Issues of international tax and trade policy conflict and co-operation
Chapter 2, titled "Hotelling Tax Competition" shows how competition among governments for mobile firms can bring about excessive differentiation in levels of taxation and public good provision. Hotelling's Principle of Minimum Differentiation is applied in the context of tax competition and shown to be invalid. Instead, when an equilibrium exists, differentiation of public good provision is maximized. Non-existence of equilibrium, which is possible, is a metaphor for intense tax competition. The chapter also shows that, to some extent, perfect tax discrimination presents a solution to the existence problem created by Hotelling tax competition, but that the efficiency problem of Hotelling tax competition is exacerbated. Chapter 3 shows how the institutional rules imposed on its signatories by the GATT created a strategic incentive for countries to liberalize gradually. Ree trade can never be achieved when punishment for deviation from a trade agreement is limited to a 'withdrawal of equivalent concessions' , the most severe form of punishment allowed (Article XXVIII). Retaliation is not allowed to entail higher tariffs than those set by the initial deviant. If, in addition, tariff bindings (Article 11) limit an initial deviation from an agreement in a similar way, then efficient self-enforcing tariff reductions must proceed in a series of steps or 'rounds'. Chapter 4 provides an answer to the question "Why are trade agreements regional? " It argues that free trade agreements (FTAs) are regional because, in their absence, optimal tariffs are higher against (close) regional partners than (distant) countries outside the region. Optimal tariffs shift rents from foreign firms to domestic citizens. Lower transport costs imply higher rents and therefore higher tariffs. So regional FTAs have a higher payoff than non-regional FTAs. Therefore, only regional FTAs may yield positive gains when sponsoring an FTA is costly. To analyze equilibrium, standard theory of non-cooperative networks is extended to allow for asymmetric players. Naive best response dynamics show that 'trade blocks can be stepping blocks' for free trade.