Endogenous Protection: Lobbying Matilde Bombardini UBC January 20, 2011 Bombardini (UBC) Endogenous Protection January 20, 2011 1 / 24
Protection for sale Grossman and Helpman (1994) Protection for Sale American Economic Review Two approaches to endogenize protection as outcome of political process: explicitly model political competition: elections and trade policy (e.g. Hillman and Ursprung (AER 1988)) incumbent politicians maximize political support (elections are not explicitly modeled) (e.g. Hillman (1989)) This paper follows second strand of literature This model provide a micro-foundation of political support function Bombardini (UBC) Endogenous Protection January 20, 2011 2 / 24
Main ingredients Small open economy Speci c factors model of trade Interest group = speci c factor Political organization is exogenous (some interest groups do not lobby government) No electoral competition, interest groups lobby incumbent government Bombardini (UBC) Endogenous Protection January 20, 2011 3 / 24
Interest groups o er monetary contributions to the government as a function of tari s Government may value monetary contributions for electoral reasons Government also cares about general welfare (again, potentially related to re-election concerns) Tari s result from trading o monetary contributions and welfare loss deriving from protection Bombardini (UBC) Endogenous Protection January 20, 2011 4 / 24
The economy and preferences Small economy, population size N Preferences are quasi-linear: u = x 0 + n i=1 u i () increasing, concave and di erentiable x 0 is numeraire, freely traded other goods potentially bear a tari : pi international price p i domestic price u i (x i ) Bombardini (UBC) Endogenous Protection January 20, 2011 5 / 24
Preferences Quasi-linear utility kills income e ects Consumption of good i depends only on p i consumption of x i is d i (p i ) rest of expenditure E spent on x 0 : E n i=1 p i d i (p i ) Indirect utility function: V (p, E ) = E + s (p) This is convenient because it reduces the degree of interaction among sectors Bombardini (UBC) Endogenous Protection January 20, 2011 6 / 24
Production x 0 is produced using only labor (one to one) assume the production of x 0 is positive =) w = 1 x i is produced under CRS with: labor sector i speci c input (capital, human capital, etc.) Return to speci c factor π i (p i ) Using Hotelling s lemma output is given by: y i (p i ) = dπ i dp i Bombardini (UBC) Endogenous Protection January 20, 2011 7 / 24
Trade Policy Restrict policy space to tari s Subsidies are more e cient, not allowed here Net tari revenues are redistributed back to consumers per capita: r (p) = n (p i pi ) d i (p i ) i=1 total imports m i (p i ) = Nd i (p i ) y i (p i ) y i (p i ) N Bombardini (UBC) Endogenous Protection January 20, 2011 8 / 24
Political organization Owners of speci c factor i have stake in price of good i May or may not organize politically Set L of sectors organize: within each sector owners of speci c factor form a cohesive interest group no modelling of incentives to organize no free-riding within sector Bombardini (UBC) Endogenous Protection January 20, 2011 9 / 24
Lobbying the government Technical innovation of paper is employing menu auction (Bernheim and Whinston, QJE 1986) Set of L interest groups try to induce government to choose costly action: common agency problem Each lobby i submits a contribution schedule C i (p) menu in the sense that it associates a monetary amount to each possible price vector The government chooses an equilibrium price vector p 0 (which translates into tari s) and collects contributions Bombardini (UBC) Endogenous Protection January 20, 2011 10 / 24
Joint welfare of members of the lobby: W i (p) = `i + π i (p i ) + α i N [r (p) + s (p)] where `i is labor income of members of lobby i and α i is share of population represented by owners of sector i speci c factor Bombardini (UBC) Endogenous Protection January 20, 2011 11 / 24
Government Unitary government (no congress/parliament) No explicit electoral competition Government payo : G = C i (p) + aw (p) i2l Aggregate welfare: W (p) = ` + π i (p i ) + N [r (p) + s (p)] i where ` is total labor income in the country Bombardini (UBC) Endogenous Protection January 20, 2011 12 / 24
Solution Bernheim and Whinston (1986) emphasize, among possible equilibria, those sustained by Truthful Contribution schedules Truthful contribution schedule: C T i (p, B i ) = max [0, W i (p) B i ] Truthful in the sense of re ecting everywhere the willingness to pay for p (no asymmetric information here) Truthful Nash Equilibria have the important property of being coalition-proof and truthful contributions are always in the best-response correspondence Bombardini (UBC) Endogenous Protection January 20, 2011 13 / 24
