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Political economy of trade liberalisation: multilateral, bilateral and unilateral. Richard E. Baldwin Professor of International Economics Graduate Institute, Geneva. Political economy of trade liberalisation. 3 mechanisms: MTN, RTA, Unilateral.

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Political economy of trade liberalisation multilateral bilateral and unilateral

Political economy of trade liberalisation: multilateral, bilateral and unilateral

Richard E. Baldwin

Professor of International Economics

Graduate Institute, Geneva


Political economy of trade liberalisation
Political economy of trade bilateral and unilateralliberalisation

  • 3 mechanisms: MTN, RTA, Unilateral.

  • Key logic: Liberalisation begets liberalisation.


Political economy
Political Economy bilateral and unilateral

  • Status quo tariff.

  • Tariff balances supply & demand for protection.

  • Supply = marginal cost curve (marginal welfare damage).

  • Demand = marginal utility curve (marginal benefit to special interests).


Protection demand benefit to domestic special interests import competitors
Protection demand bilateral and unilateral= benefit to domestic special interests (import competitors)

euros

S

Sdom

euros

Protection demand

P’

a

P

P’

a

P

T

T’

Pw

Ddom

T

T’

T

quantity


Protection supply damage to domestic welfare
Protection supply bilateral and unilateral= damage to domestic welfare

euros

S

euros

b

d

P’

c

Naïve opt’l tariff

a

Protection Supply

P

T’

e

f

Pw

g

Pw’

D

T

quantity

T’


Static political economy
Static Political Economy bilateral and unilateral

euros

Protection Supply (unil.)

Protection demand

T

T

  • Summary

  • Unilaterally politically optimal tariff balances supply & demand for protection.

    • Supply = marginal cost curve (marginal welfare damage).

    • Demand = marginal utility curve (marginal benefit to special interests).


Political economy of trade liberalisation1
Political economy of trade bilateral and unilateralliberalisation

  • 3 mechanisms: MTN, RTA, Unilateral.

  • Key logic: Liberalisation begets liberalisation.

    • Liberalisation paradox (assuming endogenous policy choices):

      • Why would a govt find it politically optimal to remove a trade barrier that it previously found optimal to impose?

      • Must focus on the changed circumstance between the two decisions.


Mtns juggernaut demi cycle 1
MTNs: Juggernaut: demi-cycle 1 bilateral and unilateral

Starting from high 1930s tariffs …

Reciprocal trade talks re-align political economy forces inside each participating nation.

Example: MTN with & without reciprocity

MTN makes exporters into anti-protectionists.

One-off tariff cut become politically optimal in all nations that play reciprocally.

Gov’t find it politically optimal to remove a tariff they previous found politically optimal to impose.


Juggernaut demi cycle 1
Juggernaut: demi-cycle 1 bilateral and unilateral

Political equilibrium tariff balances S & D for protection.

Reciprocal trade talks re-align political economy forces inside each participating nation.

Protection supply shifts up.

Exporters become anti-protectionists.

euros

Protection Supply (recip.)

Protection Supply (unil.)

Protection demand

T

T

T’


Juggernaut demi cycle 2 restructuring of import competing industry export industry
Juggernaut: demi-cycle 2 bilateral and unilateral= restructuring of import competing industry & export industry

Politically optimal tariff depends of size of import competing sector.

Perfect comp., free entry no. of firms.

Number of import competing firms rise with tariff.

Basic “SR vs LR supply curve” economics

price

Short run Supply

Long run supply

P’

Po

Q

Q’[n’]

Qo[no]


Juggernaut demi cycle 2 restructuring of import competing industry export industry1
Juggernaut: demi-cycle 2 bilateral and unilateral= restructuring of import competing industry & export industry

Translate the free entry of firms in reponse to tariff

FE curve.

Same for export sector, but can’t plot.

Better foreign market access produces more exports and more exporting firms.

Tariff -> industry size

Tariff,T

FE

To

n

no


Fold supply demand into gfoc solution to govt pol ec opt zation
Fold supply & demand into GFOC (Solution to govt pol.ec. opt’zation).

euros

Tariff,T

NB: industry size => Tariff

Protection Supply (unil.)

