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We characterize the optimal tariff bindings in a trade agreement among asymmetric countries that are subject to idiosyncratic political-economy shocks. We find that the optimal tariff binding is decreasing in the relative size of the importing country and its degree of comparative disadvantage. Moreover, under an optimal agreement a smaller country is more likely to apply a tariff that is substantially below its tariff binding. Using applied and bound tariff data from WTO member countries, we …nd strong empirical support for our predictions.

In this paper we explore the potential gains that a trade agreement (TA) can provide by regulating trade-policy uncertainty, in addition to the more standard gains from reducing the mean levels of trade barriers. We show that in a standard trade model with income-risk neutrality there tends to be an uncertainty-increasing motive for a TA. With income-risk aversion, on the other hand, the uncertainty-managing motive for a TA is determined by interesting trade-o¤s. For a given degree of risk aversion, an uncertainty-reducing motive for a TA is more likely to be present when the economy is more open, the export supply elasticity is lower and the economy is more specialized. Governments have stronger incentives to sign a TA when the trading environment is more uncertain. As exogenous trade costs decline, the gains from decreasing trade-policy uncertainty tend to become more important relative to the gains from reducing average trade barriers. We also derive a simple “su ¢ cient statistic”to determine whether there is an uncertainty-reducing motive for a TA: this is the case if, at the noncooperative equilibrium, an adjusted measure of the exporting country’s openness co-varies with the importing country’s tari ¤ as a result of the shocks. Finally, we investigate the impact of a TA on investment and trade via changes in trade-policy uncertainty.

Abstract: Many commentators argue that uncertainty about tax, spending, monetary and regulatory policy slowed the recovery from the 2007-2009 recession. To investigate this we develop a new index of economic policy uncertainty (EPU), built on three components: the frequency of newspaper references to economic policy uncertainty, the number of federal tax code provisions set to expire, and the extent of forecaster disagreement over future inflation and government purchases. This EPU index spikes near consequential presidential elections and major events such as the Gulf wars and the 9/11 attack. It also rises steeply from 2008 onward. We then evaluate our EPU index, first on a sample of 3,500 human audited news articles, and second against other measures of policy uncertainty, with these suggesting our EPU index is a good proxy for actual economic policy uncertainty. Drilling down into our index we find that the post-2008 increase was driven mainly by tax, spending and healthcare policy uncertainty. Finally, VAR estimates show that an innovation in policy uncertainty equal to the increase from 2006 to 2011 foreshadows declines of up to 2.3 % in GDP and 2.3 million in employment.