Trade Policy of a Free Trade Agreement in the Presence of Foreign Lobbying

Transcription

1 Trade Polcy of a Free Trade Agreement n the Presence of Foregn Lobbyng Andrey Stoyanov The Unversty of Brtsh Columba Frst draft: June 2007 Ths draft: Aprl 2008 Abstract Ths paper studes the e ect of foregn lobbes on trade polcy of a country whch s a member of a Free Trade Agreement (FTA). It uses a monopolstcally compettve poltcal economy model n whch the government determnes external tar s endogenously. The e ect of foregn lobbyng under the FTA s examned emprcally usng Canadan ndustry-level trade data that allow d erentatng of lobby groups by the country of orgn. The analyss suggests that the presence of foregn lobbyng has a sgn cant e ect on the domestc trade polcy. The heterogenety of foregn lobbes s also mportant: the presence of an organzed lobbyng group n an FTA partner country tends to rase trade barrers whle an organzed lobbyng group of exporters from outsde of the FTA s assocated wth less protecton. JEL Class caton codes: F12, F13, F14, D72 I am grateful to my advsors Werner Antweler, Matlde Bombardn and Bran Copeland for contnuous support and gudance. I am also grateful to Sumeet Gulat, Vadm Marmer, and Danel Tre er for useful dscussons on the topc. I also would lke to thank semnar partcpants of the Unversty of Brtsh Columba, McMaster Unversty, New Economc School, Ryerson Unversty, Syracuse Unversty, Unversty of Toronto, York Unversty, Unversty of Vctora, 2007 European Econometrcs Socety Summer Meetngs, and Canadan Economc Assocaton conference for ther comments and suggestons. Department of Economcs, East Mall, Vancouver BC, Canada V6T 1Z1; tel ; fax ; stoanov@nterchange.ubc.ca 1

2 1 Introducton In the poltcal economy lterature a growng number of studes vew trade polcy as an endogenous outcome of lobbyng actvty by specal nterest groups. Several authors (Goldberg and Magg, 1999, Gawande and Bandyopadhyay, 2000) have con rmed that lobbyng ntensty by domestc rms s one of the man determnants of the cross-ndustry pattern of protecton. More recently, Gawande, Krshna, and Robbns (2006) also nd that lobbyng by foregn rms for trade barrers reducton has a sgn cant e ect on the structure of tar s across ndustres. However, f a country s a member of a regonal free trade agreement (FTA) and foregn rms can a ect the government s decson regardng trade polcy, t becomes necessary to dstngush foregn lobbyng from wthn and outsde of the FTA. Organzed foregn nterests wth preferental market access wll lobby for more protecton aganst other foregn rms, and the trade agreement may become more protectonst wth a strong lobby group n a prospectve FTA partner country. Actve foregn lobbyng under the preferental trade agreement may not only lead to an ncrease n trade barrers, but also make welfare-reducng trade agreements poltcally feasble. In ths paper I analyze the e ect of foregn lobbyng on domestc trade polcy when the country s a member of a preferental trade agreement usng Canadan post-nafta trade data. Ths analyss reveals two man results. Frst, the actvty of foregn lobbysts n Canada s a sgn cant determnant of the Canadan trade polcy, and sectors n whch foregn rms wthout preferental market access are poltcally organzed tend to receve less protecton. Ths result supports the prevous ndng by Gawande, Krshna, and Robbns (2006) for the US. Second, NAFTA has an mportant e ect on the structure of foregn lobbes. The data con rm that foregn rms wth preferental market access lobby for more protecton just as domestc rms do. Ths result has mportant mplcatons for the e ect of an FTA on a country s trade polcy. It mples that pror to NAFTA, US rms lobbed for Canadan trade barrers reducton lke all other foregn rms, but once NAFTA was sgned, they swtch to lobbyng for trade barrers ncrease. As a result, an FTA wth a large and poltcally strong partner country may rase trade barrers and ncrease trade dstortons, makng trade polcy of regonal tradng blocks more protectonst. 1 1 Two consderatons should be taken nto account when partner country lobbyng for more protecton s consdered. Frst, the WTO tar bndng constrans the lobbyng opportuntes by the partner country rms; however, they may stll play an mportant role n the future and mpede multlateral trade lberalzaton n those sectors. Second, the WTO precludes countres from rasng 2

3 Ths paper s the rst one that analyzes from theoretcal and emprcal ponts of vew the e ect of foregn lobbyng on domestc trade polcy n the presence of an FTA. The poltcal economy model presented n ths paper ncorporates a monopolstcally compettve market structure nto the Grossman and Helpman (1994) protecton for sale setup (henceforth GH) to analyze the role of foregn lobbyng n the makng of natonal trade polcy. The framework s further extended by allowng for two types of foregn nterest groups, namely, lobbyng groups formed by rms from an FTA partner country and by rms from countres outsde of the FTA, aggregated nto the rest of the world (). Ths d erentaton of foregn lobbes by market access s mportant n the presence of an FTA. When two countres jon a regonal trade agreement, grantng zero mport tar s to each other, rms from countres wth preferental market access wll lobby for more protecton under the FTA to lock t from competton from the rms, whle rms from outsde of the FTA wll contnue to lobby for trade lberalzaton. Ths d erentaton of foregn lobbyng objectves, that follows from the presence of the FTA, mples that n a world where almost every country s a part of at least one regonal trade agreement, a complete theory of the e ect of foregn lobbng on the natonal trade system should take ths d erentaton nto account. The model of foregn lobbyng n the presence of the FTA s tested usng Canadan post-nafta trade data. The emprcal analyss suggests a strong and statstcally sgn cant e ect of domestc and foregn lobbyng on Canadan trade polcy, and ponts to the mportance of dstngushng partner country lobbyng from lobbyng. Usng data on lobbyng ntensty by sector and by country of orgn, ths paper ver es that the man predctons of the model are consstent wth the data. Frst, the mportance of both partner country and foregn lobbyng under the FTA s con rmed n the Canadan data: whle the presence of the organzed domestc lobbyng group rases ndustry mport tar by 3-5% relatve to the unorganzed ndustry, organzed partner country lobbyng would rase t by 1-2%, and foregn lobbyng from the would lower t by 2-3%. These results are economcally meanngful and con rm the man predcton of the model that foregn rms wth preferental market access behave just as domestc rms do, whch ntroduces an addtonal dstorton n the polcy makng process. Second, the emprcal evdence shows that even poltcally unorganzed sectors receve a postve level of ther tar s once the FTA s sgned. Yet foregn lobbes may oppose further tar reducton as descrbed above and use ant-dumpng and countervalng measures to gan protecton. 3

