A rationale for cooperation in trade negotiations is the internalization of terms-of-trade externalities. With the help of a simple theoretical framework we show that the textbook prediction that non-cooperative tariffs are positively correlated to the importer's market power is reversed when tariffs are set cooperatively. We use this prediction to identify the extent of cooperation re ected in WTO members' tariffs. Because many members of the WTO apply tariffs well below the negotiated tariff bounds, creating what is known as tariff water, there is also room for WTO members to set non-cooperative tariffs. As expected, we found that in the absence of tariff water, WTO tariffs are set cooperatively. Interestingly, non-cooperative tariff setting is only observed in the presence of sufficiently large amounts of tariff water, suggesting that cooperation in the WTO goes well beyond negotiated tariff bounds. We also found evidence that cooperation within WTO tariff waters can be explained by the fear of retaliation from trading partners with market power and tariff water in their schedules.
