On Subsidies in Trade Agreements

Abstract

The role of production subsidies in trade agreements has long been neglected by trade economists. To fill this gap, Bagwell and Staiger (2006) analyze this issue and show that, quite universally, market access is the sole variable that efficient trade agreements need to address and that, consequently, the prevailing WTO legislation is inefficient. The present paper shows that this argument fails when trade agreements are required to be self-enforceable. Through their effect on output, subsidies impact the trade-off between defecting from trade agreements and respecting them. Hence, welfare-maximizing trade agreements must include subsidy rules. In the most realistic scenario production subsidies are prohibited and any trade agreement that addresses market access only is necessarily inefficient. In this sense, the paper makes a strong case for the WTO subsidy rules.

Keywords: Trade Agreement, Subsidy, Self-enforceability

JEL Classification: F10, F13