Tariff Retaliation Versus Financial Compensation in the Enforcement of International Trade Agreements

We analyze whether financial compensation would be preferable to the current system of dispute settlement in the World Trade Organization (WTO) that permits member countries to impose retaliatory tariffs in response to trade violations by other members. We show that monetary fines are more efficient than tariffs in terms of granting compensation to injured parties but they suffer from an enforcement problem in that they must be paid by the violating country. If fines have to be ultimately supported by the threat of retaliatory tariffs, their use fails to yield a more cooperative outcome than the current system. We also consider the use of bonds as a means of settling disputes. If bonds can be posted with a third party (via an escrow account say), they do not have to be supported by retaliatory tariffs and can improve the negotiating position of countries that are too small to effectively threaten tariff retaliation