4 protecton from the government of 2-4 percentage ponts of the ad-valorem tar, provdng support for the mperfectly compettve structure of the model. Addtonally, an mportant contrbuton of ths work to the poltcal economy lterature of trade s ts determnaton of more plausble values for the government s valuaton of poltcal contrbutons. In ths paper, the government s estmated to value poltcal contrbutons more than natonal welfare, whch s n sharp contrast wth prevous tests of the benchmark GH spec caton n whch governments were found to have stronger preferences for welfare (Goldberg and Magg (1999), Gawande and Bandyopadhyay (2000)). Ths result explans why relatvely small poltcal contrbutons may have strong polcy e ects. My emprcal results provde new perspectve on the e ect of regonal trade blocks on trade polces of member countres. Most of the lterature on endogenous trade polcy concludes that a country s more lkely to reduce ts external tar when t enters an FTA. Rchardson (1993), Bagwell and Stager (1997), Bohara, Gawande, and Sangunett (2004), Bond, Rezman, and Syropoulos (2004) show that a welfare-maxmzng government wll lower external mport tar s once an FTA s formed. By dong ths, the government restores part of the tar revenue lost due to the shft n mport demand from the to the partner country rms. Ornelas (2005a,b) examned the poltcal economy of an FTA wthout foregn lobbyng usng an olgopolstc market structure n the GH model. He shows that FTA formaton weakens the lobbyng power of domestc rms because the elmnaton of tar s between FTA member countres shfts part of the tar rent from domestc rms towards rms from a partner country. The model n ths paper, however, allows for cross-border lobbyng actvty, whch lessens the e ect ntroduced by Ornelas (2005a,b) snce the reducton n poltcal actvty by domestc rms s coupled wth an ncrease n contrbutons for protecton by the FTA partner country rms. As a result, n the presence of foregn lobbyng a country s government may n fact want to rase external tar s under the FTA when strong lobbyng by an FTA partner country puts extra pressure on the government for hgher trade barrers. Actvtes of foregn nterest groups n natonal polcy-makng have receved a growng attenton n the poltcal economy lterature. Many scholars have evaluated the ntensty of foregn lobbyng n the US and argue that t has hgh potental for polcy n uence. Mtchell (1995) found that foregn a lates n the US contrbuted 5.6% of total corporate poltcal contrbutons n , and 42% of them hred professonal lobbysts to 4

5 promote ther nterests n Washngton. Hansen and Mtchell (2000) clam that, although foregn corporatons make lower poltcal contrbutons than domestc ones due to the exstng legal restrctons, they are just as ntensve as domestc corporatons wth respect to lobbyng actvty and lobbyng expendtures. Whle t has been argued that foregn corporatons are qute n uental n US poltcs, very lttle research has been done on ther e ect on trade polcy outcomes. In ther poneerng work, Gawande, Krshna, and Robbns (2006) demonstrate that foregn agents lobbyng expendture n the US s even greater than poltcal contrbutons by domestc corporatons, and that the elastcty of the US mport tar wth respect to foregn lobbyng s almost as bg as wth respect to the domestc one. Ther paper was the rst to show that foregn lobbyng s an mportant factor n the formaton of natonal trade polcy and argue that foregn lobbyng may be bene cal to the country s trade polcy as a counter-pressure to domestc nterests, helpng to reduce dstortonal trade barrers. In contrast, my paper suggests that the above argument s nvald n the presence of preferental trade agreements, when rms from a partner country prefer to mantan hgh dscrmnatory tar s for thrdcountry mports. Snce most of the countres are members of at least one preferental trade agreement, ths paper demonstrates that cross-border lobbyng may stmulate more protectonst trade polces of FTAs and dsrupt multlateral trade lberalzaton. The paper s structured as follows. Secton 2 provdes some evdence on the lobbyng actvtes of foregn rms n Canada. Secton 3 ntroduces the mod ed GH verson of the model that allows mperfectly compettve market structure and two groups of foregn lobbes, and motvates the emprcal methodology. Secton 4 descrbes the data and Secton?? explans the estmaton procedure. Results are presented n Secton 5 and Secton 6 concludes. 2 The role of foregn lobbes n Canada The rst law that regulates the actvty of domestc and foregn lobbysts n Canada s the Canada Electons Act, ntroduced n Ths law regulates the amount of poltcal contrbutons by Canadan natonals to poltcal partes and explctly bans the use of poltcal contrbutons from foregners. 2 2 No person or party shall accept or use contrbutons from a person who s not a Canadan ctzen..., corporaton or assocaton that does not carry on busness n Canada, foregn poltcal party, or foregn government, (S.217). 5

