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  • Self-Enforcing International Agreementsand Domestic Policy Credibility

    CSGR Working Paper No. 114/03

    Paola Conconi and Carlo Perroni

    Warwick University and ECARES

    July 2003

    AbstractWe explore the relationship between international policy coordination and do-

    mestic policy credibility when both must be self-supporting. Our arguments arepresented in the context of a two-country, two-period model of dynamic emissionabatement with transboundary pollution, where government policies suffer froma time-consistency problem. In the absence of repeated interaction, any form ofcoordinationbetween governments, and between governments and their respectiveprivate sectorsimproves policy making. Nevertheless, under repeated interactioninternational policy spillovers can make it possible to overcome the domestic cred-ibility problem; and, conversely, the inability to precommit to policy domesticallycan help support international policy cooperation.

    KEYWORDS: Policy Commitment, Self-Enforcing International Agreements.

    JEL Classification: F42, C73, H20.

    An earlier version of this paper was presented at the 2001 EURESCO Conference on the InternationalDimension of Environmental Policy, at the Mid-West International Economics Group Spring 2003 Meetingat the University of Pittsburgh and at seminars at the University of Bristol, Royal Holloway, and FreeUniversity of Brussels (ECARES). We wish to thank the participants for their comments. We are alsograteful to Mathias Dewatripont, Michael Finus, Patrick Legros, Arik Levinson, David de Meza, AndrSapir, and John Whalley, for their valuable suggestions. The usual disclaimer applies. We gratefullyacknowledge support from the University of Warwick and the ESRC.

    Correspondence to Paola Conconi, European Centre for Advanced Research in Economics and Sta-tistics (ECARES), Universit Libre de Bruxelles, Avenue F. D. Roosevelt 50, CP 114, 1050 Brussels,Belgium; Tel: +32 (0)2 650 2345; Fax: +32 (0)2 650 4475; E-mail: pconconi@ulb.ac.be

  • Non-Technical Summary

    It is often informally argued that international agreements, by making domestic policychanges more difficult to reverse, could enhance the credibility of policymakers when do-mestic policy commitment devices are not available. This argument, however, runs againstthe observation that international agreements are themselves not directly enforceable:absent a supranational authority with autonomous powers of enforcement, internationalagreements need to be sustained by the threat of credible punishment between the partiesinvolved. For example, the WTO cannot directly punish violations and can only authorizemember countries to retaliate against violators. The idea that international agreementsmust be self-enforcing has been repeatedly stressed in recent literature. If internationalagreements are not automatically binding, one could actually conjecture a reverse linkagebetween domestic policy credibility and international agreements, namely that a lack ofdomestic commitment might make it more difficult to undertake commitments vis--visinternational partners.To the best of our knowledge, this is the first paper to analyze the two-way relation-

    ship between the credibility of domestic institutions and international policy cooperationunder repeated interaction, when both must be self-supporting. The papers main con-tribution is to show that the need to internalize international policy spillovers through aself-enforcing international agreement may help governments to overcome domestic policycredibility problems in policy choices, and, conversely, the need to sustain policy reputa-tion with the private sector may help governments to support policy coordination withone another; consequently, reducing the scope for repeated strategic interaction by meansof a binding partial coordination mechanismsuch as a (hypothetically) binding interna-tional agreement or a domestic policy commitment devicemay make it more difficult tosupport efficient policies. We also show that, when the international policy coordinationproblem and the policy credibility problem are not too severe, a simultaneous increase inthe severity of both problems can be beneficial to self-enforcing policy coordination.The general conclusion one can draw from these results is that when international

    agreements and domestic policy credibility must both be self-supporting, causation be-tween them can flow in either direction: self-supporting international agreements canboost domestic policy credibility, and, vice versa, the need to sustain domestic policyreputation can help international cooperation. But co-causation is also possible: self-supporting international agreements and domestic policy credibility can complement eachother, working together to help support efficient policies.

