# **1. Introduction**

Policy makers have long believed that an important contribution of trade agreements is to increase the predictability of trade policy. The WTO and its multilateral agreements of trade in goods aim at ensuring that trade flows as smoothly, predictably and freely as possible. Specifically, WTO members make commitments not to increase tariffs above some bound rates.<sup>2</sup> Still, trade policy regimes are flexible and tariffs may change without the violation of WTO rules. In fact, a substantial portion of global trade occurs under flexible trade policy regimes. In 2011, on average 27% of world imports were either unbound or bound with a gap between the bound rate (the so-called "tariff water") and the applied rate greater than 5 percentage points. The global average level of tariff water is about 18 percentage points, ranging from about 4 percentage points in high income countries to approximately 24 percentage points in middle and low-income countries (Groppo and Piermartini, 2014).

Understanding the importance of trade policy certainty has become more prevalent in recent years following the reversal of existing trade commitments among major trading partners such as the United States and the United Kingdom. Recent events such as Brexit and unilateral trade policy decisions taken by the United States have caused concern for countries in terms of the uncertainty around future commitments to trade policy and the subsequent potential negative impacts on trade.

Using a recently built database on tariff water to measure the extent of trade policy flexibility of WTO member countries at the HS6-digit product level, this paper studies how a country's exports react to trade policy uncertainty (TPU) in the destination market. The paper also tries to assess the value of trade commitments in terms of additional global trade.

Economic literature has shown that the uncertainty of trade policy, defined as the risk of a tariff reversal, has real economic effects. In a model of trade with heterogeneous firms, Handley (2014) shows that uncertainty over future conditions of trade creates an option value of waiting to enter a new market, thus inducing firms to delay the entry in a foreign market. The risk of a trade policy reversal acts as a fixed cost to enter an export market and therefore has a negative impact on the extensive margin of trade. In this setup, tariff commitments under the WTO should increase the number of products that countries trade. More recently, Handley and Limão (2017) also show that trade policy uncertainty can have an impact on the intensive margin of trade through the effect it has on a firm's technology choice.

> 2 Economic theory has recently shown that the reduction of trade policy uncertainty could per se be a motive to enter an agreement. Even if an agreement does not reduce applied tariffs’ rates, there are welfare gains from reducing uncertainty (Limão and Maggi, 2013).  In support of these views, Groppo and Piermartini (2014) show that WTO commitments -of not increasing tariffs above a certain level- do reduce trade policy uncertainty. Mansfield and Reinhardt (2008) also find that GATT/WTO membership reduces export volatility by up to one-third.

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