International Trade Theory and Policy Political Economy and International Trade

Chapter 10 Political Economy and International Trade Trade policy analysis is often conducted from the implicit vantage point of a benevolent dictator poised to choose the best policies for a country . However , decisions about which policies to apply are rarely made by a sovereign but instead are usually made via a democratic political process . Whenever we consider how the political process affects economic decision making , we call it political economy . The political economy aspects of trade are studied in this chapter . Most important is how the concentrations and dispersion of the costs and of trade policies tend to affect the decisions . URL books 523

10 . Chapter Overview LEARNING OBJECTIVE . Understand the motivations of a government in determining the policies that affect international trade . In most economic models , it is assumed that consumers maximize utility , firms maximize profit , and governments maximize national welfare . Although one can reasonably object to any one of these assumptions , perhaps the one least likely to hold is the assumption about a government behavior . Governments are rarely comprised of a solitary decision maker whose primary interest is the maximum of the nations constituents . Such a person , if he or she existed , could be labeled a benevolent Although historically some nations have been ruled almost by dictators , most dictators could hardly be called benevolent . The assumption that governments behave as if they had a benevolent dictator may have developed out of the philosophical traditions of utilitarianism . Utilitarianism , whose roots date to writings by Jeremy in the early , suggests that the objective of society should be to produce the greatest good for the greatest number . The objective of individuals is to obtain utility ( happiness , satisfaction , being , In economic analysis , we presume that individuals obtain all their utility from the consumption of goods and services , and this motivates the behavioral assumption that consumers maximize utility . The assumption that maximize profit is based on the same logic . Profit affects the income of firm owners . The greater one income , the greater will be one consumption possibilities and thus the higher will be one utility . Thus profit is merely a means to an end , the end being greater utility . It is not unreasonable , then , that if the objective of individuals and is maximum utility , then the objective of a government might be to maximize utility for everyone . But even if governments do not seek to maximize national welfare , it is still a valid exercise to investigate which policies would lead to maximum utility . Indeed , most of the analysis of trade policies does just this . Policy analysis the differential welfare effects of various policies and points out which of these will lead to the greatest overall utility or welfare . If one prescribes policies that also maximize national welfare , then one is making the value judgment that maximum national welfare is the appropriate goal for a government . If one presumes that governments URL books . 524

do indeed seek to maximize national welfare , then the task is to explain why the choices that governments make are explainable as the outcome of a national welfare maximization exercise . An alternative approach is to consider other reasons for the choices made by governments . This is essentially the task of political economy models . Political economy is a term that the interaction between the economic system and the political system . Many traditional models of the economy make simplifying assumptions about the behavior of governments . Keeping the model simple is one reason for the assumption of a benevolent dictator . Political economy models attempt to explain more carefully the process of governments . Today , most governments can be best described as representative democracies . This means that government officials are elected , through some voting procedure , to represent the interests of their constituents in making government decisions . The key issue in political economy and trade models is to explain how political features in democratic economies affect the choice of a trade policy . Among the key questions are the following Why do countries choose protection so often , especially given that economists have been emphasizing the advantages of free trade for three hundred or more years ?

In other words , if free trade is as good as economists say , then why do nations choose to protect ?

In discussions of trade policies , why is so much attention seemingly given to a policy effects on businesses or and so little attention given to the effects on consumers ?

Why do political discussions , even today , have a mercantilist spirit , wherein exports are hailed as , while imports are treated as harmful to the country ?

Economic often seem to assume that governments will choose policies to maximize the nation welfare . most government policies arise from complex decision making in a representative democracy . is a term used to describe the process of government decisions on economic policies . I . Jeopardy Questions . As in the popular television game show , you are given an answer to a question and you must respond with the question . For example , if the answer is a tax on imports , then the correct question is What is a tariff ?

