“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 singlepeaked 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
70
Total
Dutiable
50
40
30
20
10
Year
1990
1977
1964
1951
1938
1925
1912
1899
1886
1873
1860
1847
1834
0
1821
Average Tariff
60
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



Democrat v. Republican presidents:




End of the cold war
End of traditional Ways & Means
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 politicaleconomy).
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.