metadata: authors: 0: author: Bown,Chad P.
count: World
docna: 0: docna: What’s left for the WTO ?
docty: Policy Research Working Paper
subtopic: International Trade and Trade Rules,Trade Policy,Rules of Origin,Trade and Multilateral Issues,World Trade Organization,Armed Conflict
teratopic: Conflict and Development,International Economics and Trade
abstracts: cdata!: Suppose that when addressing the
            question of “what’s left for the WTO?,” tariff negotiators
            relied not on the agenda established in 2001 but instead on
            the terms-of-trade theory of trade agreements to identify
            negotiating priorities. This paper uses the lens of the
            terms-of-trade theory to investigate three areas in which it
            is frequently alleged that currently applied tariffs remain
            “too high”; the implication being that the WTO’s job
            performance to date is incomplete. This includes applied
            tariffs for countries that are not members of the WTO,
            applied MFN tariffs for WTO members that are unbound, and
            applied MFN tariffs for WTO members set in the presence of
            large amounts of tariff binding overhang. These are almost
            exclusively the domain of developing countries’ own trade
            policies and they are collectively important; 3.5 billion
            people currently live in countries in which the WTO has had
            minimal effect for one of these three reasons. This paper
            builds upon recent developments in the empirical literature
            to present evidence—some direct, some indirect—that sheds
            light on each area. It then identifies specific needs for
            additional research to clarify policy implications for the
            future role of the WTO in the ever-changing international
            trading system.
repnme: repnme: What’s left for the WTO ?
display_title: What’s left for the WTO
listing_relative_url: /research/2015/12/25512759/what’s-left-wto
topicv3: Trade m1326924 698,Political Violence and War m1327310 2462,Trade Policy and Integration m1327407 775,Trade Policy m1327640 776,World Trade Organization Accession
            m1504273 2568
publishtoextweb_dt: 2015-12-02T00:00:00Z
historic_topic: Conflict and Development,International Economics and Trade
no_of_pages: 43
author_keys: 0: author_key: 739462
model_extractions: WPS7502 Policy Research Working Paper 7502 What’s Left for the WTO?

_Chad P. Bown_ Development Research Group Trade and International Integration Team December 2015
Policy Research Working Paper 7502

# **Abstract**

Suppose that when addressing the question of “what’s left for the WTO?,” tariff negotiators relied not on the agenda established in 2001 but instead on the terms-of-trade theory of trade agreements to identify negotiating priorities. This paper uses the lens of the terms-of-trade theory to investigate three areas in which it is frequently alleged that currently applied tariffs remain “too high”; the implication - being that the WTO’s job performance to date is incom plete. This includes applied tariffs for countries that are not members of the WTO, applied MFN tariffs for WTO members that are unbound, and applied MFN tariffs for WTO members set in the presence of large amounts of tariff binding overhang. These are almost exclusively the domain of developing countries’ own trade policies and they are collectively important; 3.5 billion people currently live in countries in which the WTO has had minimal effect for one of these three reasons. This paper builds upon recent developments in the empirical literature to present evidence—some direct, some indirect—that sheds light on each area. It then identifies specific needs for additional research to clarify policy implications for the future role of the WTO in the ever-changing international trading system.

This paper is a product of the Trade and International Integration Team, Development Research Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at cbown@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# What’s left for the WTO?<sup>_∗_</sup>

Chad P. Bown The World Bank, CEPR and CESifo JEL: F13 Keywords: WTO, tariff liberalization, MFN, developing countries, tariff bindings, binding overhang, non-members

> _∗_ Correspondence: Development Research Group (DECTI); The World Bank, 1818 H Street, NW, MSN MC3 303, Washington, DC 20433 USA; Tel: +1.202.473.9588, fax: +1.202.522.1159, email: chad.p.bown@gmail.com, web: https://sites.google.com/site/chadpbown/.

Special thanks to Kyle Bagwell and Robert Staiger for useful discussions. Maurizio Zanardi, Anna Maria Mayda, Ben Zissimos, Mostafa Beshkar, Rick Bond, Kamal Saggi, and participants at the CESifo Venice Summer Institute provided insightful comments on an earlier draft. Thanks also to Alessandro Nicita, Marcelo Olarreaga, and Peri Silva for graciously sharing their estimated trade elasticities. Research for this paper has been supported in part by the World Bank’s Multidonor Trust Fund for Trade and Development and through the Strategic Research Partnership on Economic Development. Semira Ahdiyyih provided outstanding research assistance. All remaining errors are my own.
# **1 Introduction**

While the WTO may appear ubiquitous, in reality there are substantial segments of the international trading system that remain seemingly untouched by its reaches. This paper utilizes the lens of the terms-of-trade theory of trade agreements and insights from recent empirical developments to investigate three of these areas in particular. First, at least 36 countries are not WTO members. The people living in these countries do not enjoy the basic rights and obligations of the multilateral system for 100 percent of the products that they might trade. Second, another 25 countries have now been full WTO members for more than 20 years and yet their governments have not taken on even the minimal legal commitment of binding the upper limit of their import tariffs for more than two thirds of manufactured products. Third, even for the WTO members that have legally bound their tariffs, another 45 countries have committed to binding rates that convey limited economic meaning. On average, the binding commitments are more than 15 percentage points above these countries’ applied MFN tariff rates; put differently, these countries could immediately and permanently raise their applied MFN tariffs by an average of 400 percent with only minimal notification to other WTO members and with no required compensation. Combined, more than 3.5 billion people live under one of these three sets of conditions in what are predominantly developing countries.

One reason why I highlight and choose to investigate these three areas is because of the crossroads at which the WTO currently finds itself. On one hand, trade policy negotiators seem to be moving on past the WTO. The WTO’s current and ongoing Doha Round of multilateral trade negotiations is seemingly dead; albeit, its failures may be at least partially laid at the feet of those who established the Doha negotiating agenda in 2001. Many have argued the agenda and approach to be fundamentally ill-fitted to deliver any sort of successful outcome along the lines of what the previous institutional and reciprocal negotiating frameworks of the GATT had repeatedly delivered over eight previous Rounds and more than 50 years of negotiations (Bagwell and Staiger, 2014).<sup>1</sup> Perhaps more threatening to the stasis that currently plagues the WTO, however, is that many important WTO members are turning their negotiating efforts away from the multilateral system and toward something else. This includes moving away from the GATT/WTO’s historical, “shallow”-integration approach of negotiating over tariffs and market access in favor of the “deeper” integration and direct negotiation over behind-the-border policy instruments through the “megaregional” negotiations of the Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (T-TIP), as well as a potential Regional Comprehensive Economic Partnership (RCEP) or Free Trade Area of the Asia-Pacific (FTAAP)(Bagwell, Bown and Staiger, forthcoming).<sup>2</sup> This movement away from the WTO and toward these mega-regional efforts is being led by both historical champions of the multilateral system, such as the United States, European Union, and Japan, as well as other recent and chief beneficiaries, such as China.

> 1Other explorations behind the stalled Doha Round and its ineffectiveness include Martin and Mattoo (2011) and Jones (2010). For a behind-the-scenes perspective of many of the personalities involved, see Blustein (2009).

> 2Krishna (2014) also provides a skeptical view of the proliferation of preferential trade agreements and its implications for the multilateral trading system. See also Maggi (2014).

1
On the other hand, despite the trading system’s frustration with the lack of negotiating advancements taking place under the WTO, economics _research_ has made improved strides toward clarifying the core microeconomic and institutional underpinnings behind the GATT/WTO’s relatively successful achievement of reaching and sustaining levels of import tariffs that are historically low, even despite massive macroeconomic shocks to the system (Bown, 2011a). In particular, the terms-of-trade literature of trade agreements, most closely associated with the theoretical developments introduced by Bagwell and Staiger (1999, 2002), as well as the inaugural empirical work of Broda, Lim ̃ao and Weinstein (2008), has ushered in a number of recent theoretical and empirical advancements. In Section 2, I survey the key aspects of this literature that have significantly helped clarify our understanding of the “status quo” of trade policy under the multilateral system. Many of these insights rely on understanding the fundamental role played by the WTO as a voluntary trade agreement between countries seeking to address the prisoner’s dilemma outcome of terms-of-trade externalities.

One of the primary insights from the theory is that, in order for the GATT/WTO to work at getting significant areas of the global economy to internalize such externalities, it has focused on shallow integration and the reduction of border barriers (tariffs), relied on fundamental principles such as reciprocity, most-favored nation (MFN) treatment and national treatment, and secured market access commitments implied by tariff reductions through a legal system of tariff bindings that is backed up by third party dispute settlement. The research that I review in Section 2 not only sheds light on some of the successes of this approach at getting countries to internalize termsof-trade externalities, but it has also usefully begun to reveal specific places where the impact of the historical approach has proven incomplete, and potential explanations behind why any failures have arisen. My approach is to extend this analysis of the WTO and with a particular focus on three areas of tariffs that are particularly critical to the interests of developing countries.

