The Evolution of International Subsidy Rules

Why did countries achieve a consensus to restrict export subsidies and export-promoting domestic subsidies when the World Trade Organization (WTO) began in 1995, but not decades earlier under the General Agreement on Tariffs and Trade (GATT)? This question poses a challenge for the theory of trade agreements because export promotion improves the terms of trade of importers, so subsidy restrictions reduce the welfare of importing nations. This paper argues that cross-border externalities arising from political economy and profit-shifting can explain the historical pattern of subsidy rules. Motives to restrict export promotion do not exist when trade policies are chosen noncooperatively, because import tariff revenue neutralizes any motive for export promotion. Once import tariffs fall, as in the 1950s and 1960s, then motives to restrict export promotion can arise. Governments prefer to protect domestic sales through international subsidy restraints rather than to allow consumers to benefit from unfettered subsidization. Governments could in theory have eliminated the need for subsidy rules by eliminating domestic intersectoral misallocation or by adjusting both import taxes and export subsidies consistent with the GATT principle of reciprocity, but in practice they have not done so. GATT documents and the WTO negotiating history provide support for the theory that the WTO subsidy rules address an international profit-shifting problem.