Punishments and Dispute Settlement in Trade Agreement

This paper interprets dispute settlement procedures and punishments as responses to the fact that trade agreements are incomplete contracts. I argue that this can explain prominent features and has implications for trade agreements. If no weight is given to the adjudication phase and if the degree of trade relatedness is known with certainty, the negotiated trade agreement will induce violation of the dispute settlement ruling and will deliver optimal liberalization and the optimal unilateral action. This suggests a central role, in multilateral trade liberalization, for an implicit agreement to allow countries to violate commitments if the violation implies no retreat from reciprocity. With the adjudication phase of concern the trade agreement will feature less liberalization. There is a presumption that the optimal trade agreement features commensurate punishment, or approximately commensurate punishment. The optimal trade agreement will likely induce abiding by the ruling when the negotiators attach more importance to the adjudication phase, and violating it when they attach less.

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