In Section 3, I begin this paper’s empirical contribution by introducing the applied tariffs for the 36 countries and 500 million people that are not yet a part of the WTO system. I choose this as my launching point not only because this is where the WTO has had the least impact to date, but also because this is one of the least studied areas of international trade policy. As such, much of my effort here is expositional - i.e., a contributing reason as to why so little has been studied for these countries is due to a combination of data limitations (some of which I am able to overcome) but also because these particular countries have many other economic and social problems to address in the global community that may outweigh the importance of international trade agreements. Nevertheless, this section also provides me the opportunity to compare the applied tariffs and political-economic characteristics of the current WTO non-member countries with a group of nearly 30 other countries that recently acceded to the WTO. Furthermore, I am able to utilize both newly available data and newly constructed measures of importer market power - taking advantage of newly available foreign export supply estimates provided by Nicita, Olarreaga and Silva (2013) - to reassess (and ultimately largely confirm) previously provided evidence in the terms-of-trade literature on the tariff-setting behavior for a subsample of these recent accession countries, and the role of market 2
power in affecting the changes to their trade policies upon accession to the WTO.

I then turn to a more formal empirical investigation of two areas in which the applied tariffs of current WTO members are sometimes alleged to be too high. Section 4 focuses on the applied tariffs for the products that are currently “unbound” in the WTO system. I examine a set of 25 countries (and more than 700 million people), mostly concentrated in Sub-Saharan Africa, that are longstanding WTO members that have nevertheless not yet taken on the legal commitment to bind the upper limit of their tariffs at any level for more than two thirds of their manufactured import products. Nevertheless, while there may be non-terms-of-trade motivated arguments for the WTO to encourage these countries to bind the tariffs of these currently unbound products, I fail to find evidence that the currently applied tariffs for these unbound products are positively related to the importing country’s ability to exert market power.

There is, however, evidence linking import market power influences and applied MFN tariffs for countries that have legally bound their tariffs under the WTO and yet which retain considerable discretion as to the _level_ at which they would be applied due to the existence of “tariff overhang.” In Section 5, I illustrate the 45 countries (and more than 2.4 billion people) where substantial tariff overhang still remains in the WTO system, and I provide some evidence identifying this area as potentially one in which the terms-of-trade theory could motivate the WTO as useful forum to facilitate additional liberalization.

Finally, in Section 6, I conclude by integrating this evidence alongside related work that highlights the difficulties confronting negotiators seeking to utilize the WTO system to facilitate additional tariff liberalization. As such, I also highlight priority areas and some remaining unanswered questions for policy-related research.

Before delving into the formal theoretical and empirical analysis, it is worth acknowledging two additional points. First, my focus on tariffs and the terms-of-trade theory is limited by design so as to keep the empirical analysis manageable, but it is admittedly incomplete.<sup>3</sup> Second, the role of the WTO in the multilateral trading system goes well beyond it serving as a forum for reciprocal tariff cutting. Put differently, even if the evidence were to indicate that the WTO’s tariff-liberalization function were now somehow complete - which even the evidence that I review and provide below suggests is not yet the case - the WTO _institution_ makes other substantive contributions to the system that are not currently provided by any other entity. These include it providing fora for the peaceful resolution of bilateral trade disputes between countries over its commitments and obligations (Maggi and Staiger 2011, 2015; Bown 2009, Bown and Reynolds

> 3In addition to the terms-of-trade theory described in more detail below, there are other prominent theories of trade agreements that I will not integrate into my formal analysis but which also deserve mention. The first alternative approach to trade agreements is the commitment theory (Maggi and Rodriguez-Clare 1998, 2007; Staiger and Tabellini, 1987; Lim ̃ao and Tovar, 2011) in which governments may seek an external agreement to tie their own hands vis-a-vis their private sectors. Other recent alternative theories include consideration of potential other international externalities aside from the terms-of-trade externality, e.g., that may arise through firm delocation (Ossa 2011, 2012). A third theory is motivated by the rise of offshoring (Blanchard 2007, 2010; Antr`as and Staiger 2012a,b). Bagwell, Bown and Staiger (forthcoming) provide a more extensive survey of theoretical and empirical advances in these areas as well as the terms-of-trade literature. Bown and Crowley (forthcoming) survey the empirical landscape of tariffs and other trade policy instruments in historical perspective and in more detail.

3
2015a,b) and for transparency and the dissemination of information - e.g., the Trade Policy Review Mechanism and other reporting requirements - regarding how governments make changes to their trade policies in ways that affect trading partners’ market access (Maggi, 1999).

# **2 The Terms-of-Trade Approach to Trade Agreements**

My analysis of “where to look” for evidence that the WTO’s tariff liberalization performance-todate may be incomplete is guided by the terms-of-trade theory of trade agreements and a number of recent pieces of empirical evidence. This section provides a brief description of the core insights of the terms-of-trade theory of trade agreements and recent empirical research that searches for evidence of this theory inside and outside of the GATT/WTO system. Its main purpose is to survey the state of the art of the existing research literature in this area in order to establish expectations for my formal empirical analysis that follows. I begin with the theory of the terms-oftrade motivations for trade agreements, before I turn to evidence on how this affects trade policy determination for countries outside of the GATT/WTO, for countries that change their tariffs in order to enter the WTO through accession, and for countries that have been more longstanding participants of the GATT/WTO regarding their applied and binding tariffs.

## **2.1 The terms-of-trade theory of trade agreements**

Here I review the basics of the terms-of-trade theory of trade agreements introduced in Bagwell and Staiger (1999). In a noncooperative setting characterizing the absence of a trade agreement, two large countries each have a unilateral incentive to impose import tariffs at Nash levels that are too high, relative to the jointly efficient outcome. Each Nash tariff is too high because it shifts some of the cost of the tariff - by reducing the price received by the trading partner’s exporters of the product - onto the trading partner via a terms-of-trade externality. The result of each country setting its tariff at an excessively high level is the classic, terms-of-trade driven prisoner’s dilemma outcome. Bagwell and Staiger then compare this outcome with an outcome whereby they suppose that each government was not motivated by terms-of-trade considerations in its objective function when setting its tariff, but that each government was only (potentially) concerned with the domestic price effects of its tariff choice. In this way, their model allows for the consideration of political-economy influences; e.g., a government may be interested in using its tariff to redistribute income from one group in the domestic economy to another.<sup>4</sup> The Bagwell and Staiger (1999) approach generates a number of insights that have subsequently had implications for empirical analysis.<sup>5</sup> First, a trade agreement like the GATT/WTO can be used

> 4In this way it allows for political-economy influences of many different classes of models, including Grossman and Helpman (1994).

> 5Some of the terms-of-trade externality analysis in the context of trade policy was provided by Johnson (1953-54). Bagwell and Staiger (2002) provides a book-length treatment that considers a number of alternative applications of the model to trade agreements under different settings, including consideration of some forms of nonpecuniary exernalities and domestic policy instruments.

4
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
seek to solve by establishing a trade agreement like the GATT/WTO, a first question to consider is what are the determinants of tariffs that countries set when they are not constrained by such agreements? Is there evidence that tariffs are influenced by import market power, or is the variation in import tariffs driven simply by domestic political economy influences?

Broda, Lim ̃ao and Weinstein (2008) were the first to provide an empirical approach to directly examine whether the tariffs set by a number of countries outside of the WTO - and thus countries unencumbered by (multilateral) trade agreement constraints - were influenced by market power motives. Their benchmark analysis focused on the applied tariffs set by 15 countries listed in Table 1 during the 1993-2000 period when they were not GATT Contracting Parties or (at the time) members of the WTO. They first construct estimates of foreign export supply elasticities facing those importing countries, and they then provide strong evidence that governments impose higher import tariffs in products where they are found to have market power, as captured by the inverse of the foreign export supply elasticity that their consumers face, just as is predicted by the canonical optimal tariff formula. Their first round of evidence was thus consistent with the potential termsof-trade motive for the GATT/WTO - i.e., in the absence of such agreements, governments set import tariffs that reflect their market power and a result is that some of the externality costs of those higher tariffs are imposed on trading partners through reductions in those partners’ exporterreceived prices.

