DOMESTIC POLICIES, NATIONAL SOVEREIGNTY, ANDINTERNATIONAL ECONOMIC INSTITUTIONS*KYLEBAGWELL ANDROBERTW. STAIGERTo what extent must nations cede control over their economic and socialpolicies if global efciency is to be achieved in an interdependent world? Thisquestion is at the center of the debate over the future role of the WTO (formerlyGATT) in the realm of labor and environmental standards. In this paper weestablish that the market access focus of curre nt WTO rules is well equipped tohandle the problems a ssoci ated with choices over labor and environmental stan-dards. In principle, with re lative ly modest changes that grant governments moresovereignty, not less, these rules can deliver globally efcient outcomes.I. INTRODUCTIONTo what extent must nations cede control over their economicand social po licies if global efciency is to be achieved in aninterdependent world? At a broad level, this question probes thelimits of any international economic institution, whether gearedtoward real or nancial concerns, that is designed to prom oteglobal efciency while re specting national sovereignty. Naturally,the a nswer depends upon the particular problem that the insti-tution is meant to solve. In other words, the answer depends uponthe inefciency that would arise under unilateral policy choices.At a more specic level, this question is at the center of thedebate concerning the appropriate scope of the World Trade Or-ganization (WTO, formerly GATT). Recently, member countrieshave considered ways to broaden the WTO’s orientation beyondconventional trade policy measures to include labor and environ-mental standards. T here are now initiatives to introduce theissue o f labor standards directly onto the negotiating agenda ofthe WTO, with the purpose of creating a WTO “social clause.” Thesocial clause would specify a set of minimum international laborstandards, and then permit restrictions to be placed againstimports from countries not complying with these minimum st an-dards. With regard to environmental policies, a WTO Committeeon Trade and Environment has been established to identify therelationships between trade and environmental measures, and to* We thank Donald Davis, Scott Taylor, an ano nymous referee, and seminarparticipants at the University of Illinois, Iowa State University, the New YorkFederal Reserve, the University of To ronto, the University of Washington, and theUniversity of Wisconsin for helpful comments on an ea rly version of this paper.© 2001 by the President and Fellows of Harvard College and the Massachusetts Institute ofTechnology.The Quarterly Journal of Economics, May 2001519recommend necessary modications to the WTO. To some degree,these labor and environmental initiatives are responsive to “ race-to-the-bottom” concerns. In the face of falling trade barriers withweak-standards countries, it is feared that th e labor and environ-mental standards of the industrialized world might be compro-mised in the name of international competitiveness. But suchinitiatives encroach on traditional limits of national sovereignty.They therefore raise difcult issues about the structure of inter-national economic relations among sovereign states.Motivated by the general question raised above, and by therecent debate surrounding the scope of the WTO, we ask here amore specic question: how sh ould the issue of domestic stan-dards be handled in the WTO? We answer this question in asetting where governments choose both trade and domestic stan-dards policies, and countries affect each other th rough their mar-ket in teractions, so that any externalities across countries arepurely pecuniary in nature. By ruling out nonpecuniary external-ities from the start, we are excluding “g lobal commons” issuesfrom our a nalysis, and so countries have no reason to care abouteach others’ standards choices directly. We do not deny the im-portance of global commons concerns; however, we choose toexclude them fro m our analysis, since the need to involve theWTO in such concerns is far from obvious.1But even in theabsence of such concerns, countries may still care about eachothers’ standards choices indirectly, because of thetrade effectsthat such choices could imply. Indeed, it is the competitive pres-sures exerted by these trade effects that are often identied asfueling a race to the bottom. And as these effects travel throughtrade, they are inextricably intertwined with the business of theWTO. Our paper considers the question of how labor and envi-ronmental standards should be handled in the WTO in light oftheir associated trade effects.We are, of course, not the rst to consider this question (see,for example, the inuential volumes edited by Bhagwati andHudec [1996]). However, analytical results are scarce, and ofthese even fewer are concerned with the interaction betweennegotiated reductions in trade barriers and the ch oice of domestic1. Except perhaps for reasons of enforcement, but even here the case is notwithout qualication; see, for example, Roessler [1998], Ederington [1999], andSpagnolo [1999]. On global commons issues, see Alesina and Wacziarg [1999].520 QUARTERLY JOURNAL OF ECONOMICSstandards.2Yet it is from the backdrop of previous tariff reduc-tions that the ca se for adding labor and environmental standardsto th e negotiating agenda of the WTO has been most forcefullymade. Hence, an u nderstanding of the interaction between tariffnegotiations and the determination of domestic standards seemsa necessary starting point for assessing the claim that thesestandards will suffer as a result of trade liberalization, and there-fore necessary as well for considering how labor and environmen-tal standards o ught to be approached by the WTO.3We study this question within a general equilibrium frame-work in which two countries trade tw o goods and governmentsmake decisions over their trade policies (e.g., tariffs) and theirdomestic standards (e.g., labor and environmental policies) inpursuit of their own national objectives. In modeling governmentdecisions, we build on our earlier work [Bagwell and Staiger1999a] representing the objectives of each government as a gen-eral function of its local prices and terms of trade, and we extendthis representation in order to incorporate the presence of localstandards. The advantages of this approach are twofold. First, itis very general, being consistent (as we later sho w) both with
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