6 However, ths law su ered from a lack of transparency n the lobbyng process and on September 30, 1989, a Lobbyng Regstraton Act (LRA) came nto force. Ths pece of legslaton ntroduced a de nton of a lobbyst and a requrement for lobbysts to regster wth the Lobbysts Regstrar. But more mportantly, t requres lobbysts to provde nformaton about the name and busness address of the organzaton that has a drect nterest n the outcome of the lobbysts actvtes on behalf of the clent, all of ts subsdares and corporate headquarters, f there s one. An amendment to the LRA, ntroduced n 1996, made ths nformaton publcly avalable. It also ntroduced a strct dsclosure of funds polcy appled to poltcal partes. Together wth the Canada Electons Act, the LRA made t d cult for foregn rms to lobby ther nterests n Canada drectly. Nevertheless, poltcally actve foregn rms can stll n uence trade polcy outcomes n at least two ways. Frst, they can hre Canadan agents and consultants to lobby the executve branch on ther behalf and a ect polcy outcomes n a way that suts the nterests of foregn rms. Second, subsdares of foregn enterprses can make legal poltcal contrbutons wth ther own funds to defeat legslators who are unfrendly to ther nterests. Snce there are no restrctons on the share of foregn captal n the assets of a company that makes poltcal contrbutons, any local subsdary of a foregn corporaton can make poltcal donatons from ts own funds f t carres busness n Canada. Moreover, almost any bg foregn company that exports to Canada has an ndependent local sales department, whch s legally allowed to lobby for a reducton n trade barrers on the products mported by ts parent company nto Canada. Lobbyng e orts of such subsdares wll be counter to the e orts of domestc rms and, therefore, poolng all Canadan rms together regardless of ther ownershp may lead to msleadng results and estmaton problems. In the trade polcy lterature, corporate poltcal actvty s typcally measured by nancal contrbutons to canddates and poltcal partes, whle very lttle attenton has been pad to other means of a ectng polcy outcomes such as drect lobbyng. However, earler research on the e ect of foregn companes on natonal polcy (Hansen and Mtchell, 2000) suggests that foregn corporatons prefer drect lobbyng to poltcal contrbutons not only because of legal restrctons on contrbutons, but also because of nformal legtmacy questons for poltcans wth respect to acceptng money from corporate sources wth foregn ownershp. Hansen and Mtchell found that because lobbyng s less vsble than contrbutons, foregners use t as ntensvely (and e ectvely) as domestc rms do. For these reasons, lobbyng expendtures seem to be a better measure of foregn poltcal 6

7 nvolvement, especally n countres wth legal restrctons on poltcal contrbutons by foregners. Unfortunately, data on lobbyng expendtures by domestc and foregn corporatons are unavalable for Canada. To measure the foregn lobby ntensty n Canada, I collected the nformaton on the number of lobbysts o cally regstered wth the O ce of the Regstrar of Lobbysts, as s requred by the LRA. 3 Intutvely, the number of lobbysts hred by a company or ndustry should be hghly correlated wth the lobbyng expendture and hence can serve as a proxy for poltcal actvty. The lobbysts regstraton data s publcly avalable and s dscussed n more detal n Secton 4.2, but the followng gures llustrate the relatve mportance of foregn lobbyng n Canada. In , there were 1,032 o cally regstered lobbysts representng nterests of manufacturng rms regardng Canadan trade polcy, wth 47%, 26% and 27% of them actng on behalf of Canadan, US and rms, respectvely. Ths gures hghlght the potental strength of foregn lobbysts n Canada and suggest that the number of contacts of foregn rms wth Canadan polcymakers was at least not smaller than that of domestc rms. Then, when almost every country n a world trades under preferental agreements, t s mportant to consder the e ect of foregn lobbyng under the FTA when a group of foregn rms wth preferental market access may lobby for more protecton and renforce trade dverson e ects. 3 The model The theoretcal model s based on the Grossman and Helpman (1994) poltcal economy model and presents several mod catons that allow for the presence of foregn lobbyng and facltate econometrc estmaton. In ther orgnal formulaton, Grossman and Helpman consdered a small open economy, whch leaves no room for foregn companes to lobby because pre-tar prces are xed. In ths work I develop and buld nto the GH setup a model of monopolstc competton wth d erentated goods to allow foregn rms to gan or lose from mport tar s. 4 3 The Act de nes a lobbyst as an ndvdual who, for payment, undertakes to lobby on behalf of a clent and represents an organzaton n arrangng meetngs wth publc o ce holders, or communcate wth a publc o ce holder n an attempt to n uence the development of any legslatve proposal,... the makng or amendment of any regulaton,... the development or amendment of any program or polcy. 4 The model developed n ths secton s a generalzaton of the GH model wth monopolstc competton by Chang (2005) that allows for country bas n consumers preferences, country-spec c productvty and spec c mport tar. 7

8 There are N ndustres n the model and three countres: Canada (Home country), the US (FTA Partner country) and the, denoted by H; P and, respectvely. Industres are denoted by ndex 2 f1; :::; Ng and countres by j 2 fh; P; g. There are n j rms n country j and ndustry. These rms are assumed to be symmetrc wthn the same country and ndustry,.e. they share the same cost structure and hence face the same demand functons and charge the same prces. In total, there are n H + n P + n d erent varetes of each product. A representatve consumer maxmzes a quaslnear utlty functon wth a constant elastcty of substtuton ndex nested nto a Cobb-Douglas functon: X = n H d H 1 U = X x H + n P d P 1 NX! ln X =1 1 x P + n d 1 x 1 1 (1) where X s an aggregate consumpton ndex for product,! s the share of product n the total consumer s expendture, x j s the demand for product produced n country j, > 1 s the elastcty of substtuton between varetes of product, and d j s a country-wde taste (or qualty) parameter for product mported from country j. Maxmzng (1) subject to the standard budget constrant, we obtan the demand functons and an aggregate prce ndex for product : X =! (P ) 1 ; 1 (2) x j =! d j p j p j P! 1 (3) P = n H d H (p H ) 1 + n P d P (p P ) 1 + n d (p ) (4) Frms wthn one country and sector are assumed to have the same constant margnal cost. Ths allows us to consder Canadan market ndependently from other markets,.e. prces on the Canadan market depend only on the demand elastcty, the ( xed) number of rms and the xed margnal cost structure. Denotng a spec c mport tar set by the home country government on mports of product from country j as j, we can wrte the pro t of a country j rm that sells product n the Canada as: j = (pj c j j )qj (5) 8

