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A Commitment Theory Of Subsidy Agreements, Daniel Brou, Michele Ruta
A Commitment Theory Of Subsidy Agreements, Daniel Brou, Michele Ruta
Daniel Brou
This paper examines the rationale for the rules on domestic subsidies in international trade agreements through a framework that emphasizes commitment. We build a model where the policy-maker has a tariff and a production subsidy at its disposal, taxation can be distortionary and the import-competing sector lobbies the government for favorable policies. The model shows that, under political pressures, the government will turn to subsidies when its ability to provide protection is curtailed by a trade agreement that binds tariffs only (policy substitution problem). When the factors of production are mobile in the long-run, but the investments are irreversible in …