The large literature on rules versus discretion in economic policy is almost entirely theoretical, with few applications to the real world and none relating to trade policy. In Discussion Paper No. 514, Robert Staiger and Research Fellow Guido Tabellini investigate the role of commitment by contrasting US trade policy under two institutional environments, which differ primarily in the government's capacity to commit vis-à-vis the domestic economy. The Escape Clause (section 201 of the US Trade Act of 1974) provides ample opportunity for the government to reoptimize, while the rules of the Tokyo Round of the GATT enable the government to enter into binding policy commitments.

Staiger and Tabellini develop a theoretical model of redistributive trade policy for a small open economy with two traded goods and inputs of (mobile) labour and (immobile) capital. Aggregate labour supply is fixed, and firms in each sector combine labour with their fixed capital stocks until its marginal product equals the (perfectly flexible) nominal wage. Private agents and government react to a shock that lowers the price of the imported good, when workers' decisions whether to change sector are determined solely by the intersectoral wage differential. Staiger and Tabellini consider these reactions under `discretion', when the government sets policy after the workers have chosen whether to change sectors on the basis of the expected wage differential, and `commitment', when the order of decisions is reversed so workers make their decisions knowing the actual differential.

The theoretical model indicates that commitment induces the government to pay greater attention to the tariff's distortionary effects on production relative to consumption and therefore influences the equilibrium tariff more for sectors whose wage bills are large relative to the value of consumption. The authors then test its predictions under the maintained hypothesis that commitment capacity is greater in the Tokyo Round negotiations than in the Escape Clause procedures. They use cross-industry data to estimate a profit model of tariff determination under the Escape Clause procedure and a model of tariff determination where the dependent variable is the exclusion from the general formula cut agreed under the Tokyo Round negotiations. In both cases the tariff is generally negatively and significantly related to the ratio of the wage bill to the value of consumption, as the theoretical reasoning suggests. Staiger and Tabellini note that their results support the consensus of the recent literature on trade policy and imperfect markets that activist trade policies should be pursued on a case-by-case basis if they are to be pursued at all.

Does Commitment Matter in Trade Policy?
Robert Staiger and Guido Tabellini

Discussion Paper No. 514, March 1991 (IT)