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SESSION IV THE POLITICAL ECONOMY OF REGIONALISM AND IMPLEMENTATION ISSUES. JAIME DE MELO. This version, March 2004. OUTLINE: SESSION IV. Elements of the political economy of protection. Are government commitments credible?.
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THE POLITICAL ECONOMY OF REGIONALISM AND IMPLEMENTATION ISSUES
JAIME DE MELO
This version, March 2004
Elements of the political economy of protection
Are government commitments credible?
Is regionalism likely to increase or diminish protection towards the outside world?
Application: The CET in the MERCOSUR
Regionalism as politics
Implementation issues : Rules of Origin
Application: Rules of Origin in NAFTA
Lobbying to get policy (more or less protection); type of protection (e.g. QRs)
Individual or group preferences:
factor income, cost of living, etc..
“Demand” for/against protection and type of protection
Choice of commercial policy
Politicians ’ preferences:
Level, type (QRs?) of protection
Institutional set up:
(executive vs. legislative; international obligations --WTO, RTA, WB)
“Supply” for/against protection and type of protection
BASIC QUESTIONS ON THE FRAMEWORK
Within the general framework:
1. Who are the lobbies and how do they work (box B)?
2. What is the institutional setting (box D)?
To make framework more operational in N-S RIA setting:
3. Are commitments more credible in an RIA?
4. Elements of demand and supply of protection
WHO ARE THE LOBBIES?
HOW DO LOBBIES WORK?
Public good characteristic of lobbying activity:
Public good: non rival (several consumers at a time) and non excludable (free riders cannot be excluded).
Ex: A tariff on shirt imports obtained by producer i benefits all national shirt producers = protection (as free trade and many other policies) has a public good nature
Lobbies face free-riding = incur monitoring costs
Monitoring costs are usually higher the larger the number of participants in the group = most efficient lobbies tend to be the less numerous ones = “tyranny of the many by the few”.
THE INSTITUTIONAL SET-UP
How are rules and laws decided and implemented?
“Checks and balances” limits on discretionary action?
= voting process, lobbies contributions, separation of power, law enforcement, etc...
= membership in WTO or in RTAs?
May benefit countries with weak institutions as an “external agency of restraint”, putting a lid on the amount of discretionary action in trade (and other) policies
Often policies that appear optimal ex-ante no longer are so ex-post = there is a problem of “time-consistency”
Time-consistency problem: Particularly relevant when decisions, once taken are costly to undo and the economy has rents to be fought over= LDCs
Ex.: excessive taxation of crops with high sunk costs:
Growers of tree crops (eg coffee) consider the use of fertilizers as sunk costs.
government has incentive to cheat: announce that taxes will be low, to induce producers to use fertilizers, that increase their profits and thus the tax base, … and then keep taxes high.
But: growers know from previous experience that government will cheat no fertilizers applied tax base shrinks and everybody is worse off.
So are trade policies credible or do governments have incentives (and leeway) to renege its promises?
Will N-S RIAs bring credibility to Southern countries?
….but is that sufficient if the Northern partner does not have that much interest in the Southern partner?
…and is it a diversion of scarce human capital for more negotiations?
Do RIAs change the balance of incentives and forces for external liberalism since the gains from an RIA depend on a genuine liberal external policy stance?
Compare first pressures under FTA and under CU
Regionalism and protection towards the outside world : Protectionist pressures in FTAs
Regionalism and protection towards the outside world : Protectionist pressures in FTAs (end)
Regionalism and protection towards the outside world : Protectionist pressures in Customs Unions (I)
Regionalism and protection towards the outside world : Protectionist pressures in Customs Unions (II)
CUs require the creation of supranational institutions. Are these going to increase or decrease protectionist pressures?
● Suppose that tariffs are strategic substitutes in the strategic interactions among blocs (if one blocs increases its tariff, then it is optimal for the other bloc to lower its tariffs ---as quantities in a Cournot game). → Pays to delegate and let the more aggressive member negotiate (but the opposite if tariffs are strategic complements).
