estricted to issues that admit of a simple solution that can be sustained through small numbers strategic interaction Formal modeling bearing on these issues is in its infancy. Fon and Parisi (2004) offer a simple model of custom formation that supports the intuition that customary law is more useful when the preferences of states are relatively more homogeneous. They also consider the role of what they term the " persistent objector'and"subsequent objector"doctrines that allow states to obtain an exemption from customary rules C The Economics of Treaties and Other International Agreements Virtually all of the economic writing on treaties focuses on particular subject areas, with the notable exceptions of Goldsmith Posner(2004)and Guzman(2002) cited earlier. In this section i draw to a limited extent on those two sources but also ideas developed in more specialized contexts to suggest some general points about the economics of treaties In contrast to customary international law, which can emerge through convergence of practice without much communication across states, treaties al ways involve direct communication, negotiation, and the embodiment of the results in a document. This process is costly, and the reasons for the creation of treaties are narrower or at least different from the reasons given earlier for convergence of state practice custom. The coincidence of interest explanation for some customary practices example, cannot explain why states would incur the costs of creating a treaty. The exercise of pure coercion does not require a treaty either, although to be sure a treaty may used to orchestrate an end to coercion. Treaties are likely to be valuable instead when state action creates externalities for other states, and when purely decentralized cooperation without formal communication is inadequate to address them(although a few treaties may have other functions, as discussed in later sections) The mere fact that cooperation is better orchestrated through a process of direct communication, of course, is not sufficient to justify a treaty. Much communication between states occurs without any resulting agreement, and international agreements can arise in the course of communication that are informal and never rise to the level of a treaty. Goldsmith and Posner thus consider the question of why states resort to legalization"by execu ting a treaty and m ing it"binding"as a matter of nternational law in preference to reliance on less formal, nonbinding agreements. They suggest that the legalization of an agreement may reveal information about a state's commitment to the agreement-in their terms, it shows that the state is"serious"about
restricted to issues that admit of a simple solution that can be sustained through small numbers strategic interaction. Formal modeling bearing on these issues is in its infancy. Fon and Parisi (2004) offer a simple model of custom formation that supports the intuition that customary law is more useful when the preferences of states are relatively more homogeneous. They also consider the role of what they term the “persistent objector’ and “subsequent objector” doctrines that allow states to obtain an exemption from customary rules. C. The Economics of Treaties and Other International Agreements Virtually all of the economic writing on treaties focuses on particular subject areas, with the notable exceptions of Goldsmith & Posner (2004) and Guzman (2002) cited earlier. In this section I draw to a limited extent on those two sources, but also on ideas developed in more specialized contexts to suggest some general points about the economics of treaties. In contrast to customary international law, which can emerge through convergence of practice without much communication across states, treaties always involve direct communication, negotiation, and the embodiment of the results in a document. This process is costly, and the reasons for the creation of treaties are narrower or at least different from the reasons given earlier for convergence of state practice on custom. The coincidence of interest explanation for some customary practices, for example, cannot explain why states would incur the costs of creating a treaty. The exercise of pure coercion does not require a treaty either, although to be sure a treaty may be used to orchestrate an end to coercion. Treaties are likely to be valuable instead when state action creates externalities for other states, and when purely decentralized cooperation without formal communication is inadequate to address them (although a few treaties may have other functions, as discussed in later sections). The mere fact that cooperation is better orchestrated through a process of direct communication, of course, is not sufficient to justify a treaty. Much communication between states occurs without any resulting agreement, and international agreements can arise in the course of communication that are informal and never rise to the level of a treaty. Goldsmith and Posner thus consider the question of why states resort to “legalization” by formally executing a treaty and making it “binding” as a matter of international law in preference to reliance on less formal, nonbinding agreements. They suggest that the legalization of an agreement may reveal information about a state’s commitment to the agreement—in their terms, it shows that the state is “serious” about
