Political Economy of Trading
States
International Political Economy
Prof. Tyson Roberts
Lecture Goals
• Supply & demand model
• Winners & losers from protectionist policies
• Review and extension of factor & sector
models, including the role of institutions
Supply and Demand Model
Demand curve
• Three students
– 1 loves coffee, would pay $5 (or less) per cup
– 1 likes coffee, would pay $3 (or less) per cup
– 1 only drinks coffee if it’s cheap, would pay $1 (or less)
per cup
• Draw a demand curve
– How many cups would sell at $1? At $3? At $5?
– Put price on the vertical axis
– Put quantity on the horizontal axis
Demand curve
Price
5
3
D
1
1
2
3
Quantity
Supply Curve
• Three baristas
– 1 loves to make coffee, will make cup for $1 (or more)
– 1 likes to make coffee, will make cup for $3 (or more)
– 1 dislikes making coffee, will make for $5 (or more)
• Draw a supply curve
– How many cups will be made if price is $1? $3? $5?
– Price on vertical axis, quantity on horizontal axis
Supply curve
Price
S
5
3
D
1
1
2
3
Quantity
Equilibrium
• Assume all cups of coffee must be sold at the
same price
• How many cups of coffee will be bought and
sold, if everyone makes a decision they won’t
regret? Why?
• At what price will the coffee be sold? Why?
(if you know the answer, please ask your
neighbors if they need help)
Searching for equilibrium
Price
3 willing to make but
only 1 willing to buy,
price too high
S
5
3
D
1
1
2
3
Quantity
Searching for equilibrium
Price
S
5
3
D
1
1
2
3 willing to buy but only
1 willing to make, price
too low
3
Quantity
Finding equilibrium!
Price
S
5
2 willing to buy ,
2 willing to make,
price just right
EQUILIBRIUM
3
D
1
1
2
3
Quantity
Important for this week’s problem set:
• Note that 3 different baristas are selling coffee
• If all cups of coffee are equivalent, they are
analyzed using one supply curve & one
demand curve => all coffee has one price
• If the coffees are not substitutes, then each
needs its own supply & demand curves =>
each coffee has its own price
If there is no trade, Home market price and quantity is
determined by home supply and demand
PH
Source: Krugman, Obtsfeld, & Melitz (2012)
13
Trade enables lower prices and more quantity for consumers,
but lower prices (and market share) for comparative
disadvantage producers
PH
Source: Krugman, Obtsfeld, & Melitz (2012)
14
Trade protection (e.g., tariffs) increase prices and reduces
quantity for consumers (& producers who use the tariffed good),
but higher prices for comparative disadvantage producers
Source: Krugman, Obtsfeld, & Melitz (2012)
15
Society-based models:
Production-induced preferences & coalitions
(Mobile) Factor Model
• Factors mobile (in short run)
across industries
• Abundant factor benefits
from trade (higher returns)
• Scarce factor benefits from
protection (higher returns)
• Coalitions: Abundant factors
vs. scarce factors
Society-based models:
Production-induced preferences & coalitions
(Mobile) Factor Model
• Factors mobile (in short run)
across industries
• Abundant factor benefits
from trade (higher returns)
• Scarce factor benefits from
protection (higher returns)
• Coalitions: Abundant factors
vs. scarce factors
Sector/Specific Factors Model
• Factors immobile (in short
run) across industries
• Factors employed in abundant
factor-intensive industries
benefit from trade
• Factors employed in scarce
factor-intensive industries
benefit from protection
• Coalitions: Export-oriented vs.