URL books 525 . The name for the philosophical ideas suggesting that the purpose of society is to create the greatest good for the greatest number . The name for a solitary leader of a country whose intention is to maximize the of the nation constituents . The term used to describe the interaction of the political system arid the economic system . The term used to describe a contention that exports are good and imports are bad for a co . I . Some Features of a Democratic Society LEARNING OBJECTIVE . Understand how and why lobbying is used to the policy decisions of a government . A government represents the interests of its citizens . As Abraham Lincoln said in the Gettysburg Address , a democratic government is meant to be by the people and the people . Thus , in URL books 526

a representative democracy , government officials are entrusted to take actions that are in the interests of their constituents . Periodic elections allow citizens to vote for individuals they believe will best fulfill their interests . If elected officials do not fulfill the interests of their constituents , then those constituents eventually have a chance to vote for someone else . Thus , if elected officials are perceived as good representatives of their constituents interests , they are likely to be reelected . If they follow their own individual agenda , and if that agenda does not match the general interests of their constituents , then they may lose a subsequent bid for reelection . Citizens in democratic societies are traditionally granted the right to free speech . It is generally accepted that people should be allowed to voice their opinions about anything in front of others . In particular , people should be free to voice their opinions about government policies and actions without fear of reprisal . Criticisms of , as well as recommendations for , government policy actions must be allowed if a truly representative government is to operate effectively . The Nature of Lobbying We can define lobbying as the activity wherein individual citizens voice their opinions to the government about government policy actions . It is essentially an information transmission process . By writing letters and speaking with officials , individuals inform the government about their preferences for various policy options under consideration . We can distinguish two types of lobbying casual lobbying and professional lobbying . Casual lobbying occurs when a person uses his leisure time to petition or inform government officials of his point of view . Examples of casual lobbying are when people express their opinions at a town meeting or when they write letters to their Congress members . In these cases , there is no opportunity cost for the economy in terms of lost output , although there is a cost to the individual because of the loss of leisure time . Casual lobbying , then , poses few economic costs except to the individual engaging in the activity . Professional lobbying occurs when an individual or company is hired by someone to advocate a point of View before the government . An example is a law hired by the steel industry to help win an antidumping petition . In this case , the law firm will present arguments to government to try to affect a policy outcome . The law firm fee will come from the extra revenue expected by the steel industry if it wins the petition . Since , in this case , the law is paid to provide lobbying services , there is an opportunity cost represented by the output that could have been produced had the lawyers engaged in an URL books 527

alternative productive activity . When lawyers spend time lobbying , they cant spend time writing software programs , designing buildings , building refrigerators , and so on . This poses the question , What would lawyers do if they weren lawyering ?

The lawyers actions with this type of lobbying are essentially redistributive in nature , since the lawyers incomes will derive from the losses that will accrue to others in the event that the lobbying effort is successful . If the lobbying effort is not successful , the lawyers will still be paid , only this time the losses will accrue to the that hired the lawyers . For this reason , lobbying is often called rent the fees paid to the lobbyists come from a pool of funds ( rents ) that arise when the lobbying activity is successful . Another name given to professional lobbying in the economics literature is a directly unproductive ( DUP ) activity . Lobbying is necessary for the democratic system to work . Somehow information about preferences and desires must be transmitted from citizens to the government officials who make policy decisions . Since everyone is free to petition the government , lobbying is the way in which government can learn about the desires of their constituents . Those who care most about an issue will be more likely to voice their opinions . The extent of the lobbying efforts may also inform the government about the intensity of the preferences as well . in a representative democracy , citizens have the right to both elect their representatives and discuss policy options with their elected representatives . Lobbying is the process of providing information to elected officials to the policies that are implemented . A directly unproductive ( DUP ) activity is any action that by itself does not directly produce goods and services consumed by a country consumers . I . Jeopardy Questions . As in the popular television game show , you are given an answer to a question and you must respond with the question . For example , if the answer is a tax on imports , then the correct question is What is a tariff ?

