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Exporting Under Trade Policy Uncertainty: Theory and Evidence

Policy commitment and credibility are important for inducing agents to make costly, irreversible investments.

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Policy uncertainty can delay investment and reduce the response to policy change. I provide theoretical and novel quantitative evidence for these e ects by focusing on trade policy, a ubiquitous but often overlooked source of uncertainty, when a rm's cost of export market entry is sunk. While an explicit purpose of the World Trade Organization (WTO) is to secure long term market access, little theoretical and empirical work analyzes the value of WTO institutions for reducing uncertainty for prospective exporters. Within a dynamic model of heterogeneous rms, I show that trade policy uncertainty will delay the entry of exporters into new markets and make them less responsive to applied tari reductions. Policy instruments that reduce or eliminate uncertainty such as binding trade policy commitments at the WTO can increase entry even when applied protection is unchanged. I test the model using a disaggregated and detailed dataset of product level Australian imports in 2004 and 2006. I use the variation in tari s and binding commitments across countries, products and time, to construct model-consistent measures of uncertainty. The estimates indicate that lower WTO commitments increase entry. Reducing trade policy uncertainty is at least as e ective quantitatively as unilateral applied tari reductions for Australia. These results illuminate and quantify an important new channel for trade creation in the world trade system.

No: ERSD-2011-20


Kyle Handley — Stanford University

Manuscript date: December 2011

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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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