Download Political Economy of Trade Policy

Political Economy of
Trade Policy
Sergey A. Afontsev
Institute for World Economy and
International Relations,
Moscow, Russia
Welfare Paradoxes
of Trade Policy
 In the real world, all countries practice
trade barriers in one form or another
 Choice of trade policy instruments is
often ineffective
 Traditional models usually produce
unexpectedly low estimates of
protection-generated losses
WHY ?
Principles of Political Economy
Approach
Decisions of policy makers reflect their own
preferences and interests, rather than interest
of the general public. People engaged in
policy making, just like people engaged in
ordinary economic activities, are driven by
self-interest.
Principles of Political Economy
Approach
Politics can be viewed as a sort of market where
policy decisions are sold for political support and
resource transfers.
Trade policy is determined endogenously:
Economic agents enter political markets to
influence trade policy, which in turn affects their
position on economic markets and incentives for
influencing future trade policy.
Traditional (Ad Hoc) Political
Economy Hypotheses
 The pressure group hypothesis attaches the key role to the demand
for trade policies by lobbies representing sectoral interests
 The adding machine hypothesis stresses politicians’ desire to attract
voters by implementing trade policies
 The status quo hypothesis presents trade policy as an ‘insurance’
against shocks injuring national industries
 The revenue maximization hypothesis addresses the fact that trade
policies can generate additional budget revenues
 The foreign repercussions – trade negotiation hypothesis interprets
national trade policy decisions in the context of multidimensional
system of economic and political interactions with other countries
 The ideological preference hypothesis states that ideology of the
ruling party can exercise strong influence on trade policy decisions
Traditional (Ad Hoc) Political
Economy Hypotheses
The major problem with these hypotheses
is that they are formulated on a rather ad
hoc basis and do not rest on any coherent
theoretical model.
Moreover, they often produce equivocal
predictions about the impact of different
political economy factors on trade policies.
Grossman-Helpman Model
The first coherent theoretical model of
endogenous trade policy formation was put
forward by G.Grossman and E.Helpman (1994).
It focuses on the interaction between pressure
groups representing owners of factors specific to
particular industries and the government
interested in resource transfers from these
groups and welfare of the general public,
attaching different weights to each of them.
Grossman-Helpman Model
Predictions of Grossman-Helpman model
In industries represented by lobbies, protection
decreases with higher import penetration.
In unorganized industries, on the contrary,
relationship between import penetration and trade
protection is positive.
Deviations from free trade are more likely in
industries with low import demand and/or export
supply elasticities, as low elasticities are associated
with lower welfare losses for any given level of
protection.
Empirical Tests of Political
Economy Models
Ad Hoc Models
Trade protection tends to be higher in
 labor-intensive, low-skill, low-wage, stagnant industries;
 industries with high and/or raising import penetration;
 industries producing consumer rather than producer goods,
and more generally in industries producing goods for
unorganized buyers;
 industries with intensive intra-industry trade.
 Ideological preferences were also found to influence trade
policies.
Empirical Tests of Political
Economy Models
Grossman-Helpman Model
A number of empirical tests of Grossman-Helpman model
found support for its general logic, but at the same time
produced a quite unexpected result that the weight attached
by the government to the welfare of citizens is often higher
than the weight attached to resource transfers from pressure
groups or even exceeds it.
Empirical Tests of Political
Economy Models - Russia
Ad hoc models
Empirical tests of ad hoc political economy models provide
partial support for
 the pressure group hypothesis
 the status quo hypothesis
 the adding machine hypothesis
 the revenue maximization hypothesis
Empirical Tests of Political
Economy Models - Russia
The extended Grossman-Helpman model
In the extended Grossman-Helpman model where the
government is assumed to take special care of
budget income, tariff revenues have the highest rank
in government’s preference schedule, then follows
welfare of citizens, with lobbying contributions having
the lowest rank.
Empirical results strongly favor the extended
Grossman-Helpman model against alternative ad hoc
specifications.
Empirical Tests of Political
Economy Models - Russia
Empirical analysis in the framework of the
extended Grossman-Helpman model
shows that government’s desire to
increase budget revenues by suppressing
misclassification of higher-taxed goods for
lower-taxed ones induced import tariff
structure to be more uniform in 2002 than
it would have been otherwise.
Towards More Effective
Trade Policy
In addressing the question of welfareimproving policy reform, political economy
literature concentrates on forces behind
distortive trade policies and opportunities to
limit their influence.
Towards More Effective
Trade Policy
Major factors favoring less distortive policies
 emergence of new political market actors with a
policy demand for free trade;
 internal policy commitments (tariff unification,
simplification of tariff structure) and institutional
mechanisms;
 external obligations of a country concerning trade
policy (made in the context of the WTO
negotiations, regional agreements, etc.).
General Assessment of the
Political Economy Approach
Though political economy models have still
not reached the degree of theoretical and
empirical sophistication characteristic of
traditional trade theory models, they
provide useful insights into real-world trade
policy decisions and mechanisms to
improve their efficiency.