9 where q j s the quantty suppled and cj s the margnal costs. I assume that the number of rms s large enough to gnore the e ect of ther ndvdual prcng decsons on the ndustry prce ndex P,.e. each rm takes the prce ndex as gven. Knowng product demand functons (3), each rm sets the pro t-maxmzng prce as a markup over ts margnal costs: p H = 1 c H ; p P = 1 (c P + P ); p = 1 For convenence, solate costs from (6) and wrte down equlbrum pro ts (5) as: (c + ) (6) j = 1 p j qj, 8j (7) The government chooses mport tar s to maxmze a weghted sum of natonal welfare W and poltcal contrbutons C: G( j ; C j ) = X C H + aw + b X C P + c X C (8) where C H, CP and C are ndustry-wde poltcal contrbutons from each country. Coe cent a s a weght that the government assgns to natonal welfare relatve to poltcal contrbutons. The government s allowed to value domestc and foregn contrbutons d erently as re ected by parameters b and c that show the government s preferences for the US and contrbutons, respectvely, over the contrbutons by domestc rms. As long as acceptng contrbutons from foregn rms nvolves rsk of reputaton loss or law nfracton, poltcans may prefer domestc contrbutons to overseas donatons thus both coe cents are presumably less than one. Frms n ndustry can organze themselves and form a group to lobby the local government for a change n trade polcy. 5 Frms wthn the FTA pay no mport tar s and hence lobby for more protecton, whle rms from other countres lobby for lower tar s for the opposte reason. The lobby representng ndustry of country j maxmzes ts welfare from obtanng protecton net of poltcal contrbuton: (W j C j ). As n Grossman and Helpman (1994), the equlbrum trade polcy s a soluton to a two-stage game. In the rst stage, knowng the government s objectve functon, each organzed lobbyng group provdes the government wth a schedule of poltcal contrbutons as a functon of mport tar. In the second stage, observng contrbuton schedules, the 5 Wth the number of rms n the sector beng lmted by the endowment of sector-spec c captal, rms n each ndustry have an ncentve to form a lobby group and seek for protecton from foregn competton. Here I gnore the free-rdng problem wthn each sector. See Bombardn (2008) for an extensve dscusson of rm-level contrbuton decson. 9

10 government sets trade polcy that maxmzes ts objectve functon (8). Grossman and Helpman (1994) show that for truthful contrbuton schedules the optmal trade polcy s the one that maxmzes jont surplus of the government and organzed lobbyng groups. Let denote the share of the home country populaton enttled to the domestc ndustry pro ts, and I j denote an ndex varable that takes the value of one when ndustry n country j s poltcally organzed and zero otherwse. The jont welfare functon then takes the form: NX NX = I H W H + aw + b I P W P =1 =1 + c NX =1 I W (9) where W H = n H H + (T R + CS) s welfare of the domestc ndustry gross of poltcal contrbutons, T R and CS are total tar revenue and consumer surplus, respectvely, W j = nj j ; j 2 fp; g s gross welfare of foregn ndustres from exports to the home county market, and W = P (nh H ) + T R + CS s natonal welfare. Takng the rst order condton of the jont welfare functon wth respect to the mport tar rate and rearrangng t, one obtans the expresson for the equlbrum trade polcy: " p = 1 + ( 1) P p P s P + a 1 s H I H s H + (10) a + a + + bip 1 s P + ci a + a + 1 s 1 where s j = nj pj xj P X denotes the share of country j rms on the Canadan market for product at the tax-ncluded prces. On the left-hand sde of (10), =p s the ad-valorem tar on the mports, whch s multpled by the prce elastcty of demand for the mports ". Therefore, as n the benchmark GH model, trade protecton s nversely related to the mport demand elastcty. 6 The rst term on the rght-hand sde s negatve: the model predcts that wth more d erentated varetes wll receve mport subsdy. Ths result s a drect consequence of monopolstc competton model wth spec c mport tar. 7 The second element on the rght-hand sde shows the postve relaton between the FTA external and nternal tar s and, followng Bagwell and Stager (1997), re ects a tar complementarty e ect: f the tar rate for the 6 It should be noted that wthout the MFN rule, a set of equlbrum tar s for all mporters would be determned by a system of smultaneous equatons wth the number of equatons beng equal to the number of mportng countres. Wth the MFN and the FTA, the number of equatons goes down to two. However, under complete trade lberalzaton agreement, a wthn-fta tar s exogenously set to zero and the second term on the rght-hand sde of (10) vanshes. 7 In the model of monopolstc competton, the e ect of a spec c tar on prce s ampl ed by producer s markup. Therefore, for low the prce elastcty wth respect to tar s hgh and the gan n consumer surplus from a subsdy outweghs the ncrease n government s expendture. 10

11 partner country s hgh, t s optmal for the government to rase the external tar as well. Intutvely, an ncrease n the wthn-fta tar rate causes a declne n mports from the, and tar revenue collected on the mports s hgher for hgher. Ths, n turn, rses mports from the partner country, that generates more tar revenue for hgher partner country tar rate. The tar complementarty e ect s proportonal to the market share of the partner country rms s P and s stronger f the partner country and the exports are close substtutes. In contrast to the benchmark case, even for unorganzed ndustres protecton may stll be postve due to the mperfectly compettve market structure, as emphaszed by the thrd term, snce the coe cent a a+ s postve. Because the share of domestc rms on the market re ects ther ablty to capture protecton bene ts, and the tar s more e ectve n re-dstrbutng consumers expendture towards domestc varetes when substtuton elastcty s hgh, the tar level s proportonal to s H and ncreasng wth. The fourth term s smlar to the benchmark GH model: a poltcally organzed domestc ndustry receves more protecton from the government. Moreover, the level of protecton s hgher f domestc and mported varetes are close substtutes and f the domestc sector s relatvely large, as the domestc lobby has more to gan from protecton n ths case. The fth term re ects the e ect of poltcal actvty by partner country rms on the natonal trade polcy. I p enters the equaton postvely, makng protecton more lkely n those sectors where partner country exporters are organzed nto lobbyng groups and where product varetes are closer substtutes. Smlarly to the domestc lobby, the e ect of partner country rms lobbyng on the mport tar s proportonal to ther market share. The last term s negatve and re ects the e ect of lobbyng e orts by the rms to reduce protecton. As before, the scalng factor 1 re ects hgher motvaton by the rms to lobby for trade lberalzaton when the degree of substtuton between varetes wthn a gven ndustry s hgh, but unlke domestc and partner country lobbyng, the lobbyng ntensty declnes wth the market share. The ntuton behnd ths result s an ncreased damage from protecton for small ndustres, and as a consequence these ndustres wll resst tar ncrease more ntensvely. 8 8 Ths result follows from the Cobb-Douglas utlty functon. Fxed product expendture shares mply that the mport tar mposed on one varety wll rase consumer s expendture on all varetes through aggregate prce ndex proportonally to ther market shares because large market share s ndcatve of the number of varetes produced n a gven country, productvty advantage, and consumers preferences toward varetes produced n that country. Therefore, the hgher s the market share (and the lower s the share of other varetes), the less harmful s the mport tar for the exporters. 11

