DP5160 Do Countries Free Ride on MFN?

Author(s): Rodney D Ludema, Anna Maria Mayda
Publication Date: August 2005
Keyword(s): free riding, Most-Favoured Nation (MFN) clause, principal supplier rule
JEL(s): D70, F13
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5160

The Most-Favored Nation (MFN) clause has long been suspected of creating a free rider problem in multilateral trade negotiations. To address this issue, we model multilateral negotiations as a mechanism design problem with voluntary participation. We show that an optimal mechanism induces only the largest exporters to participate in negotiations over any product, thus providing a rationalization for the Principal supplier rule. We also show that, through this channel, equilibrium tariffs vary according to the Herfindahl index of export shares: higher concentration in a sector reduces free riding and thus causes a lower tariff. Estimation of our model using sector-level tariff data for the US provides strong support for this relationship.