import-competing industries
Organizing Interests:
The Collective Action Problem and
Trade Policy Demands
18
Collective action and trade protection:
Producers lobby governments more than consumers
• Consumers
– Benefit from trade (lower prices)
– Are diffused
– Marginal benefit of lower price for each good is small
• Producers of tradeables
– Benefit from
• Protection in own country (higher prices)
• No protection in foreign country (access to markets)
– Are concentrated
– Marginal benefit of protection/access is large
19
Political Institutions & Trade Policy
• Majoritarian vs. PR electoral system
– Majoritarian increases voice of minority interests,
e.g. sector-based interests (based on geography)
– PR increases voice of larger groups, e.g., class or
factor interests, or consumers
20
http://www.youtube.com/watch?v=Ro_isihnqM
21
Example of tariffs, WTO, & distribution
of benefits
• “We had a tire case in which they were flooding
us with cheap … Chinese tires. And we put a stop
to it and as a consequence saved jobs throughout
America. I have to say that Governor Romney
criticized me for being too tough in that tire case;
said this wouldn’t be good for American workers
and that it would be protectionist. But I tell you,
those workers don’t feel that way. They feel as if
they had finally an administration who was going
to take this issue seriously.” – Barack Obama,
October 22, 2012
22
Coalition for tire protection
(from podcast)
• Tire company union
• Tire company owners
• Does this comply with the factor or sector
model?
• Does this imply factors are mobile or
immobile?
23
• “It’s not like you were going to take a 52-yearold guy and send him to internet school.”
(Podcast)
24
China responds to US anti-dumping tire tariff
with anti-dumping chicken part tariff
(US wins on tires, chicken parts still in dispute)
25
Tire tariffs saved/created ~1200 jobs in
Ohio, etc. (swing states)
(Hufbauer & Lowry 2012)
26
Estimated cost to consumers in higher tire prices
estimated at $1.1 billion, or $900,000 per job
27
Another tariff case
(LaFaive 2002, Tran 2003)
• President Bush raised tariffs on steel in 2002
• Winners: Estimated 4,400 – 8,900 steel-sector
jobs in MI & PA (swing states)
• Losers: Estimated decrease in national income
$0.5-1.5 billion; lost jobs in steel-using industries
• WTO ruled against US, authorized EU to retaliate
with tariffs against FL oranges & Harley-Davidsons
(WI, PA, etc.)
• Bush reduced steel tariffs in 2003
28
29
Take-aways
• While trade has many obvious benefits,
protectionism is a common strategy for many
reasons
– Collective action challenges (more voice for
producers than consumers)
– Winners vs. losers among producers (factors or
sectors)
– Some countries may benefit in the long run from
targeted protection policies (Lecture 8)
30
The role of veto players
• Veto player must agree for policy to change
• More veto players => more policy stability
• Institutional veto points
– President, lower house (HR), upper house (Senate)
• Partisan veto players
– Parties in institutional veto points
– Parties in coalition governments
31
If there is one veto player, he can get his ideal policy choice
Democrats
Taxes on
the rich
 SQ
Republicans
Community College
spending

If there are two veto players, the possible policy outcomes
are narrowed – both must agree
Democrats
Taxes on
the rich
 SQ

Joint gains
Republicans

Community College
spending
If there are three veto players, the possible policy
outcomes are narrowed further still – all must agree
Democrats in
Senate
Taxes on
the rich
 SQ
Republicans

President


Joint gains
Community College
spending
Consumption-induced preferences in
Ricardo-Viner
• “Real” income = Nominal income (wage,
profit, rent) ÷ Cost of consumption
• Trade reduces prices of scarce factor-intensive
goods (imports cheaper than domestic) but
not abundant-factor intensive goods
• If labor is mobile, net gain/loss depends on
wage effect and consumption effect
“Ratio of efficiency to redistribution
gains” (Rodrik pp. 57-58)
• Effects of trade:
– Increased efficiency for national economy
• Move to comparative advantage => gains at national
level
– Redistribution of income
• Comparative advantage factors/sectors win
• Disadvantage factors/sectors lose
• In US: capital owners & high tech innovators win, lowskilled workers (and their employers) lose
• In China: low-skilled workers (and their employers) win
36
“Ratio of efficiency to redistribution
gains” (Rodrik pp. 57-58)
• In China, pre-market reforms, very large
efficiency gains from trade
– (Almost) everyone wins a lot from free trade
• In US, most efficiency gains from free trade have
already been achieved
– Everyone gains a little from more free trade (slightly
lower prices)
– Some gain a lot from free trade (international
investors, high tech innovators, etc.)