12 As n the GH model, domestc and partner country s lobbyng results n overprotecton and welfare reducton relatve to the rst-best outcome. The presence of an organzed foregn lobby from the may help to (partally) restore the optmal level of mport tar s and rase natonal welfare. However, the presence of the lobbyng alone causes underprotecton and s thus welfare-reducng. Therefore, the overall net e ect from the presence of the partner country lobbyng s lkely to lead to welfare reducton, whereas the overall welfare e ect of the lobbyng actvty s unambguous: the e ect s postve f rms counter-lobby aganst the e ort of domestc and partner country rms to rase protecton and negatve f rms form a sngle organzed lobbyng group n the sector. Equaton (10) motvates the followng form of the estmaton equaton: Y = s H + 2 I H s H + 3 I P s P + 4 I [1 s ] (11) 1 = Y = 1 " p + 1 a a + ; 2 = 1 a + ; 3 = b a + ; 4 = c a + In equaton (10) the nverse elastcty was taken on the left-hand sde and both sdes were multpled by because substtuton elastcty s lkely to be measured wth error. Usng (12), the four coe cent estmates of the reduced form (11) can be used to derve four structural parameters of the model. (12) 1 4 The data The emprcal secton of ths paper estmates the e ects of domestc, partner country and lobbyng actvty on the Canadan post-nafta trade polcy. Gven the relatve sze of the US and Canadan economes, the e ect of US lobbyng n Canada wll be consderably larger than the e ect of Canadan lobbyng n the US. Therefore, focusng on Canadan data s partcularly advantageous for the emprcal analyss of foregn lobbyng under the FTA. Ths study s conducted for 249 Canadan 6-dgt NAICS manufacturng sectors (NAICS 31-33) for the perod of The US was treated as a Canadan FTA partner country, whle all other countres that have no preferental trade agreements wth Canada were aggregated nto. 9 The estmaton of equaton (10) requres the followng data: the measure for trade protecton, mports by the country of orgn and by sector, 9 Mexco also have preferental market access n Canada n 1997 but snce there s no evdence on the presence of Mexcan lobby n Canada n the data. Israel s another country that had trade agreement wth Canada at that tme and there are Israel rms 12

13 domestc output by sectors, substtuton and prce elastctes, poltcal organzaton dummes, and three sets of nstruments for market shares. 4.1 Protecton measures and market shares Domestc manufacturng shpments data for 249 NAICS-6 ndustres are provded by Industry Canada. The values of Canadan mports, as well as customs dutes collected, were obtaned from Statstcs Canada at the HTS-10 level and aggregated to NAICS-6 usng the concordances tables from the Internatonal Trade Dvson of Statstcs Canada. Prmarly, I use two measures for trade barrers: mport tar s and the share of mports that s subject to non-tar trade restrctons. Although the orgnal GH model was meant to analyze the poltcal economy of mport tar formaton, tar rates are often argued to be an mperfect measure of trade protecton for the analyss of endogenous trade polcy formaton n the presence of WTO tar regulaton. Wth lmtatons on the magntude of tar s mposed by the WTO, organzed nterests would seek non-tar protecton from mport competton that are adopted unlaterally by d erent countres, as opposed to tar s that are set cooperatvely n WTO negotatons. Nevertheless, I use tar s as a second measure of protecton. Even n the presence of WTO tar regulaton, tar s can stll re ect lobbyng actvty of Canadan and US nterest groups through smaller (larger for lobbyng) tar reductons durng WTO negotatons that take place after trade agreement s sgned. If the government takes nterests of domestc and partner country () lobby groups nto account durng negotatons, then organzed ndustres are lkely to receve smaller (larger) tar reductons durng WTO negotatons. In lght of ths, I used tar, Non-Tar Barrers (NTBs) and protecton coverage share as a measure of protecton. Ad-valorem tar rates were obtaned as the rato of aggregated duty collected by customs over the value of mports. 10 NTBs for Canadan mports were obtaned from the TRAINS database mantaned by UNCTAD, whch shows the proporton of mports that s covered by one or more qualtatve restrctons. These data were avalable at the HS-6 level and were aggregated nto NAICS-6 groups. In addton, the protecton lobbyng trade nterest n Canada. But snce ths FTA came nto force on January 1, 1997, t s hard to classfy these rms accordng to market access usng data. Therefore, I treat US as a sngle Canadan FTA partner country. 10 Therefore, tar measure controls for some non-tar dstortons as well, such as antdumpng or countervalng dutes. 13

