Assistant Professor, Seung Hoon Lee, (School of Economics) and co-author, Kyle Bagwell (Stanford University), provides a new rationale for global trade policy set by the World Trade Organization (WTO). In their forthcoming paper in the Journal of International Economics, the authors provide a new theoretical explanation for trade regulation that explains why the WTO bans direct export subsidies.
Export subsidies allow domestic firms to sell their products abroad at a lower price than they could otherwise, at the expense of the domestic taxpayer. Export subsidies benefit domestic firms that receive subsidies and typically also lead to a decrease in the price that domestic consumers face. While export subsidies are good for domestic producers, they hurt foreign producers because firms in those countries may not be able to compete with the artificially low prices of imports from subsidized countries. However, export subsidies can help consumers in foreign countries that consume the lower-priced imported good. It is even possible for export subsidies to have a net-positive gain in the welfare of a country’s citizens for both the exporting and the importing countries. If this is the case, why would the WTO ban the practice?
Lee and his coauthor explain why export subsidies are banned by the WTO. Most of the past research used a standard game theory model called the Prisoners’ Dilemma (PD) to explain why countries enact protectionist policies. The prisoner’s dilemma is an elegant game-theory model showing that when each individual pursues their own self-interest, the outcome is worse than if they had both cooperated. This theory explains well why countries impose import regulations (such as enacting tariffs) and explain why the WTO attempts to regulate and reduce this behavior in order to help raise the well-being of all countries involved.
While the standard theory explains the behavior of countries and the WTO in regards to tariffs (import restrictions), it does not explain choices made globally to enact export subsidies or the WTO’s choice to ban them. The authors develop a novel theory to explain export subsidies and the WTO’s response to them. Over time, the WTO lowered the limit for tariffs to encourage free trade, which resulted in nations responding by increasing export subsidies. The WTO responded rationally to this activity because, as the authors show, in many common circumstances export subsidies can actually decrease the wellbeing of those in other countries (the importing country). Thus, the WTO response is a rational response to policies that benefit one country at the expense of another.