the agreement. A signal ofseriousness" will only be needed when"seriousness''is private information, and will only be credible if reputational penalties are greater for the violation of a"binding " agreement than for violation of an informal agreement. Hence this explanation requires that reputation be important to state actors. A second consideration affecting the choice to legalize is the fact that informal agreements may bypass domestic constitutional constraints on the creation of treaties. In the United States, for example, the President has the capacity to conclude and execute informal agreements without Congressional oversight in many areas. Formal treaties(or Executive Agreements that must be approved by Congress) give the legislature greater opportunities to participate and may then constrain the President to less preferred options. But legislative participation may also give the agreement greater durability against changes in administrations, as well as greater force in domestic law. The President will choose between the two options depending on the balance of competing considerations in each case. A final consideration is that legalization subjects the treaty to the interpretive default rules of the Vienna Convention on Treaties. Informal agreements may be chosen out of a desire to opt out of those rules Leaving aside for now the choice between formal and informal agreements it is perhaps useful at this point to set forth the basic formal framework for modeling the externality problem and for identifying the potential gains from international cooperation Variations of this basic approach pervade the literature on individual topics. Imagine two states, denoted A and B, each of which have control over a vector of policy instruments, a and B, respectively. [ Nothing changes importantly(beyond the algebra) if the analysis is generalized to n states. The respective welfare functions for the two states are WA(a,B)and WB(a, B). Assume that each state's welfare is increasing and concave in its own policy choices. The vectors a and B can represent a myriad of policy areas--tariffs, tax rates and rules, immigration restrictions, emissions controls, and so on. In the absent of communication and agreement, each state maximizes its welfare taking the actions of the other as given, selecting a andβ such that aWA(a,β)oα=0and aWB(a, B)aB=0. Equilibrium(Nash) arises when both conditions hold, given the other states choice of policies. Will the equilibrium be efficient? The answer is plainly no in general: A point on the Pareto frontier may be derived by choosing a and B simultaneously to maximize the welfare of one state, subject to the constraint that the welfare of the other achieve some fixed, attainable value (a standard technique for deriving conditions for any optimal contract). The first order conditions for this problem require that aw^(a,β)aα+λoWB(α)α=0,andλwB(ax,B)邵β+owAa,B)β=0, where 2 is a Lagrange multiplier. With the welfare constraint binding and thus 20, it
the agreement. A signal of “seriousness” will only be needed when “seriousness” is private information, and will only be credible if reputational penalties are greater for the violation of a “binding” agreement than for violation of an informal agreement. Hence, this explanation requires that reputation be important to state actors. A second consideration affecting the choice to legalize is the fact that informal agreements may bypass domestic constitutional constraints on the creation of treaties. In the United States, for example, the President has the capacity to conclude and execute informal agreements without Congressional oversight in many areas. Formal treaties (or Executive Agreements that must be approved by Congress) give the legislature greater opportunities to participate and may then constrain the President to less preferred options. But legislative participation may also give the agreement greater durability against changes in administrations, as well as greater force in domestic law. The President will choose between the two options depending on the balance of competing considerations in each case. A final consideration is that legalization subjects the treaty to the interpretive default rules of the Vienna Convention on Treaties. Informal agreements may be chosen out of a desire to opt out of those rules. Leaving aside for now the choice between formal and informal agreements, it is perhaps useful at this point to set forth the basic formal framework for modeling the externality problem and for identifying the potential gains from international cooperation. Variations of this basic approach pervade the literature on individual topics. Imagine two states, denoted A and B, each of which have control over a vector of policy instruments, α and β, respectively. [Nothing changes importantly (beyond the algebra) if the analysis is generalized to N states.] The respective welfare functions for the two states are WA(α,β) and WB(α,β). Assume that each state’s welfare is increasing and concave in its own policy choices. The vectors α and β can represent a myriad of policy areas—tariffs, tax rates and rules, immigration restrictions, emissions controls, and so on. In the absence of communication and agreement, each state maximizes its welfare taking the actions of the other as given, selecting α and β such that ∂WA(α,β)/∂α = 0 and ∂WB(α,β)/∂β = 0. Equilibrium (Nash) arises when both conditions hold, given the other state’s choice of policies. Will the equilibrium be efficient? The answer is plainly no in general: A point on the Pareto frontier may be derived by choosing α and β simultaneously to maximize the welfare of one state, subject to the constraint that the welfare of the other achieve some fixed, attainable value (a standard technique for deriving conditions for any optimal contract). The first order conditions for this problem require that ∂WA(α,β)/∂α + λ∂WB(α,β)/∂α = 0, and λ∂WB(α,β)/∂β + ∂WA(α,β)/∂β = 0, where λ is a Lagrange multiplier. With the welfare constraint binding and thus λ>0, it is
