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Diversity and the disinterest in trade liberalization: on the prospects of self-enforcing cooperation

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Abstract

International economic order, including the rules of the game for trade, usually suffers from enforcement problems. We examine the prospects of self-enforcing cooperation as trade relationships evolve. It turns out that factor differentials and specificities are of utmost importance. In fact, prospects of self-enforcing cooperation are the lower the more diverse the countries are on that score. Differences may even result in countries showing an outright disinterest in trade liberalization. Notably, this result also holds in a recurrent, that is, in an evolutionary setting that otherwise induces cooperation in trade liberalization with self-enforcing properties.

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Notes

  1. Or, as Schelling (1960/1980) has put it: “Trust is often achieved simply by the continuity of the relation between parties and the recognition by each that what he might gain by cheating in a given instance is outweighed by the value of the tradition of trust that makes possible a long sequence of future agreements.” (p. 134f.) Rules emerging from this calculus thus can be seen as “conventions whose sanction in the aggregate is the need for . . . [cooperation] . . . , and whose sanction in each individual case is the risk that to breach a rule may collapse it and that to collapse it may lead to a jointly less favorable [rule].” (p. 260, expressions in brackets added).

  2. See Rampell (2009) on how protection is being built up in tit-for-tat manner in times of crisis.

  3. See also the dispute on whether the WTO as an external institution has had an (empirically significant) impact on the member countries (e.g. Rose 2004; Goldstein et al. 2007; Eicher and Henn 2011).

  4. As Hayek wrote “... rules come to be observed because in fact they give the group in which they are practiced superior strength (1973: 18f.), or, even more explicitly, “... [rules prevail] which lead to the formation of a more efficient order of the whole group (1978: 9). Barry (1982) provides an excellent review of the history of thought on spontaneous order which Hayek sometimes seems to see intrinsically tied to evolutionary processes.

  5. See the contributions on Hayek- versus Schelling-type coordination by Klein (1997) and Klein and Orsborn (2009). In particular, the setting outlined here lacks the catallaxy Hayek focuses on where myriads of actors as if guided by an “invisible hand” decide on what to do without thinking neither about each other nor about the system as a whole. This differs from the Schelling-type coordination of activities in which the actors choose their action facing each other and thus with a sense of knowledge as regards each other and the situation as a whole.

  6. Depending on provenience, they cite issues of path-dependency, flaws in Hayek’s argument due to the free-rider problem, the failure to take externalities fully into account or the lack of stringency in the argument as Hayek moves from individual to group selection (e.g. Arthur 1994, Campbell 1980, Vanberg 1994: Ch. 5, Sandefur 2009). See also, to name but two, Caldwell (2001, 2004) in defense of Hayek, and Hodgson (1993, 2002, 2004) in defense of evolutionary concepts borrowed from Darwinian biology applied to social matters but critically on Hayek.

  7. Magee and Magee (2008), for instance, find with respect to the US that it does not quite stand up to the facts whereas Broda et al. (2008) present evidence in favor of the terms-of-trade argument.

  8. On the role of special interests and the capability of interest groups obtaining protection see recently Jones (2007) and Jones and Ruffin (2008) as well as the survey by Alt and Gilligan (1994).

  9. On the other hand, the within-sectoral detail is usually accompanied by supposing that utility is strictly additive, a strong assumption that is also owed to tractability.

  10. See the volume by Baldwin and Evenett (2011) on the current (dismal) state.

  11. See the WTO-data base for numbers http://www.wto.org/english/tratop_e/region_e/region_e.htm as of 08 August 2011.

  12. On rules of origin as protectionist device and the true character of FTAs with respect to trade liberalization see Krueger (1999a, b).

  13. Even (external) enforcement by international institutions heavily draws on the threat of retaliation which is akin to the tit-for-tat strategy frequently employed in the absence of external institutions (see Kono 2007, Bown 2009, and the volume edited by Bown and Pauwelyn 2010). See also, on a more general account, Fiori (2006) in an attempt to reconcile constructivism and the evolution of norms in Hayek’s work (e.g. 1973). For a positive account of retaliation though on face of it a “perverse strategy for enforcing international agreements on trade” see Nzelibe (2005:215); Lawrence (2003), while not condemning the instrument of retaliation per se, is critical on the details in the context of the World Trade Organization.

