Enforcing International Trade Agreements with Imperfect Private Monitoring: Private Trigger Strategies and the Possible Role of the WTO

Abstract

International trade disputes often involve the WTO as a third party that generates impartial opinions on potential violations when countries receive imperfect and private signals of violations. To identify the role that the WTO plays in enforcing trade agreements, this paper first explores what countries can achieve without the WTO by characterizing optimal private trigger strategies (PTS) under which each country triggers a punishment phase by imposing an explicit tariff based on privately-observed imperfect signals of the other country's concealed trade barriers. It identifies the condition under which countries can restrain the use of concealed barriers based on PTS and establishes that countries will not reduce the cooperative protection level to its minimum attainable level under the optimal PTS. This paper then considers third-party trigger strategies (TTS) under which the WTO allows each country to initiate a punishment phase based on the WTO's judgment (i.e., its signals) about potential violations. The WTO thus changes the nature of punishment-triggering signals from private into public, enabling countries to use punishment phases of any length under TTS, which in turn facilitates a better cooperative equilibrium. The optimal TTS will involve an asymmetric and minimum punishment if the probability of a punishment phase being triggered is lower than a critical level, but it will entail punishments involving a permanent Nash tariff war if the probability of a punishment phase is higher than a certain level. A numerical comparison of the optimal TTS and optimal PTS indicates that the contribution of the WTO is likely to be significant when the signals of potential violations are relatively accurate, as this enables countries to use a more efficient punishment, such as an asymmetric and minimum punishment.Concealed Trade Barriers, Imperfect Private Monitoring, International Trade Agreements, Repeated Game, Trade Disputes, Trigger Strategies, WTO