14 share varable was constructed as the share of Canadan mports that s subject ether to the postve mport tar or NTBs. Descrptve statstcs for protecton measures and market shares are presented n Table 1. In 1997 the average tar rate, NTBs and protecton coverage ratos for the mports were 4.8%, 18.2% and 77.5%, respectvely. Tar s and NTBs are hghly correlated both wthn and outsde of the FTA, whch mples that d erent measures of protecton are stll hghly complementary. 4.2 Poltcal organzaton dummes Many prevous studes that have tested the GH model emprcally used rm-level poltcal contrbutons to assgn the value for the poltcal organzaton dummy varable. 11 Although these data are avalable for Canada for 1997 and afterwards, ths paper uses a d erent approach. As was prevously mentoned, foregn corporatons prefer drect lobbyng to poltcal contrbutons because transparency of poltcal contrbutons may rase concerns about foregn nterference nto poltcal processes. Furthermore, snce d erent means of poltcal nvolvement are hghly correlated (Hansen and Mtchell, 2000), drect lobbyng seems to be an approprate measure for domestc poltcal actvty as well. In ths work, the degree of poltcal actvty n an ndustry s measured by the number of lobbysts representng the corporate nterests of that ndustry. The Lobbysts Regstraton Act (LRA) requres every ndvdual to regster at the Lobby Regstrar Canada f the person seeks a meetng or a phone call to any publc o ce holder regardng the development, mod caton or cancellaton of legslatve proposals, regulatons, publc polces and programs. The assumpton that poltcal contrbutons wll be ne ectve for the determnaton of trade polcy wthout such contact seems to be reasonable and, therefore, poltcal contrbutons should be followed up by a personal contact wth a polcymaker. For ths reason, the number of regstered lobbysts s used to measure rm-level lobbyng ntensty wthn an ndustry. The man advantage of ths data set s the large amount of detaled nformaton lobbysts are requred to submt. Ths ncludes nformaton on the busness address of a corporaton that bene ts from lobbyng, ts subsdares and headquarters, and the objectve of the meetng wth a publc o ce holder. Ths nformaton s 11 For example, Goldberg and Magg (1999), Gawande and Bandyopadhyay (2000),Facchn, Besebroeck, and Wllmann (2006), Bombardn (2008). 14

15 very helpful n determnng the natonalty and ndustral a laton of lobbysts representng nterests of multproduct multnatonal corporatons. Another advantage of ths data set s that t gves a very narrow de nton of a lobbyst. Any person representng hs or her own nterests, and who s not beng pad for arrangng the meetng wth the publc o ce holder, s not oblged to regster. Ths removes nformaton on the very small rms. Large rms, whch have hgh lobbyng power and can e ectvely n uence the decsons of polcymakers, typcally use the servce of professonal consultants or corporate lobbysts, who are requred to regster. Frms were assgned a NAICS-6 ndustry code usng the Canadan Company Capablty database mantaned by Industry Canada. Assgnng an ndustry code to mult-product rms nvolves some degree of dscreton. For example, some rms n the automoble sector operate n more than ten NAICS-6 ndustres. Snce the number of such rms s relatvely small, I assgned prmary, secondary and tertary NAICS codes to such rms usng d erent nformaton sources: the Canadan Company Capablty database, the Federal Corporatons Regstry and the North Amerca Compustat database. The databases lsted above allow assgnng ndustry codes to US and rms. The LRA also requres lobbysts to declare a subject-matter n respect to whch an ndvdual undertakes to communcate wth a publc o ce holder. In many cases, nformaton on the purpose of lobbyng actvty reported n the lobbyst regstraton form allowed me to attrbute a rm to a sngle (or a small number of) prmary NAICS code. Natonal a laton of each rm that a partcular lobbyst s representng was determned from locaton of ts manufacturng facltes 12 and constructed from two sources. Frst, the lobbyst regstraton form requres regstrants to provde the name and busness address of the parent corporaton and those subsdares whch drectly bene t from the lobbyng. Sometmes, lobbysts provde ncomplete nformaton and n ths case t was complemented by the nformaton from other databases mentoned prevously. Agan, qute often the natonalty of the rm was determned by the objectve secton of the lobbyst regstraton form. 13 There are two more advantages of usng lobbysts regstry data over usng poltcal contrbuton data. Frst, the necessty of reportng the objectve of the contact wth the publc o ce holders allows one to solate e ectvely those rms that lobby partcularly for a change n trade polcy. Ths s especally a problem for 12 For example, a US company that has manufacturng facltes n Canada s treated as Canadan rm. 13 For nstance, a lobbyst of Toyota Canada Inc, Ontaro-based subsdary of Toyota Motor Corp., was attrbuted to the on the bass of the meetng purpose to secure nternatonal trade for automoble engnes as these engnes are manufactured and shpped from Japan. Moreover, ths lobbyng objectve statement allows to pn down the lobbyst to one spec c NAICS6 ndustry. 15

16 domestc lobbysts: on average, only one out of eght lobbysts, representng the domestc manufacturng sector, s concerned wth trade polcy. Therefore, poolng poltcal contrbutons by all domestc rms may cause serous measurement problems for the poltcal organzaton varable. Second, the man channel used by foregn rms to lobby ther nterest n Canada s through local subsdares, whch dstrbute the mported goods wthn Canada. Formally, these rms should be assgned to the servce sector (NAICS 41-45) and dropped from the sample, but ths would substantally underestmate lobbyng e orts by foregn rms. For each servce rm concerned wth nternatonal trade polcy ssues I used the company pro le and lobbyng objectves nformaton to assgn an approprate manufacturng ndustry code and country f the rm has a manufacturng headquarter. Therefore, lobbyng data allows to control more e ectvely for foregn lobbyng actvty n Canada. The amendment to the LRA announced n 1995 ntroduced several mportant re nements that made t more desrable to use post-1995 lobbyng data. Frst, for the purpose of transparency, the lobbysts regstry database became avalable for research purposes. Second, ths amendment extended the amount of nformaton that must be reported. But most mportantly, t made dsclosed nformaton more complete and relable. For the rst tme lobbysts were oblged to provde all the nformaton, and e ectve enforcement devces were ntroduced to encourage better complance. It extended the power of the Lobbysts Regstrar, whch was authorzed to seek clar caton of nformaton submtted. The regstrar was allowed to conduct an audt of provded nformaton and, when necessary, nvestgate the provded nformaton and mpose sanctons for volatng the LRA. 14 For these reasons, the data for poltcal actvty by rms were collected for the 1997 electon cycle and complemented wth the 1996 lobbyng data to take nto account a possble small lag n trade polcy response to lobbyng e orts. Therefore, for each ndustry I calculated the total number of Canadan, US and lobbysts and, smlarly to other studes, several thresholds for the number of lobbysts n an ndustry were set to determne the values of poltcal organzaton dummes. Descrptve statstcs for the number of lobbysts s provded n Table In 2001 an ndependent study of complance to the LRA was conducted by KPMG Consultng Inc. (2001). The already-regstered lobbysts were asked f they were aware of any non-complance behavor. Reported results ndcate that 50% of consultant lobbysts and 15% of corporate lobbysts were aware of non-regstered lobbyng, whle they evaluated the aggregate complance rate at 70% and 100%, respectvely. In general, complance was perceved to be hgh, although non-complance behavor s stll an mportant ssue. 16