  14. Incentive compatibility requires (1) that the expected payoff in case of a tit-for-tat strategy at least matches the one from choosing a defective strategy all of the time (provided the other party plays in any case tit-for-tat) and (2) that tit-for-tat does at least as well as alternating between defection and cooperation. Solving for the frequency parameter q for which both conditions hold, thus yields the respective numerical values for cooperation to obtain without external enforcement.

  15. Note that to the left of \(\left( k^{\ast}\right)_{q} \) the condition on q H exceeds unity (as indicated by the dotted horizontal).

  16. Notably, if the payoff in Cell IV is ranked better than the payoff in Cell I by any of the parties, then q > 1. That is, the requirement with respect to probabilities of facing each other again cannot materialize.

  17. As, for instance, is the case in our setup with national income in Home increasing in t in the relevant parameter range and the effect of t in the simulation shown to decrease in k  ∗ . Hence, ceteris paribus, protectionist sentiments are stronger, the smaller k  ∗  (given k = 1), that is the more diverse the countries.

  18. On the importance of veto points see Tsebelis (2002) on a general account and O’Reilly (2005) with particular reference to trade, although both from a political science perspective.

  19. The exact tradeoff between the threshold q with respect to any single pair of countries and the fraction of those adopting a tit-for-tat strategy is surely also affected by the issue of trade diversion and its distributional incidence.

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Authors and Affiliations

  1. Economics Department, Helmut Schmidt University - University of the Federal Armed Forces (FAF) Hamburg, Holstenhofweg 85, 22043, Hamburg, Germany

    Barbara Dluhosch & Stefanie Krause

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  1. Barbara Dluhosch
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Correspondence to Barbara Dluhosch.

Appendix

Appendix

1.1 Appendix 1 Check for international trade being balanced

Trade balance requires that the value of exports equals those of imports at the world relative price, i.e. for Home: \(\left(x_{1} -c_{1}\right)=p\left(c_{2}-x_{2} \right) \) with demand c 1, c 2 according to Eq. 5 and supply x 1, x 2 according to Eq. 8. So that the trade balance can be rewritten as \(\left( k+\left(1-t^{2} \right)p^{2}/4\right)\overline{L}=Y\left( 2+t\right)/\left(4\left( 1+t\right) \right) \). Finally, national income Y can be eliminated by use of Eq. 4 where \(\emph{w}\overline{L}\) can be substituted via the zero-profit condition, i.e. setting π 2 = 0 in Eq. 6, and substituting again x 2, \((\overline{K}-K_{1} ) \) and c 2 as previously. Recalling that r = 1 then shows that the RHS equals the LHS.

On the same account, Home’s exports equal Foreign’s imports at world prices, i.e. \(\left(x_{1}-c_{1} \right)=\left(c^{\ast}_{1}-x^{\ast}_{1} \right) \). Eliminating \(x_{1}, x^{\ast}_{1}\), c 1, \(c^{\ast}_{1}\) by use of Eqs. 5 and 8 yields \(k\overline{L}-\left(p\left( 1+t\right)/2 \right)^{2}-Y/2=Y^{\ast}/\left( 2\left( 1+T\right) \right)-k^{\ast}\overline{L}+p^{2}\overline{L}/\left(4\left( 1+T \right) \right)^{2} \). Substitution of Y,Y  ∗  by means of Eqs. 4 and 6 gives Eq. 10.

1.2 Appendix 2 Setting A = A  ∗  = 1

The left hand panel of Fig. 4 shows the trend in the ranking of payoffs by Home’s policy maker in case of the countries being highly diverse in terms of factor proportions with Cell II > Cell IV > Cell I > Cell III; the right hand panel shows the corresponding trends for k  ∗  larger (given k = 1) with Cell II > Cell I > Cell IV > Cell III. Hence, for k  ∗  low (and based on the real income effects of changes in the terms of trade) it is hard for cooperation in trade liberalization to obtain. This result also holds in an evolutionary setting since the ranking of Cells I and IV in terms of payoffs is crucial for retaliation to unfold its disciplinary power.

Fig. 4
figure 4

Ranking of payoffs supposing that A = A  ∗  = 1

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Dluhosch, B., Krause, S. Diversity and the disinterest in trade liberalization: on the prospects of self-enforcing cooperation. J Evol Econ 23, 455–475 (2013). https://doi.org/10.1007/s00191-012-0267-3

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