Two-Tier Asymmetric Information as a Motive for Trade, Trade Policies, and Inefficient Trade Agreements

We consider a general equilibrium model of international trade with two identical countries, two commodities, a terms-of-trade externality, and two layers of informational asymmetries. First, domestic producers have private information on their technology. Such within-country informational asymmetry impacts on the design of “behind-the-border" policies which reflect the political influence of domestic producers. Those policies create a wedge between price and marginal costs so as to contract domestic supply in response to truth-telling constraints. This causes trade with an otherwise symmetric country and thus justifies the use of an import tariff at borders. Eliminating those barriers and reaching efficient trade agreements may become impossible once governments have also private information on the political influence of domestic producers: a second layer of informational asymmetry that now impacts negotiations across countries. We present conditions for free trade to remain implementable in those informationally-constrained contexts. Otherwise, we characterize second-best trade agreements and show that, under weak conditions, governments giving an excessive political weight to high-cost domestic producers might be reluctant to adopt free trade, possibly implementing tariffs still at their non-cooperative levels