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Bilateral Trade Agreements between Countries with Asymmetric Power: An Incomplete Contract Perspective

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Abstract

This article examines the economic relevance of incomplete contract theory in a better understanding of the process of bilateral trade agreements between countries with asymmetric power. Agreement is signed under incomplete information because future trade flows are unknown when the decreases in tariffs are decided. Using a principal-agent model, we show that the powerful country makes a take-it-or- leave-it offer to the weaker country which is able, under incomplete information and non verifiability, to extract a positive information rent from the agreement, by undervaluing its exports. We further show that the threat of retaliation ensures that the truthful first best agreement will be implemented.

Suggested Citation

  • Calmette, Marie-Francoise, 2004. "Bilateral Trade Agreements between Countries with Asymmetric Power: An Incomplete Contract Perspective," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 57(4), pages 407-428.
    • Handle: RePEc:ris:ecoint:0121
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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