The term for a democratic system in which government agents are entrusted to take actions in the best interests of the voting public . The term used to describe activities to petition the government for particular policies . URL books 528 . This type of lobbying does not incur an opportunity cost of forgone production . This type of lobbying does incur an opportunity cost of forgone production . The term used to describe the extra revenues earned because of successful lobbying efforts . The term describing the purposeful effort to direct money away from others and toward oneself . Economic activities by the acronym DUP . 10 . The Economic Effects of Protection An Example LEARNING OBJECTIVE Depict numerical values for the welfare effects of a tariff by a small country . Consider the market for blue jeans in a small importing country , depicted in Figure A Market for Blue Jeans . Suppose a sudden increase in the world supply of jeans causes the world market price to fall from 35 to 30 . The price decrease causes an increase in domestic demand from nine to ten million pairs of jeans , a decrease in domestic supply from eight to six million pairs , and an increase in imports from one to four million . Figure A ' Blur ( URL books 529

I , Because of these market changes , suppose that the industry uses its trade union to organize a petition to the government for temporary protection . Let imagine that the industry calls for a tariff so as to reverse the effects of the import surge . Note that this type of action is allowable to World Trade Organization ( member countries under the escape clause or safeguards We can use the measures of producer surplus and consumer surplus to calculate the effects of a tariff . These effects are summarized in Table Welfare Effects ofan Tariff . The dollar values are calculated from the respective areas on the graph in Figure A Market for Blue Jeans . Table Welfare Effects of an Import Tariff on ( Value Consumer Surplus ( a ) million Producer Surplus a 35 million Govt . Revenue million National Welfare ( I ) million Notice that consumers lose more than the gains that accrue to the domestic producers and the government combined . This is why national welfare is shown to decrease by million . In order to assess the political of this potential policy , we will make some additional assumptions . In most markets , the number of individuals that makes up the demand side of the market is URL books 530

much larger than the number of that makes up the domestic industry . Suppose , then , that the consumers in this market are made up of millions of individual households , each of which purchases , at most , one pair of jeans . Suppose the domestic blue jeans industry is made up of separate firms . With quantities , prices , and the tariff rate , actual values for the changes in consumer producer surplus and government revenue can be determined . I . Suppose the supply and demand curves for bottles of Coke are given by , where is the price of Coke per bottle , is the quantity of Coke demand ( in millions of bottles ) and is the quantity of Coke supply ( in millions of bottles ) Suppose the free trade price of Coke is and that a tariff of is being considered by the government . Ifthe country is a small importer calculate the following . The value of the increase in producer surplus expected due to the tariff . The value of the decrease in consumer surplus expected due to the tariff . The value of the tariff revenue expected due to the tariff . The value of the change in national welfare expected due to the tariff . URL books 531

10 . The Consumers Lobbying Decision LEARNING OBJECTIVE . Learn the lobbying implications of the widely dispersed costs of protection to ' If the tariff is implemented , it will raise the price from 30 to 35 . Consumption will fall from ten million to nine million pairs of jeans . Because of our simplifying assumption of one household per pair of jeans , one million households will decide not to purchase jeans because of the higher price . They will use the 35 to buy something else they think is more valuable than jeans . The other nine million households will pay the extra . This means that , at most , a household has to pay an extra for the same pair of jeans . In terms of consumer surplus loss , nine million consumers lose each for a total of 45 million ( area a ) while the remaining one million lose a total of million ( area at ) books 532

We can now ask whether a household would be willing to lobby the government to oppose the blue jeans tariff because of the extra cost they would incur . The likely answer is no . For most households , such a small price increase would hardly be noticed . Most consumers do not purchase blue jeans frequently . Also , blue jeans with different styles and brand names typically differ considerably in price . Consumers , who rarely keep track of events affecting particular markets , are unlikely to know that a tariff has even been implemented on the product considered or discussed . If a person did know of an impending tariff , then presumably is the maximum a household would be willing to pay toward a lobbying effort , since that is the most one can gain if a tariff is prevented . One might argue that if even a fraction of the could be collected from some portion of the ten million consumer households , millions of dollars could be raised to contribute to an opposition lobbying effort . However , collecting small contributions from such a large group would be very difficult to do effectively . Consider the problems one would face in spearheading a consumer lobbying effort to oppose the blue jeans tariff in this example . A seemingly reasonable plan would be to collect a small amount of money from each household hurt by the tariff and use those funds to pay for a professional lobbying campaign directed at the key decision makers . The first problem faced is how to identify which households are likely to be affected by the tariff . Perhaps many of these households purchased blue jeans last year , but many others may be new to the market in the upcoming year . Finding the right people to solicit money from would be a difficult task . Even if you could identify them , you would have to a way to persuade them that they ought to contribute . Time spent talking to each household has an opportunity cost to the household member since that person could be doing something else . Suppose that a person values her time at the hourly wage rate that she earns at her job . If she makes 20 per hour , then you have less than fifteen minutes to convince her to contribute to the lobbying effort since fifteen minutes is worth the you are trying to save for her . The point here is that even learning about the problem is costly for the household . For small savings , a lobbying group will have to convince its contributors very quickly . Suppose we knew the names and addresses of the ten million affected households . Perhaps we could send a letter to each of them with a stamped return envelope asking to return it with a or contribution to the lobbying effort . With this plan , even purchasing the stamps to mail the envelopes would cost . One would need to get over half of the households to send in each just to cover the cost of URL books 533

