DP7695 | Do terms-of-trade effects matter for trade agreements? Evidence from WTO countries

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In the literature on the economics of international trade institutions, a key question is whether or not terms-of-trade effects drive international trade agreements. Recent empirical work addressing terms-of-trade effects has been restricted to non-WTO countries or accession countries, which differ markedly from existing WTO members and account for only a tiny fraction of world trade. This paper investigates whether MFN tariffs set by existing WTO members in the Uruguay round are consistent with the terms-of-trade hypothesis. We present a model of multilateral trade negotiations featuring free riding on MFN that leads the resulting tariff schedule to display terms-of-trade effects. Specifically, the model predicts that the level of the importer?s tariff resulting from negotiations should be negatively related to the product of exporter concentration, as measured by a Herfindahl-Hirschman index (sum of squared export shares), and the importer?s market power, as measured by the inverse elasticity of export supply, on a product-by-product basis. We test this hypothesis using data on tariffs, trade and production across more than 30 WTO countries and find strong support. We estimate that the internalization of terms of trade effects through WTO negotiations has lowered the average tariff of these countries by about 20% compared to its non-cooperative level.