► Not clear whether delegation leads to higher or lower tariffs in a CU
► Moreover, since negotiation is a continuous process (repeated game), probably a more aggressive leader will be able to extract better terms because of more credible threats
Regionalism and protection towards the outside world : Protectionist pressures in Customs Unions (III)
Typically (like the EU), a disproportionate influence is given to countries in areas in which they have a vital interest (i.e. to producer interests). So if comparative advantage is at work, over time the powerful sectors should be those that are efficient, thereby reducing protectionist pressures.
…But biases towards protectionism still there
► More layers of bureaucracy shift the influence away from voters towards producers.
► with costs of protection more thinly spread and benefits concentrated, bias towards producers and protection.
Regionalism and protection towards the outside world : Protectionist pressures in Customs Unions (end)
---two institutional failures
► restaurant bill problem (bigger bill when split evenly). Suppose benefit of a policy is proportional to its share in CU output, while costs are proportional to its share in GDP (a tariff which benefits producers at the expense of consumers has this characteristic). Countries around the negotiating table will each press for protection for goods where their share is higher than their GDP share. →All measures are added even though individually each country would have preferred no change.
►Universalism: benefits go to one country (say there are three countries each producing a type of steel: spoils go to the country that gets it, while costs are borne by all. The worst outcome is if protection passes but not for the type of steel you produce…so you back the protectionist measure.
Lobbying activities in RIAs
Examples: Citrus growers in US oppposed FTAA and got 15 years to adjust to NAFTA (among most heavily protected sectors…..)
UEMOA CET in 1998: 5% on interm., 10% on capital goods, 20% on consumer goods.
…debate led to cement being declared a consumer good!!!
Problem for gv’ts : TC hurts the most powerful lobbyists usually in import-competing activities.
Brazil wanted free trade in IT for MERCOSUR, but was a holdout on the nearly global IT Agreement of 1996.
see the following model (due to P. Krishna) where trade policy in a three-country world is entirely determined by profits
Lobbies bias RIAs towards Trade Diversion (TD)
Take two countries where oligopolists (making a positive profit) play Cournot. Then producers in A and B might well support an FTA because the gain they would make in each other’s country (notably at the expense of producers in C) would exceed the losses they would make via reduction in market share to firms in partner country
…firms likely to support a TD FTA!!!
What about incentives for firms to participate in a MTL after the FTA is formed? Most unlikely as the MTL will be essentially giving market share, and hence profits to firms in C
FTAs can well be a stumbling bloc in the road to reaching multilateral free trade!!!
RIAs: A new environment for lobbying?
Preference dilution effect. One view (see MP chapter 6 is that an RIA has a preference dilution effect because there is more opposition to overcome, more of a free-rider problem, more representatives to influence)
Assumption here is that fragmented lobbies face a unified CU government. But what about the opposite?
See the discussion in SW pp. 92-3 and the discussion about the growth of lobbying 300 in 1970 to 3000 in 1990) activity in Brussels.
In conclusion much depends on what type of institutions are adopted.
With its highly non-uniform Common External Tariff—with numerous exceptions—Mercosur is an ideal case study of the role of pressure groups in RIAs
It took several years to negotiate Mercosur’s CET, culminating in the December 1994 Ouro Preto Protocol. Each member was allowed an exceptions list and the initial CET applied only to about 75% of the universe of 9,119 tariff lines (table). Left out were capital goods, computer and telecommunication equipment, and automobiles and sugar.
Convergence to the CET should be achieved for most goods by 2006; there is no agreement on convergence dates for sugar and automobiles. The Ouro Preto Protocol also established a list of deviations from intra-Mercosur free trade. These were planned to disappear by 2000.
Olarreaga and Soloaga tried to explain variations and deviations from the CET across 27 industries, using measures of political and interest group activity such as wages, industrial concentration indices, labor/capital ratios, import penetration, intra-industry. Main conclusions:
Sectors where significant trade creation is likely tend to be exempted from internal free trade. Internal free trade is also resisted more successfully by sectors with high employment shares. This reflects government desires to avoid large-scale labor adjustments, and the voting strength and trade union presence of large sectors. High third-country import penetration, which puts competitive pressure on domestic firms, also leads to high protection.
