The Value of Multilateral Trade Liberalization and the Need for Third-Party Sanction

The GATT/WTO and preferential trade agreements help member countries to achieve further gains from trade by promoting deeper trade liberalization. In general, free trade does not automatically follow from individualistic behavior. A major reason for this has to do with the existence of monopolistic power in trade. Trade liberalization requires that countries behave cooperatively and reciprocally. In certain circumstances, greater cooperation and reciprocity can only be achieved through multilateral trade agreements, as opposed to a web of bilateral trade agreements, and sustained through third-party punishments. To illustrate, consider three countries: China, Japan, and the United States. The US would be better off if Japan would open its market to US agricultural products. However, in this case, the US has few sectors with which to reciprocate because almost all US markets are already very open to Japanese products. The lack of reciprocity discourages Japan and the US from reaching a bilateral agreement for further trade liberalizations. On the other hand, China can reduce its tariffs on electrical appliances that would help Japan since Japan is a major exporter of these goods in the world, but Japan