clear that the conditions for Pareto optimality cannot correspond to the earlier conditions for Nash equilibrium unless awB(a,B)aα=0 and awA(αβ)∂βB=0. In words,the equilibrium without international cooperation will achieve the pareto frontier only in the absence of externalities, and the function of international agreements in the presence o externalities is to enable states to commit to behavior that will move them closer to the Pareto frontier i. Factors that Facilitate or Impede international Agreement If externalities suggest an opportunity for international agreements to improve the equilibrium without them, it does not follow that states will succeed in achieving agreement. Casual empiricism suggests that useful agreements have been reached in a number of areas(e.g, trade), but that many areas laden with apparent externalities have not been successfully addressed through international agreements(e.g, immigration). In other areas, some issues have been addressed through agreement but not others(e. g investment and environment). What explains these various"successes"and"failures"? Perhaps the starting point for analysis is the Coase Theorem. One would expect international agreements to exhaust potential joint gains from solving externality problems only to the degree that those gains remain after all transaction costs have been accounted for in the calculus(which must be understood broadly to include not only monetary costs of achieving agreement but all factors that affect the political acceptability of agreement). To understand the universe of international agreements(and the areas in which they are absent), one must therefore ask not simply whether externalities arise but also whether the transaction costs of international agreements to address them are low enough to permit agreements to go forward. a variety of considerations will affect the magnitude of transaction costs Trivially, agreement can only arise if some agreement lies in the core of the bargaining game-each state that becomes party to an agreement must perceive itself better off than by refusing to participate(or by breaking off with others into a smaller numbers agreement in the multilateral case). Yet it is easy to imagine settings in which nternational externalities lead to an equilibrium off the Pareto frontier in the absence of cooperation, but the bargaining options are too limited to admit of a Pareto improvement in the core. For example, imagine two states, one of which contains a monopoly producer and exporter of widgets, and the other of which is a consumer of widgets with monopoly power over any tradable good or service. The monopolist exploits its market power with the familiar deadweight losses, although much of its monopoly profit comes
clear that the conditions for Pareto optimality cannot correspond to the earlier conditions for Nash equilibrium unless ∂WB(α,β)/∂α = 0 and ∂WA(α,β)/∂β = 0. In words, the equilibrium without international cooperation will achieve the Pareto frontier only in the absence of externalities, and the function of international agreements in the presence of externalities is to enable states to commit to behavior that will move them closer to the Pareto frontier. i. Factors that Facilitate or Impede International Agreement If externalities suggest an opportunity for international agreements to improve on the equilibrium without them, it does not follow that states will succeed in achieving agreement. Casual empiricism suggests that useful agreements have been reached in a number of areas (e.g., trade), but that many areas laden with apparent externalities have not been successfully addressed through international agreements (e.g., immigration). In other areas, some issues have been addressed through agreement but not others (e.g., investment and environment). What explains these various “successes” and “failures”? Perhaps the starting point for analysis is the Coase Theorem. One would expect international agreements to exhaust potential joint gains from solving externality problems only to the degree that those gains remain after all transaction costs have been accounted for in the calculus (which must be understood broadly to include not only monetary costs of achieving agreement but all factors that affect the political acceptability of agreement). To understand the universe of international agreements (and the areas in which they are absent), one must therefore ask not simply whether externalities arise, but also whether the transaction costs of international agreements to address them are low enough to permit agreements to go forward. A variety of considerations will affect the magnitude of transaction costs. Trivially, agreement can only arise if some agreement lies in the core of the bargaining game—each state that becomes party to an agreement must perceive itself better off than by refusing to participate (or by breaking off with others into a smaller numbers agreement in the multilateral case). Yet it is easy to imagine settings in which international externalities lead to an equilibrium off the Pareto frontier in the absence of cooperation, but the bargaining options are too limited to admit of a Pareto improvement in the core. For example, imagine two states, one of which contains a monopoly producer and exporter of widgets, and the other of which is a consumer of widgets with no monopoly power over any tradable good or service. The monopolist exploits its market power with the familiar deadweight losses, although much of its monopoly profit comes