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  • 1 Introduction

    In the literature on rules versus discretion,1 it is often informally argued that interna-tional agreements, by making domestic policy changes more difficult to reverse, couldenhance the credibility of policymakers when domestic policy commitment devices arenot available.2 Figure 1, where we plot the World Bank indicator of institutional credi-bility3 against membership (or not) in the World Trade Organization (WTO) for seventycountries, seems to support such a claim: on average, WTO members score a higher cred-ibility index than non-members.4 This argument, however, runs against the observationthat international agreements are themselves not directly enforceable: absent a suprana-tional authority with autonomous powers of enforcement, international agreements needto be sustained by the threat of credible punishment between the parties involved.5 Ifinternational agreements are not automatically binding, one could actually conjecture areverse linkage between domestic policy credibility and international agreements, namelythat a lack of domestic commitment might make it more difficult to undertake commit-

    1The idea that policy discretion might provide governments with an incentive to renege on earlierpromises, that this incentive could undermine the sustainability of optimal government policies, and thatthe adherence to policy rules might restore the credibility and therefore lead to preferred outcomes, wasintroduced in the seminal paper by Kydland and Prescott (1977). The most influential applications ofthis idea have been in monetary and fiscal policy (see Persson and Tabellini [1994] for a review), but timeinconsistency issues have been shown to arise in most areas of economics, including international trade(e.g. Staiger and Tabellini [1987], Matsuyama [1990], and Tornell [1991]) and environmental policy (e.g.Laffont and Tirole [1996]).

    2For example, Staiger and Tabellini (1987) and Matsuyama (1990) suggest that time inconsistencyproblems in trade policy could be overcome if countries could undertake binding commitments throughthe GATT/WTO. In a more recent paper, Staiger and Tabellini (1999) find that GATT rules did indeedhelp the US government to make domestic trade policy commitments to its private sector.

    3This indexwhich range from 1 (worst) to 6 (best)captures the credibility of governments policyannouncements. It was constructed by the World Bank and the International Finance Corporation onthe basis of a private sector survey conducted during 1996-1998 in seventy-four countries (see Brunettiet al. [1998]).

    4The empirical evidence on this question is otherwise scant. There have been empirical studies focusingon the relationship between price inflation, central bank independence, and membership in a monetaryunion (e.g., Cukierman [1992]); but we are not aware of any systematic cross-country examination of therelationship between domestic policy credibility and membership in international agreements.

    5For example, the WTO cannot directly punish violations and can only authorize member countriesto retaliate against violators. The idea that international agreements must be self-enforcing has beenrepeatedly stressed in recent literature (see, for example, Bagwell and Staiger [1997], Maggi [1999], andEderington [2001a,b]).

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    6W o r ld B a n k C r edibilit y I n de x

    N o n - W T O m em be r

    W T O m e m be r

    Figure 1: Domestic Credibility and WTO Membership

    ments vis--vis international partners. Indeed, this is an alternative interpretation of thepattern shown in Figure 1.This paper explores the linkage between international agreements and domestic pol-

    icy credibility when both must be self-supporting. The papers main contribution is toshow that the need to internalize international policy spillovers through a self-enforcinginternational agreement may help governments to overcome domestic policy credibilityproblems in policy choices, and, conversely, the need to sustain policy reputation with theprivate sector may help governments to support policy coordination with one another;consequently, reducing the scope for repeated strategic interaction by means of a bindingpartial coordination mechanismsuch as a (hypothetically) binding international agree-ment or a domestic policy commitment devicemay make it more difficult to supportefficient policies. We also show that, when the international policy coordination prob-lem and the policy credibility problem are not too severe, a simultaneous increase in theseverity of both problems can be beneficial to self-enforcing policy coordination.The general conclusion one can draw from these results is that when international

    agreements and domestic policy credibility must both be self-supporting, causation be-tween them can flow in either direction: self-supporting international agreements canboost domestic policy credibility, and, vice versa, the need to sustain domestic policyreputation can help inte

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