MULTILATERAL TRADE BARGAINING AND DOMINANT STRATEGIES

• Date: 01 November 2018
• Published date: 01 November 2018
• DOI: http://doi.org/10.1111/iere.12320

INTERNATIONAL ECONOMIC REVIEW

Vol. 59, No. 4, November 2018 DOI: 10.1111/iere.12320

MULTILATERAL TRADE BARGAINING AND DOMINANT STRATEGIES∗

BYKYLE BAGWELL AND ROBERT W. STAIGER 1

Stanford University, U.S.A.and NBER,U.S.A.; Dartmouth College, U.S.A. and NBER, U.S.A.

Motivated by General Agreement on Tariffs and Trade bargaining behavior and renegotiation rules, we con-

struct a three-country, two-good general-equilibrium model of trade and examine multilateral tariff bargaining

under the constraints of nondiscrimination and multilateral reciprocity. For a general representation of govern-

ment preferences, we identify the bargaining outcomes that can be achieved using dominant strategy proposals

for all countries. In our analysis, dominant strategy outcomes emerge when tariff proposals are followed by

multilateral rebalancing. The resulting bargaining outcome is efficient relative to government preferences if and

only if the initial tariff vector positions the initial world price at its “politically optimal” level.

1. INTRODUCTION

Since 1947, the General Agreement on Tariffs and Trade (GATT) and its successor organiza-

tion, the World Trade Organization (WTO), have provided the multilateral forum for bargaining

over trade policy. The GATT was formed in 1947 among 23 original signatory countries and

sponsored eight multilateral rounds of trade-policy negotiations. The final completed round,

known as the Uruguay Round, resulted in the creation of the WTO on January 1, 1995. The

WTO currently has more than 160 member countries and has struggled with its now-suspended

Doha Round. But in combination, the GATT/WTO rounds surely represent one of the most

important episodes of bargaining in economic history.

What accounts for the success of the GATT/WTO as a bargaining forum? We provide in

this article a stylized model of multilateral tariff bargaining that embodies key institutional

features of GATT/WTO practice. We argue that several of these features dramatically simplify

the bargaining environment, and, in their presence, we show that all countries have dominant

strategy proposals. We characterize the resulting bargaining outcomes, show that the associated

sequence of initial proposals followed by “multilateral rebalancing” mimics stylized facts asso-

ciated with GATT/WTO tariff bargaining, and describe conditions under which the bargaining

outcomes are efficient.

The protocols for tariff negotiations in the GATT/WTO vary somewhat from round to round

but have important common features. First, the negotiations are a form of barter: Each gov-

ernment makes commitments (offers “concessions”) on its own import tariffs in exchange for

reciprocal commitments from its trading partners. Second, the negotiations are undertaken

in the context of specific rules and norms. Under the principle of nondiscrimination as en-

shrined in GATT Article I, the tariff commitment that a country makes with respect to any

given import good must be extended to all GATT/WTO countries.2Tariffs thus must satisfy a

∗Manuscript received November 2016; revised December 2017.

1We thank Harold Cole and three anonymous referees for helpful comments. We also thank Matt Jackson, Gea Lee,

and seminar participants at LSE, Stanford, and the 2017 Research Workshop on the Economics of International Trade

Agreements in Villars for helpful discussions. We thank the NSF (Grant SES-1326940) for financial support. Bagwell

thanks CASBS at Stanford for support and hospitality. Please address correspondence to: Kyle Bagwell, Department

of Economics, Stanford University, Stanford, CA 94305, USA. E-mail: kbagwell@stanford.edu.

2GATT rules also include important exceptions to the principle of nondiscrimination; for example, GATT Article

XXIV provides conditions for the formation of preferential trading agreements.

1785

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(2018) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social

and Economic Research Association

1786 BAGWELL AND STAIGER

“most-favored nation” or MFN rule. In addition, reciprocity rules and norms shape the pattern

of negotiation.

