Gradualism in the GATT: Strategic tariff bargaining and forward manipulation

• Author: Jackie M. L. Chan
• Date: 01 February 2019
• Published date: 01 February 2019
• DOI: http://doi.org/10.1111/roie.12373

220

|

© 2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/roie Rev Int Econ. 2019;27:220–239.

1

|

INTRODUCTION

In the decades following the formation of the General Agreement on Tariffs and Trade (GATT)

in 1947, countries negotiated for the mutual reduction of trade barriers in organized trade

rounds. In the first five trade rounds (Geneva [1947], Annecy [1949], Torquay [1950–1951],

Geneva [1955–1956], and Dillon [1960–1961]), negotiations for import tariffs were made on

an item‐by‐item offer‐request basis. With multiple trading partners involved, these negotiations

proceeded sequentially and bilaterally under the most‐favored-nation (MFN) principle (i.e.,

GATT/WTO Article I). Under such conditions, countries would have a strong motive for stra-

tegic tariff bargaining to influence the outcomes of the agreement. Indeed, as once remarked

by John Evans, a former member of the U.S. delegation to the GATT: “If a round of negoti-

ations is to be followed by later rounds, one’s own tariff level takes on a value independent

of any economic reason for protection. Quite simply, it has value as bargaining counter in fu-

ture rounds” (Roessler, 1978). In particular, this suggests that early participants may have an

incentive to engage in inefficient “foot‐dragging”, and offer fewer concessions to earlier

Received: 16 January 2017

|

Revised: 16 May 2018

|

Accepted: 15 June 2018

DOI: 10.1111/roie.12373

ORIGINAL ARTICLE

Gradualism in the GATT: Strategic tariff

bargaining and forward manipulation

Jackie M. L. Chan

Department of Economics,Chinese

University of Hong Kong, Shatin, Hong

Kong

Correspondence

Jackie M. L. Chan, Department of

Economics, 9/F, Esther Lee Building,

Chinese University of Hong Kong, Shatin,

N.T., Hong Kong.

Email: jmlchan@cuhk.edu.hk

Abstract

This paper examines strategic bargaining in a non‐coop-

erative game of tariff negotiation in the General Agreement

on Tariffs and Trade (GATT). In the model, a country bar-

gains sequentially and bilaterally with multiple trading

partners under the MFN principle, making take‐it‐or‐

leave‐it offers consisting of tariffs and transfers. A dy-

namic bargaining inefficiency arises in which the country

strategically delays the reduction of its tariff until the final

stage, and extensions to the model demonstrate gradual

trade liberalization over multiple stages. Based on this

idea of forward manipulation, the theory provides an ex-

planation for gradualism in tariff reduction during the

early GATT rounds.

|

221

CHAN

negotiating partners in order to maintain a more favorable bargaining position for future negotia-

tions (Bagwell & Staiger, 2010; WTO, 2007). This incentive has been formally characterized by

Bagwell and Staiger (2010) as “forward manipulation”, in which early agreements are manipu-

lated to affect the outcomes of later negotiations.

In this paper, I argue that the forward‐manipulation problem provides an explanation for grad-

ualism in trade liberalization during the early GATT rounds. Aside from the initial Geneva (1947)

Round, the four subsequent trade rounds that relied on the item‐by‐item bargaining method did not

result in major tariff reductions (Hoekman & Kostecki, 2009, p. 136; Irwin, 1995a, 1995b). In fact,

negotiations from the Annecy to Dillon Rounds produced a cumulative reduction in tariff levels of

only 14% (WTO, 2007, Table 5). In contrast, with the adoption of across‐the‐board formulas to cut

tariffs, the Kennedy (1963–1967) and Tokyo (1973–1979) Rounds achieved reductions of 38 percent

and 33 percent, respectively. Moreover, compared with the 33,000 tariff lines bound in the Kennedy

Round, each of the four rounds after the Geneva (1947) Round had less than 10,000 tariff concessions

exchanged, with as few as 4,400 in the Dillon Round. As Cohn (2002, p. 59) states, “the method of

negotiation was the most important factor hindering the achievement of more positive results.” In

particular, across the rounds, “foot‐dragging by any important country could slow everyone’s negoti-

ations” (Diebold, 1996, p. 159).

With a stylized model of sequential bilateral bargaining in the GATT, I demonstrate the forward‐

manipulation problem and how it could lead to gradualism in tariff reduction. The basic three‐coun-

try theoretical framework mainly follows Bagwell and Staiger (2010) and Kungpanidchakul (2007),

where Country A exports to and imports from Countries B and C.1 Country A also negotiates se-

quentially and bilaterally under MFN with B and C.2 In each stage of this non‐cooperative bargaining

game, Country A makes a take‐it‐or‐leave‐it (TOL) offer consisting of its own tariff, either B or C’s

tariff levied on A’s exports, and a lump‐sum transfer payment from A to B or C. The use of transfer

payments ensures that the model is analytically tractable. While monetary transfers between GATT

contracting parties were not observed, these side‐payments can be interpreted more generally as con-

cessions on other instruments of trade policy. This includes reductions in non‐tariff barriers through

issue linkage, which has also been important in GATT trade negotiations (Bagwell & Staiger, 2010;

Hoekman & Kostecki, 2009, p. 154).

As first‐movers of this game in Stage 1, Countries A and B have an incentive to manipulate C’s

disagreement payoff, pushing C into a weaker bargaining position, thereby extracting more surplus. If

Country C rejects A’s Stage 2 offer, its disagreement payoff or outside option will depend on the Stage

1 tariffs negotiated between A and B, which remains in effect because of MFN. Thus, the dynamic

inefficiency of forward manipulation arises in which Country A preserves its bargaining chips for

Stage 2 by strategically delaying the reduction of its MFN tariff. To achieve this outcome, Country

A demands tariff concessions from B in Stage 1, and offers alternative concessions in the form of

transfers. This result also holds in alternative setups with more than three countries, size asymmetry,

and differences in bargaining power.

To generate gradual trade liberalization in which tariff reduction is observed over all stages, I

extend the basic model in three directions. First, I introduce a time lag between the two stages, so

that consumption and welfare depend on both Stage 1 and 2 tariffs. While the forward‐manipulation

incentive remains, it is mitigated by the force that drives tariffs down in Stage 2, namely, the trade‐off

between tariff concessions and transfers. Furthermore, this trade‐off is exacerbated when transfers are

limited. By introducing a constraint in which transfers are capped at an upper bound, it can be shown

that Country A must offer additional tariff concessions in Stage 1. Lastly, gradualism also arises

when the probability of negotiation breakdown is large. Again, while Country A is still incentivized