the mailing . Recipients of the letters will reasonably question the trustworthiness of the solicitation . Will the money really be put to good use ?

The chances of getting any more than a small return from this kind of solicitation is highly unlikely . If contributions can be collected , the lobbying group will face another problem that arises with large groups free . Free riding occurs when someone enjoys the of something without paying for it . The lobbying effort , if successful , will all blue jeans consumers regardless of whether they contributed to the lobbying campaign . In economic terms , we say that the lobbying effort is a public good because individual households can not be excluded from the of successful lobbying . One of the key problems with public good provision is that individuals may be inclined to free is , to obtain the benefit without having contributed to its provision . Those who do not contribute also get the added benefit of the full surplus if the lobbying campaign is successful . The main point of this discussion , though , is that despite the fact that million dollars will be lost to consumers of blue jeans if the tariff is implemented , it is very unlikely that this group will be able to form a lobbying campaign to oppose the tariff . Since each household will lose at most , it is extremely unlikely for any reasonable person to spend sufficient time to mount a successful lobbying campaign . Even if one person or group decided to spearhead the effort and collect contributions from others , the they would face would likely be insurmountable . In the end , government decision makers would probably hear very little in the way of opposition to a proposed tariff . Many of the arguments are discussed in detail in The Logic Action . One of the books key points is that large groups are much less effective than small groups in applying effective lobbying pressure on legislators . Although the loss of consumer surplus is the largest welfare effect of a tariff , because the number of consumers affected is also very large , the effect on each consumer is relatively small . Because a large number of consumers are affected to a small degree , it is to identify precisely which consumers are affected by the tariff . Because the cost of the tariff is low , most individual lobbying efforts to protest the tariff will cost the individual more than the cost of the tariff . URL books 534

Large groups are much less effective than small groups in applying effective lobbying pressure on legislators . Jeopardy Questions . As in the popular television game show , you are given an answer to a question and you must respond with the question . For example , if the answer is a tax on imports , then the correct question is What is a tariff ?

The term used to describe when a person receives a , especially a public good , without contributing a fair share to pay for it . Of concentrated or dispersed , this is how to describe the typical losses that accrue to consumers because of an import tariff . The amount of money lost by each consumer of coffee due to a tariff if 35 million is lost in consumer surplus in a market of seventy million consumers . Of small or large , this sized group is more likely to form an effective lobby . 10 . The Producers Lobbying Decision LEARNING OBJECTIVE . Learn the lobbying implications of the concentrated of protection to producer interests . On the producers side , let assume that there are separate , and equally sized , If a tariff is implemented , producers as a group would gain 35 million in producer surplus . That means each stands to gain million . Domestic producers would also supply two million additional pairs of jeans , and that would require expansion of the industry labor force . Clearly , the tariff would be beneficial to the owners and to industry workers . The potential to expand production , add workers , and increase profits by million per will provide a strong motivation to participate in a lobbying effort . In the case of the , however , organization of a lobbying effort will be much easier than the opposing effort by consumers . First of all , the million surplus accruing to each firm is pure gravy . Payments to workers and other factors are not a part of the million additional surplus thus it is money over and above the marginal costs of additional production . For this reason , profit received in this manner is often referred to as URL books 0797 ?

535 economic Since the rents are concentrated in a small number of firms , with million going to each , each will have a strong incentive to participate in a lobbying campaign . But who going to spearhead the effort ?

