A Theory of Unilateralism and Reciprocity in Trade Policy
Stanford King Center on Global Development Working Paper
Using the menu-auction approach to endogenous determination of tariffs and allowing additionally for lobby formation itself to be endogenous, this paper analyzes the impact of unilateral trade liberalization by one country on its partner's trade policies. We find that such unilateral liberalization generally induces reciprocal tariff reductions by the partner country. Intuitively, unilateral liberalization by one country has the effect of increasing the incentives for the export lobby in the partner country to form and to lobby effectively against the import competing lobby there for lower protection. The results stand in sharp contrast to the policy arguments that suggest that closing (or threatening to close) one's markets would help pry open the markets of others. The optimal tariff to be set by a large economy—with endogenous lobby formation in partner countries and the consequent reciprocation by partner countries taken into account—is shown to be smaller than it would otherwise be.