Regionalism and Multilateral Tariff Cooperation
We consider a three country world in which each country's import market is served by competing exporters from it's two trading partners. We assume that weak multilateral enforcement mechanisms prevent governments from implementing efficient trade policies through a multilateral agreement that requires tariffs to conform to the most favored nation (MFN) principle. We then ask whether exceptions from MFN for thepirpose of forming preferential agreements can lead to lower external tariffs, and thereby to a more efficient tariff structure under the multicultural agreement. We identify three opposing effects of preferential agreements on the multilateral tariff structure in this setting. A first effect, the tariff complementarity effect, works to reduce the desired external tariffs of countries that join together in a preferential agreement. Two additional effects of preferential agreements arise only when enforcement issues at the multilateral level are considered. One of these, punishment effect, weakens the ability of the member countries of a preferential agreement to punish deviations from the multilateral agreement. The other of these, the tariff discrimination effect, allows countries to discriminate against those who would "free ride" under MFN, and there for works to increase the desired external tariffs of countries that join together in a preferential agreement. The relative strengths of these three effects determine the impact of preferential agreement on the tariff structure under the multilateral agreement. Our findings suggest that preferential agreements can have their most desiravel effects on the multilateral system when the degree of multilateral cooperation is low.
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