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The Economics of Permissible WTO Retaliation

WTO arbitrators rely on economics to establish the permissible retaliation limits authorized by the Dispute Settlement Understanding (DSU) which arguably serves to enforce the overall agreement.

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We examine how theoretical and quantitative economic analysis has and can be used in this stage of the DSU process. First, we identify, characterize, and categorize the major classes of disputes — e.g., those affecting import protection versus export promotion — and use the Bagwell and Staiger interpretation of the WTO principle of reciprocity to provide a theoretical framework that arbitrators can use to identify the maximum level of retaliatory countermeasures. Second, we allocate each of the ten DSU arbitrations that have taken place thus far into one of these categories and compare the arbitrators’ actual approach with the theory. Third, we use this framework to identify three crucial elements to the arbitrators' decision-making process for each case: i) the formula that they decide to adopt for identifying appropriate countermeasures, ii) their political-legal-economic decision on a WTO-consistent counterfactual to use to implement the formula, and iii) the quantitative methods they use to necessarily construct the (unobserved) WTO-consistent counterfactual. We examine not only the arbitrations that have taken place thus far, but our approach also illustrates a template for many additional types of arbitrations likely to take place under the DSU. Finally, in the disputes in which this reciprocity approach has not been used, we identify procedural difficulties that arbitrators confront thus highlighting the constraints that hinder their use of economic analysis in practice.

No: ERSD-2008-04

Chad P. Bown — Brandeis University
Michele Ruta — WTO

Manuscript date: September 2008

Key Words:

WTO, DSU, arbitrations, reciprocity, retaliation, market access, terms-of-trade externality

JEL classification numbers:

F13, F51, K33


Disclaimer  back to top

This is a working paper, and hence it represents research in progress. This paper represents the opinions of the author, and is the product of professional research. It is not meant to represent the position or opinions of the WTO or its Members, nor the official position of any staff members. Any errors are the fault of the author. Copies of working papers can be requested from the divisional secretariat by writing to: Economic Research and Statistics Division, World Trade Organization, Rue de Lausanne 154, CH 1211 Geneva 21, Switzerland. Please request papers by number and title.

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