Imperfect competition gives rise to cross-border concerns that governments do not internalize when setting both trade policies and domestic policies.
An open question is whether these international policy externalities matter for the design of the multilateral trading system. This paper considers the
question in a monopolistically competitive environment in which countries can form agreements over import policies, export policies, and a domestic
policy that singly determines the number of firms. In this setting, the GATT principal of reciprocity guides countries toward efficient trade
policy choices, but there is inefficiency in the domestic policy choices. Hence, there is a fundamental problem for trade agreements arising from
imperfect competition. The model can rationalize the existence and evolution of contracts over domestic policies (deep integration) in the
multilateral trading system. Examples include the Agreement on Subsidies and Countervailing Measures in the 1995 World Trade Organization and
competition policy coordination in the failed 1947 International Trade Organization. Deep integration on subsidies becomes desirable for
politically-motivated governments only after countries achieve sufficient cooperation in restraining import tariffs.