Poltcal Economy and Trade Polcy
Motvaton When asked why no free trade?, most nternatonal economsts respond t must be poltcs In representatve democraces, trade polcy shaped not only by general electorate, but by specal nterests that lobby for what may be socally costly polces Two key approaches to modelng poltcal process: - poltcal competton: partes announce polces they wll mplement f elected (Magee et al., 1989) - poltcal support: ncumbent governments set polces to maxmze poltcal support (Stgler, 1971) Grossman and Helpman (1994) adopt latter approach n order to explan structure of trade protecton
The Model Small economy where all ndvduals have dentcal preferences, but dfferent factor endowments; each maxmzes utlty: u = x + 0 n u x =1 ( ) where x 0 s consumpton of good 0, and x consumpton of goods =1,2,.,n Good 0 s numerare wth world and domestc prce of 1; * s world prce of good, and p s domestc prce p Indvdual spendng E consumes x =d (p ) of, and expendture on numerare good s: x 0 = E - p d ( p ) (1)
The Model Indrect utlty takes form: V(p, E ) = E + s( p) where p=(p 1,p 2,,p n ) s vector of domestc prces, and consumer surplus s, s ( p ) u [ d ( p )]- p d ( p ) Good 0 produced from labor alone under constant returns wth nput-output coeffcent of 1, labor supply beng large enough that wage rate equals one Producton of x uses labor and sector-specfc nputs under constant returns, where specfc factors are nelastc n supply Wth wage rate fxed, aggregate reward to specfc factor n depends on domestc prce of, π ( p) (2)
The Model Government can mplement trade taxes and subsdes, drvng wedge between domestc and world prces; net revenue/capta from all taxes and subsdes: 1 r ( p ) = ( p - p * ) d ( p )- y ( p ) (3) N where N s total votng populaton, and domestc output of good s y (p )=π ( p ) Government redstrbutes revenue unformly to all voters, r(p) s net transfer to each one Typcal ndvdual derves ncome from wages and transfers, plus that from ownershp of sector-specfc nputs ncome ted to producton of good, hence they have drect stake n trade taxes/subsdes
The Model In some set of sectors L, specfc-factor owners organze nto lobbes makng poltcal contrbutons; remanng sectors/ndvduals make no contrbutons Lobby n sector makes contrbuton contngent on trade-polcy vector of government; C (p) s contrbuton schedule of, desgned to maxmze total welfare of members,.e., ncome plus surplus less contrbutons Jont welfare of lobby s V = W - C where W s grossof-contrbutons jont welfare: W ( p ) + π ( p ) + α N[ r ( p ) + s( p)] where s total labor supply (ncome) of owners of specfc factors used n and α s share of populaton ownng some of that factor (4)
The Model Contrbutons can be used to fnance campagn spendng, and voters more lkely to re-elect government delverng hgh standard of lvng Government objectve functon s: L G = C ( p ) + aw ( p) a 0 W s aggregate, gross-of-contrbutons welfare,.e., aggregate ncome plus trade tax revenues plus consumer surplus: n = 1 W ( p ) + π ( p ) + N[ r ( p ) + s( p)] Two-stage non-cooperatve game where lobbes smultaneously choose contrbuton schedules n frst stage, government sets polcy n second stage (5) (6)
Structure of Protecton Result expressed n terms of ad valorem 0 taxes/subsdes,.e., t (p 0 - p *) / p * Government chooses taxes and subsdes satsfyng: 0 0 t I - αl z = for =1,2,,n 0 0 1+ t a + αl e 0 0 0 where z = y ( p ) / m ( p ) s equlbrum rato of domestc output to mports, and elastcty of mport 0 0 0 0 demand s e = - m ( p ) p / m ( p )
Structure of Protecton Ceters parbus, ndustres wth hgh mport demand elastctes (n absolute value), have smaller ad valorem devatons from free trade Ths result follows for two reasons: - government bears poltcal cost from creatng deadweght loss (f a>0); hence, t wll prefer to rase contrbutons from sectors where cost s low - even f a=0, f α L >0, members of lobbes as a group bear deadweght loss from trade polcy; owners of specfc factors n ndustres other than bd to avod protecton n, the greater the socal cost
Structure of Protecton Deadweght loss ssues modfed by poltcal varables n determnaton of equlbrum structure of protecton: - all sectors wth lobbes protected by mport tarffs/export subsdes, and sectors wthout representaton face mport subsdes and export taxes;.e., organzed lobbes rase prces where they get proft ncome, and lower prces of goods they consume - poltcal power of organzed lobbes reflected n rato of domestc output to mports wth large domestc output, specfc-factor owners gan from prce ncrease; but, for a gven mport demand elastcty, economy has lttle to lose from protecton when mport volume s low
Structure of Protecton - the less weght attached to aggregate welfare compared to campagn fnancng, the larger are trade taxes/subsdes; however, even f a=0, nterest groups wll not want dstortons to grow too large - as share of voters that are members of lobby ncreases, rates of protecton for organzed ndustres declne; n lmt f all voters are n lobby (α L =1) and all lobbes are represented (I =1 for all ), free trade prevals n all markets groups neutralze each other - f all nterest-group members are small fracton of votng populaton, (α L =0) no trade taxes/subsdes appled to goods not represented by a lobby (I =0) when poltcal contrbutors are few, stand lttle to gan from nterventon n sectors other than ther own
Trade Polcy Optmal trade tax s: π( p )- π( p) ( I -α L) (a + I ) h 0 t LN 0 α z = 0 0 1+ t a + αl e Behavoral term [.] has mportant mplcatons even f all sectors are organzed (I =1), and everyone s n a lobby group (α L =1), trade s stll dstorted f some agents experence loss averson at free trade: 0 0 t z =h (.) 0 0 1+ t e
Protecton of US Steel Sector Freund and Özden argue US steel ndustry s one where loss averson has mattered: - protecton n 1980s and early-1990s prevented domestc prces fallng below reference prce - move away from compensatng protecton n late- 1990s as world prces fell further and US frms lost market share - loss-makng sector of ndustry, hgh-cost ntegrated steel mlls, lobbed for protecton Incorporatng loss averson and reference dependence nto utlty functons helps explan structure and dynamcs of protecton