A primary expression of GATT rules concerning reciprocity is found in GATT Article

XXVIII, which addresses rules for renegotiation. Under this article, after negotiations are

completed, a country retains the right to withdraw a tariff commitment and reposition an import

tariff at a higher level, with the understanding that its principal trading partners are then allowed

to behave in a reciprocal manner and withdraw “substantially equivalent concessions.” Thus,

GATT rules ensure that a form of reciprocity is followed when concessions are renegotiated,

and this rule is, of course, known to participating countries at the time of negotiation. As well,

when tariffs are originally negotiated within a round, a reciprocity norm shapes the expectations

of negotiators and thus the negotiating outcome.

Following Bagwell and Staiger (1999, 2002), we regard the principle of reciprocity as be-

ing satisfied when two countries exchange tariff reductions (or tariff increases, in the case of

renegotiation) such that each country experiences changes in the volume of its imports that

are equivalent in magnitude to the changes in the volume of its exports, with the changes in

trade volumes valued at existing world prices. In GATT parlance, reciprocal tariff liberalization

then facilitates a “balance of concessions.”3As Bagwell and Staiger (1999, 2002) show for a

two-good general equilibrium model of trade, when two countries make tariff changes that

satisfy the principle of reciprocity, the changes leave the world price that governs trade between

the two countries unaltered. In this way, when applied in the context of original negotiations,

reciprocity prevents countries from manipulating their terms of trade and thereby neutralizes

the fundamental source of inefficiency in noncooperative tariff setting. Moreover, when ap-

plied in the context of renegotiations, reciprocity suggests that no country can be forced to

accept a trade volume in excess of its preferred volume at the fixed terms of trade. Bagwell and

Staiger (2005) show further that, in a three-country, two-good general-equilibrium setting, if

two countries negotiate in a manner that satisfies both the principles of nondiscrimination and

reciprocity, then the preservation of the terms of trade between the countries ensures as well

the absence of any third-party externality.

The notion of reciprocity studied by Bagwell and Staiger (1999, 2002, 2005) may be understood

as a form of bilateral reciprocity. We focus in this article on a related but distinct notion of

multilateral reciprocity. For the three-country setting and under the MFN rule, we regard the

principle of multilateral reciprocity as being satisfied when the three countries undertake any

combination of tariff changes that leaves the world price unaltered. Multilateral reciprocity holds

when two countries change their respective tariffs in a way that satisfies bilateral reciprocity.

Multilateral reciprocity is a more general notion, however, since it can hold even if a country

negotiates separately with each of two trading partners where each individual negotiation

violates bilateral reciprocity. This happens when the individual negotiations push the world price

in different directions, with one movement exactly offsetting the other so that the combined

effect leaves the world price unaltered. As Bagwell et al. (2017) argue for the three-country

model under the MFN rule, by fixing the terms of trade, multilateral reciprocity neutralizes the

key source of inefficiency under noncooperative tariff setting.

The important role of multilateral as opposed to bilateral reciprocity was emphasized in

early writings on GATT negotiations. The key point is that a bilateral exchange of tariff cuts is

“multilateralized” under the MFN rule and may offer indirect benefits to other parties, where

such indirect gains can be more effectively internalized in a multilateral bargaining forum.4

GATT commentators routinely express the view that the facilitation of multilateral as opposed

to bilateral reciprocity made possible by GATT’s multilateral bargaining forum was a key

3For further discussion of the principle of reciprocity in GATT/WTO and recent research related to this topic, see

Bagwell and Staiger (2016).

4Note that, according to the findings of Bagwell and Staiger (2005) just described, bilateral tariff cuts under the MFN

rule offer potential indirect benefits to third parties only when those cuts fail to satisfy bilateral reciprocity (i.e., only

when those cuts on their own would change world prices).

MULTILATERAL TRADE BARGAINING AND DOMINANT STRATEGIES 1787

institutional innovation underlying GATT’s success (see, for example, Interim Commission for

the International Trade Organisation [ICITO], 1949, p. 10, and Curzon, 1966, pp. 75–77).