17 4.3 The elastctes of substtuton To my knowledge, there are no studes to date that estmate substtuton elastctes for Canadan NAICS-6 ndustres, especally wthn a framework of monopolstc competton. In ths study, substtuton elastctes were estmated usng the approach by Feenstra (1994), recently appled by Broda and Wensten (2006) to a large set of US mported commodtes. Table 3 presents the summary statstcs. 15 As a robustness check, I estmated the substtuton elastctes for NAICS ndustres at varous level of aggregaton and ver ed that more aggregated commodtes are more d erentated: the average value of decreased from 5.85 to 5.34 and 4.56 whle movng respectvely from sx to ve and four dgts NAICS. As another robustness check, I estmated US elastcty of substtuton usng the same estmaton procedure, tme perod, and ndustry class caton. Presumably, consumers n Canada and the US should have smlar tastes, and varetes that are close substtutes n Canada should be close substtutes n the US as well. Ths suggeston s supported by 0:69 correlaton coe cent. 4.4 Instrumental varables In equaton (10), market shares are lkely to be determned smultaneously wth the tar rates and should be properly nstrumented. Tre er (1993) proposed to nstrument the mport penetraton rato wth ndustry factor endowments as the measure of comparatve advantage ndependent of the level of protecton. Followng ths approach, a lst of nstruments for the Canadan market share ncludes: the share of producton to nonproducton workers, the captal stock n machnery and constructon, nventores, and the consumpton of fuel and electrcty. All of these data are provded by Statstcs Canada. The same lst of nstruments was constructed for the US market share n Canada usng the US Census data. To nstrument the share n the Canadan market, the gravty -type dstance measure between Canada and the average exporter was constructed. For every product, the par-wse log-dstance between Canada and the exportng country was weghted by the share of ths country n the global export of the product. 16 The 15 Prce elastctes of the mport demand were calculated from consumers demand functon: : p q ( 1)s 16 Snce the exporter s share on the Canadan market s endogenous, I use the share on the global market, assumng t s una ected by Canadan tar rate. = 17

18 total exports by country and by sector were constructed usng the UNCTAD database. The data on geographc dstance, weghted by populaton densty and economc actvty wthn each country, were taken from the Centre d Etudes Prospectves et d Informatons Internatonales. The ratonale for usng ths dstance varable s the followng: f man producers of a partcular good are located far from Canada, transportaton costs are hgh and the share n the Canadan market s lkely to be small regardless of Canadan trade polcy. Poltcal organzaton dummes are lkely to be measured wth error and are potentally endogenous. To nstrument the US and Canadan poltcal organzaton dummes, I use the nformaton ndustral concentraton, such as shares of bg and medum rms and the CR-4 concentraton rato. Industral concentraton s mostly technologcally determned and at the same tme t s easer for rms n more concentrated ndustres to overcome free-rdng problem and form a lobby group. The lobbyng ntensty s nstrumented smlarly to Gawande, Krshna, and Robbns (2006) wth the rato of exports by rms to Canada relatve to ther worldwde exports n an ndustry. The rght-hand sde varables of equaton (11) nclude non-lnear combnatons of endogenous varables and to consstently estmate ts coe cents I use LIML estmator proposed by Kelejan (1971) wth Bekker (1994) standard error correcton. Hansen, Hausman, and Newey (2006) demonstrated that ths approach has better small sample propertes than 2SLS and s asymptotcally correct n the presence of many nstruments and many weak nstruments. 5 Results 5.1 Test of a benchmark GH model As a startng pont, I wll present the results on a GH verson of the model wth homogeneous goods to test how well the new data on Canada can t the benchmark model and compare ts performance wth the results of prevous emprcal studes. Snce n the benchmark model markets are perfectly compettve and mport supply s n ntely elastc, there s no reason for foregn rms to partcpate n lobbyng, and n the benchmark case I wll consder only the e ect of domestc lobbyng groups on the home country trade polcy. Followng Grossman and Helpman (1994), the optmal mport tar for a small open economy wth poltcally 18

