We start our analysis from the setting that countries have held a negotiating round and agreed
to “bind” their tariffs, which refers to the GATT/WTO negotiating process by which governments
agree to limit their applied tariffs to a rate at or below the negotiated level. The tariff bindings
serve to establish conditions of expected market access facing exporters of trading partners.12 From
the GATT/WTO perspective, a deterioration in the conditions of market access, due to either the
imposition of a non-tariff measure or a tariff above the binding, violates that country’s GATT/WTO
obligations and would be grounds for a trade dispute.
Assume next that one government nevertheless implements a policy that results in such a deterioration
of market access thus leading to the initiation of a formal trade dispute by one of its trading
partners.13 In keeping with the GATT/WTO institutional structure, we assume that if the defendant
country loses the case and refuses to liberalize in the disputed sector, it faces the costs imposed by the
dispute settlement system. Figure 1 illustrates the important basic features of the dispute settlement
process under the GATT and WTO.14 If the dispute settlement costs are large enough, they can offset
the political and economic gains to implementing a unilateral policy that violates the terms of market
access implied by the announced tariff binding. For sufficiently large costs, the defendant government
will be able to commit credibly to trade liberalization, and the dispute settlement process will result
in an economic success.15
The literature on dispute settlement suggests two important costs facing a defendant government
which has violated its GATT/WTO obligations.16 The first cost is any stigma attached to the failure
to comply with GATT/WTO laws or rulings - what Kovenock and Thursby (1992) term the cost of
“international obligation.” This cost may be realized through a weakening of the dispute settlement
system; in future trade disputes where the current defendant is a plaintiff, the country may experience
difficulty in obtaining economic success even though it too may legally ‘win’ its case. Alternatively,
the cost may manifest itself in future GATT/WTO negotiations; for example, in a future negotiating
round the defendant’s interests may not take priority on the agenda.