To further support their analysis, Broda, Lim ̃ao and Weinstein (2008) also examine the relationship between these measures of a country’s import market power and a number of different trade policy instruments utilized by the United States. The US is different from the 15 countries in their baseline sample in that it is a country _within_ the GATT/WTO and one that the theory would predict trading partners would have been motivated to seek the terms-of-trade component of its tariffs extinguished. Indeed, Broda, Lim ̃ao and Weinstein (2008) find no statistical evidence of market power affecting US applied MFN import tariffs; this is consistent with an interpretation of decades of GATT/WTO tariff reduction negotiations having eliminated the terms-of-trade cost-shifting component from the applied US tariff. Furthermore, they do find evidence that market power considerations affect US trade policies in two other places: first, the US application of non-tariff measures - or the policies less constrained by GATT/WTO negotiations and rules;<sup>6</sup> and second, the US’s statutory (or “column 2”) tariffs, which are the tariffs that the United States applied to a number of countries that were not members of the WTO and with which the US did not have normal trading relations.

Given that countries outside of the GATT/WTO agreement may impose import tariffs in a way that reflects their market power, is there other evidence that such market power is neutralized (or at least reduced) when they eventually join the WTO? Bagwell and Staiger (2011) examine this question by empirically examining the determinants of the tariff cuts made by a group of 16 countries

> 6As I describe in more detail below, Bown and Crowley (2013a) provide a separate empirical analysis of a particular class of non-tariff barriers for the United States. That study covered a different time period and assessed the terms-oftrade implications of a slightly different theoretical model (Bagwell and Staiger, 1990), but it also provides evidence consistent with the terms-of-trade theory.

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that acceded to the WTO between 1995 and 2005, five of which (including China) overlapped with the Broda, Lim ̃ao and Weinstein sample of non-GATT countries. Unlike countries that had long been members of the GATT/WTO but whose tariff levels may have gradually been brought to more globally efficient levels over time, the Bagwell-Staiger framework investigates whether these new members brought their tariffs down from unbound (Nash-like) levels to bound (politically optimal and efficient) levels in one shot upon accession and in accordance with the terms-of-trade theory’s core predictions.<sup>7</sup> The Bagwell-Staiger evidence is broadly consistent with the theory; i.e., there is a strong positive relationship between the magnitude of tariff cuts negotiated under the WTO and the pre-negotiation volume of imports. Furthermore, for the five countries with which they have overlap with the Broda-Lim ̃ao-Weinstein sample, their evidence also holds when specifically controlling for the import market power as measured by Broda-Lim ̃ao-Weinstein estimated trade elasticities.

While these first two papers present evidence that is consistent with the terms-of-trade theory, the bulk of that evidence admittedly derives from countries either outside of the GATT/WTO (Broda, Lim ̃ao and Weinstein) or that only recently acceded to the WTO (Bagwell and Staiger). What about the trade policymaking behavior of the major economies that are both “inside” the GATT/WTO system and are the ones that have driven the GATT/WTO through sixty years of reciprocal tariff cutting under multilateral negotiating rounds? Furthermore, with the exception of the Broda-Lim ̃ao-Weinstein evidence for the United States, and the Bagwell-Staiger evidence for China, most of the countries in these samples were not major trading economies in the international system. This has the potential to raise concerns about the external validity for the terms-of-trade theory of trade agreements if, for some reason, these countries did not exhibit behavior consistent with that of the major players.

Ludema and Mayda (2013) provide one approach to address these concerns by examining the applied MFN tariffs under the WTO at the conclusion of the GATT’s Uruguay Round of negotiations for a larger sample of 26 countries, including most of the major economies.<sup>8</sup> In particular, they explore whether variation in these countries’ applied MFN tariffs is related to variation in these countries’ import market power and their trading partners’ (exporters’) industrial concentration. They find that the concentration of trading partner exporter interests at the product level, as measured by the Herfindahl-Hirschman Index (HHI), helps explain applied MFN tariff variation - i.e., products with a combined situation of (i) foreign export suppliers that are less concentrated and (ii) an importer with more market power tend to have higher tariffs even after GATT/WTO negotiations.

The Ludema-Mayda evidence is that there is variation in the extent to which the terms-of-trade component of a country’s tariff may be negotiated away under the WTO and that can be linked to the free rider problem arising from the GATT/WTO’s MFN rule. First, this empirical result

> 7To clarify, Bagwell and Staiger (2011) compare a country’s unbound (applied MFN) tariff rates before the country’s WTO accession with its legally binding tariff commitment post-WTO accession, and not its post-accession applied MFN rate.

> 8See also Ludema and Mayda (2009) for an alternative approach focused exclusively on the United States.

7
is intuitive in that it may help to explain the relatively high applied tariffs remaining under the WTO in sectors such as agriculture, textiles, and footwear that continue to persist because the exporting interests behind these products are diffuse. A limitation of the historical framework for conducting negotiations may have arisen because negotiations were voluntary and the tariff liberalization outcome would be extended to all members under the MFN rule of nondiscrimination. However, because the existence of MFN implied that countries could free ride in the negotiations, sometimes a critical mass of exporting interests may not have bothered to show up at the negotiating table in the first place. Second, an important insight arising from this research is the recognition that not all terms-of-trade effects may be fully neutralized even upon a country’s entry into the WTO, a point to which I return below. I.e., Ludema-Mayda’s results identify one potential area in which there may be more tariff-liberalizing work (for terms-of-trade neutralizing reasons) to be “done”; nevertheless in discovering it, they also identify how the historical GATT/WTO approach of relying on voluntary negotiations and MFN may have contributed to the process by which tariff liberalization (for terms-of-trade neutralizing reasons) remains currently incomplete.<sup>9</sup> Finally, given the evidence that the terms-of-trade effects matter for trade policy determination, and that the GATT/WTO system may be working to at least partially neutralize such externalities through negotiations, how economically important is the job that the WTO has done for the major economies of the system? One way to address this issue is to ask how large Nash tariffs - i.e., the combination of best-response tariffs that countries would use - would be in a trade war, and what the economic costs of eliminating current levels of trade policy cooperation would be. Using a quantitative approach, Ossa (2014) constructs counterfactual estimates for the size of Nash tariffs in a model featuring seven regions (including the US, EU, Japan, China, India, Brazil, and rest of the world) and finds the median to be 58.1 percent across countries and industries.<sup>10</sup> The quantitative model suggests substantial gains from the imposition of the tariffs that are currently in place, relative to the levels of welfare that would arise were countries to resort to imposing their Nash under a trade war.

# **2.3 Additional evidence on applied tariffs, bindings, and tariff overhang for countries inside the WTO**

The next framework that I explore is the recent theoretical and empirical contribution of Nicita, Olarreaga and Silva (2013), which examines the relationship between a WTO member’s applied tariffs and the role of import market power, contingent on whether those tariffs are constrained

> 9Bown and Crowley (2013a) provide additional evidence that terms-of-trade motives continue to affect trade policy decisions for WTO members, albeit in a different trade policy setting. They provide evidence consistent with the Bagwell and Staiger (1990) repeated game model of trade agreements by focusing on the US use of antidumping and safeguards over 1997-2006. They find for a country like the US (with applied tariffs virtually at their binding level), the flexibility of antidumping and safeguards can be seen as allowing the government to raise import protection levels in response to trade volume shocks arising for terms-of-trade motivations.

> 10This is notably higher than the estimates of the tariffs applied at the height of the Great Depression in the 1930s, after the US imposition of the Smoot-Hawley tariff in 1930 and international retaliatory response. See Bown and Irwin (2015) for a discussion of the range of tariffs more likely to have been in effect just prior to the GATT’s starting point in 1947, which they put at around 22 percent.

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by WTO tariff binding legal commitments. First, they develop a theoretical model that allows for the political influence of not only import-competing sectors but also exporting sectors. In an environment in which export policies are constrained - as under the WTO, where export subsidies are illegal - they provide a theory that predicts an exporting country government will negotiate larger tariff reductions exactly where that importing country has the most market power. Their model predicts that in the instances in which applied tariffs are at their WTO binding rates, and countries are cooperating under the WTO, there will actually be a _negative_ relationship between the importer’s market power and its negotiated tariff. The intuition is that in these instances, not only does the trade agreement get the country to cooperatively reduce its tariff (so as to neutralize the terms-of-trade externality) but in equilibrium the negotiation “overshoots” and the tariff ends up even lower so as to compensate the politically organized exporters in the trading partner. Furthermore, the theoretical prediction of the positive relationship between applied tariffs and market power also arises in their model, but it only arise for applied tariffs that are well below tariff binding rates - i.e., applied tariffs in the presence of sufficiently large amounts of tariff binding “overhang.” The second major contribution of Nicita, Olarreaga and Silva (2013) is empirical. First, they construct estimates of “foreign” export supply elasticities for 101 WTO member economies at the 6-digit Harmonized System (HS06) level, resulting in a database of hundreds of thousands of importing country-product-specific elasticities. (I will draw heavily on these elasticities in the formal empirical analysis that I introduce below.) Second, they utilize these estimated elasticities to empirically investigate their model’s theoretical predictions for applied tariffs imposed between 2000 and 2009. They find evidence that the inverse foreign export supply elasticity has a _negative_ relationship with applied MFN tariffs when there is zero tariff overhang - i.e., when countries are “cooperating” in that applied rates are set at binding levels - and they find a _positive_ relationship between the importer’s market power and the applied tariff when tariff overhang levels are positive. I further investigate empirically below this second result; i.e., for “tariff overhang” products, are their currently un-checked terms-of-trade externalities that countries are imposing through their applied tariffs that the WTO could potentially be used as a negotiating forum to eliminate?

