to coordinate tariff reductions for the governments of two large countries, neither of which would have a unilateral incentive to reduce tariffs because it would suffer terms-of-trade losses. They interpret the GATT principle of reciprocity as providing a framework for the mutual reduction of import tariffs that serves to expand trade volumes from inefficient levels of market access when under Nash tariffs to jointly efficient levels. Reciprocity allows for the mutual reduction in tariffs that serves to _neutralize_ the impact on each country’s terms-of-trade so that neither country experiences a negative price effect of its own tariff liberalization.

A second important insight, and one that often goes overlooked, is that the _only_ role for the GATT/WTO in this framework is to reduce tariffs to a level that eliminates the international (terms-of-trade) externality impact of each government’s tariff choice. I.e., in the trade agreement equilibrium, the “politically optimal” trade agreement tariffs that the government imposes may still be _positive_ . In this case, once the terms-of-trade externality has been neutralized, the jointly efficient equilibrium tariffs arising under the trade agreement may still be positive and the GATT/WTO under the terms-of-trade theory will have nothing left “to do” in terms of facilitating additional liberalization.

The key implication of the theory is that when empiricists begin to examine the tariff data, the existence of positive tariffs is not, by itself, evidence that job performance of the WTO is incomplete. Under a strict interpretation of the terms-of-trade theory, the WTO only has work to be done if any non-zero tariff is positive because the country is exercising its import market power - i.e., if, for some reason, the country is a member of the agreement but the terms-of-trade component to its tariff has not been fully exorcised. Put differently, if the non-zero tariff is positive for political or redistributive purposes (in light of the government’s preferences), and all of the import market power exertion motives have been extinguished (e.g., either through reciprocal bargaining under GATT rounds or through WTO accession negotiations), then the terms-of-trade motive for the WTO would indicate that its tariff-reducing job is done.

From the perspective of this basic theory, I use the next two subsections to review recent developments in the empirical literature on trade agreements. A number of recent contributions provide evidence supporting key elements of this basic theory. However, the evidence is also beginning to shed light on particular areas where, within the international trading system, the GATT/WTO has failed to deliver evidence consistent with the baseline theory, thus identifying potential limits as to what the GATT/WTO and the terms-of-trade approach might be able to achieve.

# **2.2 The first wave of evidence on applied and bound tariffs for countries outside and inside the WTO**

In light of the main theoretical predictions of the terms-of-trade theory described above, what is the empirical evidence? As this recent and evolving literature covers a number of different trade policy environments, samples of countries, and historical moments in time, I also use Table 1 to briefly summarize.

When contemplating whether the terms-of-trade externality is a serious problem that countries 5