Organization of a lobbying campaign will probably be easier for than for consumers . First , the industry may have an industry association that maintains continual links with in state and federal governments . The workers in the industry might also belong to a trade union , which would also have interests in supporting a lobbying effort . Or a few of the industry leaders could take it upon themselves to begin the effort ( although that is assumed away in the example ) Second , as a smaller group , it is easy to identify the likely from the tariff and to solicit contributions . The lobbying group should easily be able to collect millions of dollars to support an extensive lobbying effort . A mere contribution of per would generate million that could be used to hire a professional lobbying team . Even if the chances of a successful outcome are small , it may still be practical for the to contribute to a lobbying effort . The return on that investment would be million if successful . Thats a percent rate of higher than any investment project that might be considered . Free riding would also be less likely to occur since with only to keep track of , contributors would probably learn who is not participating . Nonparticipation would establish a poor reputation for a firm and could have unpleasant consequences in its future industry association dealings . With a lobbying effort , it would not be to make decision makers aware that there is resounding support for the tariff within the industry community . Newspaper and television ads could be purchased to raise public awareness . Interested parties could be to the capitol to speak with key decision makers . In this way , the chances of obtaining the tariff may be increased substantially . The result applies in reverse to small groups . Small groups are much more effective than large groups in applying effective lobbying pressure on legislators . KEY Although the increase in producer surplus is a small welfare effect in the example , because the number of producers affected is relatively small , the effect of the tariff on each producer is relatively large . Because a small number of producers are affected to a sizeable degree , it is easy to identify who is positively affected by the tariff . URL books 536

Because the of the tariff is high , firm lobbying efforts to promote the tariff will likely be a worthwhile investment . Small groups are much more effective than large groups in applying effective lobbying pressure on legislators . Jeopardy Questions . As in the popular television game show , you are given an answer to a question and you must respond with the question . For example , if the answer is a tax on imports , then the correct question is What is a tariff ?

Of concentrated or dispersed , this is how to describe the typical that accrue to producers because of an import tariff . The amount of money gained by each producer of coffee due to a tariff if 20 million is gained in producer surplus in a market of twenty producing firms . The rate on a lobbying expense if that lobbying results in a tariff on coffee and nets the firm an additional in profit . Of consumer groups or producer groups , this group is more likely to form an effective lobby . URL books 537

10 . The Government Decision LEARNING OBJECTIVE . Learn how the lobbying and tariff revenue implications of a tariff affect the decision of the government . How the government decides whether to offer the tariff , and who decides , will depend on the procedural rules of the democratic country in question . The tariff might be determined as a part of an administered procedure , such as a safeguards action or an antidumping action . Or the tariff may be determined as a part of a bill to be voted on by the legislature and approved , or not , by the executive . Rather than speaking about a particular type of government action , however , we shall consider the motivations of the government more generically . The first thing the government may notice when being petitioned to consider raising the tariff is that government revenues will rise by million . Relative to many government budgets , this is a small amount , and so it may have very little on decision . However , it will help reduce a budget deficit or add to the monies available for spending on government programs . Thus it could have a small . In a democratic society , governments are called on to take actions that are in the interests of their constituents . If government , in this example , merely listen to their constituents , one thing should be obvious . The arguments of the industry seeking protection will surely resonate quite loudly , while the arguments of the consumers who should be opposed to the tariff will hardly even be heard . If a government official bases his or her decision solely on the loudness of the constituents voices , then URL books 538