– Some may lose a lot (long-term unemployment)
37
“Blue Collar Blues”
• Robert Lawrence (2008):
– Rich have become much richer (capital)
– But blue collar has not become much poorer
relative to middle class (low vs. high skilled labor)
since trade with China. Why? Per Lawrence:
1. Many low-skill intensive goods no longer
produced in US (now imported)
2. US production processes are less labor intensive
than China’s
Data challenges
• Economist article:
– Limited fine-grained wage data make conclusions
difficult
• Elsby, Hobijn, Sahin (2013):
– Self-employed are often excluded from wage
statistics
– When self-employed are included (at market wage
rates), labor share of income is higher than
previously thought
54
Composition of nonfarm business
sector income
52
Self-employment share
Payroll share
Published
Replicated
50
1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
Source: Bureau of Labor Statistics, Bureau of Economic Analysis, and authors' calculations
Figure 2. Composition of nonfarm business sector income.
Percent
Quarterly observations; share of Gross Value Added of NFB sector
100
90
Profits
80
Taxes
70
Labor compensation
60
Rent, Interest
50
40
Self-employed income
Profits
Rental, interest, and depreciation
Taxes
Proprietors' income w/o CCA and IVA
Compensation
Labor share - published
30
1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
Source: Bureau of Economic Analysis, and authors' calculations
By all measures, labor share of income in US fell
after 1980 (when China entered world market)
37
and again after 2000 (increased offshoring, etc.)
Elsby, Hobijn, and Șahin
Figure 3. Alternative measures of labor share based on four estimates of self-employment labor income.
Percent
68
66
64
62
60
Published - "Labor basis"
58
"Economy-wide basis"
MFP - "Asset basis"
56
1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
Source: Bureau of Labor Statistics, Bureau of Economic Analysis, and authors' calculations
Figure 4. Nonfarm business labor share split up by income fractile.
Percent
0.56
0.2
Wages dropped
heavily in manufacturing, where0.1equipment
0.54
costs didn’t0.52fall. Suggests more capital-intensive processes
are
0
1963 1968 1973 1978 1983 1988 1993 1998 2003 2008
NOT major
source of labor share decrease since 1980s
Source: Skill share of labor and implied path of labor share based on estimates of
Acemoglu and Autor (2011) and Krusell et al. (2000).
Figure 10. Changes in payroll shares and equipment price inflation by industry.
59 NAICS sectors; size reflects value added share
payroll share, '87-'11 (%-point)
30
Securities, commodity
contracts, and investments
20
non manufacturing
10
Legal services
0
Computer systems design
and related services
-10
-20
manufacturing
-30
-40
-7
-6
-5
-4
-3
-2
-1
0
1
2
equipment price (%), '87-'11
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, and authors’ calculations
3
manufacturing
-30
Exposure to import competition is a major source of
labor share reductions in the US since 1980s
-40
-40
-30
-20
-10
0
10
20
Union coverage rate (%-point), '87-'11
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, and authors’ calculations
Figure 12. Import competition and changes in payroll shares by industry.
