How Economic Interests Explain the Pattern of Subsidy Restrictions

This paper proposes a theory of subsidy bans that aligns well with their negotiating history across major sectors. Trade agreement theories often cannot explain why importing countries would ban export-promoting subsidies that yield terms-of-trade gains. Trade negotiation records suggest a rationale: concerns over lost sales of import-competing firms dominate all other concerns as markets integrate. The challenge for building this motive into theory is that government preferences implying subsidy bans also imply that nations would not open markets in the first place. To resolve this challenge, we consider nations who seek tariff cuts for exporters, for motives apart from terms-of-trade gains. Such motives exist but disappear when assuming perfect domestic policy-setting. Given any motive to promote exporters, countries negotiate tariff cuts so large that they like price increases in import sectors. Sufficient desire to prevent price decreases in import sectors then motivates subsidy bans. The trade agreement yields the same trade volume as if countries had negotiated fully over both import policies and export policies, so the bans do not create inefficiency. The rationale for subsidy bans requires minimal structure on competition or politics. The theory aligns well with the history that countries achieved consensus subsidy restrictions first in manufacturing, then in agriculture, but not yet in services. The widespread use of red tape barriers and influence of US electoral incentives on subsidy enforcement also align well with the theory. The rationale for subsidy bans helps to discipline estimates of political economy forces in quantitative models of trade policy.