Forbearance in Optimal Multilateral Trade Agreements

By Renee Bowen
November152011| Working Paper No. 2085

I present a theory of optimal multilateral trade agreements with public political shocks. I first show that forbearance - where one country withholds retaliation when its trading partner receives a shock - is a feature of an optimal agreement. This provides a rationale for countries not acting on retaliatory rights granted under GATT. Second I show that there is a limit to forbearance allowable in a self-enforcing agreement. This limit is increasing in the number of countries in the agreement, increasing in the common discount factor, and increasing in the size of the export sector. In this sense, larger trade agreements with greater trade flows provide more insurance against political shocks.

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