GFOC (unil)

Protection demand (no)

To

T’

Protection demand (n’)

n

T

To

n’

T’

no

Intuitively: GFOC rises with n since politically optimal T rises with n. More to protect on margin.


Equilibrium tariffs and industry size
Equilibrium tariffs and industry size opt’zation).

.

Tariff -> industry size

Tariff,T

FE

Eo

To

GFOC (unil)

Tariff <- industry size

n

no


Juggernaut effect
Juggernaut effect opt’zation).

Start: unilaterally politically optimal tariff, To.

Reciprocal trade talks shift GFOC down.

Lower opt’l T for any given n (exporters are now in the game).

Recall shift in protection S&D diagram

Tariff,T

FE

GFOC (unil)

Eo

To

GFOC (recip)

n


Juggernaut effect1
Juggernaut effect opt’zation).

Immediate cut in MTN to T1

But this is not the end point.

Juggernaut rolls forward.

The lower tariffs alters the political economy landscape in every participating nation.

no falls to n1

Next MTN, Tariff is cut even more

Until new equilibrium T’.

Tariff,T

FE

GFOC (unil)

Eo

To

A

GFOC (recip)

T1

B

T’

E’

n

n1

no


Juggernaut effect2
Juggernaut effect opt’zation).

If all exports covered by the reciprocity, politically optimal tariff is zero.

Could take decades downsize the anti-trade forces (import competing firms) & build pro-trade forces (export firms).

Tariff,T

FE

GFOC (unil)

Eo

To

GFOC (MTN)

n

Efinal


Domino effect
Domino effect opt’zation).

Demi-cycle I: Idiosyncratic formation or deepening of a trade bloc re-aligns the political economy forces inside non-member nations.

Pro-membership political economy forces:

Non-member exporters: Trade diversion (fresh loses) & Trade Creation (lost opportunity).

Anti-membership political economy forces:

If deeper, may resist more.

If export sectors are politically larger than import competing sectors.

Demi-cycle II: if a new member joins, “forces for inclusion” get stronger in non-member nations.


Domino theory of regionalism
Domino theory of regionalism opt’zation).

  • Equilibrium block size

  • The nations ordered by intrinsic resistance to membership

    • RR curve

  • RR curve intersects the x-axis; assuming membership is viewed as having non-economic benefit in some nations

    • (these nations would join even if there were a mild political economic cost to doing so.)

dollars

RR

EE

E

o

number of bloc members


Domino theory of regionalism1
Domino theory of regionalism opt’zation).

  • Exporters located in non-members see more trade discrimination as bloc size rises.

    • (& lost-opportunity trade creation)

  • Rising EE curve.

dollars

RR

EE

E

o

number of bloc members


Domino theory of regionalism2
Domino theory of regionalism opt’zation).

  • Idiosyncratic shock moves EE to EE’

    • e.g. deeper integration among same members,

    • New nations “join the RTA game”

  • Move to E’, but may happen in step wise fashion as membership triggers more membership.


R t b unilateralism
R.T.B. unilateralism opt’zation).

Competition for out-sourcing jobs and investment drive nations to unilaterally cut tariffs.

Re-aligns political economy forces in DCs.

Unbundling of manufacturing process (i.e. fragmentation, vertical differentiation, slicing up value added chain) is key.

Destroys import substitution (scale, competition)

Makes export-led industrialisation more successful (foreign technology from MNC/buyers, ready market).

Finer division of labour may mean no import competing industry.

MNC role may imply imports mostly re-exported.

Importers are also exporters => no political economy conflict.


Ancillary effects
Ancillary effects opt’zation).

Intra-sectoral special interest politics.

Melitz model & reciprocal liberalisation: big firms win, small firms lose.

Add Mancur Olsen’s Asymmetry on political organisation & juggernaut effect works well on intra-industry trade.

“Losers lobby harder” (NIMBY syndrome).

Home market magnification effect.

Industry becomes more footloose, not less, as trade barriers fall.

Competition for industry becomes more fierce as tariffs fall globally. (Small preference margins can matter a lot).


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