A theory of trade policy leadership

This paper constructs a two-country model of bilateral trade negotiations in the presence of political uncertainty to demonstrate that unilateral trade liberalization may be an optimal policy for a large country. The political uncertainty is due to producer opposition to trade-agreement ratification in the foreign country. Unilateral liberalization by the home country has a salutary effect on negotiations, because it mitigates the pain of potential ratification failure on the foreign country. It also promotes foreign ratification, because it effectively punishes foreign import-competing producers for lobbying against an agreement. These benefits are shown to outweigh (up to a point) the terms-of-trade cost that the home country must suffer when it actually liberalizes unilaterally. In equilibrium, therefore, we see a pattern in which the home country unilaterally liberalizes for several periods, until ratification in the foreign country succeeds, at which point foreign country finally reciprocates. We also demonstrate that, contrary to the standard optimal tariff result, there may be an inverse relationship between the home country's monopoly power and its optimal unilateral tariff. (C) 2001 Elsevier Science B.V. All rights reserved.