Duration and Term Structure of Trade Agreements

Abstract

We use a dynamic incomplete contracting model to show that time structure of trade agreements is related to the characteristics of trade-facilitating investments. If these investments are specialised to trade in a particular homogeneous good, fixed-term agreements are more likely. Fixed-term agreements provide incentives for the initial investment but leave the parties the flexibility to revisit the need for future investment. If the agreement covers trade in multiple sectors or differentiated goods or services, inter-sectoral spillovers reduce risks of overinvestment. In this case, the parties are more likely to choose an evergreen agreement (with an advance termination notice).