In Many Sectors Protection Is Sufficiently High That The Net Costs Are Positive, Even Large (E

“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

US Average Tariff, 1821-1992

0

10

20

30

40

50

60

701821

1834

1847

1860

1873

1886

1899

1912

1925

1938

1951

1964

1977

1990

Year

Ave

rag

e Ta

riff

Total

Dutiable

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.