Under these contribution schedules, the maximization problem for the government is: " # p 0 = arg max W i (p) + aw (p) p2p i2l FOC: rw i p 0 + arw p 0 = 0 i2l Impact of change in p i on lobby i welfare: W i p i = y i + α i mi + (p i p i ) m 0 i d i (p i ) Similarly impact of change in p j on lobby i welfare: W i = α i pj p j m 0 p j j y j (p j ) Bombardini (UBC) Endogenous Protection January 20, 2011 14 / 24
Impact of change in p j on aggregate welfare: W = p j p j m 0 p j + m j d j (p j ) j {z } {z } r (p)/ p s(p)/ p W = p j p j m 0 p j j + y j (p j ) {z } π(p)/ p Verify that optimal tari is zero in the absence of lobbying =) see Grossman and Helpman (JPE 1995) for large country model with interest groups (optimal tari considerations) Substitute in the rst order condition and rearrange to nd the equilibrium level of protection Bombardini (UBC) Endogenous Protection January 20, 2011 15 / 24
Equilibrium level of protection Unique equilibrium in the tari level (multiple equilibria in level of contributions sustaining it): t 0 i α L ti 0 + 1 = I i a + α L z 0 i ei 0 where zi 0 is the inverse import penetration y i pi 0 /m p 0 i and e 0 i is the elasticity of import demand I i is an indicator function that is 1 if lobby i is politically organized and 0 if lobby i is not organized Ramsey rule for protection For politically organized sectors protection: is decreasing in elasticity of imports (more distortionary if e is high) decreasing in import penetration (more distortionary if imports are a large fraction of consumption) lower if α L higher (more lobbying to lower tari ) higher if a is lower (lower weight on welfare) Bombardini (UBC) Endogenous Protection January 20, 2011 16 / 24
For politically unorganized sectors: import subsidy (α L share of population lobbying to reduce price of imports) decreasing in import penetration and import elasticity for same reasons larger subsidy if α L is large (more lobbying) Bombardini (UBC) Endogenous Protection January 20, 2011 17 / 24
Political contributions Multiple equilibria in the level of contributions supporting tari s t 0 i Given truthful contribution schedule, each interest group i will try to lower contributions as much as possible (increase B i ) without forcing the government to ignore them when setting tari s Imagine without interest group i the government would choose price vector p i The interest group i will lower its contributions to keep government indi erent between p i and p 0 j6=i C j p i, B j + aw p i = C j p 0, B j + aw p 0 j There might be multiple levels of contributions that satisfy this condition Bombardini (UBC) Endogenous Protection January 20, 2011 18 / 24
The amount of contributions and therefore the way the surplus is split between lobbies and government depends crucially on competition among interest groups If α L = 0 there is NO competition among lobbies (no one is lobbying to reduce the price on other products); =) if government ignored sector i it would set tari to zero (free trade) =) sector i has to pay ε contribution to keep gov t indi erent If α L = 1 maximum competition, entire population is lobbying no protection (tari s are zero) but government is appropriating all rents interest groups are paying just to prevent government to place import subsidies on their product Bombardini (UBC) Endogenous Protection January 20, 2011 19 / 24
Evidence on the Protection for Sale model Two papers: Gawande and Bandyopadhyay (Restat 2000) and Goldberg and Maggi (AER 1999) Follow GB Data for 1983 on: tari s and non-tari barriers (coverage ratios) import penetration ratios import elasticity PAC monetary contributions Bombardini (UBC) Endogenous Protection January 20, 2011 20 / 24
Use political contributions to classify sectors into politically organized or not: GB try to identify the part of campaign contributions related to trade Empirical speci cation: t i 1 + t i = γ 0 + γ 1 I i z i e i + γ 2 z i e i + Z 1i + ε i Taking into account that import penetration depends on protection (Tre er 1993): 1 t i = δ 0 + δ 1 + Z 2i + η z i 1 + t i i Bombardini (UBC) Endogenous Protection January 20, 2011 21 / 24
Bombardini (UBC) Endogenous Protection January 20, 2011 22 / 24
Endogenizing political organization Mitra (1999) D. Mitra (1999) Endogenous Lobby Formation and Endogenous Protection: A Long Run Model of Trade Policy Determination American Economic Review Introduces a xed cost of organization at the level of the interest group Posits that lobby will organize if total surplus created by lobbying is larger than xed cost Bombardini (UBC) Endogenous Protection January 20, 2011 23 / 24
Endogenizing political organization Bombardini (JIE 2008) Firm heterogeneity and lobby participation Shift perspective to individual rms Empirically, in GB-type regression average rm size and dispersion (s.d.) of rm size a ect positively protection Model individual rms decision to participate in the sector lobby and pay xed cost of lobbying Obtain a modi ed GH prediction: ti 0 ti 0 + 1 = θ i α L z 0 i a + α L ei 0 Measured θ i for each sector and tested against GH Bombardini (UBC) Endogenous Protection January 20, 2011 24 / 24