as a transfer from consumers abroad; joint gains would arise if each state pursued a sensible anti-monopoly policy. But if the two states try to strike a bilateral agreement that merely requires each of them to adopt an anti-monopoly policy, the state with the monopolist may well object that such an agreement leaves it worse off than without it Two obvious and related solutions to the problem suggest themselves. The first monetary sidepayments from one state to the other. This device is sometimes employed in practice, usually in the form of a promise of monetary aid to a state that cooperates on some issue( the recent aid to Pakistan associated with its quiet assistance in the invasion of Afghanistan is illustrative. Analytically equivalent, and probably more common in practice, the scope of bargaining can be expanded to include other issues(or perhaps other states, a point explored later). The state that enjoys a widget monopoly may be willing to forego monopoly rents in exchange for valued concessions on security issues environmental matters, and so on. The general lesson is that issue linkage in international negotiations can greatly expand the scope of possible agreements. a likely recent example is the Agreement on Trade Related Aspects of Intellectual Property (TRIPs)in the WTO. Developing nations, which are primarily consumers rather than producers of intellectual property, were induced to agree to strengthen their intellectual property laws in ways that would confer considerable rents on foreign rights holders in exchange for concessions on other trade issues such as textiles and agriculture It is too opt nts and al ways eliminate the problem of an empty core. Take the monopoly hypothetical above and consider the monetary sidepayment option--if an anti-monopoly agreement is to lie in the core, the consuming state must make a monetary payment to the state with the monopolist that induces it to give up its monopoly rents. If the state with the monopolist maximizes national economic welfare, such a payment must be equal to the monopoly profit rectangle plus some share of the deadweight loss triangle. That may leave precious little gain to the consuming nation in relation to the transaction costs of negotiation. a for issue linkage, an expansion in the scope of negotiations inevitably increases their cost, and draws in a greater number of domestic political constituencies with an interest in the outcome. The resulting increase in the costs of international negotiation and of domestic political deliberation may be great enough to undermine the process Nevertheless, many international agreements display a great deal of issue linkage in the 2Although I use TRIPs as an illustration of issue linkage here, I do not mean to imply that TRIPs standing alone necessarily enhanced global welfare conventionally defined. Here, as in many other settings,one must distinguish carefully between political optima that maximize the interests of parties to negotiations, and conventional welfare optima
as a transfer from consumers abroad; joint gains would arise if each state pursued a sensible anti-monopoly policy. But if the two states try to strike a bilateral agreement that merely requires each of them to adopt an anti-monopoly policy, the state with the monopolist may well object that such an agreement leaves it worse off than without it. Two obvious and related solutions to the problem suggest themselves. The first is monetary sidepayments from one state to the other. This device is sometimes employed in practice, usually in the form of a promise of monetary aid to a state that cooperates on some issue (the recent aid to Pakistan associated with its quiet assistance in the invasion of Afghanistan is illustrative). Analytically equivalent, and probably more common in practice, the scope of bargaining can be expanded to include other issues (or perhaps other states, a point explored later). The state that enjoys a widget monopoly may be willing to forego monopoly rents in exchange for valued concessions on security issues, environmental matters, and so on. The general lesson is that issue linkage in international negotiations can greatly expand the scope of possible agreements. A likely recent example is the Agreement on Trade Related Aspects of Intellectual Property (TRIPs) in the WTO. Developing nations, which are primarily consumers rather than producers of intellectual property, were induced to agree to strengthen their intellectual property laws in ways that would confer considerable rents on foreign rights holders in exchange for concessions on other trade issues such as textiles and agriculture.2 It is too optimistic to imagine that monetary sidepayments and issue linkage will always eliminate the problem of an empty core. Take the monopoly hypothetical above and consider the monetary sidepayment option—if an anti-monopoly agreement is to lie in the core, the consuming state must make a monetary payment to the state with the monopolist that induces it to give up its monopoly rents. If the state with the monopolist maximizes national economic welfare, such a payment must be equal to the monopoly profit rectangle plus some share of the deadweight loss triangle. That may leave precious little gain to the consuming nation in relation to the transaction costs of negotiation. As for issue linkage, an expansion in the scope of negotiations inevitably increases their cost, and draws in a greater number of domestic political constituencies with an interest in the outcome. The resulting increase in the costs of international negotiation and of domestic political deliberation may be great enough to undermine the process. Nevertheless, many international agreements display a great deal of issue linkage in their 2 Although I use TRIPs as an illustration of issue linkage here, I do not mean to imply that TRIPs standing alone necessarily enhanced global welfare conventionally defined. Here, as in many other settings, one must distinguish carefully between political optima that maximize the interests of parties to negotiations, and conventional welfare optima