Utilizing recently declassified data from the GATT/WTO on tariff bargaining, Bagwell et al.

(2017) study the pattern of tariff bargaining in the GATT Torquay (1950–51) Round. Nego-

tiations in this round took a “request-offer” form, whereby the initial proposal of a country

consisted of the tariff cuts it requested from its trading partner and the tariff cuts it offered

in exchange. For our purposes here, we highlight three key findings from their study. First,

the numbers of back-and-forth offers and counteroffers in any bargain were relatively small.

Second, once the initial proposals were on the table, the focus of bargaining narrowed to each

country’s own tariff-cut offers. Countries responded to imbalances in the outstanding offers by

adjusting their own offers instead of by adjusting their requests. Third, adjustments in offers

typically took a simple and striking form. Offers for given import goods were rarely deepened as

the round progressed, suggesting an absence of strategic screening behavior along this dimen-

sion.5Instead, when adjustments in offers did occur, the adjustment typically involved a country

reducing the depth of its offer.6A potential interpretation of this pattern is that a country would

propose for a given import good the tariff that generated its preferred trade volume for a fixed

terms of trade, with the expectation that any subsequent “rebalancing” of offers necessary for

multilateral reciprocity would arise later in the round after all offers had been recorded and

might entail a reduction in the depth of its offer.

In this article, motivated by GATT bargaining behavior and renegotiation rules, we con-

struct a general-equilibrium model of trade and examine multilateral tariff bargaining under

the constraints of nondiscrimination and multilateral reciprocity. The model has two goods and

three countries, corresponding to a home country and two foreign countries, where the foreign

countries trade only with the home country. For a general representation of government pref-

erences, we construct a simple bargaining game and identify bargaining outcomes that can be

achieved using dominant strategy proposals for all countries. The resulting bargaining outcome

is efficient relative to government preferences if and only if the initial tariff vector positions the

initial world price at its “politically optimal” level.7In symmetric settings, if the initial tariffs cor-

respond to Nash tariffs, then the resulting bargaining outcome also ensures greater-than-Nash

trade volumes and welfares for all countries.

To establish these results, we develop a bargaining game inspired by the request-offer struc-

ture that we described above in the context of the Torquay Round, a structure that has been

commonly used across the GATT/WTO tariff bargaining rounds.8In this game, countries simul-

taneously make proposals concerning their own tariffs (their “offers”) and the tariffs of their

trading partners (their “requests”). For each country, we require that any proposed change

in tariffs satisfy the principles of nondiscrimination and multilateral reciprocity. We capture

GATT Article XXVIII renegotiation provisions in a short-hand way, by assuming also that the

bargaining outcome must respect “voluntary exchange,” in the specific sense that no country is

ever forced to accept a trade volume in excess of that implied by its proposal. A key issue is

that the proposals may disagree and thus be imbalanced, with one side of the market seeking

greater trade volume than the other. To address this issue, we construct a mechanism that maps

5Strategic screening occurs, for instance, in theoretical models with one-sided uncertainty in which the uniformed

party makes all the offers (e.g., Gul et al., 1986).

6A country could reduce the depth of its offer on the intensive margin (by reducing the magnitude of its tariff cut on

a given import good) or on the extensive margin (by reducing the range of import goods in a bargain). In the Torquay

Round, rebalancing typically occurred on the extensive margin. In the model that we develop here, each country has

one import good, and so we focus on intensive-margin adjustments.

7The politically optimal tariffs are the tariffs that would be selected in the hypothetical situation in which governments

are not motivated by the terms-of-trade implications of their unilateral trade-policy choices. The politically optimal

world price is then the market-clearing world price that emerges when all governments select their politically optimal

policies. See Bagwell and Staiger (1999, 2002) and Section 5 below for further discussion.

8With the exception of the Kennedy and Tokyo Rounds, which relied primarily on tariff-cutting formulas, all of the

GATT rounds and the now-suspended WTO Doha Round have made use of request-offer bargaining structures of the

kind we describe here.