In related work, Behskar, Bond and Rho (2015) provide a terms-of-trade based theory exploring the question of where a country might set its tariff binding in relationship to its applied tariff under a trade agreement. Their theoretical model predicts that governments will seek to retain flexibility and thus bind their tariffs significantly above the applied rates where the importer has little market power. They conduct an empirical examination of product-level tariff data for a sample of 108 WTO member economies over the period 1995-2007; they also partially rely on the inverse foreign export supply elasticities generated by Nicita, Olarreaga, and Silva (2013) as the measure of import market power in their sensitivity analysis. First, they find that newly acceding WTO members bind a larger share of their product lines than the historical GATT members under the WTO. Second, their various measures of import market power are negatively related to the level of the bindings 9
that countries take on, as well as the size of the tariff binding overhang.<sup>11</sup> A final stream of recent research that I briefly highlight explores additional economic implications of countries failing to constrain their applied tariffs by leaving sufficient tariff overhang between the applied rates and their tariff bindings.<sup>12</sup> Handley and Lim ̃ao (2015) develop a dynamic, heterogeneous firms model with sunk costs of exporting and show that investment and entry into export markets is reduced when trade policy is uncertain. Furthermore, they show how a credible commitment implied by a trade agreement (e.g., reducing tariff bindings) can increase trade even if applied trade barriers are already low.<sup>13</sup> Handley (2014) provides an application of some of the key elements of this theory to the context of WTO tariff bindings and the case of Australia, finding that growth of exporter-product varieties would have been 7 percent lower between 1993 and 2001 without the binding commitments that Australia took on upon its WTO entry. While the Handley results suggest gains (to the exports) of a trading partner, one would expect that the _reciprocal_ reduction of uncertainty - i.e., two countries jointly eliminating uncertainty by simultaneously binding their applied tariffs at low levels - could lead to analogous joint gains that accrue under the distinct exercise of two countries simultaneously lowering those applied rates under a terms-of-trade neutralizing trade agreement in the first place.<sup>14</sup>

> 11To clarify, Beshkar, Bond and Rho (2015) focus on the determinants of the level tariff bindings (taking applied rates as given) whereas Nicita, Olarreaga and Silva (2013) focus on the determinants of the level of _applied_ tariffs (taking binding rates as given). Nicita, Olarreaga and Silva do not investigate the impact of import market power on either the level of tariff _bindings_ or the _amount of overhang_ between the binding and the applied tariff; an IV for the amount of overhang is interacted with the measure of importer market power.

12Separately, there is some empirical evidence related to the commitment theory of trade agreements, however, it is much less developed in the literature. Examples include Tang and Wei (2009) which finds some evidence of a positive impact of WTO accession on economic growth. Bown and Crowley (2014) find evidence for some developing countries that WTO entry has committed them to change how they implement increases to their levels of import protection (in response to macroeconomic shocks) by switching to different (and WTO-sanctioned) trade policy instruments, and this is both different from how they operated before the WTO and it is similar to the commitments and trade policy use of higher income WTO members. See also Staiger and Tabellini (1999) for evidence on the role of the GATT in allowing the United States to make trade policy commitments during the Tokyo Round of negotiations.

> 13Handley and Lim ̃ao (2015) provide a structural approach to estimating the model and apply it to Portuguese firm-level data. Their policy environment does not entail the binding of tariffs under the WTO, instead they examine the 1986 Portuguese trade agreement accession to the European Economic Community which reduced trade policy uncertainty by locking in zero import tariffs from European trading partners. Francois and Martin (2004) provide an alternative theoretical approach examining the role of tariff bindings in reducing the uncertainty associated with market access. Lim ̃ao and Maggi (2015) provide a more general theory examining when trade agreements can provide gains through the reduction of trade-policy uncertainty. Conditional on the level of income risk aversion in a country, gains from reducing trade policy uncertainty are more likely to arise for economies that are more open and specialized and that have lower export supply elasticities.

> 14See also Handley and Lim ̃ao (2014) for a an examination of the resolution of trade policy uncertainty facing Chinese firms resulting from accession to the WTO in 2001 and the reduction of uncertainty surrounding US applied tariffs that had persisted during the 1990s through the annual Senate debate on whether to renew China’s MFN treatment. They find that the effect of the WTO on reducing the threat of a trade war explains 22 percent of China’s export growth to the US, and that the reduction in policy uncertainty lowered U.S. prices and increased consumers’ income by the welfare equivalent of an 8 percentage point tariff decrease.

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# **3 WTO Non-Members (and recently acceded members)**

This section focuses attention on the current WTO non-member countries in the international trading system. One ultimate question of interest - to which I will admittedly only be able to provide very indirect evidence - is whether such countries apply import tariffs that reflect market power motives and whether those would be neutralized should those countries accede to the WTO. First, I introduce the current WTO non-members and their political economic characteristics. Then I examine a comparison group of countries that recently acceded to the WTO. I then investigate empirically the implications of the term-of-trade theory of trade agreements for that second group of countries by applying the Nicita, Olarreaga and Silva (2013) foreign export supply elasticities to the basic estimation approach introduced by Bagwell and Staiger (2011).

## **3.1 Introduction and political-economic characteristics**

As Figure 1 illustrates, the current non-members of the WTO are found throughout the world; nevertheless, they are disproportionately concentrated in the Middle East and North Africa, East Africa, and Central Asia. Table 2 provides summary data for key economic characteristics of these countries, as well as comparable data for a separate list of important comparison countries that recently acceded to the WTO - i.e., between 1998 and 2014.<sup>15</sup> For ease of exposition, I rank the countries in each group by Gross National Income (GNI) per capita, and I split them roughly into three categories based on GNI per capita - I refer to the three groups as low income, lower-middle income, and middle and higher income.<sup>16</sup> For countries that are not yet members of the WTO, I also provide information on whether they have formally been granted “observer” status by the WTO.<sup>17</sup> Table 2 reveals a number of stylized facts about the current WTO non-members. First, they are disproportionately poor countries - at least 28 of the 38 countries have GNI per capita in 2013 that was less than the world average of $10,683. Second, there is a wide range in the size of the populations of these countries. Some are tiny (and relatively wealthy) city-states or islands, with less than a million people. Others are poorer and larger countries in Africa - the largest is Ethiopia at 94 million people. Combined, 490 million people live in these WTO non-member countries, or 6.9 percent of the total world population.

Most of the WTO non-member countries had imports that were greater than exports in 2013. The exceptions are mostly made up of major energy (oil and/or natural gas) producers/exporters - e.g., Algeria, Azerbaijan, Equatorial Guinea, Iran, Iraq, Kazakhstan, Libya, and Turkmenistan. For

> 15I utilize data on accessions starting only in 1998 (instead of, for example, 1996) because some of the initial wave of WTO accession countries in 1996 and 1997 were countries that may have simply waited to begin the domestic legal process to formally ratify WTO membership until after the major WTO members had done so, i.e., recalling the US experience at failing to ratify the ITO in the 1940s, which led to the GATT.

> 16Note that these three country groupings do not correspond to the World Bank’s official categories.

> 17Governments with WTO observer status are not members but they are granted limited WTO rights, such as access to certain WTO meetings, but they are also expected to uphold other obligations, such as making some (minimal) contributions to the WTO’s operating budget.

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the rest of the countries with imports substantially larger than exports, this is potentially notable for two reasons. First, the expectation might be that their imports would be limited because their import policies are legally unaffected and undisciplined by the WTO system. Second, many of the non-members are relatively poor and are therefore likely (at least in principle) to be beneficiaries of unilateral preference programs offered by WTO member countries. Ceteris paribus, their firms may face lower-than-MFN tariffs for their sales to those markets which would tend to encourage their exports. Nevertheless, at least at a first glance, the data does not suggest this to be the case.

