Law, politics, and the true cost of protectionism: the choice of trade remedies or binding overhang

The literature on escape clauses in international commerce focuses on the workings of trade remedies. The logic is that, by adhering to a strict methodology that is subject to legal review, trade remedies credibly signal that the government is only temporarily defecting from free trade. And yet, countries often turn, instead, to a measure that does not adhere to a strict methodology and is not subject to legal review: binding overhang, or the gap between a country's bound and applied tariffs. What explains a government's decision to use trade remedies or binding overhang? We argue that trade remedies are used where import surges are big enough that injury can be proven, but low enough that governments have incentive to prove it. Otherwise, binding overhang is their flexibility measure of choice. We conduct a variety of empirical analyses concerning 22 emerging economies with access to both trade remedies and binding overhang. The results strongly bear out our hypothesis, shedding new light on governments' incentives over the design of the law governing flexibility provisions.

Tariff Revenue and Tariff Caps

We characterize the design of an optimal trade agreement when governments are privately informed about the value of tariff revenue. We show that the problem of designing an optimal trade agreement in this setting can be represented as an optimal delegation problem when a money burning instrument is available. In a specification with quadratic payoffs and a uniform distribution, we find that the tariff cap and the probability of binding overhang are higher when the upper bound of the support distribution is higher and when the support distribution has greater width.

How States Ration Flexibility: Tariffs, Remedies, and Exchange Rates as Policy Substitutes

A close look at the commitments of World Trade Organization (WTO) members presents a striking paradox. Most states could raise their duties significantly before falling afoul of their WTO obligations. Moreover, such “binding overhang” varies between countries: some could more than double the amount of trade protection they offer overnight, whereas others are tightly constrained. What accounts for this variation? The author argues that more flexibility is not always better: obtaining it and subsequently using it are both costly. Rather than maximize flexibility, states thus seek an optimal amount. If they have access to policy space through other means, such as currency devaluations and trade remedies, they will exercise restraint in seeking binding overhang. The same supply-side logic holds at the domestic level: governments strategically withhold binding overhang from industries that are able to rely on trade remedies, despite the fact that these tend to have the greatest political clout.