The second cost to a guilty defendant facing dispute settlement proceedings would be the potential
economic cost of retaliation by the plaintiff country that is authorizable by the GATT/WTO.
As the defendant cannot be compelled to compensate the plaintiff, in order for the defendant to be
forced to face the economic costs of dispute settlement,
the plaintiff must have the capacity to retaliate.
Bown (2002), for example, uses a simple bargaining framework of trade dispute negotiations to
illustrate that when countries are large, a plaintiff’s ability to affect the terms of trade will greatly
influence its capacity to threaten retaliation. In that model, a tariff response by a large plaintiff country
can both increase the plaintiff’s welfare and decrease the defendant’s welfare, thus having twice
the effect on the critical benchmark or “threat point” that drives the outcome of the negotiations. A
small plaintiff country’s tariff that cannot affect the terms-of-trade will be less successful at improving
the “threat point” bargaining position, even if it is able to impose adjustment costs on the defendant,
as it will not be able to improve its own benchmark welfare relative to free trade.
In order for the defendant government to credibly commit to liberalization, the dispute settlement
costs must be large enough to offset the potential gains to the defendant government of offering
protection. Therefore, when confronted with the trade dispute, the defendant government must
weigh the tradeoffs - the potential costs of the failure to liberalize generated by the dispute settlement
process - against the political and economic costs involved with liberalizing a potentially preferred
sector. These costs are likely to differ across sectors and defendants, thus generating the variation
in liberalizing activity necessary to allow us to estimate the impact of these costs on the economic
success of the dispute settlement process.