Finally, I mention briefly some other geo-political factors that are likely contributors to the question of why these countries are not (yet) members of the WTO. First, fourteen of these countries can be characterized as states in Fragile and Conflict Affected Situations (FCS) (World Bank, 2014) - these are areas affected by civil war or other forms of violence and strife. Second, while Russia finally acceded to the WTO in 2012 and a handful of former Soviet Republics became members earlier, five of the former Soviet Republics (Azerbaijan, Belarus, Kazakhstan, Turkmenistan and Uzbekistan) have not yet gained entry.

Next compare the current WTO non-members with the list on the right-hand-side of Table 2, which includes the countries that acceded to the WTO between 1998 and 2014. The recently acceded countries are also disproportionately poor and include a range of small and large countries by population. The recent accession list also includes countries with geopolitical constraints, such as Russia and other former Republics of the Soviet Union (Armenia, Georgia, Kyrgyz Republic, Moldova, Tajikistan, and Ukraine, as well as Estonia, Latvia and Lithuania that have since also acceded to the European Union), and also FCS countries such as Nepal and Yemen. Overall, I conclude that these sets of WTO non-member and recent WTO accession countries have a number of similarities.

# **3.2 Establishing a benchmark: The experience of recently acceded WTO members**

What might accession to the WTO for current non-member countries mean? To provide context, in this section I benchmark these non-member countries’ current applied tariffs against the tariffs of a set of recently acceded WTO member countries. Table 3 introduces the most recently available information on the applied tariffs for these WTO non-member countries. The table documents the mean of their applied rates, as well as their minimum and maximum rates, and the standard deviation of applied tariffs across import products. The average tariff of these countries ranges from a high of 35.1 percent (Bahamas) to a flat import tariff of 2.5 percent applied to every imported product (Timor-Leste). Some of these countries do have tariffs that peak at rates higher than 100 percent.

Table 3 also provides important summary statistics for the tariffs of the recently acceded WTO members, as a point of comparison. For these recently acceded countries, I present four pieces of information: (i) the tariffs they applied five years prior to the their WTO membership, (ii) the share of imported products over which the country agreed to bind its tariffs upon accession to the 12
WTO, (iii) the average tariff binding rate that the country committed not to exceed when joining the WTO, and (iv) the MFN tariff rate that the country applied to all other WTO members in 2013.

First, Table 3 indicates that even the poorest recently acceded countries have bound almost 100 percent of their tariffs at some level. As I will observe in Section 4.1, this is very different from many developing countries at similar levels of income per capita that joined the WTO upon its inception in 1995 or which had previously been a Contracting Party to the GATT 1947, and which did not similarly bind all of their products’ tariffs. (I investigate and address this issue for such countries separately below.) Second, for a number of recent WTO accession countries, they were not forced to make substantial cuts (on average) to their applied tariffs upon entry into the agreement. Indeed, for more than half of the 27 recently acceded WTO members listed in Table 3, their average binding commitment under the WTO is actually higher than the average tariff the country applied five years prior to WTO entry, meaning that the country could (on average) increase its applied tariffs upon entry into the WTO and still be in compliance with its obligations. Major exceptions include a number of large economies such China, Saudi Arabia, Taiwan (China), and Ukraine. However, a notable characteristic of all of the recently acceded WTO members is the relatively limited amount of average tariff overhang between binding rates and applied MFN tariffs in 2013. With the exception of Vanuatu (30.6 percentage points), no newly acceded member has an average level of tariff overhang exceeding 13.8 percent in 2013 (Nepal) - as Section 5.1 reveals, this is also substantially different from countries that acceded to the WTO upon its entry into force in 1995; i.e., there are 45 WTO members with more than 15 percentage points of average tariff overhang in 2013.

Figure 2 illustrates the industry-level variation for these tariff data summarized by Table 3. The three panels represent the average tariffs by sector for three groupings of countries - lowincome countries, lower-middle-income countries, and middle- and higher-income countries. For each sector, there are two sets of bars - the first set reflects the average tariffs for the recently acceded WTO members, and the second set reflects the average tariffs for the current WTO nonmembers. Finally, for WTO members, for each sector there are three pieces of information - the grey bar reflects the average MFN applied rate in 2013, the white bar reflects the tariff binding overhang (or water) above the current applied rate, and the black star reflects the average applied tariff that was in place five years _prior to_ the country’s WTO accession. For the WTO non-member countries, the black bar represents the average tariff in the sector that the countries in that income group applied in 2013.

First compare the black stars with the black bars - i.e., compare the average applied tariffs for the recent accession countries five years prior to their WTO membership with the average applied tariffs of the current non-members. Overall, Figure 2 suggests the patterns are quite similar (conditional on income group) across industries; on average at least, the “future” WTO accession countries currently apply import tariffs that are similar to the applied tariff starting point of the recent accession countries before they gained WTO entry. And while there is variation across sectors and 13
income groups, if anything, the evidence would suggest that WTO non-members currently apply rates that are slightly higher than the applied rates of the recently acceded countries five years prior to their joining the WTO.

Second, focus attention on the applied tariff _changes_ for the countries that recently acceded to the WTO - i.e., the difference between the star (applied tariff level 5 years prior to WTO accession) and the grey bar (applied tariff level in effect in 2013). The pattern across industries and country groupings is that applied rates do tend to fall on average upon joining the WTO. In levels, the average changes are largest for the lower-middle-income group of countries in the middle panel - this reflects the fact that both more tariff cutting is likely expected of them (relative to low income countries) and they are starting from higher tariff levels (relative to higher income countries).

Third, consider the differences in tariff binding overhang that results upon entry into the WTO. On average in 2013, there is more tariff overhang remaining upon WTO accession for low-income countries in comparison to higher income countries.

While Table 3 and Figure 2 illustrate a suggestive path forward for current WTO non-member countries - if what is expected of them roughly corresponds to what has been the impact of WTO accession on the tariffs of recently acceded members - I have not yet provided any evidence that this is linked to the terms-of-trade theory of trade agreements. In the next section I consider the potential implications of WTO accession for current non-members through the lens of this theory and drawing from evidence arising from the experience of recent accession countries.

# **3.3 Empirical evidence from tariff bindings for recent WTO accession countries**

The first empirical question is whether it is likely that accession to the WTO by these current non-members would neutralize any terms-of-trade externalities that their currently applied tariffs impose on trading partners.

Because I do not have the ability to test this counterfactual, instead I examine whether there is evidence from the group of recently acceded WTO member countries to suggest that terms-of-trade externalities of their import tariffs were reduced when they joined the WTO. The alternative - i.e., that there is no relationship between their post-WTO accession tariffs and market power influences - would suggest that these countries joined the WTO with something else in mind, and thus some other approach aside from the terms-of-trade theory would be required to motivate why they find the WTO valuable.

In order to specifically investigate this question, I broadly follow the Bagwell and Staiger (2011) estimation approach described earlier. In particular, I examine whether there is a relationship between the binding rate that country _c_ adopts for HS06 product _g_ after WTO accession, ( _τgc_<sup>_WTO−binding_</sup> ), and two theoretically-motivated determinants: (i) the pre-accession applied tariff rate ( _τgc_<sup>_pre−WTO_</sup> ), and (ii) the inverse of the foreign export supply elasticity (1 _/ωgc_<sup>_∗_).I thus estimate</sup> models of the form 14
where _αc_ is importing country fixed effect, _αg_ is the HS06 product fixed effect, and _εgc_ is the iid error term. The Bagwell-Staiger theory clearly predicts _β_ 1 _>_ 0 and _β_ 0 _<_ 0, or that the post-WTO binding rate will be positively related to _τgc_<sup>_pre−WTO_</sup> and negatively related to the measure of the importer’s market power (1 _/ωgc_<sup>_∗_).</sup> My estimation exercise serves to complement the original Bagwell-Staiger approach in a number of ways. First, I utilize a slightly different sample of countries (see Table 1 for the list), though notably my additional countries include a number of relatively large (by population) importers - such as Russia, Saudi Arabia, and Ukraine - that acceded to the WTO only after the BagwellStaiger sample period. Second, here I rely heavily on the export supply elasticities provided by Nicita, Olarreaga and Silva (2013) that were not available at the time of the original study. Third, I utilize fixed effects to address other potential determinants of tariffs.<sup>18</sup> Before turning to the estimates, I also explain here the general approach that I take throughout the paper to address potential data limitations.<sup>19</sup> For example, one potential concern is that the elasticities are themselves estimates, and some of the estimated values are extreme.<sup>20</sup> First, I winsorize the data set of the elasticities by setting the extreme values to be the values at the 10th and 90th percentiles of the distribution. Second, in the baseline specifications to each of the regressions, I will take the log of the inverse of foreign export supply elasticity, and I will utilize as a robustness check either an indicator for “high elasticity” products (defined as those above the median of the distribution) or the _level_ of inverse of the foreign export supply elasticity. Third, I will also use as my measure of import tariffs _ln_ (1 + _τ_ ), though I frequently report as a robustness check a measure of the tariff that is simply the level of the tariff, _τ_ .