59 NAICS sectors; size reflects value added share
payroll share, '87-'11 (%-point)
30
20
10
non manufacturing
0
-10
-20
manufacturing
-30
-40
-10
0
10
20
30
import exposure (%-point), '93-'10
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, and authors’ calculations
40
If nation wins in aggregate, then winners should
be able to compensate losers => Pareto optimal
Loser from free trade
Winner from free
trade
Accept free trade
Block free trade
Compensate loser if
free trade
8, 4
4, 2
Refuse to
compensate loser
12, 0
4, 2
But if winners from free trade can influence policy more than losers (e.g., lower
collective action costs), winners can achieve free trade benefits without
compensating losers
Consumption-induced preferences in
Ricardo-Viner
• “Real” income = Nominal income (wage,
profit, rent) ÷ Cost of consumption
• Trade reduces prices of scarce factor-intensive
goods (imports cheaper than domestic) but
not abundant-factor intensive goods
• If labor is mobile, net gain/loss depends on
wage effect and consumption effect
Trade increases wages
Trade reduces wages
Trade reduces cost of living
Small cost of living impact
Trade reduces cost of living
Small cost of living impact
Source: Alt & Gilligan
Assumes labor is mobile
46
Example
• Assume
– US is land-abundant & capital abundant relative to
trade partners
– Low-skilled labor is mobile across industries
– Workers primarily consume domestic goods
• What do we expect regarding
– Workers trade policy preferences?
– Political coalitions (e.g., between labor, farm-owners,
Textile factory owners, auto factory owners?)
Trade increases wages
Trade reduces wages
Trade reduces cost of living
Small cost of living impact
Land,
Capital
Trade reduces cost of living
Labor
Source: Alt & Gilligan
Small cost of living impact
Assumes labor is mobile
48
Prediction
• Low-skilled labor favors protection from trade
• Import-competing industries also favor
protection:
– Scarce-factor is labor, so import competing
industry is labor-intensive, e.g., textiles
• Predicted coalition: Low-skilled labor & textile
factory owners
Collective action problem
Example 1
• Assume workers
– Are few in number
– Receive large benefit per person from trade policy
– Are not mobile across industries
• How do these affect labor’s ability to act
collectively?
Collective action problem
Example 2
• Assume consumers
– Are many in number
– Receive small benefit per person from trade policy
– Can easily switch from one product to another
• How do these affect consumers’ ability to act
collectively?
Collective action problem
Example 1
• Assume workers
– Are few in number
• Lower costs to organize if per-person transaction costs
• More likely that each individual will have major impact
• Lower likelihood of free-riding
– Receive large benefit per person from trade policy
• More likely that expected benefit > expected cost
– Are not mobile across industries
• Lower likelihood of free-riding – high opportunity costs
to organizing
Collective action problem
Example 2
• Assume consumers
– Are many in number
• High costs to organize if per-person transaction costs
• Less likely that each individual will have major impact
• High likelihood of free-riding
– Receive small benefit per person from trade policy
• Unlikely that expected benefit > expected cost
– Can easily switch from one product to another
• High likelihood of free-riding – consumers will switch to
other products rather than organize
Sugar quota winners: sugar farms & some foreign governments
Sugar quota losers: consumers, producers using sugar inputs,
would-be (foreign) sugar exporters
Source: Krugman, Obtsfeld, & Melitz (2012)
54
US sugar policies cost consumers $1.5B per year, transfers $1B to
US sugar growers. Free trade would benefit US consumers, US
candy producers, and (some) trade partners.
Potential free
trade winners
Free trade winners
Free trade losers
What determines political winners in
sugar trade policy conflict?
• Collective action problem
– Mobility of factors (labor, capital more mobile
than land)
– Size of groups (sugar farmers fewer than
consumers, etc.)
– Net gain per actor
• Political institutions…
Collective action costs & political institutions
may also matter (Alt & Gilligan)
Collective Action Cost
High
Low
Rampant free riding
No trade policy coalitions
Exit (?)
Rogowski
Rampant free riding
Trade policy coalitions
Exit (?)
Class-based coalitions possible,
but not necessary for victory
Factors Specific &
Majoritarian Inst.
Individual interest groups unable
to affect trade policy
Consumer groups inactive
Universalistic logroll (?)
Cross sector coalitions
(logrolling) or coalitions with
labor
Consumer groups active
Factor Specific &
Non-maj. Inst.
