• Brent J. Sackett

Referee Report 3: Copelovitch, M. S., Pevehouse, J. C. (2013). Ties that Bind? Preferential Trade Agreements and Exchange Rate Policy Choice. International Studies Quarterly, 57(2): 385-399

Summary

This paper assesses the effect of preferential trade agreements (PTAs) on exchange rate policies. When a country joins a PTA, the government’s ability to employ trade protection is constrained. This increases incentives to maintain fiscal and monetary autonomy in order to manipulate its domestic political economy. One way to do this is by implementing a flexible exchange rate policy. The authors argue that a PTA with a nation’s “base” country (the country to whom they have traditionally fixed their currency, or a country where they have extensive trade ties), makes a country less likely to adopt a fixed exchange rate. In addition, this paper argues that countries who have signed a base PTA will also tend to maintain an undervalued exchange rate level. Using an original data set of 99 countries from 1975 to 2004, the authors find empirical support for their argument.

Evaluation

My overall impression of this article is positive. In fact, I would say this article will be excellent after a few methodological problems are corrected. The paper clearly identifies a research question and provides an important insight that expands our understanding of exchange rate policy. However, I will present some comments and recommendations for improvement.

Comment 1 (Theory and Causal Mechanism)

In general, the theory and hypotheses are clearly presented and easy to understand. However, one part of the theoretical link between PTAs and exchange rate policy is missing and should be discussed more thoroughly. This may simply be a matter of terminology, or it may indicate a missing link in the causal chain. The authors assert that “PTAs generally commit members to more extensive free trade (2).” This seems to indicate the causal mechanism behind the story: PTAs tie the hands of governments who want to employ trade protection, so they resort to exchange rate policy instead of tariffs or other means.

However, PTAs are not all the same in the way they constrain behavior regarding trade protection (Baccini, Dür, Elsig & Milewicz, 2011, Kucik, 2012). While the authors note substantial cross-national variation in PTA participation, the discussion of variation in the PTAs themselves is inadequate. PTAs are not homogenous and actually vary substantially. Baccini et al. and Kucik both explain that variation in PTA design and implementation goes far beyond simple “free-trade” protections to include intellectual property, investments, enforcement, and even significantly differing tariff levels and exemptions. Is the paper’s theory based on free-trade commitments generally or PTAs specifically? In footnote 9 on page 4, the authors state that GATT/WTO membership had no influence on exchange rate choice even though in theory it should constrain trade policy choice in the same way a PTA does. This leads to some confusion about the causal mechanism that needs to be clarified.

What exactly is the causal mechanism within PTA participation and why does it fail in other commitments to free trade? In addition, I would like to know if the large variation in PTA design effects the causal mechanism. These questions need to be answered to clarify the argument.

I have a second concern regarding the assumptions behind the theory. For the causal mechanism to work, the nation must feel pressure to comply with trade restrictions in the PTA. Otherwise, there is no incentive to use exchange rate policy to circumvent the PTA. However, others research has shown that compliance with international agreements is not straightforward and the intention to comply cannot be assumed (Simmons, 1998). Some nations may join PTAs with no intention to comply at all. Others may sign a PTA because they already intended to behave in accordance with the free trade commitments anyway. In either case, the causal mechanism of the paper is undermined. If Simmons and others are correct, a PTA may not provide the restraint the authors assume it does. Although a thorough discussion of compliance is not necessary, I would like to see it mentioned at least briefly. Both of these comments lead to some concerns about the data.