Table 4 provides evidence of the expected strong negative relationship between the inverse foreign export supply elasticity and the WTO tariff binding commitment taken upon accession for this sample of 12 countries that recently acceded to the WTO. I.e., ceteris paribus, newly acceding members are requested (through WTO negotiations) to take on lower tariff binding commitments in products for which they have higher market power and thus where their tariffs (if left unchecked) would result in larger terms-of-trade externality losses for trading partners. Note that I also find a strong positive relationship between the pre-WTO applied tariff and the WTO tariff binding commitment, in line with the theoretical prediction. In column (2), I show the robustness of the results by replacing the log of the inverse foreign export supply elasticity with an indicator that takes on the value of one if the elasticity is “high” (above the median value) and zero otherwise, and again the estimated size of the coefficient is negative. Specification (3) substitutes the levels of the tariffs and the elasticities for the log levels that are used in the baseline specification and elsewhere in the table. In column (4), I add importing country fixed effects. Columns (5) and (6) split the sample in two depending on whether the importing country was large (by population)

> 18Finally, my estimation exercise here and below relies only on OLS. Unlike the prior literature, I do not implement instrumental variables estimation; thus the estimates reported here should not be interpreted as identifying magnitudes associated with causal effects.

> 19The Appendix provides a full description of the data and its sources.

> 20For a discussion of a variety of potential approaches to adopt to assess the robustness of results, see Broda, Lim ̃ao, and Weinstein (2008) and Nicita, Olarreaga and Silva (2013).

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- i.e., China, Russia, Saudi Arabia, and Ukraine - or small. While both sets of estimates on the elasticity are negative, as predicted by the theory, the estimate on the elasticity is no longer significant for the small (by population) country subsample. Nevertheless, even this nonresult is somewhat reassuring, given that I would expect the results to be more likely to break down in the small country subsample.

Overall this section suggests evidence consistent with the terms-of-trade theory of trade agreements and that the pre-existing WTO membership has negotiated tariff binding commitments for newly acceding WTO non-members that serves to reduce the negative (terms-of-trade) externality impact of their tariffs on trading partners. Again, to the extent that there are similarities between the current WTO _non-members_ ’ applied tariffs and the tariff-setting behavior of these recently acceded WTO members before their WTO accession, any future WTO accession by the current non-members could also be expected to have them take on lower tariff binding commitments where they would otherwise have more import market power.

# **4 WTO members with unbound**

This section begins my examination of the tariffs that current WTO members apply, and in particular whether there is scope for the WTO to “provide” a forum for additional terms-of-trade-motivated applied tariff reductions for these countries. Put differently, my approach for the next two sections is to examine different areas in the WTO system where speculation has been that applied tariffs remain “too high,” and I ask whether the level of applied tariffs in each area continues to remain influenced by measures of import market power. Evidence of such a relationship would be consistent with identification of additional tariff-reduction work for countries to utilize the WTO to potentially pursue under the terms-of-trade theory of trade agreements. However, an alternative may be that, while applied tariffs in one or more areas may appear “too high” (or otherwise unconstrained by the WTO); nevertheless, the applied tariffs are not related to product-level measures of the importing country’s market power. If this is the case, there may be little scope to engage the WTO in a terms-of-trade neutralizing attempt to get the country to reduce its tariffs further.

This section begins by focusing on the issue area of unbound tariffs. These are the products for which countries have not taken on the legal commitment to set any upper limit for their MFN applied import tariffs. I first introduce where it is that unbound tariffs are most prevalent in the WTO system, and then in Section 4.2 I investigate whether there is evidence linking import market power motives and applied tariff levels in the areas where tariffs are currently unbound.

## **4.1 The countries and the unbound products - descriptive**

Table 5 introduces the WTO member countries with the largest share of products for which their applied import tariffs are unbound. Given that a condition of WTO entry for all countries was the expectation that they would agree to bind all tariffs for their agricultural products, I rank the countries in the table by the share of their _non-agricultural_ tariff lines that are bound. The left 16
half of the table lists the 25 WTO member countries (“Group A”) that will serve as the main sample for the regression analysis that I describe in the next section; these are countries that have bound fewer than one third of their non-agricultural import products. Cameroon has committed to a legally binding upper limit on the smallest share of imported products at 1.7 percent, followed by Tanzania and Gambia.

An examination of the 25 WTO members with less than 33 percent of bound non-agricultural products suggests a number of common characteristics. First, they are disproportionately poor, as only one (Macao SAR, China) has GNI per capita in 2013 greater than the world average of $10,683. Second, with only a handful of exceptions (Bangladesh, Macao SAR (China), Cuba, Sri Lanka, Suriname), Figure 1 reveals that the vast majority of unbound tariffs are geographically located in Sub-Saharan Africa. Third, while there is also a range of large and small (by population) countries with substantial unbound tariffs, in total the numbers add up: more than 700 million people - or 10% of the world’s population - live in WTO member countries that have bound fewer than one third of their non-agricultural tariffs at any level. Finally, the last column on the left half of Table 5 does suggest relatively little variation in average applied tariffs across these countries - with the exception of Macao SAR, China and Mauritius, the average applied MFN tariff (over all products) for the other 23 WTO member countries ranges between 10 and 20 percent. A major element of this is due to the fact that many of these countries are part of the ECOWAS (Economic Community of West African States), which has been developing a customs union arrangement and thus a common external tariff against non-participants, including the MFN tariff that each would apply against imports arising from all other (non-participant) WTO members.

The right side of Table 5 provides similar summary statistics for WTO member countries that have bound between 33 percent and 95 percent of their non-agricultural product tariff lines. These 14 countries (“Group B”) will be used in robustness checks in the formal regression analysis in the next section, but a cursory examination of their economic characteristics suggests that they are much more diverse. At the extremes, some countries on the list are very poor (Central African Republic) and others very rich (Singapore), and with populations that are very small (Brunei and Iceland) or very large (India). The 2013 average applied MFN tariff also ranges substantially from free trade (Hong Kong SAR, China) to 18 percent (Central African Republic). Finally, a country like Turkey in particular is also notable in that - while it may have bound relatively few (only 35 percent) of its non-agricultural products legally at the WTO, it has constrained its applied MFN tariffs through other trade agreement means, i.e., by forming a customs union arrangement with the European Union covering most of its non-agricultural products, with the exception of steel and textiles.

Before moving on, the last note that I make about Table 5 concerns those countries that are _not_ found in the table. I.e., the rest of the WTO membership (more than 100 WTO members) that are not listed in the table have bound 95 percent or more of their non-agricultural products. I have already illustrated the tariff data for some of these countries - i.e., the recently acceded WTO members - in Table 3.

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Finally, consider Figure 3 which illustrates the average MFN applied tariffs by sector for the 25 WTO members with less than 33 percent of their non-agricultural products that are bound. Much of the cross-industry pattern is similar to what is commonly observed in other settings for low– income countries (see again Figure 2, for the comparable tariffs for low-income WTO non-members and recently acceded members) - e.g., relatively higher applied tariffs in sectors such as footwear, textiles, hides and skins, and lower applied tariffs for fuel, chemicals and machinery.

# **4.2 Empirical evidence for unbound tariffs**

To my knowledge, there is no theoretical or empirical work exploring the finer question of why a WTO member would choose to bind some products and yet leave other products unbound. Nevertheless, in this section I use the following model to examine empirically the question of whether measures of importer market power are related to applied tariffs for these _unbound_ products If importing countries continue to exert market power over their applied MFN import tariffs ( _τgc_<sup>_WTO−applied_</sup> ) for these unbound products, the theoretical expectation is that _γ_ 0 would be positive.

Table 6 presents the results. The general finding is that there is no evidence that market power considerations are driving applied tariff rates for unbound products when the model is estimated on the 25 countries (“Group A”) that have committed to bind their tariffs for less than 33 percent of their non-agricultural products. The first column is the baseline specification which indicates no statistically significant relationship between the log of the inverse of the foreign export supply elasticity _ln_ (1 _/ωgc_<sup>_∗_)andtheappliedMFNtariffrate,givenby</sup><sup>_ln_(1 +</sup><sup>_τ WTO_</sup> _gc_<sup>_−applied_</sup> ) _._ In fact, when I introduce importing country fixed effects in column (2), there is actually a negative and statistically significant relationship between the measures of import market power and applied MFN tariffs. While, to my knowledge, no one has previously investigated this particular area of unbound tariffs for WTO member countries, these results have some similarities to the pattern of results found by Beshkar-Bond-Rho (described earlier) that examine binding tariff levels for 108 WTO members. They find tariff binding levels are negatively related to market power, especially in the presence of substantial amounts of tariff overhang (what they refer to as “weak bindings”). Their theoretical model interprets this negative relationship between import market power and tariff binding levels (in the presence of tariff overhang) as allowing countries flexibility to raise their applied rates in response to shocks. While speculative, a similar motivation could also be at work explaining the applied tariffs for products that are unbound in the WTO system.

