A theory of trade policy leadership

This paper constructs a two-country model of bilateral trade negotiations i n the presence of political uncertainty to demonstrate that unilateral trad e liberalization may be an optimal policy for a large country. The politica l uncertainty is due to producer opposition to trade-agreement ratification in the foreign country. Unilateral liberalization by the home country has a salutary effect on negotiations, because it mitigates the pain of potenti al ratification failure on the foreign country. It also promotes foreign ra tification, because it effectively punishes foreign import-competing produc ers for lobbying against an agreement. These benefits are shown to outweigh (up to a point) the terms-of-trade cost that the home country must suffer when it actually liberalizes unilaterally. In equilibrium, therefore, we se e a pattern in which the home country unilaterally liberalizes for several periods, until ratification in the foreign country succeeds, at which point foreign country finally reciprocates. We also demonstrate that, contrary t o the standard optimal tariff result, there may be an inverse relationship between the home country's monopoly power and its optimal unilateral tariff . (C) 2001 Elsevier Science B.V. All rights reserved.