The practice of tying firms' exports to particular countries to imports - although quite common in East-West and North-South trade - is widely viewed as a return to bilateralism and reciprocity and hence a threat to the multilateral trade system. Its advocates argue, however, that such 'countertrade' can correct market distortions and may be a second-best outcome when markets are not competitive. These competing views on countertrade's economic effects relate to an earlier debate in the literature on industrial organization. In the 'leverage theory', tying enables firms with monopoly power in one market to foreclose sales in - and hence monopolize - a second market. Such 'business reciprocity' may also foreclose other sellers in the market and constitute a barrier to entry. It also, however, imposes a constraint on buyers, who may be forced to buy products of inferior quality or higher price to sell their own goods.

In Discussion Paper No, 609, Research Fellow Dalia Marin develops a model of countertrade to show how it may circumvent collusive agreements (such as the OPEC cartel) and enable the 'previously centrally planned economies' (PCPEs) and LDCs to extract part of OECD firms' monopoly profits to subsidize their own exports. This exchange of market entry for marketing assistance effectively benefits the PCPEs/ LDCs through a shift in their terms of trade. Marin then estimates the likelihood of such a shift as a function of OECD firms' market power, the extent to which PCPEs/LDCs' exports under countertrade reflect their comparative advantage, and information available to those bargaining over the terms of the contract, for a sample of 230 countertrade contracts signed during 1984-8. Her results are consistent with the PCPEs/ LDCs' use of countertrade to reduce the effective prices of their imports.

Countertrade therefore raises PCPEs/LDCs' welfare by enabling them to recapture some of the monopoly rents the OECD firms would otherwise extract from consumers in the PCPEs/LDCs. The OECD firm essentially pays a fee for the right to sell in their markets, so countertrade has better welfare properties than an import tariff: the bargaining over the terms of the countertrade contract reduces consumer prices of OECD firms' goods in the PCPEs/LDCs. Marin considers the findings of these implications for Eastern Europe, where trade liberalization and decentralization are removing the policy-making powers of the Foreign Trade Organizations. A policy of constraining the OECD firms' market power would benefit the PCPES, but setting price ceilings on imports is no longer feasible. Marin proposes that a trade tax may provide a suitable second-best alternative.

Monopoly, Tying and Reciprocity. An Application to International Trade
Dalia Marin

Discussion Paper No. 609, December 1991 (IT)