Political Economy Problems In the Analysis of Trade Policy

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Political Economy ProblemsIn the Analysis of
Trade Policy

• Doug Nelson
• School of Economics

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Blinders Law

• Blinders Law Economists have least influence on
  policy where they know most and are most agreed
  they have the most influence on policy where they
  know the least and disagree most vehemently.
• Blinders main examples of the former are
• Trade policy
• Environmental policy.

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Consider Trade Policy

• Virtually all countries provide protection which
  is
• Non-uniform across sectors and
• Seems hard to rationalize in terms of any obvious
  economic welfare argument.
• In many sectors protection is sufficiently high
  that the net costs are positive, even large (e.g.
  agriculture, textiles, steel), but
• In some sectors protection is positive, but below
  estimates of the optimal tariff, so welfare could
  be raised by increasing protection.

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How do we explain this phenomenon?

• Politicians are ignorant
• Economists are ignorant
• Politicians are (possibly very) smart, but
• their goal is something other than pure social
  welfare maximization
• That is Trade policy is a
• political economy problem

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On Political Economy Problems

• For most economists, this is a conversational
  trick meaning
• The world isnt behaving the way theory suggests
  it should, but
• it isnt our fault, so lets pass over this
  unfortunate problem in silence.
• For a small, but growing group of economists this
  is the opening gambit in an attempt to extend the
  tools of economics to the domain of political and
  political economic analysis.

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What I want to do in this lecture

• Discuss the nature of the very real successes in
  the political economic analysis of trade policy
• Discuss two political economy problem problems
• The mystery of the missing protection and
• The normative political economy problem.

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What is an Endogenous Policy Model?

• Basic Idea Embed a simple model of political
  process in a well-specified model of the economy.
• Use the economic structure to identify citizen
  preferences and
• Use the political model to map the preferences
  into outcomes.
• These are essentially models of preference
  induced equilibrium.

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What Can You Do With An Endogenous Policy Model?

• Audit the logic of informal political economy
  analyses.
• Account for policy outcomes apparently
  inconsistent with best practice
• Provide a framework for positive and normative
  analysis.

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Endogenous tariff theory and policy preferences

• Derive the effect of a tariff via comparative
  static analysis for the small country case.
• In general a tariff lowers aggregate welfare
  however
• With heterogeneity of factor-ownership or tastes
  across households, there are distributional
  effects (e.g. Stolper-Samuelson theorem) and
• Tariff income is usually redistributed in a
  welfare neutral fashion.

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Endogenous tariff theory and a tariff referendum

• Now suppose that the tariff is chosen by
  referendum in which
• All households share the same preferences, and
  own 1 unit of labor, but own different quantities
  of capital
• Preferences are single-peaked over the tariff
  and
• Individuals are non-strategic in their voting
  behavior.

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Endogenous tariff theory and a tariff referendum

• Blacks theorem states if preferences are
  single-peaked over a one-dimensional issue, the
  most preferred point of the median voter cannot
  be defeated in a majority rule contest.
• Hotelling-Downs theorem provides a mechanism for
  picking this outcome in 2-party competition.
• Majority rule over a one-dimensional issue is an
  Arrovian democratic social welfare function.

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Endogenous tariff theory and a tariff referendum

• Mayers theorem states that in almost all cases
  the equilibrium policy will involve a non-zero
  tariff.
• NOTE
• The social welfare maximizing tariff is zero (by
  the small country assumption) but
• The democratically optimal tariff is nonzero.

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Successes and Failures

• Successes of endogenous tariff theory
• Clear formalization of the political economy
  problem
• Interesting cautionary tale
• The problem is non-trivial, i.e. the problem is
  not corruption here rather
• The problem is an inconsistency between the
  democratically optimal and the welfare optimal
  trade policy.
• There are, of course, ways to make free trade
  democratically optimal (i.e. redistribution of
  income), but
• We dont observe much of this and
• If redistribution is chosen democratically along
  with trade, the dimensionality goes up with ugly
  consequences.

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Successes and Failures

• Narrow Failures
• Additional theoretical effort on
  preference-induced equilibrium generates little
  additional content.
• Empirical work on the political economy of trade
  policy is only loosely connected to the models
• Broad Failures
• The Mystery of the Missing Protection
• These models are developed to explain bad policy,
  in this case protection but the essential fact
  about modern trade policy is how liberal it is,
  not how protectionist.
• Utter lack of compelling normative analysis.

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A quick word on narrow failures

• Political economy applications with more
  empirical success
• Local public economicsschool finance
• Macro political economy
• Better match between theory and data than in the
  trade case
• Actual referenda on trade extremely rare and
• Data and models on lobbying severely
  underdeveloped

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The Mystery of Missing Protection

• Over the last three decades there have been
  hundreds of papers and books on the the political
  economy of trade.
• The overwhelming majority have focussed on the
  political economy of protection or the failure of
  liberalization.
• This might lead us to suspect that protection is
  the most significant phenomenon facing us
• This is simply not the case.

