Optimal International Agreement and Treatment of Domestic Subsidy

Abstract

TWe investigate how a domestic subsidy is treated in an international agreement, when a government, having incentive to use its subsidy as a means of import protection, can disguise its protective use of subsidy as a legitimate intervention with which to address a market imperfection in the import-competing sector. We show that any optimal agreement permits the use of a positive domestic subsidy, but it restricts the home government’s freedom to select domestic subsidy in order to increase the market-access level for foreign exporters. Our finding implies that proper restrictions on domestic subsidies are somewhere between GATT and WTO rules.Treatment of domestic subsidy, International agreement, GATT/WTO rules