19 organzed sector-spec c factors of producton takes the followng form: " p = X H + 1 X H I H (13) a + M a + M where X H s a domestc value of shpments and M s a total value of mports from the. The model predcts that the nverse mport penetraton rato enters the equaton negatvely, whle the coe cent on ts nteracton wth poltcal organzaton dummy s postve. Table 4 represents estmaton results for equaton (13) usng tar s, NTBs and protecton share data as a measure of Canadan trade barrers. As n Goldberg and Magg (1999), several thresholds were used for the number of lobbysts n the constructon of poltcal organzaton dummes to verfy that the results are not drven by the way these dummes are assgned. In the rst column of Table 4 an ndustry s consdered to be poltcally organzed f t s represented by at least one lobbyst. For the second and thrd columns the threshold s two and three lobbysts, respectvely. Frst, consder the estmaton wth tar s as a protecton measure. The estmates of the regresson model (13) are of correct sgns across all spec catons: poltcally organzed sectors receve more protecton, whle protecton n unorganzed sectors s negatve and ncreases wth mport penetraton. The latter result s statstcally sgn cant at a 5% con dence level. In organzed sectors protecton declnes wth the mport penetraton, but ths result s not statstcally sgn cant. The model estmates are very robust to the way poltcal organzaton dummes are constructed. When trade barrers are measured wth NTBs and protecton share, results correspond closely to those obtaned for the tar equaton: the parameter estmates preserve correct sgns, but are estmated wth less precson when trade barrers are measured wth protecton share. Overall, the estmates of the structural model (13) usng Canadan data are generally n the lne wth the results of the studes by Goldberg and Magg (1999) and Gawande and Bandyopadhyay (2000). The estmates of the structural parameters of the model vary consderably across d erent measures of protecton. However, the varances of these parameters are very hgh and one cannot reject hypotheses that both and a are the same across all spec catons consdered. The fracton of the populaton represented by a lobby,, s estmated to be around 0:6 for the spec catons wth tar s, 0:2 for spec catons wth protecton shares, and greater than one for spec catons wth NTBs. In general, 95% con dence nterval for ncludes the whole [0; 1] nterval and the model does not allow one to obtan a precse measure for. Nevertheless, the obtaned results do not contradct the prevous estmates of by Goldberg and Magg (1999) and Gawande and 19

20 Bandyopadhyay (2000), who estmated the share of the populaton represented by nterest groups to be around 0:85 and unty, respectvely. The estmates of the government s poltcal bas vary from 10 n the spec caton wth shares to 100 n spec caton wth tar s. The values of the parameter a greater then ten mply that the government assgns approxmately equal weghts to poltcal contrbutons and to a natonal welfare net of poltcal contrbutons, whch supports the results of studes that use US data. 17 Overall, the results of the GH model wth Canadan data are broadly consstent wth those obtaned by Goldberg and Magg (1999) and Gawande and Bandyopadhyay (2000) and other studes for the US. These results wll serve as a benchmark aganst whch the results of the monopolstc competton model wth foregn lobbyng and FTA partcpaton wll be compared n the next secton. 5.2 Estmaton results for the monopolstc competton model wth foregn lobby In ths secton I present the estmaton results for the poltcal economy model of trade wth monopolstc competton, FTA membershp and two groups of foregn lobbes. The results from the equaton (11) appear n Table 5, n whch several measures are used to measure trade barrers. Columns wth d erent numbers denote d erent threshold levels for constructon of the poltcal organzaton varable. Columns (1) and (2) report the results when an ndustry s assumed to be poltcally organzed f t has at least one and three lobbysts, respectvely. In column (3) a country s j ndustry s organzed f t s represented by at least three lobbysts and accounts for strctly more than one thrd of a total number of lobbysts n that ndustry. Ths measure was constructed to exclude sectors wth a postve but small number of lobbysts relatve to the whole ndustry. Frst, note that for any measure of protecton and poltcal organzaton, the coe cent 1 s postve and almost always statstcally sgn cant, mplyng that domestc ndustres receve a postve level of protecton regardless of poltcal economy factors. Ths s consstent wth the assumpton of mperfect competton and predcton of the model that the welfare-maxmzng government always nds t worthwhle to protect home country producers aganst competng mporters when domestc and foregn products are close substtutes and 17 The government s objectve functon C + aw s equvalent to a 1 C + a 2 (W C), n whch a = a 2, a a 1 a 1 s the weght on 2 poltcal contrbutons and a 2 s the weght on a welfare net of poltcal contrbutons. Therefore when a s much greater than one, a 1 = a+1 a2 a a 2. 20

21 markets are mperfectly compettve. The postve level of protecton for unorganzed sectors s n contrast to the benchmark GH model and nds strong support n the data. As the theory predcts, among poltcally unorganzed sectors protecton ncreases wth the share of domestc rms on the market. When protecton s measured wth tar s, the pont estmate for 1 n the most preferred spec caton n terms of the log-lkelhood functon (column (3)) s 0:21, whch converts to the welfare-maxmzng ad-valorem mport tar of 2:2% for an average Canadan ndustry, gven the average Canadan market share, prce and substtuton elastctes of 0:66, 5:32 and 5:83, respectvely. In terms of the optmal level of NTBs and protecton share, the welfare-maxmzng NTB coverage for the average ndustry s estmated to be 8:9% of total mports from outsde of the FTA, whle the welfare-maxmzng share of mports subject to any trade restrcton s 17:9%. The e ect of a poltcally organzed domestc lobbyng (coe cent 2 ) s always estmated to be postve and very sgn cant, ndependently of the constructon of the poltcal organzaton dummy and the measure of trade dstorton. Everythng else beng equal, actve domestc lobbyng n the ndustry leads to a hgher level of protecton and ths e ect s sgn cant and robust across all spec catons. The presence of a poltcally organzed domestc lobby tends to ncrease mport tar s by 5:4% for the average ndustry, the NTB coverage rato by 29:7%, and the protecton share by 31:7%. The novel results of ths secton are the estmates of coe cents 3 and 4. The coe cent 3 measures the e ect of the FTA partner country s lobbyng and s always estmated to be postve, although n spec catons wth tar s t s only margnally sgn cant. As expected, the e ect of US lobbyng s much stronger on NTBs than on tar s. Ths s consstent wth the ntal hypothess that n the presence tar regulaton by the WTO, domestc and partner country lobbysts can a ect tar s only by resstng to multlateral trade lberalzaton durng post-nafta WTO rounds of trade negotatons. In the short run, the e ect of US lobbyng on Canadan mport tar may be not as pronounced as the e ect on NTBs, adopted unlaterally by Canadan government. The e ect of the lobbyng (coe cent 4 ) s always negatve and sgn cant at 5% except for two spec catons wth NTBs, presumably because foregn lobbes are more e ectve n lobbyng for tar usng WTO mechansms. Accordng to these results, the presence of poltcally organzed US ndustres n Canada leads to hgher Canadan mport barrers and the lobbyng e ort s negatvely correlated wth the Canadan protecton measures. Thus, t seems safe to conclude that, whle our results do not allow researchers to get 21