Political economy problems in the analysis of trade policy
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“Political Economy Problems” In the Analysis of Trade Policy. Doug Nelson School of Economics. Blinder’s Law.

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“Political Economy Problems” In the Analysis of Trade Policy

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“Political Economy Problems”In the Analysis of Trade Policy

Doug Nelson

School of Economics

Blinder’s Law

  • Blinder’s 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.

  • Blinder’s main examples of the former are

    • Trade policy

    • Environmental policy.

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.

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”

On “Political Economy Problems”

  • For most economists, this is a conversational trick meaning

    • The world isn’t behaving the way theory suggests it should, but

    • it isn’t our fault, so let’s 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.

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.

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.

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.

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.

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.

Endogenous tariff theory and a tariff referendum

  • Black’s 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.

Endogenous tariff theory and a tariff referendum

  • Mayer’s 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.

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 don’t observe much of this; and

        • If redistribution is chosen democratically along with trade, the dimensionality goes up with ugly consequences.

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.

A quick word on narrow failures

  • Political economy applications with more empirical success

    • Local public economics—school 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

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.

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 can’t show anything but liberalization

      • Consider the US data

The Mystery of Missing Protection

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 can’t 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

Explaining Liberalization:Permissive Factors

  • Income tax (16th Ammendment, 1913)

  • RTAA 1934: Delegation from Legislature to Executive

  • RTAA 1934: Administered v. Legislated Protection

    • Based on Lowi’s “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

Explaining Liberalization:Fundamental 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

Explaining Liberalization:Fundamental 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.

Explaining Liberalization:No 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?

Explaining Liberalization:No 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).

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

Back to Blinder

  • Do economists really have no impact at all?

    • Is it just interests? (this is the implication of Blinder’s law and the fundamental basis of Chicago political-economy).

    • Blinder doesn’t think so, neither does Becker, neither does Paul Krugman.

    • The rest of us shouldn’t either

      So what should we be doing?

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.

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 don’t.

      • 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.

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