formation, as prominently illustrated by the WTO and NAFTA. The costs and benefits of issue linkage bear importantly on the wisdom of drawing other subjects into their ambit (such as competition policy) Moving beyond the problem of ensuring that an agreement lies in the core, the transaction costs of reaching an international agreement turn importantly on the complexity of the issues to be addressed. Some agreements entail reasonably simple commitments(such as the ban on nuclear testing in the Nonproliferation Treaties). Others equire highly complex commitments spanning a wide array of issues. The WTO is again illustrative. To make its central commitments on tariff reductions valuable. signatories must disable themselves from turning to substitute instruments of protection. The result hundreds of pages of treaty text addressing quotes, import licensing restrictions, balance of payments policy, domestic tax and regulatory policy, state trading and monopolies and many other subjects. Complexity can be said to increase not only detail involved in specifying the proper behavior of a state increases, but also as the optimal behavior across states becomes more variable. Both dimensions of complexity raise the costs of agreement not only because desired behavior becomes more costly to describe and memorialize, but also because enforcement may become more difficult as the number and variety of possible violations multiplies a third important factor affecting the transaction costs of reaching and enforcing an international agreement is the number of countries involved in it. even holding constant the complexity of the commitments(which of course may increas states participate), greater numbers of states add to the negotiation costs of reaching agreement. Logistical costs increase because of the larger numbers, and delays may develop as states hold back on what they offer to achieve agreement hoping to free ride on inducements offered by other states. a free rider problem may also manifest itself in the enforcement mechanism. Imagine that breach of agreement requires some action by nonbreaching parties to punish the party in breach. If these actions are costly, each state may prefer that others do the punishing, and unless some coordination mechanism can be designed to overcome the problem the threat of punishment may lose credibility. This observation suggests an important distinction between situations in which punishment equires actions that the punishers view as costly to themselves, and situations in which the opportunity to punish another state is welcomed. An example of the first may b military force. a state that employs military force risks the lives of its troops and consumes monetary resources, and most would no doubt be happy to have others undertake the task if they can perform it as well. By contrast, imagine an environmental agreement limiting emissions of some pollutant in each state, enforced by a threat of
formation, as prominently illustrated by the WTO and NAFTA. The costs and benefits of issue linkage bear importantly on the wisdom of drawing other subjects into their ambit (such as competition policy). Moving beyond the problem of ensuring that an agreement lies in the core, the transaction costs of reaching an international agreement turn importantly on the complexity of the issues to be addressed. Some agreements entail reasonably simple commitments (such as the ban on nuclear testing in the Nonproliferation Treaties). Others require highly complex commitments spanning a wide array of issues. The WTO is again illustrative. To make its central commitments on tariff reductions valuable, signatories must disable themselves from turning to substitute instruments of protection. The result is hundreds of pages of treaty text addressing quotes, import licensing restrictions, balance of payments policy, domestic tax and regulatory policy, state trading and monopolies, and many other subjects. Complexity can be said to increase not only as the detail involved in specifying the proper behavior of a state increases, but also as the optimal behavior across states becomes more variable. Both dimensions of complexity raise the costs of agreement not only because desired behavior becomes more costly to describe and memorialize, but also because enforcement may become more difficult as the number and variety of possible violations multiplies. A third important factor affecting the transaction costs of reaching and enforcing an international agreement is the number of countries involved in it. Even holding constant the complexity of the commitments (which of course may increase as more states participate), greater numbers of states add to the negotiation costs of reaching agreement. Logistical costs increase because of the larger numbers, and delays may develop as states hold back on what they offer to achieve agreement hoping to free ride on inducements offered by other states. A free rider problem may also manifest itself in the enforcement mechanism. Imagine that breach of agreement requires some action by nonbreaching parties to punish the party in breach. If these actions are costly, each state may prefer that others do the punishing, and unless some coordination mechanism can be designed to overcome the problem the threat of punishment may lose credibility. This observation suggests an important distinction between situations in which punishment requires actions that the punishers view as costly to themselves, and situations in which the opportunity to punish another state is welcomed. An example of the first may be military force. A state that employs military force risks the lives of its troops and consumes monetary resources, and most would no doubt be happy to have others undertake the task if they can perform it as well. By contrast, imagine an environmental agreement limiting emissions of some pollutant in each state, enforced by a threat of