clearly he or she would vote for the tariff . This is despite the fact that the overall cost of the tariff to consumers outweighs the to the industry and the government combined . Notice that the decision to favor the tariff need not be based on anything underhanded or illegal on the part of the industry lobbyists . Bribes need not be given to secure votes . Nor does the industry lobby need to provide false or misleading information . Indeed , the lobby group could provide accurate information and still win the support of the officials . Here why . It would be natural for the industry lobby group to emphasize a number of things . First , jobs would be saved ( or created ) as a result of the tariff . If a number can be attached , it will be . For example , suppose the industry supported jobs in the initial equilibrium , when eight million pairs of jeans were produced by the domestic industry . That averages to 320 jeans produced per worker . Thus , when the industry cuts production by two million units , it amounts to jobs . The lobby group could then frequently state the fact that the tariff will create jobs . Second , the lobby would emphasize how the tariff would restore the vitality of the industry . If a surge of imports contributed to the problem , then the lobby would undoubtedly blame foreign for taking jobs away from hardworking domestic citizens . Finally , the lobby would emphasize the positive government budget effects as a result of the tariff revenue . All of this information clearly would be quite true . If the lobby mentioned the higher prices that would result from the tariff , surely it would argue it is a small price to pay to save so many jobs . The lobby might even convince consumers of blue jeans that it is worth paying extra for jeans because it will save domestic jobs . After all , perhaps their own jobs will one day be in jeopardy due to imports . Plus , it is such a small price to pay at only extra , no one will even notice ! For a politician facing potential reelection , there is another reason to support the industry over the consumers , even with full information about the effects . Support of the industry will probably generate more future votes . Here why . First , since industry and a bigger stake in the outcome , they will be more likely to remember the politician support ( or lack of support ) on this issue at election time . Second , the politician can use his support for the industry in his political ads . Consider this political ad if he supports the industry I passed legislation that created over six thousand jobs ! Compare it with this URL books 539

truthful ad if he doesn support the industry By opposing protectionist legislation , I saved you five bucks on blue jeans ! Which one do you think sounds better ?

If representatives in a democracy base policy choices on the interests of their constituents and if industry lobbyists are more organized and in their demands than consumers , then governments will more likely choose policies like tariffs . Jeopardy Questions . As in the popular television game show , you are given an answer to a question and you must respond with the question . For example , if the answer is a tax on imports , then the correct question is What is a tariff ?

Of consumer voices or producer voices , these are more likely to be heard by in a representative democracy . Of consumer interests or producer interests , governments in representative democracies are more likely to implement policies favoring these . URL books 540

10 . The Lobbying Problem in a Democracy LEARNING OBJECTIVE Recognize some of the problems and pitfalls of policy choice in a representative democracy . There is a real problem with the lobbying process in democratic societies . Even though lobbying is a legitimate process of information transfer between constituents and government decision makers , it also produces some obvious disparities . Whenever policy actions generate concentrated and dispersed costs , the incentives and abilities to lobby are different across groups . Potential beneficiaries can often use the advantage of small group size and large potential to wield disproportionate on decision makers . Potential losers , whose numbers are large and whose expected costs per person are quite small , have almost no ability to lobby the government effectively . Thus , in a democratic society in which lobbying can decisions , decisions are likely to be biased in the favor of those policies that generate concentrated benefits and dispersed losses . Unfortunately , and perhaps coincidentally , most policy actions taken produce concentrated and dispersed losses . In the case of trade policies , most protectionist actions will cause concentrated to accrue to , whereas losses will be dispersed among millions of consumers . This means that protectionist policies are more likely to win political support , especially when lobbying can directly affect actions . Protectionism can easily occur even though the sum total effects of the policy may be negative . In many countries , a protectionist tendency is in the type of trade policy procedures that are available by law . Escape clause , and antidumping policies are examples of laws designed to protect and industries in particular situations . In evaluating these types of petitions in the United URL books 541

States , there is that effects on consumers be considered in reaching a decision . Clearly , these laws are designed to protect the concentrated interests of producing . It would not be surprising , and indeed it seems likely , that the concentrated interests of businesses affected the ways in which the laws were originally written . The absence of a consumer lobby would also explain why consumer effects are never considered in these actions . Democratic governments are more likely to choose policies that generate concentrated and dispersed losses , regardless of whether the sum total effects are positive or negative . I . Suppose a small country implements a tariff on chicken imports . In the table below indicate whether each group is a winner or loser and whether the effects on that group are concentrated or dispersed . TABLE POLITICAL ECONOMY EFFECTS OF A TARIFF of Group or Chicken Producers ( I or DiS ) Chicken Consumers . Suppose a small country implements an export subsidy on soybeans . In the table below indicate whether each group is a winner or loser and whether the effects on that group are concentrated or dispersed . POLITICAL ECONOMY EFFECTS OF AN EXPORT SUBSIDY ol ' I or DiS ) URL books 542