Indeed, the last two columns of Table 6 provide additional evidence of this negative relationship between importer market power and applied MFN tariffs for unbound products by altering the sample of unbound products on which the model is estimated. In column (4), I also include in the sample the unbound products for the 14 WTO member countries (in “Group B”) of Table 5 that had (overall) between 33 percent and 95 percent of their non-agricultural products bound.

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In column (5) I estimate the model on only the subsample of data from those 14 WTO member countries. In both cases, the estimate of _γ_ 0 is negative and statistically significant.

To conclude this section, I am unable to find evidence to suggest that the applied MFN tariff levels for unbound products under the WTO are positively associated with importer market power considerations. Under the basic terms-of-trade theory of trade agreements, if countries with unbound tariffs are not applying them to exert market power and impose externalities on trading partners, this suggests little role for the WTO to facilitate applied tariff reductions in this area. While there may be other theories that would motivate welfare improvements arising from countries voluntarily binding these tariffs through the external commitment of a trade agreement - e.g., the trade policy and uncertainty literature associated with Handley and Lim ̃ao (2014, 2015), Handley (2014), or Lim ̃ao and Maggi (2015) - in this instance, the motivation may not arise from the basic terms-of-trade theory itself.

# **5 WTO members with bound tariffs but substantial tariff overhang**

A second contentious area within the WTO system involves countries that, while having taken on the legal commitments to bind their tariffs at some upper limit, have set the upper limit so high relative to the MFN tariff that the country ultimately applies that the binding level is economically meaningless. The difference between the legally binding commitment and the applied tariff is, again, defined as the amount of tariff overhang. In this section I examine whether applied import tariffs are positively associated with importer market power considerations for products which are characterized by substantial tariff _overhang._ My approach in this section follows the theoretical insights and empirical framework introduced by Nicita, Olarreaga and Silva (2013) described above. To summarize, they study the applied tariffs for roughly 100 WTO member countries and provide two key empirical results. First, when applied tariffs are constrained by WTO binding commitments - e.g., in the extreme, suppose that the applied rate is equal to the binding commitment, so there is zero tariff overhang - then there is a negative relationship between importer market power and the applied tariff. Second, when applied tariffs are unconstrained by WTO binding commitments - e.g., in the extreme, suppose that there is substantial tariff overhang because tariff bindings have _not_ been negotiated down close to applied levels - then there is a positive relationship between importer market power and the applied tariff. It is this second result in particular that I investigate in more detail.

## **5.1 The countries and the products with overhang - descriptive**

First I need to identify the set of WTO member countries with bound tariffs but with significant amounts of tariff overhang remaining between their tariff binding commitments and their applied rates. Table 7 provides the list of WTO member countries that each have at least 15 percentage points of average tariff overhang. First, it is interesting to note that almost all of the countries in 19
Table 7 acceded to the WTO at the time of its inception in 1995. As is apparent from the data in Table 3 for countries that acceded to the WTO sometime later - i.e., in 1998 or after - they were only allowed to enter the WTO with much less tariff overhang in place.

Second, it is important to clarify that none of the countries listed in Table 7 overlap with the “Group A” countries (of Table 5) that had bound less than 33 percent of their non-agricultural products - i.e., these two lists are mutually exclusive. However, a handful of countries do appear in both Table 7 and on the “Group B” list of countries in Table 5, i.e., those with less than 95 percent of their non-agricultural products being bound.<sup>21</sup> While these countries’ _unbound_ products were included as part of the robustness checks provided in columns (4) and (5) of Table 6, here I only consider the countries’ _bound_ products. Therefore, because the unbound products are dropped from the analysis here, the country-product pairs included in the robustness check regressions of Table 6 and those presented next are mutually exclusive.

The countries in Table 7 share some similarities, but also a number of notable differences, with the WTO non-members and recently acceded members (see again Tables 2 and 3) and the list of WTO members with substantial unbound tariffs (see again Table 5) discussed thus far. Like the earlier lists, the countries with substantial tariff overhang are also developing countries - e.g., nearly three quarters of the 45 countries have a 2013 GNI per capita at or below the world average. Nevertheless, these developing countries with substantial tariff overhang on average do have higher GNI per capita than the developing countries that are WTO non-members, WTO members that recently acceded, or WTO members with substantial unbound products.

Next, to the extent that the countries with substantial unbound products were geographically concentrated in Sub-Saharan Africa, the countries with substantial tariff overhang tend to be geographically concentrated in Latin America (see again Figure 1). Nevertheless, there are important exceptions, including countries with substantial overhang arising in South and East Asia and North Africa. Furthermore, while relatively large population countries such as Egypt, Philippines, Brazil, Mexico, Indonesia, and India are notably on the list of countries with substantial tariff overhang, this list also contains a number of countries with tiny populations - e.g., eleven of the 45 have less than one million people - including a number of small island economies of the Caribbean. Nevertheless, the combined population of these 45 countries is over 2.4 billion people, or more than one third of the global population.

Figure 4 illustrates the average MFN applied tariffs and tariff bindings by sector for these 45 WTO members that average more than 15 percentage points of tariff overhang. The average applied tariffs exhibit cross-industry patterns similar to the other settings for developing countries - e.g., relatively higher applied tariffs in sectors such as footwear, textiles, hides and skins, and lower applied tariffs for fuel, chemicals and machinery. There are significant differentials for the binding levels across sectors, however. Tariff binding levels average over 60 percent in animals, vegetables, and foodstuffs, whereas they are closer to 40 percent for all other (non-agricultural) sectors.

> 21These countries are Israel, Turkey, Central African Republic, Philippines, Bahrain, India and Tunisia.

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# **5.2 Empirical evidence for bound tariffs with substantial overhang**

In this section I follow a modified version of Nicita, Olarreaga, and Silva (2013) to examine empirically the question of whether measures of importer market power are related to applied tariffs for the countries identified in Table 7 as having substantial tariff overhang, or an average of more than 15 percentage points between their tariff bindings and their applied MFN tariffs. In the estimation, I also condition on the country-product pairs that have 15 percentage points or more of tariff overhang as well.<sup>22</sup> The basic model that I estimate is again simply where if importing countries continue to exert market power over their applied import tariffs ( _τgc_<sup>_WTO−applied_</sup> ) for this subset of bound products over which there is substantial tariff overhang, I expect _γ_ 0 to be positive. The main difference from the approach described in the last section is not the model, it is simply the subsample of countries and products (those with bound tariffs and tariff overhang) over which the model is estimated.

Table 8 presents the results. The general finding confirms the Nicita, Olarreaga and Silva evidence for this particular subsample of countries that market power considerations are positively related to applied MFN tariff rates in 2013 for these products.

The first column of Table 8 is the baseline specification which indicates a positive and statistically significant relationship between the log of the inverse of the foreign export supply elasticity, given by ln(1 _/ωgc_<sup>_∗_)</sup><sup>_,_andthemeasureoftheappliedMFNtariffrate,givenbyln(1 +</sup><sup>_τ WTO_</sup> _gc_<sup>_−applied_</sup> ) _._ In column (2) I introduce importing country fixed effects, and in column (3) I utilize the high inverse elasticity indicator variable in lieu of the continuous measure. The results are robust to these different specifications.

The next three columns of Table 8 examine subsamples of these data. Column (4) focuses on where tariff overhang is the greatest by changing the threshold from 15 percentage points to 25 percentage points, thereby reducing the sample almost in half.<sup>23</sup> The size of the estimated impact of market power is even larger in the subsample of countries and products where tariff overhang is largest. Columns (5) and (6) split the original baseline sample in two depending on whether or not the products fall into agriculture. Interestingly, the potential influence of market power is not found in the agricultural product subsample of the data in column (6), though admittedly this is a much smaller sample of observations.

Finally, and as a last “consistency check” with expectations, the very last column of Table 8 presents estimates from the same model on a completely different subsample of data - i.e., the twelve

> 22That is, I drop from the sample all products within these 45 countries that have bound tariffs but applied MFN tariffs that are within 15 percentage points (or less) of the binding rate. Because I am therefore conditioning on a sample of countries and products that _only_ have tariff overhang, I do not need to include interaction terms a la Nicita, Olarreaga and Silva (2013) so as to thereby separate out the potential negative relationship between measures of import market power in the absence of such overhang (i.e, when the applied MFN tariff is equal to the binding rate).