Political considerations explain 58% of the variation in the CET across industries. The negotiated CET in any sector correlates with the share of capital remuneration in value added in that sector and the share of sector-specific capital in total inputs. If labor is fairly mobile and new firm entry difficult, it is existing capital that receives most of the benefits of protection. They also found a positive correlation with industry concentration: more concentrated industries find it easier to organize lobbying efforts, making them more effective lobbyists.
· The CET in a sector mainly reflects the preferences of the member country that has the greatest production in that sector. Thus, Brazil’s preferences are the main determinants of the structure of the CET, as it represents at least 70% of Mercosur production in each of the 27 sectors considered.
(See WB chp. 1 SW chp. 7)
An RIA can reduce frictions along several dimensions
Regional integration can reduce frictions along several dimensions
RoO are necessary to prevent trade deflection (i.e. importing from the low tariff partner in an FTA)
Do you need RoO in a CU? In principle no, but then ALL of trade policy should be common (e.g. in the EU it took 30 years to get there since Article 115 of Rome Treaty allowed contries to keep their NTBs at national level notably in connection with the MFA RoO were necessary)
But RoO do not prevent indirect trade deflection (i.e. exporting protection as the low tariff partner imports all its consumption needs from ROW while it exports all its inefficient production to the high tariff partner)
RoO occupy 81 pages in EU’s agreement with Poland and 200 pages in NAFTA
Also a political economy issue as in typical N-S FTA, because it is the Northern country partner that determines the rules (see NAFTA case study below)
NAFTA’s RoO for catsup (S-W: Box 3.1) .
To Chile’s dismay, the tomato catsup rules changed when CUSFTA evolved into NAFTA. Under CUSFTA, catsup processed out of imported tomato paste qualified for duty-free treatment in internal trade. Under NAFTA rules the tomato paste itself must be produced within a NAFTA member in order for the catsup to qualify for free entry. In 1992, Chile was the leading foreign supplier of tomato paste to the United States, and the US-produced catsup enjoyed free entry under CUSFTA. Mexico and Chile together accounted for over 80% of US tomato paste imports in roughly equal quantities. Under NAFTA, catsup made out of Chilean paste could no longer circulate duty-free, Chile’s share dropped to 5%, with Mexico taking the other 75% -
Dem. Rep. Congo
Viva la pasta!!!
See variety of criteria used by PANEURO and NAFTA in next slide!
See definition below in NAFTA case study
ri=1 (not restrictive)
RoO: 0 1
K= imported inputs from ROW
R() = Restricted costs
Economics of RoO (I)
This slide explains following figure 2 (from Krishna paper)
(assuming that tariffs are levied on the price which equals domestic cost)
This slide explains following figure 2 (from Krishna paper)
Figure 2: Demand, Price and Cost in and FTA
Preferences & utilization rates under NAFTA.
3 main types of RoO in NAFTA (Estevadeordal, 2000).
Estevadeordal’s (2000) observation rule:
y = 1 if y ≤ CI
y = 2 if CI < y* ≤ CS
y = 3 if CS < y* ≤ CS and RVC
y = 4 if CS and RVC < y* ≤ CH
y = 5 if CH < y* ≤ CH and RVC
y = 6 if CH and RVC < y* ≤ CC
y = 7 if CC < y* ≤ CC and TECH
y* :latent level of restrictiveness of RoO (as opposed to observed level of restrictiveness);
Table 1 : RoO map, Preferences and Utilization Rates.
All data on RoO refers to percentage of tariff lines subject to the corresponding RoO.
Figure 1: cumulative distribution on total sample.
Tariff Preference Rates
Method of revealed preference as in Anson et al.(2004) but for 2001 data.
c=τ=6.16% for 2001 [vs. 6.11% for 2000]
with τ computed on 0%<ui<100%.
Compliance costs: administrative component, , and a distortionary component :
Assumption: administrative costs negligible for firms on their participation constraint (0%<ui<100%) when ri≤2 (values corresponding to CH).
Calculating the average preference margins for utilization rates close to 100% (say ui=95%) when ri≤2 gives an upper bound of the distortionary component,
or 2000 .
Summary: averagesfor 2000 :
Administrative cost estimate for 2001 less than for 2000 (both in absolute terms and in relative terms), as it falls from 45% to 42% of the total compliance costs. Learning!