External Tariff Rate And Efficiency Differences over Exporting Firms From Member and Non-Member Countries: A Race to the Bottom?

Abstract

This paper provides a theoretical background on why countries set their external tariff rates at the lower level than their MFN ones when the exporting company in the non-member country is more efficient than that in the member country. Given this result, this paper verifies that there will not be a race to the bottom insetting the external tariff rates because countries are supposed to mitigate trade diversion effects, occurred by forming any binding regional trade agreement, and to consider efficiency levels of exporting firms from member and non-member countries. In addition, this paper shows that if there is no efficiency difference over exporting firms from member and non-member countries, the Host government will have an incentive to violate the GATT Article XXIV by setting its external tariff rate at the higher level than the previous MFN one. It is also found in this paper that MNCs in non-member countries need to compare their rival firms' efficiencies with those of their own and to consider their fixed cost of establishing a foreign affiliate in Host, when they make decisions over exporting and FDI.