Opportunities for Cooperation in Removing Prohibitive Trade Barriers

Much potential for trade liberalization exists in industries and markets with trade barriers that are prohibitive for all or many firms. In standard political economic theories of trade policy, observed prohibitive barriers must be globally optimal according to both individual and joint government preferences, leaving no possibility for a trade agreement. This chapter shows that in a standard imperfectly competitive model, observed prohibitive barriers may be optimal according to individual government preferences but not joint government preferences, so that a trade agreement would be valuable. Theory can then further identify market characteristics for which liberalization is most likely to be feasible. To illustrate, we consider a two-country model with Cournot firms in segmented markets. For plausible ranges of political weights on firm profits, there is a role for a trade agreement in eliminating prohibitive trade barriers. We then consider how the potential for cooperation varies with trade costs, Ricardian technological differences, competition, and firm heterogeneity. The implications of these results are discussed for negotiations involving developing countries, for whom prohibitive trade barriers remain important.