The Political Economy of International Trade Cooperation Chapter 3 The Political Economy of International Trade Cooperation

Absolute Advantage The principle upon which Adam Smith first claimed that free-trade benefits all countries. It holds that a country benefits from trade when it produces a particular good at a lower cost (in terms of labor input) than it costs to produce the good in any other country. By specializing in the production and export of this good and importing goods whose production costs are higher than in other countries, the country can consume more of both goods. In trade theories, this principle was later replaced by the principle of comparative advantage. (See comparative advantage.)

Comparative Advantage First fully stated by David Ricardo in the early nineteenth century, this concept holds that a country has a comparative advantage in a good if it can produce that good more cheaply than it can produce other goods. By specializing in the production of goods in which it holds a comparative advantage and importing the other goods, the country can consume more of all goods. In contrast to Adam Smith, therefore, this principle states that a country need not have an absolute advantage in any good to benefit from trade. The principle provides a powerful justification for liberal international trade by asserting that all countries benefit from such trade.

Hecksher-Ohlin Model A model of the determinants of comparative advantage that argues that comparative advantage arises from cross-national differences in factor endowments. A country’s comparative advantage will lie in goods produced through heavy reliance on its abundant factors. Capital-abundant countries have a comparative advantage in capital-intensive goods, and labor-abundant countries have a comparative advantage in labor-intensive goods. (See factor endowments.)

Factor Endowments The amount of land, labor, and capital a country has available. Countries have different relative factor endowments, and in the Hecksher-Ohlin model of international trade, these differences are the source of comparative advantage.

Prisoners’ Dilemma A game-theoretic model often used to depict the difficulties that governments face when trying to cooperate in the global economy. Emphasizes the incentives that governments have to “cheat” on any international agreements into which they enter and shows how those incentives make governments reluctant to enter into cooperative agreements.

Reciprocity The central principle upon which bargaining within the World Trade Organization is based. The concessions that each government makes to its partners in multilateral trade negotiations are roughly the same size as the concessions it gains from its trading partners.

Tit-for-Tat A strategy often associated with iterated play of the prisoners’ dilemma in which each actor plays the strategy its partner played in the prior round of play. If I play cooperation in the current round, you play cooperation in the next round. Tit-for-tat was found to support cooperation in an iterated prisoners’ dilemma.

Nash Equilibrium An outcome in a game theoretic model in which none of the players has an incentive to change their strategy unilaterally.

The WTO exists because it facilitates international cooperation, thereby enabling societies to capture the welfare gains available from trade. Trade raises social welfare by enabling consumers to enjoy a higher level of utility than if they could consume only goods produced at home. The principle of comparative advantage tells us that these welfare gains do not require a country to have an absolute advantage in anything. As long as a country is better at doing some things than others, it gains by specializing in what it does relatively well and trading for everything else.

Politics, however, makes it difficult for societies to realize these gains from trade. For reasons we examine in greater detail in the next chapter, governments often neglect consumer interests in favor of producer interests. Consequently, governments can capture the gains from trade only by negotiating agreements in which they exchange market access commitments. In such bargaining, governments strive to gain access to foreign markets for their comparatively advantaged industries in exchange for granting access to their markets in their comparatively disadvantaged industries. Consequently, governments employ bargaining power in an attempt to gain maximum access in exchange for minimal concessions.

By providing a forum for bargaining, the WTO enables governments to liberalize trade more than they would be willing to do unilaterally. Yet, concluding trade agreements is also complicated by the enforcement problem. Governments must believe that cooperation on their part will be reciprocated by cooperation from their partners. They must believe that their partners will not try to take advantage of them.

And as the prisoners’ dilemma highlights, unless such assurances are provided, governments have little incentive to cooperate. The international trade system lacks the equivalent of a state to enforce agreements, and thus governments face a pervasive enforcement problem when they try to cooperate for mutual gain. Consequently, it is difficult for governments to conclude mutually beneficial agreements, and as a result, societies have lower standards of living. The WTO helps governments solve this enforcement problem. By enabling governments to feel reasonably secure that their partners will comply with the agreements they enter, the WTO provides the assurances necessary to achieve cooperation.

Strictly speaking, the WTO is not an international equivalent of a state because the WTO does not have the authority or the capacity to punish governments that fail to comply with trade agreements. Instead, the WTO facilitates international cooperation by providing an infrastructure that allows governments to enforce agreements themselves. By providing a set of mutually agreed on rules, by helping governments monitor the extent to which their partners comply with these rules, and by providing a dispute-settlement mechanism that helps governments resolve those issues of compliance that do arise, the WTO enables governments to enforce effectively the trade agreements that they reach.

The WTO thus provides enough assurance that all governments will live up to the agreements that they enter into and that no government will be able to take advantage of the others. By providing this infrastructure, the WTO enables governments to conclude the trade agreements necessary to capture the welfare gains from trade.

To delve more deeply into the logic of international cooperation and the role international institutions play in facilitating such cooperation, see Robert Axelrod, The Evolution of Cooperation (New York: Basic Books, 1984).