remaining errors are, of course, my own. ' For example, Brian R. Copeland (1990) examined negotiation over one trade barrier, leaving a secondary trade barrier (e.g., nontariff barriers, domestic legislation, etc.) to be set noncooperatively. He shows that trade liberalization will induce substitution toward the less efficient, nonnegotiable instrument of protection due to the unilateral incentives to maintain trade protection facing countries. Thus, within a cooperative framework, the two types of barriers serve as imperfect substitutes for each other. 2 As stated by Kenneth W. Dam in his review of the GATT institution: "The best guarantee that a commitment of any kind will be kept (particularly in an international setting where courts are of limited importance and, even more important, marshals and jails are nonexistent) is that the parties continue to view adherence to their agreement in their mutual interest ... Thus, the GATT system, unlike most legal systems ... , is not designed to exclude self-help in the form of retaliation. Rather, retaliation, subjected to established procedures and kept within prescribed bounds, is made the heart of the GATT system" (Dam, 1970 pp. 80-81).