Uncertainty and Trade Agreements
In this paper we explore the potential gains that a trade agreement (TA) can provide by regulating trade-policy uncertainty, in addition to the more standard gains from reducing the mean levels of trade barriers. We show that in a standard trade model with income-risk neutrality there tends to be an uncertainty- increasing motive for a TA. With income-risk aversion, on the other hand, the uncertainty-managing motive for a TA is determined by interesting trade-offs. For a given degree of risk aversion, an uncertainty- reducing motive for a TA is more likely to be present when the economy is more open, the export supply elasticity is lower and the economy is more specialized. Governments have stronger incentives to sign a TA when the trading environment is more uncertain. As exogenous trade costs decline, the gains from decreasing trade-policy uncertainty tend to become more important relative to the gains from reducing average trade barriers. We also derive simple "sufficient statistics" to determine the direction of the uncertainty motive for a TA and the associated welfare gains, and we apply them to the trading relationship between US and Cuba before 1934. Finally, we examine how the uncertainty motive for a TA is affected by the presence of ex-ante investments, and examine conditions under which an uncertainty-reducing TA will increase investment in the export sector.
We thank Kyle Bagwell, Mostafa Beshkar, Paola Conconi, Swati Dhingra, Avinash Dixit, Robert Staiger for helpful comments as well as participants in the 2012 AEA meetings, the 2012 Venice CAGE/CEP Workshop, the 2012 Princeton IES Summer Workshop, the Australasian Econometric Society and seminars at Stanford, Wisconsin, Oxford, LSE, Warwick, Notingham and USP. Limao thanks the Yale University's Leitner Program for support during part of this project. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Nuno Limão & Giovanni Maggi, 2015. "Uncertainty and Trade Agreements," American Economic Journal: Microeconomics, vol 7(4), pages 1-42. citation courtesy of