> 23For the countries involved in this subsample, see again Table 7, and the bottom two thirds of the listed countries, beginning with Peru (26.1 percent).

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countries that recently acceded to the WTO that were part of the formal econometric analysis of tariff bindings presented in Table 4. Not surprisingly, the relationship in column (7) between the inverse foreign export supply elasticity and applied import tariffs for these twelve countries is not only not positive, but it is negative and statistically significant. Recall from Table 3 that upon entry to the WTO, countries like China, Russia and Ukraine not only took on nearly universal tariff binding coverage, but they bound their tariffs at relatively low levels compared to their applied rates. I.e., average tariff overhang for the countries and products in the column (7) sample is only 3.6 percentage points, and less than 5 percent of observations in that sample have 15 percentage points or more of tariff overhang.<sup>24</sup> The applied tariffs for the recently acceded WTO members thus have a very different empirical relationship with measures of import market power than the applied tariffs for the WTO members that have been around since the agreements’ inception and which continue to have large amounts of tariff overhang.

The evidence from this section suggests that products for countries that have taken on WTO bindings but for which substantial tariff overhang remains have applied MFN import tariffs that continue to reflect import market power considerations. As such, this may constitute an area where additional WTO-facilitated negotiations for applied MFN tariff reductions would be consistent with the insights of the terms-of-trade theory of trade agreements.

# **6 Conclusions and Policy Implications**

This paper uses the lens provided by the terms-of-trade theory of trade agreements, as well as recent empirical and data advances arising in the literature, to assess whether there may be a market power neutralization motive for the WTO to facilitate additional tariff reductions in three distinct areas: (i) applied tariffs for current WTO non-members, (ii) applied tariffs for current members where they are unbound, and (iii) applied tariffs for current members where there is substantial tariff overhang.

An open policy question is how could the WTO be redeployed to address these areas where additional terms-of-trade motivated liberalization might take place? While I have provided a mix of direct and indirect evidence for where there remains a positive relationship between import market power and applied import tariffs, nevertheless, I have refrained from assessing why it is that currently “high” applied import tariffs (that reflect terms-of-trade motives) have yet to be extinguished even by WTO negotiations, as well as whether institutional impediments might be overcome that would allow for their negotiated reduction.

A first promising line of research involves the Bagwell, Staiger, and Yurukoglu (2015) examination of the _historical_ process of reciprocal trade negotiations that took place product-by-product under the early GATT Rounds. There may be lessons to be learned from the details of such experiences for any additional liberalization remaining to be undertaken today.

> 24While not presented in the Table, I can also confirm another relationship identified by Nicita, Olarreaga, and Silva (2013) for this particular sample of countries - that when applied rates are equal to binding rates (so “cooperation” is the strongest), the relationship between market power and the applied MFN tariff is still negative.

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Nevertheless, one additional possible starting point arises out of the results that I have developed here in Section 5.2. WTO members that currently retain substantial amounts of tariff overhang and have applied MFN tariffs that continue to reflect market power influences could potentially be grouped with one another to identify reciprocal liberalization matches in the spirit suggested by the Bagwell and Staiger (1999) theory. While obviously these regression results are only suggestive of where negotiators could potentially look in greater detail, the countries in this sample include Argentina, Brazil, India, Indonesia, and Mexico - all members of the Group of 20 (G20) and potential future leaders with a vested interest in sustaining the multilateral trading system.<sup>25</sup> On the other hand, the last set of results of Section 5.2 presents no evidence that, on average, currently applied MFN tariffs and market power remain positively related for the set of recently acceded WTO members that includes China and Russia. Such evidence would tend to suggest that the recent WTO accession countries may not be great candidates to lead a new set of reciprocal tariff liberalization negotiations.

Furthermore, I have already noted one particularly important strand of research in the termsof-trade literature that identifies variation in the concentration of export interests across countries as presenting an additional bottleneck that may mitigate the effectiveness of the GATT/WTO’s reciprocal, shallow-integration approach to tariff cutting (Ludema and Mayda, 2013). The LudemaMayda evidence was based on a 26 country sample that included of a number of high-income countries and it does suggest that not all of the terms-of-trade motives may have (as yet) been exercised for the high-income economy applied MFN tariffs. While this would imply that such countries could also plausibly be part of future reciprocal bargains still to be struck, the current difficulty for the WTO and trade negotiators may rest in how to make those matches and strike those bargains. Put differently, the second insight from the Ludema-Mayda evidence is that the real world of trade negotiations is certainly even more complicated than simply getting two large importing countries together to reciprocally reduce their import tariffs. The potential asymmetry of exporters in a many-country world, or the concentration (or lack thereof) of exporting interests for a particular product, may make implementation of the GATT/WTO’s historical “principal supplier rule” approach to pairing negotiating interests difficult. To what extent might third party intermediaries (such as an institution like the WTO) be needed to organize _triangular_ liberalization efforts, say, if bilateral trade liberalization opportunities between partners are unlikely due to trade imbalances or other asymmetries? More research is certainly required to further investigate all of these questions.

An additional and potentially related concern requiring additional exploration is that the importing countries that continue to impose positive tariffs reflecting their market power incentives may also not face significantly large “foreign” tariffs on their exported products to generate the trade-off necessary for the neutralization of the terms-of-trade cut under the traditional, reciprocal

> 25However, this is complicated by the fact that many of the countries on this list - e.g., Mexico, Colombia, Peru, and Chile - are actively involved in the formation of preferential tariff agreements with major high-income economies. These agreements may serve as an alternative to neutralizing the terms-of-trade motives associated with certain applied _bilateral_ tariffs (vis-a-vis major trading partners at least) if not their applied MFN tariffs.

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approach. This may be because the importing country receives preferential tariff treatment from trading partners for its exports, either through unilateral preferences such as GSP, or through _reciprocal_ preferential trade agreements. Alternatively, “intermediate” (but not “latecomer” nonmember) countries to the system may find that they already receive MFN treatment of very low applied tariffs from the major markets of other WTO members for their exports. While the WTO system has seemingly been able to overcome this hurdle when it comes to neutralizing the termsof-trade motives behind recently acceded WTO member countries (Bagwell and Staiger 2011, see also the results in Section 3.3), it appears that it may have been much less successful in doing so when it allowed in the initial tranche of acceding members in 1995, when it did not require these countries especially to take on particularly stringent tariff binding commitments (see the results of Section 5 and Nicita, Olarreaga and Silva 2013).

There are other complications to the historical GATT/WTO approach to reciprocal liberalization that the theoretical literature has begun to identify and explore that may also serve as impediments for future liberalization. These include trade in products where prices are determined by bilateral bargaining and not market-clearing conditions (e.g., Antr`as and Staiger 2012a,b) and environments characterized by cross-border ownership and foreign direct investment (Blanchard 2007, 2010). While these particular impediments may be more suited to the relatively complex trade in parts and tasks that is commonly associated with high-income countries, nevertheless, as Johnson and Noguera (2014) document, the importance of such trade is increasing almost everywhere over time.

Finally, I conclude by pointing out that even once countries are inside of the WTO and the terms-of-trade incentives may have been extinguished from their applied MFN tariffs, significant institutionally-provided flexibilities exist so that trade policy is not truly and permanently locked in at levels that may turn out to be too low in the face of political-economic shocks. Bown and Crowley (2013a), for example, provide evidence consistent with the Bagwell and Staiger (1990) theoretical, repeated-game framework of trade agreements that interprets some use of antidumping and safeguards as governments managing the terms-of-trade pressure - even once they have bound their applied MFN tariffs at low levels - associated with trade volume shocks.<sup>26</sup> Thus while the WTO may still have some work to do, so as to more completely exorcise the terms-of-trade incentives from its members’ applied MFN tariffs, even after potential completion of those efforts, some trade policy flexibility (and influence of terms-of-trade motives affecting the use of such flexibility) may likely remain.

> 26For evidence that macroeconomic shocks - real exchange rate shocks, real GDP and unemployment shocks - also trigger new import protection under such temporary trade barrier policies permitted under the WTO, see Bown and Crowley (2013b,2014) for cross-country studies on high-income and emerging economies. respectively, in the spirit of the Bagwell and Staiger (2003) theoretical framework. Vandenbussche and Zanardi (2008) describe motivations for the rise of antidumping laws - the most commonly invoked temporary trade barrier policy - across the WTO membership over time, Bown (2011b) provides a recent empirical accounting of use of the policies across countries over time.

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