Standard trade policy
Model (Pareto,Olson, etc)
Lobbying for protection
Consumer groups inactive
Cross sector coalitions
(logrolling) or coalitions with
labor possible, but not
necessary for victory
Consumer groups active
Factors Mobile &
Majoritarian Inst. (e.g.,
democracy, not oligarchy)
Factors Mobile &
Non-maj. Inst. (e.g.,
oligarchy)
Political Institutions & Trade Policy
• Majoritarian vs. Non-majoritarian/elitist political
system
– Majoritarian increases voice of labor
– Non-majoritarian may increase voice of minorities,
perhaps capital (in factor model) or “special interests”
(in sector model)
• Majoritarian vs. PR electoral system
– Majoritarian increases voice of minority interests, e.g.
sector-based interests (based on geography)
– PR increases voice of larger groups, e.g., class or factor
interests, or consumers
59
US Political System
• Majoritarian or non-majoritarian political
system?
– How does this affect sugar policy example?
• Majoritarian or PR electoral system?
– How does this affect sugar policy example?
US Political System
• Majoritarian or non-majoritarian political
system? Majoritarian (relatively)
– How does this affect sugar policy example?
– Doesn’t(?) – same outcome possible with nonmajoritarian
• Majoritarian or PR electoral system?
Majoritarian
– How does this affect sugar policy example?
– Farmer & sugar company votes capture legislators
Based on the sugar policy example, where would
you place the US?
Collective Action Cost
High
Low
Rampant free riding
No trade policy coalitions
Exit (?)
Rogowski
Rampant free riding
Trade policy coalitions
Exit (?)
Class-based coalitions possible,
but not necessary for victory
Factors Specific &
Majoritarian Inst.
Individual interest groups unable
to affect trade policy
Consumer groups inactive
Universalistic logroll (?)
Cross sector coalitions
(logrolling) or coalitions with
labor
Consumer groups active
Factor Specific &
Non-maj. Inst.
Standard trade policy
Model (Pareto,Olson, etc)
Lobbying for protection
Consumer groups inactive
Cross sector coalitions
(logrolling) or coalitions with
labor possible, but not
necessary for victory
Consumer groups active
Factors Mobile &
Majoritarian Inst. (e.g.,
democracy, not oligarchy)
Factors Mobile &
Non-maj. Inst. (e.g.,
oligarchy)
Based on the sugar policy example, where would
you place the US?
Collective Action Cost
High
Low
Rampant free riding
No trade policy coalitions
Exit (?)
Rogowski
Rampant free riding
Trade policy coalitions
Exit (?)
Class-based coalitions possible,
but not necessary for victory
Factors Specific &
Majoritarian Inst.
Individual interest groups unable
to affect trade policy
Consumer groups inactive
Universalistic logroll (?)
Cross sector coalitions
(logrolling) or coalitions with
labor
Consumer groups active
Factor Specific &
Non-maj. Inst.
Standard trade policy
Model (Pareto,Olson, etc)
Lobbying for protection
Consumer groups inactive
Cross sector coalitions
(logrolling) or coalitions with
labor possible, but not
necessary for victory
Consumer groups active
Factors Mobile &
Majoritarian Inst. (e.g.,
democracy, not oligarchy)
Factors Mobile &
Non-maj. Inst. (e.g.,
oligarchy)
?
Universalistic logroll example
• Farm bill
– Traditionally includes subsidies for virtually all
farmers (rural interests) and food stamps for lowincome workers (urban interests)
– July, 2013:
• Republicans in House passed farm bill with farm
subsidies but without food stamps (many from rural
districts)
• Democrats uniformly opposed (many from urban
districts)
Conclusions
• Trade policy outcomes, including economic
beneficiaries and political coalitions, depend
upon various conditions, including factor
mobility, political institutions, and collective
action costs
• Solving collective action problems (for larger
groups) and majoritarian political institutions
increase the likelihood of policies that benefit
the majority of the population