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The Mystery of Missing Protection

• At least for industrial countries the single most
  striking fact of the last half century is the
  liberality of trade.
• The average tariff has reached a historical low
  and shows no likelihood of increasing.
• Statutory tariffs are locked in by GATT/WTO
  commitments
• Standard data cant show anything but
  liberalization
• Consider the US data

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The Mystery of Missing Protection
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The Mystery of Missing Protection

• At least for industrial countries the single most
  striking fact of the last half century is the
  liberality of trade.
• The average tariff has reached a historical low
  and shows no likelihood of increasing.
• Statutory tariffs are locked in by GATT/WTO
  commitments
• Standard data cant show anything but
  liberalization
• Consider the US data
• Administered protection provides increase at the
  margin
• Empirical work finds it very hard to tap this
  protection.
• This is small potatoes compared to the magnitude
  of liberalization

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Explaining LiberalizationPermissive Factors

• Income tax (16th Ammendment, 1913)
• RTAA 1934 Delegation from Legislature to
  Executive
• RTAA 1934 Administered v. Legislated Protection
• Based on Lowis Arenas Typology
• Legislated protection as distributive politics
  (private good)
• Administered protection as regulatory politics
  (public good)
• Shift in definition of arena induces shift in
  lobbying consistent with a lower equilibrium
  tariff.
• GATT/WTO Role of international commitments in
  policy lock-in

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Explaining LiberalizationFundamental Accounts

• Congressional learning Congress learned that
  the Hawley-Smoot Tariff caused the Great
  Depression.
• Two Problems
• No evidence of link between tariff and depression
• Timing of changed voting behavior inconsistent
• Changed economic fundamentals
• Link between factor mobility and politics of
  protection
• Changed factor mobility changes politics

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Explaining LiberalizationFundamental Accounts

• Changed political fundamentals
• Based on Key/Burnham theory of party systems
• Transition from System of 96 to New Deal
  involved disappearance of trade as a political
  issue
• Hall/Kao/Nelson (1998) argue that female
  franchise is consistent with both the collapse of
  the System of 96 and the disappearance of trade
  as a political issue.

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Explaining LiberalizationNo General Theory of
the Specific

• External Events
• Both changed fundamentals stories are of this
  sort
• Macroeconomic Crisis
• Leadership
• Harberger A Handful of Heroes
• Institutional change and the need for leadership
• The unprotecting of liberalization in the US
• End of the cold war
• End of traditional Ways Means
• Democrat v. Republican presidents
• Carter v. Reagan
• Clinton v. Bush
• Pro-Business should not be confused for
  Pro-market.
• What do leaders do?

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Explaining LiberalizationNo General Theory of
the Specific

• Learning
• Elite learning interesting problem
• Clear transition in elite opinion on trade
• No one has studied how this occurred
• Public learning
• Hall/Nelson (2002) show strong evidence of
  footloose public preferences on NAFTA and
• Provide a simple theory based on information
  cascades.
• This approach provides leverage for informed
  policy advice (though it also supports all kinds
  of propaganda).

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The Normative Political Economy Problem

• This is where political-economy research on trade
  policy begins Tullock and Krueger on
  rent-seeking Bhagwati on DUP
• As political-economic welfare analysis, this is
  misguided
• All lack a coherent welfare analysis of political
  activity
• Some political activity is clearly corrupt and
  undermines democratic legitimacy, but much has
  the positive value of participation.
• A closely related problem is normative analysis
  without a politically plausible alternative
• Consider the case of antidumping

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Back to Blinder

• Do economists really have no impact at all?
• Is it just interests? (this is the implication of
  Blinders law and the fundamental basis of
  Chicago political-economy).
• Blinder doesnt think so, neither does Becker,
  neither does Paul Krugman.
• The rest of us shouldnt either
• So what should we be doing?

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Back to Blinder

• More Blinders, Beckers, and Krugmans
• We need to be better engaged, explaining to real
  people, in language they can understand, why we
  believe that markets work.
• Expecting most people to think like professional
  economists is just a mistake.
• In my belief this extends to the structure and
  content of economics education at the principles
  level.

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Back to Blinder

• More honesty
• Admit that getting the gains from trade means
  adjustment which is costly and falls
  asymmetrically.
• If we are going to argue for liberalization we
  need either to argue for income transfers that
  support general gains and general political
  support or explain why we dont.
• Potential gains from trade arguments convince no
  one.
• More real political realism (not cheap cynicism)
• This means more and better political economy
• Which is where we started.